progress says may not get synfuel tax credits UPDATE 4-Progress...

progress says may not get synfuel tax credits UPDATE 4-Progress says may not get synfuel tax credits
July 7, 2004 5:36pm ET (Reuters)

(Adds S&P comments, paragraph 7, updates share price, paragraph 9, adds TECO, Marriott statements, paragraphs 17-18)

By Carolyn Koo

NEW YORK, July 7 (Reuters) - Tax authorities have signaled that four Progress Energy Inc. synthetic fuel facilities do not qualify for federal tax credits, and a final adverse ruling could reduce the power company's earnings by $942 million, Progress said on Wednesday

However, the company said it expects the issue to be ultimately resolved in its favor, and it has no plans to alter its synthetic fuel production schedule or change its 2004 earnings forecast of $3.50 to $3.65 a share.

Synthetic fuel, or synfuel, facilities treat coal with chemicals and generate generous income tax credits for owners of the plants. The U.S. Internal Revenue Service has been investigating whether such plants justify their tax credits by achieving true chemical change in coal and by being placed in service by a certain date.

The tax credits for synthetic fuel plants are set to expire at the end of 2007.

"It's clearly a significant issue, and it's a lot of money that's at stake, close to $1 billion," said Paul Patterson, an analyst at independent research firm Glenrock Associates.

"In terms of future cash flows and everything, it's very significant."

Ratings agency Standard & Poor's said a worst-case outcome would reduce the company's liquidity and worsen its credit protection ranges which could trigger a lower rating. But the agency said the timing of a final outcome is uncertain and there would be no any immediate rating or outlook change.

Through March 31, 2004, Progress has claimed $942 million of tax credits from its Earthco synfuel facilities. If these credits are disallowed, the company's earnings and equity would be reduced by that amount, and its one-time exposure for cash tax payments would be $229 million before interest.

Shares of Progress -- which owns the Progress Energy Carolinas and Progress Energy Florida utilities -- closed down $1.05, or 2.38 percent, at $43.15 on the New York Stock Exchange.

PROCESS IS ONGOING

Now that IRS field auditors expect to rule that the company's four Earthco synfuel facilities were not placed in service before July 1, 1998, the IRS is withdrawing from a pre-filing agreement program with Progress Energy that would have accelerated the IRS exam process.

As a result, the review of Progress' Earthco facilities is back on the "normal procedural" audit path of the company's tax returns, according to the Raleigh, North Carolina, company.

Progress expects that the IRS field audit team will provide a written recommendation by the end of this summer, at which point the company can appeal the IRS decision. The appeal process could take up to two years, it said.

Given that time frame, analyst Robert Rubin of Deutsche Bank believes it is too early to be concerned.

"There could be the potential for the need for equity in the event that this company loses, but that's several years away, and we think it's preliminary to think about it," he said.

"Clearly, it creates an overhang. It creates a further headline. But, ultimately, the Progress Energy business is driven by its two utilities, not synfuels."

Progress expects to earn roughly $200 million a year from synthetic fuels, of which about 75 percent is generated by the Earthco facilities.

Later on Wednesday, TECO Energy Inc. , another power company which has synfuel facilities, said the IRS audited its synfuel operations as a normal part of its 2000 federal income tax return audit and concluded the audit with no adjustments.

Hotel operator Marriott International Inc. , however, also said IRS auditors are challenging its synthetic fuel facilities' qualification for tax credits but expected the issue to be resolved in its favor.