UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006 Or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-32853
DUKE ENERGY CORPORATION
(Formerly Duke Energy Holding Corp.)
(Exact Name of Registrant as Specified in its Charter)
Delaware | 20-2777218 | |
(State or Other Jurisdiction of Incorporation) | (IRS Employer Identification No.) | |
526 South Church Street
Charlotte, NC |
28202-1803 | |
(Address of Principal Executive Offices) | (Zip Code) |
704-594-6200
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ¨ No x
Indicate the number of shares outstanding of each of the Issuers classes of common stock, as of the latest practicable date.
Number of shares of Common Stock, par value $0.001, outstanding as of November 3, 2006 | 1,255,275,068 |
DUKE ENERGY CORPORATION
FORM 10-Q FOR THE QUARTER ENDED
SEPTEMBER 30, 2006
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This document includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are based on managements beliefs and assumptions. These forward-looking statements are identified by terms and phrases such as anticipate, believe, intend, estimate, expect, continue, should, could, may, plan, project, predict, will, potential, forecast, and similar expressions. Forward-looking statements involve risks and uncertainties that may cause actual results to be materially different from the results predicted. Factors that could cause actual results to differ materially from those indicated in any forward-looking statement include, but are not limited to:
| State, federal and foreign legislative and regulatory initiatives, including costs of compliance with existing and future environmental requirements; |
| Costs and effects of legal and administrative proceedings, settlements, investigations and claims; |
| Industrial, commercial and residential growth in Duke Energys service territories; |
| Additional competition in electric or gas markets and continued industry consolidation; |
| Political and regulatory uncertainty in other countries in which Duke Energy conducts business; |
| The influence of weather and other natural phenomena on company operations, including the economic, operational and other effects of hurricanes and ice storms; |
| The timing and extent of changes in commodity prices, interest rates and foreign currency exchange rates; |
| Unscheduled generation outages, unusual maintenance or repairs and electric transmission or gas pipeline system constraints; |
| The results of financing efforts, including Duke Energys ability to obtain financing on favorable terms, which can be affected by various factors, including Duke Energys credit ratings and general economic conditions; |
| Declines in the market prices of equity securities and resultant cash funding requirements for Duke Energys defined benefit pension plans; |
| The level of credit worthiness of counterparties to Duke Energys transactions; |
| Employee workforce factors, including the potential inability to attract and retain key personnel; |
| Growth in opportunities for Duke Energys business units, including the timing and success of efforts to develop domestic and international power, pipeline, gathering, processing and other projects; |
| The performance of electric generation, pipeline and gas processing facilities and of projects undertaken by Duke Energys non-regulated businesses; |
| The extent of success in connecting natural gas supplies to gathering and processing systems and in connecting and expanding gas and electric markets; |
| The effect of accounting pronouncements issued periodically by accounting standard-setting bodies; and |
| The ability to successfully complete merger, acquisition or divestiture plans, such as the announced spin-off of the natural gas transmission businesses, including the prices at which Duke Energy is able to sell assets; regulatory or other limitations imposed as a result of a merger, acquisition or divestiture; and the success of the business following a merger, acquisition or divestiture. |
In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than Duke Energy has described. Duke Energy undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In millions, except per-share amounts)
Item 1. | Financial Statements. |
Three Months Ended
September 30, |
Nine Months Ended
September 30, |
||||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||||
Operating Revenues |
|||||||||||||||
Non-regulated electric, natural gas, natural gas liquids and other |
$ | 958 | $ | 672 | $ | 2,540 | $ | 6,877 | |||||||
Regulated electric |
2,402 | 1,614 | 5,717 | 4,099 | |||||||||||
Regulated natural gas and natural gas liquids |
814 | 742 | 3,091 | 2,654 | |||||||||||
Total operating revenues |
4,174 | 3,028 | 11,348 | 13,630 | |||||||||||
Operating Expenses |
|||||||||||||||
Natural gas and petroleum products purchased |
235 | 316 | 1,404 | 5,679 | |||||||||||
Operation, maintenance and other |
1,124 | 777 | 3,076 | 2,479 | |||||||||||
Fuel used in electric generation and purchased power |
1,112 | 488 | 2,482 | 1,229 | |||||||||||
Depreciation and amortization |
563 | 406 | 1,523 | 1,349 | |||||||||||
Property and other taxes |
214 | 134 | 564 | 432 | |||||||||||
Impairment and other charges |
| 17 | | 140 | |||||||||||
Total operating expenses |
3,248 | 2,138 | 9,049 | 11,308 | |||||||||||
Gains on Sales of Investments in Commercial and Multi-Family Real Estate |
30 | 63 | 201 | 117 | |||||||||||
Gains on Sales of Other Assets and Other, net |
247 | 580 | 269 | 589 | |||||||||||
Operating Income |
1,203 | 1,533 | 2,769 | 3,028 | |||||||||||
Other Income and Expenses |
|||||||||||||||
Equity in earnings of unconsolidated affiliates |
195 | 176 | 564 | 256 | |||||||||||
(Losses) Gains on sales and impairments of equity investments |
| (20 | ) | (20 | ) | 1,225 | |||||||||
Gain on sale of subsidiary stock |
15 | | 15 | | |||||||||||
Other income and expenses, net |
83 | (40 | ) | 140 | 19 | ||||||||||
Total other income and expenses |
293 | 116 | 699 | 1,500 | |||||||||||
Interest Expense |
337 | 228 | 925 | 813 | |||||||||||
Minority Interest Expense |
20 | 10 | 50 | 508 | |||||||||||
Earnings From Continuing Operations Before Income Taxes |
1,139 | 1,411 | 2,493 | 3,207 | |||||||||||
Income Tax Expense from Continuing Operations |
422 | 487 | 855 | 1,095 | |||||||||||
Income From Continuing Operations |
717 | 924 | 1,638 | 2,112 | |||||||||||
Income (Loss) From Discontinued Operations, net of tax |
46 | (883 | ) | (162 | ) | (894 | ) | ||||||||
Net Income |
763 | 41 | 1,476 | 1,218 | |||||||||||
Dividends and Premiums on Redemption of Preferred and Preference Stock |
| 3 | | 7 | |||||||||||
Earnings Available For Common Stockholders |
$ | 763 | $ | 38 | $ | 1,476 | $ | 1,211 | |||||||
|
|
||||||||||||||
Common Stock Data |
|||||||||||||||
Weighted-average shares outstanding |
|||||||||||||||
Basic |
1,254 | 926 | 1,141 | 936 | |||||||||||
Diluted |
1,263 | 964 | 1,162 | 973 | |||||||||||
Earnings per share (from continuing operations) |
|||||||||||||||
Basic |
$ | 0.57 | $ | 0.99 | $ | 1.43 | $ | 2.25 | |||||||
Diluted |
$ | 0.56 | $ | 0.96 | $ | 1.41 | $ | 2.17 | |||||||
Earnings (Loss) per share (from discontinued operations) |
|||||||||||||||
Basic |
$ | 0.04 | $ | (0.95 | ) | $ | (0.14 | ) | $ | (0.96 | ) | ||||
Diluted |
$ | 0.04 | $ | (0.92 | ) | $ | (0.14 | ) | $ | (0.92 | ) | ||||
Earnings per share |
|||||||||||||||
Basic |
$ | 0.61 | $ | 0.04 | $ | 1.29 | $ | 1.29 | |||||||
Diluted |
$ | 0.60 | $ | 0.04 | $ | 1.27 | $ | 1.25 | |||||||
Dividends per share |
$ | | $ | | $ | 0.94 | $ | 0.86 |
See Notes to Unaudited Consolidated Financial Statements
3
PART I
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In millions)
September 30,
2006 |
December 31,
2005 |
|||||
ASSETS |
||||||
Current Assets |
||||||
Cash and cash equivalents |
$ | 820 | $ | 511 | ||
Short-term investments |
2,097 | 632 | ||||
Receivables (net of allowance for doubtful accounts of $103 at September 30, 2006 and $127 at December 31, 2005) |
1,969 | 2,580 | ||||
Inventory |
1,243 | 863 | ||||
Assets held for sale |
1,395 | 1,528 | ||||
Unrealized gains on mark-to-market and hedging transactions |
70 | 87 | ||||
Other |
588 | 1,756 | ||||
Total current assets |
8,182 | 7,957 | ||||
Investments and Other Assets |
||||||
Investments in unconsolidated affiliates |
2,512 | 1,933 | ||||
Nuclear decommissioning trust funds |
1,666 | 1,504 | ||||
Goodwill |
8,212 | 3,775 | ||||
Intangibles, net |
981 | 65 | ||||
Notes receivable |
221 | 138 | ||||
Unrealized gains on mark-to-market and hedging transactions |
151 | 62 | ||||
Assets held for sale |
653 | 3,597 | ||||
Investments in residential, commercial and multi-family real estate (net of accumulated depreciation of $17 at December 31, 2005) |
| 1,281 | ||||
Other |
3,115 | 2,678 | ||||
Total investments and other assets |
17,511 | 15,033 | ||||
Property, Plant and Equipment |
||||||
Cost |
57,538 | 40,823 | ||||
Less accumulated depreciation and amortization |
16,735 | 11,623 | ||||
Net property, plant and equipment |
40,803 | 29,200 | ||||
Regulatory Assets and Deferred Debits |
||||||
Deferred debt expense |
325 | 269 | ||||
Regulatory assets related to income taxes |
1,377 | 1,338 | ||||
Other |
2,084 | 926 | ||||
Total regulatory assets and deferred debits |
3,786 | 2,533 | ||||
Total Assets |
$ | 70,282 | $ | 54,723 | ||
|
See Notes to Unaudited Consolidated Financial Statements
4
PART I
DUKE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS(Continued)
(Unaudited)
(In millions, except per-share amounts)
September 30,
2006 |
December 31,
2005 |
|||||
LIABILITIES AND COMMON STOCKHOLDERS EQUITY |
||||||
Current Liabilities |
||||||
Accounts payable |
$ | 1,225 | $ | 2,431 | ||
Notes payable and commercial paper |
932 | 83 | ||||
Taxes accrued |
687 | 327 | ||||
Interest accrued |
312 | 230 | ||||
Liabilities associated with assets held for sale |
848 | 1,488 | ||||
Current maturities of long-term debt |
1,637 | 1,400 | ||||
Unrealized losses on mark-to-market and hedging transactions |
145 | 204 | ||||
Other |
1,491 | 2,255 | ||||
Total current liabilities |
7,277 | 8,418 | ||||
Long-term Debt |
18,678 | 14,547 | ||||
Deferred Credits and Other Liabilities |
||||||
Deferred income taxes |
6,960 | 5,253 | ||||
Investment tax credit |
178 | 144 | ||||
Unrealized losses on mark-to-market and hedging transactions |
111 | 10 | ||||
Liabilities associated with assets held for sale |
418 | 2,085 | ||||
Asset retirement obligations |
2,221 | 2,058 | ||||
Other |
7,132 | 5,020 | ||||
Total deferred credits and other liabilities |
17,020 | 14,570 | ||||
Commitments and Contingencies |
||||||
Minority Interests |
811 | 749 | ||||
Common Stockholders Equity |
||||||
Common stock, $0.001 par value, 2 billion shares authorized; 1,255 million and zero shares outstanding at September 30, 2006 and December 31, 2005, respectively |
1 | | ||||
Common stock, no par, 2 billion shares authorized; zero and 928 million shares outstanding at September 30, 2006 and December 31, 2005, respectively |
| 10,446 | ||||
Additional paid-in capital |
19,775 | | ||||
Retained earnings |
5,670 | 5,277 | ||||
Accumulated other comprehensive income |
1,050 | 716 | ||||
Total common stockholders equity |
26,496 | 16,439 | ||||
Total Liabilities and Common Stockholders Equity |
$ | 70,282 | $ | 54,723 | ||
|
See Notes to Unaudited Consolidated Financial Statements
5
PART 1
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)
Nine Months Ended
September 30, |
||||||||
2006 | 2005 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net income |
$ | 1,476 | $ | 1,218 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and amortization (including amortization of nuclear fuel) |
1,652 | 1,463 | ||||||
Gains on sales of investments in commercial and multi-family real estate |
(201 | ) | (117 | ) | ||||
Gains on sales of equity investments and other assets |
(333 | ) | (1,279 | ) | ||||
Impairment charges |
20 | 123 | ||||||
Deferred income taxes |
204 | (252 | ) | |||||
Minority Interest |
50 | 508 | ||||||
Equity in earnings of unconsolidated affiliates |
(564 | ) | (256 | ) | ||||
Purchased capacity levelization |
(12 | ) | (12 | ) | ||||
Contributions to company-sponsored pension plans |
(159 | ) | (32 | ) | ||||
(Increase) decrease in |
||||||||
Net realized and unrealized mark-to-market and hedging transactions |
24 | 922 | ||||||
Receivables |
1,341 | 22 | ||||||
Inventory |
96 | (131 | ) | |||||
Other current assets |
1,362 | (997 | ) | |||||
Increase (decrease) in |
||||||||
Accounts payable |
(1,879 | ) | (276 | ) | ||||
Taxes accrued |
153 | 611 | ||||||
Other current liabilities |
(958 | ) | 817 | |||||
Capital expenditures for residential real estate |
(322 | ) | (276 | ) | ||||
Cost of residential real estate sold |
143 | 159 | ||||||
Other, assets |
625 | (76 | ) | |||||
Other, liabilities |
22 | 365 | ||||||
Net cash provided by operating activities |
2,740 | 2,504 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Capital expenditures |
(2,285 | ) | (1,662 | ) | ||||
Investment expenditures |
(82 | ) | (21 | ) | ||||
Acquisitions, net of cash acquired |
(89 | ) | (293 | ) | ||||
Cash acquired from acquisition of Cinergy |
147 | | ||||||
Purchases of available-for-sale securities |
(23,022 | ) | (30,454 | ) | ||||
Proceeds from sales and maturities of available-for-sale securities |
21,419 | 29,801 | ||||||
Net proceeds from the sales of equity investments and other assets, |
||||||||
and sales of and collections on notes receivable |
2,049 | 2,366 | ||||||
Proceeds from the sales of commercial and multi-family real estate |
254 | 185 | ||||||
Settlement of net investment hedges and other investing derivatives |
(134 | ) | (244 | ) | ||||
Purchases of emission allowances |
(182 | ) | (18 | ) | ||||
Sales of emission allowances |
161 | | ||||||
Other |
29 | (15 | ) | |||||
Net cash used in investing activities |
(1,735 | ) | (355 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Proceeds from the: |
||||||||
Issuance of long-term debt |
1,832 | 286 | ||||||
Issuance of common stock and common stock related to employee benefit plans |
67 | 36 | ||||||
Payments for the redemption of: |
||||||||
Long-term debt |
(1,186 | ) | (1,021 | ) | ||||
Preferred stock of a subsidiary |
(12 | ) | | |||||
Decrease in cash overdrafts |
(2 | ) | | |||||
Notes payable and commercial paper |
136 | 150 | ||||||
Distributions to minority interests |
(268 | ) | (576 | ) | ||||
Contributions from minority interests |
219 | 528 | ||||||
Dividends paid |
(1,083 | ) | (812 | ) | ||||
Repurchase of common shares |
(500 | ) | (933 | ) | ||||
Proceeds from Duke Energy Income Fund |
104 | | ||||||
Other |
19 | 34 | ||||||
Net cash used in financing activities |
(674 | ) | (2,308 | ) | ||||
Changes in cash and cash equivalents included in assets held for sale |
(22 | ) | 3 | |||||
Net increase (decrease) in cash and cash equivalents |
309 | (156 | ) | |||||
Cash and cash equivalents at beginning of period |
511 | 533 | ||||||
Cash and cash equivalents at end of period |
$ | 820 | $ | 377 | ||||
|
|
|||||||
Supplemental Disclosures |
||||||||
Acquisition of Cinergy Corp. |
||||||||
Fair value of assets acquired |
$ | 17,306 | $ | | ||||
Liabilities assumed |
$ | 12,662 | $ | | ||||
Issuance of common stock |
$ | 8,993 | $ | | ||||
Significant non-cash transactions: |
||||||||
Conversion of convertible notes to stock |
$ | 632 | $ | | ||||
AFUDCequity component |
$ | 42 | $ | 19 |
See Notes to Unaudited Consolidated Financial Statements
6
PART I
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In millions)
Accumulated Other Comprehensive Income (Loss) |
|||||||||||||||||||||||||||||||||
Common
Stock Shares |
Common
Stock |
Additional
Paid-in Capital |
Retained
Earnings |
Foreign
Currency Adjustments |
Net Gains
(Losses) on Cash Flow Hedges |
Minimum
Pension Liability Adjustment |
Other | Total | |||||||||||||||||||||||||
Balance December 31, 2004 |
957 | $ | 11,266 | $ | | $ | 4,525 | $ | 540 | $ | 526 | $ | (416 | ) | $ | | $ | 16,441 | |||||||||||||||
Net income |
| | | 1,218 | | | | | 1,218 | ||||||||||||||||||||||||
Other Comprehensive Income |
|||||||||||||||||||||||||||||||||
Foreign currency translation adjustments (a) |
| | | | 365 | | | | 365 | ||||||||||||||||||||||||
Net unrealized gains on cash flow hedges (b) |
| | | | | 401 | | | 401 | ||||||||||||||||||||||||
Reclassification into earnings from cash flow hedges (c) |
| | | | | (876 | ) | | | (876 | ) | ||||||||||||||||||||||
|
|
|
|||||||||||||||||||||||||||||||
Total comprehensive income |
1,108 | ||||||||||||||||||||||||||||||||
Dividend reinvestment and employee benefits |
3 | 77 | | | | | | | 77 | ||||||||||||||||||||||||
Stock repurchase |
(34 | ) | (933 | ) | | | | | | | (933 | ) | |||||||||||||||||||||
Common stock dividends |
| | | (805 | ) | | | | | (805 | ) | ||||||||||||||||||||||
Preferred and preference stock dividends |
| | | (7 | ) | | | | | (7 | ) | ||||||||||||||||||||||
Other capital stock transactions, net |
| | | 33 | | | | | 33 | ||||||||||||||||||||||||
|
|
||||||||||||||||||||||||||||||||
Balance September 30, 2005 |
926 | $ | 10,410 | $ | | $ | 4,964 | $ | 905 | $ | 51 | $ | (416 | ) | $ | | $ | 15,914 | |||||||||||||||
Balance December 31, 2005 |
928 | $ | 10,446 | $ | | $ | 5,277 | $ | 846 | $ | (87 | ) | $ | (60 | ) | $ | 17 | $ | 16,439 | ||||||||||||||
Net income |
| | | 1,476 | | | | | 1,476 | ||||||||||||||||||||||||
Other Comprehensive Income |
|||||||||||||||||||||||||||||||||
Foreign currency translation adjustments |
| | | | 294 | | | | 294 | ||||||||||||||||||||||||
Net unrealized gains on cash flow hedges (b) |
| | | | | 6 | | | 6 | ||||||||||||||||||||||||
Reclassification into earnings from cash flow hedges (c) |
| | | | | 25 | | | 25 | ||||||||||||||||||||||||
Other (d) |
| | | | | | | 9 | 9 | ||||||||||||||||||||||||
|
|
|
|||||||||||||||||||||||||||||||
Total comprehensive income |
1,810 | ||||||||||||||||||||||||||||||||
Retirement of old Duke Energy shares |
(927 | ) | (10,399 | ) | | | | | | | (10,399 | ) | |||||||||||||||||||||
Issuance of new Duke Energy shares |
927 | 1 | 10,398 | | | | | | 10,399 | ||||||||||||||||||||||||
Common stock issued in connection with Cinergy merger |
313 | | 8,993 | | | | | | 8,993 | ||||||||||||||||||||||||
Conversion of Cinergy options to Duke Energy options |
| | 59 | | | | | | 59 | ||||||||||||||||||||||||
Dividend reinvestment and employee benefits |
4 | 22 | 93 | | | | | | 115 | ||||||||||||||||||||||||
Stock repurchase |
(17 | ) | (69 | ) | (431 | ) | | | | | | (500 | ) | ||||||||||||||||||||
Common stock dividends |
| | | (1,083 | ) | | | | | (1,083 | ) | ||||||||||||||||||||||
Conversion of debt to equity |
27 | | 632 | | | | | | 632 | ||||||||||||||||||||||||
Tax benefit due to conversion of debt to equity |
| | 34 | | | | | | 34 | ||||||||||||||||||||||||
Other capital stock transactions, net |
| | (3 | ) | | | | | | (3 | ) | ||||||||||||||||||||||
|
|
||||||||||||||||||||||||||||||||
Balance September 30, 2006 |
1,255 | $ | 1 | $ | 19,775 | $ | 5,670 | $ | 1,140 | $ | (56 | ) | $ | (60 | ) | $ | 26 | $ | 26,496 |
(a) | Foreign currency translation adjustments, net of $62 tax benefit for the nine months ended September 30, 2005. The 2005 tax benefit related to the settled net investment hedges (see Note 15). Substantially all of the 2005 tax benefit is a correction of an immaterial accounting error related to prior periods. |
(b) | Net unrealized gains on cash flow hedges, net of $2 tax benefit and $230 tax expense for the nine months ended September 30, 2006 and 2005, respectively. |
(c) | Reclassification into earnings from cash flow hedges, net of $18 tax expense and $501 tax benefit for the nine months ended September 30, 2006 and 2005, respectively. Reclassification into earnings from cash flow hedges for the nine months ended September 30, 2005 is primarily due to the recognition of Duke Energy North America's (DENA) unrealized net gains related to hedges on forecasted transactions that will no longer occur as a result of the sale to LS Power of substantially all of DENA's assets and contracts outside the Midwestern United States and certain contractual positions related to the Midwestern assets (see Notes 13 and 15). |
(d) | Net of $4 tax expense for the nine months ended September 30, 2006. |
See Notes to Unaudited Consolidated Financial Statements
7
PART I
Notes To Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
Nature of Operations and Basis of Consolidation. Duke Energy Corporation (collectively with its subsidiaries, Duke Energy), is an energy company located in the Americas. These Consolidated Financial Statements include, after eliminating intercompany transactions and balances, the accounts of Duke Energy and all majority-owned subsidiaries where Duke Energy has control, and those variable interest entities where Duke Energy is the primary beneficiary. These Consolidated Financial Statements also reflect Duke Energys 12.5% undivided interest in the Catawba Nuclear Station.
Duke Energy Holding Corp. (Duke Energy HC) was incorporated in Delaware on May 3, 2005 as Deer Holding Corp., a wholly-owned subsidiary of Duke Energy Corporation (Old Duke Energy). On April 3, 2006, in accordance with their previously announced merger agreement, Old Duke Energy and Cinergy Corp. (Cinergy) merged into wholly-owned subsidiaries of Duke Energy HC, resulting in Duke Energy HC becoming the parent entity. In connection with the closing of the merger transactions, Duke Energy HC changed its name to Duke Energy Corporation (New Duke Energy or Duke Energy) and Old Duke Energy converted into a limited liability company named Duke Power Company LLC (subsequently renamed Duke Energy Carolinas, LLC (Duke Energy Carolinas) effective October 1, 2006). As a result of the merger transactions, each outstanding share of Cinergy common stock was converted into 1.56 shares of common stock of Duke Energy, which resulted in the issuance of approximately 313 million shares. Additionally, each share of common stock of Old Duke Energy was converted into one share of Duke Energy common stock. Old Duke Energy is the predecessor of Duke Energy for purposes of U.S. securities regulations governing financial statement filing. Therefore, the accompanying Consolidated Financial Statements reflect the results of operations of Old Duke Energy for the three months ended March 31, 2006 and the three and nine months ended September 30, 2005 and the financial position of Old Duke Energy as of December 31, 2005. New Duke Energy had separate operations for the period beginning with the effective date of the Cinergy merger, and references to amounts for periods after the closing of the merger relate to New Duke Energy. Cinergys results have been included in the accompanying Consolidated Statements of Operations from the effective date of acquisition and thereafter (see Cinergy Merger in Note 2). Both Old Duke Energy and New Duke Energy are referred to as Duke Energy herein.
Shares of common stock of New Duke Energy carry a stated par value of $0.001, while shares of common stock of Old Duke Energy had been issued at no par. In April 2006, as a result of the conversion of all outstanding shares of Old Duke Energy common stock to New Duke Energy common stock, the par value of the shares issued was recorded in Common Stock within Common Stockholders Equity in the Consolidated Balance Sheets and the excess of issuance price over stated par value was recorded in Additional Paid-in Capital within Common Stockholders Equity in the Consolidated Balance Sheets. Prior to the conversion of common stock from shares of Old Duke Energy to New Duke Energy, all proceeds from issuances of common stock were solely reflected in Common Stock within Common Stockholders Equity in the Consolidated Balance Sheets.
These Consolidated Financial Statements reflect all normal recurring adjustments that are, in the opinion of management, necessary to fairly present Duke Energys financial position and results of operations. Amounts reported in the interim Consolidated Statements of Operations are not necessarily indicative of amounts expected for the respective annual periods due to the effects of seasonal temperature variations on energy consumption, the timing of maintenance on electric generating units, changes in mark-to-market valuations, changing commodity prices and other factors. These Consolidated Financial Statements and other information included in this quarterly report should be read in conjunction with the Consolidated Financial Statements and Notes in Duke Energys Form 10-K for the year ended December 31, 2005.
On September 7, 2006, Duke Energy deconsolidated Crescent Resources, LLC (Crescent) due to a reduction in ownership and its inability to exercise control over Crescent (see Note 2). Crescent has been accounted for as an equity method investment since the date of deconsolidation.
Effective July 1, 2005, Duke Energy deconsolidated Duke Energy Field Services, LLC (DEFS) due to a reduction in ownership and its inability to exercise control over DEFS (see Note 2). DEFS has been accounted for as an equity method investment since July 1, 2005.
Use of Estimates. To conform with generally accepted accounting principles (GAAP) in the United States, management makes estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and Notes To Consolidated Financial Statements. Although these estimates are based on managements best available knowledge at the time, actual results could differ from those estimates.
8
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Reclassifications. As discussed further in Note 14, as a result of the merger with Cinergy, effective in the second quarter of 2006, Duke Energy adopted new business segments and certain prior period amounts have been recast to conform to the new segment presentation. Certain other prior period amounts within the Consolidated Statements of Operations and Consolidated Statements of Cash Flows have been reclassified to conform to the presentation for the current period.
Accounting For Sales of Stock by a Subsidiary. Duke Energy accounts for sales of stock by a subsidiary under Staff Accounting Bulletin (SAB) No. 51, Accounting for Sales of Stock of a Subsidiary. Under SAB 51, companies may elect, via an accounting policy decision, to record a gain on the sale of stock of a subsidiary equal to the amount of proceeds received in excess of the carrying value of the shares. Duke Energy has elected to treat such excesses as gains in earnings, which are reflected in Gain on Sale of Subsidiary Stock in the Consolidated Statements of Operations. During the three and nine months ended September 30, 2006, Duke Energy recognized a gain of approximately $15 million related to the sale of securities of the Duke Energy Income Fund (Income Fund) (see Note 19).
Accounting For Purchases and Sales of Emission Allowances. Duke Energy recognizes emission allowances in earnings as they are consumed or sold. Gains or losses on sales of emission allowances for non-regulated businesses are presented on a net basis in Gains on Sales of Other Assets and Other, net, in the accompanying Consolidated Statements of Operations. For regulated businesses that do provide for direct recovery of emission allowances, any gains or losses on sales of recoverable emission allowances are included in the rate structure of the regulated entity and are deferred as a regulatory asset or liability. Future rates charged to retail customers are impacted by any gain or loss on sales of recoverable emission allowances and, therefore, as the recovery of the gain or loss is recognized in operating revenues, the regulatory asset or liability related to the emission allowance activity is recognized as a component of Fuel Used in Electric Generation and Purchased Power in the Consolidated Statements of Operations. For regulated businesses that do not provide for direct recovery of emission allowances through a cost tracking mechanism, gains and losses on sales of emission allowances are included in Gains on Sales of Other Assets and Other, net in the Consolidated Statements of Operations, or are deferred, depending on level of regulatory certainty. Purchases and sales of emission allowances are presented gross as investing activities on the Consolidated Statements of Cash Flows.
Excise Taxes . Certain excise taxes levied by state or local governments are collected by Duke Energy from its customers. These taxes, which are required to be paid regardless of Duke Energys ability to collect from the customer, are accounted for on a gross basis. When Duke Energy acts as an agent, and the tax is not required to be remitted if it is not collected from the customer, the taxes are accounted for on a net basis. Duke Energys excise taxes accounted for on a gross basis and recorded as revenues in the accompanying Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005 were as follows:
Three Months Ended September 30, 2006 |
Three Months Ended September 30, 2005 |
Nine Months Ended September 30, 2006 |
Nine Months Ended September 30, 2005 |
|||||||||
(in millions) | ||||||||||||
Excise Taxes |
$ | 72 | $ | 36 | $ | 163 | $ | 92 |
2. Acquisitions and Dispositions
Acquisitions. Duke Energy consolidates assets and liabilities from acquisitions as of the purchase date, and includes earnings from acquisitions in consolidated earnings after the purchase date. Assets acquired and liabilities assumed are recorded at estimated fair values on the purchase date. The purchase price minus the estimated fair value of the acquired assets and liabilities meeting the definition of a business as defined in Emerging Issues Task Force (EITF) Issue No. 98-3, Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business is recorded as goodwill. The allocation of the purchase price may be adjusted as additional, requested information is received during the allocation period, which generally does not exceed one year from the consummation date, however, it may be longer for certain income tax items.
Cinergy Merger. On April 3, 2006, the previously announced merger between Duke Energy and Cinergy was consummated (see Note 1 for additional information). For accounting purposes, the effective date of the merger was April 1, 2006. The merger combines the Duke Energy and Cinergy regulated franchises as well as deregulated generation in the Midwestern United States. The merger provides more regulatory, geographic and weather diversity to Duke Energys earnings. See Note 16 for discussion of regulatory impacts of the merger.
The merger has been accounted for under the purchase method of accounting with Duke Energy treated as the acquirer for accounting purposes. As a result, the assets and liabilities of Cinergy were recorded at their respective fair values as of April 3, 2006 and the results of Cinergys operations are included in the Duke Energy consolidated financial statements beginning as of the effective date of the merger. Except for an adjustment related to pension and other postretirement benefit obligations, as mandated by Statement of Financial
9
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Accounting Standards (SFAS) No. 87, Employers Accounting for Pensions and SFAS No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions, the accompanying consolidated financial statements do not reflect any pro forma adjustments related to Cinergys regulated operations that are accounted for pursuant to SFAS No. 71, Accounting for the Effects of Certain Types of Regulation, which are comprised of Duke Energy Ohio, Inc. (Duke Energy Ohio) (formerly The Cincinnati Gas & Electric Companys (CG&E) regulated transmission and distribution), Duke Energy Indiana, Inc. (Duke Energy Indiana) (formerly PSI Energy, Inc. (PSI)) and Duke Energy Kentucky, Inc. (Duke Energy Kentucky) (formerly The Union Light, Heat and Power Company (ULH&P)). Under the rate setting and recovery provisions currently in place for these regulated operations which provide revenues derived from cost, the fair values of the individual tangible and intangible assets and liabilities are considered to approximate their carrying values.
The fair values of the assets acquired and liabilities assumed are preliminary and are subject to change as valuation analyses are finalized and remaining information on the fair values is received. However, Duke Energy does not currently anticipate any such changes to have a material impact on Duke Energys consolidated results of operations, cash flows or financial position.
In connection with the merger, Duke Energy issued 1.56 shares of Duke Energy common stock for each outstanding share of Cinergy common stock, which resulted in the issuance of approximately 313 million shares of Duke Energy common stock. Based on the market price of Duke Energy common stock during the period including the two trading days before through the two trading days after May 9, 2005, the date Duke Energy and Cinergy announced the merger, the transaction is valued at approximately $9.1 billion and has resulted in preliminary incremental goodwill to Duke Energy of approximately $4.5 billion. The amount of goodwill results from significant strategic and financial benefits of the merger including:
| increased financial strength and flexibility; |
| stronger utility business platform; |
| greater scale and fuel diversity, as well as improved operational efficiencies for the merchant generation business; |
| broadened electric distribution platform; |
| improved reliability and customer service through the sharing of best practices; |
| increased scale and scope of the electric and gas businesses with stand-alone strength; |
| complementary positions in the Midwest; |
| greater customer diversity; |
| combined expertise; and |
| significant cost savings synergies. |
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
Purchase Price Allocation
April 3, 2006
|
|||
(in millions) | |||
Purchase price |
$ | 9,111 | |
|
|
||
Current assets |
2,677 | ||
Investments and other assets |
1,610 | ||
Property, plant and equipment (a) |
10,578 | ||
Intangible assets |
1,091 | ||
Regulatory assets and deferred debits |
1,350 | ||
|
|
||
Total assets acquired |
17,306 | ||
Current liabilities |
4,088 | ||
Long-term debt |
4,295 | ||
Deferred credits and other liabilities |
4,268 | ||
Minority interests |
11 | ||
|
|
||
Net assets acquired |
4,644 | ||
|
|
||
Preliminary goodwill |
$ | 4,467 | |
|
|
(a) | Amounts recorded for regulated property, plant and equipment by Duke Energy on the acquisition date are net of approximately $3,995 million of accumulated depreciation of acquired assets. |
10
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Goodwill recorded as of September 30, 2006 resulting from Duke Energys merger with Cinergy is $4,467 million, none of which is deductible for income tax purposes. Of this amount, approximately $155 million has been allocated to assets held for sale related to the disposition of Cinergy Marketing and Trading, LP, and Cinergy Canada, Inc. (collectively CMT) (see Note 13). The approximate $178 million increase in goodwill from the merger at September 30, 2006 from the June 30, 2006 initial allocation relates primarily to decreases in property, plant and equipment valuations as a result of additional information received after the June 30, 2006 preliminary valuation. The valuation and other assessment procedures required to allocate this goodwill to the appropriate reporting units and reportable segments are currently in process and are anticipated to be completed during 2006. While the allocation is not yet complete, Duke Energy anticipates that the goodwill will be allocated to the U.S. Franchised Electric and Gas and Commercial Power segments, as well as Other, with the majority of the goodwill being allocated to the U.S. Franchised Electric and Gas segment (see Note 9).
The following unaudited consolidated pro forma financial results are presented as if the Cinergy merger had occurred at the beginning of each of the periods presented:
Unaudited Consolidated Pro Forma Results
Three Months Ended
2005 |
Nine Months Ended September 30, |
||||||||
2006
|
2005
|
||||||||
(in millions, except per share amounts) | |||||||||
Operating revenues |
$ | 4,286 | $ | 12,936 | $ | 17,198 | |||
Income from continuing operations |
1,018 | 1,696 | 2,324 | ||||||
Net income |
150 | 1,535 | 1,446 | ||||||
Earnings available for common stockholders |
147 | 1,535 | 1,439 | ||||||
Earnings per share (from continuing operations) |
|||||||||
Basic |
$ | 0.82 | $ | 1.36 | $ | 1.86 | |||
Diluted |
$ | 0.80 | $ | 1.34 | $ | 1.81 | |||
Earnings per share |
|||||||||
Basic |
$ | 0.12 | $ | 1.23 | $ | 1.15 | |||
Diluted |
$ | 0.12 | $ | 1.21 | $ | 1.12 |
Pro forma results for the nine months ended September 30, 2006 include approximately $97 million of charges related to costs to achieve the merger and related synergies, which are recorded within Operating Expenses on the Consolidated Statements of Operations. Pro forma results for the three months ended September 30, 2006 are not presented since the merger occurred prior to the beginning of the period presented and do not include any significant transactions completed by Duke Energy other than the merger with Cinergy. The pre-tax impacts of purchase accounting on the results of operations of Duke Energy are expected to be charges of approximately $100 million during 2006. The pre-tax impacts of purchase accounting on the consolidated results of operations for the three and nine months ended September 30, 2006 was approximately $15 million and $60 million, respectively.
Other Acquisitions. During the first quarter of 2006, Duke Energy International (DEI) closed on two transactions which resulted in the acquisition of an additional 27% interest in the Aguaytia Integrated Energy Project (Aguaytia), located in Peru, for approximately $31 million (approximately $18 million net of cash acquired). The projects scope includes the production and processing of natural gas, sale of liquefied petroleum gas (LPG) and natural gas liquids and the generation, transmission and sale of electricity from a 177 megawatt power plant. These acquisitions increased DEIs ownership in Aguaytia to 66% and resulted in Duke Energy accounting for Aguaytia as a consolidated entity. Prior to the acquisition of this additional interest, Aguaytia was accounted for as an equity method investment.
During the first quarter of 2006, Duke Energy North America (DENA) acquired the remaining 33 1/3% interest in Bridgeport Energy LLC (Bridgeport) from United Bridgeport Energy LLC (UBE) for approximately $71 million. The assets and liabilities of Bridgeport were included as part of DENAs power generation assets which were sold to a subsidiary of LS Power Equity Partners (LS Power) (see Note 13).
In May 2006, Duke Energy announced an agreement to acquire an approximate 825 megawatt power plant located in Rockingham County, North Carolina, from Dynegy for approximately $195 million. The Rockingham plant is a peaking power plant used during times of high electricity demand, generally in the winter and summer months and consists of five 165 megawatt combustion turbine units capable of using either natural gas or oil to operate. The acquisition is consistent with Duke Energys plan to meet customers electric needs for the foreseeable future. The transaction, which is anticipated to close in the fourth quarter of 2006, required approvals by the North Carolina Utilities Commission (NCUC) and the Federal Energy Regulatory Commission (FERC). In addition, approval was required from either the
11
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
U.S. Department of Justice or the U.S. Federal Trade Commission (FTC) under the Hart-Scott-Rodino Antitrust Improvement Act. The FTC approved the transaction on July 20, 2006, and the NCUC approved it on July 25, 2006. Application for FERC approval was filed on July 28, 2006 and on October 31, 2006 the FERC issued an order conditionally authorizing the transaction.
Dispositions. For the three months ended September 30, 2006, the sale of other assets and businesses resulted in approximately $1.6 billion in proceeds and net pre-tax gains of $247 million recorded in Gains on Sales of Other Assets and Other, net on the Consolidated Statements of Operations. For the nine months ended September 30, 2006, the sale of other assets and businesses resulted in approximately $1.6 billion in proceeds and net pre-tax gains of $269 million recorded in Gains on Sales of Other Assets and Other, net on
the Consolidated Statements of Operations. These sales exclude assets that were held for sale and reflected in discontinued operations, both of which are discussed in Note 13, and sales by Crescent prior to deconsolidation which are discussed separately below. Significant sales of other assets during the nine months ended September 30, 2006 are detailed as follows:
| On September 7, 2006, an indirect wholly owned subsidiary of Duke Energy closed an agreement to create a joint venture of Crescent (the Crescent JV) with Morgan Stanley Real Estate Fund V U.S., L.P. (MSREF) and other affiliated funds controlled by Morgan Stanley (collectively the MS Members). Under the agreement, the Duke Energy subsidiary contributed all of the membership interests in Crescent to a newly-formed joint venture, which was ascribed an enterprise value of approximately $2.1 billion as of December 31, 2005. In conjunction with the formation of the Crescent JV, the joint venture, Crescent and Crescents subsidiaries entered into a credit agreement with third party lenders under which Crescent borrowed approximately $1.23 billion, of which approximately $1.19 billion was immediately distributed to Duke Energy. Immediately following the debt transaction, the MS Members collectively acquired a 49% membership interest in the Crescent JV from Duke Energy for a purchase price of approximately $415 million. The MS Members 49% interest reflects a 2% interest in the Crescent JV issued by the joint venture to the President and Chief Executive Officer of Crescent which is subject to forfeiture if the executive voluntarily leaves the employment of the Crescent JV within a three year period. Additionally, this interest can be put back to the Crescent JV after three years or possibly earlier upon the occurrence of certain events at an amount equal to 2% of the fair value of the Crescent JVs equity as of the put date. Therefore, the Crescent JV will accrue the obligation related to the put as a liability over the three year forfeiture period. Accordingly, Duke Energy has an effective 50% ownership in the equity of Crescent JV for financial reporting purposes. |
In conjunction with this transaction, Duke Energy has recognized a pre-tax gain on the sale of approximately $250 million which has been classified as a component of Gains on Sales of Other Assets and Other, net in the accompanying Consolidated Statement of Operations for the three and nine months ended September 30, 2006. As a result of the Crescent transaction, Duke Energy no longer controls the Crescent JV and on September 7, 2006 deconsolidated its investment in Crescent and subsequently will account for its investment in the Crescent JV utilizing the equity method of accounting. Duke Energys equity investment in the Crescent JV is approximately $163 million as of September 30, 2006. The proceeds from the sale were recorded on the Consolidated Statements of Cash Flows as follows: approximately $1.2 billion in long-term debt proceeds, net of issuance costs, were classified as Proceeds from the issuance of long-term debt within Financing Activities, and approximately $380 million, which represents cash received from the MS Members net of cash held by Crescent as of the transaction date, were classified as Net proceeds from the sales of and distributions from equity investments and other assets, and sales of and collections on notes receivable within Investing Activities.
| Natural Gas Transmissions sale of certain Stone Mountain natural gas gathering system assets resulted in proceeds of $18 million (which is reflected in Net proceeds from the sales of equity investments and other assets, and sales of and collections on notes receivable within Cash Flows from Investing Activities in the Consolidated Statements of Cash Flows), and pre-tax gain of $5 million which was recorded in Gains on Sales of Other Assets and Other, net in the accompanying Consolidated Statements of Operations. In addition, Natural Gas Transmissions sale of stock, received as consideration for the settlement of a customers transportation contract, resulted in proceeds of approximately $24 million (which is reflected in Other, assets within Cash Flows from Operating Activities in the Consolidated Statements of Cash Flows) and a pre-tax gain of $24 million, of which approximately $23 million was recorded in Gains on Sales of Other Assets and Other, net and approximately $1 million was recorded in Other Income and Expenses, net in the accompanying Consolidated Statements of Operations (see Note 10). |
For the period from July 1, 2006 to September 7, 2006, Crescent commercial and multi-family real estate sales resulted in $33 million of proceeds and $30 million of net pre-tax gains recorded in Gains on Sales of Investments in Commercial and Multi-Family Real Estate on the Consolidated Statements of Operations. For the period from January 1, 2006 to September 7, 2006, Crescent commercial and multi-family real estate sales resulted in $254 million of proceeds and $201 million of net pre-tax gains recorded in Gains on Sales of
12
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Investments in Commercial and Multi-Family Real Estate on the Consolidated Statements of Operations. Sales primarily consisted of two office buildings at Potomac Yard in Washington, D.C. for a pre-tax gain of $81 million and land at Lake Keowee in northwestern South Carolina for a pre-tax gain of $52 million, as well as several other large land tract sales.
For the three months ended September 30, 2005, the sale of other assets, businesses and equity investments resulted in approximately $1 billion in proceeds and pre-tax gains of $580 million recorded in Gains on Sales of Other Assets and Other, net on the Consolidated Statements of Operations. For the nine months ended September 30, 2005, the sale of other assets, businesses and equity investments resulted in approximately $2.2 billion in proceeds, net pre-tax gains of $589 million recorded in Gains on Sales of Other Assets and Other, net and pre-tax gains of $1.2 billion recorded in (Losses) Gains on Sales and Impairments of Equity Investments on the Consolidated Statements of Operations. These sales exclude assets held for sale as of September 30, 2005 and reflected in discontinued operations, both of which are discussed in Note 13, and sales by Crescent which are discussed separately below. Significant sales of other assets and equity investments during the nine months ended September 30, 2005 are detailed as follows:
| In February 2005, DEFS sold its wholly-owned subsidiary Texas Eastern Products Pipeline Company, LLC (TEPPCO GP), which is the general partner of TEPPCO Partners, LP (TEPPCO LP), for approximately $1.1 billion and Duke Energy sold its limited partner interest in TEPPCO LP for approximately $100 million, in each case to Enterprise GP Holdings LP, an unrelated third party. These transactions resulted in pre-tax gains of $1.2 billion, which have been classified as (Losses) Gains on Sales and Impairments of Equity Investments on the Consolidated Statement of Operations for the nine months ended September 30, 2005. Minority Interest Expense of $343 million was recorded in the Consolidated Statement of Operations for the nine months ended September 30, 2005 to reflect ConocoPhillips proportionate share in the pre-tax gain on sale of the TEPPCO GP. |
Additionally, in July 2005, Duke Energy completed the agreement with ConocoPhillips, Duke Energys co-equity owner in DEFS, to reduce Duke Energys ownership interest in DEFS from 69.7% to 50% (the DEFS disposition transaction), which results in Duke Energy and ConocoPhillips becoming equal 50% owners in DEFS. Duke Energy has received, directly and indirectly through its ownership interest in DEFS, a total of approximately $1.1 billion from ConocoPhillips and DEFS, consisting of approximately $1.0 billion in cash and approximately $0.1 billion of assets. The DEFS disposition transaction resulted in a pre-tax gain of approximately $575 million, which was recorded in Gains on Sales of Other Assets and Other, net, on the accompanying Consolidated Statements of Operations. The DEFS disposition transaction includes the transfer to Duke Energy of DEFS Canadian natural gas gathering and processing facilities. Additionally, the DEFS disposition transaction included the acquisition of ConocoPhillips interest in the Empress System, which is a natural gas processing and NGL marketing business. Subsequent to the closing of the DEFS disposition transaction, effective on July 1, 2005, DEFS is no longer consolidated into Duke Energys consolidated financial statements and is accounted for by Duke Energy as an equity method investment. See Note 15 for the impacts of this transaction on certain cash flow hedges. The Canadian natural gas gathering and processing facilities and the Empress System are included in the Natural Gas Transmission segment.
| Additional asset and business sales during the nine months ended September 30, 2005 totaled approximately $26 million in proceeds. These sales resulted in net pre-tax gains of approximately $14 million which were recorded in Gains on Sales of Other Assets and Other, net in the Consolidated Statements of Operations. |
For the three months ended September 30, 2005, Crescents commercial and multi-family real estate sales resulted in $108 million of proceeds and $63 million of net pre-tax gains recorded in Gains on Sales of Investments in Commercial and Multi-Family Real Estate on the Consolidated Statements of Operations. For the nine months ended September 30, 2005, Crescents commercial and multi-family real estate sales resulted in $185 million of proceeds and $117 million of net pre-tax gains recorded in Gains on Sales of Investments in Commercial and Multi-Family Real Estate on the Consolidated Statements of Operations. Sales included a large land sale in Lancaster County, South Carolina during the three months ended September 30, 2005 that resulted in $41 million of pre-tax gains and several other legacy land sales. Additionally, in the third quarter of 2005, Crescent had a $45 million gain on sale of an interest in a portfolio of commercial office buildings which was recognized in Other Income and Expenses, net, on the Consolidated Statements of Operations.
3. Earnings Per Common Share (EPS)
Basic EPS is computed by dividing earnings available for common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing earnings available for common stockholders, as adjusted, by the diluted weighted-average number of common shares outstanding during the period. Diluted EPS reflect the potential dilution that could occur if securities or other agreements to issue common stock, such as stock options, stock-based performance unit awards, contingently convertible debt and phantom stock awards, were exercised, settled or converted into common stock.
13
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
The following table illustrates Duke Energys basic and diluted EPS calculations and reconciles the weighted-average number of common shares outstanding to the diluted weighted-average number of common shares outstanding for the three and nine months ended September 30, 2006 and 2005.
Income
|
Average
Shares |
EPS
|
|||||||
(in millions, except per-share data) | |||||||||
Three Months Ended September 30, 2006 |
|||||||||
Income from continuing operations |
$ | 717 | |||||||
Less: Dividends and premiums on redemption of preferred and preference stock |
| ||||||||
|
|
|
|||||||
Income from continuing operationsbasic |
$ | 717 | 1,254 | $ | 0.57 | ||||
|
|
||||||||
Effect of dilutive securities: |
|||||||||
Stock options, phantom, performance and unvested stock |
4 | ||||||||
Contingently convertible bond |
| 5 | |||||||
|
|
|
|
||||||
Income from continuing operationsdiluted |
$ | 717 | 1,263 | $ | 0.56 | ||||
|
|
|
|
|
|
||||
Three Months Ended September 30, 2005 |
|||||||||
Income from continuing operations |
$ | 924 | |||||||
Less: Dividends and premiums on redemption of preferred and preference stock |
(3 | ) | |||||||
|
|
|
|||||||
Income from continuing operationsbasic |
$ | 921 | 926 | $ | 0.99 | ||||
|
|
||||||||
Effect of dilutive securities: |
|||||||||
Stock options, phantom, performance and unvested stock, and common stock derivatives |
5 | ||||||||
Contingently convertible bond |
2 | 33 | |||||||
|
|
|
|
||||||
Income from continuing operationsdiluted |
$ | 923 | 964 | $ | 0.96 | ||||
|
|
|
|
|
|
||||
Nine Months Ended September 30, 2006 |
|||||||||
Income from continuing operations |
$ | 1,638 | |||||||
Less: Dividends and premiums on redemption of preferred and preference stock |
| ||||||||
|
|
|
|||||||
Income from continuing operationsbasic |
$ | 1,638 | 1,141 | $ | 1.43 | ||||
|
|
||||||||
Effect of dilutive securities: |
|||||||||
Stock options, phantom, performance and unvested stock |
4 | ||||||||
Contingently convertible bond |
4 | 17 | |||||||
|
|
|
|
||||||
Income from continuing operationsdiluted |
$ | 1,642 | 1,162 | $ | 1.41 | ||||
|
|
|
|
|
|
||||
Nine Months Ended September 30, 2005 |
|||||||||
Income from continuing operations |
$ | 2,112 | |||||||
Less: Dividends and premiums on redemption of preferred and preference stock |
(7 | ) | |||||||
|
|
|
|||||||
Income from continuing operationsbasic |
$ | 2,105 | 936 | $ | 2.25 | ||||
|
|
||||||||
Effect of dilutive securities: |
|||||||||
Stock options, phantom, performance and unvested stock, and common stock derivatives |
4 | ||||||||
Contingently convertible bond |
6 | 33 | |||||||
|
|
|
|
||||||
Income from continuing operationsdiluted |
$ | 2,111 | 973 | $ | 2.17 | ||||
|
|
|
|
|
|
14
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
The increase in weighted-average shares outstanding for the three and nine months ended September 30, 2006 compared to the same periods in 2005 was due primarily to the April 2006 issuance of approximately 313 million shares in conjunction with the merger with Cinergy (see Note 2), the conversion of debt into approximately 27 million shares of Duke Energy common stock during the nine months ended September 30, 2006 (see Note 4), and the repurchase and retirement of approximately 17.5 million shares of Duke Energy common stock during the nine months ended September 30, 2006 (see Note 4).
As of September 30, 2006 and 2005, approximately 14 million and 17 million, respectively, of options, unvested stock, performance and phantom stock awards were not included in the effect of dilutive securities in the above table because either the option exercise prices were greater than the average market price of the common shares during those periods, or performance measures related to the awards had not yet been met.
4. Common Stock
In February 2005, Duke Energy announced plans to execute up to approximately $2.5 billion in common stock repurchases over a three year period. In May 2005, Duke Energy suspended additional repurchases, pending further assessment. At the time of suspension, Duke Energy had repurchased approximately $933 million of common stock. In the first quarter of 2006, as a result of the March 10, 2006 shareholder approval of the Cinergy merger, Duke Energys Board of Directors authorized the repurchase of up to an additional $1 billion of common stock under the previously announced share repurchase plan. In June 2006, Duke Energy suspended additional repurchases of Duke Energy common stock under the repurchase plan due to its plan to spin off the natural gas businesses (see Matters Impacting Future Results within Natural Gas Transmissions Results of Operations in Item 2, Managements Discussion and Analysis of Results of Operations and Financial Condition). Prior to the June 2006 suspension, Duke Energy repurchased 17.5 million shares for total consideration of approximately $500 million during 2006. The repurchases and corresponding commissions and other fees were recorded in Common Stockholders Equity as a reduction in Common Stock and Additional Paid-in Capital. In October 2006, Duke Energys Board of Directors authorized the reactivation of the share repurchase plan for Duke Energy of up to $500 million of share repurchases after the spin-off of the natural gas businesses has been completed.
On March 18, 2005, Duke Energy entered into an accelerated share repurchase transaction whereby Duke Energy repurchased and retired 30 million shares of its common stock from an investment bank at the March 18, 2005 closing price of $27.46 per share. Total consideration paid to repurchase the shares of approximately $834 million, including approximately $10 million in commissions and other fees, was recorded in Common Stockholders Equity as a reduction in Common Stock. Additionally, Duke Energy entered into a separate open-market purchase plan on March 18, 2005 to repurchase up to an additional 20 million shares of its common stock, of which approximately 2.6 million shares were repurchased prior to the May 2005 suspension of the program at a weighted average price of $28.97 per share. As part of the accelerated share repurchase transaction, Duke Energy simultaneously entered into a forward sale contract with the investment bank that was to mature no later than November 8, 2005. Under the terms of the forward sale contract, the investment bank was required to purchase, in the open market, 30 million shares of Duke Energy common stock during the term of the contract to fulfill its obligation related to the shares it borrowed from third parties and sold to Duke Energy. At settlement, Duke Energy, at its option, was required to either pay cash or issue registered or unregistered shares of its common stock to the investment bank if the investment banks weighted average purchase price was higher than the March 18, 2005 closing price of $27.46 per share, or the investment bank was required to pay Duke Energy either cash or shares of Duke Energy common stock, at Duke Energys option, if the investment banks weighted average price for the shares purchased was lower than the March 18, 2005 closing price of $27.46 per share. On September 22, 2005, Duke Energy, at its option, paid approximately $25 million in cash to the investment bank to settle the forward sale contract as the investment bank had repurchased the full 30 million shares in the open market and fulfilled all of its obligations. The amount paid to the investment bank was based upon the difference between the investment banks weighted average price paid for the 30 million shares purchased of $28.42 per share and the March 18, 2005 closing price of $27.46 per share. Duke Energy recorded the approximately $25 million paid at settlement in Common Stockholders Equity as a reduction in Common Stock. Total consideration paid to repurchase the shares of approximately $933 million, including commissions and other fees, was recorded in Common Stockholders Equity as a reduction in Common Stock and Additional Paid-in Capital.
During the second and third quarters of 2006, Duke Energys $742 million of convertible debt became convertible into approximately 31.7 million shares of Duke Energy common stock due to the market price of Duke Energy common stock achieving a specified threshold for each respective quarter. Holders of the convertible debt were able to exercise their right to convert on or prior to each quarter end. During the second and third quarter, approximately $632 million of debt was converted into approximately 27 million shares
15
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
of Duke Energy common stock. At September 30, 2006, the balance of the convertible debt is approximately $110 million and remains convertible in the fourth quarter of 2006 into approximately 4.7 million shares of Duke Energy common stock as a result of the stock having achieved the specified price threshold during the third quarter.
See Note 2 for discussion of common stock issued in April 2006 as a result of the merger with Cinergy.
Effective in the third quarter 2006, the Board of Directors of Duke Energy approved a quarterly dividend increase of $0.01 per share, increasing the annual dividend to $1.28 per share.
5. Stock-Based Compensation
Effective January 1, 2006, Duke Energy adopted the provisions of SFAS No. 123(R), Share-Based Payment (SFAS No. 123(R)). SFAS No. 123(R) establishes accounting for stock-based awards exchanged for employee and certain nonemployee services. Accordingly, for employee awards, equity classified stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. Duke Energy previously applied Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and FIN 44, Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB Opinion 25) and provided the required pro forma disclosures of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). Since the exercise price for all options granted under those plans was equal to the market value of the underlying common stock on the grant date, no compensation cost was recognized in the accompanying Consolidated Statements of Operations.
Compensation expense for awards with graded vesting provisions is recognized in accordance with FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. Duke Energy elected to adopt the modified prospective application method as provided by SFAS No. 123(R), and accordingly, financial statement amounts from the prior periods presented in this Form 10-Q have not been restated. There were no modifications to outstanding stock options prior to the adoption of SFAS 123(R).
Duke Energy recorded pre-tax stock-based compensation expense for the three and nine months ended September 30, 2006 and 2005 as follows, the components of which are further described below:
Three Months Ended
September 30 |
Nine Months Ended
September 30 |
|||||||||||
2006
|
2005
|
2006
|
2005
|
|||||||||
(in millions) | ||||||||||||
Stock Options |
$ | 2 | $ | | $ | 7 | $ | | ||||
Stock Appreciation Rights |
| | 1 | 1 | ||||||||
Phantom Stock |
8 | 6 | 28 | 16 | ||||||||
Performance Awards |
12 | 6 | 24 | 20 | ||||||||
Other Stock Awards |
1 | | 2 | 1 | ||||||||
|
|
|
|
|
|
|
|
|||||
Total |
$ | 23 | $ | 12 | $ | 62 | $ | 38 | ||||
|
|
|
|
|
|
|
|
The tax benefit associated with the recorded expense for the nine months ended September 30, 2006 and 2005 was approximately $23 million and $14 million, respectively. There were no material differences in income from continuing operations, income tax expense, net income, cash flows, or basic and diluted earnings per share from the adoption of SFAS No. 123(R).
The following table shows what earnings available for common stockholders, basic earnings per share and diluted earnings per share would have been if Duke Energy had applied the fair value recognition provisions of SFAS No. 123 to all stock-based compensation awards during prior periods.
16
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Pro Forma Stock-Based Compensation
Three months ended September 30, 2005 |
Nine months ended September 30, 2005 |
|||||||
(in millions, except per share amounts) | ||||||||
Earnings available for common stockholders, as reported |
$ | 38 | $ | 1,211 | ||||
|
|
|
|
|
|
|||
Add: stock-based compensation expense included in reported net income, net of related tax effects |
8 | 24 | ||||||
Deduct: total stock-based compensation expense determined under fair value-based method for all awards, net of related tax effects |
(8 | ) | (24 | ) | ||||
|
|
|
|
|
|
|||
Pro forma earnings available for common stockholders, net of related tax effects |
$ | 38 | $ | 1,211 | ||||
Earnings per share |
||||||||
Basicas reported |
$ | 0.04 | $ | 1.29 | ||||
Basicpro forma |
$ | 0.04 | $ | 1.29 | ||||
Dilutedas reported |
$ | 0.04 | $ | 1.25 | ||||
Dilutedpro forma |
$ | 0.04 | $ | 1.25 |
Duke Energys 1998 Long-term Incentive Plan, as amended (the 1998 Plan), reserved 60 million shares of common stock for awards to employees and outside directors. Under the 1998 Plan, the exercise price of each option granted cannot be less than the market price of Duke Energys common stock on the date of grant and the maximum option term is 10 years. The vesting periods range from immediate to five years. Duke Energy issues new shares upon exercising or vesting of share-based awards.
Upon the acquisition of Westcoast Energy, Inc (Westcoast), Duke Energy converted all stock options outstanding under the 1989 Westcoast Long-term Incentive Share Option Plan to Duke Energy stock options. Certain of these options also provide for share appreciation rights under which the holder of a stock option may, in lieu of exercising the option, exercise the share appreciation right. The exercise price of these options equals the market price on the date of grant and the maximum option term is 10 years. The vesting periods range from immediate to four years.
Upon the acquisition of Cinergy, Duke Energy converted all stock options outstanding under the Cinergy 1996 Long-Term Incentive Compensation Plan and Cinergy Corp. Stock Option Plan to Duke Energy stock options. The exercise price of these options equaled the market price on the date of grant and the maximum option term is 10 years. The vesting periods are generally three years.
Stock Option Activity
Options (in thousands) |
Weighted-Average Exercise Price |
Weighted-Average Remaining Life (in years) |
Aggregate Intrinsic Value (in millions) |
||||||||
Outstanding at December 31, 2005 |
25,506 | $ | 29 | ||||||||
Granted (a) |
9,167 | 24 | |||||||||
Exercised |
(3,387 | ) | 22 | ||||||||
Forfeited or expired |
(1,224 | ) | 33 | ||||||||
|
|
||||||||||
Outstanding at September 30, 2006 |
30,062 | 29 | 4.9 | $ | 138 | ||||||
|
|
||||||||||
Exercisable at September 30, 2006 |
25,160 | $ | 30 | 4.3 | $ | 100 | |||||
|
|
(a) | Includes 7,289,222 converted Cinergy stock options |
On December 31, 2005, Duke Energy had 22 million exercisable options with a $32 weighted-average exercise price. The total intrinsic value of options exercised during the nine months ended September 30, 2006 and 2005 was approximately $26 million and $16 million, respectively. Cash received from options exercised during the nine months ended September 30, 2006 was approximately $73 million, with a related tax benefit of approximately $10 million.
17
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
In addition to the conversion of the Cinergy stock options noted above, Duke Energy granted 1,877,646 options (fair value of approximately $10 million based on a Black-Scholes model valuation) during the nine months ended September 30, 2006. There were no options granted during the year ended December 31, 2005. Remaining compensation expense to be recognized for unvested converted Cinergy options was determined using a Black-Scholes model.
Weighted-Average Assumptions for Option Pricing
2006
|
||
Risk-free interest rate (1) |
4.78% | |
Expected dividend yield (2) |
4.40% | |
Expected life (3) |
6.29 yrs. | |
Expected volatility (4) |
24% |
(1) | The risk free rate is based upon the U.S. Treasury Constant Maturity rates as of the grant date. |
(2) | The expected dividend yield is based upon annualized dividends and the 1-year average closing stock price, |
(3) | The expected term of options is derived from historical data. |
(4) | Volatility is based upon 50% historical and 50% implied volatility. Historic volatility is based on the weighted average between Duke and Cinergy historical volatility over the expected life using daily stock prices. Implied volatility is the average for all option contracts with a term greater than six months using the strike price closest to the stock price on the valuation date. |
The 1998 Plan allows for a maximum of twelve million shares of common stock to be issued under various stock-based awards. Payments for cash settled awards during the period were immaterial.
Stock-based performance awards outstanding under the 1998 Plan generally vest over three years. Vesting for certain stock-based performance awards can occur in three years, at the earliest, if performance is met. Certain performance awards granted in 2006 contain market conditions based on the total shareholder return (TSR) of Duke Energy stock (relative TSR). These awards are valued using a path-dependent model that incorporates expected relative TSR into the fair value determination of Duke Energys performance-based share awards with the adoption of SFAS No. 123(R). The model uses three year historical volatilities and correlations for all companies in the pre-defined peer group, including Duke Energy, to simulate Duke Energys relative TSR as of the end of the performance period. For each simulation, Duke Energys relative TSR associated with the simulated stock price at the end of the performance period plus expected dividends within the period results in a value per share for the award portfolio. The average of these simulations is the expected portfolio value per share. Actual life to date results of Duke Energys relative TSR for each grant is incorporated within the model. Other awards not containing market conditions are measured at grant date price. Duke Energy awarded 1,608,820 shares (fair value of approximately $32 million) in the nine months ended September 30, 2006, and 1,274,780 shares (fair value of approximately $34 million, based on the market price of Duke Energys common stock at the grant date) in the nine months ended September 30, 2005.
Performance Awards
The following table summarizes information about stock-based performance awards outstanding at September 30, 2006:
Shares
|
Weighted Average Grant Date Fair Value |
|||||
Number of Stock-based Performance Awards: |
||||||
Outstanding at December 31, 2005 |
2,940,768 | $ | 25 | |||
Granted |
1,608,820 | 20 | ||||
Vested |
(114,000 | ) | 27 | |||
Forfeited |
(246,436 | ) | 26 | |||
Canceled |
| | ||||
|
|
|||||
Outstanding at September 30, 2006 |
4,189,152 | $ | 23 |
The total fair value of the shares vested during the nine months ended September 30, 2006 and 2005 was approximately $3 million. As of September 30, 2006, Duke Energy had approximately $40 million of future compensation cost which is expected to be recognized over a weighted-average period of 1.3 years.
18
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Phantom stock awards outstanding under the 1998 Plan generally vest over periods from immediate to five years. Duke Energy awarded 1,147,950 shares (fair value of approximately $33 million) based on the market price of Duke Energys common stock at the grant dates in the nine months ended September 30, 2006, and 1,139,690 shares (fair value of approximately $31 million) in the nine months ended September 30, 2005. Converted Cinergy phantom stock awards are paid in cash and are measured and recorded as liability awards.
Phantom Stock Awards
The following table summarizes information about phantom stock awards outstanding at September 30, 2006:
Shares
|
Weighted Average Grant Date Fair Value |
|||||
Number of Phantom Stock Awards: |
||||||
Outstanding at December 31, 2005 |
2,517,020 | $ | 25 | |||
Granted (b) |
1,180,112 | 29 | ||||
Vested |
(845,886 | ) | 25 | |||
Forfeited |
(153,927 | ) | 26 | |||
Canceled |
| | ||||
|
|
|||||
Outstanding at September 30, 2006 |
2,697,319 | $ | 27 | |||
|
|
(b) | Includes 32,162 converted Cinergy awards |
The total fair value of the shares vested during the nine months ended September 30, 2006 and 2005 was approximately $21 million and $7 million, respectively. As of September 30, 2006, Duke Energy had approximately $32 million of future compensation cost which is expected to be recognized over a weighted-average period of 3.2 years.
Other stock awards outstanding under the 1998 Plan generally vest over periods from three to five years. Duke Energy awarded 279,000 shares (fair value of
approximately $8 million) based on the market price of Duke Energys common stock at the grant dates in the nine months ended September 30, 2006, and 38,000 shares (fair value of approximately $1 million) in the nine months ended
Other Stock Awards
The following table summarizes information about other stock awards outstanding at September 30, 2006:
Shares
|
Weighted Average Grant Date Fair Value |
|||||
Number of Other Stock Awards: |
||||||
Outstanding at December 31, 2005 |
178,337 | $ | 25 | |||
Granted (c) |
329,980 | 28 | ||||
Vested |
(69,610 | ) | 26 | |||
Forfeited |
| | ||||
Canceled |
| | ||||
|
|
|||||
Outstanding at September 30, 2006 |
438,707 | $ | 27 | |||
|
|
(c) | Includes 50,980 converted Cinergy awards |
The total fair value of the shares vested during the nine months ended September 30, 2006 and 2005 was approximately $2 million and $1 million, respectively. As of September 30, 2006, Duke Energy had approximately $8 million of future compensation cost which is expected to be recognized over a weighted-average period of 3.0 years.
19
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
6. Inventory
Inventory is recorded at the lower of cost or market value, primarily using the average cost method. The increase in inventory at September 30, 2006 as compared to December 31, 2005 is primarily attributable to inventory acquired as part of the merger with Cinergy.
Inventory
September 30, 2006 |
December 31, 2005 |
|||||
(in millions) | ||||||
Materials and supplies |
$ | 597 | $ | 434 | ||
Natural gas |
321 | 269 | ||||
Coal held for electric generation |
284 | 115 | ||||
Petroleum products |
41 | 45 | ||||
|
|
|
|
|||
Total inventory |
$ | 1,243 | $ | 863 | ||
|
|
|
|
7. Debt and Credit Facilities
As discussed in Note 4, during the second and third quarters of 2006, Duke Energys $742 million of convertible debt became convertible into approximately 31.7 million shares of Duke Energy common stock due to the market price of Duke Energy common stock achieving a specified threshold for each respective quarter. During the second and third quarters of 2006, approximately $632 million of debt was converted into approximately 27 million shares of Duke Energy common stock.
Duke Energys debt balance increased at September 30, 2006 as compared to December 31, 2005 primarily as a result of the merger with Cinergy (see Note 2).
In June 2006, Duke Energy Indiana issued $325 million principal amount of 6.05% senior unsecured notes due June 15, 2016. Proceeds from the issuance were used to repay $325 million of 6.65% First Mortgage Bonds that matured on June 15, 2006.
In August 2006, Duke Energy Kentucky issued approximately $77 million principal amount of floating rate tax-exempt notes due August 1, 2027. Proceeds from the issuance were used to refund a like amount of debt on September 1, 2006 then outstanding at Duke Energy Ohio. Approximately $27 million of the floating rate debt was swapped to a fixed rate concurrent with closing.
In September 2006, prior to the completion of the joint venture transaction of Crescent, as discussed in Note 2, the Crescent JV, Crescent and Crescents subsidiaries borrowed approximately $1.23 billion principal amount of debt. The net proceeds from the debt issuance of approximately $1.21 billion were recorded as a cash inflow within Financing Activities on the Consolidated Statements of Cash Flows and were distributed to Duke Energy. As a result of Duke Energys deconsolidation of Crescent effective September 7, 2006, Crescents outstanding debt balance of $1,298 million was removed from Duke Energys Consolidated Balance Sheets.
In September 2006, Union Gas Limited (Union Gas) entered into a fixed-rate financing agreement denominated in 165 million Canadian dollars (approximately $148 million in U.S. dollar equivalents as of the issuance date) due in 2036 with an interest rate of 5.46%.
In October 2006, Duke Energy Carolinas issued $150 million in tax-exempt floating-rate bonds. The bonds are structured as variable-rate demand bonds, subject to weekly remarketing and bear a final maturity of 2031. The initial interest rate was set at 3.72%. The bonds are supported by an irrevocable 3-year direct-pay letter of credit and were issued through the North Carolina Capital Facilities Finance Agency to fund a portion of the environmental capital expenditures at the Marshall and Belews Creek Steam Stations.
Available Credit Facilities and Restrictive Debt Covenants. In the second quarter of 2006, Duke Energy closed on the syndication of $3.1 billion in revolving credit facilities in the U.S. and 600 million in Canadian dollars. These syndications, which were amendments to and extensions of existing U.S. and Canadian credit facilities, extended the terms of the credit facilities by one year and built in covenant flexibility where appropriate to allow Duke Energy to pursue certain strategic activities, including the separation of the gas and electric businesses. Additionally, terms for the Cinergys facilities were conformed to less restrictive Duke covenants.
During the nine months ended September 30, 2006, Duke Energys consolidated credit capacity increased by approximately $763 million, primarily due to the merger with Cinergy. This increase was net of other reductions in credit capacity due to the terminations of an $800 million syndicated credit facility and $460 million in bi-lateral credit facilities. The terminations of these credit facilities primarily
20
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
reflect Duke Energys reduced liquidity needs as a result of exiting the DENA business (see Note 13). During October 2006, the $130 million bi-lateral credit facility at Duke Capital was cancelled. In addition, the remaining $120 million bi-lateral facility at Duke Capital was cancelled in November 2006 and reissued at Duke Energy for the same amount with the same terms and conditions.
The issuance of commercial paper, letters of credit and other borrowings reduces the amount available under the available credit facilities.
Duke Energys debt and credit agreements contain various financial and other covenants. Failure to meet those covenants beyond applicable grace periods could result in accelerated due dates and/or termination of the agreements. As of September 30, 2006, Duke Energy was in compliance with those covenants. In addition, credit agreements allow for acceleration of payments or termination of the agreements due to nonpayment, or in some cases, due to the acceleration of other significant indebtedness of the borrower or some of its subsidiaries. None of the debt or credit agreements contain material adverse change clauses.
As of September 30, 2006, approximately $479 million of pollution control bonds and approximately $300 million of commercial paper, which are short-term obligations by nature, were classified as long-term debt on the Consolidated Balance Sheets due to Duke Energys intent and ability to utilize such borrowings as long-term financing. Duke Energys credit facilities with non-cancelable terms in excess of one year as of the balance sheet date give Duke Energy the ability to refinance these short-term obligations on a long-term basis.
Credit Facilities Summary as of September 30, 2006 (in millions)
Amounts Outstanding
|
||||||||||||||
Expiration Date
|
Credit Facilities Capacity |
Commercial Paper |
Letters of Credit |
Total
|
||||||||||
Duke Energy Carolinas, LLC |
||||||||||||||
$500 multi-year syndicated (a), (b), (c) |
June 2011 | |||||||||||||
$75 three-year bi-lateral (a), (b), (d) |
September 2009 | |||||||||||||
$75 three-year bi-lateral (a), (b), (d) |
September 2009 | |||||||||||||
Total Duke Energy Carolinas, LLC |
$ | 650 | $ | 300 | $ | | $ | 300 | ||||||
Duke Capital LLC |
||||||||||||||
$600 multi-year syndicated (a), (b), (e) |
June 2010 | |||||||||||||
$130 three-year bi-lateral (b), (j) |
October 2007 | |||||||||||||
$120 multi-year bi-lateral (b) , (k) |
July 2009 | |||||||||||||
Total Duke Capital LLC |
850 | | 310 | 310 | ||||||||||
Westcoast Energy Inc. |
||||||||||||||
$180 multi-year syndicated (c), (f) |
June 2011 | 180 | | | | |||||||||
Union Gas Limited |
||||||||||||||
$359 364-day syndicated (g) |
June 2007 | 359 | | | | |||||||||
Cinergy Corp. |
||||||||||||||
$2,000 multi-year syndicated (a), (b), (h) |
June 2011 | 2,000 | 932 | 16 | 948 | |||||||||
|
|
|
|
|
|
|
|
|||||||
Total (i) |
$ | 4,039 | $ | 1,232 | $ | 326 | $ | 1,558 | ||||||
|
|
|
|
|
|
|
|
(a) | Credit facility contains an option allowing borrowing up to the full amount of the facility on the day of initial expiration for up to one year. |
(b) | Credit facility contains a covenant requiring the debt-to-total capitalization ratio to not exceed 65%. |
(c) | In June 2006, credit facility expiration date was extended from June 2010 to June 2011. |
(d) | Credit facility executed in September 2006 to replace $150 million bi-lateral facility which expired in September 2006. |
(e) | In June 2006, credit facility expiration date was extended from June 2009 to June 2010. |
(f) | Credit facility is denominated in Canadian dollars totaling 200 million Canadian dollars and contains a covenant that requires the debt-to-total capitalization ratio to not exceed 75%. |
(g) | In June 2006, credit facility was amended to increase the amount from 300 to 400 million Canadian dollars, in addition to extending the maturity from June 2006 to June 2007. It contains a covenant requiring the debt-to-total capitalization ratio to not exceed 75% and an option at maturity allowing for the conversion of all outstanding loans to a term loan repayable up to one year after maturity date but not exceeding 18 months from the date of draw. |
(h) | Contains $500 million sub limits each for Duke Energy Ohio and Duke Energy Indiana. In June 2006, the credit facility expiration date was extended from September 2010 to June 2011. |
(i) | Various credit facilities that support ongoing or discontinued operations and miscellaneous transactions are not included in this credit facilities summary. |
(j) | In October 2006, credit facility was cancelled. |
(k) | In November 2006, credit facility was cancelled and reissued at Duke Energy for the same amount with the same terms and conditions. |
21
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
8. Employee Benefit Obligations
The following tables show the components of the net periodic pension costs (income) for Duke Energys U.S. retirement plans and Westcoast Canadian retirement plans. Net periodic pension costs of Cinergy are included in the below tables (Duke Energy U.S.) for the period from the date of acquisition and thereafter.
Components of Net Periodic Pension Costs: Qualified Pension Benefits (Income)
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||||||
(in millions) | ||||||||||||||||
Duke Energy U.S. |
||||||||||||||||
Service cost |
$ | 31 | $ | 14 | $ | 78 | $ | 45 | ||||||||
Interest cost on projected benefit obligation |
68 | 39 | 172 | 118 | ||||||||||||
Expected return on plan assets |
(81 | ) | (57 | ) | (218 | ) | (171 | ) | ||||||||
Amortization of prior service credit |
| | (1 | ) | (1 | ) | ||||||||||
Amortization of loss |
13 | 9 | 40 | 26 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Net periodic pension costs |
$ | 31 | $ | 5 | $ | 71 | $ | 17 | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Westcoast |
||||||||||||||||
Service cost |
$ | 4 | $ | 2 | $ | 10 | $ | 6 | ||||||||
Interest cost on projected benefit obligation |
7 | 7 | 23 | 22 | ||||||||||||
Expected return on plan assets |
(8 | ) | (7 | ) | (24 | ) | (20 | ) | ||||||||
Amortization of prior service cost |
1 | 1 | 1 | 1 | ||||||||||||
Amortization of loss |
2 | 1 | 7 | 3 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Net periodic pension costs |
$ | 6 | $ | 4 | $ | 17 | $ | 12 | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Components of Net Periodic Pension Costs: Non-Qualified Pension Benefits
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||
(in millions) | ||||||||||||
Duke Energy U.S. |
||||||||||||
Service cost |
$ | 1 | $ | 1 | $ | 3 | $ | 1 | ||||
Interest cost on projected benefit obligation |
2 | 2 | 5 | 4 | ||||||||
Amortization of prior service cost |
| | 1 | 1 | ||||||||
Amortization of net transition asset |
| | | 1 | ||||||||
|
|
|
|
|
|
|
|
|||||
Net periodic pension costs |
$ | 3 | $ | 3 | $ | 9 | $ | 7 | ||||
|
|
|
|
|
|
|
|
|||||
Westcoast |
||||||||||||
Service cost |
$ | 1 | $ | 1 | $ | 1 | $ | 1 | ||||
Interest cost on projected benefit obligation |
1 | 1 | 3 | 3 | ||||||||
Amortization of loss |
| | 1 | | ||||||||
|
|
|
|
|
|
|
|
|||||
Net periodic pension costs |
$ | 2 | $ | 2 | $ | 5 | $ | 4 | ||||
|
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|
|
|
|
|
|
Duke Energys policy is to fund amounts for U.S. retirement plans on an actuarial basis to provide sufficient assets to meet benefit payments to plan participants. During the three and nine months ended September 30, 2006, Duke Energy contributed approximately $124 million to the legacy Cinergy qualified pension plans. Duke Energy does not anticipate making any additional contributions to its U.S. qualified pension plans during the remainder of 2006.
22
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Westcoasts policy is to fund its defined benefit (DB) retirement plans on an actuarial basis and in accordance with Canadian pension standards legislation, in order to accumulate assets sufficient to meet benefit payments. Contributions to the defined contribution (DC) retirement plans are determined in accordance with the terms of the plans. Duke Energy has contributed $11 million to the Westcoast DB plans for the three month period ended September 30, 2006 and $32 million for the nine months ended September 30, 2006. Duke Energy anticipates that it will make total contributions of approximately $45 million in 2006. Duke Energy has contributed $1 million to the Westcoast DC plans for the three months ended September 30, 2006 and $3 million for the nine months ended September 30, 2006, and anticipates that it will make total contributions of approximately $4 million in 2006.
The following table shows the components of the net periodic post-retirement benefit costs for the Duke Energy U.S. other post-retirement benefit plans and the Westcoast other post-retirement benefit plans.
Components of Net Periodic Post-Retirement Benefit Costs (Income)
Three Months Ended
September 30, |
Nine Months Ended September 30, |
|||||||||||||||
2006
|
2005
|
2006
|
2005
|
|||||||||||||
(in millions) | ||||||||||||||||
Duke Energy U.S. |
||||||||||||||||
Service cost benefit |
$ | 3 | $ | 1 | $ | 9 | $ | 4 | ||||||||
Interest cost on accumulated postretirement benefit obligation |
17 | 11 | 45 | 34 | ||||||||||||
Expected return on plan assets |
(4 | ) | (4 | ) | (12 | ) | (13 | ) | ||||||||
Amortization of net transition liability |
4 | 4 | 12 | 12 | ||||||||||||
Amortization of loss |
3 | 2 | 8 | 6 | ||||||||||||
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|
|
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|
|
|
|
|||||
Net periodic post-retirement benefit costs |
$ | 23 | $ | 14 | $ | 62 | $ | 43 | ||||||||
|
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|
|
|
|
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|
|
|
|||||
Westcoast |
||||||||||||||||
Service cost benefit |
$ | 1 | $ | 1 | $ | 3 | $ | 2 | ||||||||
Interest cost on accumulated postretirement benefit obligation |
2 | 2 | 5 | 4 | ||||||||||||
Amortization of prior service credit |
(1 | ) | (1 | ) | (1 | ) | (1 | ) | ||||||||
Amortization of loss |
1 | | 2 | 1 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Net periodic post-retirement benefit costs |
$ | 3 | $ | 2 | $ | 9 | $ | 6 | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Duke Energy also sponsors employee savings plans that cover substantially all U.S. employees. Duke Energy expensed employer matching contributions of $18 million for the three months ended September 30, 2006 compared to $14 million for the three months ended September 30, 2005. Duke Energy expensed employer matching contributions of approximately $59 million for the nine months ended September 30, 2006 compared to $48 million for the nine months ended September 30, 2005.
23
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
9. Goodwill and Intangibles
Duke Energy evaluates the impairment of goodwill under the guidance of SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). As a result of the annual impairment tests required by SFAS No. 142, no charge for the impairment of goodwill was recorded in 2006. As discussed further in Note 2, in April 2006, Duke Energy and Cinergy consummated the previously announced merger, which resulted in Duke Energy recording goodwill and intangible assets of approximately $5.6 billion. The following table shows the components of goodwill at September 30, 2006:
Changes in the Carrying Amount of Goodwill
Balance December 31, 2005 |
Acquisitions
(a)
|
Other
(b)
|
Balance September 30, 2006 |
||||||||||
(in millions) | |||||||||||||
Natural Gas Transmission |
$ | 3,512 | $ | | $ | 121 | $ | 3,633 | |||||
International Energy |
256 | | 11 | 267 | |||||||||
Crescent (c) |
7 | | (7 | ) | | ||||||||
Unallocated (a) |
| 4,467 | (155 | ) | 4,312 | ||||||||
|
|
|
|
|
|
|
|
|
|||||
Total consolidated |
$ | 3,775 | $ | 4,467 | $ | (30 | ) | $ | 8,212 | ||||
|
|
|
|
|
|
|
|
|
(a) | Goodwill recorded as of September 30, 2006 resulting from Duke Energys merger with Cinergy is $4,467 million. The valuation and other assessment procedures required to allocate this goodwill to the appropriate reporting units and reportable segments is currently in process and is anticipated to be completed by the end of 2006. While the allocation is not yet complete, Duke Energy anticipates that the goodwill will be allocated to the U.S. Franchised Electric and Gas and Commercial Power segments, as well as Other, with the majority of the goodwill likely relating to the U.S. Franchised Electric and Gas segment (see Note 2). |
(b) | Primarily relates to foreign currency translation and approximately $155 million of goodwill allocated to the disposition of CMT (see Note 13). |
(c) | Reduction in goodwill at September 30, 2006 reflects the deconsolidation of Crescent in September 2006 (see Note 2). |
Intangible Assets
Intangible assets acquired via merger with Cinergy. In April 2006, in connection with the merger with Cinergy, Duke Energy recorded gross intangible assets of approximately $1,091 million, primarily relating to approximately $712 million of emission allowances, approximately $295 million of gas, coal and power contracts and approximately $84 million of other intangible assets.
The carrying amount and accumulated amortization of intangible assets as of September 30, 2006 and December 31, 2005 are as follows:
September 30,
2006 |
December 31,
2005 |
Weighted
Average Life |
|||||||||
(in millions) | |||||||||||
Emission allowances |
$ | 650 | $ | 24 | (a | ) | |||||
Gas, coal and power contracts |
315 | 23 | (b | ) | |||||||
Other |
68 | 23 | 25 | ||||||||
|
|
|
|
|
|
||||||
Total gross carrying amount |
1,033 | 70 | |||||||||
|
|
|
|
|
|
||||||
Accumulated amortizationgas, coal and power contracts |
(29 | ) | (1 | ) | |||||||
Accumulated amortizationother |
(23 | ) | (4 | ) | |||||||
|
|
|
|
|
|
||||||
Total accumulated amortization |
(52 | ) | (5 | ) | |||||||
|
|
|
|
|
|
||||||
Total intangible assets, net |
$ | 981 | $ | 65 | |||||||
|
|
|
|
|
|
(a) | Emission allowances do not have a contractual term or expiration date. |
(b) | Of this balance, approximately $115 million will be amortized on a consumption basis and does not have a definitive life, approximately $155 million will be amortized on a straight line basis over 20 years, and the remaining balance of approximately $45 million will be amortized on a straight line basis over a weighted average life of approximately 14 years. |
24
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Emission allowances sold or consumed during the three and nine months ended September 30, 2006 were $150 million and $286 million, respectively. Emission allowances sold or consumed during the three and nine months ended September 30, 2005 were $3 million and $6 million, respectively.
Amortization expense for intangible assets for the three months ended September 30, 2006 and 2005 was approximately $15 million and $1 million, respectively. Amortization expense for intangible assets for the nine months ended September 30, 2006 and 2005 was approximately $31 million and $1 million, respectively.
The table below shows the expected amortization expense for the next five years for intangible assets as of September 30, 2006. The expected amortization expense includes estimates of emission allowances consumption and estimates of consumption of commodities such as gas and coal under existing contracts. The amortization amounts discussed below are estimates. Actual amounts may differ from these estimates due to such factors as changes in consumption patterns, sales or impairments of emission allowances or other intangible assets, additional intangible acquisitions and other events.
2007
|
2008
|
2009
|
2010
|
2011
|
|||||||||||
(in millions) | |||||||||||||||
Amortization expense |
$ | 198 | $ | 108 | $ | 97 | $ | 236 | $ | 14 |
In April 2006, Duke Energy recorded an intangible liability in connection with the merger with Cinergy amounting to approximately $113 million associated with the Market Based Standard Service Offer (MBSSO) in Ohio that will be recognized in earnings over the remaining regulatory period, which ends on December 31, 2008. The carrying amount of this intangible liability was approximately $89 million at September 30, 2006. Amortization expense related to the MBSSO is estimated to amount to approximately $5 million for the remainder of 2006, $27 million of income in 2007 and $67 million of income in 2008. Duke Energy also recorded approximately $56 million of intangible liabilities associated with other power sale contracts in connection with the merger with Cinergy. The carrying amount of this intangible liability was approximately $45 million at September 30, 2006. This balance will be amortized to income as follows: $5 million during the remainder of 2006, approximately $17 million in 2007, approximately $6 million in each of the years 2008 through 2010, and approximately $4 million in 2011.
10. Marketable Securities
During the nine months ended September 30, 2006, Duke Energys Natural Gas Transmission business unit received shares of stock as consideration for settlement of a customers transportation contract. The market value of the equity securities, determined by quoted market prices on the date of receipt, of approximately $23 million is reflected in Gains on Sales of Other Assets and Other, net in the Consolidated Statements of Operations for the nine months ended September 30, 2006. Subsequent to receipt, these securities were accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities , as trading securities. During the nine months ended September 30, 2006, these securities were sold and an additional gain of approximately $1 million was recognized in Other Income and Expenses, net in the Consolidated Statements of Operations for the nine months ended September 30, 2006.
11. Severance
During the period from the effective date of the Cinergy merger through September 30, 2006, Duke Energy accrued approximately $70 million related to voluntary and involuntary severance as a result of the merger with Cinergy (see Note 2). Additionally, Duke Energy recorded approximately $38 million in severance liabilities related to legacy Cinergy that was included in goodwill at the merger date. Substantially all of the remaining payments related to this severance program are expected to be made by the end of 2006.
As discussed in Note 13, in June 2006, Duke Energy announced it had reached an agreement to sell CMT, as well as associated contracts managed by these companies, to Fortis, a Benelux-based financial services group. As such, results of operations for CMT have been reflected in Income (Loss) from Discontinued Operations, net of tax, from the date of the Cinergy acquisition to September 30, 2006. The sale of CMT was consummated in October 2006 and Duke Energy did not record any material severance liabilities as a result of the disposal.
As discussed further in Note 13, during the third quarter of 2005, the Board of Directors of Duke Energy authorized and directed management to execute the sale or disposition of substantially all of DENAs remaining assets and contracts outside the Midwestern
25
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
United States and certain contractual positions related to the Midwestern assets. As a result of this exit plan, DENA terminated approximately 207 employees through the end of the third quarter of 2006. Management anticipates future severance costs related to this exit plan not included in the following table will be immaterial.
Severance Reserve
Balance at January 1, 2006 |
Provision/ Adjustments |
Cash Reductions |
Balance at September 30, 2006 |
||||||||||
(in millions) | |||||||||||||
Natural Gas Transmission |
$ | 3 | $ | | $ | (1 | ) | $ | 2 | ||||
Other (b) |
28 | 109 | (86 | ) | 51 | ||||||||
|
|
|
|
|
|
|
|
|
|||||
Total (a)(c) |
$ | 31 | $ | 109 | $ | (87 | ) | $ | 53 | ||||
|
|
|
|
|
|
|
|
|
(a) | Of the $109 million in the provision/adjustments column for the nine months ended September 30, 2006, approximately $70 million was recorded as a charge to income, approximately $38 million was recorded in goodwill and approximately $1 million was deferred as a regulatory asset. |
(b) | Amounts associated with DENAs discontinued operations are included as part of Other (see Note 13). |
(c) | Substantially all remaining severance payments are expected to be applied to the reserves within one year from the date that the provision was recorded. |
12. Impairments and Other Charges
International Energy. In the second quarter of 2006, International Energy recorded a $55 million other-than-temporary impairment charge related to an investment in Compañía de Servicios de Compresión de Campeche, S.A. de C.V. (Campeche), a natural gas compression facility in the Cantarell oil field in the Gulf of Mexico. Campeche project revenues are generated from the gas compression services agreement (GCSA) with the Mexican National Oil Company (PEMEX). The current GCSA expired on October 26, 2006 and a nine month extension was executed on November 2, 2006. In the second quarter of 2006, based on ongoing discussions with PEMEX, it was determined that there was a limited future need for Campeches gas compression services. Management of International Energy determined that it is probable that the Campeche investment will ultimately be sold or the GCSA will be renewed for a significantly lower rate. An other-than-temporary impairment loss was recorded to reduce the carrying value to managements best estimate of realizable value. The charges consist of a $17 million impairment of the carrying value of the equity method investment, which has been classified within (Losses) Gains on Sales and Impairments of Equity Investments in the Consolidated Statements of Operations for the nine months ended September 30, 2006, and a $38 million reserve against notes receivable from Campeche, which has been classified within Operations, Maintenance and Other in the Consolidated Statements of Operations for the nine months ended September 30, 2006. The facility ownership will transfer to PEMEX in August 2007. The carrying value of the note at September 30, 2006 was $17 million, which is managements best estimate of the net realizable value of the note receivable from Campeche.
Field Services. During the nine months ended September 30, 2005, the Field Services business unit recorded a charge of approximately $120 million due to the reclassification into earnings of pre-tax unrealized losses from accumulated other comprehensive income (AOCI) as a result of the discontinuance of certain cash flow hedges entered into to hedge Field Services commodity price risk. See Note 15 for a discussion of the impacts of the DEFS disposition transaction on certain cash flow hedges.
Crescent. In the third quarter of 2005, Crescent recognized pre-tax impairment charges of approximately $16 million related to a residential community near Hilton Head Island, South Carolina, that includes both residential lots and a golf club, to reduce the carrying value of the community to its estimated fair value. This impairment was recognized as a component of Impairment and Other Charges in the accompanying Consolidated Statements of Operations. This community has incurred higher than expected costs and has been impacted by lower than anticipated sales volume. The fair value of the remaining community assets was determined based upon managements estimate of discounted future cash flows generated from the development and sale of the community.
26
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
13. Discontinued Operations and Assets Held for Sale
The following table summarizes the results classified as Income (Loss) From Discontinued Operations, net of tax, in the Consolidated Statements of Operations.
Operating Revenues |
Operating (Loss) Gain
|
Net Gain (Loss) on Dispositions
|
|||||||||||||||||||||||||||||
Pre-tax
Operating (Loss) Gain |
Income
Tax (Benefit) Expense |
Operating
(Loss) Gain, Net of Tax |
Pre-tax
Gain (Loss) on Dispositions |
Income Tax
Expense (Benefit) |
Gain (Loss)
on Dispositions, Net of Tax |
Income (Loss)
From Discontinued Operations, Net of Tax |
|||||||||||||||||||||||||
(in millions) | |||||||||||||||||||||||||||||||
Three Months Ended September 30, 2006 |
|||||||||||||||||||||||||||||||
Other (a) |
$ | 22 | $ | (17 | ) | $ | (10 | ) | $ | (7 | ) | $ | 59 | $ | 21 | $ | 38 | $ | 31 | ||||||||||||
Commercial Power |
32 | 12 | 8 | 4 | 14 | 3 | 11 | 15 | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
Total consolidated |
$ | 54 | $ | (5 | ) | $ | (2 | ) | $ | (3 | ) | $ | 73 | $ | 24 | $ | 49 | $ | 46 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
Three Months Ended September 30, 2005 |
|||||||||||||||||||||||||||||||
Other (a) |
$ | 663 | $ | (855 | ) | $ | (307 | ) | $ | (548 | ) | $ | (546 | ) | $ | (219 | ) | $ | (327 | ) | $ | (875 | ) | ||||||||
International Energy |
| (10 | ) | (1 | ) | (9 | ) | | | | (9 | ) | |||||||||||||||||||
Crescent |
1 | 1 | 1 | | 2 | 1 | 1 | 1 | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
Total consolidated |
$ | 664 | $ | (864 | ) | $ | (307 | ) | $ | (557 | ) | $ | (544 | ) | $ | (218 | ) | $ | (326 | ) | $ | (883 | ) | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
Nine Months Ended September 30, 2006 |
|||||||||||||||||||||||||||||||
Other (a) |
$ | 511 | $ | (71 | ) | $ | (19 | ) | $ | (52 | ) | $ | (175 | ) | $ | (63 | ) | $ | (112 | ) | $ | (164 | ) | ||||||||
International Energy |
| (1 | ) | (1 | ) | | (10 | ) | (3 | ) | (7 | ) | (7 | ) | |||||||||||||||||
Commercial Power |
34 | 1 | 5 | (4 | ) | 8 | (5 | ) | 13 | 9 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
Total consolidated |
$ | 545 | $ | (71 | ) | $ | (15 | ) | $ | (56 | ) | $ | (177 | ) | $ | (71 | ) | $ | (106 | ) | $ | (162 | ) | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
Nine Months Ended September 30, 2005 |
|||||||||||||||||||||||||||||||
Other (a) |
$ | 1,540 | $ | (881 | ) | $ | (318 | ) | $ | (563 | ) | $ | (546 | ) | $ | (219 | ) | $ | (327 | ) | $ | (890 | ) | ||||||||
International Energy |
| (6 | ) | (1 | ) | (5 | ) | | | | (5 | ) | |||||||||||||||||||
Crescent |
2 | 1 | 1 | | 2 | 1 | 1 | 1 | |||||||||||||||||||||||
Field Services |
4 | | | | | | | | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||
Total consolidated |
$ | 1,546 | $ | (886 | ) | $ | (318 | ) | $ | (568 | ) | $ | (544 | ) | $ | (218 | ) | $ | (326 | ) | $ | (894 | ) | ||||||||
|
|
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|
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|
|
|
(a) | Other includes the results for DENAs discontinued operations, which were previously reported in the DENA segment |
The following table presents the carrying values of the major classes of assets and associated liabilities held for sale in the Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005.
Summarized Balance Sheet Information for Assets and Associated Liabilities Held for Sale
September 30, 2006
|
December 31, 2005
|
|||||
(in millions) | ||||||
Current assets |
$ | 1,395 | $ | 1,528 | ||
Investments and other assets |
523 | 2,059 | ||||
Property, plant and equipment, net (a) |
130 | 1,538 | ||||
|
|
|
|
|||
Total assets held for sale |
$ | 2,048 | $ | 5,125 | ||
|
|
|
|
|||
Current liabilities |
$ | 848 | $ | 1,488 | ||
Long-term debt |
| 61 | ||||
Deferred credits and other liabilities |
418 | 2,024 | ||||
|
|
|
|
|||
Total liabilities associated with assets held for sale |
$ | 1,266 | $ | 3,573 | ||
|
|
|
|
(a) | Property, plant and equipment, net includes approximately $106 million related to a plant in the U.S. Franchised Electric and Gas segment that is reflected as Assets Held For Sale on the Consolidated Balance Sheets but does not qualify for discontinued operations treatment under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. |
27
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Other
During the third quarter of 2005, Duke Energys Board of Directors authorized and directed management to execute the sale or disposition of substantially all of DENA remaining assets and contracts outside the Midwestern United States and certain contractual positions related to the Midwestern assets. The DENA assets to be divested include:
| Approximately 6,100 megawatts (MW) of power generation located primarily in the Western and Eastern United States, including all of the commodity contracts (primarily forward gas and power contracts) related to these facilities, |
| All remaining commodity contracts related to DENAs Southeastern generation operations, which were substantially disposed of in 2004, and certain commodity contracts related to DENAs Midwestern power generation facilities, and |
| Contracts related to DENAs energy marketing and management activities, which include gas storage and transportation, structured power and other contracts. |
As of the September 2005 exit announcement date, management anticipated that additional charges would be incurred related to the exit plan, including termination costs for gas transportation, storage, structured power and other contracts of approximately $600 million to $800 million, which included approximately $40 million to $60 million of severance, retention and other transaction costs (see Note 11). Approximately $700 million has been incurred from the announcement date through September 30, 2006, of which approximately $230 million was incurred during the nine months ended September 30, 2006, and was recognized in Income (Loss) From Discontinued Operations, net of tax. No material charges were recognized in the three months ended September 30, 2006.
In January 2006, Duke Energy signed an agreement to sell to LS Power DENAs entire fleet of power generation assets outside the Midwest, representing approximately 6,100 MW of power generation located in the Western and Northeast United States. In May 2006, the transaction with LS Power closed and total proceeds from the sale were approximately $1.56 billion, including certain working capital adjustments. Additional proceeds of up to approximately $40 million were subject to LS Power obtaining certain state regulatory approvals. On July 20, 2006 the Public Utilities Commission of the State of California approved a toll arrangement related to the Moss Landing facility previously sold to LS Power. In August 2006, LS Power made an additional payment to DENA of approximately $40 million, which DENA recorded as an additional gain on the sale of assets.
As of September 30, 2006, the DENA exit activities are substantially complete. As of September 30, 2006 and December 31, 2005, DENAs remaining assets and liabilities to be disposed of under the exit plan were classified as Assets Held for Sale in the Consolidated Balance Sheets. At September 30, 2006, contracts with a net fair value of approximately $6 million remain in Assets Held for Sale and represent contracts that have yet to be novated by Barclays Bank PLC (Barclays). Duke Energy has taken all steps necessary to novate these remaining contracts and is awaiting counterparty action. Barclays handles all administrative aspects of the remaining contracts and there are no cash flows to Duke Energy associated with the remaining contracts, nor does Duke Energy have any continuing involvement with the remaining contracts. In connection with the Barclays transaction, Duke Energy entered into a series of Total Return Swaps (TRS) with Barclays, which are accounted for as mark-to-market derivatives. The fair value of the TRS as of September 30, 2006 is a net liability of approximately $6 million, which offsets the net fair value of the underlying contracts. The TRS will be cancelled as the underlying transactions are transferred to Barclays.
In October 2006, DENA recognized an approximate $38 million pre-tax gain on the sale of available-for-sale securities that were included in Assets Held For Sale on the Consolidated Balance Sheets at September 30, 2006.
The results of operations of DENAs Western and Eastern United States generation assets, including related commodity contracts, certain contracts related to DENAs energy marketing and management activities and certain general and administrative costs, are required to be classified as discontinued operations for current and prior periods in the accompanying Consolidated Statements of Operations. GAAP requires an ongoing assessment of the continued qualification for discontinued operations presentation for the period up through one year following disposal. While this assessment requires judgment, management is not currently aware of any matters or events that are likely to occur that would impact the presentation of these operations as discontinued operations.
DENAs Midwestern generation assets have been retained and, therefore, the results of operations for these assets, including related commodity contracts, did not qualify for discontinued operations classification and remain in continuing operations. Additionally, DENAs Southeastern generation operations, which were sold in 2004, including related commodity contracts, did not meet the requirements for discontinued operations classification due to Duke Energys continuing involvement with these operations. In addition, the results for Duke Energy Trading and Marketing, LLC (DETM) will continue to be reported in continuing operations until the wind down of these operations is complete.
28
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
In the first quarter of 2005, DENAs Grays Harbor facility was sold to an affiliate of Invenergy LLC, resulting in a pre-tax gain of approximately $21 million (excluding any potential contingent consideration).
Commercial Power
In June 2006, Duke Energy announced it had reached an agreement to sell CMT, as well as certain Duke Energy Ohio trading contracts, to Fortis, a Benelux-based financial services group. Results of operations for CMT, as well as certain Duke Energy Ohio trading contracts, have been reflected in Income (Loss) from Discontinued Operations, net of tax, from the date of the Cinergy acquisition to September 30, 2006. In October 2006, the sale transaction was completed. Under the purchase and sale agreement, Fortis purchased CMT at a base price of approximately $210 million. In addition, Fortis paid approximately $200 million for the portfolio of contracts and an amount equal to the estimated net working capital associated with these companies at the time of close. In October 2006, Duke Energy received total pre-tax cash proceeds of approximately $700 million and recorded an approximate $25 million gain on the sale.
In October 2006, in connection with this transaction, Duke Energy entered into a series of Total Return Swaps (TRS) with Fortis, which are accounted for as mark to market derivatives. The TRS offsets the net fair value of the contracts being sold to Fortis. The TRS will be cancelled for each underlying contracts as each is transferred to Fortis. All economic and credit risk associated with the contracts has been transferred to Fortis as of the date of the sale through the TRS.
International Energy
International Energy held a receivable from Norsk Hydro ASA (Norsk) related to the 2003 sale of International Energys European business. In the first quarter of 2006, based on managements best estimate of recoverability, International Energy recorded an allowance of approximately $19 million ($12 million after tax) against this receivable, which was recorded in Income (Loss) From Discontinued Operations, net of tax on the Consolidated Statements of Operations. This allowance reduced the carrying value of the receivable to approximately $24 million at March 31, 2006. During the second quarter of 2006, International Energy and Norsk signed a settlement agreement in which Norsk agreed to pay International Energy approximately $34 million in full settlement of International Energys receivable. In connection with this settlement, International Energy recorded an approximate $9 million write-up ($5 million after tax) of the receivable through a reduction in the valuation allowance, which was recorded in Income (Loss) From Discontinued Operations, net of tax on the Consolidated Statements of Operations during the nine months ended September 30, 2006. In July 2006, International Energy received the settlement proceeds.
Crescent
Crescent routinely develops real estate projects and operates those facilities until they are substantially leased and a sales agreement is finalized. If Crescent does not have significant continuing involvement after the sale, Crescent classifies the projects as discontinued operations as required by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
In the third quarter of 2005, Crescent sold one commercial property resulting in sales proceeds of approximately $14 million. The after-tax gain on that sale was included in Income (Loss) From Discontinued Operations, net of tax, on the Consolidated Statements of Operations. Additionally, Crescent had two commercial properties, which were sold during the fourth quarter of 2005, for which the results of operations were included in Income (Loss) From Discontinued Operations, net of tax, on the Consolidated Statements of Operations.
14. Business Segments
In conjunction with the merger with Cinergy, effective with the second quarter of 2006, Duke Energy has adopted new business segments that management believes properly align the various operations of the merged companies with how the chief operating decision maker views the business. Prior period segment information has been retrospectively adjusted to conform to the new segment structure. Accordingly, the Duke Energy reportable business segments are as follows:
| U.S. Franchised Electric and Gasconsists of Duke Energy Carolinas (regulated electric utility business in North Carolina and South Carolina), and the following legacy Cinergy regulated operations: Duke Energy Ohio, Duke Energy Indiana and Duke Energy Kentucky (legacy Cinergy operations collectively known as Duke Energy Midwest) |
| Natural Gas Transmissionsegment is the same as former Duke Energy business segment |
29
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
| Field Servicessegment is the same as former Duke Energy business segment |
| Commercial PowerDuke Energy Ohios non-regulated generation including DENAs Midwestern operations (pre-merger included in Other) and Duke Energy Generation Services (formerly Cinergy Solutions) |
| International Energyconsists of Duke Energy International (DEI) and Cinergys international equity interest in a gas distribution system |
| Crescentsegment is the same as former Duke Energy business segment |
Cinergy, a Delaware corporation organized in 1993, owns all outstanding common stock of its public utility companies, Duke Energy Ohio and Duke Energy Indiana, which are public utilities, as well as other businesses including (a) cogeneration and energy efficiency investments and (b) natural gas and power marketing and trading operations, conducted primarily through CMT, which was sold to Fortis in October 2006 (see Note 13).
Duke Energy Ohio, an Ohio corporation organized in 1837, is a combination electric and gas public utility company that provides service in the southwestern portion of Ohio and, through Duke Energy Kentucky, in nearby areas of Kentucky. Its principal lines of business include generation, transmission, and distribution of electricity, the sale of and/or transportation of natural gas, and power marketing and trading.
Duke Energy Indiana, an Indiana corporation organized in 1942, is a vertically integrated and regulated electric utility that provides service in north central, central, and southern Indiana. Its primary line of business is generation, transmission, and distribution of electricity.
Duke Energys chief operating decision maker regularly reviews financial information about each of these business units in deciding how to allocate resources and evaluate performance. All of the business units are considered reportable segments under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Prior to the September 2005 announcement of the exiting of the majority of DENAs businesses, DENAs operations were considered a separate reportable segment. There is no aggregation within Duke Energys defined business segments.
The remainder of Duke Energys operations is presented as Other. While it is not considered a business segment, Other primarily includes DENAs discontinued operations, certain unallocated corporate costs, including certain costs to achieve related to the merger with Cinergy, certain discontinued hedges, DukeNet Communications, LLC, Duke Energy Merchants, LLC (DEM), DETM, Bison Insurance Company Limited (Bison), Duke Energys wholly-owned, captive insurance subsidiary, and Duke Energys 50% interest in Duke/Fluor Daniel (D/FD).
On September 7, 2006, Duke Energy deconsolidated Crescent due to a reduction in ownership and its inability to exercise control over Crescent (see Note 2). Crescent has been accounted for as an equity method investment since the date of deconsolidation.
In February 2005, DEFS sold its wholly-owned subsidiary TEPPCO GP, which is the general partner of TEPPCO LP, and Duke Energy sold its limited partner interest in TEPPCO LP, in each case to Enterprise GP Holdings LP, an unrelated third party (see Note 2).
In July 2005, Duke Energy completed the agreement with ConocoPhillips to reduce Duke Energys ownership interest in DEFS from 69.7% to 50% (see Note 2). In connection with the DEFS disposition transaction, DEFS transferred its Canadian natural gas gathering and processing facilities to Duke Energys Natural Gas Transmission segment.
During the first quarter of 2005, Duke Energy discontinued hedge accounting for certain contracts related to Field Services commodity price risk and changes in the fair value of these contracts subsequent to hedge discontinuance have been classified in Other. See Note 15 for further discussion.
During the first quarter of 2005, Duke Energy recognized a charge to increase liabilities associated with mutual insurance companies of $28 million in Other, which was a correction of an immaterial accounting error related to prior periods.
Duke Energys reportable segments offer different products and services and are managed separately as business units. Accounting policies for Duke Energys segments are the same as those described in the Notes to the Consolidated Financial Statements in Duke Energys Annual Report on Form 10-K for the year ended December 31, 2005. Management evaluates segment performance based on earnings before interest and taxes (EBIT) from continuing operations, after deducting minority interest expense related to those profits.
30
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
On a segment basis, EBIT excludes discontinued operations, represents all profits from continuing operations (both operating and non-operating) before deducting interest and taxes, and is net of the minority interest expense related to those profits. Cash, cash equivalents and short-term investments are managed centrally by Duke Energy, so the associated realized and unrealized gains and losses from foreign currency transactions and interest and dividend income on those balances are excluded from the segments EBIT.
Transactions between reportable segments are accounted for on the same basis as unaffiliated revenues and expenses in the accompanying Consolidated Financial Statements.
31
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Business Segment Data (a)
Unaffiliated Revenues |
Intersegment Revenues |
Total Revenues |
Segment EBIT / Consolidated Earnings from Continuing Operations before Income Taxes |
Depreciation and Amortization |
|||||||||||||||
(in millions) | |||||||||||||||||||
Three Months Ended September 30, 2006 |
|||||||||||||||||||
U.S. Franchised Electric and Gas |
$ | 2,477 | $ | 5 | $ | 2,482 | $ | 678 | $ | 363 | |||||||||
Natural Gas Transmission |
870 | 1 | 871 | 303 | 120 | ||||||||||||||
Field Services (c) |
| | | 158 | | ||||||||||||||
Commercial Power |
494 | 3 | 497 | 57 | 45 | ||||||||||||||
International Energy |
238 | | 238 | 68 | 19 | ||||||||||||||
Crescent (d) |
66 | | 66 | 300 | 1 | ||||||||||||||
|
|||||||||||||||||||
Total reportable segments |
4,145 | 9 | 4,154 | 1,564 | 548 | ||||||||||||||
Other |
29 | 38 | 67 | (111 | ) | 15 | |||||||||||||
Eliminations |
| (47 | ) | (47 | ) | | | ||||||||||||
Interest expense |
| | | (337 | ) | | |||||||||||||
Interest income and other (b) |
| | | 23 | | ||||||||||||||
|
|||||||||||||||||||
Total consolidated |
$ | 4,174 | $ | | $ | 4,174 | $ | 1,139 | $ | 563 | |||||||||
|
|||||||||||||||||||
Three Months Ended September 30, 2005 |
|||||||||||||||||||
U.S. Franchised Electric and Gas |
$ | 1,614 | $ | 5 | $ | 1,619 | $ | 606 | $ | 248 | |||||||||
Natural Gas Transmission |
857 | 12 | 869 | 329 | 116 | ||||||||||||||
Field Services (c) |
| | | 701 | | ||||||||||||||
Commercial Power |
(25 | ) | 103 | 78 | (11 | ) | 15 | ||||||||||||
International Energy |
186 | | 186 | 63 | 17 | ||||||||||||||
Crescent (d) |
105 | | 105 | 120 | | ||||||||||||||
|
|||||||||||||||||||
Total reportable segments |
2,737 | 120 | 2,857 | 1,808 | 396 | ||||||||||||||
Other |
291 | (66 | ) | 225 | (165 | ) | 10 | ||||||||||||
Eliminations |
| (54 | ) | (54 | ) | | | ||||||||||||
Interest expense |
| | | (228 | ) | | |||||||||||||
Interest income and other (b) |
| | | (4 | ) | | |||||||||||||
|
|||||||||||||||||||
Total consolidated |
$ | 3,028 | $ | | $ | 3,028 | $ | 1,411 | $ | 406 | |||||||||
|
|||||||||||||||||||
Nine Months Ended September 30, 2006 |
|||||||||||||||||||
U.S. Franchised Electric and Gas |
$ | 5,890 | $ | 14 | $ | 5,904 | $ | 1,388 | $ | 953 | |||||||||
Natural Gas Transmission |
3,325 | (1 | ) | 3,324 | 1,102 | 361 | |||||||||||||
Field Services (c) |
| | | 450 | | ||||||||||||||
Commercial Power |
955 | 5 | 960 | 50 | 114 | ||||||||||||||
International Energy |
719 | | 719 | 181 | 56 | ||||||||||||||
Crescent (d) |
221 | | 221 | 515 | 1 | ||||||||||||||
|
|||||||||||||||||||
Total reportable segments |
11,110 | 18 | 11,128 | 3,686 | 1,485 | ||||||||||||||
Other |
238 | 100 | 338 | (343 | ) | 38 | |||||||||||||
Eliminations |
| (118 | ) | (118 | ) | | | ||||||||||||
Interest expense |
| | | (925 | ) | | |||||||||||||
Interest income and other (b) |
| | | 75 | | ||||||||||||||
|
|||||||||||||||||||
Total consolidated |
$ | 11,348 | $ | | $ | 11,348 | $ | 2,493 | $ | 1,523 | |||||||||
|
|||||||||||||||||||
Nine Months Ended September 30, 2005 |
|||||||||||||||||||
U.S. Franchised Electric and Gas |
$ | 4,103 | $ | 15 | $ | 4,118 | $ | 1,216 | $ | 743 | |||||||||
Natural Gas Transmission |
2,732 | 92 | 2,824 | 1,044 | 339 | ||||||||||||||
Field Services (c) |
5,470 | 60 | 5,530 | 1,784 | 143 | ||||||||||||||
Commercial Power |
(28 | ) | 155 | 127 | (44 | ) | 45 | ||||||||||||
International Energy |
536 | | 536 | 217 | 48 | ||||||||||||||
Crescent (d) |
281 | | 281 | 210 | 1 | ||||||||||||||
|
|||||||||||||||||||
Total reportable segments |
13,094 | 322 | 13,416 | 4,427 | 1,319 | ||||||||||||||
Other |
536 | (106 | ) | 430 | (452 | ) | 30 | ||||||||||||
Eliminations |
| (216 | ) | (216 | ) | | | ||||||||||||
Interest expense |
| | | (813 | ) | | |||||||||||||
Interest income and other (b) |
| | | 45 | | ||||||||||||||
|
|||||||||||||||||||
Total consolidated |
$ | 13,630 | $ | | $ | 13,630 | $ | 3,207 | $ | 1,349 | |||||||||
|
(a) | Segment results exclude results of any discontinued operations. |
(b) | Other includes foreign currency transaction gains and losses, and additional minority interest expense not allocated to the segment results. |
(c) | In July 2005, Duke Energy completed the agreement with ConocoPhillips to reduce Duke Energys ownership interest in DEFS from 69.7% to 50%. Field Services segment data includes DEFS as a consolidated entity for periods prior to July 1, 2005 and as an equity method investment for periods after June 30, 2005. |
(d) | In September 2006, Duke Energy completed a joint venture transaction of Crescent (see Note 2). As a result, Crescent segment data includes Crescent as a consolidated entity for periods prior to September 7, 2006 and as an equity method investment for periods subsequent to September 7, 2006. |
32
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Segment assets in the following table exclude all intercompany assets.
Segment Assets
September 30, 2006 |
December 31, 2005 |
||||||
(in millions) | |||||||
U.S. Franchised Electric and Gas (a) |
$ | 29,983 | $ | 18,739 | |||
Natural Gas Transmission |
19,214 | 18,823 | |||||
Field Services |
1,455 | 1,377 | |||||
Commercial Power (a)(b) |
7,554 | 1,619 | |||||
International Energy |
3,230 | 2,962 | |||||
Crescent (c) |
163 | 1,507 | |||||
Unallocated Goodwill (d) |
4,312 | | |||||
|
|
|
|
|
|||
Total reportable segments |
65,911 | 45,027 | |||||
Other (b) |
4,409 | 9,402 | |||||
Reclassifications (e) |
(38 | ) | 294 | ||||
|
|
|
|
|
|||
Total consolidated assets |
$ | 70,282 | $ | 54,723 | |||
|
|
|
|
|
(a) | Increase in segment assets primarily attributable to merger with Cinergy |
(b) | Includes impacts of the reclassification of DENAs Midwestern power generating assets from Other to Commercial Power |
(c) | Decrease in Crescent segment assets due to the joint venture transaction of Crescent completed in September 2006 and resulting deconsolidation of Crescent (see Note 2). Balance at September 30, 2006 represents Duke Energys effective 50% investment in Crescent as a result of the deconsolidation. |
(d) | Unallocated Goodwill recorded as of September 30, 2006 resulting from Duke Energys merger with Cinergy. The valuation and other assessment procedures required to allocate this goodwill to the appropriate reporting units and reportable segments is currently in process and is anticipated to be completed by the end of 2006. While the allocation is not yet complete, Duke Energy anticipates that the goodwill will be allocated to the U.S. Franchised Electric and Gas and Commercial Power segments, as well as Other, with the majority of the goodwill likely relating to the U.S. Franchised Electric and Gas segment. |
(e) | Represents reclassification of federal tax balances in consolidation. |
15. Risk Management Instruments
The following table shows the carrying value of Duke Energys derivative portfolio as of September 30, 2006, and December 31, 2005.
Derivative Portfolio Carrying Value
September 30,
2006 |
December 31,
2005 |
|||||||
(in millions) | ||||||||
Hedging |
$ | 4 | $ | (17 | ) | |||
Trading |
| 5 | ||||||
Undesignated |
(39 | ) | (53 | ) | ||||
|
|
|
|
|
|
|||
Total |
$ | (35 | ) | $ | (65 | ) | ||
|
|
|
|
|
|
The amounts in the table above represent the combination of assets and (liabilities) for unrealized gains and losses on mark-to-market and hedging transactions on Duke Energys Consolidated Balance Sheets, excluding approximately $847 million of derivative assets and $726 million of derivative liabilities presented as assets and liabilities held for sale at September 30, 2006.
The $14 million change in the undesignated derivative portfolio fair value is due primarily to realized losses on certain contracts held by Duke Energy related to Field Services commodity price risk, partially offset by realized MTM gains at DENA and mark-to-market movement due to change in crude oil prices. As a result of the transfer of 19.7% interest in DEFS to ConocoPhillips and the third quarter 2005 deconsolidation of its investment in DEFS, Duke Energy has discontinued hedge accounting for certain contracts held by Duke Energy related to Field Services commodity price risk, which were previously accounted for as cash flow hedges. These contracts were originally entered into as hedges of forecasted future sales by Field Services, and have been retained as undesignated derivatives. Since discontinuance of hedge accounting, these contracts have been marked-to-market in the Consolidated Statements of Operations. As a result, approximately $355 million of pre-tax losses were recognized in earnings by Duke Energy during the nine months ended
33
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
September 30, 2005. These charges have been classified in the accompanying Consolidated Statements of Operations as follows: upon discontinuance of hedge accounting approximately $120 million of pre-tax losses were recognized as a component of Impairments and Other Charges, approximately $130 million of pre-tax losses prior to the deconsolidation of DEFS were recognized as a component of Non-Regulated Electric, Natural Gas, Natural Gas Liquids, and Other Revenues, and $105 million of pre-tax losses subsequent to the deconsolidation of DEFS were recognized as a component of Other Income and Expenses, net for the nine months ended September 30, 2005. Approximately $20 million and $25 million of realized and unrealized pre-tax gains and losses, respectively, related to these contracts were recognized in earnings by Duke Energy during the three and nine months ended September 30, 2006, respectively, as a component of Other Income and Expenses, net as of a result of Duke Energys investment in DEFS being accounted for using the equity method. Cash settlements on these contracts during the nine months ended September 30, 2006 of approximately $134 million are classified as a component of net cash used in investing activities in the accompanying Consolidated Statements of Cash Flows.
Included in Other Current Assets in the Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005 are collateral assets of approximately $114 million and $1,279 million, respectively, excluding approximately $306 million which is classified as held for sale associated with the announced sale of CMT. Collateral assets represent cash collateral posted by Duke Energy with other third parties. Included in Other Current Liabilities and Other Deferred Credits and Other Liabilities in the Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005 are collateral liabilities of approximately $306 million and $708 million, respectively, excluding approximately $41 million which is classified as held for sale primarily associated with the announced sale of CMT. Collateral liabilities represent cash collateral posted by other third parties to Duke Energy. Subsequent to December 31, 2005, in connection with the sale to Barclays of contracts related to DENAs energy marketing and management activities, which includes structured power and other contracts, Barclays provided DENA cash equal to the net collateral posted by DENA under the contracts. Net cash collateral received by Duke Energy in January 2006 was approximately $540 million based on current market prices of the contracts (see Note 13).
During the first quarter of 2005, Duke Energy settled certain hedges which were documented and designated as net investment hedges of the investment in Westcoast on their scheduled maturity and paid approximately $162 million. Losses recognized on this net investment hedge have been classified in AOCI as a component of foreign currency adjustments and will not be recognized in earnings unless the complete or substantially complete liquidation of Duke Energys investment in Westcoast occurs.
Commodity Cash Flow Hedges. Some Duke Energy subsidiaries are exposed to market fluctuations in the prices of various commodities related to their ongoing power generating and natural gas gathering, distribution, processing and marketing activities. Duke Energy closely monitors the potential impacts of commodity price changes and, where appropriate, enters into contracts to protect margins for a portion of future sales and generation revenues and fuel expenses. Duke Energy uses commodity instruments, such as swaps, futures, forwards and options as cash flow hedges for natural gas, electricity and natural gas liquid transactions. Duke Energys hedging exposures to the price variability of these commodities does not extend beyond one year.
As of September 30, 2006, $28 million of pre-tax deferred net losses on derivative instruments related to commodity cash flow hedges were accumulated on the Consolidated Balance Sheet in AOCI, and are expected to be recognized in earnings during the next 12 months as the hedged transactions occur. However, due to the volatility of the commodities markets, the corresponding value in AOCI will likely change prior to its reclassification into earnings.
The ineffective portion of commodity cash flow hedges resulted in the recognition of a pre-tax gain of approximately $3 million in the three and nine months ended September 30, 2006, respectively, as compared to a pre-tax gain of approximately $19 million and a pre-tax loss of approximately $11 million in the three and nine months ended September 30, 2005, respectively. The amount recognized for transactions that no longer qualified as cash flow hedges was a pre-tax loss of approximately $67 million as of September 30, 2006 and is reported in Income (Loss) From Discontinued Operations, net of tax. The amount recognized for transactions that no longer qualify as cash flow hedges was a pre-tax gain of approximately $1.2 billion in the three and nine months ended September 30, 2005, and is reported in Income (Loss) From Discontinued Operations, net of tax in the Consolidated Statement of Operations. The disqualified cash flow hedges were primarily associated with DENAs unrealized net gains on natural gas and power cash flow hedge positions.
Commodity Fair Value Hedges. Some Duke Energy subsidiaries are exposed to changes in the fair value of some unrecognized firm commitments to sell generated power or natural gas due to market fluctuations in the underlying commodity prices. Duke Energy actively evaluates changes in the fair value of such unrecognized firm commitments due to commodity price changes and, where appropriate, uses various instruments to hedge its market risk. These commodity instruments, such as swaps, futures and forwards, serve as
34
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
fair value hedges for the firm commitments associated with generated power. The ineffective portion of commodity fair value hedges resulted in an immaterial amount and a pre-tax gain of $7 million in the three and nine months ended September 30, 2006, respectively, as compared to immaterial amounts in the three and nine months ended September 30, 2005, respectively.
Other Derivative Contracts. In connection with the Barclays transaction discussed in Note 13, Duke Energy entered into a series of TRS with Barclays, which are accounted for as mark-to-market derivatives. The TRS offsets the net fair value of the contracts being sold to Barclays. At September 30, 2006, contracts with a net fair value of approximately $6 million remain in Assets Held for Sale and represent contracts that have yet to be novated by Barclays. Duke Energy has taken all steps necessary to novate these remaining contracts and is awaiting counterparty action. Barclays handles all administrative aspects of the remaining contracts and there are no cash flows to Duke Energy associated with the remaining contracts, nor does Duke Energy have any continuing involvement with these contracts. The fair value of the TRS as of September 30, 2006 is a net liability of approximately $6 million, which offsets the net fair value of the underlying contracts. The TRS will be cancelled as the underlying transactions are transferred to Barclays.
In connection with the Fortis transaction discussed in Note 13, Duke Energy entered into a series of TRS with Fortis, which are accounted for as mark-to-market derivatives. The TRS offsets the net fair value of the contracts being sold to Fortis. The TRS will be cancelled as the underlying contracts are transferred to Fortis. There are no future cash flows associated with these contracts, nor does Duke Energy have any continuing involvement with these contracts.
Normal Purchases and Normal Sales. The amount recognized for transactions that no longer qualified as normal purchases/normal sales was a pretax net loss of approximately $1.9 billion in the three and nine months ended September 30, 2005, and is reported in Income (Loss) From Discontinued Operations, net of tax in the accompanying Consolidated Statement of Operations. The net loss recorded during the third quarter of 2005, which primarily included certain contracts that were being accounted for as normal purchases/normal sales, was recognized due to managements plan for the sale or disposition of substantially all of DENAs physical and commercial assets outside the midwestern United States and certain contractual positions related to the Midwestern assets.
16. Regulatory Matters
Regulatory Merger Approvals. As discussed in Note 1 and Note 2, on April 3, 2006, the merger between Duke Energy and Cinergy was consummated to create a newly formed company, Duke Energy Holding Corp. (subsequently renamed Duke Energy Corporation). As a condition to the merger approval, the Public Utilities Commission of Ohio (PUCO), the Kentucky Public Service Commission (KPSC), the Public Service Commission of South Carolina (PSCSC) and the NCUC required that certain merger related savings be shared with consumers in Ohio, Kentucky, South Carolina, and North Carolina, respectively. The commissions also required Duke Energy Holding Corp., Cinergy, Duke Energy Ohio, Duke Energy Kentucky, and/or Duke Energy Carolinas to meet additional conditions. While the merger itself was not subject to approval by the Indiana Utility Regulatory Commission (IURC), the IURC approved certain affiliate agreements in connection with the merger subject to similar conditions. Key elements of these conditions include:
| The PUCO required that Duke Energy Ohio provide (i) a rate reduction of approximately $15 million for one year to facilitate economic development in a time of increasing rates and market prices (ii) a reduction of approximately $21 million to Duke Energy Ohios gas and electric consumers in Ohio for one year, with both credits beginning January 1, 2006. In April 2006, the Office of the Ohio Consumers Council (OCC) filed a Notice of Appeal with the Supreme Court of Ohio, requesting the Court remand the PUCOs merger approval for a full evidentiary hearing. The OCC alleged that the PUCO improperly failed to: (i) set the matter for a full evidentiary hearing; (ii) consider evidence regarding the transfer of certain DENA assets to Duke Energy Ohio; and (iii) lift the stay on discovery. Duke Energy Ohio and the OCC settled this matter and in June 2006, the Court granted the OCCs motion to dismiss. As of September 30, 2006, Duke Energy Ohio has returned $11 million and $15 million, respectively, on each of these rate reductions. |
| The KPSC required that Duke Energy Kentucky provide $8 million in rate reductions to Duke Energy Kentucky customers over five years, ending when new rates are established in the next rate case after January 1, 2008. As of September 30, 2006, Duke Energy Kentucky has returned $1 million to customers on this rate reduction. |
| The PSCSC required that Duke Energy Carolinas provide a $40 million rate reduction for one year and a three-year extension to the Bulk Power Marketing profit sharing arrangement. Approximately $15 million of the rate reduction has been passed through to customers since the ruling by the PSCSC. |
35
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
| The NCUC required that Duke Energy Carolinas provide (i) a rate reduction of approximately $118 million for Duke Energy Carolinas North Carolina customers through a credit rider to existing base rates for a one-year period following the close of the merger, and (ii) $12 million to support various low income, environmental, economic development and educationally beneficial programs, the cost of which was incurred in the second quarter of 2006. Approximately $28 million of the rate reduction has been passed through to customers since the ruling by the NCUC. |
In its order approving Duke Energys merger with Cinergy, the NCUC stated that the merger will result in a significant change in Duke Energys organizational structure which constitutes a compelling factor that warrants a general rate review. Therefore, as a condition of its merger approval and no later than June 2007, Duke Energy Carolinas is required to file a general rate case or demonstrate that Duke Energy Carolinas existing rates and charges should not be changed. This review will be consolidated with the proceeding that the NCUC is required to undertake in connection with the North Carolina clean air legislation to review the companys environmental compliance costs. The NCUC specifically noted that it has made no determination that the rates currently being charged by Duke Energy Carolinas are, in fact, unjust or unreasonable.
| The IURC required that Duke Energy Indiana provide a rate reduction of $40 million to Duke Energy Indiana customers over a one year period and $5 million over a five year period for low-income energy assistance and clean coal technology. In April 2006, Citizens Action Coalition of Indiana, Inc., an intervenor in the merger proceeding, filed a Verified Petition for Rehearing and Reconsideration claiming that Duke Energy Indiana should be ordered to provide an additional $5 million in rate reduction to customers to be consistent with the terms of the NCUCs order approving the merger. In May 2006, the IURC denied the petition for rehearing and reconsideration. As of September 30, 2006, Duke Energy Indiana has returned approximately $17 million to customers on this rate reduction. |
| The FERC approved the merger without conditions. In January 2006, Public Citizens Energy Program, Citizens Action Coalition of Indiana, Inc., Ohio Partners for Affordable Energy and Southern Alliance for Clean Energy requested rehearing of the FERC approval. In February 2006, the FERC issued an order granting rehearing of FERCs order for further consideration. A decision by FERC is expected in the fourth quarter of 2006. |
U.S. Franchised Electric and Gas. Rate Related Information. The NCUC, PSCSC, IURC and KPSC approve rates for retail electric and gas sales within their states. The PUCO approves rates and market prices for retail electric and gas sales within Ohio. The FERC approves rates for electric sales to wholesale customers served under cost-based rates.
NC Clean Air Act Compliance. In 2002, the state of North Carolina passed clean air legislation that freezes electric utility rates from June 20, 2002 to December 31, 2007 (rate freeze period), subject to certain conditions, in order for North Carolina electric utilities, including Duke Energy Carolinas, to significantly reduce emissions of sulfur dioxide (SO 2 ) and nitrogen oxides (NOx) from coal-fired power plants in the state. The legislation allows electric utilities, including Duke Energy Carolinas, to accelerate the recovery of compliance costs by amortizing them over seven years (2003-2009). The legislation provides for significant flexibility in the amount of annual amortization recorded, allowing utilities to vary the amount amortized, within limits, although the legislation does require that a minimum of 70% of the originally estimated total cost of $1.5 billion be amortized within the rate freeze period (2002 to 2007). Duke Energy Carolinas amortization expense related to this clean air legislation totals approximately $825 million from inception, with approximately $62 million and $85 million recorded in the third quarter of 2006 and 2005, respectively, and approximately $188 million and $241 million recorded for the first nine months of 2006 and 2005, respectively. As of September 30, 2006, cumulative expenditures totaled approximately $717 million, with $291 million incurred for the first nine months of 2006 and $222 million incurred for the first nine months of 2005 and are included in Net Cash Used In Investing Activities on the Consolidated Statements of Cash Flows. In filings with the NCUC, Duke Energy Carolinas has estimated the costs to comply with the legislation as approximately $1.7 billion. Actual costs may be higher or lower than the estimate based on changes in construction costs, final federal and state environmental regulations, including, among other things, the North Carolina Clean Air legislation and the Clean Air Interstate Rule, and Duke Energy Carolinas continuing analysis of its overall environmental compliance plan. Any change in compliance costs will be included in future filings with the NCUC.
Duke Energy Indiana Environmental Compliance Case. In November 2004, Duke Energy Indiana applied to the IURC for approval of its plan for complying with SO 2 , NO X , and mercury emission reduction requirements. Duke Energy Indiana also requested approval of cost recovery for certain proposed compliance projects. An evidentiary hearing was held in May 2005. In December 2005, Duke Energy Indiana, the Indiana Office of Utility Consumer Counselor (OUCC), and the Duke Energy Indiana Industrial Group filed a settlement agreement providing for approval of Duke Energy Indianas compliance plan, and approval of financing, depreciation, and operation and main -
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tenance cost recovery. In May 2006, the IURC approved the settlement agreement in its entirety. The approved Settlement Agreement provides for: (1) the construction of Phase 1 Clean Air Interstate Rule (CAIR) and Clean Air Mercury Rule (CAMR) projects with estimated expenditures of approximately $1.08 billion, (2) timely recovery of financing, construction, operation and maintenance cost and depreciation associated with the Phase 1 CAIR and CAMR plan, (3) recovery of emission allowances in connection with SO 2 , NOx and mercury, (4) accelerated 20 year depreciation rate, (5) timely recovery of Phase 1 plan development and presentation costs and Phase 2 plan development, engineering and pre-construction, and coal and equipment testing costs, and (6) authority to defer post-in-service allowance for funds used during construction (AFUDC), depreciation costs and operation and maintenance cost until applicable costs are reflected in rates.
Duke Energy Ohio Electric Rate Filings. Duke Energy Ohio operates under a Market Based Standard Service Offer (MBSSO) which was approved by the PUCO in November 2004. In March 2005, the OCC appealed the Commissions approval of the MBSSO to the Supreme Court of Ohio. The Supreme Court of Ohio recently ruled on the MBSSOs for two other Ohio utilities, and in each of those rulings, upheld the market prices charged by the utility to its consumers as approved by the Commission but overturned the competitive bid process approved by the Commission on the basis that the Commission rejected the bid price on behalf of consumers and the applicable statute requires customer involvement. Duke Energy Ohios MBSSO does not contain a competitive bid process pursuant to a statutory exception. Duke Energy Ohio does not expect a significant, if any, change to its MBSSO as a result of this case but cannot predict the outcome of its case. Duke Energy and Duke Energy Ohio expect the court to decide the case in 2006. On August 2, 2006, Duke Energy Ohio filed an application with the PUCO to extend Duke Energy Ohios MBSSO. The proposal provides for continued electric system reliability, a simplified market price structure and clear price signals for customers, while helping to maintain a stable revenue stream for Duke Energy Ohio. The application is pending and Duke Energy Ohio cannot predict the outcome of this proceeding.
Duke Energy Ohios MBSSO includes a fuel clause recovery component which is audited annually by the PUCO. In January 2006, Duke Energy Ohio entered into a settlement resolving all open issues identified in the 2005 audit. The PUCO approved the settlement in February 2006. Duke Energy and Duke Energy Ohio do not expect the agreement to have a material impact on their consolidated results of operations, cash flows or financial position.
Duke Energy Ohio filed a distribution rate case to recover certain distribution costs and certain costs that Duke Energy Ohio has deferred in 2004 and 2005 pursuant to its MBSSO. The parties to the proceeding agreed upon and filed a settlement setting the recommended annual revenue increase at approximately $50 million. In December 2005, the PUCO issued an order approving the settlement agreement.
Duke Energy Kentucky Electric Rate Case. In May 2006, Duke Energy Kentucky filed an application for an increase in its base electric rates. The application, which seeks an increase of approximately $67 million in revenue, or approximately 28 percent, to be effective in January 2007 was filed pursuant to the KPSCs 2003 Order approving the transfer of 1,100 MW of generating assets from Duke Energy Ohio to Duke Energy Kentucky. Duke Energy Kentucky also seeks to reinstitute its fuel cost recovery mechanism which has been frozen since 2001, and has proposed to refresh the pricing for the back-up power supply contract to reflect current market pricing. After Duke Energy Kentucky supplemented its filing in June 2006, the KPSC issued an order in June 2006, shortening the notice period for new rates from 30 to 20 days and suspending rates for six months, until January 6, 2007. Duke Energy Kentucky has reached a settlement agreement in principle with all parties to this proceeding resolving all the issues raised in the proceeding. Among other things, the settlement agreement provides for a $49 million increase in Duke Energy Kentuckys base electric rates. The KPSC is expected to render a decision on the settlement agreement during the fourth quarter of 2006. At the present time, Duke Energy and Duke Energy Kentucky cannot predict the outcome of this matter.
Duke Energy Kentucky Gas Rate Cases. In 2002, the KPSC approved Duke Energy Kentuckys gas base rate case which included, among other things, recovery of costs associated with an accelerated gas main replacement program. The approval authorized a tracking mechanism to recover certain costs including depreciation and a rate of return on the programs capital expenditures. The Kentucky Attorney General appealed to the Franklin Circuit Court the KPSCs approval of the tracking mechanism as well as the KPSCs subsequent approval of annual rate adjustments under this tracking mechanism. In 2005, both Duke Energy Kentucky and the KPSC requested that the court dismiss these cases. At the present time, Duke Energy and Duke Energy Kentucky cannot predict the timing or outcome of this litigation.
In February 2005, Duke Energy Kentucky filed a gas base rate case with the KPSC requesting approval to continue the tracking mechanism and for a $14 million annual increase in base rates. A portion of the increase is attributable to recovery of the current cost of the accelerated main replacement program in base rates. In December 2005, the KPSC approved an annual rate increase of $8 million
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and re-approved the tracking mechanism through 2011. In February 2006, the Kentucky Attorney General appealed the KPSCs order to the Franklin Circuit Court, claiming that the order improperly allows Duke Energy Kentucky to increase its rates for gas main replacement costs in between general rate cases, and also claiming that the order improperly allows Duke Energy Kentucky to earn a return on investment for the costs recovered under the tracking mechanism which permits Duke Energy Kentucky to recover its gas main replacement costs. At this time, Duke Energy and Duke Energy Kentucky cannot predict the outcome of this litigation.
Bulk Power Marketing (BPM) Profit Sharing . The NCUC approved Duke Energy Carolinas proposal in June 2004 to share an amount equal to fifty percent of the North Carolina retail allocation of the profits from certain wholesale sales of bulk power from Duke Energy Carolinas generating units at market based rates (BPM Profits). Duke Energy Carolinas also informed the NCUC that it would no longer include BPM Profits in calculating its North Carolina retail jurisdictional rate of return for its quarterly reports to the NCUC. As approved by the NCUC, the sharing arrangement provides for fifty percent of the North Carolina allocation of BPM Profits to be distributed through various assistance programs, up to a maximum of $5 million per year. Any amounts exceeding the maximum are used to reduce rates for industrial customers in North Carolina.
On June 28, 2006, the NCUC issued an order ruling on a dispute between Duke Energy Carolinas, the NCUC Public Staff and the Carolina Utility Customers Association (CUCA) regarding the method for determining the incremental costs of emission allowances used to calculate the BPM Profits under the sharing arrangement. The Public Staff and CUCA each proposed methods that differ from the method intended by Duke Energy Carolinas when it initially requested approval of the sharing arrangement. Duke Energy Carolinas has consistently used its originally intended method since it first implemented the sharing arrangement. The NCUC adopted the Public Staffs method and ordered Duke Energy Carolinas to file a revised rate rider on June 29, 2006, and to implement the new rider effective July 1, 2006. This ruling resulted in an $18 million charge during the nine months ended September 30, 2006, of which $11 million related to wholesale sales in 2005. On June 29, 2006, Duke Energy Carolinas filed a motion to postpone the effective date of the NCUCs order to allow time for Duke Energy Carolinas to consider its options and to gather the necessary data to employ the Public Staffs method and implement a revised rider. The NCUC approved Duke Energy Carolinas request on June 30, 2006. On July 17, 2006, Duke Energy Carolinas filed a Motion for Reconsideration requesting that the NCUC reconsider its June 28, 2006 order. In the alternative, Duke Energy Carolinas requested that the NCUC make its order effective only prospectively with respect to sharing periods beginning January 1, 2007. Duke Energy Carolinas also requested that if the NCUC was not inclined to grant its request to reinstate its proposed rider, then the NCUC should approve Duke Energy Carolinas withdrawal of the rider at its option. The NCUC heard oral arguments on the Motion on August 29, 2006. On September 15, 2006, Duke Energy Carolinas and the Public Staff filed an Offer of Settlement under which Duke Energys method would be used through June 30, 2006 and the Public Staffs method would be used from July 1, 2006 through the end of the sharing arrangement. Additionally, the sharing arrangement would be extended for the shorter of 1 year (through December 31, 2008) or the effective date of a general rate order from the NCUC addressing the ratemaking treatment of BPM revenues. If approved, the settlement allows Duke Energy Carolinas to reverse the $18 million charge previously recognized. On November 2, 2006, the NCUC ordered this matter set for hearing on January 9, 2007.
Duke Energy Carolinas Fuel Factor. On June 27, 2006, the NCUC issued its order approving a fuel factor of 1.6691 cents/kWh for the July 2006 through June 2007 billing period for Duke Energy Carolinas. The approved factor is a 13% increase from the previously approved fuel factor of 1.4769 cents/kWh.
On September 29, 2006, the PSCSC issued its order approving Duke Energy Carolinas requested fuel factor of 1.7760 cents/kWh for the October 2006 through September 2007 billing period. The factor was agreed to by all parties to the case and presented to the PSCSC at a hearing on August 24, 2006. The new factor is approximately 12% higher than the current factor of 1.5802 cents/kWh.
Other. U.S. Franchised Electric and Gas is engaged in planning efforts to meet projected load growth in its service territory. Long-term projections indicate a need for significant capacity additions, which may include new nuclear, integrated gasification combined cycle (IGCC) and coal facilities. Because of the long lead times required to develop such assets, U.S. Franchised Electric and Gas is taking steps now to ensure those options are available. In March 2006, Duke Energy Carolinas announced that it has entered into an agreement with Southern Company to evaluate potential construction of a new nuclear plant at a site jointly owned in Cherokee County, South Carolina. With selection of the Cherokee County site, Duke Energy Carolinas is moving forward with previously announced plans to develop an application to the U.S. Nuclear Regulatory Commission (NRC) for a combined construction and operating license (COL) for two Westinghouse AP1000 (advanced passive) reactors. Each reactor is capable of producing approximately 1,117 MW. The COL application submittal to the NRC is anticipated in late 2007 or early 2008. Submitting the COL application does not commit Duke Energy Carolinas to build nuclear units. On September 20, 2006, Duke Energy Carolinas filed an application with the NCUC for authority to recover certain
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expenses related to its development and evaluation of the proposed nuclear generation facility (the William States Lee III Nuclear Station). Specifically, Duke Energy Carolinas requests an NCUC order (1) finding that work performed by Duke Energy Carolinas to ensure the availability of nuclear generation by 2016 for its customers is prudent and consistent with the promotion of adequate, reliable, and economical utility service to the citizens of North Carolina and the polices expressed in North Carolina General Statute 62-2, and (2) providing expressly that Duke Energy Carolinas may recover in rates, in a timely fashion, the North Carolina allocable portion of its share of costs prudently incurred to evaluate and develop a new nuclear generation facility through December 31, 2007, whether or not a new nuclear facility is constructed. The application is pending.
On June 2, 2006, Duke Energy Carolinas also filed an application with the NCUC for a Certificate of Public Convenience and Necessity (CPCN) to construct two 800 MW state of the art coal generation units at its existing Cliffside Steam Station in North Carolina. The NCUC held public hearings in August 2006, and an evidentiary hearing in Raleigh, North Carolina concluded on September 14, 2006. Post-hearing briefs and proposed orders were filed on October 13, 2006. After the evidentiary hearing, Duke Energy Carolinas received competitive proposals for two major scopes of equipment for the Cliffside Project which suggest that the capital costs for these major components are increasing significantly due to various market pressures that will likely impact utility generation construction projects across the United States. On October 25, 2006, Duke Energy Carolinas filed a Notice of Updated Cost Information informing the NCUC of the increasing cost estimate and requesting that the NCUC issue a CPCN by mid-December 2006. Duke Energy Carolinas also requested that, to the extent the NCUC will require a further evidentiary hearing, such a hearing should be for the limited purpose of receiving evidence as to the new cost information and should be on an expedited basis in order to enable issuance of a CPCN in time to allow commencement of construction on or before April 1, 2007. On November 3, 2006, the NCUC issued an order requiring a further hearing on January 17, 2007 to consider evidence relevant to Duke Energy Carolinas updated cost information for the project.
In May 2006, Duke Energy Carolinas announced an agreement to acquire an approximate 825 megawatt power plant located in Rockingham County, North Carolina, from Rockingham Power, LLC, an affiliate of Dynegy for approximately $195 million. The Rockingham plant is a peaking power plant used during times of high electricity demand, generally in the winter and summer months and consists of five 165 megawatt combustion turbine units capable of using either natural gas or oil to operate. The acquisition is consistent with Duke Energys plan to meet customers electric needs for the foreseeable future. The transaction, which is anticipated to close in the fourth quarter of 2006, required approvals by the NCUC and FERC. In addition, approval was required from either the U.S. Department of Justice or the FTC under the Hart-Scott-Rodino Antitrust Improvement Act. The FTC approved the transaction on July 20, 2006, and the NCUC approved it on July 25, 2006. Application for FERC approval was filed on July 28, 2006, and on October 31, 2006 the FERC issued an order conditionally authorizing the transaction.
Duke Energy Indiana filed an application with the IURC for approval of study and preconstruction costs related to the joint development of an IGCC project with Southern Indiana Gas and Electric Company d/b/a Vectren Energy Delivery of Indiana, Inc. (Vectren). Duke Energy Indiana and Vectren reached a Settlement Agreement with the OUCC providing for the recovery of such costs if the IGCC project is approved and constructed and for the partial recovery of such costs if the IGCC project does not go forward. The IURC issued an order on July 26, 2006 approving the Settlement Agreement in its entirety.
On September 7, 2006, Duke Energy Indiana and Vectren filed a joint petition with the IURC seeking certificates of public convenience and necessity for the construction of a 630 MW IGCC power plant at Duke Energy Indianas Edwardsport Generating Station in Knox County, Indiana. The petition describes the applicants need for additional baseload generating capacity and requests timely recovery of all construction and operating costs related to the proposed generating station, including financing costs, together with certain incentive ratemaking treatment. Duke Energy Indiana and Vectren filed their cases in chief with the IURC on October 24, 2006. A prehearing conference and preliminary hearing is scheduled for November 28, 2006. A hearing on the petition is expected during the first quarter of 2007.
On August 15, 2006, Duke Energy Indiana filed a petition with the IURC requesting recovery of its costs of purchasing electricity to be produced by a 100 megawatt wind energy farm under development pursuant to a 20-year purchased power agreement between Duke Energy Indiana and Benton County Wind Farm, LLC. Duke Energy Indiana and the OUCC have both filed testimony and an evidentiary hearing was conducted before the IURC on October 24, 2006. An order is expected on this case by the end of 2006.
Duke Energy Indiana recovers its actual fuel costs quarterly through a rate adjustment mechanism. In two recent fuel clause proceedings, certain industrial customers and the Citizens Action Coalition of Indiana, Inc. have intervened and sub-dockets have been established to address issues raised by the OUCC and the intervenors concerning the allocation of fuel costs between native load customers and
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non-native load sales, the reasonableness of various Midwest Independent System Operator, Inc. (Midwest ISO) costs for which Duke
Energy Indiana has sought recovery and Duke Energy Indianas recovery of costs associated with certain power hedging activities. Duke
Energy Indiana is defending its practices, its costs, and the allocation of such costs. A hearing was conducted in one of these proceedings on September 20, 2006. A decision is not expected before the end of the year. Duke Energy Indiana has been authorized to collect through rates its costs for which it sought recovery in the two sub-docket proceedings, subject to refund pending the outcome of these proceedings. Duke Energy and Duke Energy Indiana cannot predict the outcome of these proceedings but do not expect the outcome to be material to their consolidated results of operations, cash flows or financial position.
Natural Gas Transmission. Rate Related Information . In November 2005, The British Columbia Pipeline System (BC Pipeline) filed an application with the National Energy Board (NEB) for interim and final tolls for 2006. In December 2005, the NEB approved the 2006 interim tolls as filed and BC Pipeline started negotiations with its shippers to reach a settlement on final tolls for years 2006 and 2007. BC Pipeline reached a toll settlement agreement in principle with its customers for the 2006 and 2007 fiscal years on March 30, 2006. The toll settlement agreement was filed with the NEB on June 21, 2006 and on July 11, 2006 pursuant to the NEBs Revised Guidelines for Negotiated Settlements, the NEB has asked for comments from interested parties due July 26, 2006. NEB approval was received on August 17, 2006.
Union Gas has rates that are approved by the Ontario Energy Board (OEB). Effective January 1, 2006, Union Gas implemented new rates approved by the OEB in December 2005, reflecting items previously approved. Union Gas earnings for 2006 continue to be subject to the earnings sharing mechanism implemented by the OEB in 2005.
In December 2005, Union Gas filed an application with the OEB for new rates effective January 1, 2007. In May 2006, Union Gas reached a comprehensive agreement with intervenors on all financial issues, except storage regulation and Demand Side Management (DSM), and on most non-financial issues. Storage regulation and DSM are being addressed through separate proceedings initiated by the OEB. The OEB accepted this agreement on May 23, 2006. The agreement includes an increase in the common equity component of
Union Gas capital structure, from 35% to 36%. A decision on the remaining non-financial issues was issued by the OEB on June 29, 2006. As a result of the comprehensive agreement reached in May 2006, the DSM decision, and the decrease in return on equity, 2007 rates are expected to increase by approximately 1.7%, excluding the impact of the pending decision on storage rates.
Rates for the sale of gas are adjusted quarterly to reflect updated commodity price forecasts. The difference between the approved and the actual cost of gas incurred in the current period is deferred for future recover from or return to customers, subject to approval by the OEB. These differences are directly flowed through to customers and, therefore, no rate of return is earned on the related deferred balances. The OEBs review and approval of these gas purchase costs primarily considers the prudence of the cost incurred.
Effective January 1, 2005, new rates (interim rates) for Maritimes & Northeast Pipeline L.L.C. (M&N) took effect, subject to refund, as a result of a rate case filed by M&N in 2004. In June 2005, a settlement agreement to resolve the proceeding was reached with customers that would provide for a rate increase over rates charged prior to January 1, 2005. On May 15, 2006 the FERC issued an order approving the settlement agreement. In June 2006, M&N refunded the difference between the settlement rates and the interim rates, plus interest, to each shipper due a refund.
Management believes that the effects of these matters will have no material adverse effect on Duke Energys future consolidated results of operations, cash flows or financial position.
17. Commitments and Contingencies
Environmental
Duke Energy is subject to international, federal, state and local regulations regarding air and water quality, hazardous and solid waste disposal and other environmental matters.
Remediation activities. Like others in the energy industry, Duke Energy and its affiliates are responsible for environmental remediation at various contaminated sites. These include some properties that are part of ongoing Duke Energy operations, sites formerly owned or used by Duke Energy entities, and sites owned by third parties. Remediation typically involves management of contaminated soils and may involve groundwater remediation. Managed in conjunction with relevant federal, state and local agencies, activities vary with site conditions and locations, remedial requirements, complexity and sharing of responsibility. If remediation activities involve statutory joint and several liability provisions, strict liability, or cost recovery or contribution actions, Duke Energy or its affiliates could potentially be held responsible for contamination caused by other parties. In some instances, Duke Energy may share liability asso -
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ciated with contamination with other potentially responsible parties, and may also benefit from insurance policies or contractual indemnities that cover some or all cleanup costs. All of these sites generally are managed in the normal course of business or affiliate operations. Management believes that completion or resolution of these matters will have no material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position.
Clean Water Act. The U. S. Environmental Protection Agencys (EPAs) final Clean Water Act Section 316(b) rule became effective July 9, 2004. The rule establishes aquatic protection requirements for existing facilities that withdraw 50 million gallons or more of water per day from rivers, streams, lakes, reservoirs, estuaries, oceans, or other U.S. waters for cooling purposes. Eight of Duke Energys eleven coal and nuclear-fueled generating facilities in North Carolina and South Carolina are affected sources under the rule. Six of Cinergys eleven coal-fueled generating facilities in which Cinergy is either a whole or partial owner are affected sources under the rule. The rule requires a Comprehensive Demonstration Study (CDS) for each affected facility to provide information needed to determine necessary facility-specific modifications and cost estimates for implementation. These studies will be completed over the next three to five years. Once compliance measures are determined and approved by regulators, a facility will typically have five or more years to implement the measures. Due to the wide range of measures potentially applicable to a given facility, and since the final selection of compliance measures will be at least partially dependent upon the CDS information, Duke Energy is not able to estimate its cost for complying with the rule at this time.
Clean Air Mercury Rule. The EPA finalized its Clean Air Mercury Rule (CAMR) in May 2005. The rule limits total annual mercury emissions from coal-fired power plants across the United States through a two-phased cap-and-trade program. Phase 1 begins in 2010 and Phase 2 begins in 2018. The rule gives states the option of participating in a national emissions allowance trading program. If a state chooses not to participate, then the rule sets a fixed limit on annual mercury emissions from that states coal-fired power plants. The emission controls Duke Energy is installing to comply with North Carolina clean air legislation and EPAs Clean Air Interstate Rule will contribute significantly to achieving compliance with the CAMR requirements. Duke Energy currently estimates that the additional cost of complying with Phase 1 of the CAMR will have no material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position, and is currently unable to estimate the cost of complying with Phase 2 of the CAMR.
Clean Air Interstate Rule. The EPA finalized its Clean Air Interstate Rule (CAIR) in May 2005. The rule limits total annual and summertime NOx emissions and annual SO 2 emissions from electric generating facilities across the Eastern United States through a two-phased cap-and-trade program. Phase 1 begins in 2009 for NOx and in 2010 for SO 2 . Phase 2 begins in 2015 for both NOx and SO 2 . The rule requires region wide SO 2 and NOx emissions to be cut 70 percent and 65 percent, respectively by 2015. The rule gives states the option of participating in the national emissions allowance trading program. If a state chooses not to participate, then the rule sets a fixed limit on the emissions from that states affected sources. The emission controls that Duke Energy is installing to comply with North Carolina clean air legislation will contribute significantly to achieving compliance with the CAIR requirements (see Note 16). Duke Energy currently estimates that it will spend approximately $1.23 billion between 2006 and 2011 to comply with Phase I of the CAIR/CAMR at its Midwest electric operations. The Indiana Utility Regulatory Commission recently issued an order granting Duke Energy approximately $1.08 billion in rate recovery to cover its estimated CAIR/CAMR compliance costs in Indiana (see Note 16). In Ohio, Duke Energy receives partial recovery of depreciation and financing costs related to environmental compliance projects for 2005-2008 through its rate stabilization plan. Any remaining costs that Duke Energy might incur to comply with Phase I of the CAIR, such as for the purchase of emission allowances, will have no material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position. Duke Energy is currently unable to estimate the cost of complying with Phase 2 of the CAIR. On July 11, 2005, Duke Energy and others filed petitions with the U.S. Court of Appeals for the District of Columbia Circuit requesting the Court to review certain elements of the EPAs CAIR. Duke Energy is seeking to have the EPA revise the method of allocating SO 2 emission allowances to entities under the rule.
Extended Environmental Activities, Accruals. Included in Other Current Liabilities and Other Deferred Credits and Other Liabilities on the Consolidated Balance Sheets were total accruals related to extended environmental-related activities of approximately $75 million and $55 million as of September 30, 2006 and December 31, 2005, respectively. These accruals represent Duke Energys provisions for costs associated with remediation activities at some of its current and former sites, as well as other relevant environmental contingent liabilities. Management believes that completion or resolution of these matters will have no material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position.
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Litigation
New Source Review (NSR)/EPA/Carbon Dioxide Litigation. In 2000, the U.S. Justice Department, acting on behalf of the EPA, filed a complaint against Duke Energy in the U.S. District Court in Greensboro, North Carolina, for alleged violations of the Clean Air Act (CAA). The EPA claims that 29 projects performed at 25 of Duke Energys coal-fired units were major modifications, as defined in the CAA, and that Duke Energy violated the CAA when it undertook those projects without obtaining permits and installing emission controls for SO 2 , NOx and particulate matter. The complaint asks the Court to order Duke Energy to stop operating the coal-fired units identified in the complaint, install additional emission controls and pay unspecified civil penalties. Duke Energy asserts that there were no CAA violations because the applicable regulations do not require permitting in cases where the projects undertaken are routine or otherwise do not result in a net increase in emissions. In August 2003, the trial Court issued a summary judgment opinion adopting Duke Energys legal positions, and on April 15, 2004, the Court entered Final Judgment in favor of Duke Energy. The government appealed the case to the U.S. Fourth Circuit Court of Appeals. On June 15, 2005, the Fourth Circuit ruled in favor of Duke Energy and effectively adopted Duke Energys view that permitting of projects is not required unless the work performed implicates a net increase in the hourly rate of emissions. The Fourth Circuit did not reach the question of routine. The EPA sought rehearing in the Fourth Circuit, which was denied. On November 1, 2006, oral arguments were made before the U.S. Supreme Court.
In November 1999, and through subsequent amendments, the United States brought a lawsuit in the United States Federal District Court for the Southern District of Indiana against Cinergy, Duke Energy Ohio, and Duke Energy Indiana alleging various violations of the CAA. Specifically, the lawsuit alleges that Duke Energy violated the CAA by not obtaining Prevention of Significant Deterioration (PSD), Non-Attainment New Source Review, and Ohio and Indiana SIP permits for various projects at Duke Energy owned and co-owned generating stations. Additionally, the suit claims that Duke Energy violated an Administrative Consent Order entered into in 1998 between the EPA and Cinergy relating to alleged violations of Ohios SIP provisions governing particulate matter at Unit 1 at Duke Energy Ohios W.C. Beckjord Station. The suit seeks (1) injunctive relief to require installation of pollution control technology on various generating units at Duke Energy Ohios W.C. Beckjord and Miami Fort Stations, and Duke Energy Indianas Cayuga, Gallagher, Wabash River, and Gibson Stations, and (2) civil penalties in amounts of up to $27,500 per day for each violation. In addition, three northeast states and two environmental groups have intervened in the case. In August 2005, the district court issued a ruling regarding the emissions test that it will apply to Cinergy, Duke Energy Ohio, and Duke Energy Indiana at the trial of the case. Contrary to Cinergys, Duke Energy Ohios, and Duke Energy Indianas argument, the district court ruled that in determining whether a project was projected to increase annual emissions, it would not hold hours of operation constant. However, the district court subsequently certified the matter for interlocutory appeal to the Seventh Circuit Court of Appeals. In August 2006, the Seventh Circuit upheld the district courts opinion. This issue is before the U.S. Supreme Court in the Duke Energy NSR case, and we do not expect further dispositive legal proceedings in this case until after the Supreme Court ruling.
In March 2000, the United States also filed in the United States District Court for the Southern District of Ohio an amended complaint in a separate lawsuit alleging violations of the CAA relating to PSD, NSR, and Ohio State Implementation Plan (SIP) requirements regarding various generating stations, including a generating station operated by Columbus Southern Power Company (CSP) and jointly-owned by CSP, The Dayton Power and Light Company (DP&L), and Duke Energy Ohio. The EPA is seeking injunctive relief and civil penalties of up to $27,500 per day for each violation. This suit is being defended by CSP. In April 2001, the United States District Court for the Southern District of Ohio in that case ruled that the Government and the intervening plaintiff environmental groups cannot seek monetary damages for alleged violations that occurred prior to November 3, 1994; however, they are entitled to seek injunctive relief for such alleged violations. Neither party appealed that decision. This matter was heard in trial in July 2005. A decision is pending.
In addition, Cinergy and Duke Energy Ohio have been informed by DP&L that in June 2000, the EPA issued a Notice of Violation (NOV) to DP&L for alleged violations of PSD, NSR, and Ohio SIP requirements at a station operated by DP&L and jointly-owned by DP&L, CSP, and Duke Energy Ohio. The NOV indicated the EPA may (1) issue an order requiring compliance with the requirements of the Ohio SIP, or (2) bring a civil action seeking injunctive relief and civil penalties of up to $27,500 per day for each violation. In September 2004, Marilyn Wall and the Sierra Club brought a lawsuit against Duke Energy Ohio, DP&L and CSP for alleged violations of the CAA at this same generating station. This case is currently in discovery in front of the same judge who has the CSP case.
In July 2004, the states of Connecticut, New York, California, Iowa, New Jersey, Rhode Island, Vermont, Wisconsin, and the City of New York brought a lawsuit in the United States District Court for the Southern District of New York against Cinergy, American Electric Power Company, Inc., American Electric Power Service Corporation, The Southern Company, Tennessee Valley Authority, and Xcel Energy Inc. A similar lawsuit was filed in the United States District Court for the Southern District of New York against the same companies by
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Open Space Institute, Inc., Open Space Conservancy, Inc., and The Audubon Society of New Hampshire. These lawsuits allege that the defendants emissions of CO 2 from the combustion of fossil fuels at electric generating facilities contribute to global warming and amount to a public nuisance. The complaints also allege that the defendants could generate the same amount of electricity while emitting significantly less CO 2 . The plaintiffs are seeking an injunction requiring each defendant to cap its CO 2 emissions and then reduce them by a specified percentage each year for at least a decade. In September 2005, the district court granted the defendants motion to dismiss the lawsuit. The plaintiffs have appealed this ruling to the Second Circuit Court of Appeals. Oral argument was held before the Second Circuit Court of Appeals on June 7, 2006.
It is not possible to predict with certainty whether Duke Energy will incur any liability or to estimate the damages, if any, that Duke Energy might incur in connection with these matters.
Western Energy and Natural Gas Litigation and Regulatory Matters. Duke Energy and several of its affiliates, as well as other energy companies, are parties to 34 lawsuits filed by or on behalf of electricity and/or natural gas purchasers in several Western states. Many of the suits seek class-action certification. The plaintiffs allege that the defendants conspired to manipulate the electricity and/or natural gas markets in violation of state and/or federal antitrust, unfair business practices and other laws. Plaintiffs in some of the cases further allege that such activities, including engaging in round trip trades, providing false information to natural gas trade publications and unlawfully exchanging information, resulted in artificially high energy prices. Plaintiffs seek aggregate damages or restitution of billions of dollars from the defendants. Six of these cases were dismissed on filed rate and/or federal preemption grounds, and the plaintiffs in each of these dismissed cases have appealed their respective rulings to the U.S. Ninth Circuit Court of Appeals. In September 2006, Duke Energy reached an agreement in principle to settle the 12 class action cases pending in California. Such agreement is subject to execution of mutually acceptable agreements and approval by the class members and the court. Duke Energy does not expect that the proposed settlement will have a material adverse effect on its consolidated results of operations, cash flows or financial position. With respect to the remaining cases, it is not possible to predict with certainty whether Duke Energy will incur any liability or to estimate the damages, if any, that Duke Energy might incur in connection with these lawsuits, but Duke Energy does not presently believe the outcome of these matters will have a material adverse effect on Duke Energys results of operations, cash flows or financial position.
In 2002, Southern California Edison Company initiated arbitration proceedings regarding disputes with DETM relating to amounts owed in connection with the termination of bi-lateral power contracts between the parties in early 2001. This matter proceeded to hearing in November 2005. In January 2006, the parties reached an agreement in principle to resolve the matters at issue in the arbitration. The parties entered into a Settlement Agreement and Mutual Release dated as of March 10, 2006, and on March 24, 2006, DETM paid the settlement amount, including interest, into escrow. The agreement received final regulatory approval in October 2006. The resolution of this matter did not have a material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position.
Trading Related Litigation. Commencing August 2003, plaintiffs filed three class-action lawsuits in the U.S. District Court for the Southern District of New York on behalf of entities who bought and sold natural gas futures and options contracts on the New York Mercantile Exchange during the years 2000 through 2002. DETM and CMT, along with numerous other entities, were named as defendants. The plaintiffs claim that the defendants violated the Commodity Exchange Act by reporting false and misleading trading information to trade publications, resulting in monetary losses to the plaintiffs. Plaintiffs seek class action certification, unspecified damages and other relief. On September 24, 2004, the court denied a motion to dismiss the plaintiffs claims filed on behalf of DETM and other defendants, and on September 30, 2005, the court certified the class. Duke Energy has reached an agreement with the plaintiffs in these consolidated cases to resolve all issues and on February 8, 2006, the court granted preliminary approval of this settlement. The Final Judgment and Order of Dismissal were entered in May 2006. The resolution of this matter did not have a material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position.
On January 28, 2005, four plaintiffs filed suit in Tennessee Chancery Court against Duke Energy affiliates and other energy companies seeking class action certification on behalf of indirect purchasers of natural gas. On August 8, 2005, a plaintiff filed a lawsuit in state court in Kansas against Duke Energy and DETM, as well as other energy companies. On September 26, 2005, a petition was filed in state court in Kansas and on May 19, 2006 another petition was filed in Colorado state court. In October 2006, the Missouri Public Service Commission filed a lawsuit in state court in Missouri. These cases were also filed against Duke Energy and DETM, as well as other energy companies. Each of these five cases contains similar claims, that the respective plaintiffs, and the classes they claim to represent, were harmed by the defendants alleged manipulation of the natural gas markets by various means, including providing false information to natural gas trade publications and entering into unlawful arrangements and agreements in violation of the antitrust laws of the respective
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Notes To Consolidated Financial Statements(Continued)
states. Plaintiffs seek damages in unspecified amounts. Duke Energy is unable to express an opinion regarding the probable outcome or estimate damages, if any, related to these matters at this time.
Trading Related Investigations. Beginning in February 2004, Duke Energy has received requests for information from the U.S. Attorneys office in Houston focused on the natural gas price reporting activities of certain individuals involved in DETM trading operations. Duke Energy has cooperated with the government in this investigation and is unable to express an opinion regarding the probable outcome or estimate damages, if any, related to this matter at this time.
Sonatrach/Sonatrading Arbitration . Duke Energy LNG Sales Inc. (Duke LNG) claims in an arbitration commenced in January 2001 in London that Sonatrach, the Algerian state-owned energy company, together with its subsidiary, Sonatrading Amsterdam B.V. (Sonatrading), breached their shipping obligations under a liquefied natural gas (LNG) purchase agreement and related transportation agreements (the LNG Agreements) relating to Duke LNGs purchase of LNG from Algeria and its transportation by LNG tanker to Lake Charles, Louisiana. Duke LNG seeks damages of approximately $27 million. Sonatrading and Sonatrach, on the other hand, claim that Duke LNG repudiated the LNG Agreements by allegedly failing to diligently perform LNG marketing obligations. Sonatrading and Sonatrach seek damages in the amount of approximately $250 million. In 2003, an arbitration tribunal issued a Partial Award on liability issues, finding that Sonatrach and Sonatrading breached their obligations to provide shipping. The tribunal also found that Duke LNG breached the LNG Purchase Agreement by failing to perform marketing obligations. The final hearing on damages was concluded in March 2006 and the parties are awaiting a ruling from the tribunal.
Citrus Trading Corporation (Citrus) Litigation. In conjunction with the Sonatrach LNG Agreements, Duke LNG entered into a natural gas purchase contract (the Citrus Agreement) with Citrus. Citrus filed a lawsuit in March 2003 in the U.S. District Court for the Southern District of Texas against Duke LNG and PanEnergy Corp alleging that Duke LNG breached the Citrus Agreement by failing to provide sufficient volumes of gas to Citrus. Duke LNG contends that Sonatrach caused Duke LNG to experience a loss of LNG supply that affected Duke LNGs obligations and termination rights under the Citrus Agreement. Citrus seeks monetary damages and a judicial determination that Duke LNG did not experience such a loss. After Citrus filed its lawsuit, Duke LNG terminated the Citrus Agreement and filed a counterclaim asserting that Citrus had breached the agreement by, among other things, failing to provide sufficient security under a letter of credit for the gas transactions. Citrus denies that Duke LNG had the right to terminate the agreement and contends that Duke LNGs termination of the agreement was itself a breach, entitling Citrus to terminate the agreement and recover damages in the amount of approximately $190 million (excluding interest). The Court has made preliminary rulings regarding the issues of fact and law that remain for trial. A jury trial is scheduled to commence on December 5, 2006. It is not possible to predict with certainty whether Duke Energy will incur any liability or to estimate the damages, if any, that Duke Energy might incur in connection with the Sonatrach and Citrus matters.
Exxon Mobil Disputes. In April 2004, Mobil Natural Gas, Inc. (MNGI) and 3946231 Canada, Inc. (3946231, and collectively with MNGI, Exxon Mobil) filed a Demand for Arbitration against Duke Energy, DETMI Management Inc. (DETMI), DTMSI Management Ltd. (DTMSI) and other affiliates of Duke Energy. MNGI and DETMI are the sole members of DETM. DTMSI and 3946231 are the sole beneficial owners of Duke Energy Marketing Limited Partnership (DEMLP, and with DETM, the Ventures). Among other allegations, Exxon Mobil alleges that DETMI and DTMSI engaged in wrongful actions relating to affiliate trading, payment of service fees, expense allocations and distribution of earnings in breach of agreements and fiduciary duties relating to the Ventures. Exxon Mobil seeks to recover actual damages, plus attorneys fees and exemplary damages; aggregate damages were specified at the arbitration hearing and totaled approximately $125 million (excluding interest). Duke Energy denies these allegations, and has filed counterclaims asserting that Exxon Mobil breached its Venture obligations and other contractual obligations. By order dated May 2, 2005, the arbitrators granted Duke Energys Motion for Partial Summary Judgment, effectively eliminating a significant portion of Exxon Mobils claims. Exxon Mobil filed a motion for reconsideration of the ruling as well as for an extension of the date for the arbitration hearing. Exxon Mobil also filed a motion to dismiss certain of Duke Energys counterclaims. Following a hearing in December 2005 on the motion for reconsideration, the arbitrators issued their ruling on January 26, 2006, generally reaffirming the original order, with a limited exception with respect to affiliate trades that is not expected to have a significant impact on the case. The panel also dismissed one of Duke Energys counterclaims. The parties agreed that the damages due to Duke Energy on its counterclaim will be determined in the upcoming hearing scheduled in the Canadian arbitration proceedings. The arbitration hearing in the U.S. arbitration was held in October 2006 in Houston, Texas. In August 2004, DEMLP initiated arbitration proceedings in Canada against certain Exxon Mobil entities asserting that those entities wrongfully terminated two gas supply agreements with the DEMLP and wrongfully failed to assume certain related gas supply agreements with other parties. A hearing in the Canadian arbitration was held in March 2006. The arbitrators issued their award in June, 2006 finding that (1) the two gas supply agreements were improperly terminated by ExxonMobil; but (2) ExxonMobil was not required to take assignment of the related third party gas
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Notes To Consolidated Financial Statements(Continued)
supply agreements. A hearing to determine the damages to be paid as the result of the first ruling, as well as the damages to be paid to
Duke Energy as the result of the termination of the U.S. gas supply agreement is scheduled for November 9 and 10, 2006, before the
same panel of arbitrators. At this time Duke Energy is unable to estimate the amount of any damage award to be received in resolution of this matter. The gas supply agreements with other parties, under which DEMLP continues to remain obligated, are currently estimated to result in losses of between $100 million and $150 million through 2011. However, these losses are subject to change in the future in the event of changes in market conditions and underlying assumptions.
Duke Energy Retirement Cash Balance Plan . A class action lawsuit has been filed in federal court in South Carolina against Duke Energy and the Duke Energy Retirement Cash Balance Plan, alleging violations of Employee Retirement Income Security Act (ERISA) and the Age Discrimination in Employment Act. These allegations arise out of the conversion of the Duke Energy Company Employees Retirement Plan into the Duke Energy Retirement Cash Balance Plan. The case also raises some Plan administration issues, alleging errors in the application of Plan provisions ( e.g. , the calculation of interest rate credits in 1997 and 1998 and the calculation of lump-sum distributions). The plaintiffs seek to represent present and former participants in the Duke Energy Retirement Cash Balance Plan. This group is estimated to include approximately 36,000 persons. The plaintiffs also seek to divide the putative class into sub-classes based on age. Six causes of action are alleged, ranging from age discrimination, to various alleged ERISA violations, to allegations of breach of fiduciary duty. The plaintiffs seek a broad array of remedies, including a retroactive reformation of the Duke Energy Retirement Cash Balance Plan and a recalculation of participants/ beneficiaries benefits under the revised and reformed plan. Duke Energy filed its answer in March 2006. A second class action lawsuit was filed in federal court in South Carolina, alleging similar claims and seeking to represent the same class of defendants. The second case has been voluntarily dismissed, without prejudice, effectively consolidating it with the first case. It is not possible to predict with certainty whether Duke Energy will incur any liability or to estimate the damages, if any, that Duke Energy might incur in connection with this matter.
Hurricane Katrina Lawsuit. In April 2006, Duke Energy and Cinergy were named in the third amended complaint of a purported class action lawsuit filed in the United States District Court for the Southern District of Mississippi. Plaintiffs claim that Duke Energy and Cinergy, along with numerous other utilities, oil companies, coal companies and chemical companies, are liable for damages relating to losses suffered by victims of Hurricane Katrina. Plaintiffs claim that defendants greenhouse gas emissions contributed to the frequency and intensity of storms such as Hurricane Katrina. In October 2006, Duke Energy and Cinergy were served with this lawsuit. It is not possible to predict with certainty whether Duke Energy or Cinergy will incur any liability or to estimate the damages, if any, that Duke Energy or Cinergy might incur in connection with this matter.
Asbestos-related Injuries and Damages Claims. Duke Energy has experienced numerous claims relating to damages for personal injuries alleged to have arisen from the exposure to or use of asbestos in connection with construction and maintenance activities conducted by Duke Energy Carolinas on its electric generation plants during the 1960s and 1970s. Duke Energy has third-party insurance to cover losses related to these asbestos-related injuries and damages above a certain aggregate deductible. The insurance policy, including the policy deductible and reserves, provided for coverage to Duke Energy up to an aggregate of $1.6 billion when purchased in 2000. Probable insurance recoveries related to this policy are classified in the Consolidated Balance Sheets as Other within Investments and Other Assets. Amounts recognized as reserves in the Consolidated Balance Sheets, which are not anticipated to exceed the coverage, are classified in Other Deferred Credits and Other Liabilities and Other Current Liabilities and are based upon Duke Energys best estimate of the probable liability for future asbestos claims. These reserves are based upon current estimates and are subject to uncertainty. Factors such as the frequency and magnitude of future claims could change the current estimates of the related reserves and claims for recoveries reflected in the accompanying Consolidated Financial Statements. However, management of Duke Energy does not currently anticipate that any changes to these estimates will have any material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position.
Duke Energy Indiana and Duke Energy Ohio have been named as defendants or co-defendants in lawsuits related to asbestos at their electric generating stations. Currently, there are approximately 130 pending lawsuits (the majority of which are Duke Energy Indiana cases). In these lawsuits, plaintiffs claim to have been exposed to asbestos-containing products in the course of their work as outside contractors. The plaintiffs further claim that as the property owner of the generating stations, Duke Energy Indiana and Duke Energy Ohio should be held liable for their injuries and illnesses based on an alleged duty to warn and protect them from any asbestos exposure. The impact on Duke Energys financial position, cash flows, or results of operations of these cases to date has not been material.
Of these lawsuits, one case filed against Duke Energy Indiana has been tried to verdict. The jury returned a verdict against Duke Energy Indiana on a negligence claim and a verdict for Duke Energy Indiana on punitive damages. Duke Energy Indiana appealed this
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Notes To Consolidated Financial Statements(Continued)
decision up to the Indiana Supreme Court. In October 2005, the Indiana Supreme Court upheld the jurys verdict. Duke Energy Indiana paid the judgment of approximately $630,000 in the fourth quarter of 2005. In addition, Duke Energy Indiana has settled over 150 other
claims for amounts, which neither individually nor in the aggregate, are material to Duke Energy Indianas financial position or results of operations. Based on estimates under varying assumptions, concerning uncertainties, such as, among others: (i) the number of contractors potentially exposed to asbestos during construction or maintenance of Duke Energy Indiana generating plants; (ii) the possible incidence of various illnesses among exposed workers, and (iii) the potential settlement costs without federal or other legislation that addresses asbestos tort actions, Duke Energy estimates that the range of reasonably possible exposure in existing and future suits over the next 50 years could range from an immaterial amount to approximately $60 million, exclusive of costs to defend these cases. This estimated range of exposure may change as additional settlements occur and claims are made in Indiana and more case law is established.
Duke Energy Ohio has been named in fewer than 10 cases and as a result has virtually no settlement history for asbestos cases. Thus, Duke Energy is not able to reasonably estimate the range of potential loss from current or future lawsuits. However, potential judgments or settlements of existing or future claims could be material to Duke Energy.
Other Litigation and Legal Proceedings. Duke Energy and its subsidiaries are involved in other legal, tax and regulatory proceedings arising in the ordinary course of business, some of which involve substantial amounts. Management believes that the final disposition of these proceedings will not have a material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position.
Duke Energy has exposure to certain legal matters that are described herein. As of September 30, 2006, Duke Energy has recorded reserves of approximately $1.25 billion for these proceedings and exposures. Duke Energy has insurance coverage for certain of these losses incurred. As of September 30, 2006, Duke Energy has recognized approximately $1.0 billion of probable insurance recoveries related to these losses. These reserves represent managements best estimate of probable loss as defined by SFAS No. 5, Accounting for Contingencies.
Duke Energy expenses legal costs related to the defense of loss contingencies as incurred.
Other Commitments and Contingencies
Cinergy produces synthetic fuel from a facility that qualifies for tax credits (through 2007) in accordance with Section 29/45K of the Internal Revenue Code if certain requirements are satisfied. These credits reduce Duke Energys income tax liability and therefore Duke Energys effective tax rate. Cinergys sale of synthetic fuel has generated $339 million in tax credits through December 31, 2005. After reducing for the possibility of phase-outs in 2006, the amount of additional credits generated through September 30, 2006 is immaterial. Section 29/45K provides for a phase-out of the credit if the average price of crude oil during a calendar year exceeds a specified threshold. The phase-out is based on a prescribed calculation and definition of crude oil prices. Based on current crude oil prices, Duke Energy believes that for 2006 and 2007 the amount of the tax credits will be reduced, perhaps significantly. Through September 2006, oil prices were at a level where Duke Energy had idled the plant, as the value of the credits may not have exceeded the net costs to produce the synthetic fuel during that time period. During the first quarter of 2006, an agreement was in place with the plant operator which would indemnify Duke Energy in the event that tax credits are insufficient to support operating expenses. This agreement did not continue in the second and third quarters of 2006. Duke Energys net investment in the plants at September 30, 2006 was approximately $20 million. As a result of the decline in oil prices, the plants began production in October 2006 under a similar indemnification agreement as referenced above.
In August 2006, Duke Energy successfully completed the sale of one of its synthetic fuel facilities resulting in a gain of approximately $6 million. This sale was driven by Internal Revenue Service (IRS) requirements that stipulate that in order to qualify for tax credits in accordance with Section 29/45K, the sales of the synthetic fuel must be made to an unrelated third party.
The IRS has completed the audit of Cinergy for the 2002, 2003, and 2004 tax years including the synthetic fuel facility owned during that period. That facility represents $219 million of tax credits generated during that audit period. The IRS has not proposed any adjustment that would disallow the credits claimed during that period. Subsequent periods are still subject to audit. Duke Energy believes that it operates in conformity with all the necessary requirements to be allowed such credits under Section 29/45K.
Other . As part of its normal business, Duke Energy is a party to various financial guarantees, performance guarantees and other contractual commitments to extend guarantees of credit and other assistance to various subsidiaries, investees and other third parties.
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Notes To Consolidated Financial Statements(Continued)
These arrangements are largely entered into by Duke Capital LLC (Duke Capital). To varying degrees, these guarantees involve elements of performance and credit risk, which are not included on the Consolidated Balance Sheets. The possibility of Duke Energy or Duke Capi
tal having to honor its contingencies is largely dependent upon future operations of various subsidiaries, investees and other third parties, or the occurrence of certain future events. (For further information see Note 18.)
In addition, Duke Energy enters into various fixed-price, non-cancelable commitments to purchase or sell power (tolling arrangements or power purchase contracts), take-or-pay arrangements, transportation or throughput agreements and other contracts that may or may not be recognized on the Consolidated Balance Sheets. Some of these arrangements may be recognized at market value on the Consolidated Balance Sheets as trading contracts or qualifying hedge positions included in Unrealized Gains or Losses on Mark-to-Market and Hedging Transactions. (See Note 18 for discussion of Calpine guarantee obligation).
18. Guarantees and Indemnifications
Duke Energy and its subsidiaries have various financial and performance guarantees and indemnifications which are issued in the normal course of business. As discussed below, these contracts include performance guarantees, stand-by letters of credit, debt guarantees, surety bonds and indemnifications. Duke Energy and its subsidiaries enter into these arrangements to facilitate a commercial transaction with a third party by enhancing the value of the transaction to the third party.
Duke Capital has issued performance guarantees to customers and other third parties that guarantee the payment and performance of other parties, including certain non-wholly-owned entities. The maximum potential amount of future payments Duke Capital could have been required to make under these performance guarantees as of September 30, 2006 was approximately $558 million. Of this amount, approximately $318 million relates to guarantees of the payment and performance of less than wholly-owned consolidated entities. Approximately $352 million of the performance guarantees expire between 2006 and 2007, with the remaining performance guarantees expiring after 2007 or having no contractual expiration. Additionally, Duke Capital has issued joint and several guarantees to some of the D/FD project owners, guaranteeing the performance of D/FD under its engineering, procurement and construction contracts and other contractual commitments. These guarantees have no contractual expiration and no stated maximum amount of future payments that Duke Capital could be required to make. Additionally, Fluor Enterprises Inc., as 50% owner in D/FD, has issued similar joint and several guarantees to the same D/FD project owners. In accordance with the D/FD partnership agreement, each of the partners is responsible for 50% of any payments to be made under those guarantees.
Duke Capital has issued guarantees to customers or other third parties related to the payment or performance obligations of certain entities that were previously wholly-owned by Duke Energy but which have been sold to third parties, such as DukeSolutions, Inc. (DukeSolutions) and Duke Engineering & Services, Inc. (DE&S). These guarantees are primarily related to payment of lease obligations, debt obligations, and performance guarantees related to provision of goods and services. Duke Energy has received back-to-back indemnification from the buyer of DE&S indemnifying Duke Energy for any amounts paid by Duke Capital related to the DE&S guarantees. Duke Energy also received indemnification from the buyer of DukeSolutions for the first $2.5 million paid by Duke Capital related to the DukeSolutions guarantees. Further, Duke Energy granted indemnification to the buyer of DukeSolutions with respect to losses arising under some energy services agreements retained by DukeSolutions after the sale, provided that the buyer agreed to bear 100% of the performance risk and 50% of any other risk up to an aggregate maximum of $2.5 million (less any amounts paid by the buyer under the indemnity discussed above). Additionally, for certain performance guarantees, Duke Energy has recourse to subcontractors involved in providing services to a customer. These guarantees have various terms ranging from 2006 to 2021, with others having no specific term. Duke Energy is unable to estimate the total maximum potential amount of future payments under these guarantees, since some of the underlying agreements have no limits on potential liability.
Cinergy has issued performance guarantees to customers and other third parties that guarantee the payment and performance of certain non-wholly-owned consolidated entities. The maximum potential amount of future payments Cinergy could have been required to make under these performance guarantees as of September 30, 2006 was approximately $113 million. Approximately $101 million of the performance guarantees expire between 2009 and 2019, with the remaining performance guarantees having no contractual expiration.
Westcoast has issued performance guarantees to third parties guaranteeing the performance of unconsolidated entities, such as equity method investments, and of entities previously sold by Westcoast to third parties. Those guarantees require Westcoast to make payment to the guaranteed third party upon the failure of such unconsolidated or sold entity to make payment under some of its contractual obligations, such as debt, purchase contracts and leases. The maximum potential amount of future payments Westcoast could
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Notes To Consolidated Financial Statements(Continued)
have been required to make under those performance guarantees as of September 30, 2006 was approximately $15 million. Of those guarantees, approximately $10 million expire in 2006, with the remainder having no contractual expiration.
Duke Capital and Cinergy use bank-issued stand-by letters of credit to secure the performance of non-wholly-owned entities to a third party or customer. Under these arrangements, Duke Capital or Cinergy has payment obligations to the issuing bank which are triggered by a draw by the third party or customer due to the failure of the non-wholly-owned entity to perform according to the terms of its underlying contract. The maximum potential amount of future payments Duke Capital could have been required to make under these letters of credit as of September 30, 2006 was approximately $50 million. The maximum potential amount of future payments Cinergy could have been required to make under these letters of credit as of September 30, 2006 was approximately $15 million. Substantially all of these letters of credit were issued on behalf of less than wholly-owned consolidated entities and expire in 2006 or 2007.
In connection with Duke Energys sale of the Murray merchant generation facility to KGen Partners LLC (KGEN), in August 2004, Duke Capital guaranteed in favor of a bank the repayment of any draws under a $120 million letter of credit issued by the bank to Georgia Power Company. The letter of credit, which expires in 2006, is related to the obligation of a KGen subsidiary under a seven-year power sales agreement, commencing in May 2005. Duke Capital will be required to ensure reissuance of this letter of credit or issue similar credit support until the power sales agreement expires in 2012. Duke Energy will operate the sold Murray facility under an operation and maintenance agreement with the KGen subsidiary. As a result, the guarantee has an immaterial fair value. Further, KGen has agreed to indemnify Duke Energy for any payments Duke Capital makes with respect to the $120 million letter of credit.
Duke Capital has guaranteed certain issuers of surety bonds, obligating itself to make payment upon the failure of a non-wholly-owned entity to honor its obligations to a third party. As of September 30, 2006, Duke Capital had guaranteed approximately $200 million of outstanding surety bonds related to obligations of non-wholly-owned entities. The majority of these bonds expire in various amounts in 2007.
In 1999, the Industrial Development Corp of the City of Edinburg, Texas (IDC) issued approximately $100 million in bonds to purchase equipment for lease to Duke Hidalgo (Hidalgo), a subsidiary of Duke Capital. Duke Capital unconditionally and irrevocably guaranteed the lease payments of Hidalgo to IDC through 2028. In 2000, Hidalgo was sold to Calpine Corporation and Duke Capital remained obligated under the lease guaranty. In January 2006, Hidalgo and its subsidiaries filed for bankruptcy protection in connection with the previous bankruptcy filing by its parent, Calpine Corporation in December 2005. Gross, undiscounted exposure under the guarantee obligation as of September 30, 2006 is approximately $200 million, which includes principal and interest. Duke Energy does not believe a loss under the guarantee obligation is probable as of September 30, 2006, but continues to evaluate the situation. Therefore, no reserves have been recorded for any contingent loss as of September 30, 2006. No demands for payment of principal or interest have been made under the guarantee. If future losses are incurred under the guarantee, Duke Capital has certain rights which should allow it to mitigate such loss.
Natural Gas Transmission and International Energy have issued guarantees of debt and performance guarantees associated with non-consolidated entities and less than wholly-owned consolidated entities. If such entities were to default on payments or performance, Natural Gas Transmission or International Energy would be required under the guarantees to make payment on the obligation of the less than wholly-owned entity. As of September 30, 2006, Natural Gas Transmission was the guarantor of approximately $18 million of debt at Westcoast associated with less than wholly-owned entities, which expire in 2019. International Energy was the guarantor of approximately $13 million of performance guarantees associated with less than wholly-owned entities. Substantially all of these guarantees expire between 2006 and 2008.
Duke Energy has entered into various indemnification agreements related to purchase and sale agreements and other types of contractual agreements with vendors and other third parties. These agreements typically cover environmental, tax, litigation and other matters, as well as breaches of representations, warranties and covenants. Typically, claims may be made by third parties for various periods of time, depending on the nature of the claim. Duke Energys potential exposure under these indemnification agreements can range from a specified amount, such as the purchase price, to an unlimited dollar amount, depending on the nature of the claim and the particular transaction. Duke Energy is unable to estimate the total potential amount of future payments under these indemnification agreements due to several factors, such as the unlimited exposure under certain guarantees.
As of September 30, 2006, the amounts recorded for the guarantees and indemnifications mentioned above are immaterial, both individually and in the aggregate.
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Notes To Consolidated Financial Statements(Continued)
In June 2006, the Board of Directors of Duke Energy authorized management to pursue a plan to create two separate publicly traded companies by spinning off Duke Energys natural gas businesses to Duke Energy shareholders. The new gas company, which would be named Spectra Energy, would consist of Duke Energys Natural Gas Transmission businesses segment, which would include Union Gas, and would also include Duke Energys 50-percent ownership interest in DEFS. The businesses remaining in Duke Energy will be the U.S. Franchised Electric and Gas business segment, the Commercial Power business segment, the International business segment and Duke Energys 50-percent interest in the Crescent JV. While the actual timing of the spin-off, if it occurs, is dependent upon the resolution of certain regulatory and other matters, Duke Energy is currently targeting a January 1, 2007 effective date for the transaction. At September 30, 2006, Duke Energy has certain guarantees of wholly-owned subsidiaries that it expects will become guarantees of third party performance upon the separation of the gas and power businesses. Duke Energy expects to receive back-to-back indemnification from the new gas company indemnifying Duke Energy for any amounts paid related to these guarantees.
19. Related Party Transactions
As discussed in Note 2, in September 2006, Duke Energy deconsolidated its investment in Crescent JV as a result of a reduction in ownership and subsequently has accounted for the investment using the equity method of accounting. Duke Energys investment in Crescent JV as of September 30, 2006 was approximately $163 million. Equity earnings for the period from the date of deconsolidated (September 7, 2006) through September 30, 2006 were immaterial. Summary balance sheet information for Crescent, which is accounted for under the equity method, as of September 30, 2006 is as follows:
September 30,
2006 |
|||
(in millions) | |||
Current assets |
$ | 215 | |
Non-current assets |
$ | 1,587 | |
Current liabilities |
$ | 169 | |
Non-current liabilities |
$ | 1,344 | |
Minority interest |
$ | 30 |
Additionally, as discussed in Note 2, in February 2005, DEFS sold its wholly-owned subsidiary TEPPCO GP, the general partner of TEPPCO Partners, L.P. (TEPPCO), for approximately $1.1 billion and Duke Energy sold its limited partner interest in TEPPCO for approximately $100 million. Prior to the completion of these sale transactions, Duke Energy accounted for its investment in TEPPCO under the equity method of accounting. For the three months ended March 31, 2005, TEPPCO had operating revenues of approximately $1,524 million, operating expenses of approximately $1,463 million, operating income of approximately $61 million, income from continuing operations of approximately $46 million, and net income of approximately $47 million.
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Notes To Consolidated Financial Statements(Continued)
In July 2005, Duke Energy completed the transfer of a 19.7% interest in DEFS to ConocoPhillips, Duke Energys co-equity owner in DEFS, which reduced Duke Energys ownership interest in DEFS from 69.7% to 50% and resulted in Duke Energy and ConocoPhillips becoming equal 50% owners of DEFS. As a result of this transaction, Duke Energy deconsolidated its investment in DEFS and subsequently has accounted for the investment using the equity method of accounting (see Note 2). Duke Energys 50% of equity in earnings of DEFS for the three and nine months ended September 30, 2006 was approximately $159 million and $454 million, respectively, and Duke Energys investment in DEFS as of September 30, 2006 was $1,351 million, which is included in Investments in Unconsolidated Affiliates in the accompanying Consolidated Balance Sheets. Duke Energys 50% of equity in earnings of DEFS for the three months ended September 30, 2005 was approximately $126 million. During the three months ended September 30, 2006, Duke Energy had gas sales to and other operating expenses from affiliates of DEFS of approximately $40 million and $3 million, respectively. During the nine months ended September 30, 2006, Duke Energy had gas sales to, purchases from, and other operating expenses from affiliates of DEFS of approximately $110 million, $36 million and $24 million, respectively. During the three months ended September 30, 2005, Duke Energy had gas sales to and purchases from affiliates of approximately $28 million and $30 million, respectively. As of September 30, 2006, Duke Energy had payables to affiliates of DEFS of approximately $58 million. Additionally, Duke Energy received approximately $385 million in distributions of earnings from DEFS in the nine months ended September 30, 2006, which are included in Other, assets within Cash Flows from Operating Activities in the accompanying Consolidated Statements of Cash Flows. Duke Energy has recognized an approximate $98 million receivable as of September 30, 2006 due to its share of a distribution declared by DEFS in September 2006 but paid in October 2006. Summary financial information for DEFS, which is accounted for under the equity method, as of and for the three and nine months ended September 30, 2006 is as follows:
Three months Ended September 30, 2006 |
Three months Ended September 30, 2005 |
Nine months Ended September 30, 2006 |
|||||||
(in millions) | |||||||||
Operating revenues |
$ | 3,190 | $ | 3,386 | $ | 9,501 | |||
Operating expenses |
$ | 2,841 | $ | 3,105 | $ | 8,492 | |||
Operating income |
$ | 349 | $ | 281 | $ | 1,009 | |||
Net income |
$ | 318 | $ | 252 | $ | 908 |
September 30, 2006 |
|||
(in millions) | |||
Current assets |
$ | 2,524 | |
Non-current assets |
$ | 4,759 | |
Current liabilities |
$ | 2,515 | |
Non-current liabilities |
$ | 2,028 | |
Minority interest |
$ | 102 |
DEFS is a limited liability company which is a pass-through entity for U.S. income tax purposes. DEFS also owns corporations who file their own respective, federal, foreign and state income tax returns and income tax expense related to these corporations is included in the income tax expense of DEFS. Therefore, DEFS net income does not include income taxes for earnings which are pass-through to the members based upon their ownership percentage and Duke Energy recognizes the tax impacts of its share of DEFS pass-through earnings in its income tax expense from continuing operations in the accompanying Consolidated Statements of Operations.
In December 2005, Duke Energy completed a 140 million Canadian dollars initial public offering on its Canadian income trust fund, the Income Fund and sold 14 million Trust Units at an offering price of 10 Canadian dollars per Trust Unit. In January 2006, a subsequent greenshoe sale of 1.4 million additional Trust Units, pursuant to an overallotment option, were sold at a price of 10 Canadian dollars per Trust Unit. Subsequent to the January 2006 sale of additional Trust Units, Duke Energy held an approximate 58% ownership interest in the Income Fund. Proceeds of approximately 14 million Canadian dollars are included in Proceeds from Duke Energy Income Fund within Cash Flows from Financing Activities in the Consolidated Statements of Cash Flows. In September 2006, the Income Fund sold approximately 9 million previously unissued Trust Units at a price of 12.15 Canadian dollars per Trust Unit for total proceeds of 104 million Canadian dollars, net of commissions and expenses of other expenses of issuance, which is included in Proceeds from Duke Energy Income Fund within Cash Flows from Financing Activities in the Consolidated Statements of Cash Flows. The sale of approximately 9 million Trust Units reduced Duke Energys ownership interest in the Income Fund to approximately 46% at September 30, 2006. As a result of the sale of additional Trust Units, Duke Energy recognized an approximate $15 million U.S. Dollar pre-tax SAB No. 51 gain on the sale of subsidiary stock, which is classified in Gain on Sale of Subsidiary Stock on the Consolidated Statements of Operations. The pro -
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DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
ceeds from the offering plus the draw down of approximately 39 million Canadian dollars on an available credit facility were used by the Income Fund to acquire a 100% interest in Westcoast Gas Services, Inc. There were no deferred taxes recorded as a result of this transaction.
Also see Notes 2, 12, 14 and 18 for additional related party information.
20. New Accounting Standards
The following new accounting standards were adopted by Duke Energy subsequent to September 30, 2005 and the impact of such adoption, if applicable, has been presented in the accompanying Consolidated Financial Statements:
Statement of Financial Accounting Standards (SFAS) No. 123(R) Share-Based Payment (SFAS No. 123(R). In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. For Duke Energy, timing for implementation of SFAS No. 123(R) was January 1, 2006. The pro forma disclosures previously permitted under SFAS No. 123 are no longer an acceptable alternative. Instead, Duke Energy is required to determine an appropriate expense for stock options and record compensation expense in the Consolidated Statements of Operations for stock options. Duke Energy implemented SFAS No. 123(R) using the modified prospective transition method, which required Duke Energy to record compensation expense for all unvested awards beginning January 1, 2006.
Duke Energy currently also has retirement eligible employees with outstanding share-based payment awards (unvested stock awards, stock based performance awards and phantom stock awards). Compensation cost related to those awards was previously expensed over the stated vesting period or until actual retirement occurred. Effective January 1, 2006, Duke Energy is required to recognize compensation cost for new awards granted to employees over the requisite service period, which generally begins on the date the award is granted through the earlier of the date the award vests or the date the employee becomes retirement eligible. Awards, including stock options, granted to employees that are already retirement eligible are deemed to have vested immediately upon issuance, and therefore, compensation cost for those awards is recognized on the date such awards are granted.
The adoption of SFAS No. 123(R) did not have a material impact on Duke Energys consolidated results of operations, cash flows or financial position in 2006 based on awards outstanding as of the implementation date. However, the impact to Duke Energy in periods subsequent to adoption of SFAS No. 123(R) will be largely dependent upon the nature of any new share-based compensation awards issued to employees. (See Note 5.)
SFAS No. 153, Exchanges of Nonmonetary Assetsan amendment of APB Opinion No. 29 (SFAS No. 153). In December 2004, the FASB issued SFAS No. 153 which amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, by eliminating the exception to the fair-value principle for exchanges of similar productive assets, which were accounted for under APB Opinion No. 29 based on the book value of the asset surrendered with no gain or loss recognition. SFAS No. 153 also eliminates APB Opinion No. 29s concept of culmination of an earnings process. The amendment requires that an exchange of nonmonetary assets be accounted for at fair value if the exchange has commercial substance and fair value is determinable within reasonable limits. Commercial substance is assessed by comparing the entitys expected cash flows immediately before and after the exchange. If the difference is significant, the transaction is considered to have commercial substance and should be recognized at fair value. SFAS No. 153 is effective for nonmonetary transactions occurring on or after July 1, 2005. The adoption of SFAS No. 153 did not have a material impact on Duke Energys consolidated results of operations, cash flows or financial position.
Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment (SAB No. 107). On March 29, 2005, the Securities and Exchange Commission (SEC) staff issued SAB No. 107 to express the views of the staff regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations and to provide the staffs views regarding the valuation of share-based payment arrangements for public companies. Duke Energy adopted SFAS No. 123(R) and SAB No. 107 effective January 1, 2006.
FASB Interpretation (FIN) No. 47 Accounting for Conditional Asset Retirement Obligations (FIN No. 47). In March 2005, the FASB issued FIN No. 47, which clarifies the accounting for conditional asset retirement obligations as used in SFAS No. 143, Accounting for Asset Retirement Obligations, (SFAS No. 143). A conditional asset retirement obligation is an unconditional 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. Therefore, an entity is required to recognize a liability for the fair value of a conditional asset retirement obliga -
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DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
tion under SFAS No. 143 if the fair value of the liability can be reasonably estimated. The provisions of FIN No. 47
were effective for Duke Energy as of December 31, 2005, and resulted in an increase in assets of $31 million, an increase in liabilities of $35 million and a net-of-tax cumulative effect adjustment to earnings of approximately $4 million.
FASB Staff Position (FSP) No. APB 18-1, Accounting by an Investor for Its Proportionate Share of Accumulated Other Comprehensive Income of an Investee Accounted for under the Equity Method in Accordance with APB Opinion No. 18 upon a Loss of Significant Influence (FSP No. APB 18-1). In July 2005, the FASB staff issued FSP No. APB 18-1 which provides guidance for how an investor should account for its proportionate share of an investees equity adjustments for other comprehensive income (OCI) upon a loss of significant influence. APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB Opinion No. 18), requires a transaction of an equity method investee of a capital nature be accounted for as if the investee were a consolidated subsidiary, which requires the investor to record its proportionate share of the investees adjustments for OCI as increases or decreases to the investment account with corresponding adjustments in equity. FSP No. APB 18-1 requires that an investors proportionate share of an investees equity adjustments for OCI should be offset against the carrying value of the investment at the time significant influence is lost and equity method accounting is no longer appropriate. However, to the extent that the offset results in a carrying value of the investment that is less than zero, an investor should (a) reduce the carrying value of the investment to zero and (b) record the remaining balance in income. The guidance in FSP No. APB 18-1 was effective for Duke Energy beginning October 1, 2005. The adoption of FSP No. APB 18-1 did not have a material impact on Duke Energys consolidated results of operations, cash flows or financial position.
FSP No. FAS 123(R)-4, Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event (FSP No. FAS 123(R)-4). In February 2006, the FASB staff issued FSP FAS No. 123(R)-4 to address the classification of options and similar instruments issued as employee compensation that allow for cash settlement upon the occurrence of a contingent event. The guidance amends SFAS No. 123(R). FSP No. FAS 123(R)-4 provides that cash settlement features that can be exercised only upon the occurrence of a contingent event that is outside the employees control does not require classifying the option or similar instrument as a liability until it becomes probable that the event will occur. FSP No. FAS 123(R)-4 applies only to options or similar instruments issued as part of employee compensation arrangements. The guidance in FSP No. FAS 123(R)-4 was effective for Duke Energy as of April 1, 2006. Duke Energy adopted SFAS No. 123(R) as of January 1, 2006 (see Note 5). The adoption of FSP No. FAS 123(R)-4 did not have a material impact on Duke Energys consolidated statement of operations, cash flows or financial position.
FSP No. FAS 115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (FSP No. FAS 115-1 and 124-1). The FASB issued FSP No. FAS 115-1 and 124-1 in November 2005, which was effective for Duke Energy beginning January 1, 2006. This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18 . The adoption of FSP No. FAS 115-1 and 124-1 did not have a material impact on Duke Energys consolidated results of operations, cash flows or financial position.
FSP No. FIN 46(R)-6, Determining the Variability to Be Considered In Applying FASB Interpretation No. 46(R) (FSP No. FIN 46(R)-6). In April 2006, the FASB staff issued FSP No. FIN 46(R)-6 to address how to determine the variability to be considered in applying FIN 46(R), Consolidation of Variable Interest Entities. The variability that is considered in applying FIN 46(R) affects the determination of whether the entity is a variable interest entity (VIE), which interests are variable interests in the entity, and which party, if any, is the primary beneficiary of the VIE. The variability affects the calculation of expected losses and expected residual returns. This guidance is effective for all entities with which Duke Energy first becomes involved or existing entities for which a reconsideration event occurs after July 1, 2006. The adoption of FSP No. FIN 46 (R)-6 did not have a material impact on Duke Energys consolidated results of operations, cash flows or financial position.
EITF Issue No. 05-1, Accounting for the Conversion of an Instrument that Becomes Convertible Upon the Issuers Exercise of a Call Option (EITF No. 05-1). In June 2006, the EITF reached a consensus on EITF No. 05-1. The consensus requires that the issuance of equity securities to settle a debt instrument (pursuant to the instruments original conversion terms) that became convertible upon the issuers exercise of a call option be accounted for as a conversion if the debt instrument contained a substantive conversion feature as of its issuance date. If the debt instrument did not contain a substantive conversion option as of its issuance date, the issuance of equity
52
PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
securities to settle the debt instrument should be accounted for as a debt extinguishment. The consensus was effective for Duke Energy
for all conversions within its scope that resulted from the exercise of call options beginning July 1, 2006. The adoption of EITF No. 05-1 did not have a material impact on Duke Energys consolidated results of operations, cash flows or financial position.
The following new accounting standards have been issued, but have not yet been adopted by Duke Energy as of September 30, 2006:
SFAS No. 155, Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and 140 (SFAS No. 155). In February 2006, the FASB issued SFAS No. 155, which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for at fair value at acquisition, at issuance, or when a previously recognized financial instrument is subject to a remeasurement (new basis) event, on an instrument-by-instrument basis, in cases in which a derivative would otherwise have to be bifurcated. SFAS No. 155 is effective for Duke Energy for all financial instruments acquired, issued, or subject to remeasurement after January 1, 2007, and for certain hybrid financial instruments that have been bifurcated prior to the effective date, for which the effect is to be reported as a cumulative-effect adjustment to beginning retained earnings. Duke Energy does not anticipate the adoption of SFAS No. 155 will have any material impact on its consolidated results of operations, cash flows or financial position.
SFAS No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement No. 140 (SFAS No. 156). In March 2006, the FASB issued SFAS No. 156, which amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 156 requires recognition of a servicing asset or liability when an entity enters into arrangements to service financial instruments in certain situations. Such servicing assets or servicing liabilities are required to be initially measured at fair value, if practicable. SFAS No. 156 also allows an entity to subsequently measure its servicing assets or servicing liabilities using either an amortization method or a fair value method. SFAS No. 156 is effective for Duke Energy as of January 1, 2007, and must be applied prospectively, except that where an entity elects to remeasure separately recognized existing arrangements and reclassify certain available-for-sale securities to trading securities, any effects must be reported as a cumulative-effect adjustment to retained earnings. Duke Energy does not anticipate the adoption of SFAS No. 156 will have any material impact on its consolidated results of operations, cash flows or financial position.
SFAS No. 157, Fair Value Measurements (SFAS No. 157). In September 2006, the FASB issued SFAS No. 157, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. However, in some cases, the application of SFAS No. 157 may change Duke Energys current practice for measuring and disclosing fair values under other accounting pronouncements that require or permit fair value measurements. For Duke Energy, SFAS No. 157 is effective as of January 1, 2008 and must be applied prospectively except in certain cases. Duke Energy is currently evaluating the impact of adopting SFAS No. 157, and cannot currently estimate the impact of SFAS No. 157 on its consolidated results of operations, cash flows or financial position.
SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment to of FASB Statements No. 87, 88, 106, and 132(R) (SFAS No. 158) . In October 2006, the FASB issued SFAS No. 158, which changes the recognition and disclosure provisions and measurement date requirements for an employers accounting for defined benefit pension and other postretirement plans. The recognition and disclosure provisions require an employer to (1) recognize the funded status of a benefit planmeasured as the difference between plan assets at fair value and the benefit obligationin its statement of financial position, (2) recognize as a component of OCI, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost, and (3) disclose in the notes to financial statements certain additional information. SFAS No. 158 does not change the amounts recognized in the income statement as net periodic benefit cost. Duke Energy is required to initially recognize the funded status of its defined benefit pension and other postretirement plans and to provide the required additional disclosures as of December 31, 2006. Retrospective application is not permitted. Duke Energy anticipates that adoption of SFAS No. 158 recognition and disclosure provisions will result in a decrease in total assets of approximately $175 million, an increase in total liabilities of approximately $418 million and a decrease in accumulated other comprehensive income, net of tax, of approximately $593 million as of December 31, 2006. Duke Energy does not anticipate the adoption of SFAS No. 158 will have any material impact on its consolidated results of operations or cash flows.
Under the measurement date requirements of SFAS No. 158, an employer is required to measure defined benefit plan assets and obligations as of the date of the employers fiscal year-end statement of financial position (with limited exceptions). Historically, Duke
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DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
Energy has measured its plan assets and obligations up to three months prior to the fiscal year-end, as allowed under the authoritative accounting literature. The measurement date requirement is effective for the year ending December 31, 2008, and early application is encouraged. Duke Energy intends to adopt the change in measurement date effective January 1, 2007 by remeasuring plan assets and benefit obligations as of that date, pursuant to the transition requirements of SFAS No. 158. Net periodic benefit cost for the three-month period between September 30, 2006 and December 31, 2006 will be recognized, net of tax, as a separate adjustment of retained earnings as of January 1, 2007, except for any gain or loss arising from curtailments or settlement, if any, during that three-month period, which would be recognized in earnings in 2006. Additionally, changes in plan assets and plan obligations between September 30, 2006 and December 31, 2006 not related to net periodic benefit cost will be recognized, net of tax, as an adjustment to OCI.
SAB No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (SAB No. 108) . In September 2006 the SEC issued SAB No. 108, which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. Traditionally, there have been two widely-recognized approaches for quantifying the effects of financial statement misstatements. The income statement approach focuses primarily on the impact of a misstatement on the income statementincluding the reversing effect of prior year misstatementsbut its use can lead to the accumulation of misstatements in the balance sheet. The balance sheet approach, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach (a dual approach) and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material.
SAB No. 108 is effective for Duke Energys year ending December 31, 2006. SAB No. 108 permits existing public companies to initially apply its provisions either by (i) restating prior financial statements as if the dual approach had always been used or (ii), under certain circumstances, recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. Duke Energy currently uses a dual approach for quantifying identified financial statement misstatements. Therefore, Duke Energy does not anticipate the adoption of SAB No. 108 will have any material impact on its consolidated results of operations, cash flows or financial position.
FIN No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN No. 48) . On July 13, 2006, the FASB issued FIN No. 48, which interprets SFAS No. 109, Accounting for Income Taxes. FIN No. 48 provides guidance for the recognition, measurement, classification and disclosure of the financial statement effects of a position taken or expected to be taken in a tax return (tax position). The financial statement effects of a tax position must be recognized when there is a likelihood of more than 50 percent that based on the technical merits, the position will be sustained upon examination and resolution of the related appeals or litigation processes, if any. A tax position that meets the recognition threshold must be measured initially and subsequently as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority. The Interpretation is effective for Duke Energy as of January 1, 2007. Duke Energy is currently evaluating the impact of adopting FIN No. 48, and cannot currently estimate the impact of FIN No. 48 on its consolidated results of operations, cash flows or financial position.
FSP No. FAS 123(R)-5, Amendment of FASB Staff Position FAS 123(R)-1 (FSP No. FAS 123(R)-5) . In October 2006, the FASB staff issued FSP No. FAS 123(R)-5 to address whether a modification of an instrument in connection with an equity restructuring should be considered a modification for purposes of applying FSP No. FAS 123(R)-1, Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R) (FSP No. FAS 123(R)-1). In August 2005, the FASB staff issued FSP FAS 123(R)-1 to defer indefinitely the effective date of paragraphs A230A232 of SFAS No. 123(R), and thereby require entities to apply the recognition and measurement provisions of SFAS No. 123(R) throughout the life of an instrument, unless the instrument is modified when the holder is no longer an employee. The recognition and measurement of an instrument that is modified when the holder is no longer an employee should be determined by other applicable generally accepted accounting principles. FSP No. FAS 123(R)-5 addresses modifications of stock-based awards made in connection with an equity restructuring and clarifies that for instruments that were originally issued as employee compensation and then modified, and that modification is made to the terms of the instrument solely to reflect an equity restructuring that occurs when the holders are no longer employees, no change in the recognition or the measurement (due to a change in classification) of those instruments will result if certain conditions are met. This FSP is effective for Duke Energy as of January 1, 2007. Duke Energy is currently evaluating the impact of adopting FSP No. FAS 123(R)-5 and cannot currently estimate the impact of adopting FAS 123(R)-5 on its consolidated results of operations, cash flows or financial position.
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PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
FSP No. AUG AIR-1, Accounting for Planned Major Maintenance Activities, (FSP No. AUG AIR-1). In September 2006, the FASB Staff issued FSP No. AUG AIR-1. This FSP prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods, if no liability is required to be recorded for an asset retirement obligation based on a legal obligation for which the event obligating the entity has occurred. The FSP also requires disclosures regarding the method of accounting for planned major maintenance activities and the effects of implementing the FSP. The guidance in this FSP is effective for Duke Energy as of January 1, 2007 and will be applied retrospectively for all financial statements presented. Duke Energy does not anticipate the adoption of FSP No. AUG-AIR-1 will have any material impact on its consolidated results of operations, cash flows or financial position.
EITF Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation) (EITF No. 06-3) . In June 2006, the EITF reached a consensus on EITF No. 06-3 to address any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales, use, value added, and some excise taxes. For taxes within the issues scope, the consensus requires that entities present such taxes on either a gross (i.e. included in revenues and costs) or net (i.e. exclude from revenues) basis according to their accounting policies, which should be disclosed. If such taxes are reported gross and are significant, entities should disclose the amounts of those taxes. Disclosures may be made on an aggregate basis. The consensus is effective for Duke Energy beginning January 1, 2007. Duke Energy does not anticipate the adoption of EITF No. 06-3 will have any material impact on its consolidated results of operations, cash flows or financial position.
EITF Issue No. 06-5, Accounting for Purchases of Life InsuranceDetermining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (EITF No. 06-5) . In June 2006, the EITF reached a consensus on the accounting for corporate-owned and bank-owned life insurance policies. EITF No. 06-5 requires that a policyholder consider the cash surrender value and any additional amounts to be received under the contractual terms of the policy in determining the amount that could be realized under the insurance contract. Amounts that are recoverable by the policyholder at the discretion of the insurance company must be excluded from the amount that could be realized. Fixed amounts that are recoverable by the policyholder in future periods in excess of one year from the surrender of the policy must be recognized at their present value. EITF No. 06-5 is effective for Duke Energy as of January 1, 2007 and must be applied as a change in accounting principle through a cumulative-effect adjustment to retained earnings or other components of equity as of January 1, 2007. Duke Energy is currently evaluating the impact of adopting EITF No. 06-5, and cannot currently estimate the impact of EITF No. 06-5 on its consolidated results of operations, cash flows or financial position.
21. Income Tax Expense
Although the outcome of tax audits is uncertain, management believes that adequate provisions for income and other taxes, such as sales and use, franchise, and property, have been made for potential liabilities resulting from such matters. As of September 30, 2006, Duke Energy has total provisions of approximately $235 million for uncertain tax positions, as compared to approximately $150 million as of December 31, 2005, including interest. The increase in total provisions from year end is primarily attributable to the merger with Cinergy. Duke Energy is also negotiating for Federal Income Tax refunds, including interest, that are not reflected in the financial statements. Management is not aware of any issues for open tax years that upon final resolution are expected to have a material adverse effect on Duke Energys consolidated results of operations, cash flows or financial position.
The effective tax rate for the three months ended September 30, 2006 was approximately 37.1% as compared to the effective tax rate of 34.5% for the same period in 2005. The increase in the effective tax rate is primarily due to an increase in state taxes as a result of setting up an additional tax reserve attributed to the sale of interest in Crescent. The effective tax rate for the nine months ended September 30, 2006 was approximately 34.3% as compared to the effective tax rate of 34.1% for the same period in 2005. The increase in the effective tax rate was primarily attributable to the increase in state taxes as a result of setting up an additional tax reserve attributed to the sale of interest in Crescent, offset by the reduction in state deferred tax liabilities related to the merger with Cinergy.
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PART I
DUKE ENERGY CORPORATION
Notes To Consolidated Financial Statements(Continued)
22. Comprehensive Income and Accumulated Other Comprehensive Income
Comprehensive Income . Comprehensive income includes net income and all other non-owner changes in equity. Components of other comprehensive income and accumulated other comprehensive income for the nine months ended September 30, 2006 and 2005 are presented in the Consolidated Statements of Common Stockholders Equity.
Total Comprehensive Income (Loss) | ||||||||
Three Months
September 30, |
||||||||
2006
|
2005
|
|||||||
(in millions) | ||||||||
Net Income |
$ | 763 | $ | 41 | ||||
|
|
|
|
|
|
|||
Other comprehensive income |
||||||||
Foreign currency translation adjustments |
(17 | ) | 309 | |||||
Net unrealized gains on cash flow hedges a |
9 | 165 | ||||||
Reclassification into earnings from cash flow hedges b |
8 | (878 | ) | |||||
Other |
3 | | ||||||
|
|
|
|
|
|
|||
Other comprehensive income (loss), net of tax |
3 | (404 | ) | |||||
|
|
|
|
|
|
|||
Total Comprehensive Income (Loss) |
$ | 766 | $ | (363 | ) | |||
|
|
|
|
|
|
a | Net unrealized gains on cash flow hedges, net of $4 million and $107 million tax expense for the three months ended September 30, 2006 and 2005, respectively. |
b | Reclassification into earnings from cash flow hedges, net of $4 million tax expense and $502 million tax benefit for the three months ended September 30, 2006 and 2005, respectively. Reclassification into earnings from cash flow hedges for the three months ended September 30, 2005, is primarily due to the recognition of Duke Energy North Americas (DENAs) unrealized net gains on related to hedges on forecasted future transactions that will no longer occur as a result of the sale to LS Power of substantially all of DENAs assets and contracts outside of the Midwestern United States and certain contractual positions related to the Midwestern assets (see Notes 13 and 15). |
23. Subsequent Events
For information on subsequent events related to acquisitions and dispositions, common stock, debt and credit facilities, severance, discontinued operations and assets held for sale, risk management instruments, regulatory matters, commitments and contingencies and related party transactions, see Notes 2, 4, 7, 11, 13, 15, 16 and 17 and 19, respectively.
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PART I
Item 2. Managements Discussion and Analysis of Results of Operations and Financial Condition.
INTRODUCTION
Managements Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements.
Duke Energy Holding Corp. (Duke Energy HC) was incorporated in Delaware on May 3, 2005 as Deer Holding Corp., a wholly-owned subsidiary of Duke Energy Corporation (Old Duke Energy). On April 3, 2006, in accordance with their previously announced merger agreement, Old Duke Energy and Cinergy Corp. (Cinergy) merged into wholly-owned subsidiaries of Duke Energy HC, resulting in Duke Energy HC becoming the parent entity. In connection with the closing of the merger transactions, Duke Energy HC changed its name to Duke Energy Corporation (New Duke Energy or Duke Energy) and Old Duke Energy converted into a limited liability company named Duke Power Company LLC (subsequently renamed Duke Energy Carolinas, LLC effective October 1, 2006). As a result of the merger transactions, each outstanding share of Cinergy common stock was converted into 1.56 shares of common stock of Duke Energy, which resulted in the issuance of approximately 313 million shares. Additionally, each share of common stock of Old Duke Energy was converted into one share of Duke Energy common stock. Old Duke Energy is the predecessor of Duke Energy for purposes of U.S. securities regulations governing financial statement filing. Therefore, the accompanying Consolidated Financial Statements reflect the results of operations of Old Duke Energy for the three months ended March 31, 2006 and the three and nine months ended September 30, 2005 and the financial position of Old Duke Energy as of December 31, 2005. New Duke Energy had separate operations for the period beginning with the quarter ended June 30, 2006, and references to amounts for periods after the closing of the merger relate to New Duke Energy. Cinergys results have been included in the accompanying Consolidated Statements of Operations from the date of acquisition and thereafter.
Executive Overview
In 2006, management of Duke Energy established a goal to achieve a business model that would give both Duke Energys electric and gas businesses stand-alone strength and additional scope and scale along with steady and stable earnings growth. So far in 2006, management has executed this strategy primarily through strategically completed and pending acquisitions, as well as dispositions of certain businesses with higher risk profiles, such as the Duke Energy North America (DENA) operations outside the Midwest and the Cinergy commercial marketing and trading businesses.
On April 3, 2006, Duke Energy and Cinergy consummated the previously announced merger, which combined the Duke Energy and Cinergy regulated franchises as well as deregulated generation in the Midwestern United States. The merger with Cinergy increased the size and scope of Duke Energys electric utility operations. Duke Energy management expects to achieve numerous synergies, both immediately and over time, in all regions impacted by the merger.
In line with giving the electric utility operations more scope and scale, Duke Energy has announced an agreement with Southern Company to evaluate the potential construction of a new nuclear power plant at a site jointly owned in Cherokee County, South Carolina. Additionally, Duke Energy continues to evaluate other opportunities to re-invest in the electric utility operations, by modernizing and expanding older coal-fired plants in the Carolinas and exploring the replacement of an aging coal plant in Indiana with a coal gasification plant. Duke Energy has also announced an agreement to acquire from Dynegy an approximate 825 megawatt power plant located in Rockingham County, North Carolina. The transaction is anticipated to close in the fourth quarter of 2006. This peaking plant, which will primarily be used during times of high electricity demand, generally in the winter and summer months, will provide customers with competitively priced peaking capacity and helps to ensure Duke Energy can meet growing customer demands for electricity in the foreseeable future.
As a result of the additional size and scope of the electric utility operations discussed above, in June 2006, the Board of Directors of Duke Energy authorized management to pursue a plan to create two separate publicly traded companies by spinning off Duke Energys natural gas businesses to Duke Energy shareholders. The new natural gas company, which would be named Spectra Energy, would principally consist of Duke Energys Natural Gas Transmission business segment, which would include Union Gas, and would also include Duke Energys 50-percent ownership interest in Duke Energy Field Services, LLC (DEFS). If completed, the spin off of the natural gas business is expected to deliver long-term value to shareholders as the two stand-alone companies would be able to more easily participate in growth opportunities in their own industries as well as the gas and power industry consolidations. It is anticipated that approximately $9 billion of debt currently at Duke Capital LLC (Duke Capital) and its consolidated subsidiaries would transfer to the new natural gas company at the time of the spin-off. While the actual timing of the spin-off, if it occurs, is dependent upon the resolution of certain regulatory and other matters, Duke Energy is currently targeting a January 1, 2007 effective date for the transaction. The results of the natural gas businesses are expected to be treated as discontinued operations in the period the spin-off is consummated.
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The primary businesses remaining in Duke Energy post-spin are anticipated to be principally the U.S. Franchised Electric and Gas business segment, the Commercial Power business segment, the International Energy business segment and Duke Energys 50% interest in the Crescent JV.
In connection with the effort to reduce the risk profile of Duke Energy and to focus on businesses that can be expected to contribute steady, stable earnings growth, during 2006 Duke Energy has finalized the sale of the former DENA power generation fleet outside of the Midwest to LS Power Equity Partners (LS Power) and agreed to sell the Cinergy commercial marketing and trading business to Fortis, a Benelux-based financial services group (Fortis). The sale to Fortis closed in October 2006 and resulted in Duke Energy receiving approximately $700 million of pre-tax proceeds.
Additionally, the Board of Directors of Duke Energy authorized management to explore the potential value of bringing in a joint venture partner at Crescent to expand the business and create a platform for increased growth. On September 7, 2006, an indirect wholly owned subsidiary of Duke Energy closed an agreement to create a joint venture of Crescent (the Crescent JV) with Morgan Stanley Real Estate Fund V U.S., L.P. (MSREF) and other affiliated funds controlled by Morgan Stanley (collectively the MS Members). Under the agreement, the Duke Energy subsidiary contributed all of the membership interests in Crescent to a newly-formed joint venture, which was ascribed an enterprise value of approximately $2.1 billion as of December 31, 2005. In conjunction with the formation of the Crescent JV, the joint venture, Crescent and Crescents subsidiaries entered into a credit agreement with third party lenders under which Crescent borrowed approximately $1.23 billion, of which approximately $1.19 billion was immediately distributed to Duke Energy and has been classified as a financing activity in the accompanying Consolidated Statement of Cash Flows for the nine months ended September 30, 2006. Immediately following the debt transaction, the MS Members collectively acquired a 49% membership interest in the Crescent JV from Duke Energy for a purchase price of approximately $415 million. The MS Members 49% interest reflects a 2% interest in the Crescent JV issued by the joint venture to the President and Chief Executive Officer of Crescent which is subject to forfeiture if the executive voluntarily leaves the employment of the Crescent JV within a three year period. Additionally, this interest can be put back to the Crescent JV after three years or possibly earlier upon the occurrence of certain events at 2% of the fair value of the Crescent JVs equity as of the put date. Therefore, the Crescent JV will accrue the obligation related to the put as a liability over the three year forfeiture period. Accordingly, Duke Energy has an effective 50% ownership in the equity of the Crescent JV for financial reporting purposes. In conjunction with this transaction, Duke Energy recognized a pre-tax gain of approximately $250 million on the sale. As a result of the Crescent transaction, Duke Energy no longer controls the Crescent JV and on September 7, 2006 deconsolidated its investment in Crescent and subsequently will account for its investment in the Crescent JV utilizing the equity method of accounting.
Proceeds from the sales of the commercial marketing and trading business and Crescent are anticipated to be used to reduce commercial paper outstanding at Cinergy and to partially fund capital expenditure requirements for Duke Energy over the near-term.
Effective with the third quarter 2006, the Board of Directors of Duke Energy has approved a quarterly dividend increase of $0.01 per share, increasing the annual dividend to $1.28 per share. Additionally, during 2006 Duke Energy has repurchased approximately 17.5 million shares of its common stock for approximately $500 million. In connection with the above mentioned plan to spin off Duke Energys natural gas business to Duke Energy shareholders, the share repurchase program has been suspended. In October 2006, Duke Energys Board of Directors authorized the reactivation of the share repurchase plan for Duke Energy of up to $500 million of share repurchases after the spin-off of the natural gas businesses has been completed.
For the three months ended September 30, 2006, Duke Energy reported net income of $763 million and diluted earnings per share of $0.60 as compared to net income and diluted earnings per share of $41 million and $0.04, respectively, for the three months ended September 30, 2005. The increase in earnings per share was due primarily to an approximate $0.8 billion after-tax impairment charge (approximately $1.3 billion pre-tax) in 2005 related to DENA, an approximate $250 million pre-tax gain recorded in 2006 on Duke Energys sale of 50% of its interest in Crescent and the absence of prior year hedge losses associated with de-designated Field Services hedges, partially offset by an approximate $575 million pre-tax gain recorded in 2005 as a result of the DEFS disposition transaction, which reduced Duke Energys ownership interest in DEFS from 69.7% to 50% effective July 1, 2005. These results include the impacts of former Cinergy for the quarter ended September 30, 2006.
For the nine months ended September 30, 2006, Duke Energy reported net income of $1,476 million and diluted earnings per share of $1.27 as compared to net income and diluted earnings per share of $1,218 million and $1.25, respectively, for the nine months ended September 30, 2005. These amounts include the results of former Cinergy for the six months ended September 30, 2006. The increase in net income and earnings per share was due primarily to an approximate $0.8 billion after-tax impairment charge (approximately $1.3 billion pre-tax) in 2005 related to DENA, an approximate $250 million pre-tax gain recorded in 2006 on Duke Energys sale of 50% of its interest in Crescent and the absence of prior year hedge losses associated with de-designated Field Services hedges, partially offset by the pre-tax gains of approximately $900 million (net of minority interest of approximately $343 million) recorded in 2005 related to DEFS sale of Texas Eastern Products Pipeline Company, LLC (TEPPCO GP), which is the general partner of TEPPCO Partners, LP
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(TEPPCO LP) and Duke Energys sale of its limited partner interests in TEPPCO LP, and an approximate $575 million gain recorded in 2005 as a result of the DEFS disposition transaction. Diluted earnings per share for the three and nine months ended September 30, 2006 as compared to the diluted earnings per share for the three and nine months ended September 30, 2005 were negatively impacted by the significant increase in the weighted-average common stock shares outstanding for the three and nine months ended September 30, 2006, primarily as a result of the issuance of approximately 313 million shares in conjunction with the Cinergy merger and the conversion of debt into approximately 27 million shares, partially offset by the repurchase of approximately 17.5 million shares under the share repurchase program.
The highlights for the three and nine months ended September 30, 2006 include:
| U.S. Franchised Electric and Gas, which is comprised of Duke Energy Carolinas (formerly known as Duke Power) and the regulated portion of the legacy Cinergy utilities located in the Midwest, delivered higher results for the three and nine months ended September 30, 2006 as compared to the same periods in the prior year, due primarily to the inclusion of legacy Cinergy for the three and six months ended September 30, 2006, reduced regulatory amortization expense and customer growth in the service territories, partially offset by lower wholesale power revenues, rate reductions related to merger savings, higher operating and maintenance costs and milder weather; |
| Natural Gas Transmissions earnings decreased for the three months ended September 30, 2006 compared to the same period in the prior year due primarily to higher operating and maintenance costs, lower earnings on Canadian operations and lower equity earnings related to project financing, partially offset by higher natural gas processing primarily from the addition of the Empress assets acquired in 2005. For the nine months ended September 30, 2006, Natural Gas Transmissions earnings increased over the same period in the previous year due to higher natural gas processing primarily Empress assets, business expansion, favorable resolution of property tax issues and the impact of a strengthening Canadian currency, partially offset by higher operating costs and lower equity earnings related to interest expense; |
| Field Services earnings decreased in 2006 as compared to the same periods in the prior year, primarily as a result of the gain from the sale of TEPPCO in 2005, the gain in 2005 resulting from the DEFS disposition transaction, as well as the impact of the reduction in ownership percentage by Duke Energy as a result of the DEFS disposition transaction, and decreased volumes, partially offset by strong commodity prices during 2006, natural gas liquids (NGL) and gas marketing results and lower hedge losses recognized with the discontinuance of certain cash flow hedges in 2005; |
| Commercial Power, which consists of Duke Energy Ohio, Inc.s non-regulated generation, including DENAs Midwest power operations and Duke Energy Generation Services, reported improved earnings over the same periods in the prior year. Improved results were primarily driven by the addition of Cinergys non-regulated businesses in the Midwest and improved results from DENAs power generation assets in the region. These improvements were partially offset by approximately $17 million and $65 million in purchase accounting adjustments recorded during three and six months ended September 30, 2006, respectively, and operating costs associated with Cinergys synthetic fuel facilities; |
| International Energy earnings increased for the three months ended September 30, 2006 compared to the same period in the prior year due primarily to an equity investment impairment related to Campeche recorded in the third quarter 2005 and favorable hydrology in Argentina, partially offset by unfavorable hydrology in Peru and Brazil, and an unplanned outage at National Methanol Company (NMC). For the nine months ended September 30, 2006, International Energy experienced lower earnings compared to the same period in the prior year primarily driven by a second quarter 2006 impairment of the Campeche equity investment in Mexico and related note receivable, increased power purchases as a result of an unplanned outage in Peru, unfavorable hydrology in Peru and Brazil, and unplanned outages at NMC. These results were partially offset by favorable hydrology in Argentina and favorable currency impactsmainly in Brazil; |
| Crescent had improved results compared to same periods in the prior year, driven primarily by the gain recorded in the third quarter 2006 on Duke Energys sale of 50% of its interest in Crescent and an approximate $133 million gain on the sales of properties at Potomac Yard in Washington, DC and a land sale at Lake Keowee in South Carolina in the second quarter 2006, partially offset by third quarter 2005 gains of $86 million on the sales of a commercial office building portfolio and legacy land; |
| Other losses decreased for the three months ended September 30, 2006 compared to the same period in the prior year due primarily to impacts of certain discontinued cash flow hedges, offset slightly by charges in 2006 associated with the Cinergy merger and third party costs incurred for the Gas Spin-off. For the nine months ended September 30, 2006, Other losses decreased compared to the same period in the prior year primarily as a result of lower losses on Field Services hedges, the recognition of reserves for estimated property damage related to hurricanes and business interruption losses in 2005, and timing of other captive insurance claims, partially offset by Cinergy merger related costs and third party costs incurred for the Gas Spin-off; and |
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| Income (loss) from discontinued operations, primarily related to the exit of the DENA business, improved in 2006 compared to the same periods in the prior year due primarily to a charge in 2005 for the impairment of assets and the discontinuance of hedge accounting for certain positions at DENA, as a result of the decision to exit substantially all DENA operations except for the Midwestern operations, remaining Southeastern operations, and Duke Energy Trading and Marketing (DETM). The 2006 results reflect the impacts of termination or sale of the final remaining contracts at DENA. Additionally, in the second quarter of 2006, an exit plan for the Cinergy commercial marketing and trading business was announced and 2006 results reflects this portion of the business as discontinued operations subsequent to the date of acquisition. |
RESULTS OF OPERATIONS
Results of Operations and Variances
Three Months Ended September 30, |
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Operating revenues |
$ | 4,174 | $ | 3,028 | $ | 1,146 | $ | 11,348 | $ | 13,630 | $ | (2,282 | ) | ||||||||||
Operating expenses |
3,248 | 2,138 | 1,110 | 9,049 | 11,308 | (2,259 | ) | ||||||||||||||||
Gains on sales of investments in commercial and multi-family real estate |
30 | 63 | (33 | ) | 201 | 117 | 84 | ||||||||||||||||
Gains on sales of other assets and other, net |
247 | 580 | (333 | ) | 269 | 589 | (320 | ) | |||||||||||||||
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Operating income |
1,203 | 1,533 | (330 | ) | 2,769 | 3,028 | (259 | ) | |||||||||||||||
Other income and expenses, net |
293 | 116 | 177 | 699 | 1,500 | (801 | ) | ||||||||||||||||
Interest expense |
337 | 228 | 109 | 925 | 813 | 112 | |||||||||||||||||
Minority interest expense |
20 | 10 | 10 | 50 | 508 | (458 | ) | ||||||||||||||||
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Earnings from continuing operations before income taxes |
1,139 | 1,411 | (272 | ) | 2,493 | 3,207 | (714 | ) | |||||||||||||||
Income tax expense from continuing operations |
422 | 487 | (65 | ) | 855 | 1,095 | (240 | ) | |||||||||||||||
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Income from continuing operations |
717 | 924 | (207 | ) | 1,638 | 2,112 | (474 | ) | |||||||||||||||
Income (loss) from discontinued operations, net of tax |
46 | (883 | ) | 929 | (162 | ) | (894 | ) | 732 | ||||||||||||||
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Net income |
763 | 41 | 722 | 1,476 | 1,218 | 258 | |||||||||||||||||
Dividends and premiums on redemption of preferred and preference stock |
| 3 | (3 | ) | | 7 | (7 | ) | |||||||||||||||
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Earnings available for common stockholders |
$ | 763 | $ | 38 | $ | 725 | $ | 1,476 | $ | 1,211 | $ | 265 | |||||||||||
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Consolidated Operating Revenues
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated operating revenues for the three months ended September 30, 2006 increased $1,146 million, compared to the same period in 2005. This change was driven primarily by:
| An approximate $1,350 million increase due to the merger with Cinergy, and |
| A $52 million increase at International Energy due primarily to increased ownership and resulting consolidation of Aguaytia (approximately $33 million). |
Partially offsetting this increase in revenues were:
| A $158 million decrease in Other due primarily to the continued wind-downs of DETM, Duke Energy Merchants, LLC (DEM) and Duke Energys 50% interest in Duke/Fluor Daniel (D/FD), and a prior year gain related to DENAs hedge discontinuance in the Southeast (approximately $30 million), |
| An approximate $50 million decrease associated with the DENA Midwest plants due primarily to lower plant production and unfavorable hedge results, and |
| A $39 million decrease at Crescent driven primarily by lower residential developed lot sales, due primarily to decreased sales in Florida. |
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PART I
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated operating revenues for the nine months ended September 30, 2006 decreased $2,282 million, compared to the same period in 2005. This change was driven primarily by:
| A $5,530 million decrease due to the deconsolidation of DEFS, effective July 1, 2005 |
| An approximate $203 million decrease in Other due to the continued wind-downs of DETM, DEM and Duke Energys 50% interest in D/FD, and |
| An approximate $91 million decrease associated with the DENA Midwest plants due primarily to lower plant production and unfavorable hedge results. |
Partially offsetting this decrease in revenues were:
| An approximate $2,653 million increase due to the merger with Cinergy |
| A $500 million increase at Natural Gas Transmission due primarily to new Canadian assets, primarily higher processing revenues on the Empress System (approximately $298 million), recovery of higher natural gas commodity costs (approximately $152 million), resulting from higher natural gas prices passed through to customers without a mark-up at Union Gas, and favorable Canadian dollar foreign exchange impacts (approximately $134 million), partially offset by lower gas usage due to unseasonably warmer weather (approximately $150 million) |
| A $183 million increase at International Energy due primarily to increased ownership and resulting consolidation of Aguaytia (approximately $81 million), higher energy prices in El Salvador (approximately $41 million), favorable exchange rates in Brazil (approximately $28 million) and higher electricity volumes and prices in Argentina (approximately $25 million), and |
| An approximate $130 million increase in Other related to the prior year impact of the realized and unrealized mark-to-market losses of Field Services hedges that had been recorded in operating revenues prior to the deconsolidation of DEFS. |
For a more detailed discussion of operating revenues, see the segment discussions that follow.
Consolidated Operating Expenses
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated operating expenses for the three months ended September 30, 2006 increased $1,110 million, compared to the same period in 2005. This change was driven primarily by:
| An approximate $1,135 million increase due to the merger with Cinergy |
| An approximate $81 million increase at Duke Energy Carolinas driven primarily by increased fuel expenses, due primarily to higher coal costs, and increased purchase power expense, due primarily to less generation availability during third quarter of 2006 as a result of outages at base load stations, partially offset by lower regulatory amortization, due primarily to reduced amortization of compliance costs related to clean air legislation |
| A $48 million increase at International Energy due primarily to increased ownership and resulting consolidation of Aguaytia (approximately $20 million), and increased purchased power and regulatory fees in Latin America (approximately $30 million), and |
| An approximate $29 million increase in Other associated with costs to achieve the Cinergy merger and the anticipated spin-off of Duke Energys natural gas businesses. |
Partially offsetting this increase in expenses were:
| An approximate $143 million decrease in Other due to the continued wind-downs of DETM, DEM and Duke Energys 50% interest in D/FD, and |
| An approximate $65 million decrease associated with the DENA Midwest plants due primarily to lower plant production and improved fuel hedge results. |
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated operating expenses for the nine months ended September 30, 2006 decreased $2,259 million, compared to the same period in 2005. This change was driven primarily by:
| An approximate $5,087 million decrease due to the deconsolidation of DEFS, effective July 1, 2005 |
| An approximate $249 million decrease in Other due to the continued wind-downs of DETM, DEM and Duke Energys 50% interest in D/FD |
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| An approximate $120 million decrease associated with the prior year recognition of unrealized losses in accumulated other comprehensive income (AOCI) as a result of the discontinuance of certain cash flow hedges entered into to hedge Field Services commodity price risk, which were previously accounted for as cash flow hedges (see Note 15 to the Consolidated Financial Statements, Risk Management Instruments), and |
| An approximate $101 million decrease associated with the DENA Midwest plants due primarily to lower plant production and improved fuel hedge results. |
Partially offsetting this decrease in expenses were:
| An approximate $2,327 million increase due to the merger with Cinergy |
| A $467 million increase at Natural Gas Transmission due primarily to new Canadian assets, primarily the Empress System (approximately $225 million), increased natural gas prices at Union Gas (approximately $152 million), resulting from high natural gas prices passed through to customers without a mark-up at Union Gas, Canadian dollar foreign exchange impacts (approximately $106 million), partially offset by lower gas purchase costs due to unseasonably warmer weather (approximately $127 million) |
| A $192 million increase at International Energy due primarily to increased ownership and resulting consolidation of Aguaytia (approximately $64 million), an allowance on a note receivable from the Campeche equity investment (approximately $38 million), and higher fuel prices and volumes, and purchased power costs in Latin America (approximately $90 million) |
| An approximate $157 million increase at Duke Energy Carolinas driven primarily by increased fuel expenses, due primarily to higher coal costs, increased operating and maintenance and increased purchase power expense, due primarily to less generation availability during 2006 as a result of outages at base load stations, partially offset by lower regulatory amortization, due primarily to reduced amortization of compliance costs related to clean air legislation, and |
| An approximate $114 million increase in Other associated with costs to achieve the Cinergy merger and the anticipated spin-off of Duke Energys natural gas businesses. |
For a more detailed discussion of operating expenses, see the segment discussions that follow.
Consolidated Gains on Sales of Investments in Commercial and Multi-Family Real Estate
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated gains on sales of investments in commercial and multi-family real estate decreased $33 million compared to the same period in 2005. This decrease was driven primarily by a $41 million land sale gain at Catawba Ridge in South Carolina in the third quarter of 2005 compared to lesser activity in the third quarter of 2006.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated gains on sales of investments in commercial and multi-family real estate increased $84 million compared to the same period in 2005. This increase was primarily due to an approximate $81 million gain on the sale of two office buildings at Potomac Yard in Washington, D.C. and an approximate $52 million gain on a land sale at Lake Keowee in northwestern South Carolina in 2006, partially offset by a $41 million land sale gain at Catawba Ridge in South Carolina in 2005.
Consolidated Gains on Sales of Other Assets and Other, Net
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated gains on sales of other assets and other, net for the three months ended September 30, 2006 decreased $333 million, compared to the same period in 2005. The decrease was due primarily to an approximate $575 million gain recorded in 2005 as a result of the DEFS disposition transaction, partially offset by an approximate $250 million gain in 2006 on the sale of an effective 50% interest in Crescent, creating a joint venture between Duke Energy and MSREF.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated gains on sales of other assets and other, net for the nine months ended September 30, 2006 decreased $320 million, compared to the same period in 2005. The decrease was due primarily to an approximate $575 million gain recorded in 2005 as a result of the DEFS disposition transaction, partially offset by an approximate $250 million gain in 2006 on the sale of an effective 50% interest in Crescent, creating a joint venture between Duke Energy and MSREF and an approximate $23 million gain on the settlement of a customers transportation contract at Natural Gas Transmission in 2006.
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PART I
Consolidated Operating Income
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated operating income for the three months ended September 30, 2006 decreased $330 million, compared to the same period in 2005. Decreased operating income was primarily related to an approximate $575 million gain in 2005 resulting from the DEFS disposition transaction, partially offset by an approximate $250 million gain in 2006 on the sale of a 50% interest in Crescent. Other drivers to operating income are discussed above.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated operating income for the nine months ended September 30, 2006 decreased $259 million, compared to the same period in 2005. Decreased operating income was primarily related to an approximate $575 million gain in 2005 resulting from the DEFS disposition transaction and the impacts of the deconsolidation of DEFS, effective July 1, 2005, which amounted to approximately $443 million for the nine months ended September 30, 2005 . Partially offsetting these decreases were an approximate $250 million gain in 2006 on the sale of a 50% interest in Crescent, an approximate $250 million negative impact to operating income in 2005 related to the discontinuance of certain cash flow hedges entered into to hedge Field Services commodity price risk and approximately $325 million of operating income generated by legacy Cinergy in 2006 as a result of the merger. Other drivers to operating income are discussed above.
For more detailed discussions, see the segment discussions that follow.
Consolidated Other Income and Expenses, net
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated other income and expenses, net for the three months ended September 30, 2006 increased $177 million, compared to the same period in 2005. The increase was due primarily to approximately $20 million of mark-to-market gains on DEFS hedges due to decreases in crude oil prices for the three months ended September 30, 2006 as compared to losses of approximately $105 million in the same period in the prior year, an increase of approximately $19 million in equity in earnings of unconsolidated affiliates primarily due to the increased earnings at DEFS, approximately $20 million of impairment charges on equity method investments recorded in the third quarter 2005, primarily International Energys investment in Campeche (see Note 12 to the Consolidated Financial Statements, Impairments and Other Charges) and a Staff Accounting Bulletin (SAB) No. 51 gain of $15 million in 2006 related to the Duke Energy Income Funds (Income Fund) issuance of additional units of the Canadian income trust fund, which resulted in a dilution of Duke Energys ownership.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated other income and expenses, net for the nine months ended September 30, 2006 decreased $801 million, compared to the same period in 2005. The decrease was due primarily to the $1,245 million pre-tax gains on sales of equity investments recorded in 2005, primarily associated with the sale of TEPPCO GP and Duke Energys limited partner interest in TEPPCO LP, as discussed above, partially offset by an increase of approximately $308 million in equity in earnings of unconsolidated affiliates primarily due to the deconsolidation of DEFS starting July 1, 2005 and an approximate $80 million increase related to mark-to-market impacts associated with DEFS hedges resulting from prior year losses of approximately $105 million offset by 2006 losses of approximately $25 million.
Consolidated Interest Expense
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated interest expense for the three months ended September 30, 2006 increased $109 million, compared to the same period in 2005. This increase is primarily attributable to the increase in long-term debt as a result of the merger with Cinergy.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated interest expense for the nine months ended September 30, 2006 increased $112 million, compared to the same period in 2005. This increase is primarily attributable to the increase in long-term debt as a result of the merger with Cinergy, partially offset by reduced interest expense associated with DEFS, which was deconsolidated on July 1, 2005.
Consolidated Minority Interest Expense
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated minority interest expense for the nine months ended September 30, 2006 decreased $458 million, compared to the same period in 2005. The decrease primarily resulted from the 2005 gain associated with the sale of TEPPCO GP and the impact of deconsolidation of DEFS.
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PART I
Consolidated Income Tax Expense from Continuing Operations
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated income tax expense from continuing operations for the three months ended September 30, 2006 decreased $65 million, compared to the same period in 2005. The decrease primarily resulted from lower pre-tax earnings. The effective tax rate increased in the three months ended September 30, 2006 (37.1%) compared to the same period in 2005 (34.5%), due primarily to an increase in state taxes as a result of setting up an additional tax reserve attributed to the sale of the interest in Crescent.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated income tax expense from continuing operations for the nine months ended September 30, 2006 decreased $240 million, compared to the same period in 2005. This decrease primarily resulted from lower pre-tax earnings, due primarily to the 2005 gains associated with the sale of TEPPCO GP and Duke Energys limited partner interest in TEPPCO LP as discussed above, offset by the 2006 gain on Crescent. The effective tax rate increased in the nine months ended September 30, 2006 (34.3%) compared to the same period in 2005 (34.1%), due primarily to the increase in state taxes as a result of setting up an additional tax reserve attributed to the sale of the interest in Crescent, offset by a reduction in state deferred tax liabilities related to the merger with Cinergy.
Consolidated Income (Loss) from Discontinued Operations, net of tax
Three Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated income (loss) from discontinued operations, net of tax for the three months ended September 30, 2006 improved $929 million, compared to the same period in 2005. This increase primarily resulted from approximately $31 million of after-tax income at DENA during the three months ended September 30, 2006 as a result of certain contract terminations or sales, as compared to an approximate $0.8 billion after-tax charge (approximately $1.3 billion pre-tax) in 2005 for the impairment of assets and the discontinuance of hedge accounting for certain positions at DENA, as a result of the decision to exit substantially all DENA operations except for the Midwestern operations, remaining Southeastern operations, and DETM (see Note 13 to the Consolidated Financial Statements, Discontinued Operations and Assets Held for Sale). Additionally, Commercial Power recognized approximately $15 million of after-tax income during the three months ended September 30, 2006 associated with exiting the Cinergy commercial marketing and trading operations.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005. Consolidated income (loss) from discontinued operations, net of tax for the nine months ended September 30, 2006 improved $732 million compared to the same period in 2005. This decrease primarily resulted from approximately $164 million of after-tax losses at DENA in 2006 associated with certain contract terminations or sales, as compared to an approximate $0.8 billion, after-tax impairment charge (approximately $1.3 billion pre-tax) in 2005 related to DENA, discussed above.
Segment Results
Management evaluates segment performance based on earnings before interest and taxes from continuing operations, after deducting minority interest expense related to those profits (EBIT). On a segment basis, EBIT excludes discontinued operations, represents all profits from continuing operations (both operating and non-operating) before deducting interest and taxes, and is net of the minority interest expense related to those profits. Cash, cash equivalents and short-term investments are managed centrally by Duke Energy, so the gains and losses on foreign currency remeasurement, and interest and dividend income on those balances, are excluded from the segments EBIT. Management considers segment EBIT to be a good indicator of each segments operating performance from its continuing operations, as it represents the results of Duke Energys ownership interest in operations without regard to financing methods or capital structures.
Duke Energys segment EBIT may not be comparable to a similarly titled measure of another company because other entities may not calculate EBIT in the same manner. Segment EBIT is summarized in the following table, and detailed discussions follow.
See Note 14 to the Consolidated Financial Statements, Business Segments, for a discussion of Duke Energys new segment structure. Additionally, the results of operations and segment assets for DENA Midwestern operations are included in the Commercial Power segment, whereby previously DENAs Midwestern operations were included in Other.
64
PART I
EBIT by Business Segment
Three Months Ended September 30, |
Nine Months Ended September 30, |
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2006
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2005
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2006
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2005
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(in millions) | ||||||||||||||||
U.S. Franchised Electric and Gas |
$ | 678 | $ | 606 | $ | 1,388 | $ | 1,216 | ||||||||
Natural Gas Transmission |
303 | 329 | 1,102 | 1,044 | ||||||||||||
Field Services (a) |
158 | 701 | 450 | 1,784 | ||||||||||||
Commercial Power |
57 | (11 | ) | 50 | (44 | ) | ||||||||||
International Energy |
68 | 63 | 181 | 217 | ||||||||||||
Crescent (c) |
300 | 120 | 515 | 210 | ||||||||||||
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Total reportable segment EBIT |
1,564 | 1,808 | 3,686 | 4,427 | ||||||||||||
Other |
(111 | ) | (165 | ) | (343 | ) | (452 | ) | ||||||||
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Total reportable segment and other EBIT |
1,453 | 1,643 | 3,343 | 3,975 | ||||||||||||
Interest expense |
(337 | ) | (228 | ) | (925 | ) | (813 | ) | ||||||||
Interest income and other (b) |
23 | (4 | ) | 75 | 45 | |||||||||||
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Consolidated earnings from continuing operations before income taxes |
$ | 1,139 | $ | 1,411 | $ | 2,493 | $ | 3,207 | ||||||||
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(a) | In July 2005, Duke Energy completed the agreement with ConocoPhillips to reduce Duke Energys ownership interest in DEFS from 69.7% to 50%. Field Services segment data includes DEFS as a consolidated entity for periods prior to July 1, 2005 and an equity method investment for periods after June 30, 2005. |
(b) | Other includes foreign currency transaction gains and losses, additional minority interest expense not allocated to the segment results. |
(c) | In September 2006, Duke Energy completed a joint venture transaction of Crescent (see Note 2 to the Consolidated Financial Statements, Acquisitions and Dispositions). As a result, Crescent EBIT for the three and nine months ended September 30, 2006 includes Crescent as a consolidated entity for periods prior to September 7, 2006 and as an equity method investment for periods subsequent to September 7, 2006. |
The amounts discussed below include intercompany transactions that are eliminated in the Consolidated Financial Statements.
U.S. Franchised Electric and Gas
Three Months Ended
September 30, |
Nine Months Ended September 30, |
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2006
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2005
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Increase
(Decrease) |
2006
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2005
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Increase (Decrease) |
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(in millions, except where noted) | |||||||||||||||||||||
Operating revenues |
$ | 2,482 | $ | 1,619 | $ | 863 | $ | 5,904 | $ | 4,118 | $ | 1,786 | |||||||||
Operating expenses |
1,814 | 1,026 | 788 | 4,543 | 2,916 | 1,627 | |||||||||||||||
Gains on sales of other assets and other, net |
(1 | ) | 1 | (2 | ) | 1 | 2 | (1 | ) | ||||||||||||
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Operating income |
667 | 594 | 73 | 1,362 | 1,204 | 158 | |||||||||||||||
Other income and expenses, net |
11 | 12 | (1 | ) | 26 | 12 | 14 | ||||||||||||||
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EBIT |
$ | 678 | $ | 606 | $ | 72 | $ | 1,388 | $ | 1,216 | $ | 172 | |||||||||
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Duke Energy Carolinas GWh sales (a) |
22,755 | 23,724 | (969 | ) | 63,279 | 65,318 | (2,039 | ) | |||||||||||||
Duke Energy Midwest GWh sales (a)(b) |
16,505 | 16,505 | 31,309 | 31,309 |
(a) | Gigawatt-hours (GWh) |
(b) | Relates to operations of former Cinergy |
65
PART I
The following table shows the changes in GWh sales and average number of customers for Duke Energy Carolinas. The table below excludes amounts related to former Cinergy since results of operations of Cinergy are only included from the date of acquisition and thereafter.
Increase (decrease) over prior year |
Three Months Ended
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Nine Months Ended
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Residential sales a |
1.8 | % | 0.3 | % | ||
General service sales a |
2.9 | % | 2.0 | % | ||
Industrial sales a |
(4.1 | )% | (2.8 | )% | ||
Wholesale sales |
(73.8 | )% | (43.3 | )% | ||
Total DE Carolinas sales b |
(4.1 | )% | (3.1 | )% | ||
Average number of customers |
2.1 | % | 2.0 | % |
a | Major components of DE Carolinas retail sales |
b | Consists of all components of DE Carolinas sales, including retail sales, and wholesale sales to incorporated municipalities and to public and private utilities and power marketers. |
Three Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The increase was driven primarily by:
| An $881 million increase in regulated revenues due to the acquisition of Cinergy |
| A $67 million increase in fuel revenues driven by increased fuel rates for retail customers due primarily to increased coal costs and increased GWh sales to retail customers. Sales to residential and commercial customers increased by approximately 2%, resulting in more fuel revenue collections from those customers. The delivered cost of coal in 2006 is approximately $15 per ton higher than the same period in 2005, representing a 27% increase |
| A $16 million increase related to the sharing of profits from wholesale power sales with industrial customers in North Carolina in 2006. For the three months ended September 30, 2006, the sharing of profits was less than $1 million, while for the same period in 2005 the sharing of profits was $16 million, partially offset by |
| A $61 million decrease in wholesale power revenues. Sales volumes decreased by 74% due to production constraints caused by generation outages and mild weather. Additionally, 2006 pricing was lower compared to 2005 due to the impact of hurricanes in 2005 |
| A $39 million decrease related to the sharing of anticipated merger savings by way of a rate decrement rider with regulated customers in North Carolina and South Carolina. As a requirement of the merger, Duke Energy Carolinas is required to share anticipated merger savings of approximately $117 million with North Carolina customers and approximately $40 million with South Carolina customers over a one year period, and |
| A $17 million decrease related to GWh sales to retail customers due to unfavorable weather conditions compared to the same period in 2005. Weather statistics for cooling degree days were approximately 3% above normal in third quarter 2006 compared to 19% above normal during the same period in 2005. |
Operating Expenses. The increase was driven primarily by:
| A $707 million increase in regulated operating expenses due to the acquisition of Cinergy |
| A $60 million increase in fuel expenses due primarily to higher coal costs. Fossil generation fueled by coal accounted for slightly more than 50% of total generation during the third quarter of 2006 and 2005 and the delivered cost of coal is approximately $15 per ton higher than the same period in 2005 |
| A $24 million increase in purchased power expense, due primarily to less generation availability during third quarter of 2006 as a result of outages at base load stations |
| A $20 million increase in operating and maintenance expenses, primarily related to higher nuclear costs, increases in insurance premiums, environmental charges and workers compensation costs, partially offset by |
| A $23 million decrease in regulatory amortization, due to reduced amortization of compliance costs related to clean air legislation during the third quarter of 2006 as compared to the same period in 2005. Regulatory amortization expenses were approximately $62 million for the three months ended September 30, 2006 as compared to approximately $85 million during the same period in 2005. |
66
PART I
EBIT . The increase in EBIT resulted primarily from the acquisition of the regulated operations of Cinergy and less regulatory amortization, partially offset by decreased sales to wholesale customers due to limited market opportunities, sharing of anticipated merger savings, increased purchased power costs, higher operating and maintenance expenses and less favorable weather conditions.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The increase was driven primarily by:
| A $1,729 million increase in regulated revenues due to the acquisition of Cinergy |
| A $144 million increase in fuel revenues driven by increased fuel rates for retail customers due primarily to increased coal costs. The delivered cost of coal in 2006 is approximately $11 per ton higher than the same period in 2005, representing a 19% increase |
| A $19 million increase related to demand from retail customers, due primarily to continued growth in the number of residential and general service customers in the DE Carolinas service territory. The number of customers in 2006 has increased by approximately 44,000 compared to the same period in 2005, partially offset by |
| A $76 million decrease in wholesale power revenues. Sales volumes decreased by 43% due to production constraints caused by generation outages and milder weather. Additionally, 2006 pricing was unfavorable compared to 2005 due to the impact of hurricanes in 2005 |
| A $42 million decrease related to the sharing of anticipated merger savings by way of a rate decrement rider with regulated customers in North Carolina and South Carolina. As a requirement of the merger, Duke Energy Carolinas is required to share anticipated merger savings of approximately $117 million with North Carolina customers and approximately $40 million with South Carolina customers over a one year period, and |
| A $12 million decrease related to GWh sales to retail customers due to unfavorable weather conditions compared to the same period in 2005. Weather statistics for both heating and cooling periods in 2006 were unfavorable compared to the same periods in 2005. |
Operating Expenses. The increase was driven primarily by:
| A $1,470 million increase in regulated operating expenses due to the acquisition of Cinergy |
| A $140 million increase in fuel expenses, due primarily to higher coal costs. Fossil generation fueled by coal accounted for slightly more than 50% of total generation for year to date September 30, 2006 and 2005 and the delivered cost of coal is approximately $11 per ton higher than the same period in 2005 |
| A $36 million increase in operating and maintenance expenses, primarily related to base load station maintenance costs, increases in insurance premiums, environmental charges and workers compensation costs |
| A $20 million increase in purchased power expense, due primarily to less generation availability during 2006 as a result of outages at base load stations, partially offset by |
| A $53 million decrease in regulatory amortization, due to reduced amortization of compliance costs related to clean air legislation during 2006 as compared to the same period in 2005. Regulatory amortization expenses were approximately $188 million for the nine months ending September 30, 2006 as compared to approximately $241 million during the same period in 2005. |
Other Income and Expenses, net. The increase in other income was driven primarily by the acquisition of Cinergy.
EBIT . The increase in EBIT resulted primarily from the acquisition of the regulated operations of Cinergy, increased demand from retail customers and less regulatory amortization, partially offset by lower wholesale power sales, sharing of anticipated merger savings and increased operating and maintenance costs.
67
PART I
Natural Gas Transmission
Three Months Ended September 30, |
Nine Months Ended September 30, |
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2006
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2005
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Increase (Decrease) |
2006
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2005
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Increase (Decrease) |
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(in millions, except where noted) | ||||||||||||||||||||
Operating revenues |
$ | 871 | $ | 869 | $ | 2 | $ | 3,324 | $ | 2,824 | $ | 500 | ||||||||
Operating expenses |
586 | 549 | 37 | 2,276 | 1,809 | 467 | ||||||||||||||
Gains on sales of other assets and other, net |
2 | | 2 | 31 | 4 | 27 | ||||||||||||||
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Operating income |
287 | 320 | (33 | ) | 1,079 | 1,019 | 60 | |||||||||||||
Other income and expenses, net |
25 | 17 | 8 | 52 | 48 | 4 | ||||||||||||||
Minority interest expense |
9 | 8 | 1 | 29 | 23 | 6 | ||||||||||||||
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EBIT |
$ | 303 | $ | 329 | $ | (26 | ) | $ | 1,102 | $ | 1,044 | $ | 58 | |||||||
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Proportional throughput, TBtu a |
729 | 759 | (30 | ) | 2,398 | 2,534 | (136 | ) |
a | Trillion British thermal units. Revenues are not significantly impacted by pipeline throughput fluctuations, since revenues are primarily composed of demand charges. |
Three Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The slight increase was driven primarily by:
| A $32 million increase due to foreign exchange rates favorably impacting revenues from the Canadian operations as a result of the strengthening Canadian dollar (partially offset by currency impacts to expenses) |
| A $31 million increase due primarily to higher processing revenues on the Empress System, as a result of increased commodity prices |
| A $7 million increase from recovery of higher natural gas commodity costs, resulting from higher natural gas prices passed through to customers without a mark-up at Union Gas. This revenue increase is offset in expenses, and |
| A $6 million increase from completed and operational pipeline expansion projects in the United States, partially offset by |
| A $47 million decrease in gas distribution revenues at Union Gas primarily resulting from lower gas usage, and |
| A $12 million decrease in US business operations driven by lower processing revenues and a 2005 insurance recovery. |
Operating Expenses. The increase was driven primarily by:
| A $35 million increase in the U.S. primarily related to higher insurance premiums, benefits costs, pipeline integrity costs, and other increased transmission and storage operation expenses, |
| A $25 million increase caused by foreign exchange impacts (offset by currency impacts to revenues, as discussed above), |
| A $7 million increase related to increased natural gas prices at Union Gas. This amount is offset in revenues. |
| A $4 million increase at British Columbia Pipeline System for higher plant maintenance turnaround costs, and |
| A $3 million increase due primarily to higher gas purchase cost associated with the Empress System, partially offset by |
| A $46 million decrease in gas purchase costs at Union Gas, primarily resulting from lower gas usage. |
Other Income and Expenses, net. The increase was driven primarily by a pre-tax SAB No. 51 gain of $15 million related to a dilution gain on the Income Funds issuance of additional units of the Canadian income trust fund, partially offset by a $3 million decrease in Gulfstream equity due to lower earnings from increased interest expense.
EBIT. The decrease in EBIT is due primarily to the increase in U.S. operating and maintenance expenses, a decrease in U.S business operations, and a 2005 insurance recovery, partially offset by increased processing earnings (Empress System), the gain on the Income Funds issuance of additional units of the Canadian income trust fund, and the strengthening Canadian currency.
68
PART I
Nine Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The increase was driven primarily by:
| A $298 million increase due to new Canadian assets, primarily higher processing revenues on the Empress System as a result of commodity prices |
| A $152 million increase from recovery of higher natural gas commodity costs, resulting from higher natural gas prices passed through to customers without a mark-up at Union Gas. This revenue increase is offset in expenses. |
| A $134 million increase due to foreign exchange rates favorably impacting revenues from the Canadian operations as a result of the strengthening Canadian dollar (partially offset by currency impacts to expenses), |
| A $29 million increase in U.S. business operations driven by increased processing revenues associated with transportation, partially offset by a 2005 insurance recovery, and |
| A $21 million increase from completed and operational pipeline expansion projects in the U.S., partially offset by |
| A $150 million decrease in gas distribution revenues at Union Gas primarily resulting from lower gas usage due to warmer weather compared to 2005. |
Operating Expenses. The increase was driven primarily by:
| A $225 million increase due to new Canadian assets, primarily gas purchase cost associated with the Empress System |
| A $152 million increase related to increased natural gas prices at Union Gas. This amount is offset in revenues |
| A $106 million increase caused by foreign exchange impacts (offset by currency impacts to revenues, as discussed above) and |
| A $66 million increase in U.S. primarily related to higher insurance premiums, benefits costs, IT costs, pipeline integrity costs, and other increased transmission and storage operation expenses, partially offset by |
| A $127 million decrease in gas purchase costs at Union Gas, primarily resulting from lower gas usage due to unseasonably warmer weather and |
| A $15 million decrease related to the resolution in 2006 of prior tax years ad valorem tax issues. |
Gain on Sales of Other Assets and Other, net. The increase was driven primarily by a $23 million gain in 2006 on the settlement of a customers transportation contract, and a $5 million gain on the sale of Stone Mountain assets in 2006.
Other Income and Expenses, net. The increase was driven primarily a pre-tax SAB No. 51 gain of $15 million related to the Income Funds issuance of additional units of the Canadian income trust fund, partially offset by a $5 million construction fee received in 2005 from an affiliate as a result of the successful completion of the Gulfstream Natural Gas System, LLC (Gulfstream), 50% owned by Duke Energy, Phase II project, and Natural Gas Transmissions 50% share of operating and maintenance expenses in 2006 on the Southeast Supply Header project.
EBIT. The increase in EBIT is due primarily to the increase in processing earnings (Empress System), the gain on settlement of a customers transportation contract, U.S. business expansion and operations, the gain on the Income Funds issuance of additional units of the Canadian income trust fund and the strengthening Canadian currency, partially offset by increased U.S. operating and maintenance expenses, the 2005 Gulfstream success fee and unfavorable Union weather and operations.
Matters Impacting Future Results
In June 2006, the Board of Directors of Duke Energy authorized management to pursue a plan to create two separate publicly traded companies by spinning off Duke Energys natural gas businesses to Duke Energy shareholders. The new natural gas company, which would be named Spectra Energy, would principally consist of Duke Energys Natural Gas Transmission business segment, which would include Union Gas, and would also include Duke Energys 50-percent ownership interest in DEFS. Approximately $9 billion of debt currently at Duke Capital and its consolidated subsidiaries is anticipated to transfer to the new natural gas company at the time of the spin-off. If completed, the decision to spin off the natural gas business is expected to deliver long-term value to shareholders. While the actual timing of the spin-off, if it occurs, is dependent upon the resolution of certain regulatory and other matters, Duke Energy is currently targeting a January 1, 2007 effective date for the transaction. The results of the natural gas businesses are expected to be treated as discontinued operations in the period the spin-off is consummated.
During the quarter ended September 30, 2006, Natural Gas Transmission recognized a $15 million pre-tax gain on the sale of additional units of the Canadian income trust fund, the Duke Energy Income Fund (Income Fund). If the Income Fund issues additional units in the future to finance its cash needs, Natural Gas Transmission could recognize future SAB No. 51 gain or loss transactions.
69
PART I
On October 31, 2006, the Minister of Finance in Canada announced proposed changes to the income tax treatment of flow-through entities, including income trusts, such as the Income Fund. If the proposal is implemented in its current form, income trusts will be subject to tax at corporate rates on the taxable portion of their distributions which would apply beginning with the 2011 taxation year of the Income Fund. Duke Energy will monitor the impact of these proposed changes on the Income Fund and on the future use of such entities, but does not currently expect significant impacts to Natural Gas Transmission as a result of these changes.
Field Services
Three Months Ended
September 30, |
Nine Months Ended September 30, |
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2006
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2005
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Increase (Decrease) |
2006
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2005
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Increase (Decrease) |
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(in millions, except where noted) | |||||||||||||||||||||||
Operating revenues |
$ | | $ | | $ | | $ | | $ | 5,530 | $ | (5,530 | ) | ||||||||||
Operating expenses |
1 | | 1 | 4 | 5,211 | (5,207 | ) | ||||||||||||||||
Gains on sales of other assets and other, net |
| 576 | (576 | ) | | 577 | (577 | ) | |||||||||||||||
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Operating income |
(1 | ) | 576 | (577 | ) | (4 | ) | 896 | (900 | ) | |||||||||||||
Equity in earnings of unconsolidated affiliates (a) |
159 | 126 | 33 | 454 | 126 | 328 | |||||||||||||||||
Other income and expenses, net |
| (1 | ) | 1 | | 1,259 | (1,259 | ) | |||||||||||||||
Minority interest expense |
| | | | 497 | (497 | ) | ||||||||||||||||
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EBIT (a) |
$ | 158 | $ | 701 | $ | (543 | ) | $ | 450 | $ | 1,784 | $ | (1,334 | ) | |||||||||
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Natural gas gathered and processed/transported, TBtu/d (b) |
6.7 | 6.7 | | 6.8 | 6.8 | | |||||||||||||||||
NGL production, MBbl/d (c) |
361 | 342 | 19 | 361 | 355 | 6 | |||||||||||||||||
Average natural gas price per MMBtu (d)(e) |
$ | 6.58 | $ | 8.37 | $ | (1.79 | ) | $ | 7.45 | $ | 7.12 | $ | 0.33 | ||||||||||
Average NGL price per gallon (e) |
$ | 1.02 | $ | 0.91 | $ | 0.11 | $ | 0.96 | $ | 0.80 | $ | 0.16 |
(a) | Includes Duke Energys 50% equity in earnings of DEFS net income subsequent to the deconsolidation of DEFS effective July 1, 2005. Results of DEFS prior to July 1, 2005 are presented on a consolidated basis. |
(b) | Trillion British thermal units per day |
(c) | Thousand barrels per day |
(d) | Million British thermal units. Average price based on NYMEX Henry Hub |
(e) | Does not reflect results of commodity hedges. |
In July 2005, Duke Energy completed the transfer of a 19.7% interest in DEFS to ConocoPhillips, Duke Energys co-equity owner in DEFS, which reduced Duke Energys ownership interest in DEFS from 69.7% to 50% (the DEFS disposition transaction) and resulted in Duke Energy and ConocoPhillips becoming equal 50% owners in DEFS. As a result of the DEFS disposition transaction, Duke Energy deconsolidated its investment in DEFS and subsequently has accounted for DEFS as an investment utilizing the equity method of accounting.
Three months ended September 30, 2006 as Compared to September 30, 2005
Gains on Sales of Other Assets and Other, net. The decrease was due primarily to an approximate pre-tax gain of $575 million on the DEFS disposition transaction during the prior year.
Equity in Earnings of Unconsolidated Affiliates . The increase is due to Duke Energys 50% of equity earnings of DEFS net income for the three months ended September 30, 2006 as compared to the three months ended September 30, 2005. DEFS earnings during the three months ended September 30, 2006 have continued to be favorably impacted by increased NGL and crude oil prices as compared to the prior period, as well as increased trading and marketing gains due primarily to changes in natural gas prices and the timing of derivative and inventory transactions.
EBIT . The decrease in EBIT resulted mainly from the pre-tax gain of $575 million on the DEFS disposition transaction during the prior year, offset by the increase in equity in earnings for the three months ended September 30, 2006 as compared to the prior year.
Nine months ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The decrease was due to the DEFS disposition transaction and subsequent deconsolidation of DEFS.
Operating Expenses. The decrease was due to the DEFS disposition transaction and subsequent deconsolidation of DEFS. Operating expenses for the nine months ended September 30, 2005 were also impacted by approximately $120 million of losses recognized due to the reclassification of pre-tax unrealized losses in AOCI as a result of the discontinuance of certain cash flow hedges entered into to hedge Field Services commodity price risk, which were previously accounted for as cash flow hedges.
70
PART I
Gains on Sales of Other Assets and Other, net. The decrease was due primarily to an approximate pre-tax gain of $575 million on the DEFS disposition transaction during the prior year.
Equity in Earnings of Unconsolidated Affiliates. The increase is due to Duke Energys 50% of equity in earnings of DEFS net income for the nine months ended September 30, 2006 as compared to equity in earnings of DEFS net income for the three months ended September 30, 2005. DEFS earnings during the nine months ended September 30, 2006 have continued to be favorably impacted by increased NGL and crude oil prices as compared to the prior period, as well as increased trading and marketing gains due primarily to changes in natural gas prices and the timing of derivative and inventory transactions. These increases have been partially offset by higher operating costs and expenses for repair and maintenance for the nine months ended September 30, 2006.
Other Income and Expenses, net . The decrease is due to the DEFS disposition transaction and subsequent deconsolidation of DEFS. During the nine months ended September 30, 2005, DEFS had a pre-tax gain on the sale of its wholly-owned subsidiary, TEPPCO GP, the general partner of TEPPCO LP of $1.1 billion, and Duke Energy had a pre-tax gain on the sale of its limited partner interest in TEPPCO LP of approximately $97 million. TEPPCO GP and Duke Energys limited partner interest in TEPPCO LP were each sold to Enterprise GP Holdings LP, an unrelated third party.
Minority Interest Expense. The decrease was due to the DEFS disposition transaction and subsequent deconsolidation of DEFS. Minority interest expense for the nine months ended September 30, 2005 was due primarily to the gain on the sale of TEPPCO GP to Enterprise GP Holdings LP for approximately $1.1 billion, as discussed above.
EBIT . The decrease in EBIT resulted primarily from the gain on sale of TEPPCO GP and Duke Energys limited partner interest in TEPPCO LP during the nine months ended September 30, 2005 and gain on the the DEFS disposition transaction, which reduced Duke Energys ownership interest in DEFS from 69.7% to 50%. These decreases were partially offset by increased commodity prices for the nine months ended September 30, 2006 as compared to the prior period.
Supplemental Data
Below is supplemental information for DEFS operating results for the three and nine months ended September 30, 2006 and the three months ended September 30, 2005:
(in millions) |
Three Months Ended
September 30, 2006 |
Three Months Ended
September 30, 2005 |
Nine Months Ended September 30, 2006 |
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Operating revenues |
$ | 3,190 | $ | 3,386 | $ | 9,501 | ||||
Operating expenses |
2,841 | 3,105 | 8,492 | |||||||
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Operating income |
349 | 281 | 1,009 | |||||||
Other income and expenses, net |
| 2 | 10 | |||||||
Interest expense, net |
29 | 33 | 89 | |||||||
Income tax expense (benefit) |
2 | (2 | ) | 22 | ||||||
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Net income |
$ | 318 | $ | 252 | $ | 908 | ||||
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Matters Impacting Future Results
As previously mentioned, in June 2006, the Board of Directors of Duke Energy authorized management to pursue a plan to create two separate publicly traded companies by spinning off Duke Energys natural gas businesses to Duke Energy shareholders. The new natural gas company, which would be named Spectra Energy, would principally consist of Duke Energys Natural Gas Transmission business segment, which would include Union Gas, and would also include Duke Energys 50-percent ownership interest in DEFS. If completed, the decision to spin off the natural gas business is expected to deliver long-term value to shareholders. While the actual timing of the spin-off, if it occurs, is dependent upon the resolution of certain regulatory and other matters, Duke Energy is targeting a January 1, 2007 effective date for the transaction. The results of the natural gas businesses are expected to be treated as discontinued operations in the period the spin-off is consummated.
In July 2006, the State of New Mexico Environment Department issued Compliance Order to DEFS that list air quality violations during the past five year at three DEFS owned or operated facilities in New Mexico. DEFS intends to contest these allegations. Management of DEFS does not believe this matter will result in a material impact on DEFS future consolidated results of operations, cash flows or financial position.
71
PART I
Commercial Power
Three Months Ended
September 30, |
Nine Months Ended September 30, |
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2006
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2005
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Increase (Decrease) |
2006
|
2005
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Increase (Decrease) |
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(in millions, except where noted) | ||||||||||||||||||||||||
Operating revenues |
$ | 497 | $ | 78 | $ | 419 | $ | 960 | $ | 127 | $ | 833 | ||||||||||||
Operating expenses |
452 | 89 | 363 | 928 | 172 | 756 | ||||||||||||||||||
Gains on sales of other assets and other, net |
(4 | ) | | (4 | ) | (9 | ) | | (9 | ) | ||||||||||||||
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Operating income |
41 | (11 | ) | 52 | 23 | (45 | ) | 68 | ||||||||||||||||
Other income and expenses, net |
16 | | 16 | 27 | 1 | 26 | ||||||||||||||||||
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EBIT |
$ | 57 | $ | (11 | ) | $ | 68 | $ | 50 | $ | (44 | ) | $ | 94 | ||||||||||
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Actual Plant Production, Gwh |
6,599 | 958 | 5,641 | 11,978 | 1,664 | 10,314 |
Three Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The increase was primarily driven by the acquisition of Cinergy assets for which results, including the impacts of purchase accounting, are reflected for the three months ended September 30, 2006, but are not included in the same period in 2005. Operating revenues associated with the DENA Midwest plants were approximately $50 million lower for the three months ended September 30, 2006 compared to the same period in the prior year primarily due to lower plant production and unfavorable hedge results.
Operating Expenses. The increase was primarily driven by the acquisition of Cinergy assets for which results, including the impacts of purchase accounting, are reflected for the three months ended September 30, 2006, but are not included in the same period in 2005. Operating expenses associated with the DENA Midwest plants were approximately $65 million lower for the three months ended September 30, 2006 compared to the same period in the prior year primarily due to lower plant production and improved fuel hedge results.
Gain on Sales of Other Assets and Other, net. The decrease was driven primarily by losses of approximately $9 million on sales of emission allowances, offset by an approximate $6 million gain on the sale of the Pine Mountain synthetic fuel facility.
EBIT. The increase was due primarily to the acquisition of Cinergy assets for which results, including the impacts of purchase accounting, are reflected for the three months ended 2006, but are not included in 2005. Results for the three months ended September 30, 2005 relate to the DENA Midwest assets. EBIT losses for these assets decreased approximately $15 million for the three months ended September 30, 2006 as compared to the same period in the previous year.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The increase was primarily driven by the acquisition of Cinergy assets for which results, including the impacts of purchase accounting, are reflected from the date of acquisition and thereafter, but are not included in the same period in 2005. Operating revenues associated with the DENA Midwest plants were approximately $91 million lower for the nine months ended September 30, 2006 compared to the same period in the prior year primarily due to lower plant production and unfavorable hedge results.
Operating Expenses. The increase was primarily driven by the acquisition of Cinergy assets for which results, including the impacts of purchase accounting, are reflected from the date of acquisition and thereafter, but are not included in the same period in 2005. Operating expenses associated with the DENA Midwest plants were approximately $101 million lower for the nine months ended September 30, 2006 compared to the same period in the prior year primarily due to lower plant production and improved fuel hedge results.
Gain on Sales of Other Assets and Other, net. The decrease was driven primarily by losses of approximately $15 million on sales of emission allowances, offset by an approximate $6 million gain on the sale of the Pine Mountain synthetic fuel facility.
EBIT. The increase was due primarily to the acquisition of Cinergy assets for which results, including the impacts of purchase accounting, are reflected from the date of acquisition and thereafter, but are not included in the same period in 2005. Results for the nine months ended 2005 relate to the DENA Midwest assets. EBIT losses for these assets decreased approximately $10 million in 2006 compared to the same period in the prior year.
72
PART I
International Energy
Three Months Ended
September 30, |
Nine Months Ended September 30, |
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2006
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2005
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Increase
(Decrease) |
2006
|
2005
|
Increase (Decrease) |
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(in millions, except where noted) | ||||||||||||||||||||||
Operating revenues |
$ | 238 | $ | 186 | $ | 52 | $ | 719 | $ | 536 | $ | 183 | ||||||||||
Operating expenses |
187 | 139 | 48 | 577 | 385 | 192 | ||||||||||||||||
Gains on sales of other assets and other, net |
(1 | ) | 1 | (2 | ) | (1 | ) | 1 | (2 | ) | ||||||||||||
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Operating income |
50 | 48 | 2 | 141 | 152 | (11 | ) | |||||||||||||||
Other income and expenses, net |
25 | 19 | 6 | 56 | 74 | (18 | ) | |||||||||||||||
Minority interest expense |
7 | 4 | 3 | 16 | 9 | 7 | ||||||||||||||||
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EBIT |
$ | 68 | $ | 63 | 5 | $ | 181 | $ | 217 | $ | (36 | ) | ||||||||||
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Sales, GWh |
5,485 | 4,493 | 992 | 15,715 | 13,555 | 2,160 | ||||||||||||||||
Proportional megawatt capacity in operation |
3,995 | 4,064 | (69 | ) |
Three Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The increase was driven primarily by:
| A $41 million increase in Peru due to increased ownership and resulting consolidation of Aguaytia (See Note 2 in the Consolidated Financial Statements, Acquisitions and Dispositions), and increased thermal generation in Egenor, and |
| A $7 million increase in Argentina primarily due to higher electricity generation due to favorable hydrology, higher electricity prices and increased gas marketing sales. |
Operating Expenses. The increase was driven primarily by:
| A $39 million increase in Peru due to increased ownership and resulting consolidation of Aguaytia (See Note 2 in the Consolidated Financial Statements, Acquisitions and Dispositions), and increased purchased power and fuel costs in Egenor, and |
| A $10 million increase in Brazil due to unfavorable exchange rates, increased regulatory fees, and increased purchased power. |
Other Income and Expenses, net . The increase was driven primarily by a $20 million equity investment impairment recorded in the prior year related to Campeche, offset by an $8 million decrease in equity earnings in 2006 from NMC due to lower MTBE margins and an unplanned outage.
EBIT. The increase in EBIT was primarily due to the prior year impairment as discussed above, offset by higher purchased power costs in Egenor, and lower MTBE margins and an unplanned outage at NMC in 2006.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The increase was driven primarily by:
| A $89 million increase in Peru due to increased ownership and resulting consolidation of Aguaytia (See Note 2 in the Consolidated Financial Statements, Acquisitions and Dispositions) and an increase in energy sales in Egenor. |
| A $41 million increase in El Salvador primarily due to higher energy prices as a result of a favorable regulatory price bid methodology. |
| A $28 million increase in Brazil due to favorable exchange rates and higher average energy prices, offset by lower volumes, and |
| A $25 million increase in Argentina mainly due to higher electricity generation as a result of favorable hydrology, higher electricity prices and increased gas marketing sales. |
Operating Expenses. The increase was driven primarily by:
| A $88 million increase in Peru due to increased ownership and resulting consolidation of Aguaytia (See Note 2 in the Consolidated Financial Statements, Acquisitions and Dispositions) and increased purchased power and fuel costs in Egenor |
| A $36 million increase in El Salvador primarily due to higher fuel prices and increased fuel consumption |
| A $32 million increase in Mexico mainly due to an allowance on notes receivable from the Campeche equity investment, and |
| A $30 million increase in Brazil due to unfavorable exchange rates, increased regulatory fees, and purchased power costs |
73
PART I
Other Income and Expenses, net . The decrease was primarily due to the increased ownership and resulting consolidation of Aguaytia (See Note 2 in the Consolidated Financial Statements, Acquisitions and Dispositions), in addition to lower MTBE margins and unplanned outages at NMC.
EBIT. The decrease in EBIT was primarily due to an impairment of the Campeche equity investment and notes receivable as discussed above and higher purchased power costs in Egenor due to lower hydrology, offset by favorable hydrology and pricing in Argentina.
Matters Impacting Future Results
The Bolivian government has announced plans to nationalize its energy infrastructure. As a result, management is currently monitoring the
potential impact on its 50 percent interest in Corani. Depending upon future actions of the Bolivian government, Duke Energys investment in Corani could become impaired. Additionally, Duke Energy is evaluating various options related to
certain of its operations, principally in Bolivia and Ecuador, which could include the sale or other disposition of these operations. Impairments or losses could be recognized in future periods if Duke Energy decides to pursue such a sale or
Crescent (a)
Three Months Ended
September 30, |
Nine Months Ended September 30, |
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2006
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2005
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Increase (Decrease) |
2006
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2005
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Increase (Decrease) |
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(in millions) | |||||||||||||||||||||||
Operating revenues |
$ | 66 | $ | 105 | $ | (39 | ) | $ | 221 | $ | 281 | $ | (60 | ) | |||||||||
Operating expenses |
37 | 95 | (58 | ) | 158 | 225 | (67 | ) | |||||||||||||||
Gains on sales of investments in commercial and multi-family real estate |
30 | 63 | (33 | ) | 201 | 117 | 84 | ||||||||||||||||
Gains on sales of other assets and other, net |
246 | | 246 | 246 | | 246 | |||||||||||||||||
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Operating income |
305 | 73 | 232 | 510 | 173 | 337 | |||||||||||||||||
Equity in earnings of unconsolidated affiliates |
(4 | ) | | (4 | ) | (4 | ) | | (4 | ) | |||||||||||||
Other income and expenses, net |
1 | 46 | (45 | ) | 14 | 44 | (30 | ) | |||||||||||||||
Minority interest expense |
2 | (1 | ) | 3 | 5 | 7 | (2 | ) | |||||||||||||||
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EBIT |
$ | 300 | $ | 120 | $ | 180 | $ | 515 | $ | 210 | $ | 305 | |||||||||||
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(a) | In September 2006, Duke Energy completed a joint venture transaction at Crescent. As a result, Crescent segment data includes Crescent as a consolidated entity for periods prior to September 7, 2006 and as an equity investment for the periods subsequent to September 7, 2006. |
Three Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The decrease was driven primarily by a $31 million decrease in residential developed lot sales, primarily due to decreased sales at the LandMar division in Florida.
Operating Expenses. The decrease was driven primarily by a $23 million decrease in the cost of residential developed lot sales as noted above and a $16 million impairment charge in the third quarter 2005 related to a residential community in South Carolina (Oldfield).
Gains on Sales of Investments in Commercial and Multi-Family Real Estate . The decrease was driven primarily by a $41 million land sale gain at Catawba Ridge in South Carolina in the third quarter of 2005 compared to lesser activity in the third quarter of 2006.
Gains on Sales of Other Assets and Other, net . The increase was due to an approximate $250 million pre-tax gain on Duke Energys sale of 50% of its interest in Crescent (see Note 2 to the Consolidated Financial Statements, Acquisitions and Dispositions).
Other Income and expenses, net . The decrease is primarily due to the $45 million gain from the sale of assets owned by Crescent Brookdale Associates, an unconsolidated joint venture, in the third quarter of 2005 with no comparable gains in the third quarter of 2006.
EBIT . The increase is due primarily to an approximate $250 million gain on the sale of ownership interests in Crescent in the third quarter 2006, as discussed above, partially offset by the gains on the sale of Catawba Ridge and Brookdale in the third quarter of 2005 as noted above.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues. The decrease was driven primarily by a $51 million decrease in residential developed lot sales, primarily due to decreased sales at the LandMar division in Florida.
74
PART I
Operating Expenses. The decrease was driven primarily by a $41 million decrease in the cost of residential developed lot sales as noted above and a $16 million impairment charge in 2005 related to a residential community in South Carolina (Oldfield).
Gains on Sales of Investments in Commercial and Multi-Family Real Estate . The increase was driven primarily by an $81 million gain on the sale of two office buildings at Potomac Yard in Washington, DC along with a $52 million land sale at Lake Keowee in northwestern South Carolina in 2006, partially offset by a $41 million land sale at Catawba Ridge in South Carolina in 2005.
Gains on Sales of Other Assets and Other, net . The increase was due to an approximate $250 million pre-tax gain on Duke Energys sale of 50% of its interest in Crescent (see Note 2 to the Consolidated Financial Statements, Acquisitions and Dispositions).
Other Income and Expenses, net . The decrease is primarily due to the $45 million gain from the sale of assets owned by Crescent Brookdale Associates, an unconsolidated joint venture, in the third quarter of 2005 with no comparable gains during the nine months ended September 30, 2006.
EBIT. The increase was primarily due to the sale of the Potomac Yard office buildings and the sale of an ownership interest in Crescent as noted above.
Matters Impacting Future Results
In September 2006, Duke Energy closed an agreement to create a joint venture of Crescent and sold an effective 50% interest in Crescent to the MS Members. In conjunction with the formation of the Crescent JV, the joint venture, Crescent and Crescents subsidiaries entered into a credit agreement with third party lenders under which Crescent borrowed approximately $1.23 billion, of which $1.19 billion was immediately distributed to Duke Energy. Subsequent to the sale, Duke Energy deconsolidated its investment in the Crescent JV and has accounted for the investment under the equity method of accounting. The combination of Duke Energys reduction in ownership and the increased interest expense at Crescent JV as a result of the debt transaction, the impacts of which will be reflected in Duke Energys future equity earnings, will likely significantly impact the amount of equity earnings of the Crescent JV that Duke Energy will recognize in future periods. Since the Crescent JV will capitalize interest as a component of project costs, the impacts of the interest expense on Duke Energys equity earnings will be recognized as projects are sold by the Crescent JV.
Other
Three Months Ended September 30, |
Nine Months Ended September 30, |
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2006
|
2005
|
Increase (Decrease) |
2006
|
2005
|
Increase (Decrease) |
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(in millions) | ||||||||||||||||||||||||
Operating revenues |
$ | 67 | $ | 225 | $ | (158 | ) | $ | 338 | $ | 430 | $ | (92 | ) | ||||||||||
Operating expenses |
211 | 293 | (82 | ) | 679 | 796 | (117 | ) | ||||||||||||||||
Gains on sales of other assets and other, net |
3 | 3 | | | 7 | (7 | ) | |||||||||||||||||
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Operating income |
(141 | ) | (65 | ) | (76 | ) | (341 | ) | (359 | ) | 18 | |||||||||||||
Other income and expenses, net |
32 | (103 | ) | 135 | (7 | ) | (100 | ) | 93 | |||||||||||||||
Minority interest expense |
2 | (3 | ) | 5 | (5 | ) | (7 | ) | 2 | |||||||||||||||
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EBIT |
$ | (111 | ) | $ | (165 | ) | $ | 54 | $ | (343 | ) | $ | (452 | ) | $ | 109 | ||||||||
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Three Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues . The decrease was driven primarily by:
| A $130 million decrease due to the continued wind-downs of DETM, DEM and Duke Energys 50% interest in D/FD |
| A $30 million decrease due to a prior year mark-to-market gain related to DENAs hedge discontinuance in the Southeast. |
Operating Expenses . The decrease was driven primarily by:
| A $143 million decrease due to the continued wind-downs of DETM, DEM and Duke Energys 50% interest in D/FD |
| A $46 million decrease due primarily to the recognition of reserves for estimated property damage related to hurricanes and business interruption losses in 2005, and timing of other captive insurance claims, partially offset by |
| A $55 million increase in charges for liabilities associated with mutual insurance companies |
| A $23 million increase in corporate governance and other costs due primarily to the merger with Cinergy in April 2006 |
75
PART I
| A $19 million increase due to costs-to-achieve in 2006 related to the Cinergy merger |
| A $10 million increase due to costs-to-achieve in 2006 related to the anticipated spin-off of Duke Energys natural gas business. |
Other Income and Expenses, net . The increase was driven primarily by an approximate $125 million favorable variance resulting from the realized and unrealized mark-to-market impacts associated with certain discontinued cash flow hedges originally entered into to hedge Field Services commodity price risk which are recorded in Other income and expenses, net on the Consolidated Statements of Operations subsequent to the deconsolidation of DEFS, effective July 1, 2005.
EBIT. The increase was due primarily to the favorable variance related to realized and unrealized mark-to-market impacts of certain discontinued cash flow hedges originally entered into to hedge Field Services commodity price risk. This increase was partially offset by decreases due to charges in 2006 associated with Cinergy merger and natural gas business spin-off costs-to-achieve, and an increase in corporate governance and other costs due to the merger with Cinergy.
Nine Months Ended September 30, 2006 as Compared to September 30, 2005
Operating Revenues . The decrease was driven primarily by:
| A $203 million decrease due to the continued wind-downs of DETM, DEM and Duke Energys 50% interest in D/FD |
| A $30 million decrease due to a prior year mark-to-market gain related to DENAs hedge discontinuance in the Southeast, partially offset by |
| An approximate $130 million increase as a result of the prior year impact of realized and unrealized mark-to-market losses on certain discontinued cash flow hedges originally entered into to hedge Field Services commodity price risk which were accounted for as Operating Revenues prior to the deconsolidation of DEFS, effective July 1, 2005. |
Operating Expenses . The decrease was driven primarily by:
| A $249 million decrease due to the continued wind-downs of DETM, DEM and Duke Energys 50% interest in D/FD |
| A $38 million decrease due primarily to the recognition of reserves for estimated property damage related to hurricanes and business interruption losses in 2005, and timing of other captive insurance claims, partially offset by |
| A $13 million increase in charges for liabilities associated with mutual insurance companies |
| A $43 million increase in corporate governance and other costs due primarily to the merger with Cinergy in April 2006 |
| A $97 million increase due to costs-to-achieve in 2006 related to the Cinergy merger |
| A $17 million increase due to costs-to-achieve in 2006 related to the anticipated spin-off of Duke Energys natural gas business. |
Other Income and Expenses, net . The increase was driven primarily by an approximate $80 million favorable variance resulting from the realized and unrealized mark-to-market impacts associated with certain discontinued cash flow hedges originally entered into to hedge Field Services commodity price risk which are recorded in Other income and expenses, net on the Consolidated Statements of Operations subsequent to the deconsolidation of DEFS, effective July 1, 2005.
EBIT. The increase was due primarily to the favorable variance related to realized and unrealized mark-to-market impacts of certain discontinued cash flow hedges originally entered into to hedge Field Services commodity price risk, and favorable captive insurance results. These increases were partially offset by decreases due to charges in 2006 associated with Cinergy merger and natural gas business spin-off costs-to-achieve, and an increase in corporate governance and other costs due to the merger with Cinergy.
LIQUIDITY AND CAPITAL RESOURCES
Operating Cash Flows
Net cash provided by operating activities increased $236 million for the nine months ended September 30, 2006 compared to the same period in 2005. This change was driven primarily by:
| The impacts of the merger with Cinergy, effective April 3, 2006, |
| Collateral received by Duke Energy (approximately $540 million) in 2006 from Barclays, partially offset by |
| The settlement of the payable to Barclays (approximately $600 million) in 2006, and |
| An approximate $400 million decrease in 2006 due to the net settlement of remaining DENA contracts. |
76
PART I
Investing Cash Flows
Net cash used in investing activities increased $1,380 million for the nine months ended September 30, 2006 compared to the same period in 2005. This change was driven primarily by:
| An approximate $950 million increase in short-term investments in 2006 as compared to 2005, due primarily to proceeds from the Crescent debt financing, and |
| An approximate $480 million increase in 2006 capital and investment expenditures, primarily related to Cinergy. |
Financing Cash Flows and Liquidity
Net cash used in financing activities decreased $1,634 million for the nine months ended September 30, 2006, compared to the same period in 2005. This change was driven primarily by:
| An approximate $1.4 billion increase in the proceeds from the issuance of long-term debt in 2006, net of redemptions, due to the Crescent JV transaction |
| An approximate $400 million decrease in share repurchases under the accelerated share repurchase plan due to the repurchase of 32.6 million shares of common stock for approximately $933 million during the nine months ended September 30, 2005, compared to the repurchase of 17.5 million shares for approximately $500 million during the nine months ended September 30, 2006, partially offset by |
| An approximate $271 million increase in dividends paid due to the increase in the quarterly dividend paid per share combined with a larger number of shares outstanding primarily due to the merger with Cinergy. |
Duke Energy previously announced plans to execute up to approximately $2.5 billion in common stock repurchases over a three year period. On May 9, 2005, in connection with the announcement of the merger with Cinergy, Duke Energy suspended additional repurchases, pending further assessment. At the time of suspension, Duke Energy had repurchased approximately $933 million of common stock. In the first quarter of 2006, as a result of the March 10, 2006 shareholder approval of the merger, Duke Energys Board of Directors authorized the repurchase of up to an additional $1 billion of common stock under the previously announced share repurchase plan. During the nine months ended September 30, 2006, Duke Energy repurchased approximately 17.5 million shares for total consideration of approximately $500 million. The repurchases and corresponding commissions and other fees were recorded in Common Stockholders Equity as a reduction in common stock and additional paid-in capital. In June 2006, Duke Energy suspended additional repurchases of Duke Energy common stock under the repurchase plan due to its plan to spin off the natural gas businesses. At the time of the June 2006 suspension of the repurchase plan, Duke Energy had repurchased approximately 50 million shares of common stock for approximately $1.4 billion since inception of the repurchase plan. In October 2006, Duke Energys Board of Directors authorized the reactivation of the share repurchase plan for Duke Energy of up to $500 million of share repurchases after the spin-off of the natural gas businesses has been completed.
Significant Financing Activities. During the nine months ended September 30, 2006, Duke Energys consolidated credit capacity increased by approximately $763 million, primarily due to the merger with Cinergy. This increase was net of other reductions in credit capacity due to the terminations of an $800 million syndicated credit facility and $460 million of other bi-lateral credit facilities. The terminations of these credit facilities primarily reflect Duke Energys reduced liquidity needs as a result of exiting the DENA business.
In June 2006, Duke Energy Indiana issued $325 million principal amount of 6.05% senior unsecured notes due June 15, 2016. Proceeds from the issuance were used to repay $325 million of 6.65% First Mortgage Bonds that matured on June 15, 2006.
In August 2006, Duke Energy Kentucky issued approximately $77 million principal amount of floating rate tax-exempt notes due August 1, 2027. Proceeds from the issuance were used to refund a like amount of debt on September 1, 2006 then outstanding at Duke Energy Ohio, Inc. (Duke Energy Ohio). Approximately $27 million of the floating rate debt was swapped to a fixed rate concurrent with closing.
In September 2006, prior to the completion of the partial sale of Crescent to the MS Members as discussed in Note 2, Crescent issued approximately $1.23 billion principal amount of debt. The net proceeds from the debt issuance of approximately $1.21 billion were distributed by Crescent to Duke Energy and recorded as a Financing Activity on the Consolidated Statements of Cash Flows. As a result of Duke Energys deconsolidation of Crescent effective September 7, 2006, Crescents outstanding debt balance of $1,298 million was removed from Duke Energys Consolidated Balance Sheets.
During the three months ended September 30, 2006, Duke Energy increased the portion of outstanding commercial paper and pollution control bond balances classified as long-term from $300 million to $779 million. This non-current classification is due to the existence of long-term credit facilities which back-stop these balances along with Duke Energys intent to refinance such balances on a long-term basis.
77
PART I
In September 2006, Union Gas entered into a fixed-rate financing agreement denominated in 165 million Canadian dollars (approximately $148 million in U.S. dollar equivalents as of the issuance date) due in 2036 with an interest rate of 5.46%.
In October 2006, Duke Energy Carolinas issued $150 million in tax-exempt floating-rate bonds. The bonds are structured as variable-rate demand bonds, subject to weekly remarketing and bear a final maturity of 2031. The initial interest rate was set at 3.72%. The bonds are supported by an irrevocable 3-year direct-pay letter of credit and were issued through the North Carolina Capital Facilities Finance Agency to fund a portion of the environmental capital expenditures at the Marshall and Belews Creek Steam Stations.
During October 2006, the $130 million bi-lateral credit facility at Duke Capital was cancelled. In addition, the remaining $120 million bi-lateral credit facility was cancelled in November 2006 and reissued at Duke Energy for the same amount with the same terms and conditions.
During 2006, Duke Energy has repurchased approximately 17.5 million shares of its common stock for approximately $500 million. In connection with the plan to spin off Duke Energys natural gas business to Duke Energy shareholders (see Other Issues), the share repurchase program has since been suspended.
During the second and third quarters of 2006, Duke Energys $742 million of convertible debt became convertible into approximately 31.7 million shares of Duke Energy common stock due to the market price of Duke Energy common stock achieving a specified threshold during each respective quarter. Holders of the convertible debt were able to exercise their right to convert on or prior to each quarter end. During the second and third quarters, approximately $632 million of debt was converted into approximately 27 million shares of Duke Energy Common Stock. At September 30, 2006, the balance of the convertible debt is approximately $110 million and remains convertible in the fourth quarter of 2006 into approximately 4.7 million shares of Duke Energy common stock as a result of the stock having achieved a specified price threshold during the third quarter.
In October 2006, Duke Energy received pre-tax proceeds of approximately $700 million from the sale of Cinergy Marketing and Trading, LP, and Cinergy Canada, Inc. (collectively CMT) to Fortis.
In December 2004, Duke Energy reached an agreement to sell its partially completed Grays Harbor power generation facility to an affiliate of Invenergy LLC. In 2004, Duke Energy terminated its capital lease with the dedicated pipeline which would have transported natural gas to Grays Harbor. As a result of this termination, approximately $94 million was paid by Duke Energy in January 2005.
On March 1, 2005, redemption notices were sent to the bondholders of the $100 million PanEnergy 8.625% bonds due in 2025. These bonds were redeemed on April 15, 2005 at a redemption price of 104.03 or approximately $104 million.
During the three-month period ended March 31, 2005, Duke Energy increased the portion of outstanding commercial paper balances classified as long-term debt from $150 million to $300 million. This non-current classification is due to the existence of long-term credit facilities which back-stop these commercial paper balances along with Duke Energys intent to refinance such balances on a long-term basis.
In August 2005, Duke Energys International business unit issued project-level debt in Peru, of which $75 million is denominated in U.S. dollars and approximately $34 million (in U.S. dollar equivalents) is denominated in Peru Nuevos Soles. This debt has terms ranging from four to six years as well as variable and fixed interest rate terms, as applicable.
On September 21, 2005, Union Gas entered into a fixed-rate financing denominated in 200 million Canadian dollars (approximately $171 million in U.S. dollar equivalents) due in 2016 with an interest rate of 4.64%.
Duke Energys U.S. Franchised Electric & Gas business is evaluating the construction of several large, new electric generating plants in North Carolina, South Carolina, and Indiana. During this evaluation process, Duke Energy has begun to see significant increases in the estimated costs of these projects driven by strong domestic and international demand for the material, equipment, and labor necessary to construct these facilities. As a result of such increases, Duke Energy recently made a filing with the North Carolina Utilities Commission related to the Duke Energy Carolinas request for a Certificate of Public Convenience and Necessity (CPCN) to build two 800-megawatt coal units at its existing Cliffside Steam Station. In this filing, Duke Energy Carolinas states the rising costs described above could increase the cost of building the Cliffside units from approximately $2 billion to approximately $3 billion. Duke Energy made this updated filing so that the Commission would have the most current cost information prior to issuing a CPCN in this proceeding.
Duke Energy Indianas estimated costs associated with the potential construction of an Integrated Gasification and Combined Cycle plant in Indiana have also increased. Duke Energy Indianas publicly filed testimony with the Indiana Utility Regulatory Commission indicates that industry (EPRI) total capital requirement estimates for a facility of this type and size are now in the range of $1.6 billion to $2.1 billion (including escalation to 2011 and owners specific site costs).
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Effective with the third quarter 2006, the Board of Directors of Duke Energy have approved a quarterly dividend increase of $0.01 per share, increasing the annual dividend to $1.28 per share.
Available Credit Facilities and Restrictive Debt Covenants. Duke Energys debt and credit agreements contain various financial and other covenants. Failure to meet those covenants beyond applicable grace periods could result in accelerated due dates and/or termination of the agreements. As of September 30, 2006, Duke Energy was in compliance with those covenants. In addition, some credit agreements may allow for acceleration of payments or termination of the agreements due to nonpayment, or to the acceleration of other significant indebtedness of the borrower or some of its subsidiaries. None of the debt or credit agreements contain material adverse change clauses.
Credit Ratings. Duke Energy and certain subsidiaries each hold credit ratings by Standard & Poors (S&P), Moodys Investors Service (Moodys) and Dominion Bond Rating Service (DBRS).
The most recent rating action by S&P occurred in September 2006 when S&P changed the outlook of Duke Capital, Texas Eastern Transmission, LP, Union Gas and Westcoast Energy Inc. (collectively the gas entities) from developing to positive following the completion of their assessment of Duke Energys announcement of the separation of the electric and gas businesses. S&P had earlier in June 2006 changed the outlook of the gas entities from positive to developing due to S&Ps uncertainty as to how the new gas company would be capitalized and funded. In May 2006, S&P changed the outlook of Duke Energy and all of its subsidiaries (with the exception of Maritimes & Northeast Pipeline, LLC and Maritimes & Northeast Pipeline, LP (collectively M&N Pipeline) and Duke Energy Trading and Marketing, LLC from stable to positive reflecting Duke Energys announcement to sell Cinergys commercial trading and marketing operations. In April 2006, following the completion of Duke Energys merger with Cinergy, S&P lowered the credit rating of Cinergy Corp. and raised the credit rating of Duke Capital each one ratings level as disclosed in the table below. At the same time, S&P removed Cinergy and its subsidiaries from credit-watch negative, assigned a credit rating to Duke Energy Carolinas, LLC (formerly Duke Power Company LLC) and left the remaining credit ratings in the table disclosed below unchanged. At the completion of S&Ps April action, all the credit ratings were on stable outlook. S&Ps ratings action in April also included a lowering of Cinergys Corporate Credit Rating (CCR) consistent with Duke Energys CCR as disclosed in the table below. S&P last affirmed its rating for M&N Pipeline in July 2006 where it has remained unchanged with a stable outlook for the last several years.
The most recent rating action by Moodys occurred in October 2006 when the credit ratings of Duke Capital and Texas Eastern Transmission, LP were placed under review for possible upgrade following Moodys preliminary assessment of Duke Capitals pending restructuring as a subsidiary of the new natural gas company, which would be named Spectra Energy. In April 2006 upon Duke Energys completion of the merger with Cinergy, Moodys upgraded the credit ratings of Duke Energy Carolinas, LLC (formerly rated as Duke Energy by Moodys prior to the merger), Duke Capital and Texas Eastern Transmission, LP one ratings level each and assigned an issuer rating to New Duke Energy as disclosed in the table below. Moodys concluded their April action placing New Duke Energy and Duke Energy Carolinas, LLC on positive outlook and Duke Capital and Texas Eastern Transmission, LP on stable outlook. Moodys also confirmed all of Cinergy and its subsidiaries credit ratings and changed the outlook to positive with the exception of Duke Energy Indiana, Inc. (formerly PSI Energy, Inc.) which was left on stable outlook. Moodys noted in their April action the substantial reduction in business and operating risk of Duke Energy Carolinas, LLC from the distribution of its ownership in Duke Capital to a new holding company and the substantial reduction in business and operating risk of Duke Capital through the restructuring of its ownership in DEFS and the divestiture of the Duke Energy North America merchant generation assets and trading book. Moodys also noted the upgrade at Texas Eastern Transmission, LP in connection to its parent Duke Capital. In August 2005, Moodys concluded a review of M&N Pipeline and downgraded the credit ratings one ratings level to the respective ratings disclosed in the table below concluding this action with a stable outlook. Moodys action was primarily as a result of their concerns over the downward revisions in the reserve estimates for the Sable Offshore Energy Project (SOEI) and reduced production by SOEI producers. In August 2006, Moodys revised the outlook for Maritimes & Northeast Pipeline, LLC to negative, noting the potential for a somewhat weaker shipper profile resulting from a recently announced expansion project on the U.S. portion of the pipeline.
The most recent rating action by DBRS occurred in June 2006 when DBRS confirmed the stable trend of the entities disclosed in the table below following Duke Energys announcement of the separation of the electric and gas businesses. Each of the credit ratings assigned by DBRS to the entities below has remained unchanged for the last several years with a stable trend.
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The following table summarizes the November 1, 2006 credit ratings from the agencies retained by Duke Energy to rate its securities, its principal funding
Credit Ratings Summary as of November 1, 2006
Standard
and
|
Moodys
Service |
Dominion Bond
Rating Service |
||||
Duke Energy (a) |
BBB | Baa2 | Not applicable | |||
Duke Energy Carolinas, LLC (b) |
BBB | A3 | Not applicable | |||
Duke Capital LLC (b) |
BBB | Baa2 | Not applicable | |||
Cinergy (b) |
BBB- | Baa2 | Not applicable | |||
Duke Energy Ohio, Inc. (b) |
BBB | Baa1 | Not applicable | |||
Duke Energy Indiana, Inc. (b) |
BBB | Baa1 | Not applicable | |||
Duke Energy Kentucky, Inc. (b) |
BBB | Baa1 | Not applicable | |||
Texas Eastern Transmission, LP (b) |
BBB | Baa1 | Not applicable | |||
Westcoast Energy Inc. (b) |
BBB | Not applicable | A(low) | |||
Union Gas (b) |
BBB | Not applicable | A | |||
Maritimes & Northeast Pipeline, LLC (c) |
A | A2 | A | |||
Maritimes & Northeast Pipeline, LP (c) |
A | A2 | A | |||
Duke Energy Trading and Marketing, LLC (d) |
BBB- | Not applicable | Not applicable |
(a) | Represents corporate credit rating and issuer rating for S&P and Moodys respectively |
(b) | Represents senior unsecured credit rating |
(c) | Represents senior secured credit rating |
(d) | Represents corporate credit rating |
These entities credit ratings are dependent upon, among other factors, the ability to generate sufficient cash to fund capital and investment expenditures, while maintaining the strength of their current balance sheets. In addition, the M&N Pipeline ratings are dependent upon, among other factors, the future gas supply availability and potential changes in customer credit profiles. These credit ratings could be negatively impacted if as a result of market conditions or other factors, these entities are unable to maintain their current balance sheet strength, or if earnings and cash flow outlook materially deteriorates, or if the gas supply availability contracted on the M&N pipeline materially deteriorates, or the M&N customer credit profiles materially deteriorates.
During the third quarter of 2005, the Board of Directors of Duke Energy authorized and directed management to execute the sale or disposition of substantially all of DENAs remaining assets and contracts outside the Midwestern United States. On November 18, 2005, Duke Energy announced it signed an agreement to transfer substantially all of the DENA portfolio of derivatives contracts to Barclays. Under the agreement, Barclays acquired substantially all of DENAs outstanding gas and power derivatives contracts which essentially eliminated Duke Energys credit, collateral, market and legal risk associated with DENAs derivative trading positions effective on the date of signing. Substantially all of the underlying contracts have been transferred to Barclays.
Duke Energy operates a commercial marketing and trading business that was acquired as part of the merger with Cinergy in April 2006. In June 2006, Duke Energy announced it had reached an agreement to sell CMT, as well as associated contracts. The sale closed in October 2006 and, upon closing, the buyer assumed the credit, collateral, market and legal risk associated with the trading positions acquired.
A reduction in the credit rating of Cinergy Corp to below investment grade as of September 30, 2006 would have required the posting of additional collateral of up to approximately $285 million, of which $79 million is related to Duke Energy Ohio, a wholly-owned subsidiary of Cinergy Corp.
A reduction in the credit rating of Duke Capital to below investment grade as of September 30, 2006 would have resulted in Duke Capital posting additional collateral of up to approximately $358 million. The majority of this collateral is related to outstanding surety bonds.
Duke Energy would fund any additional collateral requirements through a combination of cash on hand and the use of credit facilities. Additionally, if credit ratings for Duke Energy or its affiliates fall below investment grade there is likely to be a negative impact on its working capital and terms of trade that is not possible to fully quantify, in addition to the posting of additional collateral and segregation of cash described above.
Other Financing Matters. As of September 30, 2006, Duke Energy and its subsidiaries had effective SEC shelf registrations for up to $2,467 million in gross proceeds from debt and other securities, which include approximately $925 million of effective registrations at legacy Cinergy. Additionally, as of September 30, 2006, Duke Energy had 935 million Canadian dollars (approximately U.S. $838 million) available under Canadian shelf registrations for issuances in the Canadian market. Of the 935 million Canadian dollars available under Canadian shelf registrations, 500 million expires in May 2008 and 435 million expires in August 2008.
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Off-Balance Sheet Arrangements
During the nine months ended September 30, 2006, there were changes to Duke Energys off-balance sheet arrangements, primarily related to the merger with Cinergy. Cinergy has an agreement to sell certain of their accounts receivable and related collections to Cinergy Receivables, which is a qualified special purpose entity pursuant to SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, (SFAS No. 140) and therefore is an unconsolidated entity of Duke Energy. For further information on Cinergys off-balance sheet arrangements, see Off-Balance Sheet Arrangements in Cinergys Annual Report on Form 10-K for the year-ended December 31, 2005. For information on Duke Energys off-balance sheet arrangements, see Off-Balance Sheet Arrangements in Duke Energys Annual Report on Form 10-K for the year-ended December 31, 2005.
Contractual Obligations
Duke Energy enters into contracts that require cash payment at specified periods, based on specified minimum quantities and prices. During the nine months ended September 30, 2006, there were material changes in Duke Energys contractual obligations from the amounts reported in Duke Energys Annual Report on Form 10-K for the year-ended December 31, 2005. These changes primarily relate to approximately $7 billion of contractual obligations assumed as part of the merger with Cinergy, which are primarily comprised of payments on long-term debt, payments under operating and capital leases and contracts to purchase fuel, primarily coal. For an in-depth discussion of Duke Energys contractual obligations, see Contractual Obligations and Quantitative and Qualitative Disclosures about Market Risk in Managements Discussion and Analysis of Results of Operations and Financial Condition in Duke Energys Annual Report
on Form 10-K for the year ended December 31, 2005. Additionally, for information related to Cinergy, see Contractual Cash Obligations in Managements Discussion and AnalysisLiquidity and Capital Resources in Cinergys Annual Report of Form 10-K for the year ended December 31, 2005.
OTHER ISSUES
Plan to Separate Duke Energys Natural Gas and Electric Power Businesses . In June 2006, the Board of Directors of Duke Energy authorized management to pursue a plan to create two separate publicly traded companies by spinning off Duke Energys natural gas businesses to Duke Energy shareholders. The new natural gas company, which would be named Spectra Energy, would principally consist of Duke Energys Natural Gas Transmission business segment, which includes Union Gas, and Duke Energys 50-percent ownership interest in DEFS. The primary businesses remaining in Duke Energy post-spin are anticipated to principally be the U.S. Franchised Electric and Gas business segment, the Commercial Power business segment, the International Energy business segment and Duke Energys 50% interest in the Crescent JV. It is anticipated that approximately $9 billion of debt currently at Duke Capital and its consolidated subsidiaries would transfer to the new natural gas company at the time of the spin-off. While the actual timing of the spin-off, if it occurs, is dependent upon the resolution of certain regulatory and other matters, Duke Energy is currently targeting a January 1, 2007 effective date for the transaction. Duke Energy expects the transaction to qualify for tax-free treatment for U.S. federal income tax purposes to both Duke Energy and its shareholders and is still evaluating other income tax impacts of the transaction. The transaction required Virginia State Corporation Commission approval, which was received during the third quarter of 2006. In addition, approval from the Federal Communications Commission is required for the indirect change in control over various licenses from Duke Energy to the new gas company. Duke Energy made the requisite applications in the third quarter 2006. The results of the natural gas businesses are expected to be treated as discontinued operations in the period the spin-off is consummated.
(For additional information on other issues related to Duke Energy, see Note 16 to the Consolidated Financial Statements, Regulatory Matters and Note 17 to the Consolidated Financial Statements, Commitments and Contingencies.)
New Accounting Standards
The following new accounting standards have been issued, but have not yet been adopted by Duke Energy as of September 30, 2006:
Statement of Financial Accounting Standards (SFAS) No. 155, Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and 140 (SFAS No. 155). In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS No. 140 . SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for at fair value at acquisition, at issuance, or when a previously recognized financial instrument is subject to a remeasurement (new basis) event, on an instrument-by-instrument basis, in cases in which a derivative would otherwise have to be bifurcated. SFAS No. 155 is effective for Duke Energy for all financial instruments acquired, issued, or subject to remeasurement after January 1, 2007, and for certain hybrid financial instruments that have been bifurcated prior to
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the effective date, for which the effect is to be reported as a cumulative-effect adjustment to beginning retained earnings. Duke Energy does not anticipate the adoption of SFAS No. 155 will have any material impact on its consolidated results of operations, cash flows or financial position.
SFAS No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement No. 140 (SFAS No. 156). In March 2006, the FASB issued SFAS No. 156, which amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 156 requires recognition of a servicing asset or liability when an entity enters into arrangements to service financial instruments in certain situations. Such servicing assets or servicing liabilities are required to be initially measured at fair value, if practicable. SFAS No. 156 also allows an entity to subsequently measure its servicing assets or servicing liabilities using either an amortization method or a fair value method. SFAS No. 156 is effective for Duke Energy as of January 1, 2007, and must be applied prospectively, except that where an entity elects to remeasure separately recognized existing arrangements and reclassify certain available-for-sale securities to trading securities, any effects must be reported as a cumulative-effect adjustment to retained earnings. Duke Energy does not anticipate the adoption of SFAS No. 156 will have any material impact on its consolidated results of operations, cash flows or financial position.
SFAS No. 157, Fair Value Measurements (SFAS No. 157). In September 2006, the FASB issued SFAS No. 157, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. However, in some cases, the application of SFAS No. 157 may change Duke Energys current practice for measuring and disclosing fair values under other accounting pro
nouncements that require or permit fair value measurements. For Duke Energy, SFAS No. 157 is effective as of January 1, 2008 and must be applied prospectively except in certain cases. Duke Energy is currently evaluating the impact of adopting SFAS No. 157, and cannot currently estimate the impact of SFAS No. 157 on its consolidated results of operations, cash flows or financial position
SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment to of FASB Statements No. 87, 88, 106, and 132(R) (SFAS No. 158) . In October 2006, the FASB issued SFAS No. 158, which changes the recognition and disclosure provisions and measurement date requirements for an employers accounting for defined benefit pension and other postretirement plans. The recognition and disclosure provisions require an employer to (1) recognize the funded status of a benefit planmeasured as the difference between plan assets at fair value and the benefit obligationin its statement of financial position, (2) recognize as a component of Other Comprehensive Income (OCI), net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost, and (3) disclose in the notes to financial statements certain additional information. SFAS No. 158 does not change the amounts recognized in the income statement as net periodic benefit cost. Duke Energy is required to initially recognize the funded status of its defined benefit pension and other postretirement plans and to provide the required additional disclosures as of December 31, 2006. Retrospective application is not permitted. Duke Energy anticipates that adoption of SFAS No. 158 recognition and disclosure provisions will result in a decrease in total assets of approximately $175 million, an increase in total liabilities of approximately $418 million and a decrease in accumulated other comprehensive income, net of tax, of approximately $593 million as of December 31, 2006. Duke Energy does not anticipate the adoption of SFAS No. 158 will have any material impact on its consolidated results of operations or cash flows.
Under the measurement date requirements of SFAS No. 158, an employer is required to measure defined benefit plan assets and obligations as of the date of the employers fiscal year-end statement of financial position (with limited exceptions). Historically, Duke Energy has measured its plan assets and obligations up to three months prior to the fiscal year-end, as allowed under the authoritative accounting literature. The measurement date requirement is effective for the year ending December 31, 2008, and early application is encouraged. Duke Energy intends to adopt the change in measurement date effective January 1, 2007 by remeasuring plan assets and benefit obligations as of that date, pursuant to the transition requirements of SFAS No. 158. Net periodic benefit cost for the three-month period between September 30, 2006 and December 31, 2006 will be recognized, net of tax, as a separate adjustment of retained earnings as of January 1, 2007, except for any gain or loss arising from curtailments or settlements, if any, during that three-month period, which would be recognized in earnings in 2006. Additionally, changes in plan assets and plan obligations between September 30, 2006 and December 31, 2006 not related to net periodic benefit cost will be recognized, net of tax, as an adjustment to Other Comprehensive Income (OCI).
Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (SAB No 108) . In September 2006 the SEC issued SAB No. 108, which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. Traditionally, there have been two widely-recognized approaches for quantifying the effects of financial statement misstatements. The income statement approach focuses primarily on the impact of a misstatement on the income statementincluding the reversing
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effect of prior year misstatementsbut its use can lead to the accumulation of misstatements in the balance sheet. The balance sheet approach, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach (a dual approach) and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material.
SAB No. 108 is effective for Duke Energys year ending December 31, 2006. SAB No. 108 permits existing public companies to initially apply its provisions either by (i) restating prior financial statements as if the dual approach had always been used or (ii), under certain circumstances, recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. Duke Energy currently uses a dual approach for quantifying identified financial statement misstatements. Therefore, Duke Energy does not anticipate the adoption of SAB No. 108 will have any material impact on its consolidated results of operations, cash flows or financial position.
FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN No. 48) . On July 13, 2006, the FASB issued FIN No. 48, which interprets SFAS No. 109, Accounting for Income Taxes. FIN No. 48 provides guidance for the recognition, measurement, classification and disclosure of the financial statement effects of a position taken or expected to be taken in a tax return (tax position). The financial statement effects of a tax position must be recognized when there is a likelihood of more than 50 percent that based on the technical merits, the position will be sustained upon examination and resolution of the related appeals or litigation processes, if any. A tax position that meets the recognition threshold must be measured initially and
subsequently as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority. The Interpretation is effective for Duke Energy as of January 1, 2007. Duke Energy is currently evaluating the impact of adopting FIN No. 48, and cannot currently estimate the impact of FIN No. 48 on its consolidated results of operations, cash flows or financial position.
FASB Staff Position (FSP) No. FAS 123(R)-5, Amendment of FASB Staff Position FAS 123(R)-1 (FSP No. FAS 123(R)-5). In October 2006, the FASB staff issued FSP No. FAS 123(R)-5 to address whether a modification of an instrument in connection with an equity restructuring should be considered a modification for purposes of applying FSP No. FAS 123(R)-1, Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R) (FSP No. FAS 123(R)-1). In August 2005, the FASB staff issued FSP FAS 123(R)-1 to defer indefinitely the effective date of paragraphs A230A232 of SFAS No. 123(R), and thereby require entities to apply the recognition and measurement provisions of SFAS No. 123(R) throughout the life of an instrument, unless the instrument is modified when the holder is no longer an employee. The recognition and measurement of an instrument that is modified when the holder is no longer an employee should be determined by other applicable generally accepted accounting principles. FSP No. FAS 123(R)-5 addresses modifications of stock-based awards made in connection with an equity restructuring and clarifies that for instruments that were originally issued as employee compensation and then modified, and that modification is made to the terms of the instrument solely to reflect an equity restructuring that occurs when the holders are no longer employees, no change in the recognition or the measurement (due to a change in classification) of those instruments will result if certain conditions are met. This FSP is effective for Duke Energy as of January 1, 2007. Duke Energy is currently evaluating the impact of adopting FSP No. FAS 123(R)-5 and cannot currently estimate the impact of adopting FAS 123(R)-5 on its consolidated results of operations, cash flows or financial position.
FSP No. AUG AIR-1, Accounting for Planned Major Maintenance Activities, (FSP AUG AIR-1). In September 2006, the FASB Staff issued FSP No. AUG AIR-1. This FSP prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods, if no liability is required to be recorded for an asset retirement obligation based on a legal obligation for which the event obligating the entity has occurred. The FSP also requires disclosures regarding the method of accounting for planned major maintenance activities and the effects of implementing the FSP. The guidance in this FSP is effective for Duke Energy as of January 1, 2007 and will be applied and retrospectively for all financial statements presented. Duke Energy does not anticipate the adoption of FSP No. AUG-AIR-1 will have any material impact on its consolidated results of operations, cash flows or financial position.
Emerging Issues Task Force (EITF) Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation) (EITF No. 06-3) . In June 2006, the EITF reached a consensus on EITF No. 06-3 to address any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales, use, value added, and some excise taxes. For taxes within the issues scope, the consensus requires that entities present such taxes on either a gross (i.e. included in revenues and costs) or net (i.e. exclude from revenues) basis according to their accounting policies, which should be disclosed. If such taxes are reported gross and are significant, entities should disclose the amounts of those taxes. Disclosures may be made on an aggregate basis.
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The consensus is effective for Duke Energy beginning January 1, 2007. Duke Energy does not anticipate the adoption of EITF No. 06-3 will have any material impact on its consolidated results of operations.
EITF Issue No. 06-5, Accounting for Purchases of Life InsuranceDetermining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (EITF No. 06-5) . In June 2006, the EITF reached a consensus on the accounting for corporate-owned and bank-owned life insurance policies. EITF No. 06-5 requires that a policyholder consider the cash surrender value and any additional amounts to be received under the contractual terms of the policy in determining the amount that could be realized under the insurance contract. Amounts that are recoverable by the policyholder at the discretion of the insurance company must be excluded from the amount that could be realized. Fixed amounts that are recoverable by the policyholder in future periods in excess of one year from the surrender of the policy must be recognized at their present value. EITF No. 06-5 is effective for Duke Energy as of January 1, 2007 and must be applied as a change in accounting principle through a cumulative-effect adjustment to retained earnings or other components of equity as of January 1, 2007. Duke Energy is currently evaluating the impact of adopting EITF No. 06-5, and cannot currently estimate the impact of EITF No. 06-5 on its consolidated results of operations, cash flows or financial position.
Subsequent Events
For information on subsequent events related to acquisitions and dispositions, common stock, debt and credit facilities, severance, discontinued operations and assets held for sale, risk management instruments, regulatory matters, commitments and contingencies and related party transactions, see Note 2, Acquisitions and Dispositions, Note 4, Common Stock, Note 7, Debt and Credit Facilities, Note 11, Severance, Note 13, Discontinued Operations and Assets Held For Sale, Note 15, Risk Management Instruments, Note 16, Regulatory Matters, Note 17, Commitments and Contingencies, and Note 19, Related Party Transactions, to the Consolidated Financial Statements.
I tem 3. Quantitative and Qualitative Disclosures about Market Risk
For an in-depth discussion of Duke Energys market risks, see Managements Discussion and Analysis of Quantitative and Qualitative Disclosures about Market Risk in Duke Energys Annual Report on Form 10-K for the year ended December 31, 2005.
Commodity Price Risk
Duke Energy is exposed to the impact of market fluctuations in the prices of natural gas, electricity, NGLs and other energy-related products marketed and purchased as a result of its ownership of energy related assets, remaining proprietary trading contracts, and interests in structured contracts classified as undesignated. Price risk represents the potential risk of loss from adverse changes in the market price of electricity or other energy commodities. Duke Energy employs established policies and procedures to manage its risks associated with these market fluctuations using various commodity derivatives, including forward contracts, futures, swaps and options.
Duke Energys largest commodity exposure is due to market price fluctuations of NGLs primarily in the Field Services segment and, to a lesser extent, in the Natural Gas Transmission segment. Based on a sensitivity analysis as of September 30, 2006, it was estimated that a price change of fifteen cents per gallon in the price of NGLs (net of related hedges and an equivalent price change in crude oil) would have a corresponding effect on pre-tax income from continuing operations of approximately $157 million over the next 12 months. Comparatively, a fifteen cent price change sensitivity analysis as of December 31, 2005 would have impacted pre-tax income from continuing operations by approximately $105 million over the next 12 months. The increase is due primarily to the NGL production after December 31, 2006 being included in the September 30, 2006 sensitivity which is currently not hedged.
Normal Purchases and Normal Sales . During 2005, the Board of Directors of Duke Energy authorized and directed management to execute the sale or disposition of substantially all of DENAs remaining physical and commercial assets outside the Midwestern United States and certain contractual positions related to the Midwestern assets. As a result, Duke Energy recognized a pre-tax loss of approximately $1.9 billion in 2005 for the disqualification of its power and gas forward sales contracts previously designated under the normal purchases normal sales exception. This loss is partially offset by the recognition of a pre-tax gain of approximately $1.2 billion for the discontinuance of hedge accounting for natural gas and power cash flow hedges. Duke Energy retained the Midwestern generation assets of DENA, representing approximately 3,600 megawatts of power generation and combined them with Cinergys commercial operations in the Midwest (see Note 2 to the Consolidated Financial Statements, Acquisitions and Dispositions, for further details on the Cinergy merger).
Trading and Undesignated Portfolio Risk . Duke Energys current energy marketing and trading activities principally consist of the Cinergy commercial marketing and trading business natural gas marketing and trading operations and Duke Energy Ohios power marketing and trading operations. In June 2006, Duke Energy announced it had reached an agreement to sell the Cinergy marketing and trading business (see Note 13 to the Consolidated Financial Statements, Discontinued Operations and Assets Held for Sale). The sale closed in
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October 2006. In connection with the sale transaction, Duke Energy entered into a series of Total Return Swaps (TRS) with Fortis, which are accounted for as mark-to-market derivatives. The TRS offsets the net fair value of the contracts being sold to Fortis. The TRS will be cancelled as the underlying contracts are transferred to Fortis.
Duke Energys domestic operations market and trade over-the-counter (an informal market where the buying/selling of commodities occurs) contracts for the purchase and sale of electricity (primarily in the midwest region of the United States), natural gas, and other energy-related products, including coal and emission allowances. Duke Energys natural gas domestic operations provide services that manage storage, transportation, gathering and processing activities. In addition, Duke Energys domestic operations market and trade natural gas and other energy-related products on the New York Mercantile Exchange.
Natural gas marketing and trading operations also extend to Canada where natural gas marketing and management services are provided to producers and industrial customers. Duke Energys Canadian operations also market and trade over-the-counter contracts as well as energy-related products on the New York Mercantile Exchange.
Many of these energy commodity contracts commit Duke Energy to purchase or sell electricity, natural gas, and other energy-related products at fixed prices in the future. The majority of the contracts in the natural gas and other energy-related products portfolios are financially settled contracts (i.e., there is no physical delivery related with these items). Duke Energys risk management policies contain limits associated with the overall size of net open positions for each trading operation.
Once Duke Energy completes its announced exit from the Cinergy commercial marketing and trading business (which have been classified as discontinued operations), its exposure to movements in the price of electricity and other energy commodities will be reduced and, as a result, may lead to decreased future earnings volatility.
Duke Energy currently measures the market risk inherent in the trading portfolio, employing value at risk (VaR) analysis and other methodologies, which utilize forward price curves in electric power and natural gas markets to quantify estimates of the magnitude and probability of future value changes related to open contract positions. Subsequent to the merger with Cinergy, Duke Energy adopted a VaR methodology for disclosure purposes, in line with how Duke Energy currently manages the portfolio. VaR is a statistical measure used to quantify the potential change in the economic value of the trading portfolio over a particular period of time, with a specified likelihood of occurrence, due to market movement. Duke Energy, through some of its non-regulated subsidiaries, markets and trades physical natural gas and electricity and trades derivative commodity instruments which are usually settled in cash including: forwards, futures, swaps, and options.
Any proprietary trading transaction, whether settled physically or financially, is included in the VaR calculation. VaR is reported based on a 95 percent confidence interval, utilizing a one-day holding period. This means that on a given day (one-day holding period) there is a 95 percent chance (confidence level) that Duke Energys trading portfolio will not lose more than the stated amount. VaR is measured using a Monte Carlo simulation methodology that considers implied forward-looking volatilities and historical 21 day correlations. Duke Energys VaR amounts for commodity derivatives recorded using the mark-to-market model of accounting are shown in the following table.
Value at Risk
September 30,
2006 One-Day Impact on Pre-tax Income from Continuing Operations for 2006 |
Estimated
Impact on
|
High One-Day
Impact on Pre-tax Income from Continuing Operations for Third Quarter 2006 |
Low One-Day
Impact on Pre-tax Income from Continuing Operations for Third Quarter 2006 |
|||||
( | (in millions) | |||||||
Calculated VaR |
$3 | $4 | $6 | $2 |
(1) | The VaR figures above do not include the hedges which were de-designated as a result of the transfer of 19.7% of Duke Energys interest in DEFS to ConocoPhillips, (see Note 15 to the Consolidated Financial Statements, Risk Management Instruments). |
(2) | DENA VaR at September 30, 2006 was not material. |
(3) | VaR primarily represents earnings volatility associated with Cinergy Marketing and Trading, LP which was sold in October 2006. |
Duke Energy historically used daily earnings at risk (DER) to measure and monitor the mark-to-market portfolios impact on earnings. DER computations are based on historical simulation, which uses price movements over an eleven day period. The historical simulation emphasizes the most recent market activity, which is considered the most relevant predictor of immediate future market movements for natural gas, electricity and other energy-related products. DER computations use several key assumptions, including a 95% confidence level for the resultant price movement and the holding period specified for the calculation.
85
PART I
Duke Energy disclosed a DER of $12 million as of December 31, 2005, which was primarily comprised of DENA derivative positions. DENAs DER at September 30, 2006 was zero due to the DENA wind-down. The DER figures do not include the hedges which were de-designated as a result of the transfer of 19.7% of Duke Energys interest in DEFS to ConocoPhillips. The calculated consolidated DER at December 31, 2005 consists of approximately $11 million related to discontinued operations and less than $1 million related to continuing operations.
DETM, the 60%/40% unregulated joint venture with Exxon Mobil continues to prudently manage down its legacy natural gas positions. While the venture was originally created to actively trade and market natural gas following de-regulation, the venture is a very different business today. No active trading is occurring now other than transacting to meet contractual obligations and to optimize remaining legacy gas positions. These legacy positions do not generate any material earnings volatility for Duke Energy.
Generation Portfolio Risks. Duke Energy optimizes the value of its non-regulated portfolio. The portfolio includes generation assets (power and capacity), fuel, and emission allowances. Modeled forecasts of future generation output, fuel requirements, and emission allowance requirements are based on forward power, fuel and emission allowance markets. The component pieces of the portfolio are bought and sold based on this model in order to manage the economic value of the portfolio. With the issuance of SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS 149), most forward power transactions and certain coal transactions from management of the portfolio are accounted for at fair value. The other component pieces of the portfolio are
typically not subject to SFAS 149 and are accounted for using the accrual method, where changes in fair value are not recognized. As a result, these forward sales and purchases are subject to earnings volatility via mark-to-market gains or losses from changes in the value of the contracts accounted for using fair value. In addition, the generation portfolio not utilized to serve native load or committed load is subject to commodity price fluctuations. This is primarily related to the Midwestern generation assets retained from DENA. A spark spread sensitivity on these MWH was immaterial at September 30, 2006.
Credit Risk
Credit risk represents the loss that Duke Energy would incur if a counterparty fails to perform under its contractual obligations. To reduce credit exposure, Duke Energy seeks to enter into payment netting agreements with counterparties that permit Duke Energy to offset receivables and payables with such counterparties. Duke Energy attempts to further reduce credit risk with certain counterparties by entering into agreements that enable Duke Energy to obtain collateral or to terminate or reset the terms of transactions after specified time periods or upon the occurrence of credit-related events. Duke Energy may, at times, use credit derivatives or other structures and techniques to provide for third-party credit enhancement of Duke Energys counterparties obligations.
Duke Energys principal customers for power and natural gas marketing and transportation services are industrial end-users, marketers, local distribution companies and utilities located throughout the U.S., Canada and Latin America. Duke Energy has concentrations of receivables from natural gas and electric utilities and their affiliates, as well as industrial customers and marketers throughout these regions. These concentrations of customers may affect Duke Energys overall credit risk in that risk factors can negatively impact the credit quality of the entire sector. Where exposed to credit risk, Duke Energy analyzes the counterparties financial condition prior to entering into an agreement, establishes credit limits and monitors the appropriateness of those limits on an ongoing basis.
In 1999, the Industrial Development Corp of the City of Edinburg, Texas (IDC) issued approximately $100 million in bonds to purchase equipment for lease to Duke Hidalgo (Hidalgo), a subsidiary of Duke Capital. Duke Capital unconditionally and irrevocably guaranteed the lease payments of Hidalgo to IDC through 2028. In 2000, Hidalgo was sold to Calpine Corporation and Duke Capital remained obligated under the lease guaranty. In January 2006, Hidalgo and its subsidiaries filed for bankruptcy protection in connection with the previous bankruptcy filing by its parent, Calpine Corporation in December 2005. Gross exposure under the guarantee obligation as of September 30, 2006 is approximately $200 million, which includes principal and interest. Duke Energy does not believe a loss under the guarantee obligation is probable as of September 30, 2006, but continues to evaluate the situation. Therefore, no reserves have been recorded for any contingent loss as of September 30, 2006. No demands for payment of principal or interest have been made under the guarantee. If future losses are incurred under the guarantee, Duke Capital has certain rights which should allow it to mitigate such loss.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by Duke Energy in the reports it files or submits under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized, and reported, within the time periods specified by the Securities and Exchange Commissions (SEC) rules and forms.
86
PART I
Disclosure controls and procedures include, without limitation, controls and procedures designed to provide reasonable assurance that information required to be disclosed by Duke Energy in the reports it files or submits under the Exchange Act is accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of management, including the chief executive officer and chief financial officer, Duke Energy has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2006, and, based upon this evaluation, the chief executive officer and chief financial officer have concluded that these controls and procedures are effective in providing reasonable assurance that information requiring disclosure is recorded, processed, summarized, and reported within the timeframe specified by the SECs rules and forms.
Changes in Internal Control over Financial Reporting
Under the supervision and with the participation of management, including the chief executive officer and chief financial officer, Duke Energy has evaluated changes in internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fiscal quarter ended September 30, 2006 and, other than the Duke Energy and Cinergy merger discussed below, found no change that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
On April 3, 2006, the previously announced merger between Duke Energy and Cinergy was consummated. Duke Energy is currently in the process of integrating Cinergys operations and will be conducting control reviews pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. See Notes 1, 2 and 14 to the Consolidated Financial Statements for additional information relating to the merger.
87
For information regarding legal proceedings that became reportable events or in which there were material developments in the third quarter of 2006, see Note 16 to the Consolidated Financial Statements, Regulatory Matters and Note 17 to the Consolidated Financial Statements, Commitments and Contingencies.
In addition to the other information set forth in this report, careful consideration should be given to the factors discussed in Part I, Item 1A. Risk Factors in Duke Energys and Cinergys Annual Reports on Form 10-K for the year ended December 31, 2005, as have been updated in Duke Energys Quarterly Reports on Form 10-Q for the periods ended March 31, 2006 and June 30, 2006, which could materially affect Duke Energys financial condition or future results. Additional risks and uncertainties not currently known to Duke Energy or that Duke Energy currently deems to be immaterial also may materially adversely affect Duke Energys financial condition and/or results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities for Third Quarter of 2006
There were no issuer purchases of equity securities during the third quarter of 2006.
Duke Energy previously announced plans to execute up to approximately $2.5 billion in common stock repurchases over a three year period. On May 9, 2005, Duke Energy announced plans to suspend additional repurchases under the open-market purchase plan, pending further assessment, primarily due to the merger with Cinergy. At the time of suspension, Duke Energy had repurchased 32.6 million shares of common stock for approximately $0.9 billion. During the first quarter of 2006, Duke Energy announced the commencement of up to $1 billion of additional share repurchases under the previously announced plan. During the first six months of 2006, Duke Energy repurchased approximately 17.5 million shares of common stock for approximately $0.5 billion. In June 2006, in connection with the plan to spin off Duke Energys natural gas businesses to Duke Energy shareholders, the share repurchase program has since been suspended. At the time of suspension, Duke Energy has repurchased approximately 50 million shares of common stock for approximately $1.4 billion under this repurchase plan. The dollar value of shares that may yet be purchased under the plan as of September 30, 2006 is approximately $1.1 billion.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of Duke Energys security holders during the third quarter of 2006.
88
PART II.
(a) Exhibits
Exhibits filed or furnished herewith are designated by an asterisk (*). All exhibits not so designated are incorporated by reference to a prior filing, as indicated. Items constituting management contracts or compensatory plans or arrangements are designated by a double asterisk (**).
Exhibit
Number |
||
10.1** | Form of Amendment to Performance Award Agreement and Phantom Stock Award Agreement (filed with Form 8-K of Duke Energy Corporation, File No. 1-32853, August 24, 2006, as exhibit 10.1). | |
10.2** | Form of Amendment to Phantom Stock Award Agreement (filed with Form 8-K of Duke Energy Corporation, File No. 1-32853, August 24, 2006, as exhibit 10.2). | |
*10.3 | Formation and Sale Agreement by and among Duke Ventures, LLC, Crescent Resources, LLC, Morgan Stanley Real Estate Fund V U.S. L.P., Morgan Stanley Real Estate Fund V Special U.S., L.P., Morgan Stanley Real Estate Investors V U.S., L.P., MSP Real Estate Fund V, L.P., and Morgan Stanley Strategic Investments, Inc., dated as of September 7, 2006. | |
*31.1 | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
*31.2 | Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
*32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
*32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
The total amount of securities of the registrant or its subsidiaries authorized under any instrument with respect to long-term debt not filed as an exhibit does not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. The registrant agrees, upon request of the Securities and Exchange Commission, to furnish copies of any or all of such instruments to it.
89
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
DUKE ENERGY CORPORATION | ||||
Date: November 9, 2006 |
/s/ D AVID L. H AUSER |
|||
David L. Hauser
Group
Executive and
|
||||
Date: November 9, 2006 |
/s/ S TEVEN K. Y OUNG |
|||
Steven K. Young Vice President and Controller |
90
EXHIBIT 10.3
EXECUTION VERSION
FORMATION AND SALE AGREEMENT
by and among
Duke Ventures, LLC,
Crescent Resources, LLC,
Morgan Stanley Real Estate Fund V U.S., L.P.,
Morgan Stanley Real Estate Fund V Special U.S., L.P.,
Morgan Stanley Real Estate Investors V U.S., L.P.,
MSP Real Estate Fund V, L.P.,
and
Morgan Stanley Strategic Investments, Inc.
Dated as of September 7, 2006
TABLE OF CONTENTS
P
AGE
|
||||||
ARTICLE I D EFINITIONS | 1 | |||||
Section 1.1 |
Definitions | 1 | ||||
ARTICLE II C LOSING A CTIONS | 7 | |||||
Section 2.1 |
Closing | 7 | ||||
Section 2.2 |
Closing Actions | 7 | ||||
Section 2.3 |
Closing Deliveries | 8 | ||||
Section 2.4 |
Post-Closing Adjustment of Net Contribution/Distribution Amount | 8 | ||||
ARTICLE III R EPRESENTATIONS AND W ARRANTIES OF D UKE V ENTURES | 9 | |||||
Section 3.1 |
Organization | 9 | ||||
Section 3.2 |
Authority | 9 | ||||
Section 3.3 |
No Conflicts | 10 | ||||
Section 3.4 |
Claims | 10 | ||||
Section 3.5 |
Brokers | 10 | ||||
Section 3.6 |
Ownership | 10 | ||||
Section 3.7 |
No Other Representation | 10 | ||||
ARTICLE IV R EPRESENTATIONS AND W ARRANTIES OF C RESCENT | 10 | |||||
Section 4.1 |
Organization | 10 | ||||
Section 4.2 |
Authority | 11 | ||||
Section 4.3 |
No Conflicts | 11 | ||||
Section 4.4 |
Claims; Orders | 11 | ||||
Section 4.5 |
Brokers | 11 | ||||
Section 4.6 |
Capitalization | 11 | ||||
Section 4.7 |
Financial Statements | 12 | ||||
Section 4.8 |
Permits; Compliance with Laws | 12 | ||||
Section 4.9 |
Absence of Certain Changes | 12 | ||||
Section 4.10 |
Taxes | 13 | ||||
Section 4.11 |
Contracts | 14 | ||||
Section 4.12 |
Environmental Matters | 16 | ||||
Section 4.13 |
Insurance | 16 | ||||
Section 4.14 |
Intellectual Property | 16 | ||||
Section 4.15 | Labor Matters | 17 | ||||
Section 4.16 |
Employee Benefits | 17 | ||||
Section 4.17 |
Real Property | 18 | ||||
Section 4.18 |
Personal Property | 20 | ||||
Section 4.19 |
Accounts Receivable | 20 | ||||
Section 4.20 |
Financing Districts | 20 | ||||
Section 4.21 |
Related Party Transactions | 20 | ||||
Section 4.22 |
Bankruptcy | 20 | ||||
Section 4.23 |
No Other Representation | 20 | ||||
ARTICLE V R EPRESENTATIONS AND W ARRANTIES OF THE M S M EMBERS | 21 | |||||
Section 5.1 |
Organization | 21 | ||||
Section 5.2 |
Authority | 21 | ||||
Section 5.3 |
No Conflicts | 21 | ||||
Section 5.4 |
Claims | 21 | ||||
Section 5.5 |
Brokers | 21 | ||||
Section 5.6 |
Acknowledgement | 21 | ||||
Section 5.7 |
No Registration | 21 | ||||
Section 5.8 |
No Other Representation | 22 |
i
P
AGE
|
||||||
ARTICLE VI C OVENANTS | 22 | |||||
Section 6.1 |
Legacy Land | 22 | ||||
Section 6.2 |
Tax Matters | 22 | ||||
Section 6.3 |
Public Announcements | 22 | ||||
Section 6.4 |
Employee Benefits | 22 | ||||
Section 6.5 |
Environmental | 22 | ||||
Section 6.6 |
Insurance | 22 | ||||
Section 6.7 |
Leased Personal Property; Licensed Software | 23 | ||||
Section 6.8 |
Surety Bonds; Letters of Credit | 24 | ||||
Section 6.9 |
Reasonable Best Efforts; Further Assurances | 25 | ||||
Section 6.10 |
Sale of Additional Interests in Holdco | 25 | ||||
Section 6.11 |
Corporate Names | 25 | ||||
ARTICLE VII I NDEMNIFICATION , L IMITATIONS OF L IABILITY , W AIVERS AND T HIRD P ARTY C LAIMS | 26 | |||||
Section 7.1 |
Indemnification | 26 | ||||
Section 7.2 |
Limitations of Liability | 26 | ||||
Section 7.3 |
Waiver of Other Representations | 28 | ||||
Section 7.4 |
Waiver of Remedies | 29 | ||||
Section 7.5 |
Procedure with Respect to Third Party Claims | 29 | ||||
ARTICLE VIII M ISCELLANEOUS |
30 | |||||
Section 8.1 |
Notices | 30 | ||||
Section 8.2 |
Entire Agreement | 31 | ||||
Section 8.3 |
Expenses | 31 | ||||
Section 8.4 |
Disclosure | 31 | ||||
Section 8.5 |
Waiver | 31 | ||||
Section 8.6 |
Amendment | 31 | ||||
Section 8.7 |
No Third Party Beneficiary | 31 | ||||
Section 8.8 |
Assignment; Binding Effect | 32 | ||||
Section 8.9 |
Headings | 32 | ||||
Section 8.10 |
Invalid Provisions | 32 | ||||
Section 8.11 |
Counterparts; Facsimile | 32 | ||||
Section 8.12 |
Governing Law; Venue; and Jurisdiction; Waiver of Trial by Jury | 32 | ||||
Section 8.13 |
Attorneys Fees | 32 | ||||
Section 8.14 |
MS Member Representative; Joint Liability | 33 | ||||
Exhibit A Amended and Restated Limited Liability Company Agreement of Crescent Holdings, LLC |
||||||
Exhibit B Amended and Restated Articles of Organization of Crescent Resources, LLC |
||||||
Exhibit C Amended and Restated Operating Agreement of Crescent Resources, LLC |
||||||
Exhibit D Transition Services Agreement |
||||||
Exhibit E Employee Matters Agreement |
||||||
Exhibit F Certificate of Formation of Crescent Holdings, LLC |
||||||
Exhibit G Purchase Price Calculation |
||||||
Exhibit H Estimated Transaction Expenses of the Parties |
ii
FORMATION AND SALE AGREEMENT
This FORMATION AND SALE AGREEMENT (this Agreement ) dated as of September 7, 2006 (the Effective Date ) is made and entered into by and among (i) Duke Ventures, LLC , a Nevada limited liability company ( Duke Ventures ), (ii) Crescent Resources, LLC , a Georgia limited liability company ( Crescent ), and (iii) Morgan Stanley Real Estate Fund V U.S., L.P. , a Delaware limited partnership ( MSREF ), Morgan Stanley Real Estate Fund V Special U.S., L.P. , a Delaware limited partnership ( MSREF Special ), Morgan Stanley Real Estate Investors V U.S., L.P. , a Delaware limited partnership ( MSREI ), MSP Real Estate Fund V, L.P. , a Delaware limited partnership ( MSP ), and Morgan Stanley Strategic Investments, Inc. , a Delaware corporation ( MSSI and, together with MSREF, MSREF Special, MSREI, and MSP are collectively referred to herein as the MS Members ).
W I T N E S S E T H
WHEREAS, immediately prior to the consummation of the transactions contemplated hereby, Duke Ventures owns one hundred percent (100%) of the issued and outstanding membership interests of Crescent (the Crescent Membership Interests ); and
WHEREAS, concurrently herewith (i) in accordance with the terms and conditions of this Agreement, Duke Ventures will contribute one hundred percent (100%) of the Crescent Membership Interests to Crescent Holdings, LLC, a newly formed Delaware limited liability company ( Holdco ), in exchange for the issuance to Duke Ventures of ninety-eight percent (98%) of the issued and outstanding membership interests of Holdco (the Holdco Membership Interests ) and (ii) Crescent and Mr. Arthur W. Fields ( Mr. Fields ) are entering into an employment agreement (the Employment Agreement ) providing for, among other things, the issuance to Mr. Fields of two percent (2%) of the Holdco Membership Interests; and
WHEREAS, immediately following the transactions referred to above, Crescent will enter into a Credit Agreement dated as of the Effective Date, with Bank of America, N.A. and the other lenders named therein (collectively, the Lender ), pursuant to which Crescent is receiving $1,225,000,000 of proceeds (the New Debt Financing ), of which the net proceeds in the amount of $1,187,000,000 will be immediately distributed to Holdco, and Holdco will distribute the same solely to Duke Ventures; and
WHEREAS, in accordance with the terms and conditions of this Agreement, immediately following the distribution of the net proceeds of the New Debt Financing referred to above, the MS Members will collectively purchase from Duke Ventures fifty percent (50%) of the Holdco Membership Interests held by Duke Ventures (such Holdco Membership Interests being transferred in accordance herewith being forty-nine percent (49%) of the total outstanding Holdco Membership Interests and are referred to herein as the Purchased Interests ); and
WHEREAS, concurrently herewith, Duke Ventures, the MS Members and Mr. Fields are entering into an amended and restated limited liability company agreement of Holdco in the form attached hereto as Exhibit A (the Operating Agreement ); and
WHEREAS, following the consummation of the transactions contemplated by this Agreement and the execution of the Operating Agreement, the MS Members will collectively own forty-nine percent (49%) of the Holdco Membership Interests, Duke Ventures will own forty-nine percent (49%) of the Holdco Membership Interests and Mr. Fields will own two percent (2%) of the Holdco Membership Interests;
NOW THEREFORE, in consideration of the mutual agreements contained herein and for other good and valuable consideration described herein, the parties to this Agreement, intending to be legally bound hereby, agree as follows:
ARTICLE I
D EFINITIONS
Section 1.1 Definitions. As used in this Agreement, the following capitalized terms have the meanings set forth below:
AAA means the American Arbitration Association.
Accounting Expert has the meaning given to it in Section 2.4(b).
Administer and Administration shall mean the process of adjusting Third Party Insurance Claims, including the process of providing defense and indemnification if and to the extent any defense and indemnification is required under Section 6.6 below.
Advanced Amounts has the meaning given to it in Section 4.6(d).
Affiliate means any Person that, directly or indirectly through one or more intermediaries, controls, is controlled by or is under common control with the Person specified. For purposes of this definition, control of a Person means the power, direct or indirect, to direct or cause the direction of the management and policies of such Person whether through ownership of voting securities or ownership interests, by contract or otherwise, and specifically with respect to a corporation, partnership or limited liability company, also includes direct or indirect ownership of more than ten percent (10%) of the voting securities in such corporation or of the voting interest in a partnership or limited liability company.
Agreement has the meaning given to it in the introduction to this Agreement.
ALTA means the American Land Title Association, whose address is 1828 L St., N.W., Suite 705, Washington, D.C. 20036.
ALTA Survey means a survey made in accordance with the Minimum Standard Detail Requirements for ALTA/ACSM Land Title Surveys, jointly established and adopted by ALTA and NSPS in 2005, and includes items 2, 3, 4, 6, 7(a), 8, 9, 10, 11(a), 16, 17 & 18 from Table A thereof.
Amended and Restated Articles of Organization means those certain Amended and Restated Articles of Organization of Crescent, in the form attached hereto as Exhibit B, which are being filed with the Secretary of State of the State of Georgia concurrently herewith.
Amended and Restated Operating Agreement means that certain Amended and Restated Limited Liability Company Agreement of Crescent, in the form attached hereto as Exhibit C, which is being executed concurrently herewith.
Assets of any Person means all assets and properties of every kind, nature, character and description (whether real, personal or mixed, whether tangible or intangible and wherever situated), including the goodwill related thereto, operated, owned or leased by such Person.
Assignment Agreement has the meaning given to it in Section 2.3(a)(vii).
Association has the meaning given to it in Section 4.17(j).
Association Document has the meaning given to it in Section 4.17(j)
Auditors Net Contribution/Distribution Amount Determination has the meaning given to it in Section 2.4(b).
Automobile Policy has the meaning given to in the definition of Duke Occurrence-Based Insurance Policies.
Balance Sheet has the meaning given to it in Section 4.7.
Benefit Plans has the meaning given to it in Section 4.16(a).
Business means, as to Crescent, the business of developing high quality commercial, residential and multifamily real estate projects, managing and acting as leasing agent for commercial buildings and properties and managing land holdings primarily in the southeastern and southwestern United States.
Business Day means a day other than Saturday, Sunday or any day on which banks located in the State of New York are authorized or obligated to close.
Charter Documents means, with respect to any Person, the articles of incorporation and by-laws, the limited partnership agreement, the partnership agreement or the limited liability company operating agreement and certificate of formation or articles of organization or such other organizational documents of such Person which establish the legal personality of such Person.
Claim means any demand, claim, action, investigation, legal proceeding (whether at law or in equity) or arbitration.
Claiming Party has the meaning given to it in Section 7.5(a).
Closing means the closing of the transactions contemplated by this Agreement, as provided for in Section 2.2.
Code means the United States Internal Revenue Code of 1986, as amended.
Commercial Leases has the meaning given to it in Section 4.17(i).
Confidentiality Agreement means that certain Confidentiality Agreement, dated May 17, 2006, between Duke Parent and MSREF V U.S.GP, L.L.C., on behalf of itself and MSREF, MSREI, MSREF Special, MSP, MSP Co-Investment Partnership V., L.P. and MSREF V Domestic Funding, L.P., as amended from time to time.
Contract means any contract, lease, license, evidence of indebtedness, mortgage, indenture, purchase order, binding bid, letter of credit, security agreement or other legally binding arrangement, including any of the foregoing entered into with any Governmental Authority.
Credit Support Instrument has the meaning given to it in Section 4.11(b).
Crescent has the meaning given to it in the introduction to this Agreement.
Crescent Consents has the meaning given to it in Section 4.3.
Crescent Disclosure Letter has the meaning given to it in the introduction to ARTICLE IV.
Crescent Membership Interests has the meaning given to it in the Recitals to this Agreement.
Crescent Subsidiary means any corporation, partnership, limited partnership, limited liability company, joint venture or other legal entity of which (i) Crescent or a Crescent Subsidiary is the general partner or manager or (ii) Crescent or any Crescent Subsidiary owns, directly or indirectly, fifty percent (50%) or more of the stock or other equity or partnership interests, it being understood that LandMar Group, LLC, Rough Hollow Development, Ltd., Las Ventanas Land Partners, Ltd., and JH West Land Ventures, Ltd. shall constitute Crescent Subsidiaries.
2
Developable Property means, as to any parcel of Real Property, that portion of the land which is located outside of all of the following, to the extent delineated or reasonably susceptible of delineation from information in the possession of Crescent: (a) any lakes, streams, rivers or other bodies or courses of water; (b) any swamps or marshes; (c) the floodway or the 100-year flood plain as designated on recent flood zone maps produced by the Federal Emergency Management Agency; (d) any areas designated by the U.S. Environmental Protection Agency or other federal or state agency as areas where development is prohibited or restricted due to the presence of threatened or endangered wildlife; (e) currently designated mineral drill sites; (f) easement areas; (g) wetlands and/or waters that are regulated by federal and/or state agencies; and (h) any other areas upon which no development activities can occur for any reason.
Duke Disclosure Letter has the meaning given to it in the introduction to ARTICLE III.
Duke Liability Insurance Policies shall mean the policies of insurance maintained by Duke Parent or any Non-Crescent Affiliate prior to the Closing identified as Part I.E and Part I.F of Section 4.13(i) of the Crescent Disclosure Letter.
Duke Occurrence-Based Insurance Policies shall mean the policies of insurance maintained by Duke Parent or any Non-Crescent Affiliate prior to the Closing identified as Part I.A, Part I.C and Part I.D of Section 4.13(i) of the Crescent Disclosure Letter (the Automobile Policy ) and Part II.A, II.B, II.C and II.E of Section 4.13(i) of the Crescent Disclosure Letter (the Workers Compensation Policy ).
Duke Parent means Duke Energy Corporation, a Delaware corporation.
Duke Release Date has the meaning given to it in Section 6.8(a).
Duke Ventures has the meaning given to it in the introduction to this Agreement.
Effective Date has the meaning given to it in the introduction to this Agreement.
Employee Matters Agreement has the meaning given to it in Section 2.3(a)(iv).
Employment Agreement has the meaning given to it in the Recitals to this Agreement.
Enterprise Value means $2,075,000,000.
Environmental Law means the applicable Laws of any Governmental Authority having jurisdiction over the assets in question relating to the prevention of pollution, regulating discharge or emission of Hazardous Materials, remediation of contamination, protection of natural resources, or the preservation of environmental quality, each as amended on or prior to the Effective Date.
Environmental Representations has the meaning given to it in Section 7.2(a).
Equity Value has the meaning given to it in the definition of Purchase Price.
ERISA has the meaning given to it in Section 4.16(a).
ERISA Affiliate has the meaning given to it in Section 4.16(b).
ERISA Representations has the meaning given to it in Section 7.2(a).
ESA has the meaning given to it in Section 6.5.
Estimated Net Contribution/Distribution Amount means $30,000,000, which Duke Ventures represents is a good faith estimate of the Net Contribution/Distribution Amount.
Expenses means all reasonable out-of-pocket documented expenses (including Transfer Taxes and all fees and expenses of counsel, accountants, financing sources, experts and consultants to a Party hereto and its Affiliates and fees and expenses incurred in connection with obtaining title commitments, Title Policies, environmental reports and other reports and creating the electronic data room maintained by Crescent in connection with the transactions contemplated by this Agreement) incurred by a Party or on its behalf on or prior to the thirtieth (30 th ) day following the Effective Date in connection with or related to the transactions contemplated in this Agreement, including the authorization, preparation, negotiation, execution and performance of this Agreement, the Operating Agreement, the Amended and Restated Articles of Organization, the Amended and Restated Operating Agreement and the New Debt Financing, the formation of Holdco and the MS Members due diligence review of Crescent, the Crescent Subsidiaries and their Assets and the other transactions contemplated in this Agreement, but in all events excluding fees and expenses of investment bankers or financial advisors.
Final Net Contribution/Distribution Amount has the meaning given to it in Section 2.4(c).
Financial Statements has the meaning given to it in Section 4.7.
Financing District has the meaning given to it in Section 4.20.
Flooding Easements has the meaning given to it in the definition of Permitted Lien.
GAAP means generally accepted accounting principles in the United States, applied on a consistent basis.
Governmental Authority means any applicable federal, state or local government, regulatory or administrative authority, or any court, agency, commission, tribunal, or judicial or arbitral body or self-regulated entity, whether domestic or foreign.
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Hazardous Material means each substance designated as a hazardous waste, hazardous substance, hazardous material, pollutant, contaminant or toxic substance under any Environmental Law, including, without limitation, any asbestos, polychlorinated biphenyls, urea formaldehyde foam insulation, and petroleum or any fraction of petroleum.
Holdco has the meaning given to it in the Recitals to this Agreement.
Holdco Membership Interests has the meaning given to it in the Recitals to this Agreement.
Indemnified Party has the meaning given to it in Section 7.1(a).
Indemnifying Party has the meaning given to it in Section 7.1(a).
Independent Accounting Firm means and includes any of the following independent certified public accounting firms: PricewaterhouseCoopers, LLP, KPMG LLP, Deloitte & Touche LLP, Ernst & Young LLP and any combined entity including one or more of such firms; or any other certified public accounting firm approved by the Parties.
Intellectual Property means the following intellectual property rights, whether arising by statute or under common law: (a) copyrights, registrations and applications for registration thereof, (b) trademarks, service marks, trade names, slogans, domain names, logos, trade dress, and registrations and applications for registrations thereof, (c) patents, as well as any reissued and reexamined patents and extensions corresponding to the patents, and any patent applications, as well as any related continuation, continuation in part and divisional applications and patents issuing therefrom and (d) trade secrets and confidential information, including ideas, designs, concepts, compilations of information, methods, techniques, procedures, processes and other know-how, whether or not patentable.
IRS has the meaning given to it in Section 4.16(a).
Knowledge when used with respect to Duke Ventures means the actual knowledge of the individuals listed in Section 1.1(i) of the Duke Disclosure Letter; when used with respect to Crescent means the actual knowledge of the individuals listed in Section 1.1(i) of the Crescent Disclosure Letter; and when used with respect to the MS Members means the actual knowledge of the individuals listed in Section 1.1(i) of the MS Disclosure Letter.
Lake Mary Environmental Condition has the meaning given to it in Section 7.1(b).
Lake Mary Site has the meaning given to it in Section 7.1(b).
Landmar Certificate means the certificate signed by Edward E. Burr and LandMar Management, Inc. with respect to certain matters relating to Landmar Group, LLC.
Laws means all laws, rules, regulations, ordinances, court orders and other pronouncements having the effect of law of any Governmental Authority.
Leased Personal Property has the meaning given to it in Section 6.7(a).
Legacy Land means the Real Property listed as such in Section 1.1(ii) of the Crescent Disclosure Letter.
Legacy Land Agreements have the meaning given to it in Section 2.3(a)(v).
Lender has the meaning given to it in the Recitals to this Agreement.
Letters means, collectively, the Duke Disclosure Letter, the Crescent Disclosure Letter and the MS Disclosure Letter.
Licensed Software has the meaning given to it in Section 6.7(b).
Lien means any mortgage, pledge, deed of trust, assessment, security interest, charge, lien, option, warranty, purchase right, lease or other similar property interest or encumbrance.
Loss means any and all judgments, losses, liabilities, amounts paid in settlement, damages, fines, penalties, deficiencies, losses and expenses (including interest, court costs, reasonable fees of attorneys, accountants and other experts or other reasonable expenses of litigation or other proceedings or of any claim, default or assessment).
Material Adverse Effect means any circumstance, event, occurrence, change or effect that is, would be, or would reasonably be expected to be, individually or in the aggregate, materially adverse to the Business, Assets, condition (financial or otherwise) or results of operations of Crescent and the Crescent Subsidiaries, taken as a whole; provided , however , that none of the following shall in and of itself constitute, and no event, occurrence, change or effect resulting from or related to any of the following shall constitute, a Material Adverse Effect: (a) any change generally applicable to the industry or market in which Crescent operates or changes or effects that are consequences of war, terrorist activity or weather or meteorological events, (b) any change in general political, regulatory or economic conditions, including the financial and securities markets, (c) any change in any Laws (including Environmental Laws) of national or statewide effect, (d) any change in the financial condition or results of operation of Crescent caused by the transactions contemplated by this Agreement, (e) any actions to be taken pursuant to or in accordance with this Agreement and (f) the negotiation, execution, announcement or pendency of this Agreement and the transactions contemplated in this Agreement, except that the exclusions set forth in clauses (a), (b) and (c) shall only be effective if Crescent is not disproportionately impacted by such events when compared to other companies in
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the industries and markets in which Crescent operates; provided further that a Material Adverse Effect shall be deemed to include any (i) circumstance, event, occurrence, change or effect that is, would be, or would reasonably be expected to result in the cessation of lot sales at Palmetto Bluff for a period of twenty-four (24) months or longer or (ii) substantial damage, destruction, or loss (whether or not covered by insurance) to the Inn at Palmetto Bluff that would reasonably be expected to cause the Inn at Palmetto Bluff to be closed for a period of eighteen (18) months or longer.
Material Contracts has the meaning given to it in Section 4.11(a).
Material Lease has the meaning given to it in Section 4.11(a)(vii).
Material Properties means each of the Projects listed on Section 1.1(iii) of the Crescent Disclosure Letter.
Mr. Fields has the meaning given to it in the Recitals to this Agreement.
MS Disclosure Letter has the meaning given to it in the introduction to ARTICLE V.
MS Members has the meaning given to it in the introduction to this Agreement.
MSP has the meaning given to it in the introduction to this Agreement.
MSREF has the meaning given to it in the introduction to this Agreement.
MSREF Special has the meaning given to it in the introduction to this Agreement.
MSREI has the meaning given to it in the introduction to this Agreement.
MSSI has the meaning given to it in the introduction to this Agreement.
Net Contribution/Distribution Amount means an amount equal to (x) the sum of all capital contributions by Duke Ventures to the equity of Crescent from January 1, 2006 to and including the Effective Date, minus (y) all dividends or other distributions of capital of Crescent by Crescent to Duke Ventures from January 1, 2006 to and including the Effective Date (exclusive of the Net Debt Proceeds), it being understood that such amount may be a positive or a negative number.
Net Contribution/Distribution Amount Determination has the meaning given to it in Section 2.4(a).
Net Contribution/Distribution Amount Dispute Notice has the meaning given to it in Section 2.4(b).
Net Contribution/Distribution Amount Review Period has the meaning given to it in Section 2.4(b).
Net Debt Proceeds has the meaning given to it in the definition of Purchase Price.
New Credit Support Instruments has the meaning given to it in Section 6.8(a).
New Debt Financing has the meaning given to it in the Recitals to this Agreement.
No Further Action Letter has the meaning given to it in Section 7.2(o).
Non-Crescent Affiliate means any Affiliate of Duke Ventures, except for Holdco, Crescent and the Crescent Subsidiaries.
NSPS means the National Society of Professional Surveyors, Inc., whose address is 6 Montgomery Village Avenue, Suite 403, Gaithersburg, MD 20879.
Occurrence shall mean an accident or other event that gives rise to a Third Party Insurance Claim, and the term Occurrence shall be interpreted in accordance with and as construed under applicable law and Duke Liability Insurance Policies.
Operating Agreement has the meaning given to it in the Recitals to this Agreement.
Other Interests has the meaning given to it in Section 4.6(b).
Parties means each of the parties to this agreement identified in the Preamble to this Agreement and their respective successors and permitted assigns.
Permits has the meaning given to it in Section 4.8.
Permitted Lien means:
(a) any Lien for Taxes not yet due or delinquent, or being contested in good faith by Duke Ventures or Crescent by appropriate proceedings (i) for which adequate reserves have been provided in the Balance Sheet as a current liability or (ii) that results from a liability for Taxes that arose or was incurred after December 31, 2005;
(b) any Lien arising in the ordinary course of business by operation of Law with respect to a liability that is not yet due or delinquent, or that is being contested in good faith by Duke Ventures or Crescent (i) for which adequate reserves have been provided in the Balance Sheet as a current liability or (ii) that results from a liability that arose or was incurred after December 31, 2005;
(c) imperfections or irregularities of title and other non-monetary Liens of a type not covered by other clauses of this definition that would not reasonably be expected to result in a Loss with respect to the affected Real Property in excess of $250,000 for all Real Property within any single Project or $250,000 for any Real Property within a single parcel of Legacy Land;
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(d) zoning, planning and other similar limitations and restrictions, and all rights of any Governmental Authority to regulate real property;
(e) mechanics and materialmens Liens (i) for which adequate reserves have been provided in the Balance Sheet as a current liability or (ii) that result from work performed after December 31, 2005;
(f) the terms and conditions of the Material Contracts and other Contracts listed in Section 4.11(a) of the Crescent Disclosure Letter or of leases which are not Material Leases;
(h) the matters identified in Section 1.1(iv) of the Crescent Disclosure Letter;
(i) easements (other than Flooding Easements, which are addressed by subsection (m) below) for utilities, access, drainage, open space, buffer areas, conservation and similar purposes that would not reasonably be expected to interfere materially with the use or development of such Real Property for purposes contemplated by Crescent as of the Effective Date;
(j) declarations of covenants, conditions and restrictions that would not reasonably be expected to interfere materially with the use or development of such Real Property for purposes contemplated by Crescent as of the Effective Date;
(k) any other non-monetary Lien, encumbrance or matter affecting title, of a nature not otherwise covered by other clauses of this definition, and which is (i) reflected in the Title Policies obtained by Crescent, the Lender or the MS Members on or prior to the Effective Date or (ii) reflected in the title policies, title reports or title commitments delivered by or made available by Crescent to the MS Members on or prior to the Effective Date provided that the impact thereof is reasonably ascertainable in the absence of a current survey;
(l) with respect to Legacy Land, easements, cartways and similar restrictions or rights (other than Flooding Easements, which are addressed by subsection (m) below) for utilities, transmission lines, access, drainage, flood plains, open space, buffer areas, conservation and similar purposes that, to Crescents Knowledge, would not reasonably be expected to interfere materially with the use or development of such property for purposes contemplated by Crescent as of the date hereof; and
(m) rights, privileges and easements reserved by Duke Power Company LLC over Legacy Land, including Projects being developed on former Legacy Land, for backing, ponding, raising, flooding or diverting the waters of a lake or river; provided , however , that such rights, privileges and easements shall not extend to a contour at an elevation of more than 10 feet above the contour of at the elevation of the common boundary of the Real Property and such lake or river except for Real Property fronting Lake Keowee as to which the easement elevations may vary, but in no event shall any such right, privilege or easement materially interfere with the use or development of such Real Property for purposes contemplated by Crescent as of the date hereof ( Flooding Easements ).
Person means any natural person, corporation, general partnership, limited partnership, limited liability company, unlimited liability corporation, proprietorship, other business organization, trust, union, association or Governmental Authority.
Project means a residential or commercial development owned, completed or currently planned to be completed by Crescent or a Crescent Subsidiary on any portion of the Real Property.
Purchase Price means $415,030,000, representing the amount equal to the product of (A) forty-nine percent (49%) and (B) an amount equal to (i) the Enterprise Value minus $71,000,000 (which the Parties acknowledge is the outstanding indebtedness of Crescent as of December 31, 2005); plus (ii) $30,000,000, representing the Estimated Net Contribution/ Distribution Amount; minus (iii) $1,187,000,000, representing the actual amount of net proceeds of the New Debt Financing distributed to Duke Ventures (which, for avoidance of doubt, represents the gross proceeds of the New Debt Financing, less (x) the financing fees, any reserves required under the terms of the New Debt Financing and related transaction costs of Crescent in connection with the New Debt Financing, (y) Expenses reimbursed by Crescent pursuant to Section 8.3 hereof and (z) initial working capital in the amount of $10,000,000 (the amount set forth in this clause (iii) is referred to herein as the Net Debt Proceeds )); provided, that all charges by Duke Ventures to Crescent that relate to federal or state income Taxes, payroll and benefits, allocated benefit plan and retirement plan costs, and other services (including, without limitation, surveying, vehicle maintenance, legal representation, and computer time sharing) that Crescent treats for accounting purposes as equity distributions to Duke Ventures upon payment shall not be deemed to constitute dividends or other distributions of capital of Crescent for purposes of determining the Net Contribution/Distribution Amount (the amount calculated in accordance with this clause (B) is referred to herein as the Equity Value ).
Purchased Interests has the meaning given to it in the Recitals to this Agreement.
Real Property means all real property that is owned or leased or used by Crescent or any Crescent Subsidiary or that is reflected as an asset of Crescent or any Crescent Subsidiary on Crescents consolidated balance sheet.
Release means any release, spill, emission, migration, leaking, pumping, injection, deposit, disposal or discharge of any Hazardous Materials into the environment.
Relevant Entity or Relevant Entities has the meaning given to it in Section 4.10(a).
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Relevant Projects has the meaning given to it in Section 4.6(d).
Report or Reported shall mean, with respect to an Occurrence, that Crescent has informed Duke Ventures in writing of (a) the factual circumstances of the Occurrence known by employees of Crescent familiar with the factual circumstances of the Occurrence and the name(s) of any Persons suffering bodily injury, property damage, and other damage or injury as a result thereof, (b) Crescents good faith estimate of the amount of any claim that may arise therefrom, (c) the location of the Occurrence, and (d) the name(s) of Crescents employee(s) most knowledgeable about and familiar with the factual circumstances of the Occurrence. An Occurrence shall be deemed to be Reported when such writing is actually received by Duke Ventures.
Representatives means, as to any Person, its and its Affiliates officers, directors, partners, members, employees, counsel, accountants, financial advisers and consultants.
Responding Party has the meaning given to it in Section 7.5(a).
Securities Act has the meaning given to it in Section 5.7.
Subsidiary Entity or Subsidiary Entities has the meaning given to it in Section 4.10(a)(i).
Surety Bond Release has the meaning given to it in Section 6.8(c).
Survey Representations has the meaning given to it in Section 7.2(a)(i).
Tax or Taxes means all taxes, charges, fees, imposts, levies or other assessments, including all or any such tax on net income, alternative minimum, gross receipts, premium, capital, sales, use, gains, ad valorem, value added, transfer, franchise, profits, inventory, goods and services, capital stock, license, withholding, payroll, employment, social security, unemployment, disability, welfare, workers compensation, excise, severance, stamp, documentary stamp, occupation, real or personal property, mortgage recording, environmental, estimated and other taxes of the same or of a similar nature to any of the foregoing, together with any interest, penalties, or additions thereto imposed by a Governmental Authority.
Tax Representations has the meaning given to it in Section 7.2(a)(i).
Third Party Claim has the meaning given to it in Section 7.5(a).
Third Party Insurance Claim shall mean a claim against Crescent or any Crescent Subsidiary for payment of damages, defense costs and any other losses covered by insurance, which claim (a) arises out of an underlying claim asserted by a third party against Crescent or any Crescent Subsidiary or with respect to which Crescent or any Crescent Subsidiary is alleged to have liability, and (b) would have been covered under the Duke Liability Insurance Policies immediately prior to the Effective Date.
Title Policies means the extended coverage ALTA owners form (or its equivalent in any jurisdiction where such form is not available) title policies listed on Section 1.1(v) of the Crescent Disclosure Letter.
Title and Authority Representations has the meaning given to it in Section 7.2(a)(i).
Trademarks and Logos has the meaning given to it in Section 6.11(a).
Transfer Taxes means all share transfer, real property transfer, documentary, sales, use, registration and other such Taxes and related fees (including any penalties, interest and additions to Tax) incurred in connection with this Agreement and the transactions contemplated in this Agreement.
Transition Services Agreement has the meaning given to it in Section 2.3(a)(iii).
Workers Compensation Policy has the meaning given to in the definition of Duke Occurrence-Based Insurance Policies.
ARTICLE II
C LOSING A CTIONS
Section 2.1 Closing. The Closing shall take place at the offices of Skadden, Arps, Slate, Meagher & Flom LLP, 4 Times Square, New York, New York 10036 concurrently with the execution hereof, or such other location as the Parties may determine.
Section 2.2 Closing Actions. At the Closing, the following events shall occur:
(a) Duke Ventures shall contribute to the capital of Holdco one hundred percent (100%) of the Crescent Membership Interests, and Holdco will issue one hundred percent (100%) of the Holdco Membership Interests to Duke Ventures;
(b) in accordance with the Employment Agreement, Holdco will then issue additional Holdco Membership Interests to Mr. Fields such that the Holdco Membership Interests will then be held 98% by Duke Ventures and 2% by Mr. Fields;
(c) simultaneously with the transactions contemplated by Sections 2.2(a) and 2.2(b), the Lender shall advance loans to Crescent in an amount of $1,225,000,000 (equal to the New Debt Financing), and Crescent shall immediately thereafter distribute $1,187,000,000 (equal to the Net Debt Proceeds) to Holdco, which will then distribute the Net Debt Proceeds solely to Duke Ventures as a distribution of capital;
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(d) immediately following the transactions contemplated by Sections 2.2(a) through 2.2(c), Duke Ventures shall sell, assign, convey, transfer and deliver to the MS Members jointly, and the MS Members shall jointly purchase and acquire from Duke Ventures, all of Duke Ventures right, title and interest in and to the Purchased Interests, for a cash payment equal to the Purchase Price, payable by wire transfer of immediately available funds to an account designated by Duke Ventures; and
(e) immediately following the foregoing transactions contemplated by Sections 2.2(a) through 2.2(d), the ownership of Holdco shall be as follows: Duke Ventures (49%), the MS Members (49%) and Mr. Fields (2%).
Section 2.3 Closing Deliveries. In addition to the actions set forth in Section 2.2, the Parties agree to make their respective deliveries set forth below.
(a) At the Closing, Duke Ventures shall deliver, or cause to be delivered, to the MS Members the following deliveries:
(i) the Crescent Consents marked with an asterisk (*) in Section 4.3(a) of the Crescent Disclosure Letter;
(ii) the Operating Agreement, duly executed by Duke Ventures;
(iii) the Transition Services Agreement, dated as of the Effective Date, by and among Duke Energy Business Services LLC and Crescent in the form attached hereto as Exhibit D (the Transition Services Agreement ), duly executed by Duke Energy Business Services LLC and Crescent;
(iv) the Employee Matters Agreement, dated as of the Effective Date, by and among Duke Parent, CRE, LLC and Crescent in the form attached hereto as Exhibit E (the Employee Matters Agreement ), duly executed by Duke Parent and CRE, LLC and Crescent;
(v) the Agreement Relating to Certain Legacy Land, dated as of the Effective Date, by and among Holdco, Crescent and Duke Ventures (the Legacy Land Agreement ), duly executed by Holdco, Crescent and Duke Ventures, and the Right of First Offer Agreement, dated as of the Effective Date, by and among Duke Energy Business Services LLC and Crescent duly executed by Duke Energy Business Services LLC and Crescent (collectively, the Legacy Land Agreements );
(vi) the Title Policies;
(vii) the Assignment and Assumption of Membership Interests relating to the transfer of the Purchased Interests from Duke Ventures to the MS Members, dated as of the Effective Date, by and among Duke Ventures and the MS Members (the Assignment Agreement ), duly executed by Duke Ventures;
(viii) the Landmar Certificate, executed by Edward E. Burr and LandMar Management, Inc.; and
(ix) a certificate under Section 1445(b)(2) of the Code providing that Duke Parent is not a foreign person.
(b) At the Closing, the MS Members shall deliver, or cause to be delivered, to Duke Ventures the following deliveries:
(i) the Operating Agreement, duly executed by each of the MS Members;
(ii) the Legacy Land Agreement, acknowledged by each of the MS Members;
(iii) the Assignment Agreement, duly executed by each of the MS Members; and
(iv) a cash payment equal to the Purchase Price.
(c) At or prior to the Closing, Duke Ventures and the MS Members shall cause Holdco to make all filings with Governmental Authorities that are necessary in connection with the formation of Holdco, including the filing of a Certificate of Formation in the form of Exhibit F with the Secretary of State of the State of Delaware.
(d) At or prior to the Closing, Duke Ventures and the MS Members shall (i) cause Crescent to amend and restate its Articles of Organization by filing with the Secretary of State of the State of Georgia the Amended and Restated Articles of Organization and (ii) cause Crescent to amend and restate the Limited Liability Company Agreement of Crescent by entering into the Amended and Restated Operating Agreement.
(e) Attached hereto as Exhibit G is a calculation of the Purchase Price.
(f) Each of Duke Ventures obligation, on the one hand, and the MS Members obligation, on the other hand, to make the foregoing closing deliveries set forth in this Section 2.3, and the other provisions of this ARTICLE II, is conditioned upon receipt by such Party of the other Partys foregoing closing deliveries set forth in this ARTICLE II. Each of the closing deliveries is deemed to occur in a sequence consistent with the terms of Section 2.2.
Section 2.4 Post-Closing Adjustment of Net Contribution/Distribution Amount.
(a) As promptly as practicable, but no later than thirty (30) days after the Effective Date, Duke Ventures shall prepare and deliver to the MS Members a written statement setting forth the final Net Contribution/Distribution Amount together with a certificate of Duke Ventures that such statement has been prepared in good faith in accordance with the requirements of this Agreement and
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shall provide the MS Members with a written copy of such statement, along with reasonable supporting information and calculations (the Net Contribution/Distribution Amount Determination ).
(b) The MS Members shall have thirty (30) days following receipt of the Net Contribution/Distribution Amount Determination (the Net Contribution/Distribution Amount Review Period ) to review the Net Contribution/Distribution Amount Determination. During such 30-day period the MS Members and its auditors shall be permitted to review the working papers relating to the Net Contribution/Distribution Amount Determination. If the MS Members object to the Net Contribution/Distribution Amount Determination, then the MS Members shall provide Duke Ventures written notice thereof within thirty (30) days after receiving the Net Contribution/Distribution Amount Determination, specifying the specific matters in dispute (the Net Contribution/Distribution Amount Dispute Notice ). If the Parties are unable to agree on the Net Contribution/Distribution Amount within 30 days following delivery of Net Contribution/Distribution Amount Dispute Notice, the Parties shall, within five days after the expiration of the foregoing 30-day period, mutually agree upon and engage an audit partner at an Independent Accounting Firm (the Accounting Expert ) to resolve such dispute as provided below; provided , however , that if the MS Members and Duke Ventures are unable to agree upon and engage such Accounting Expert within such five-day period, then either Party may submit to the AAA the responsibility for the selection of the Accounting Expert, which selection shall be final and binding on both Parties; and provided , further, that if the Accounting Expert from an Independent Accounting Firm is unable or unwilling to serve as the Accounting Expert, an Accounting Expert may be chosen from such other nationally recognized independent certified public accounting firm as the Parties may mutually agree or as the AAA shall select. The Parties shall refer such dispute to the Accounting Expert, which shall make a final and binding determination as to all matters in dispute (and only such matters) and thus the Net Contribution/Distribution Amount on a timely basis and promptly shall notify the Parties in writing of its resolution (the Auditors Net Contribution/Distribution Amount Determination ). The Accounting Expert shall not have the power to modify or amend any term or provision of this Agreement. The determination of the Accounting Expert shall be final and binding on the Parties and may be entered and enforced in any court having proper jurisdiction. Crescent shall bear the fees and other costs charged by the Accounting Expert. If the MS Members do not object to the Net Contribution/Distribution Amount Determination within the time period and in the manner set forth in the first sentence of this Section 2.4(b), or if the MS Members accept the Net Contribution/Distribution Amount Determination, then in each case the Net Contribution/Distribution Amount as set forth in the Net Contribution/Distribution Amount Determination shall become final and binding upon the Parties for all purposes hereunder.
(c) Following the end of the Net Contribution/Distribution Amount Review Period (if timely Net Contribution/Distribution Amount Dispute Notice is not given), or upon the resolution of all matters set forth in the Net Contribution/Distribution Amount Dispute Notice by the mutual agreement of the Parties or by the issuance of an Auditors Net Contribution/Distribution Amount Determination, there shall be an adjustment equal to the amount by which (if any) the Net Contribution/Distribution Amount, as finally determined pursuant to this Section 2.4 (the Final Net Contribution/Distribution Amount ), is greater (expressed as a positive number) or less (expressed as a negative number) than the Estimated Net Contribution/Distribution Amount. If the Final Net Contribution/Distribution Amount exceeds the Estimated Net Contribution/Distribution Amount, then the MS Members shall pay, or shall cause one of its Affiliates to pay, to Duke Ventures an amount equal to 49% of such excess (together with interest thereon at the rate of 8% per annum from the Effective Date to and including the date paid) within five (5) Business Days after such final determination. Alternatively, if the Estimated Net Contribution/Distribution Amount exceeds the Final Net Contribution/Distribution Amount, then Duke Ventures shall pay, or shall cause one of its Affiliates to pay, to the MS Members an aggregate amount equal to 49% of such excess (together with interest thereon at the rate of 8% per annum from the Effective Date to and including the date paid) within five (5) Business Days after final determination of the Net Contribution/Distribution Amount.
ARTICLE III
R EPRESENTATIONS AND W ARRANTIES OF D UKE V ENTURES
Concurrently with the execution and delivery of this Agreement, Duke Ventures has delivered to the MS Members a letter (the Duke Disclosure Letter ) setting forth, among other things, items the disclosure of which is necessary or appropriate either in response to an express disclosure requirement contained in a provision hereof or as an exception to one or more of Duke Ventures representations or warranties contained in this ARTICLE III. Duke Ventures represents and warrants to the MS Members as follows:
Section 3.1 Organization. Duke Ventures is a limited liability company duly organized, validly existing and in good standing under the Laws of the state of Nevada. Duke Ventures is duly qualified or licensed to do business in each other jurisdiction where the nature of the business conducted by it or the character or location of its Assets and the actions to be performed by it hereunder makes such qualification or licensing necessary, except in those jurisdictions where the failure to be so qualified or licensed would not reasonably be expected to result in a material adverse effect on Duke Ventures ability to perform such actions hereunder.
Section 3.2 Authority. Duke Ventures has all requisite limited liability company power and authority to execute and deliver this Agreement and to perform its obligations hereunder and has the authority to execute, deliver and perform the other documents and agree -
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ments contemplated hereby to be executed, delivered and performed by it. The execution and delivery by Duke Ventures of this Agreement, and the performance by Duke Ventures of its obligations hereunder, have been duly and validly authorized by all necessary limited liability company action. This Agreement has been duly and validly executed and delivered by Duke Ventures and constitutes the legal, valid and binding obligation of Duke Ventures enforceable against Duke Ventures in accordance with its terms, subject to the effect of any general principles of equity, whether applied in a court of law or a court of equity, and by bankruptcy, insolvency and similar Laws affecting creditors rights and remedies generally, including all Laws relating to fraudulent transfers.
Section 3.3 No Conflicts. The execution and delivery by Duke Ventures of this Agreement, the performance by Duke Ventures of its obligations hereunder and the consummation of the transactions contemplated in this Agreement do not (a) conflict with or result in a violation or breach of any of the terms, conditions or provisions of the Charter Documents of Duke Ventures, (b) (i) conflict with, violate or breach any material term or provision of any Law applicable to Duke Ventures or (ii) require any material consent or approval of any Governmental Authority or material notice to, or material declaration, filing or registration with, any Governmental Authority under any Law or judgment applicable to Duke Ventures, or (c) conflict with or result in a violation or breach of any of the terms, conditions or provisions of any indenture, mortgage, deed of trust, agreement, instrument, order, arbitration award, judgment, decree or Contract, except in the cases of (b) and (c) above as would not reasonably be expected to have a material adverse effect on Duke Ventures ability to perform its obligations hereunder.
Section 3.4 Claims. Except as set forth in Section 3.4 of the Duke Disclosure Letter, no Claim is pending or, to Duke Ventures Knowledge, has been threatened against Duke Ventures that seeks a writ, judgment, order or decree restraining, enjoining or otherwise prohibiting or making illegal any of the transactions contemplated by this Agreement.
Section 3.5 Brokers. Except as provided in this Agreement, none of Duke Ventures or any of the Non-Crescent Affiliates has any liability or obligation to pay fees or commissions to any broker, finder or agent with respect to the transactions contemplated by this Agreement for which the MS Members, their Affiliates, Holdco or Crescent or any Crescent Subsidiary could become liable or obligated.
Section 3.6 Ownership.
(a) Duke Ventures owns one hundred percent (100%) of the Crescent Membership Interests free and clear of all Liens other than those (a) arising pursuant to this Agreement or the Charter Documents of Crescent or (b) for Taxes that would constitute a Permitted Lien under clause (a) of the definition thereof. The issuance of the Crescent Membership Interests was duly authorized by Crescent, and the Crescent Membership Interests are not subject to any voting agreements or any Contracts restricting or otherwise relating to the voting, distribution or disposition of such Crescent Membership Interests, other than those arising hereunder or pursuant to the Charter Documents of Crescent.
(b) Duke Ventures owns the Purchased Interests free and clear of all Liens other than those arising pursuant to this Agreement or the Operating Agreement. The issuance of the Purchased Interests was duly authorized by Holdco, and the Purchased Interests are not subject to any voting agreements or any Contracts restricting or otherwise relating to the voting, distribution or disposition of such Purchased Interests, other than those arising hereunder or pursuant to the Operating Agreement.
Section 3.7 No Other Representation. Except as expressly set forth in this Agreement, neither Duke Ventures, its Representatives nor any other Person has made any representation or warranty, expressed or implied, to the MS Members as to any matter relating to Duke Ventures, Crescent, the Crescent Subsidiaries or the transactions contemplated by this Agreement, including as to the accuracy or completeness of any information regarding Duke Ventures, Crescent or the Crescent Subsidiaries furnished or made available to the MS Members and their Representatives, including any information, documents or material made available to the MS Members in any physical or electronic data rooms, management presentations or in any other form in connection with the other transactions contemplated by this Agreement.
ARTICLE IV
R EPRESENTATIONS AND W ARRANTIES OF C RESCENT
Concurrently with the execution and delivery of this Agreement, Crescent has delivered to the MS Members a letter (the Crescent Disclosure Letter ) setting forth, among other things, items the disclosure of which is necessary or appropriate either in response to an express disclosure requirement contained in a provision hereof or as an exception to one or more of Crescents representations or warranties contained in this ARTICLE IV. Crescent represents and warrants to the MS Members as follows:
Section 4.1 Organization. Each of Crescent and the Crescent Subsidiaries is a corporation, limited partnership, limited liability company or other entity duly organized, validly existing and in good standing (in each instance where such concepts are legally applicable) under the Laws of the jurisdiction of its organization and has the requisite corporate, limited company, partnership, limited liability company or other entity (as the case may be) power and authority to own, lease and operate its properties and to carry on its business as it is now being conducted. Each of Crescent and the Crescent Subsidiaries is duly licensed or qualified in all material respects to do business
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in each jurisdiction (whether federal, state, provincial, territorial, local or foreign) in which the nature of the Business or the character or location of the Real Property and its Assets makes such licensing or qualification necessary.
Section 4.2 Authority. Crescent has all requisite limited liability company power and authority to execute and deliver this Agreement and to perform its obligations hereunder. The execution and delivery by Crescent of this Agreement, and the performance by Crescent of its obligations hereunder, have been duly and validly authorized by all necessary limited liability company action. This Agreement has been duly and validly executed and delivered by Crescent and constitutes the legal, valid and binding obligation of Crescent enforceable against Crescent in accordance with its terms, subject to the effect of any general principles of equity, whether applied in a court of law or a court of equity, and by bankruptcy, insolvency and similar Laws affecting creditors rights and remedies generally, including all Laws relating to fraudulent transfers.
Section 4.3 No Conflicts. The execution and delivery by Crescent of this Agreement, the performance by Crescent of its obligations hereunder and the consummation of the transactions contemplated in this Agreement do not (a) subject to receipt of those consents set forth in Section 4.3(a) of the Crescent Disclosure Letter (the Crescent Consents ), (i) conflict with or result in a violation or breach of any of the terms, conditions or provisions of the Charter Documents of Crescent, or any Crescent Subsidiary, (ii) trigger any change of control, buy-sell, buy-out, right of first offer or refusal or termination rights or remedies, give rise to any Lien (other than any Permitted Lien) or accelerate any rights or remedies thereunder, or (iii) violate or result in a default (or give rise to any right of termination, cancellation or acceleration or the creation of any Lien (other than any Permitted Lien)) under any Material Contract, or (b) (i) conflict with, violate or breach any material term or provision of any Law or judgment applicable to Crescent or any Crescent Subsidiary or (ii) require any material consent or approval of any Governmental Authority or material notice to, or material declaration, filing or registration with, any Governmental Authority under any Law applicable to Crescent or any Crescent Subsidiary, except in the cases of (a)(ii), (a)(iii), and (b) above as would not reasonably be expected to have a Material Adverse Effect or a material adverse effect on Crescents ability to perform its obligations hereunder.
Section 4.4 Claims; Orders. Except as set forth in Section 4.4 of the Crescent Disclosure Letter, no Claim is pending or, to Crescents Knowledge, has been threatened against Duke Ventures, Crescent or any Crescent Subsidiary, including any Claim that seeks a writ, judgment, order or decree restraining, enjoining or otherwise prohibiting or making illegal any of the transactions contemplated by this Agreement. There are no judgments, orders, decrees or injunctions imposed upon or otherwise affecting Crescent or the Crescent Subsidiaries or any of their respective Assets.
Section 4.5 Brokers. Except as provided in this Agreement, none of Duke Ventures, Crescent or any of the Crescent Subsidiaries has any liability or obligation to pay fees or commissions to any broker, finder or agent with respect to the transactions contemplated by this Agreement for which the MS Members, their Affiliates, Holdco, Crescent or any Crescent Subsidiary could become liable or obligated.
Section 4.6 Capitalization.
(a) The Crescent Membership Interests are the only authorized, issued or outstanding membership interests or securities of Crescent, including any securities or membership interests convertible therein to or exchangeable therefor. Duke Ventures is not in default under any of the Charter Documents of Crescent. Crescent is not a party to any agreement for the purchase, subscription, allotment or issue of any unissued interests, units or other securities (including convertible securities, warrants or convertible obligations of any nature) or for the purchase or redemption of any outstanding interests, units or other securities of Crescent other than those set forth in Section 4.6(a) of the Crescent Disclosure Letter or arising hereunder or arising pursuant to the Charter Documents of Crescent.
(b) Each outstanding share of capital stock (or other unit of equity interest) of each Crescent Subsidiary is duly authorized, validly issued, fully paid and nonassessable (where such concepts are legally applicable) and was issued free of preemptive (or similar) rights, and, except as set forth in Section 4.6(b)(i) of the Crescent Disclosure Letter, each such share, unit or other equity interest is owned by Crescent and/or by one or more wholly owned Crescent Subsidiaries, free and clear of all options, rights of first refusal, agreements, limitations on Crescents or, except as set forth in the applicable Charter Documents any Crescent Subsidiarys voting, dividend or transfer rights, charges and other encumbrances or Liens of any nature whatsoever. None of Crescent or any Crescent Subsidiaries is a party to any agreement for the purchase, subscription, allotment or issue of any unissued interests, units or other securities (including convertible securities, warrants or convertible obligations of any nature) or for the purchase or redemption of any outstanding interests, units or other securities of such Crescent Subsidiary other than those set forth in Section 4.6(a) of the Crescent Disclosure Letter or arising pursuant to the Charter Documents of such Crescent Subsidiary. Sections 4.6(b)(ii) and 4.6(b)(iii) of the Crescent Disclosure Letter set forth (w) a true and complete list of all Crescent Subsidiaries, (x) the jurisdiction of organization of each Crescent Subsidiary and all jurisdictions in which it is licensed or qualified to do business, (y) the ownership of all outstanding equity interests in the Crescent Subsidiaries that are held by Crescent or any Crescent Subsidiary, and (z) a true and complete list of all other Persons in which Crescent or any Crescent Subsidiary owns an equity interest (the Other Interests ), and, to Crescents Knowledge, the owners of all other outstanding equity interests in such Persons. For each Crescent Subsidiary, there are no voting trusts or other agreements to which such Crescent Subsidiary, Crescent or any other Crescent
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Subsidiary is a party or to which any of them are bound relating to the voting of the equity capital interests in such Crescent Subsidiary, other than the Charter Documents of such Crescent Subsidiary. Except for the capital stock of, or other equity interests in, the Crescent Subsidiaries disclosed in Section 4.6(b)(ii) of the Crescent Disclosure Letter and the Other Interests described in Section 4.6(b)(iii) of the Crescent Disclosure Letter, neither Crescent nor any Crescent Subsidiary owns any stock or other ownership or equity interest in any Person. Neither Crescent nor any Crescent Subsidiary has violated any provision of any organizational documents governing or otherwise relating to its rights in any Other Interests that would constitute a Material Adverse Effect.
(c) Crescent has provided or made available to the MS Members a complete and accurate copy of the Charter Documents for Crescent and each Crescent Subsidiary. Each Charter Document is in full force and effect, and no other documents, instruments, agreements or certificates are in effect that govern the relative rights and obligations of the shareholders, partners or members in those capacities, as applicable, of any of the Crescent Subsidiaries. Neither Crescent nor any Crescent Subsidiary is in material breach of, or material default under, any Crescent Subsidiary Charter Document, and no event has occurred that, with the giving of notice or the passage of time, or both, would constitute a material default by Crescent or any Crescent Subsidiary under any Crescent Subsidiary Charter Document (other than the Charter Document of a Crescent Subsidiary directly or indirectly wholly owned by Crescent), and neither Crescent nor any Crescent Subsidiary has given written notice to, or received any written notice that, any third party is in material breach of, or material default under, any of the Crescent Subsidiary Charter Documents.
(d) Section 4.6(d) of the Crescent Disclosure Letter sets forth the amount of funds advanced by Crescent or the applicable Crescent Subsidiary as of June 30, 2006 (the Advanced Amounts ) to the entities in respect of the Projects identified thereon (the Relevant Projects ) since the initial capitalization of the Relevant Projects. Crescent or the applicable Crescent Subsidiaries are entitled to receive distributions (if any) made by the Relevant Projects up to the applicable portion of the Advanced Amounts made by the applicable Relevant Project entity before payment of any portion of such distributions (if any) is made to any other equity holders of such Relevant Projects.
Section 4.7 Financial Statements. Crescent has delivered or made available to the MS Members (a) the audited consolidated balance sheets of Crescent and the Crescent Subsidiaries as of December 31, 2005 and December 31, 2004 and the audited consolidated statements of income, members equity and cash flow for the years ended on such dates, together with the related notes thereto and a report thereon from Deloitte & Touche LLP, and (b) the unaudited consolidated balance sheet of Crescent and the Crescent Subsidiaries as of June 30, 2006, and the unaudited consolidated statements of income, members equity and cash flow for the six (6) months ended on such date (the audited consolidated balance sheet of Crescent and the Crescent Subsidiaries as of December 31, 2005 being the Balance Sheet, and all of the foregoing being the Financial Statements ). The Financial Statements fairly present, in all material respects and in accordance with GAAP, the financial position, the results of operations and cash flows, as the case may be, of Crescent, as at the dates and for the periods indicated, except for the absence of footnotes and for normal year-end adjustments in the unaudited Financial Statements. None of Crescent or any Crescent Subsidiary has any liabilities (whether accrued, absolute or contingent), except for liabilities (i) reflected or reserved against in the Financial Statements, (ii) disclosed in Section 4.7 or any other Section of the Crescent Disclosure Letter, (iii) incurred in the ordinary course of business consistent with past practice since June 30, 2006 and which would not reasonably be expected to result in a Material Adverse Effect or (iv) arising under any Contract to which Crescent or any Crescent Subsidiary is a party, but exclusive of any liabilities arising from a material default by Crescent or any Crescent Subsidiary under any such Contract.
Section 4.8 Permits; Compliance with Laws. Crescent and the Crescent Subsidiaries hold all licenses, franchises, registrations, permits and authorizations ( Permits ) necessary for the ownership of the Assets and lawful conduct of the Business under and pursuant to applicable Law, and, except as disclosed on Section 4.8 of the Company Disclosure Letter, are in compliance with all Laws applicable to Crescent and the Crescent Subsidiaries or by which any of their respective Assets are bound, except in the cases where the failure to hold any such Permit or any such noncompliance would not reasonably be expected to result in a Material Adverse Effect; provided , however , that this Section 4.8 does not address matters relating to Taxes, which are exclusively addressed by Section 4.10, matters relating to Environmental Laws, which are exclusively addressed by Section 4.12, or matters relating to Benefit Plans, which are exclusively addressed by Section 4.16. The Permits are in full force and effect, and neither Crescent, nor any Crescent Subsidiary is in default or violation of any of the Permits, except in the cases where such default or violation would not reasonably be expected to result in a Material Adverse Effect.
Section 4.9 Absence of Certain Changes. Except as set forth in Section 4.9 of the Crescent Disclosure Letter or as contemplated by this Agreement, at all times after December 31, 2005 through the Effective Date, Crescent and the Crescent Subsidiaries have operated in the ordinary course of business and there has not been (nor has Crescent or any Crescent Subsidiary committed to take any action that could result in):
(a) any event which would reasonably be expected to result in a Material Adverse Effect;
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(b) any increase in compensation (including severance or termination pay) payable to or to become payable to any consultants, officers, directors, employees or agents working in connection with the Business or any change in any insurance, pension or other benefit plan, payment or arrangement made to, for or with any of such consultants, officers, directors, employees or agents, in each case other than increases that are in accordance with past practice and are not material in the aggregate;
(c) any hiring or employment, or termination of employment of any officer or employee of Crescent or any Crescent Subsidiary making in excess of $150,000 per annum of total compensation;
(d) any change in financial accounting methods, principles or practices by Crescent which materially affects its Assets, liabilities or Business, except insofar as may have been required by a change in GAAP or as would not reasonably be expected to result in a Material Adverse Effect;
(e) any indebtedness for borrowed money incurred by Crescent or any Crescent Subsidiary or any issuance of debt securities by Crescent or any Crescent Subsidiary or the creation of any Lien related to a third-party financing (other than (i) a Permitted Lien or (ii) the Liens contemplated by the New Debt Financing) against any of Crescents Assets;
(f) any damage, destruction, or loss (whether or not covered by insurance) experienced by Crescent or any Crescent Subsidiary with respect to their respective Assets, where the cost to repair, replace or restore such Assets exceeds $5,000,000;
(g) any amendment of the Charter Documents of Crescent or any Crescent Subsidiary or the liquidation, dissolution or other winding up of Crescent or any Crescent Subsidiary or the merger or consolidation with any other Person or any amendment of any term of any outstanding security of Crescent or any Crescent Subsidiary;
(h) any issuance, sale, pledge, disposition of or creation of any Lien on any shares of any class of capital stock or other equity interest of Crescent or any Crescent Subsidiary or any options, warrants, convertible securities or other rights of any kind to acquire any shares of such capital stock or any other equity interest of Crescent or any Crescent Subsidiary;
(i) any material capital expenditure other than (i) pursuant to the terms of any existing Contract, including tenant improvements required under existing Commercial Leases; (ii) capital expenditures in the ordinary course of business and consistent with past practice or current development plans; (iii) any other capital expenditure not exceeding $250,000 individually or $5,000,000 in the aggregate; and (iv) capital expenditures in accordance with the annual budget of Crescent or any project budget for any Project;
(j) any acquisition (by merger, consolidation, acquisition of entity interests or assets or any other business combination or by entering into an option to acquire or by exercising an option or other right or election) of (1) any corporation, partnership, limited liability company, joint venture or other business organization or property exceeding $1,000,000 or (2) any real property exceeding $1,000,000;
(k) any sale, lease, transfer or disposition of any of the Assets of Crescent or the Crescent Subsidiaries having a book value in excess of $5,000,000, in each case other than (1) pursuant to the terms of any existing Contract; (2) Commercial Leases other than Material Leases; (3) sales of Legacy Land, sales of parcels that are not divided into lots in a Project, and bulk sales of lots in a Project, in a single transaction or series of related transactions, less than $5,000,000; (4) sales of single-family residential lots or condominium units to homeowners in the ordinary course of business and (5) as disclosed to the MS Members in management presentations prior to the Effective Date;
(l) any new, or change in any existing, material election with respect to Taxes;
(m) any failure to maintain in full force and effect the existing material insurance policies or to replace such insurance policies with comparable insurance policies covering Crescent, the Crescent Subsidiaries and their respective properties, assets and businesses;
(n) any new or amended agreement or arrangement with Duke Parent or any Affiliate of Duke Parent or Crescent;
(o) any waiver, release, assignment, settlement or compromise of any pending or threatened action or claim other than settlements or compromises for litigation (other than any litigation described in the definition of Lake Mary Environmental Condition) where the amount paid (after reduction by any insurance proceeds actually received) does not exceed $500,000 in the aggregate; or
(p) any agreement or commitment to do any of the foregoing.
Section 4.10 Taxes. Except as set forth in Section 4.10 of the Crescent Disclosure Letter:
(a) (i) each of Crescent and the Crescent Subsidiaries (each a Relevant Entity and collectively, the Relevant Entities ) and, to Crescents Knowledge, each other entity in which Crescent has a direct or indirect interest (collectively, with the Relevant Entities, the Subsidiary Entities , and each of them, a Subsidiary Entity ) is and has been classified either as a partnership or a disregarded entity for U.S. federal income tax purposes since the later of December 31, 2004 or its inception, (ii) no election has been filed with any U.S. federal or state Tax authority electing to treat any Relevant Entity or, to Crescents Knowledge, any Subsidiary Entity, as an entity other than a partnership or disregarded entity for U.S. federal or state income tax purposes, and
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(iii) each Relevant Entity and, to Crescents Knowledge, each Subsidiary Entity, that is required to file a partnership Tax return has filed Tax returns as a partnership for U.S. federal or state income tax purposes since the date it was required to do so, and to Crescents Knowledge, no partner or member nor any Tax authority has taken a position inconsistent with such treatment.
(b) Duke Ventures and each Relevant Entity have accurately prepared in all material respects and filed or caused to be filed in a timely manner (within any applicable extension periods) all material Tax returns required to be filed by the Code or by applicable state, local or foreign tax laws. All material Taxes of Duke Ventures and each Relevant Entity shown as due and payable on such Tax returns have been timely paid in full to the respective Tax authority or have been properly accrued and will be timely paid in full by the due date thereof.
(c) No material Tax return of a Relevant Entity is under audit or examination by any Tax authority and no written notice of an intention to commence such an audit or examination of a Relevant Entity or, to Crescents Knowledge, a Subsidiary Entity has been received from any Tax authority by Duke Ventures, Crescent or the Relevant Entities. There are no outstanding agreements extending or waiving the statutory period of limitations applicable to any material Tax return of a Relevant Entity and no request for any such waiver or extension is currently pending.
(d) No Relevant Entity has any material liability for the Taxes of any Person other than itself (i) under Treasury Regulations Section 1.1502-6 (or any similar provisions of state, local or foreign law), (ii) as a transferee or successor, or (iii) by Contract.
(e) None of the Relevant Entities has engaged in any transaction that has given rise to or could be reasonably expected to give rise to (i) a disclosure obligation with respect to any Person under Section 6111 of the Code, the regulations promulgated thereunder, and published tax administrative guidance as of the Effective Date, (ii) a list of maintenance obligations with respect to any Person under Section 6112 of the Code, the regulations promulgated thereunder, and published tax administrative guidance as of the Effective Date, or (iii) a disclosure obligation as a reportable transaction under Section 6011 of the Code, the regulations promulgated thereunder, and published tax administrative guidance as of the Effective Date.
(f) None of the Relevant Entities is party to or bound by any material tax sharing agreement, tax indemnity obligation or similar agreement with respect to Taxes.
(g) Duke Ventures and all of the Relevant Entities have in all material respects, properly withheld and remitted to the proper Tax authority all material Taxes required to be withheld with respect to amounts paid or owed to any employee, independent contractor, partner, member, creditor, or other Person.
(h) Duke Ventures and Crescent are not foreign persons for purposes of Section 1445 of the Code.
(i) None of Duke Ventures, Crescent or any Crescent Subsidiary has requested or received any private letter ruling from the IRS or comparable ruling from any other Tax authority.
(j) None of the Relevant Entities has outstanding a power of attorney with respect to U.S. federal income Taxes on Form 2848.
(k) Duke Ventures has made available to the MS Members true and correct copies of all material federal, state and local Tax returns filed by the Relevant Entities on which the statute of limitations has not expired.
(l) The transactions contemplated by this Agreement will not cause a termination of any of the Subsidiary Entities for purposes of Section 708(b) of the Code which would be prohibited under any Contract or under any Charter Document of a Subsidiary Entity and would result in a material liability thereunder.
Section 4.11 Contracts.
(a) Excluding Contracts pursuant to which neither Crescent nor any Crescent Subsidiary, nor any of their respective Assets, will be bound or have liability after the Closing, and excluding Benefit Plans, Section 4.11(a) of the Crescent Disclosure Letter sets forth a list as of the Effective Date of the following Contracts to which Crescent or any Crescent Subsidiary is a party or by which their respective Assets may be bound (the Contracts listed in Section 4.11(a) of the Crescent Disclosure Letter that meet the descriptions in Section 4.11(a) being collectively, the Material Contracts ):
(i) each Contract under which Crescent or any Crescent Subsidiary has incurred, assumed or guaranteed any outstanding indebtedness for borrowed money (excluding performance or surety bonds incurred in the ordinary course of business) or any material capitalized lease obligation, or under which any of their material Assets are subjected to a Lien securing outstanding indebtedness for borrowed money;
(ii) each Contract with Duke Ventures or any Non-Crescent Affiliate;
(iii) each Contract that purports by its terms to materially limit the freedom of Crescent or any Crescent Subsidiary, or, to Crescents Knowledge, any of their officers, to compete in, or conduct, any line of business or in any geographic area, other than radius clauses in shopping center leases entered into in the ordinary course of business, none of which would reasonably be expected to result in a Material Adverse Effect;
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(iv) each Contract entered into after January 1, 2003 pursuant to which Crescent or any Crescent Subsidiary has material continuing indemnification, earn-out or contingent payment obligations, pursuant to which the maximum liability is reasonably likely to exceed $500,000, excluding any Contract relating to the sale of Real Property entered into after such time;
(v) each Charter Document of a Crescent Subsidiary (other than Crescent Subsidiaries directly or indirectly wholly owned by Crescent) and of any Person relating to the Other Interests;
(vi) each Contract (or group of Contracts entered into in connection with the same capital expenditure or acquisition of fixed assets) for capital expenditures or the acquisition of fixed assets requiring aggregate future payments by Crescent or any Crescent Subsidiary in excess of $5,000,000 other than Contracts for purchase of Real Property;
(vii) each Contract (or group of Contracts entered into in connection with the same lease) for the lease of any Real Property by Crescent or a Crescent Subsidiary as landlord of (A) 5,000 rentable square feet or more for retail use or (B) 10,000 rentable square feet or more leased for any other use (a Material Lease );
(viii) each Contract (or group of Contracts entered into in connection with the same lease) for the lease of over 5,000 rentable square feet of Real Property to Crescent or a Crescent Subsidiary as tenant;
(ix) each Contract (or group of Contracts entered into in connection with the same lease) for the lease of personal property or equipment to or from any Person providing for lease payments in excess of $250,000 per annum;
(x) each Contract (or group of such Contracts entered into in connection with the same transaction) for the sale of Real Property entered into since December 31, 2004, other than (A) sales of single-family residential lots and condominium units to homeowners in the ordinary course of business and (B) sales of Legacy Land, sales of parcels that are not divided into lots in a Project, and bulk sales of lots in a Project, in a single transaction or series of related transactions, less than $5,000,000, none of which would reasonably be expected to result in a Material Adverse Effect;
(xi) each Contract (or group of such Contracts entered into in connection with the same purchase) for the purchase by Crescent or any Crescent Subsidiary of Real Property entered into after December 31, 2005, other than any purchase of parcels of Real Property not greater than $1,000,000;
(xii) each Contract (or group of related Contracts) for the purchase or sale of supplies, products or other personal property by Crescent or any Crescent Subsidiary requiring payments in excess of $500,000, other than Contracts terminable without penalty upon sixty (60) days or less prior written notice;
(xiii) each Contract (or group of related Contracts) for the furnishing or receiving of services, including management, operating, listing, brokerage, supply, leasing, construction management, marketing, advertising and maintenance agreements which require annual payments by Crescent in excess of $250,000 or which may result in total payments by or liability of Crescent or any Crescent Subsidiary in excess of $1,000,000, other than Contracts terminable without penalty upon sixty (60) days or less prior written notice or Contracts entered into in the ordinary course of business with respect to any Project that are included in the project budget for such Project;
(xiv) each Contract relating to the development or construction of any Real Property, including Contracts for the future funding of streets, sewer and water lines, drainage facilities and similar infrastructure necessary for the continued development of any Real Property, any subsisting master plan, development order or other similar land development or planning document, but only if such Contract provides for aggregate remaining payment or performance obligations of Crescent or any Crescent Subsidiary reasonably expected to cost in excess of $5,000,000;
(xv) each Contract (other than any Charter Documents) that provides for any indemnification by or between Crescent or any Crescent Subsidiary, on the one hand, and any manager or officer or director of Crescent or any Crescent Subsidiary, on the other hand;
(xvi) each consulting services Contract of an individual providing for annual fees in excess of $100,000 and each Contract of employment;
(xvii) each Contract that provides for any payment or benefit (or acceleration thereof), termination or renegotiation rights upon consummation of the transactions contemplated hereby;
(xviii) each Contract (or group of Contracts entered into with respect to the same facilities) relating to off-site facilities necessary or desirable for the ownership, development, operation or resale of any Real Property, including environmental land banks, parking facilities, access easements, beach use and/or access, golf, or any other Project amenity, other than Contracts which are not reasonably expected to result in total payments by or liability of Crescent or any Crescent Subsidiary greater than $500,000 per annum per Project; and
(xix) each other Contract (or group of Contracts entered into in connection with the same matter or undertaking), other than Contracts for the purchase of Real Property, not described above which would reasonably be expected to result in (A) total
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payments by or liability of Crescent or any Crescent Subsidiary or (B) total payments to Crescent or any Crescent Subsidiary, in each case in excess of $5,000,000 over the term of the Contract, other than Contracts terminable without penalty upon thirty (30) days or less prior written notice.
(b) Section 4.11(b) of the Crescent Disclosure Letter sets forth a list of all letters of credit, performance or surety bonds, cash deposits or similar items issued or procured by Duke Ventures or any Non-Crescent Affiliate to any Person for the account of Crescent or any Crescent Subsidiary outstanding as of the Effective Date (each, a Credit Support Instrument ).
(c) Crescent has delivered to the MS Members or otherwise made available to the MS Members true and complete copies of all Material Contracts, including any amendment thereto. Each Material Contract is a legal, valid and binding obligation of Crescent or Crescent Subsidiary party thereto enforceable against Crescent or such Crescent Subsidiary in accordance with its terms, subject to the effect of any general principles of equity, whether applied in a court of law or a court of equity, and by bankruptcy, insolvency and similar Laws affecting creditors rights and remedies generally, including all Laws relating to fraudulent transfers. Neither Crescent nor any Crescent Subsidiary is in breach or default under any Material Contract to which it is a party, except any such breach or default that would not reasonably be expected to result in a Material Adverse Effect. To Crescents Knowledge, no other party to any of the Material Contracts is in breach or default thereunder, except for any such breach or default that would not reasonably be expected to result in a Material Adverse Effect.
Section 4.12 Environmental Matters.
(a) Section 4.12(a) of the Crescent Disclosure Letter sets forth a list of all the reports of material environmental investigations conducted on any portion of the Real Property that are in the possession of Crescent or any Crescent Subsidiary, and true and complete copies of all such environmental reports have been delivered or made available to the MS Members.
(b) Except as set forth in Section 4.12(b) of the Crescent Disclosure Letter, (i) Crescent and the Crescent Subsidiaries are in compliance with Environmental Laws and have obtained or timely applied for all permits required by Environmental Laws; (ii) none of Crescent or the Crescent Subsidiaries has received any written notice of any material Claims under any Environmental Laws that are currently outstanding, and, to Crescents Knowledge, no such Claims are threatened against Crescent or any Crescent Subsidiary by any Person; (iii) there is no site to which Crescent or any Crescent Subsidiary has transported or arranged for the transport of Hazardous Materials associated with the Business that, to Crescents Knowledge, is the subject of any environmental action by any Governmental Authority or that would reasonably be expected to result in a material Claim under any Environmental Laws against Crescent or any Crescent Subsidiary; and (iv) there has been no Release by Crescent, any Crescent Subsidiary, Duke Ventures or any Affiliate of Duke Ventures or Crescent (or, to the Knowledge of Crescent, any other Person) of any Hazardous Material at or from Real Property owned or operated by Crescent or any Crescent Subsidiary that would reasonably be expected to result in a material Claim under any Environmental Laws against Crescent or any Crescent Subsidiary.
(c) Notwithstanding Section 4.12(b), for any individual Real Property site for which a Phase I environmental site assessment (or the material equivalent thereof) has not been provided to the MS Members prior to the Effective Date, the representations and warranties provided in Section 4.12(b) shall not be qualified with respect to materiality or Knowledge. All of the individual Real Property sites to which the foregoing sentence applies are listed in Section 4.12(c) of the Crescent Disclosure Letter, which list shall govern the applicability of the foregoing sentence.
Section 4.13 Insurance. Section 4.13 of the Crescent Disclosure Letter sets forth a list of all material insurance policies covering Crescent, the Crescent Subsidiaries, and their respective tangible Assets or Businesses, other than any such insurance policies related to Benefit Plans. The insurance policies set forth in Section 4.13 of the Crescent Disclosure Letter are in full force and effect. Crescent has delivered to the MS Members or otherwise made available to the MS Members true and complete copies of all such insurance policies issued to Crescent or any Crescent Subsidiary in effect as of the Effective Date, and has made available to the MS Members true and complete copies of all insurance policies issued to Duke Parent or any Non-Crescent Affiliate and covering Crescent, the Crescent Subsidiaries or their respective tangible Assets or Businesses in effect as of the Effective Date listed on Section 4.13(i) of the Crescent Disclosure Letter. All premiums due and payable under such policies have been paid, and Crescent is otherwise in material compliance with the terms and conditions of all such policies. To the Knowledge of Crescent, there is no threatened termination of any of such policies. As of the Effective Date, there is no pending claim by Crescent or any Crescent Subsidiary under such policies which if denied, would have a Material Adverse Effect.
Section 4.14 Intellectual Property. (a) Crescent or a Crescent Subsidiary owns or has a license or right to use all the Intellectual Property used in the Business, except as would not reasonably be expected to result in a Material Adverse Effect.
(b) Except as disclosed in Section 4.14(b) of the Crescent Disclosure Letter, (i) all Intellectual Property owned by Crescent or a Crescent Subsidiary is held free and clear of any Liens, except as would not reasonably be expected to result in a Material Adverse Effect, and Crescent or a Crescent Subsidiary owns the entire right, title and interest in and to such Intellectual Property; (ii) to Crescents Knowledge the conduct of the Business has not in the past six (6) years infringed, violated or misappropriated and does
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not now infringe, violate or misappropriate the Intellectual Property of any other Person, in each case except as would not reasonably be expected to result in a Material Adverse Effect; (iii) to Crescents Knowledge no Person has in the past six (6) years challenged the validity of the Intellectual Property owned by Crescent or a Crescent Subsidiary, in each case where such act has had, or is expected to result in, a Material Adverse Effect; (iv) to Crescents Knowledge no Person has in the past six (6) years infringed, violated, or misappropriated or now infringes, violates or misappropriates the Intellectual Property owned by Crescent or a Crescent Subsidiary, in each case where such act has had, or is expected to result in, a Material Adverse Effect; and (v) Crescent and each Crescent Subsidiary have used reasonable efforts to protect the confidentiality of all confidential information held by Crescent or a Crescent Subsidiary.
(c) Section 4.14(c) of the Crescent Disclosure Letter lists all patents, registered trademarks, domain names, and registered copyrights owned by Crescent or a Crescent Subsidiary. All filing, issue, registration, renewal, maintenance or other official registry fees due with respect to such patents, domain names, trademarks, and copyrights have been paid and will be paid until Closing.
Section 4.15 Labor Matters.
(a) Except as described in Section 4.15(a) of the Crescent Disclosure Letter, there has not occurred, nor to Crescents Knowledge has there been threatened, a labor strike or dispute, unfair labor practice complaints, request for representation, organizing campaign, work stoppage, slowdown or lockout involving employees of Crescent or any Crescent Subsidiary in the past two (2) years, except any such events or occurrences that would not reasonably be expected to result in a Material Adverse Effect. There are no charges or complaints with respect to or relating to any employee of Crescent or any Crescent Subsidiary pending, or to Crescents Knowledge, threatened to be brought, before the Equal Employment Opportunity Commission, the Department of Labor, the Occupation Safety and Health Administration or any other federal or state agency responsible for the prevention of unlawful employment practices, except any such charges or complaints that would not reasonably be expected to result in a Material Adverse Effect.
(b) Except as set forth in Section 4.15(b) of the Crescent Disclosure Letter, neither Crescent nor any Crescent Subsidiary is, or at any time has been, a party to any collective bargaining agreement or other labor union agreements applicable to Persons employed by Crescent or any Crescent Subsidiary, nor is any such collective bargaining agreement being negotiated.
(c) There are no material claims by any employees of either Crescent or any Crescent Subsidiary pending, or to Crescents Knowledge, threatened against Crescent or any Crescent Subsidiary for indemnification under any indemnification agreements of Crescent or any of the Crescent Subsidiaries which are not covered by insurance.
Section 4.16 Employee Benefits.
(a) Section 4.16(a) of the Crescent Disclosure Letter sets forth a true and complete list of all material employee benefit plans (as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ( ERISA )), all material bonus, stock option, stock purchase, restricted stock, incentive, deferred compensation, retiree medical or life insurance, supplemental retirement, severance or other benefit plans, programs or arrangements, and all material employment, termination, severance or other Contracts or commitments to which Crescent or any Crescent Subsidiary is a party, or which are maintained, contributed to or sponsored by Duke Parent, Duke Ventures, Crescent or any Crescent Subsidiary for the benefit of any current or former employee, consultant, officer or director of Crescent or any Crescent Subsidiary (collectively, the Benefit Plans ). Crescent or Duke Ventures has made available to the MS Members a true and complete copy (where applicable) of (i) each Benefit Plan (or, where a Benefit Plan has not been reduced to writing, a summary of all material terms of such Benefit Plan), (ii) each trust or funding arrangement prepared in connection with each such Benefit Plan, (iii) the most recently filed annual report on Internal Revenue Service ( IRS ) Form 5500 or any other annual report required by applicable Law, (iv) the most recently received IRS determination letter, if any, for each such Benefit Plan, (v) the most recently prepared actuarial report and financial statement in connection with each such Benefit Plan, and (vi) the most recent summary plan description, any summaries of material modifications and any employee handbooks concerning the extent of the benefits provided under a Benefit Plan. Except as set forth in Section 4.16(a) of the Crescent Disclosure Letter, none of Duke Parent, Duke Ventures, Crescent nor any Crescent Subsidiary has any plan or commitment to establish any new material Benefit Plan or to materially modify any Benefit Plan with respect to any current or former employee, consultant, officer or director of Crescent or any Crescent Subsidiary.
(b) Except as set forth in Section 4.16(b) of the Crescent Disclosure Letter, none of Crescent or any Crescent Subsidiary or any other Person or entity that, together with Crescent or any Crescent Subsidiary, is treated as a single employer under Section 414(b), (c), (m) or (o) of the Code (each, together with Crescent and any Crescent Subsidiary, an ERISA Affiliate ), contributes to, sponsors or maintains (i) a pension plan (within the meaning of Section 3(2) of ERISA) subject to Section 412 of the Code or Title IV of ERISA; (ii) a multiemployer plan (within the meaning of Section 3(37) or 4001(a)(3) of ERISA or the comparable provisions of any other applicable Law); or (iii) a single employer pension plan (within the meaning of Section 4001(a)(15) of ERISA) for which an ERISA Affiliate would reasonably be expected to incur Liability under Section 4063 or 4064 of ERISA. Except as set forth in Section 4.16(b) of the Crescent Disclosure Letter, no Benefit Plan exists that would reasonably be expected to result in the payment to any present
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or former employee, director or consultant of Crescent or any Crescent Subsidiary of any money or other property or accelerate or provide any other rights or benefits to any current or former employee, director or consultant of Crescent or any Crescent Subsidiary as a result of the consummation of the transactions contemplated in this Agreement (whether alone or in connection with any other event). Except as set forth in Section 4.16(b) of the Crescent Disclosure Letter, neither the execution and delivery of this Agreement nor the consummation of the transactions contemplated in this Agreement will (either alone or in combination with another event) result in any payment or other benefit that has been or may be made to any current or former employee or independent contractor of Crescent or any Crescent Subsidiary under any employment, severance or termination agreement, other compensation arrangement or employee benefit plan or arrangement with Crescent or any Crescent Subsidiary to be characterized as an excess parachute payment, as such term is defined in Section 280G of the Code. None of Crescent or any Crescent Subsidiary is a party to any material Contract or plan pursuant to which it is bound to compensate any Person for any excise or other additional Taxes paid pursuant to Section 409A or 4999 of the Code or any similar provision of state, local or foreign Law.
(c) Each Benefit Plan has been established and administered in accordance with its terms, and in compliance with the applicable provisions of ERISA, the Code and other applicable Laws, except to the extent such noncompliance would not have a Material Adverse Effect, and, except as set forth in Section 4.16(c) of the Crescent Disclosure Letter, no Benefit Plan provides post-termination welfare benefits, and neither Crescent nor any Crescent Subsidiary has any obligation to provide any post-termination welfare benefits other than for health care continuation as required by Section 4980B of the Code or any similar statute.
(d) All contributions (including all employer contributions and employee salary reduction contributions) or premium payments required to have been made under the terms of any Benefit Plan, or in accordance with applicable Law, have been timely made or reflected on Crescents financial statements in accordance with GAAP. No accumulated funding deficiency as defined in Section 302 of ERISA or Section 412 of the Code, whether or not waived, exists with respect to any Benefit Plan subject to Section 302 of ERISA or Section 412 of the Code and Crescent is not, and does not expect to be, subject to (i) any requirement to post security pursuant to Section 412(f) of the Code or (ii) any Lien pursuant to Section 412(n) of the Code.
Section 4.17 Real Property. Section 4.17 of the Crescent Disclosure Letter sets forth a complete list and location and ownership status (i.e. owned or leased) of all Real Property and Crescent or Crescent Subsidiary that owns or leases each such Real Property. With respect to the Real Property:
(a) Title . Except as set forth in Section 4.17(a) of the Crescent Disclosure Letter, each of Crescent and each of the Crescent Subsidiaries owns fee simple title to each parcel of Real Property shown thereon as being owned by it, and a valid leasehold interest in each parcel of Real Property shown thereon to be leased by it, in each case free and clear of Liens other than (i) Permitted Liens and (ii) in the case of leased Real Property, the interest of the lessor thereof.
(b) Title Policies . Section 4.17(b) of the Crescent Disclosure Letter lists (i) all fee title insurance policies insuring title of Crescent and the Crescent Subsidiaries in the Material Properties that are in the possession of Crescent or the Crescent Subsidiaries and all other fee title insurance policies insuring title of Crescent and the Crescent Subsidiaries in owned Real Property that are in the possession of Crescent at its Charlotte, North Carolina headquarters and (ii) the most current surveys in the possession of Crescent or any Crescent Subsidiary of the Material Properties and other surveys of owned Real Property that are in the possession of Crescent at its Charlotte, North Carolina headquarters, and true and complete copies of all such policies and surveys (other than maps, surveys and drawings of Legacy Land) have been delivered or made available to the MS Members.
(c) Options . Except as set forth on Section 4.17(c) of the Crescent Disclosure Letter, neither Crescent nor any Crescent Subsidiary has granted any unexpired option agreement, right of first offer, right of first negotiation or right of first refusal with respect to the purchase of any Real Property or any portion thereof, other than any Material Contract.
(d) Condemnation . Except as set forth in Section 4.17(d) of the Crescent Disclosure Letter, none of Crescent or any Crescent Subsidiary has received any written condemnation notice from a Governmental Authority with respect to any portion of the Real Property; no condemnation or similar proceedings are pending with respect to any portion of the Real Property; and to Crescents Knowledge, there are no condemnation or similar proceedings threatened regarding any portion of the Real Property, excluding in all cases any dedication of Real Property to a Governmental Authority in connection with or incident to development activity of Crescent and the Crescent Subsidiaries consistent with Crescents current development plans.
(e) Site and Zoning Approval . All work required to be performed, payments required to be made and actions required to be taken prior to the Effective Date pursuant to any Contract entered into with a Governmental Authority in connection with a site approval, zoning reclassification or other similar action relating to any Real Property (e.g., local improvement district, road improvement district, environmental mitigation) have been performed, paid or taken, as the case may be, other than any such actions the failure of which would not result in a liability to Crescent or any Crescent Subsidiary in excess of $500,000.
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(f) Real Property Taxes . Except as disclosed on Section 4.17(f) of the Crescent Disclosure Letter, to Crescents Knowledge, all Real Property Taxes are paid in the ordinary course of business and such payments are reflected in the books and records of Crescent and the Crescent Subsidiaries.
(g) Project Schedule . Section 4.17(g) of the Crescent Disclosure Letter sets forth for each Project the following information as of July 1, 2006:
(i) the Project name and location;
(ii) whether such Project comprises predominately (A) commercial property, (B) multi-family residential property, or (C) single-family residential property;
(iii) with respect to each Project that includes commercial property: (A) the status of the construction of the improvements located (or to be located) thereon and (B) the approximate amount of rentable square feet currently existing or which will exist upon completion of construction of such Project, broken down by type (i.e., office, warehouse, industrial or retail);
(iv) with respect to the residential properties included in each Project that includes single-family residential property, to Crescents Knowledge: (A) the number of lots that are shown on a recorded plat with respect to such Project and (B) the number of unimproved lots that are currently contemplated to be created within the remaining acreage of Developable Property in accordance with the current internal general plan for the continued development of the Project; and
(v) with respect to each Project that includes multi-family residential property: (A) the status of the improvements located (or to be located) thereon, including the total number of currently contemplated condominium units or rental apartments within the Project; (B) the number of condominium units or apartments completed; (C) if applicable, the number of condominium units under Contract to be sold; and (D) if applicable, the number of condominium units remaining to be sold.
(h) Legacy Land . Section 4.17(h) of the Crescent Disclosure Letter sets forth the state and county in which each parcel of Legacy Land is located and the approximate acreage thereof.
(i) Commercial Property . Section 4.17(i) of the Crescent Disclosure Letter sets forth a rent roll with respect to each Project that is a commercial property; and such rent roll contains a true and correct list of the leases of space within such commercial property (the Commercial Leases ), and for each such Commercial Lease sets forth the name of the tenant, base rent and percentage rent, any rent escalations, any tenant security deposit, the commencement and expiration dates and any renewal or expansion rights of the Commercial Leases. Except for unfunded work allowances, commissions and other obligations listed in such rent roll or otherwise listed in Section 4.17(i) of the Crescent Disclosure Letter, Crescent and the Crescent Subsidiaries have performed all material obligations currently required to be performed by them to date under each Material Lease. Section 4.17(i) of the Crescent Disclosure Letter sets forth a true and correct list of tenants under the Material Leases for which a tenant is currently in occupancy as of the dates set forth on Section 4.17(i) of the Crescent Disclosure Letter and Crescent or any Crescent Subsidiary has received written notice of lease termination or lease cancellation. Except as disclosed in Section 4.17(i) of the Crescent Disclosure Letter, no tenant or other Person has any unrecorded option to purchase or first refusal rights to purchase the building in which space is leased under such Commercial Lease. All rent has been properly calculated and billed to tenants in all material respects pursuant to the Commercial Leases, except as would not have a Material Adverse Effect; no rentals or other amounts due under the Commercial Leases have been paid more than one month in advance; and all security and other deposits of any type required under the Commercial Leases have been paid in full and are being held by Crescent or a Crescent Subsidiary, as applicable.
(j) Residential Property . With respect to the portion of any Project comprising residential property that is one hundred percent (100%) owned by Crescent and/or the Crescent Subsidiaries, Section 4.17(j) of the Crescent Disclosure Letter lists all of the condominium or homeowners associations (each an Association ). Except as listed in Section 4.17(j) of the Crescent Disclosure Letter, there are no unpaid sums due and payable by Crescent or any Crescent Subsidiary under the Charter Documents governing the association (each an Association Document ), other than amounts in the ordinary course of business or being contested in good faith, and none of Crescent or the Crescent Subsidiaries is in material default under any of the Association Documents.
(k) Access Rights . Except as set forth on Section 4.17(k) of the Crescent Disclosure Letter, each parcel of the Real Property either abuts and has actual vehicular and pedestrian access to and from a public right of way or has an insurable appurtenant easement for vehicular or pedestrian access over and across adjacent land which provides such access to and from the Real Property and a public right of way; provided , however , that for any Project or Legacy Land that is comprised of more than one parcel, it shall not be considered a breach if not all of such parcels are benefited with such access rights so long as the parcels that are not directly benefited with such access rights can indirectly obtain the benefit of such access rights over one or more contiguous parcels included in the Real Property.
(l) Survey Issues . Other than Permitted Liens and such matters listed on Section 4.17(l) of the Crescent Disclosure Letter, there exists no encumbrance, encroachment, claim or other title defect on the Real Property (other than Legacy Land) that would be disclosed by an inspection of an accurate ALTA Survey of the Real Property and would reasonably be expected to interfere materially
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with the marketability or financeability or use or development of such property for purposes contemplated by Crescent for such property as of the Effective Date.
Section 4.18 Personal Property.
(a) As of the Effective Date, Crescent and the Crescent Subsidiaries own and hold valid title to the personal property owned, leased or used by them in their respective businesses, free and clear of all Liens, except for Permitted Liens and such Liens which, individually or in the aggregate, would not reasonably be expected to cause a Material Adverse Effect.
(b) None of the material personal property used by Crescent or the Crescent Subsidiaries for the use, operation, repair or maintenance of any Real Property as currently used, operated, maintained and repaired is leased from or otherwise owned by third parties, except (i) for equipment owned or leased by third party vendors providing maintenance or repair services to any Real Property or (ii) for leases of operating equipment or vehicles which leases either are Material Contracts or provide for lease payments below the threshold in Section 4.11(a)(ix).
Section 4.19 Accounts Receivable. The accounts receivable of Crescent and each Crescent Subsidiary reflect actual transactions, arise from bona fide transactions in the ordinary course of conduct of the business of and by Crescent and the Crescent Subsidiaries and to Crescents Knowledge, are not subject to any setoff or counterclaim.
Section 4.20 Financing Districts. Section 4.20 of the Crescent Disclosure Letter sets forth a true and accurate list as to any individual Project of (a) amounts heretofore expended by Crescent or any Crescent Subsidiary in connection with any Project for which Crescent or any Crescent Subsidiary, as applicable, currently projects being reimbursed) by a community development district, municipal utility district, or other analogous governmental agency program (a Financing District ) and (b) amounts that Crescent or any Crescent Subsidiary expects to be reimbursed following future expenditures in connection with development of each such Project. None of Crescent or any of the Crescent Subsidiaries has taken any action or failed to take any action that would limit, restrict, or impair the ability of any Financing District to issue bonds as necessary to make such reimbursements. None of Crescent or the Crescent Subsidiaries is in breach or default under any agreement with any Financing District. To Crescents Knowledge, no Financing District is in breach or default under any such agreement. None of Crescent or the Crescent Subsidiaries has sold, factored, or encumbered any of their rights to any such reimbursement from a Financing District.
Section 4.21 Related Party Transactions. Except for (i) the Transition Services Agreement, (ii) the Employee Matters Agreement, (iii) the Legacy Land Agreements, (iv) the letters of credit, performance or surety bonds, cash deposits or similar items identified on Section 4.11(b) of the Crescent Disclosure Letter, (v) other transactions contemplated by this Agreement, (vi) the arrangements relating to Leased Personal Property and Licensed Software described in Section 6.7 hereof and (vii) the matters set forth on Section 4.21 of the Crescent Disclosure Letter, there are no material agreements or any indebtedness for borrowed money between Duke Ventures and/or any Non-Crescent Affiliate, on the one hand, and Crescent and/or any Crescent Subsidiary, on the other hand. For the avoidance of doubt, all accounts payable by Crescent and/or any Crescent Subsidiary, on the one hand, and Duke Ventures and/or any Non-Crescent Affiliate, on the other hand, will remain outstanding after the Effective Date and will be paid in the ordinary course of business consistent with past practice (which amount is estimated to be $4,000,000 payable by Crescent or any Crescent Subsidiary to Duke or any Non-Crescent Affiliate).
Section 4.22 Bankruptcy. There is no petition in bankruptcy or any petition or answer seeking an assignment for the benefit of creditors, the appointment of a receiver or trustee, liquidation or dissolution or similar relief under the U.S. Bankruptcy Code or any state law filed by or against or threatened to be filed by or against any of Duke Ventures, Crescent or the Crescent Subsidiaries.
Section 4.23 No Other Representation. Except as expressly set forth in this Agreement, neither Crescent, its Representatives nor any other Person has made any representation or warranty, expressed or implied, to the MS Members as to any matter relating to Crescent or the Crescent Subsidiaries or the transactions contemplated by this Agreement, including as to the accuracy or completeness of any information regarding Crescent or the Crescent Subsidiaries furnished or made available to the MS Members and their Representatives, including any information, documents or material made available to the MS Members in any physical or electronic data rooms, management presentations or in any other form in connection with the other transactions contemplated by this Agreement.
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ARTICLE V
R EPRESENTATIONS AND W ARRANTIES OF THE MS M EMBERS
Concurrently with the execution and delivery of this Agreement, the MS Members have delivered to Duke Ventures a letter (the MS Disclosure Letter ) setting forth, among other things, items the disclosure of which is necessary or appropriate either in response to an express disclosure requirement contained in a provision hereof or as an exception to one or more of the MS Members representations or warranties contained in this ARTICLE V. Each of the MS Members jointly and severally represents and warrants to Duke Ventures as follows:
Section 5.1 Organization. Each of the MS Members is duly formed, validly existing and in good standing under the Laws of its jurisdiction of formation. Each of the MS Members is duly qualified or licensed to do business in each other jurisdiction where the actions to be performed by it hereunder make such qualification or licensing necessary, except in those jurisdictions where the failure to be so qualified or licensed would not reasonably be expected to result in a material adverse effect on such MS Members ability to perform such actions hereunder.
Section 5.2 Authority. Each of the MS Members has all requisite power and authority to execute and deliver this Agreement and to perform its obligations hereunder. The execution and delivery by each of the MS Members of this Agreement, and the performance by each of the MS Members of its obligations hereunder, have been duly and validly authorized by all necessary action. This Agreement has been duly and validly executed and delivered by each of the MS Members and constitutes the legal, valid and binding obligation of each of the MS Members enforceable against it in accordance with its terms, subject to the effect of any general principles of equity, whether applied in a court of law or a court of equity, and by bankruptcy, insolvency and similar Laws affecting creditors rights and remedies generally, including all Laws relating to fraudulent transfers.
Section 5.3 No Conflicts. The execution and delivery by each of the MS Members of this Agreement, the performance by each of the MS Members of its obligations hereunder and the consummation of the transactions contemplated in this Agreement do not (a) conflict with or result in a violation or breach of any of the terms, conditions or provisions of the Charter Documents of such MS Member or (b) (i) conflict with, violate or breach any material term or provision of any Law or judgment applicable to such MS Member or (ii) require any material consent or approval of any Governmental Authority, or material notice to, or material declaration, filing or registration with, any Governmental Authority under any Law applicable to such MS Member, except in the cases of (a) and (b) above as would not reasonably be expected to have a material adverse effect on such MS Members ability to perform its obligations hereunder.
Section 5.4 Claims. Except as set forth in Section 5.4 of the MS Disclosure Letter, no Claim is pending or, to the Knowledge of the MS Members, has been threatened against any of the MS Members that seeks a writ, judgment or order restraining, enjoining or otherwise prohibiting or making illegal any of the transactions contemplated by this Agreement.
Section 5.5 Brokers. None of the MS Members nor any of their respective Affiliates has any liability or obligation to pay fees or commissions to any broker, finder or agent with respect to the transactions contemplated by this Agreement for which Duke Ventures, the Non-Crescent Affiliates, Holdco, Crescent or any Crescent Subsidiary could become liable or obligated.
Section 5.6 Acknowledgement. The MS Members have conducted their own independent investigation, review and analysis of the Business, Assets, liabilities, financial condition, results of operations and prospects of Crescent and the Crescent Subsidiaries. Each of the MS Members acknowledges that it and its Representatives have been permitted full and complete access to the books and records, facilities, equipment, Tax returns, Contracts, insurance policies (or summaries thereof) and other Assets of Crescent and the Crescent Subsidiaries that it and its Representatives have desired or requested to see or review, and that it and its Representatives have had a full opportunity to meet with the officers and employees of Crescent and the Crescent Subsidiaries to discuss the Business. In entering into this Agreement, each of the MS Members acknowledges that it has relied solely on such independent investigation and not on any factual representations of Duke Ventures, Crescent or their respective Representatives (other than those expressly set forth in the Agreement). Each of the MS Members further agrees, to the fullest extent permitted by applicable Law, that none of Duke Ventures, Crescent or the Crescent Subsidiaries shall have any liability on any basis based on information regarding Crescent and the Crescent Subsidiaries furnished or made available to the MS Members and their Representatives, including any information, documents or material made available to the MS Members in any physical or electronic data rooms, management presentations or in any other form in connection with the transactions contemplated by this Agreement, except that the foregoing limitations shall not apply (i) in the event of fraud or willful misrepresentation or (ii) to Duke Ventures or Crescent insofar as Duke Ventures and Crescent have made the express representations and warranties in this Agreement, but always subject to the limitations set forth in ARTICLE VII.
Section 5.7 No Registration . Each of the MS Members understands and acknowledges that (i) the Purchased Interests have not been registered under the Securities Act of 1933, as amended (the Securities Act ), or any state securities laws and are being offered and sold in reliance upon exemptions provided in the Securities Act and state securities laws for transactions not involving any public offering and, therefore, cannot be resold or transferred unless they are subsequently registered under the Securities Act and applicable
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state laws or unless an exemption from such registration is available and (ii) the MS Members are purchasing the Purchased Interests for investment purposes only for the account of the MS Members and not with any view toward a distribution thereof.
Section 5.8 No Other Representation. Except as expressly set forth in this Agreement, none of the MS Members, their respective Representatives nor any other Person has made any representation or warranty, expressed or implied, to Duke Ventures or Crescent as to any matter relating to the MS Members or the transactions contemplated by this Agreement, including as to the accuracy or completeness of any information regarding the MS Members furnished or made available to Duke Ventures, Crescent and their Representatives, including any information, documents or material made available to Duke Ventures or Crescent in any form in connection with the other transactions contemplated by this Agreement.
ARTICLE VI
C OVENANTS
Section 6.1 Legacy Land. The Parties acknowledge and agree that certain matters regarding certain Legacy Land held by Crescent are governed by the Legacy Land Agreements.
Section 6.2 Tax Matters.
(a) No election shall be made by Duke Ventures, the MS Members or any of their respective Affiliates to classify Crescent, any Crescent Subsidiary or any Subsidiary Entity as an association taxable as a corporation pursuant to U.S. Treasury Regulation Section 301.7701-3 or any comparable provision of state or local law.
(b) Duke Ventures shall cause elections under Section 754 of the Code to be timely made by each Subsidiary Entity that is a partnership for U.S. federal income tax purposes in order to allow for an adjustment to the tax basis of the assets of each such Subsidiary Entity as necessary to reflect the acquisition by the MS Members of the Purchased Interests as contemplated by this Agreement, and Crescent and Holdco shall each also timely make such an election to make an adjustment to the tax basis of their assets to reflect such acquisition.
(c) The Parties agree to allocate U.S. federal income tax items of income, gain, deduction and loss, under an interim closing of the books method unless a different method is required by the Code and the applicable Treasury Regulations thereunder.
(d) The Parties agree to report the transactions described in this Agreement as a sale by Duke Ventures of a forty-nine percent (49%) interest in Holdco, subject to Section 741 of the Code, to the MS Members occurring after the transactions set forth in
Section 2.2(a), (b) and (c) hereof. None of Duke Ventures, Mr. Fields nor the MS Members or any of their respective Affiliates shall take any position inconsistent with such treatment for U.S. federal income tax purposes.
Section 6.3 Public Announcements. The initial press releases issued by each Party announcing the transactions contemplated by this Agreement shall be in a form that is mutually acceptable to Duke Ventures and the MS Members. Thereafter, Duke Ventures and MSREF, on behalf of the MS Members, shall consult with one another before issuing any press releases or otherwise making any public announcements with respect to the transactions contemplated by this Agreement, and except as may be required by applicable Laws or by the rules and regulations of the New York Stock Exchange shall not issue any such press release or make any such announcement prior to such consultation, except that (a) Duke Ventures and MSREF, on behalf of the MS Members, shall agree on the content of the first announcement made to Crescents employees regarding the execution of this Agreement and the transactions contemplated in this Agreement and (b) Crescent may, with reasonable advance notice to MSREF, on behalf of the MS Members, otherwise communicate with Crescents employees as it deems appropriate with respect to the transactions contemplated by this Agreement, provided , that such communications are not inconsistent with the announcement agreed to in clause (a).
Section 6.4 Employee Benefits. The Parties acknowledge that certain employee benefits matters are governed by the terms of the Employee Matters Agreement.
Section 6.5 Environmental. At any Real Property site at which Lender, in the course of providing the New Debt Financing, requires a Phase I environmental site assessment ( ESA ), Crescent shall engage a nationally recognized environmental consulting firm to prepare such ESA pursuant to ASTM Standard E-1527.05 or, if acceptable to Lender, ASTM Standard E-2247-02. In the event any such ESA identifies Recognized Environmental Conditions (as that phrase is defined in ASTM Standard E-1527.05), the response to any such Recognized Environmental Condition (including further investigation, sampling, and remediation) shall be limited to such response as would be undertaken by a reasonably prudent owner or operator of such Real Property site, in the context of the site use and the nature of the Recognized Environmental Condition, or as required by Environmental Law. Copies of all such ESA reports shall be promptly provided to Duke Ventures and the MS Members.
Section 6.6 Insurance.
(a) Claim Reports . Duke Ventures shall cause each insured act or occurrence that is known by Duke Ventures and involves or relates to Crescent or any Crescent Subsidiary which is required to be reported to its insurer(s) under any policy of insurance
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maintained by Duke Parent or any Non-Crescent Affiliate that provides coverage for Crescent or any Crescent Subsidiary, to be promptly reported to such insurer(s) in accordance with the applicable insurance policy or policies. Except as provided below, all insurance maintained by Duke Parent or any Non-Crescent Affiliate that provides coverage for Crescent or any Crescent Subsidiary shall be terminated as of the Closing as to any claims made or reported under such insurance policies after the Closing, and neither Duke Parent nor any of its Non-Crescent Affiliates shall have any liability under this Section 6.6 for any such claim. Crescent shall be solely responsible for providing its own insurance after the Closing. Notwithstanding the foregoing, Duke Ventures and the MS Members may agree to provide such additional insurance coverage in respect of Crescent and the Crescent Subsidiaries under policies of insurance held by Duke Parent and/or the MS Members, or their respective Affiliates, in lieu of providing such coverage through new policies of insurance to be held by Crescent and the Crescent Subsidiaries.
(b) Third Party Coverage .
(i) If and to the extent that an Occurrence for which coverage is available under the Duke Liability Insurance Policies, in whole or in part, happens prior to the Closing, and a claim arising therefrom has been or is eventually asserted against Crescent or any Crescent Subsidiary and such claim is Reported on or before the date which is one hundred eighty (180) days after the Effective Date with respect to any of the Duke Liability Insurance Policies, then Duke Ventures shall cause an insurance carrier selected by Duke Ventures (or, at Duke Ventures option, Duke Parent or any Non-Crescent Affiliate) to Administer the Third Party Insurance Claim arising therefrom. Except as specifically provided in this Section 6.6(b)(i), no Duke Liability Insurance Policy shall be available for payment of any damages, costs of defense, or other sums with respect to any other Occurrence, and Crescent agrees and covenants (on behalf of itself, Crescent and each Crescent Subsidiary) not to make any claim or assert any rights against Duke Ventures, any Non-Crescent Affiliate, or any Duke Liability Insurance Policy with respect to any such Occurrence.
(ii) Duke Ventures shall maintain, or caused to be maintained, coverage for Third Party Insurance Claims under the Duke Liability Insurance Policies during the one-hundred eighty (180) day period described in Section 6.6(b)(i) above. For the avoidance of doubt, the terms of this Section 6.6(b) shall not limit the coverage under the Duke Occurrence-Based Insurance Policies as provided in Section 6.6(d).
(c) Other . Neither Duke Ventures nor any Non-Crescent Affiliate has any obligation to reimburse Crescent or the MS Members or any of their Affiliates under this Section 6.6 for the amount of any Third Party Insurance Claim (or any other loss, expenditure, payment, or damage) (i) for which coverage under any Duke Liability Insurance Policy is unavailable (in whole or part) for any reason (other than as a result of a breach of Section 6.6(b)(ii)) or (ii) in excess of the policy limits specified for the applicable Duke Liability Insurance Policy on Section 4.13(i) of the Crescent Disclosure Letter. Neither Duke Ventures nor any Non-Crescent Affiliate shall be required to bear the cost of the Administration of any Third Party Insurance Claim to the extent that Crescent or any Crescent Subsidiary Administers such Third Party Insurance Claim. Duke Ventures shall use commercially reasonable efforts to Administer all Third Party Insurance Claims in a manner consistent with the administration by Duke Ventures or a Non-Crescent Affiliate of Duke Ventures insurance claims. The Parties agree that Crescent shall provide (and shall cause the Crescent Subsidiaries to provide) such assistance and resources as Duke Ventures may reasonably request in connection with the Administration of any Third Party Insurance Claim hereunder. Crescent shall promptly Report to Duke Ventures its receipt of notice of any Occurrence that occurs prior to the Closing.
(d) Duke Occurrence-Based Insurance Policies . Duke Ventures agrees that, notwithstanding anything to the contrary contained herein (i) the insurance coverage under the Duke Occurrence-Based Insurance Policies shall continue to remain available for the benefit of Crescent and the Crescent Subsidiaries to the extent provided for in such policies of insurance and (ii) Duke Ventures or its Non-Crescent Affiliate shall be responsible for (A) all losses subject to the Automobile Policy in excess of $25,000 and (B) all losses subject to the Workers Compensation Policy, in each case, up to the limits set forth on Section 4.13 of the Company Disclosure Letter applicable to such policies. For avoidance of doubt, neither Duke Ventures nor any Non-Crescent Affiliate shall be required to renew any Duke Occurrence-Based Insurance Policies beyond the term of such policies in effect on the Effective Date.
Section 6.7 Leased Personal Property; Licensed Software.
(a) From the Effective Date until December 31, 2006, the Parties shall use commercially reasonable efforts to cause each lessor of all computers, servers and related hardware, copiers and fax machines leased by Duke Parent or any of its Non-Crescent Affiliates and currently used primarily by Crescent (collectively, the Leased Personal Property ) to agree as soon as reasonably practicable to (i) have Duke Parent or any of its Non-Crescent Affiliates assign the lease related to such Leased Personal Property to Crescent, effective as soon as practicable (but in no event later than December 31, 2006, unless such date is extended by the Parties in accordance with Transition Services Agreement) and (ii) release Duke Parent or any of its Non-Crescent Affiliates from all obligations under any such lease that accrue or arise after the Effective Date. Such efforts shall include, without limitation, Crescent providing financial information regarding Crescent to such lessors, and meeting with such lessors. Duke Ventures and the MS Members agree to cause Holdco to execute a guaranty (in a form reasonably acceptable to Parties) of the lessees obligations under
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any such lease if requested by the lessor. In the event that on or prior to December 31, 2006, any lessor of any Leased Personal Property does not agree as provided in the first sentence of this Section 6.7(a), then from and after December 31, 2006 (or such later date agreed to by the Parties in accordance with the Transition Services Agreement), (a) Crescent shall have no right to use such Leased Personal Property; (b) Duke Parent or such lessor shall have the right to remove and take possession of such Leased Personal Property; and (c) no party hereto shall have any further obligations to perform under the first sentence of this Section 6.7(a) related to such Leased Personal Property. Set forth on Section 6.7(a) of the Crescent Disclosure Letter is a listing of the Leased Personal Property reflected on Crescents records as of the date set forth thereon.
(b) From the date hereof until December 31, 2006, the Parties shall use commercially reasonable efforts to cause each licensor of all software licensed by Duke Parent or any of its Non-Crescent Affiliates and currently used primarily by Crescent (collectively, the Licensed Software ) to agree to (i) have Duke Parent or any of its Non-Crescent Affiliates assign the license related to such Licensed Software to Crescent, effective as soon as practicable (but in no event later than December 31, 2006, unless such date is extended by the Parties in accordance with Transition Services Agreement) and (ii) release Duke Parent or any of its Non-Crescent Affiliates from all obligations under any such license that accrue or arise after the date of the assignment to Crescent. Such efforts shall include, without limitation, Crescent providing financial information regarding Crescent to such licensors, and meeting with such licensors. Duke Ventures and the MS Members agree to cause Holdco to execute a guaranty (in a form reasonably acceptable to Holdco) of the licensee obligations under any such license if requested by the licensor. In the event that on or prior to December 31, 2006, any licensor of any Licensed Software does not agree as provided in the first sentence of this Section 6.7(b), then from and after December 31, 2006 (or such later date agreed to by the Parties in accordance with the Transition Services Agreement), (a) Crescent shall have no right to use such Licensed Software; (b) Duke Parent or such licensor shall have the right to remove and take possession of such Licensed Software; and (c) no party hereto shall have any further obligations to perform under the first sentence of this Section 6.7(b) related to such Licensed Software. To the extent any Licensed Software is supported by a maintenance agreement with any third party, it is Crescents sole responsibility to change, at Crescents sole expense, the beneficiary of such maintenance agreement effective as soon as practicable (but in no event later than December 31, 2006) from Duke Parent or any of its Non-Crescent Affiliates to Crescent. Set forth as Section 6.7(b) of the Crescent Disclosure Letter is a listing of the Licensed Software reflected on Crescents records as of the date set forth thereon.
Section 6.8 Surety Bonds; Letters of Credit.
(a) Duke Ventures agrees that the Credit Support Instruments shall remain outstanding following the Effective Date for a period not to exceed the third anniversary of the Effective Date (the Duke Release Date ). Crescent shall continue to pay all fees, costs and expenses in respect of the Credit Support Instruments which it has historically paid in a manner consistent with past practice, and Duke Ventures shall continue to pay all fees, costs and expenses in respect of the Credit Support Instruments which it has historically paid in a manner consistent with past practice and shall cause the applicable Non-Crescent Affiliate to continue to use their financial statements consistent with past practice to support such Credit Support Instruments along with any new letters of credit, performance or surety bonds, cash deposits or similar items ( New Credit Support Instruments ) for existing projects (but not new projects) provided that in no event shall the aggregate face amount of the Credit Support Instruments and the New Credit Support Instruments for which Duke Parent and any applicable Non-Crescent Affiliate must continue to use their financial statements for support exceed $215,000,000.
(b) From and after the Effective Date, Crescent shall be solely responsible for procuring New Credit Support Instruments for new projects, and in all other cases under Section 6.8(a) where Duke Ventures is not responsible for causing Duke Parent and any applicable Non-Crescent Affiliate to continue to provide their financial statements for support.
(c) Notwithstanding the provisions of Section 6.8(a), Crescent shall take such action as is necessary to (i) obtain complete and unconditional release of Duke Ventures and any Non-Crescent Affiliates with respect to each of the Credit Support Instruments and the New Credit Support Instruments supported by Duke Ventures or any Non-Crescent Affiliate, in each case, outstanding at such time, and (ii) cause the beneficiary or beneficiaries of each such Credit Support Instrument and New Credit Support Instrument to terminate and redeliver to Duke Ventures and such Non-Crescent Affiliates such Credit Support Instruments and New Credit Support Instruments (collectively, the Surety Bond Release ), in each case on or prior to the Duke Release Date. The actions required by this Section 6.8(c) shall include offer and delivery to the beneficiary of such Credit Support Instrument and New Credit Support Instrument, promptly upon request by Duke Ventures (i) in the case such Credit Support Instrument or New Credit Support Instrument is a surety or performance bond, a replacement surety or performance bond issued to such beneficiary by a Person having a net worth or a credit rating at least equal to those of the issuer of such existing surety or performance bond, and which replacement surety or performance bond contains terms and conditions that are substantially identical to the terms and conditions of such existing surety or performance bond or (ii) in the case such Credit Support Instrument or New Credit Support Instrument is a letter of credit, a replacement letter of credit issued to such beneficiary by a Person having a net worth or a credit rating at least equal to those of the issuer of such existing letter of credit, and which replacement letter of credit contains terms and conditions that are substantially identical to the terms and conditions of such existing letter of credit.
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(d) In the event any Credit Support Instrument or any New Credit Support Instrument supported by Duke Ventures or any Non-Crescent Affiliate is not replaced as of the Duke Release Date as contemplated by Section 6.8(c), then from and after such date, Crescent shall transfer to Duke Ventures and the Non-Crescent Affiliates an amount in cash or one or more letters of credit reasonably satisfactory to Duke Ventures and the Non-Crescent Affiliates, in either case, equal to the aggregate Credit Support Instruments and New Credit Support Instruments outstanding at such date until the complete and unconditional release of Duke Ventures and any Non-Crescent Affiliates obligations with respect to each such Credit Support Instrument or New Credit Support Instrument (which amount will be reimbursed to Crescent as and to the extent any such Credit Support Instruments or New Credit Support Instruments expire or Duke Ventures or the Non-Crescent Affiliates are otherwise fully and unconditionally released). In the event Crescent does not timely comply with its obligation under the foregoing sentence, the Parties agree that, from and after the Duke Release Date, no distributions shall be made by Holdco to its Members until such time as Crescent has complied with the foregoing sentence. Duke Ventures shall be permitted to retain the funds transferred by Crescent to Duke Ventures as described in the initial sentence of this Section 6.8(d) to the extent that Duke Ventures or the Non-Crescent Affiliates incurs any Losses arising from or related to any Credit Support Instrument or New Credit Support Instrument supported by Duke Ventures or any Non-Crescent Affiliate.
(e) From and after the Effective Date, Crescent hereby agrees to indemnify and hold harmless Duke Ventures and each Non-Crescent Affiliate that is a party to or has furnished any Credit Support Instrument or New Credit Support Instrument supported by Duke Ventures or any Non-Crescent Affiliate from and against any and all Losses suffered or incurred by Duke Ventures or any Non-Crescent Affiliate arising from or related to any Credit Support Instrument or New Credit Support Instrument.
Section 6.9 Reasonable Best Efforts; Further Assurances. Upon the terms and subject to the conditions of this Agreement, each Party agrees to use its reasonable best efforts to effect the consummation of the transactions contemplated in this Agreement as soon as practicable after the Effective Date. From time to time, as and when requested by any Party, the other Parties shall execute and deliver, or cause to be executed and delivered, all such documents and instruments and shall take, or cause to be taken, all such further or other actions (subject to Section 6.3), as such Party may reasonably deem necessary or desirable to consummate the transactions contemplated by this Agreement.
Section 6.10 Sale of Additional Interests in Holdco. Within ninety (90) days following the Effective Date, subject to and in accordance with applicable Laws (including federal and state securities laws) and Section 3.01(b) of the Operating Agreement, the Parties acknowledge that it is their intent to cause Holdco to offer to sell additional Holdco Membership Interests to certain employees (not to exceed ten (10)) covered by the Employee Matters Agreement as determined by the Executive Committee of Holdco in consultation with the Chief Executive Officer of Holdco in an aggregate amount not to exceed three percent (3%) of the then-issued and outstanding Holdco Membership Interests.
Section 6.11 Corporate Names.
(a) Crescent and Duke Ventures acknowledge that, from and after the Effective Date, Crescent and Duke Ventures shall have no rights with respect to any names, marks, trade names, trademarks and logos (collectively, Trademarks and Logos ) incorporating MSREF or Morgan Stanley by themselves or in combination with any other Trademark or Logo, including the corporate design logos associated therewith, and that the MS Members shall retain absolute and exclusive proprietary rights thereto or goodwill represented thereby or pertaining thereto. From and after the Effective Date, unless the MS Members agree in writing otherwise, Crescent and Duke Ventures shall not, nor shall they permit any of their respective Affiliates to, use any name, phrase or logo incorporating MSREF or Morgan Stanley or such corporate design logo or any confusingly similar name, phrase, logo or corporate design logo in or on any of its literature, sales materials or products or otherwise in connection with the sale of any products or services.
(b) Crescent and the MS Members acknowledge that, from and after the Effective Date, Crescent and the MS Members shall have no rights with respect to Trademarks and Logos incorporating Duke by itself or in combination with any other Trademark or Logo, including the corporate design logos associated therewith, and that Duke shall retain absolute and exclusive proprietary rights thereto or goodwill represented thereby or pertaining thereto. From and after the Effective Date, unless Duke Ventures agrees in writing otherwise, in Crescent and the MS Members shall not, nor shall they permit any of their respective Affiliates to, use any name, phrase or logo incorporating Duke or such corporate design logo or any confusingly similar name, phrase, logo or corporate design logo in or on any of its literature, sales materials or products or otherwise in connection with the sale of any products or services; provided , however , that Crescent may continue to use any signage, printed literature, sales materials, purchase orders and sales or lease agreements, and sell any products, that are included in the inventories of Crescent or the Crescent Subsidiaries on the Effective Date and that bear a name, phrase or logo incorporating Duke or such corporate design logo, until the supplies thereof existing on the Effective Date have been exhausted, but in any event for not longer than one-hundred eighty (180) days from the Effective Date.
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ARTICLE VII
I NDEMNIFICATION , L IMITATIONS OF L IABILITY , W AIVERS
AND T HIRD P ARTY C LAIMS
Section 7.1 Indemnification. (a) Subject to Section 7.2, from and after the Closing, each of Duke Ventures, on the one hand, and the MS Members, on the other hand (the Indemnifying Party ) shall indemnify, defend and hold harmless the other Party (being the MS Members, on the one hand, or Duke Ventures, on the other hand, as the case may be) and its or their respective Affiliates, directors, officers, equityholders, Representatives, agents and employees (the Indemnified Party ) from and against all Losses incurred or suffered by such other Party resulting from:
(i) any breach or inaccuracy of any representation or warranty of the Indemnifying Party contained in this Agreement; and
(ii) any breach of any covenant or agreement of the Indemnifying Party contained in this Agreement.
(b) Subject to Section 7.2(e) through 7.2(k) hereof, and Sections 7.2(m) through 7.2(o) hereof, Duke Ventures shall indemnify, defend and hold harmless the MS Members and any of their respective Affiliates, directors, officers, equity holders, Representatives, agents and employees from and against any and all Losses or Claims arising from the Lake Mary Environmental Condition, provided that, (i) such indemnification shall not be subject to the provisions of Sections 7.2(a), (b), (c), (d) or (l) hereof, and (ii) for the purposes of this Section 7.1(b), Losses shall also include any diminution in the fair market value of the Lake Mary Site as of the third anniversary of the Effective Date attributable to the presence of Hazardous Materials at such site on such anniversary except to the extent that either (A) the appropriate Governmental Authority either has issued a No Further Action Letter or has agreed that the remediation may be limited to periodic groundwater monitoring, with respect to such Hazardous Materials or (B) the Parties reasonably agree that the Lake Mary Site has been adequately remediated (except for long term monitoring of groundwater) to permit such site to be developed for commercial purposes on or before such third anniversary. The indemnification provided in this Section 7.1(b) shall survive the Closing without time limit. For purposes of this Agreement, the following terms shall have the meanings specified below:
Lake Mary Environmental Condition means (i) Hazardous Materials located on or released at the Lake Mary Site prior to the Effective Date, (ii) Hazardous Materials located on or released from the adjacent Siemens property prior to the Effective Date that impacted the Lake Mary Site, including a chlorinated solvent plume in the drinking water aquifer in the area, and (iii) the current and any future litigation brought against Crescent actually or allegedly arising out of the foregoing, including Brottem et al. v. Crescent Resources LLC, et al., Case No. 6:06-cv-306-Orl-31KRS, and related cases pending in the U.S. District Court, Middle District of Florida, Orlando Division, brought by workers or former workers at the Siemens property, Brottem et al. v. Siemens Communications, Inc. f/k/a/ Siemens Information and Communications Networks, Inc., et al., Case No. 06-CA-1543-11-K, and Cycle Canada et al. v. Siemens Communications Networks, Inc. et al. Case No. 06-CA-1544-11-W.
Lake Mary Site means the Real Property owned or operated by Crescent as of the Effective Date and abutting Interstate Highway 4 and Rinehart Road, in Lake Mary, Seminole County, Florida containing approximately 175 acres, and which is sometimes referred to as the New Century Park and Primera-Rinehart tracts.
(c) Notwithstanding anything else set forth in this Agreement, for purposes of this Agreement, Duke Ventures shall be the Indemnifying Party with respect to any Losses incurred or suffered by the MS Members for which Crescent would otherwise be considered the Indemnifying Party, and Duke Ventures shall be the Indemnified Party with respect to any Losses incurred or suffered by Crescent for which Crescent would otherwise be considered the Indemnified Party.
Section 7.2 Limitations of Liability . Notwithstanding anything in this Agreement to the contrary (but subject to the limitations on applicability set forth in Section 7.1(b)):
(a) the representations, warranties, covenants, agreements and obligations in this Agreement shall survive the Closing; provided , however , that no Party may make or bring a Claim for liability with respect to (i) any representations or warranties contained in ARTICLES III, IV or V (other than those representations and warranties contained in Sections 3.2, 3.6, 4.2, 4.6 and 5.2 hereof (collectively, the Title and Authority Representations ), Section 4.10 hereof (the Tax Representations ), Section 4.12 hereof (the Environmental Representations ), Section 4.16 hereof (the ERISA Representations ) and Section 4.17(l) (the Survey Representations )) after March 31, 2008, (ii) the Title and Authority Representations, the Environmental Representations and the Survey Representations after the three-year anniversary of the Effective Date, and (iii) the Tax Representations and the ERISA Representations and the covenants in Section 6.2 (Tax Matters), after the expiration of sixty (60) days following the expiration of the applicable statute of limitations (including extensions thereof consented to in writing by the Parties, such consent not to be unreasonably withheld, conditioned or delayed);
(b) any breach of a representation or warranty in this Agreement in connection with any single item or group of related items that results in Losses of less than $100,000 shall be deemed, for all purposes of this ARTICLE VII, not to be a breach of such
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representation or warranty; provided , however , that the foregoing limitation shall not apply to any Losses as a result of a breach of the Tax Representations;
(c) no Party shall have any liability for breaches of representations or warranties in this Agreement until the aggregate amount of all Losses incurred by the other Party (which term shall include the MS Members as a group, and not individually) equals or exceeds $4,000,000 (and then, subject to Section 7.2(d), only to the extent such aggregate Losses exceed such amount); provided , however , that the foregoing shall not apply to Duke Ventures indemnification obligations with respect to breaches of the Tax Representations;
(d) in no event shall a Partys aggregate liability (i) arising out of or relating to breaches of representations or warranties in this Agreement (other than a breach of a Title and Authority Representation, ERISA Representation or Tax Representation) exceed $40,000,000, except as set forth in Section 7.2(d)(ii) hereof and (ii) arising out of or relating to a breach of a Title and Authority Representation, ERISA Representation or Tax Representation (together with the aggregate liability pursuant to Section 7.2(d)(i) hereof) exceed the Purchase Price (for the avoidance of doubt, the indemnity set forth in Section 7.1(b) shall not be subject to this Section 7.2(d));
(e) the right to indemnification, reimbursement or other remedy based upon such representations, warranties, covenants and obligations shall not be affected by any investigation (including environmental investigation or assessment) conducted with respect to, or any Knowledge acquired (or capable of being acquired) at any time, whether before or after the execution and delivery of this Agreement or the Effective Date, with respect to the accuracy or inaccuracy of or compliance with any such representation, warranty, covenant or obligation;
(f) a Party must give written notice to the other Party within a reasonable period of time after becoming aware of any material breach by such other Party of any representation, warranty, covenant, agreement or obligation in this Agreement; provided , however , that such notification or the failure to give such notice shall have no effect for the purpose of determining whether any Person is entitled to indemnification pursuant to this ARTICLE VII, except to the extent that such other Party is prejudiced by the failure to give such notice;
(g) the Parties shall use reasonable best efforts to mitigate any Loss in connection with this Agreement;
(h) the Parties shall use commercially reasonable efforts to structure any indemnity payment in a manner such that the Indemnifying Party will obtain any deduction or other Tax benefit arising from having made such indemnification payment in order to avoid any duplication of after-Tax benefit to the Indemnified Party;
(i) the amount of any Losses incurred by the Indemnified Party shall be reduced by the amount of any insurance benefit received by the Indemnified Party or by Crescent in respect of such Losses;
(j) any liability for indemnification under this Agreement shall be determined without duplication of recovery by reason of the state of facts giving rise to such liability constituting a breach of more than one representation, warranty, covenant or agreement;
(k) no matter shall be the subject of any Claim hereunder to the extent that the Party bringing such Claim has otherwise been compensated therefor, including through calculation of the Purchase Price;
(l) no claim or cause of action for indemnification under this ARTICLE VII arising out of the inaccuracy or breach of any representation or warranty of the Indemnifying Party may be made following the termination of the applicable survival period; it being understood that in the event good faith notice of any claim for indemnification under this ARTICLE VII shall have been given within the applicable survival period, the representations and warranties that are the subject of such indemnification claim shall survive until such time as such claim is finally resolved. The Parties intend to shorten the statute of limitations and agree that, after the Effective Date, with respect to the Parties, any claim or cause of action against any of the Parties, or any of their respective directors, officers, employees, Affiliates, successors, permitted assigns, advisors, agents, or Representatives based upon, directly or indirectly, any of the representations, warranties, covenants or agreements contained in this Agreement, or any other agreement, document or instrument to be executed and delivered in connection with this Agreement may be brought only as expressly provided in this ARTICLE VII;
(m) for the avoidance of doubt, (i) the MS Members shall be deemed to have suffered a Loss equal to forty-nine percent (49%) of any Loss suffered directly or indirectly by Crescent or Holdco and (ii) in the event that any Loss for which the MS Members may become entitled to indemnification under this ARTICLE VII shall also constitute a direct or indirect Loss of Crescent, Duke Ventures obligation to provide indemnification to the MS Members shall be limited to forty-nine percent (49%) of such Loss;
(n) with respect to any matter which is the subject of a claim for indemnification (A) arising from a breach of the representations and warranties provided in Section 4.12 hereof (Environmental Matters), or which otherwise arises under Environmental Law for which the amount of the Claim is reasonably expected to exceed $5,000,000, or (B) which arises under Section 7.1(b) hereof (Lake Mary Site environmental indemnification), the Parties agree that Duke Ventures shall have the right, at its sole expense, to conduct and retain exclusive control over any investigation, remedial action, correction of noncompliance, or other action to be undertaken in
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response thereto, including, without limitation, the exclusive right, at its sole expense, to (i) investigate any suspected contamination or noncompliance, (ii) conduct and obtain any tests, reports, surveys and investigations, (iii) contact, negotiate or otherwise deal with Governmental Authorities, (iv) prepare any plan for such investigation, remedial action, correction of noncompliance, or other action, (v) conduct or direct any such investigation, remedial action, correction of noncompliance, or other action and (vi) conduct any legal proceedings, provided , that Duke Ventures shall in all events act in a timely manner with due diligence and with reasonable efforts to minimize disturbance to the development or occupancy of the affected property, and, if requested by MSREF, on behalf of the MS Members, Duke Ventures shall use reasonable efforts to consult with MSREF, on behalf of the MS Members, in good faith prior to conducting any such investigation, remedial action, correction of noncompliance, or other action; and
(o) Duke Ventures indemnification obligations provided herein for the Lake Mary Environmental Condition or Environmental Representations shall be subject to the following limitations: Any investigation, remedial action, correction of noncompliance, or other action (x) shall be the most commercially reasonable method under the circumstances and based upon the understanding that the relevant Real Property site is and will continue to be used for the purposes reasonably anticipated as of the Effective Date (except to the extent of circumstances preventing such use which are not related to the environmental condition of such site), (y) shall not exceed the least stringent requirements of any applicable Environmental Law or any clean-up standards set forth, established, published, proposed or promulgated under, pursuant to or by an Environmental Law or Governmental Authority having jurisdiction over such remedial action, correction of noncompliance, or action, in each case as in effect on the date of such remedial action, correction of noncompliance, or other action or any requirement or order of any Governmental Authority having jurisdiction over such remedial action, correction of noncompliance, or action, and (z) shall be conducted in compliance with all Environmental Laws. To the extent necessary to achieve the purposes set forth in the preceding sentence, Crescent shall agree to a deed restriction or other institutional controls on the Real Property site that is subject to such action, provided that such deed restriction or other institutional controls shall not materially restrict or limit the commercial use to which such site was reasonably anticipated to be used as of the Effective Date (except to the extent of circumstances preventing such use which are not related to the environmental condition of such site). The cost of any such maintenance required for such deed restriction or institutional controls shall be considered a Loss subject to Duke Ventures indemnification obligations provided herein for the Lake Mary Environmental Condition or Environmental Representations. Crescent shall, in good faith, seek to enter, when necessary, into an agreement with the Governmental Authority having jurisdiction over the remedial action, correction of noncompliance or other action, to allow Crescent to use the most commercially reasonable method and least stringent standard in connection with remedial action, correction of noncompliance, or other action under such circumstances and use. The issuance of a no further action letter or the equivalent indicia of completion issued by any Governmental Authority having jurisdiction over the condition, area of concern, or operable unit or the like ( No Further Action Letter ) shall constitute completion of Duke Ventures obligation under this Agreement for any such condition, except in the event of a third party claim or compliance with any conditions set forth in such No Further Action Letter. Duke Ventures shall provide MSREF, on behalf of the MS Members, with any material correspondence, report, technical data or other material information generated as a result of such investigation, remedial action, correction of noncompliance, or other action conducted by Duke Ventures. Any expenditures incurred by the MS Members to review such work or monitor Duke Ventures conduct of such investigation, remedial action, correction of noncompliance, or other action (including retention of third party contractors or services of in-house employees) shall be at the sole expense of the MS Members.
Section 7.3 Waiver of Other Representations.
(a) NOTWITHSTANDING ANYTHING IN THIS AGREEMENT TO THE CONTRARY, IT IS THE EXPLICIT INTENT OF EACH PARTY, AND THE PARTIES HEREBY AGREE, THAT NO PARTY NOR ANY OF THEIR RESPECTIVE AFFILIATES OR REPRESENTATIVES HAS MADE OR IS MAKING ANY REPRESENTATION OR WARRANTY WHATSOEVER, EXPRESS OR IMPLIED, WRITTEN OR ORAL, INCLUDING ANY IMPLIED REPRESENTATION OR WARRANTY AS TO THE CONDITION, MERCHANTABILITY, USAGE, SUITABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE WITH RESPECT TO THE BUSINESS, CRESCENT ITSELF OR ANY OF CRESCENTS ASSETS, OR ANY PART THEREOF, EXCEPT THOSE REPRESENTATIONS AND WARRANTIES CONTAINED IN ARTICLES III, IV AND V OR IN ANY DOCUMENTS DELIVERED AT CLOSING. IN PARTICULAR, AND WITHOUT IN ANY WAY LIMITING THE FOREGOING, (i) NO PARTY MAKES ANY REPRESENTATION OR WARRANTY REGARDING ANY ENVIRONMENTAL MATTERS EXCEPT AS EXPRESSLY SET FORTH IN SECTION 4.12 AND (ii) NO PARTY MAKES ANY REPRESENTATION OR WARRANTY WITH RESPECT TO ANY FINANCIAL PROJECTIONS OR FORECASTS RELATING TO CRESCENT OR CRESCENTS ASSETS.
(b) EXCEPT AS OTHERWISE EXPRESSLY PROVIDED IN THE REPRESENTATIONS AND WARRANTIES IN ARTICLE IV, THE MS MEMBERS ARE ACQUIRING THEIR INTERESTS IN CRESCENT AND ITS ASSETS AS IS, WHERE IS, WITH ALL FAULTS, AND EACH PARTY EXPRESSLY DISCLAIMS ANY REPRESENTATIONS OR WARRANTIES OF ANY KIND OR NATURE, EXPRESS OR IMPLIED, AS TO THE CONDITION, VALUE OR QUALITY OF THE BUSINESS, CRESCENT AND ITS ASSETS OR THE PROSPECTS (FINANCIAL OR OTHERWISE), RISKS AND OTHER INCIDENTS OF CRESCENT AND ITS ASSETS.
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Section 7.4 Waiver of Remedies.
(a) The Parties hereby agree that no Party shall have any liability, and no Party shall make any Claim, for any Loss or other matter, under, relating to or arising out of this Agreement or any other document, agreement, certificate or other matter delivered pursuant hereto, whether based on contract, tort, strict liability, other Laws or otherwise, except as provided in this ARTICLE VII.
(b) Notwithstanding anything in this Agreement to the contrary, no Representative or Affiliate of a Party shall have any liability to another Party or any other Person as a result of the breach of any representation, warranty, covenant, agreement or obligation of such Party in this Agreement.
Section 7.5 Procedure with Respect to Third Party Claims.
(a) If any Indemnified Party becomes subject to a pending or threatened Claim of a third party (a Third Party Claim ) and such Party (the Claiming Party ) believes it has a claim against the other Party (the Responding Party ) as a result, then the Claiming Party shall notify the Responding Party in writing of the basis for such Claim setting forth the nature of the Claim in reasonable detail. The failure of the Claiming Party to so notify the Responding Party shall not relieve the Responding Party of liability hereunder except to the extent that the defense of such Claim is prejudiced by the failure to give such notice.
(b) If any Third Party Claim is made and the Claiming Party gives notice to the Responding Party pursuant to Section 7.5(a), then the Responding Party shall be entitled to participate in such proceeding and, to the extent that it wishes, to assume the defense of such proceeding, if (i) the Responding Party provides written notice to the Claiming Party that the Responding Party intends to undertake such defense, (ii) the Responding Party conducts the defense of the Third Party Claim actively and diligently with counsel reasonably satisfactory to the Claiming Party, and (iii) if the Responding Party is a party to the proceeding, the Responding Party or the Claiming Party has not determined in good faith that joint representation would be inappropriate because of a conflict in interest. The Claiming Party shall, in its sole discretion, have the right to employ separate counsel (who may be selected by the Claiming Party in its sole discretion) in any such action and to participate in the defense thereof, and the fees and expenses of such counsel shall be paid by such Claiming Party. The Claiming Party shall fully cooperate with the Responding Party and its counsel in the defense or compromise of such Third Party Claim. If the Responding Party assumes the defense of a proceeding, no compromise or settlement of such Claims may be effected by the Responding Party without the Claiming Partys consent unless (A) there is no finding or admission of any violation of Law or any violation of the rights of any Person and no effect on any other Claims that may be made against the Claiming Party and (B) the sole relief provided is monetary damages that are paid in full by the Responding Party.
(c) If (i) notice is given to the Responding Party of the commencement of any third party legal proceeding and the Responding Party does not, within thirty (30) days after the Claiming Partys notice is given, give notice to the Claiming Party of its election to assume the defense of such legal proceeding, (ii) any of the conditions set forth in Sections 7.5(b)(i) through 7.5(b)(iii) become unsatisfied, (iii) a Claiming Party determines in good faith that the Claiming Party and Responding Party have significantly divergent interests, (iv) the named parties to such Third Party Claim include both the Responding Party and the Claiming Party and the Claiming Party has defenses available to it that are unavailable to the Responding Party, or (v) such Third Party Claim seeks injunctive relief, specific performance, or other equitable relief from, or seeks to impose any criminal penalty, fine or sanction on, the Claiming Party, then the Claiming Party shall (upon notice to the Responding Party) have the right to undertake the defense, compromise or settlement of such Third Party Claim; provided , however , that the Responding Party shall reimburse the Claiming Party for the costs of defending against such Third Party Claim (including reasonable attorneys fees and expenses) and shall remain otherwise responsible for any liability with respect to amounts arising from or related to such Third Party Claim, in both cases to the extent it is ultimately determined that such Responding Party is liable with respect to such Third Party Claim for a breach under this Agreement. The Responding Party may elect to participate in such legal proceedings, negotiations or defense at any time at its own expense.
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ARTICLE VIII
M ISCELLANEOUS
Section 8.1 Notices.
(a) Unless this Agreement specifically requires otherwise, any notice, demand or request provided for in this Agreement, or served, given or made in connection with it, shall be in writing and shall be deemed properly served, given or made if delivered in person or sent by facsimile or sent by registered or certified mail, postage prepaid, or by a nationally recognized overnight courier service that provides a receipt of delivery, in each case, to the Parties at the addresses specified below:
If to Duke Ventures, to:
Duke Ventures, LLC
c/o Duke Energy Corporation
526 South Church Street
Charlotte, North Carolina 28202
Attention: General Counsel
Facsimile No.: (704) 382-7705
With a copy to:
Duke Energy Corporation
526 South Church Street
Charlotte, North Carolina 28202
Attention: Anders K. Torning, Esq.
Facsimile No.: (704) 382-8137
With an additional copy to:
Skadden, Arps, Slate, Meagher & Flom LLP
1440 New York Avenue, NW
Washington, DC 20005
Attention: Pankaj K. Sinha, Esq.
Facsimile No.: (202) 393-5760
If to Crescent, to:
Crescent Resources, LLC
400 South Tryon Street, Suite 1300
Charlotte, North Carolina 28202
Attn: Arthur W. Fields Facsimile No.: (704) 382-5429
With a copy to:
If to any MS Member, to:
c/o MSREF V U.S.GP, L.L.C.
1585 Broadway, 37th Floor
New York, New York 10036
Attn: Michael J. Franco
Facsimile No.: (212) 507-4571
With a copy to:
MSREF V U.S.GP, L.L.C.
1585 Broadway, 37th Floor
New York, New York 10036
Attn: Michael E. Quinn
Facsimile No.: (212) 507-4175
With an additional copy to:
Jones Day
2727 North Harwood Street
Dallas, Texas 75201
Attn: David J. Lowery, Esq.
Facsimile No.: (214) 969-5100
30
With an additional copy to:
Morgan Stanley Strategic Investments, Inc.
1585 Broadway
New York, New York 10036
Attn: James Bolin and Thomas Doster
Facsimile No.: (212) 507-4213
(b) Notice given by personal delivery, mail or overnight courier pursuant to this Section 8.1 shall be effective upon physical receipt. Notice given by facsimile pursuant to this Section 8.1 shall be effective as of the date of confirmed delivery if delivered before 5:00 P.M. Eastern Time on any Business Day at the place of receipt or the next succeeding Business Day if confirmed delivery is after 5:00 P.M. Eastern Time on any Business Day or during any non-Business Day at the place of receipt.
Section 8.2 Entire Agreement. Except for the Confidentiality Agreement, the Employee Matters Agreement, the Transition Services Agreement and the Legacy Land Agreements, this Agreement together with the Letters supersedes all prior discussions and agreements among the Parties and their respective Affiliates with respect to the subject matter hereof and contains the sole and entire agreement among the Parties and their respective Affiliates with respect to the subject matter hereof.
Section 8.3 Expenses.
(a) Each Party represents that the amount of Expenses set forth on Exhibit H opposite such Partys name is a good faith estimate of such Partys aggregate actual Expenses to be incurred in connection with this Agreement and the other transactions contemplated hereby.
(b) Simultaneously with the execution hereof, the Parties shall cause Holdco to reimburse each of the MS Members and Duke Ventures an amount equal to the good faith estimate of the Expenses each such Party incurred in connection with this Agreement and the other transactions contemplated hereby as set forth on Exhibit H, but in no event shall the aggregate amount reimbursed to the MS Members and Duke Ventures exceed $12,500,000 without the approval of the Executive Committee of Holdco (other than Expenses incurred in connection with the New Debt Financing, which shall not be subject to the foregoing cap); provided , however , that if the aggregate amount of such Expenses exceeds $12,500,000, the amounts reimbursed to the MS Members, on the one hand, and Duke Ventures, on the other hand, shall be reduced by a proportionate amount that each Partys Expenses bears to the aggregate Expenses. Within forty-five (45) days following the Effective Date, each Party shall provide Crescent with copies of all invoices in respect of Expenses, and Crescent shall promptly reimburse such Party such additional amount of Expenses actually incurred by such Party less any amount previously reimbursed; provided , however , in the event that the amount previously
reimbursed to a Party exceeds the actual Expenses, such Party shall promptly reimburse Crescent in an amount equal to such excess.
(c) Except as otherwise expressly provided in this Agreement, each Party shall pay its own costs and expenses incurred in anticipation of, relating to and in connection with the negotiation and execution of this Agreement and the transactions contemplated in this Agreement.
Section 8.4 Disclosure. Duke Ventures, Crescent or the MS Members may, at their option, include in the Letters items that are not material in order to avoid any misunderstanding, and any such inclusion, or any references to dollar amounts, shall not be deemed to be an acknowledgment or representation that such items are material, to establish any standard of materiality or to define further the meaning of such terms for purposes of this Agreement. Information disclosed in any section of any Letter shall constitute a disclosure for purposes of all other section of such Letter notwithstanding the lack of specific cross-reference thereto. Notwithstanding anything in this Agreement to the contrary, the mere inclusion of an item in a Letter as an exception to a representation, warranty or covenant shall not be deemed an admission by a Party that such item represents a material exception to such representation, warranty or covenant.
Section 8.5 Waiver. Any term or condition of this Agreement may be waived at any time by the Party or Parties that are entitled to the benefit thereof, but no such waiver shall be effective unless set forth in a written instrument duly executed by or on behalf of the Party or Parties waiving such term or condition. No waiver by any Party of any term or condition of this Agreement, in any one or more instances, shall be deemed to be or construed as a waiver of the same or any other term or condition of this Agreement on any future occasion.
Section 8.6 Amendment. This Agreement may be amended or supplemented only by a written instrument duly executed by or on behalf of each Party.
Section 8.7 No Third Party Beneficiary. The terms and provisions of this Agreement are intended solely for the benefit of the Parties and their respective successors or permitted assigns, and, except for the rights of the Non-Crescent Affiliates set forth in Section 6.8 hereof, it is not the intention of the Parties to confer third party beneficiary rights upon any other Person, including any employee of Crescent, any beneficiary or dependents thereof, or any collective bargaining representative thereof.
31
Section 8.8 Assignment; Binding Effect. Neither this Agreement nor any right, interest or obligation hereunder may be assigned by any Party without the prior written consent of the other Parties, and any attempt to do so shall be void, except for assignments and
transfers by operation of Law; provided , however , that, upon ten (10) days prior written notice from MSREF, on behalf of the MS Members, to Duke Ventures, any of the MS Members shall have the right at any time on or after the Effective Date and without Duke Ventures consent to assign all or a part of such MS Members rights and obligations under this Agreement to any MS Permitted Transferee (as such term is defined in the Operating Agreement), provided that such MS Permitted Transferee is controlled by Morgan Stanley. Any such assignee shall execute and deliver to Duke Ventures and Crescent a written assumption agreement whereby it shall agree to be bound by this Agreement as if a Party hereto to the extent of the interest assigned to it and whereupon such assignee shall be jointly and severally obligated hereunder as if one of the Parties encompassed by the term MS Member. MSREF, on behalf of the MS Members, must obtain the written consent of Duke Ventures for any other assignment of this Agreement, which consent may be withheld or conditioned in Duke Ventures sole discretion. Any assignment not made in accordance with this Section 8.8 will be null and void. No assignment described in this Section 8.8 shall release any of the MS Members from any liability under this Agreement. Subject to this Section 8.8, this Agreement is binding upon, inures to the benefit of and is enforceable by the Parties and their respective successors and permitted assigns.
Section 8.9 Headings. The headings used in this Agreement have been inserted for convenience of reference only and do not define or limit the provisions hereof.
Section 8.10 Invalid Provisions. If any provision of this Agreement is held to be illegal, invalid or unenforceable under any present or future Law, and if the rights or obligations of any Party under this Agreement will not be materially and adversely affected thereby, such provision shall be fully severable, this Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof, the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom and, in lieu of such illegal, invalid or unenforceable provision, there shall be added automatically as a part of this Agreement a legal, valid and enforceable provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible.
Section 8.11 Counterparts; Facsimile. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. Any facsimile copies hereof or signature hereon shall, for all purposes, be deemed originals.
Section 8.12 Governing Law; Venue; and Jurisdiction; Waiver of Trial by Jury.
(a) This Agreement shall be governed by and construed in accordance with the Laws of the State of Delaware, without giving effect to any conflict or choice of law provision that would result in the imposition of another jurisdictions Law.
(b) Any suit, action or proceeding seeking to enforce any provision of, or based on any matter arising out of or in connection with this Agreement or the transactions contemplated hereby or thereby shall be brought in a federal court sitting in New Castle County, Delaware and each Party hereby consents to the exclusive jurisdiction of any federal court sitting in New Castle County, Delaware (and of the appropriate appellate courts there from) in any suit, action or proceeding, and irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of the venue of any such suit, action or proceeding in any such court or that any such suit, action or proceeding which is brought in any such court has been brought in an inconvenient forum; provided , that , if any federal court in New Castle County, Delaware would not have subject matter jurisdiction over such suit, action or proceeding, it shall be brought in any state court in New Castle County, Delaware. Each Party hereby waives the right to commence an action, suit or proceeding seeking to enforce any provisions of, or based on any matter arising out of or in connection with this Agreement or the transactions contemplated hereby or thereby in any court outside of New Castle County, Delaware. Any judgment in any such suit, action or proceeding rendered by such federal court sitting in New Castle County, Delaware, may be entered, filed, registered and enforced by suit upon such judgment in any court of competent jurisdiction (within or outside of New Castle County, Delaware) or as otherwise permitted by applicable law. Any judgment in any such suit, action or proceeding rendered by such federal or state court sitting in New Castle County, Delaware, may be entered, filed, registered and enforced by suit upon such judgment in any court of competent jurisdiction (within or outside of New Castle County, Delaware) or as otherwise permitted by applicable law. Process in any suit, action or proceeding may be served on any party anywhere in the world, whether within or without the jurisdiction of any court. Without limiting the foregoing, each party agrees that service of process on such party as provided in Section 8.1 shall be deemed effective service of process on such party.
(c) EACH OF THE PARTIES HEREBY WAIVES TO THE FULLEST EXTENT PERMITTED BY LAW TRIAL BY JURY IN ANY ACTION ARISING OUT OF MATTERS RELATED TO THIS AGREEMENT, WHICH WAIVER IS INFORMED AND VOLUNTARY.
Section 8.13 Attorneys Fees. If any of the Parties shall bring an action to enforce the provisions of this Agreement, the prevailing Party shall be entitled to recover its reasonable attorneys fees and expenses incurred in such action from the unsuccessful Party.
32
Section 8.14 MS Member Representative; Joint Liability. The Parties acknowledge and agree that MSREF shall be the agent for the MS Members for purposes of delivering or receiving notices or other communications required or permitted to be delivered by or to the MS Members hereunder. The obligations of MSREF, MSREF Special, MSREI, MSP, MSSI and each other MS Member under this Agreement shall be joint and several.
[signature page follows]
33
IN WITNESS WHEREOF, this Agreement has been duly executed and delivered by the duly authorized officer of each Party as of the date first above written.
DUKE VENTURES: | DUKE VENTURES, LLC | |||||||
By: | ||||||||
Name: | ||||||||
Title: | ||||||||
CRESCENT: | CRESCENT RESOURCES, LLC | |||||||
By: | ||||||||
Name: | ||||||||
Title: |
MS MEMBERS: |
MORGAN STANLEY REAL ESTATE FUND V U.S., L.P., a Delaware limited partnership |
|||||||||
By: | MSREF V U.S.-GP, L.L.C., a Delaware limited liability company, its General Partner | |||||||||
By: | ||||||||||
Name: | ||||||||||
Title: | ||||||||||
MSP REAL ESTATE FUND V, L.P., a Delaware limited partnership |
||||||||||
By: | MSREF V U.S.-GP, L.L.C., a Delaware limited liability company, its General Partner | |||||||||
By: | ||||||||||
Name: | ||||||||||
Title: | ||||||||||
MORGAN STANLEY REAL ESTATE INVESTORS V U.S., L.P., a Delaware limited partnership |
||||||||||
By: | MSREF V U.S.-GP, L.L.C., a Delaware limited liability company, its General Partner | |||||||||
By: | ||||||||||
Name: | ||||||||||
Title: | ||||||||||
MORGAN STANLEY REAL ESTATE FUND V SPECIAL U.S., L.P., a Delaware limited partnership |
||||||||||
By: | MSREF V U.S.-GP, L.L.C., a Delaware limited liability company, its General Partner | |||||||||
By: | ||||||||||
Name: | ||||||||||
Title: | ||||||||||
MORGAN STANLEY STRATEGIC INVESTMENTS, INC., a Delaware corporation |
||||||||||
By: | ||||||||||
Name: | ||||||||||
Title: |
EXHIBIT A
AMENDED AND RESTATED LIMITED LIABILITY COMPANY AGREEMENT
OF CRESCENT HOLDINGS, LLC
EXHIBIT B
AMENDED AND RESTATED ARTICLES OF ORGANIZATION
OF CRESCENT RESOURCES, LLC
These Amended and Restated Articles of Organization of Crescent Resources, LLC (the Company) are made pursuant to Section 14-11-210 of the Georgia Limited Liability Company Act (the Act) and are hereby filed with the Secretary of State of the State of Georgia pursuant to Section 14-11-206 of the Act.
(a) The name of the limited liability company is Crescent Resources, LLC;
(b) The original Articles of Organization were filed on December 31, 2000;
(c) Those Articles of Organization are hereby amended to convert the Company from being manager managed to being member managed (and eliminate Article 2 thereof); and
(d) Those Articles of Organization are hereby amended and restated in their entirety to read as follows:
1. Name . The name of the limited liability company continues to be Crescent Resources, LLC;
2. Management. The Company shall be managed by its Members (as set forth in that certain Amended and Restated Limited Liability Company Agreement entered into effective as of September 7, 2006, as amended from time to time).
3. Registered Office and Registered Agent . The name of the Companys registered agent for service of process will continue to be CT Corporation Systems, and the address of the Companys registered agent and the address of the Companys registered office in the State of Georgia will continue to be 1201 Peachtree Street, N.E., Atlanta, Georgia 30361.
IN WITNESS WHEREOF, the undersigned has executed these Amended and Restated Articles of Organization, to be effective on the date of their filing with the Secretary of State of Georgia.
CRESCENT HOLDINGS, LLC, a Delaware limited liability Company |
By: |
Name: |
Title: |
EXHIBIT C
AMENDED AND RESTATED OPERATING AGREEMENT
OF CRESCENT RESOURCES, LLC
EXHIBIT D
TRANSITION SERVICES AGREEMENT
EXHIBIT E
EMPLOYEE MATTERS AGREEMENT
EXHIBIT F
FORM OF CERTIFICATE OF FORMATION
OF CRESCENT HOLDINGS, LLC
CERTIFICATE OF FORMATION
OF
CRESCENT HOLDINGS, LLC
1. | The name of the limited liability company is Crescent Holdings, LLC. |
2. | The address of its registered office in the State of Delaware is c/o The Corporation Trust Company, 1209 Orange Street, Wilmington, New Castle County, Delaware 19801. |
3. | The name of its registered agent at such address is The Corporation Trust Company. |
IN WITNESS WHEREOF, the undersigned has executed this Certificate of Formation of Crescent Holdings, LLC on this 30 th day of August, 2006.
Crescent Holdings, LLC |
||
By: |
|
|
Name: Title: Authorized Person |
EXHIBIT G
PURCHASE PRICE CALCULATION
1. Enterprise Value: |
$2,075,000,000 | ||
2. less debt of Crescent as December 31, 2005: |
($71,000,000 | ) | |
3. plus the Estimated Net Contribution/ Distribution Amount (estimate of net capital contributions made by Duke Ventures, and capital distributions made to Duke Ventures, from January 1, 2006 through the Effective Date): |
$30,000,000 | ||
4. less the actual amount of net proceeds from the New Debt Financing distributed to Duke Ventures: |
($1,187,000,000 | ) | |
|
|
||
Equity Value: |
$847,000,000 | ||
5. multiplied by 49%: |
*0.49 | ||
|
|
||
Purchase Price: |
$415,030,000 |
EXHIBIT H
ESTIMATED TRANSACTION EXPENSES OF THE PARTIES
Duke Ventures: |
$ | 5,500,000 | |
MS Members: |
$ | 3,500,000 |
EXHIBIT 31.1
CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, James E. Rogers, certify that:
1) | I have reviewed this quarterly report on Form 10-Q of Duke Energy Corporation; |
2) | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3) | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4) | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Acts Rules 13a 15(f) and 15d 15(f)) for the registrant and have: |
a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) | Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d) | Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5) | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions): |
a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and |
b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting. |
Date: November 9, 2006
/s/ JAMES E. ROGERS |
James E. Rogers President and Chief Executive Officer |
EXHIBIT 31.2
CERTIFICATION OF THE CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, David L. Hauser, certify that:
1) | I have reviewed this quarterly report on Form 10-Q of Duke Energy Corporation; |
2) | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3) | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4) | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Acts Rules 13a 15(f) and 15d 15(f)) for the registrant and have: |
a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) | Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d) | Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5) | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions): |
a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and |
b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting. |
Date: November 9, 2006
/s/ DAVID L. HAUSER |
David L. Hauser Group Executive and Chief Financial Officer |
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Duke Energy Corporation (Duke Energy) on Form 10-Q for the period ending September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, James E. Rogers, President and Chief Executive Officer of Duke Energy, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
(2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Duke Energy. |
/s/ J AMES E. R OGERS |
James E. Rogers
President
and Chief Executive Officer
November 9, 2006 |
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Duke Energy Corporation (Duke Energy) on Form 10-Q for the period ending September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, David L. Hauser, Group Executive and Chief Financial Officer of Duke Energy, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
(2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Duke Energy. |
/s/ D AVID L. H AUSER |
David L. Hauser
Group
Executive and Chief Financial Officer
November 9, 2006 |