UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] For the quarterly period ended March 31, 2003
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 1-14161
KEYSPAN CORPORATION
(Exact name of Registrant as specified in its Charter)
New York 11-3431358
-------- ----------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
One MetroTech Center, Brooklyn, New York 11201
175 East Old Country Road, Hicksville, New York 11801
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(Address of principal executive offices) (Zip Code)
(718) 403-1000 (Brooklyn)
(631) 755-6650 (Hicksville)
---------------------------
(Registrant's 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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock Outstanding at April 16, 2003
--------------------- -----------------------------
$.01 par value 157,321,304
KEYSPAN CORPORATION AND SUBSIDIARIES
INDEX
-----
Part I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheet -
March 31, 2003 and December 31, 2002 3
Consolidated Statement of Income -
Three Months Ended March 31, 2003 and 2002
5
Consolidated Statement of Cash Flows -
Three Months Ended March 31, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 31
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 56
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 60
Item 6. Exhibits and Reports on Form 8-K 60
Signatures 62
2
CONSOLIDATED BALANCE SHEET
(Unaudited)
- -------------------------------------------------------------------------------------------
(In Thousands of Dollars) March 31, 2003 December 31, 2002
- -------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 244,062 $ 170,617
Accounts receivable 1,626,587 1,122,022
Unbilled revenue 505,477 473,060
Allowance for uncollectible accounts (79,949) (63,029)
Gas in storage, at average cost 87,569 297,060
Material and supplies, at average cost 121,221 113,519
Other 63,386 93,980
------------------ --------------------
2,568,353 2,207,229
------------------ --------------------
Investments and Other 268,878 265,977
Property
Gas 6,202,733 6,124,281
Electric 2,027,866 1,974,352
Other 395,732 394,374
Accumulated depreciation (2,807,495) (2,740,516)
Gas exploration and production, at cost 2,567,738 2,438,998
Accumulated depletion (1,010,770) (973,889)
------------------ --------------------
7,375,804 7,217,600
------------------ --------------------
Deferred Charges
Regulatory assets 444,388 438,516
Goodwill, net of amortization 1,789,166 1,789,751
Other 684,217 695,233
------------------ --------------------
2,917,771 2,923,500
------------------ --------------------
Total Assets $ 13,130,806 $ 12,614,306
================== ====================
- -------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEET
(Unaudited)
- --------------------------------------------------------------------------------------------
(In Thousands of Dollars) March 31, 2003 December 31, 2002
- --------------------------------------------------------------------------------------------
LIABILITIES AND CAPITALIZATION
Current Liabilities
Current Redemption of long-term debt $ 11,414 $ 11,413
Accounts payable and other liabilities 1,212,406 1,061,649
Commercial paper 677,332 915,697
Dividends payable 71,166 64,714
Taxes accrued 254,687 51,276
Customer deposits 38,876 38,387
Interest accrued 85,416 77,092
------------------ ---------------------
2,351,297 2,220,228
------------------ ---------------------
Deferred Credits and Other Liabilities
Regulatory liabilities 72,230 84,479
Deferred income tax 887,708 877,013
Postretirement benefits and other reserves 867,681 759,731
Other 205,934 189,912
------------------ ---------------------
2,033,553 1,911,135
------------------ ---------------------
Commitments and Contingencies (See Note 8) - -
Capitalization
Common stock 3,481,607 3,005,354
Retained earnings 694,630 522,835
Other comprehensive income (114,221) (108,423)
Treasury stock (448,867) (475,174)
------------------ ---------------------
Total common shareholders' equity 3,613,149 2,944,592
Preferred stock 83,849 83,849
Long-term debt 4,740,231 5,224,081
------------------ ---------------------
Total Capitalization 8,437,229 8,252,522
------------------ ---------------------
Minority Interest in Subsidiary Companies 308,727 230,421
------------------ ---------------------
Total Liabilities and Capitalization $ 13,130,806 $ 12,614,306
================== =====================
- --------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
4
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
- ------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars, Except Per Share Amounts) 2003 2002
- ------------------------------------------------------------------------------------------
Revenues
Gas Distribution $ 1,832,701 $ 1,222,966
Electric Services 334,394 314,685
Energy Services 192,371 241,559
Gas Exploration and Production 127,847 76,926
Energy Investments 25,212 17,442
----------------------------------
Total Revenues 2,512,525 1,873,578
----------------------------------
Operating Expenses
Purchased gas for resale 1,196,165 649,360
Fuel and purchased power 97,522 84,372
Operations and maintenance 498,189 498,075
Depreciation, depletion and amortization 144,971 125,997
Operating taxes 124,713 113,902
----------------------------------
Total Operating Expenses 2,061,560 1,471,706
----------------------------------
Operating Income 450,965 401,872
----------------------------------
Other Income and (Deductions)
Interest charges (68,939) (72,612)
Gain on sale of subsidiary stock 19,020 -
Cost of debt redemption (18,194) -
Minority interest (18,054) (4,431)
Other 21,126 15,111
----------------------------------
Total Other Income and (Deductions) (65,041) (61,932)
----------------------------------
Earnings Before Income Taxes 385,924 339,940
Income Taxes
Current 129,575 (68,292)
Deferred 13,258 193,601
----------------------------------
Total Income Taxes 142,833 125,309
----------------------------------
Earnings Before Change in Accounting Principle 243,091 214,631
Cummulative Effect of Change in Accounting Principle 174 -
----------------------------------
Net Income 243,265 214,631
Preferred stock dividend requirements 1,461 1,476
----------------------------------
Earnings for Common Stock $ 241,804 $ 213,155
==================================
Basic Earnings Per Share:
Before Change in Accounting Principle,
less preferred stock dividends $ 1.54 $ 1.52
Change in Accounting Principle - -
----------------------------------
Basic Earnings Per Share $ 1.54 $ 1.52
==================================
Diluted Earnings Per Share
Before Change in Accounting Principle,
less preferred stock dividends $ 1.53 $ 1.51
Change in Accounting Principle - -
----------------------------------
Diluted Earnings Per Share $ 1.53 $ 1.51
==================================
Average Common Shares Outstanding (000) 156,886 140,039
Average Common Shares Outstanding - Diluted (000) 158,045 141,012
- ------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
5
CONSOLIDATED STATEMENT OF CASH FLOWS
- ---------------------------------------------------------------------------------------
(Unaudited) Three Months Ended March 31,
(In Thousands of Dollars) 2003 2002
- ---------------------------------------------------------------------------------------
Operating Activities
Net Income $ 243,265 $ 214,631
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Depreciation, depletion and amortization 144,971 125,997
Deferred income tax 13,258 19,822
Income from equity investments (6,425) (4,154)
Amortization of interest rate swap (2,500) -
Changes in assets and liabilities
Accounts receivable (520,062) (109,904)
Materials and supplies, fuel oil and gas in storage 201,789 181,101
Accounts payable and other liabilities 349,722 (219,144)
Interest accrued 8,324 43,874
Other 57,547 80,326
---------------------------------
Net Cash Provided by Operating Activities 489,889 332,549
---------------------------------
Investing Activities
Construction expenditures (220,779) (244,153)
Proceeds from monetization of Houston Exploration 79,200 -
---------------------------------
Net Cash Used in Investing Activities (141,579) (244,153)
---------------------------------
Financing Activities
Treasury stock issued 26,307 34,058
Equity Issuance 473,573 -
Issuance of long-term debt 39,161 10,401
Payment of long-term debt (72,565) (25,356)
Payment of commercial paper (238,365) (9,947)
Redemption of Promissory Notes (447,005) -
Preferred stock dividends paid (1,461) (1,476)
Common stock dividends paid (63,557) (62,207)
Other 9,047 (2,420)
---------------------------------
Net Cash Used in Financing Activities (274,865) (56,947)
---------------------------------
Net Increase in Cash and Cash Equivalents $ 73,445 $ 31,449
Cash and Cash Equivalents at Beginning of Period 170,617 159,252
---------------------------------
Cash and Cash Equivalents at End of Period $ 244,062 $ 190,701
=================================
- ---------------------------------------------------------------------------------------
Cash equivalents are short-term marketable securities purchased with maturities
of three months or less that were carried at cost which approximates fair value.
See accompanying Notes to the Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
KeySpan Corporation (referred to in the Notes to the Financial Statements as
"KeySpan," "we," "us" and "our") is a registered holding company under the
Public Utility Holding Company Act of 1935, as amended ("PUHCA"). KeySpan
operates six regulated utilities that distribute natural gas to approximately
2.5 million customers in New York City, Long Island, Massachusetts and New
Hampshire, making KeySpan the fifth largest gas distribution company in the
United States and the largest in the Northeast. We also own and operate electric
generating plants in Nassau and Suffolk Counties on Long Island and in Queens
County in New York City and are the largest investor owned electric generation
operator in New York State. Under contractual arrangements, we provide power,
electric transmission and distribution services, billing and other customer
services for approximately one million electric customers of the Long Island
Power Authority ("LIPA"). KeySpan's other subsidiaries are involved in gas and
oil exploration and production; gas storage; wholesale and retail gas and
electric marketing; appliance service; plumbing; heating, ventilation and air
conditioning and other mechanical services; large energy-system ownership,
installation and management; engineering and consulting services; and fiber
optic services. We also invest and participate in the development of, natural
gas pipelines, natural gas processing plants, and other energy-related projects,
domestically and internationally. (See Note 2 "Business Segments" for additional
information on each operating segment.)
1. BASIS OF PRESENTATION
In our opinion, the accompanying unaudited Consolidated Financial Statements
contain all adjustments necessary to present fairly KeySpan's financial position
as of March 31, 2003, and the results of operations for the three months ended
March 31, 2003 and March 31, 2002, as well as cash flows for the three months
ended March 31, 2003 and March 31, 2002. The accompanying financial statements
should be read in conjunction with the consolidated financial statements and
notes included in KeySpan's Annual Report on Form 10K for the year ended
December 31, 2002. The December 31, 2002 financial statement information has
been derived from the 2002 audited financial statements. Income from interim
periods may not be indicative of future results. Certain reclassifications were
made to conform prior period financial statements with the current period
financial statement presentation.
Basic earnings per share ("EPS") is calculated by dividing earnings available
for common stock by the weighted average number of shares of common stock
outstanding during the period. No dilution for any potentially dilutive
securities is included. Diluted EPS assumes the conversion of all potentially
dilutive securities and is calculated by dividing earnings available for common
stock, as adjusted, by the sum of the weighted average number of shares of
common stock outstanding plus all potentially dilutive securities.
7
We have approximately 2.1 million common stock options outstanding at March 31,
2003, that were not included in the calculation of diluted EPS since the
exercise price associated with these options was greater than the average market
price of our common stock.
Under the requirements of Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share" our basic and diluted EPS are as follows:
- ------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars, Except Per Share Amounts) 2003 2002
- ------------------------------------------------------------------------------------------
Earnings for common stock $ 241,804 $ 213,155
Interest savings on convertible preferred stock 133 142
Houston Exploration dilution (87) (96)
- ------------------------------------------------------------------------------------------
Earnings for common stock - adjusted $ 241,850 $ 213,201
- ------------------------------------------------------------------------------------------
Weighted average shares outstanding (000) 156,886 140,039
Add dilutive securities:
Options 931 729
Convertible preferred stock 228 244
- ------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution 158,045 141,012
- ------------------------------------------------------------------------------------------
Basic earnings per share $ 1.54 $ 1.52
- ------------------------------------------------------------------------------------------
Diluted earnings per share $ 1.53 $ 1.51
- ------------------------------------------------------------------------------------------
2. BUSINESS SEGMENTS
We have four reportable segments: Gas Distribution, Electric Services, Energy
Services and Energy Investments.
The Gas Distribution segment consists of six gas distribution subsidiaries.
KeySpan Energy Delivery New York ("KEDNY") provides gas distribution services to
customers in the New York City Boroughs of Brooklyn, Queens and Staten Island.
KeySpan Energy Delivery Long Island ("KEDLI") provides gas distribution services
to customers in the Long Island Counties of Nassau and Suffolk and the Rockaway
Peninsula of Queens County. The remaining gas distribution subsidiaries, Boston
Gas Company, Colonial Gas Company, Essex Gas Company and EnergyNorth Natural
Gas, Inc., collectively referred to as KeySpan Energy Delivery New England
("KEDNE"), provide gas distribution service to customers in Massachusetts and
New Hampshire.
The Electric Services segment consists of subsidiaries that: operate the
electric transmission and distribution system owned by LIPA; own and provide
capacity to and produce energy for LIPA from our generating facilities located
on Long Island; and manage fuel supplies for LIPA to fuel our Long Island
generating facilities. These services are provided in accordance with long-term
service contracts having remaining terms that range from four to twelve years.
Also, in the summer of 2002, we placed two 79.9 megawatt generating facilities
into service; the capacity of and energy from these facilities are dedicated to
LIPA under 25 year contracts. The Electric Services segment also includes
8
subsidiaries that own, lease and operate the 2,200 megawatt Ravenswood electric
generation facility ("Ravenswood facility"), located in Queens, New York. All of
the energy, capacity and ancillary services related to the Ravenswood facility
is sold to the New York Independent System Operator ("NYISO") energy markets.
The Energy Services segment includes companies that provide energy-related
services to customers located within the New York City metropolitan area
including New Jersey and Connecticut, as well as Rhode Island, Pennsylvania,
Massachusetts and New Hampshire, through the following three lines of business:
(i) Home Energy Services, which provides residential customers with service and
maintenance of energy systems and appliances, as well as the retail marketing of
electricity to residential and small commercial customers; (ii) Business
Solutions, which provides plumbing, heating, ventilation, air conditioning and
mechanical services, as well as operation and maintenance, design, engineering
and consulting services to commercial and industrial customers; and (iii) Fiber
Optic Services, which provides various services to carriers of voice and data
transmission on Long Island and in New York City.
The Energy Investments segment consists of our gas exploration and production
investments, as well as certain other domestic and international energy-related
investments. Our gas exploration and production subsidiaries are engaged in gas
and oil exploration and production, and the development and acquisition of
domestic natural gas and oil properties. These investments consist of our 56%
equity interest in The Houston Exploration Company ("Houston Exploration"), an
independent natural gas and oil exploration company, as well as KeySpan
Exploration and Production, LLC, our wholly owned subsidiary engaged in a joint
venture with Houston Exploration. On February 26, 2003, we reduced our ownership
interest in Houston Exploration from 66% to 56% following the repurchase, by
Houston Exploration, of three million shares of common stock owned by KeySpan.
We realized net proceeds of $79 million in connection with this repurchase.
KeySpan follows an accounting policy of income statement recognition for Parent
company gains or losses from common stock transactions initiated by its
subsidiaries. As a result, KeySpan realized a gain of $19 million on this
transaction. Income taxes were not provided, since this transaction was
structured as a return of capital.
KeySpan subsidiaries also hold a 20% equity interest in the Iroquois Gas
Transmission System LP, a pipeline that transports Canadian gas supply to
markets in the Northeastern United States; a 50% interest in the Premier
Transmission Pipeline and a 24.5% interest in Phoenix Natural Gas, both in
Northern Ireland; and investments in certain midstream natural gas assets in
Western Canada through KeySpan Canada. With the exception of KeySpan Canada,
which is consolidated in our financial statements, these subsidiaries are
accounted for under the equity method. Accordingly, equity income from these
investments is reflected in Other Income and (Deductions) in the Consolidated
Statement of Income.
9
The accounting policies of the segments are the same as those used for the
preparation of the Consolidated Financial Statements. The segments are strategic
business units that are managed separately because of their different operating
and regulatory environments. Operating results of our segments are evaluated by
management on an operating income basis. At March 31, 2003, the total assets of
each reportable segment have not changed materially from those levels reported
at December 31, 2002. The reportable segment information is as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
Energy Investments
--------------------------
Gas
Exploration
Gas Electric Energy and Other
(InThousands of Dollars) Distribution Services Services Production Investments Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2003
Unaffiliated revenue 1,832,701 334,394 192,371 127,847 25,212 - 2,512,525
Intersegment revenue - 25 1,426 - 1,252 (2,703) -
Operating Income 364,937 39,670 (9,148) 55,590 4,467 (4,551) 450,965
Three Months Ended March 31, 2002
Unaffiliated revenue 1,222,966 314,685 241,559 76,926 17,442 - 1,873,578
Intersegment revenue - 25 - - 194 (219) -
Operating Income 331,019 61,494 (9,358) 19,825 551 (1,659) 401,872
- -----------------------------------------------------------------------------------------------------------------------------------
Eliminating items include intercompany interest income and expense, the
elimination of certain intercompany accounts, as well as activities of our
corporate and administrative areas.
Because of the nature of our Electric Services business, electric revenues are
derived from two large customers - the NYISO and LIPA. Electric Services
revenues from these customers of $334.4 million and $314.7 million for the three
months ended March 31, 2003 and 2002 represent approximately 13% and 17% of our
consolidated revenues, respectively.
3. COMPREHENSIVE INCOME
The table below indicates the components of comprehensive income.
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars) 2003 2002
- --------------------------------------------------------------------------------------------------------------------
Net Income $ 243,265 $ 214,631
- --------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Net losses (gains) on derivative instruments 2,354 (7,287)
Foreign currency translation adjustments 9,753 (1,713)
Unrealized gains (losses) on marketable securities (3,156) (1,041)
Accrued unfunded pension obligation - (1,132)
Unrealized losses on derivative financial instruments (14,749) (23,785)
- --------------------------------------------------------------------------------------------------------------------
Other comprehensive loss, net of tax (5,798) (34,958)
- --------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 237,467 $ 179,673
- --------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Net losses (gains) on derivative instruments 1,267 $ (3,924)
Foreign currency translation adjustments 5,252 (923)
Unrealized gains (losses) on marketable securities (1,699) (560)
Accrued unfunded pension obligation - (610)
Unrealized losses on derivative financial instruments (7,942) (12,807)
- --------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense $ (3,122) $ (18,824)
- --------------------------------------------------------------------------------------------------------------------
10
4. CAPITAL STOCK
On January 17, 2003, we issued 13.9 million shares of common stock in a public
offering that generated net proceeds of approximately $473 million. All shares
were offered by KeySpan pursuant to the effective shelf registration statement
filed with the Securities and Exchange Commission ("SEC").
5. LONG-TERM DEBT
In connection with the KeySpan/Long Island Lighting Company ("LILCO") business
combination in 1998, KeySpan and certain of its subsidiaries issued promissory
notes to LIPA to support certain debt obligations assumed by LIPA. At December
31, 2002, the remaining principal amount of promissory notes issued to LIPA was
approximately $600 million. To mitigate the dilutive effect of the equity
issuance previously mentioned in Note 4, in March 2003, we called approximately
$447 million aggregate principal amount of such promissory notes at the
applicable redemption prices plus accrued and unpaid interest through the dates
of redemption. We applied the provisions of Statement of Financial Accounting
Standards ("SFAS") 145 "Rescission of FASB Statement No. 4, 44 and 64, Amendment
of FASB Statement No. 13, and Technical Corrections" and recorded an expense of
$18.2 million, reflecting redemption costs, as well as the write-off of
previously deferred debt issuance costs. This expense has been recorded in Other
Income and Deductions in the Consolidated Statement of Income.
In April 2003, we issued $300 million of medium-term and long-term debt. The
debt was issued in the following two series: (i) $150 million 4.65% Notes due
2013; and (ii) $150 million 5.875% Notes due 2033. The proceeds of this issuance
were used to pay down outstanding commercial paper.
KeySpan has the ability under the Public Utility Holding Company Act ("PUHCA")
to issue up to $2.2 billion of securities through December 31, 2003. Following
the recent common stock offering previously mentioned and shares of common stock
expected to be issued for employee benefit and dividend reinvestment plans, we
have approximately $25 million available for the issuance of new securities
under our current PUHCA authorization. However, the issuance of securities in
connection with the redemption of existing securities (including the promissory
notes discussed previously) is permitted under our PUHCA authorization
notwithstanding the foregoing limit. We intend to seek authorization from the
SEC in the near term to enable us to among, other things, issue additional
securities in an aggregate amount not yet determined. It is anticipated that
this authorization will be obtained before the end of the year.
11
6. HEDGING AND DERIVATIVE FINANCIAL INSTRUMENTS
Financially-Settled Commodity Derivative Instruments: From time to time KeySpan
has utilized derivative financial instruments, such as futures, options and
swaps, for the purpose of hedging exposure to commodity price risk and to hedge
the cash flow variability associated with a portion of peak electric energy
sales.
Houston Exploration has utilized collars, as well as over-the-counter ("OTC")
swaps, to hedge the cash flow variability associated with forecasted sales of a
portion of its natural gas and oil production. As of March 31, 2003, Houston
Exploration has hedged approximately 67% and 38% of its estimated 2003 and 2004
gas production, respectively. Further, Houston Exploration may enter into
additional derivative positions for 2004. Houston Exploration used standard New
York Mercantile Exchange ("NYMEX") futures prices and published volatility in
its Black-Scholes calculation to value its outstanding derivatives. The maximum
length of time over which Houston Exploration has hedged such cash flow
variability associated with: (i) forecasted natural gas production is through
December 2004; and (ii) forecasted oil production is through June 2003. The
estimated amount of losses associated with such derivative instruments that are
reported in Other Comprehensive Income and that are expected to be reclassified
into earnings over the next twelve months is $52.2 million, or $33.9 million
after-tax.
With respect to price exposure associated with fuel purchases for the Ravenswood
facility, KeySpan employs standard NYMEX natural gas futures contracts and
over-the-counter financially settled natural gas basis swaps to hedge the cash
flow variability of a portion of forecasted purchases of natural gas. KeySpan
also employs the use of financially-settled oil swap contracts to hedge the cash
flow variability of a portion of forecasted purchases of fuel oil that will be
consumed at the Ravenswood facility. The maximum length of time over which we
have hedged cash flow variability associated with: (i) forecasted purchases of
natural gas is through October 2003; and (ii) forecasted purchases of fuel oil
is through April 2004. We used standard NYMEX futures prices to value the gas
futures contracts and industry published oil indices for number 6 grade fuel oil
to value the oil swap contracts. The estimated amount of gains associated with
all such derivative instruments that are reported in Other Comprehensive Income
and that are expected to be reclassified into earnings over the next twelve
months is $3.0 million, or $2.0 million after-tax.
Our retail gas and electric marketing subsidiary, our domestic gas distribution
operations and KeySpan Canada employ NYMEX natural gas futures contracts and
natural gas swaps to lock-in a price for expected future natural gas purchases.
As applicable, we used standard NYMEX futures prices and relevant natural gas
indices to value the outstanding contracts. The maximum length of time over
which we have hedged such cash flow variability is through October 2004. The
estimated amount of gains associated with such derivative instruments that are
reported in Other Comprehensive Income and that are expected to be reclassified
into earnings over the next twelve months is $3.7 million, or $2.4 million
after-tax.
12
We have also engaged in the use of cash-settled swap instruments to hedge the
cash flow variability associated with (i) a portion of forecasted peak electric
energy sales from the Ravenswood facility and (ii) forecasted sales of Unforced
Capacity ("UCAP") to the NYISO. The maximum length of time over which we have
hedged cash flow variability is through March 2004. We used NYISO-location zone
published indices as well as published NYISO bidding prices to value these
outstanding derivatives. The estimated amount of losses associated with such
derivative instruments that are reported in Other Comprehensive Income and that
are expected to be reclassified into earnings over the next twelve months is
$0.9 million, or $0.6 million after-tax.
KeySpan Canada also employs electricity swap contracts to lock-in the purchase
price of electricity needed to operate its gas processing plants. These
contracts are not exchange-traded and local published indices were used to value
these outstanding swap agreements. The maximum length of time over which we have
hedged such cash flow variability is through December 2003. The estimated amount
of losses associated with such derivative instruments that are reported in Other
Comprehensive Income and that are expected to be reclassified into earnings over
the next twelve months is $1.1 million, or $0.7 million after-tax.
The following tables set forth selected financial data associated with these
derivative financial instruments noted above that were outstanding at March 31,
2003.
- --------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Current Fair Value
Type of Contract Maturity mmcf Floor $ Ceiling $ Price $ Price $ ($000)
- --------------------------------------------------------------------------------------------------------------------------------
Gas
Collars 2003 41,250 3.48 4.92 - 5.06 - 5.30 (24,881)
2004 36,600 3.75 5.05 - 4.33 - 5.38 (10,200)
Swaps/Futures - Short Natural Gas 2003 11,214 - - 3.19 - 3.57 4.22 - 5.30 (21,519)
Swaps/Futures - Long Natural Gas 2003 4,550 - - 3.14 - 4.92 5.06 - 5.30 6,249
2004 90 - - 3.49 - 4.35 3.90 - 4.40 31
- --------------------------------------------------------------------------------------------------------------------------------
93,704 (50,320)
- --------------------------------------------------------------------------------------------------------------------------------
13
- -------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Fair Value
Type of Contract Maturity Barrels Fixed Price $ Current Price $ ($000)
- -------------------------------------------------------------------------------------------------------------------------------
Oil
Swaps - Short Fuel Oil 2003 91,000 29.70 28.03 - 30.42 (116)
Swaps - Long Fuel Oil 2003 81,697 20.60 - 23.50 26.41 - 33.58 639
2004 5,548 20.50 - 23.70 25.49 - 26.07 22
- -------------------------------------------------------------------------------------------------------------------------------
178,245 545
- -------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Year of Fixed Margin/ Fair Value
Type of Contract Maturity Capacity MWh Price $ Current Price $ ($000)
- ---------------------------------------------------------------------------------------------------------------------------------
Electricity
Swaps - Energy 2003 - 447,200 30.50 - 61.91 36.02 - 49.52 (647)
2004 99,200 14.00 23.56 - 32.41 (1,488)
Swaps - Capacity 2003 100 - 7.75 7.00 75
- ---------------------------------------------------------------------------------------------------------------------------------
100 546,400 (2,060)
- ---------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
2003
Change in Fair Value of Derivative Instruments ($000)
- ------------------------------------------------------------------------------
Fair value of contracts at January 1, $ (32,628)
Losses on contracts realized 3,621
Fair value of new contracts when entered into during period -
(Decrease) in fair value of all open contracts (22,828)
- ------------------------------------------------------------------------------
Fair value of contracts outstanding at March 31, $ (51,835)
- ------------------------------------------------------------------------------
14
- -----------------------------------------------------------------------------------------------------
(In Thousands of Dollars)
- -----------------------------------------------------------------------------------------------------
Fair Value of Contracts
- -----------------------------------------------------------------------------------------------------
Maturity Maturity Total
Sources of Fair Value 2003 2004 Fair Value
- -----------------------------------------------------------------------------------------------------
Prices actively quoted $ (29,898) $ 31 $ (29,867)
Prices provided by external sources 417 - 417
Prices based on models and
other valuation methods (16,423) (4,424) (20,847)
Local published indicies (1,538) - (1,538)
- -----------------------------------------------------------------------------------------------------
$ (47,442) $ (4,393) $ (51,835)
- -----------------------------------------------------------------------------------------------------
NYMEX futures are also used to economically hedge the cash flow variability
associated with the purchase of fuel for a portion of our fleet vehicles.
Further, KeySpan Canada has a portfolio of financially-settled natural gas
collars and natural gas liquid swap transactions. Such contracts are executed by
KeySpan Canada to: (i) synthetically fix the price that is paid or received by
KeySpan Canada for certain physical transactions involving natural gas and
natural gas liquids and (ii) transfer the price exposure of such instruments to
counterparties. These derivative financial instruments do not qualify for hedge
accounting under SFAS 133. At March 31, 2003, these instruments had a net fair
market value of $0.06 million, that was recorded on the Consolidated Balance
Sheet. Based on the non-hedge designation of these instruments, the gain was
recognized in the Consolidated Statement of Income.
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative
financial instruments to reduce the cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations. Our strategy is to minimize fluctuations in firm
gas sales prices to our regulated firm gas sales customers in our New York and
New Hampshire service territories. Since these derivative instruments are
employed to reduce the variability of the purchase price of natural gas to be
sold to regulated firm gas sales customers, the accounting for these derivative
instruments is subject to SFAS 71 "Accounting for the Effects of Certain Types
of Regulation". Therefore, changes in the market value of these derivatives have
been recorded as a Regulatory Asset or Regulatory Liability on the Consolidated
Balance Sheet. Gains or losses on the settlement of these contracts are
initially deferred and then refunded to or collected from our firm gas sales
customers consistent with regulatory requirements.
The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at March 31, 2003.
- ---------------------------------------------------------------------------------------------------------------------
Year of Volumes Fair Value
Type of Contract Maturity mmcf Fixed Price $ Current Price $ ($000)
- ---------------------------------------------------------------------------------------------------------------------
Options 2003 1,030 4.01 - 6.00 5.06 - 5.30 (27)
2004 2,140 5.00 - 6.00 4.54 - 5.38 (793)
Swaps 2003 10,470 4.01 - 5.84 5.06 - 5.30 (2,682)
2004 3,890 4.42 - 5.93 4.41 - 5.38 (1,337)
- ---------------------------------------------------------------------------------------------------------------------
17,530 (4,839)
- ---------------------------------------------------------------------------------------------------------------------
15
Physically-Settled Commodity Derivative Instruments: Derivative Implementation
Group ("DIG") Issue C15 and C16 of Statement of Financial Accounting Standard
133, "Accounting for Derivative Instruments and Hedging Activities", as amended
and interpreted, incorporating SFAS 137 and SFAS 138 and certain implementation
issues (collectively "SFAS 133") establishes criteria that must be satisfied in
order for option-type and forward contracts in electricity to be exempted as
normal purchases and sales, and relates to the exemption (as normal purchases
and normal sales) of contracts that combine a forward contract and a purchased
option contract. Based upon a continuing review of our physical commodity
contracts, we determined that certain contracts for the physical purchase of
natural gas are not exempt as normal purchases from the requirements of SFAS
133. At March 31, 2003, the fair value of these contracts was a negative $4.9
million. Since these contracts are for the purchase of natural gas sold to
regulated firm gas sales customers, the accounting for these contracts is
subject to SFAS 71. Therefore, changes in the market value of these contracts
have been recorded as a Regulatory Asset or Regulatory Liability on the
Consolidated Balance Sheet.
Interest Rate Derivative Instruments: During 2002 we had interest rate swap
agreements in which approximately $1.3 billion of fixed rate debt had been
synthetically modified to floating rate debt. Under the terms of the agreements,
we received the fixed coupon rate associated with these bonds and paid the
counterparties a variable interest rate that was reset on a quarterly basis.
These swaps were designated as fair-value hedges and qualified for "short-cut"
hedge accounting treatment under SFAS 133.
In 2002, we terminated two interest rate swap agreements with an aggregate
notional amount of $1.0 billion. The remaining swap, which had a notional amount
of $270.0 million, was terminated on February 25, 2003. We received $18.4
million from our swap counterparties as a result of the latter termination, of
which $8.1 million represented accrued swap interest. The difference between the
termination settlement amount and the amount of accrued interest, $10.3 million,
was recorded to earnings in the first quarter of 2003. This swap was used to
hedge a portion of our outstanding promissory notes to LIPA. As discussed in
Note 5 "Long-Term Debt", we called a portion of these promissory notes during
the first quarter of 2003.
Additionally, we had an interest rate swap agreement that hedged the cash flow
variability associated with the forecasted issuance of a series of commercial
paper offerings. This hedge expired in March 2003.
16
Weather Derivatives: The utility tariffs associated with KEDNE's operations do
not contain weather normalization adjustments. As a result, fluctuations from
normal weather may have a significant positive or negative effect on the results
of these operations. To mitigate a substantial portion of the effect of
fluctuations from normal weather on our financial position and cash flows, we
sold heating degree-day call options and purchased heating-degree day put
options for the November 2002-March 2003 winter season. With respect to sold
call options, KeySpan was required to make a payment of $40,000 per heating
degree day to its counterparties when actual weather experienced during the
November 2002 - March 2003 time frame was above 4,470 heating degree days, which
equates to approximately 1% colder than normal weather. With respect to
purchased put options, KeySpan would receive a $20,000 per heating degree day
payment from its counterparties when actual weather was below 4,150 heating
degree days, or approximately 7% warmer than normal. Based on the terms of such
contracts, we account for such instruments pursuant to the requirements of EITF
99-2, "Accounting for Weather Derivatives." In this regard, we account for such
instruments using the "intrinsic value method" as set forth in such guidance.
During the first quarter of 2003, weather was 10% colder than normal and, as a
result, $11.9 million has been recorded as a reduction to revenues.
Derivative contracts are primarily used to manage exposure to market risk
arising from changes in commodity prices and interest rates. In the event of
nonperformance by a counterparty to a derivative contract, the desired impact
may not be achieved. The risk of counterparty nonperformance is generally
considered credit risk and is actively managed by assessing each counterparty
credit profile and negotiating appropriate levels of collateral and credit
support.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 143,
"Accounting for Asset Retirement Obligations." SFAS 143 requires an entity to
record a liability and corresponding asset representing the present value of
legal obligations associated with the retirement of tangible, long-lived assets.
SFAS 143 was effective for fiscal years beginning after June 2002.
At March 31, 2003, the present value of our future Asset Retirement Obligation
("ARO") was approximately $57 million, primarily related to our investment in
Houston Exploration. The cumulative effect of SFAS 143 and the change in
accounting principle was a benefit to net income of $0.6 million, or $0.2
million, after-tax. KeySpan's largest asset base is its gas transmission and
distribution system. A legal obligation exists due to certain safety
requirements at final abandonment. In addition, a legal obligation may be
construed to exist with respect to KeySpan's liquefied natural gas ("LNG")
storage tanks due to clean up responsibilities upon cessation of use. However,
mass assets such as storage, transmission and distribution assets are believed
to operate in perpetuity and, therefore, have indeterminate cash flow estimates.
Since that exposure is in perpetuity and cannot be measured, no liability will
be recorded. KeySpan's ARO will be re-evaluated in future periods until
sufficient information exists to determine a reasonable estimate of fair value.
17
KeySpan recovers certain asset retirement costs through rates charged to
customers as a portion of depreciation expense. When depreciable properties are
retired, the original cost plus cost of removal less salvage, is charged to
accumulated depreciation. As of March 31, 2003, KeySpan had costs recovered in
excess of costs incurred totaling $422.5 million.
In January 2003, the FASB issued FASB Interpretation No. 46 "FIN 46",
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. We currently have an arrangement
with a variable interest entity through which we lease a portion of the
Ravenswood facility and we will apply the provisions of FIN 46 beginning July 1,
2003. (See Note 9 "Variable Interest Entity" for a detailed description of this
leasing arrangement).
8. FINANCIAL GUARANTEES AND CONTINGENCIES
Environmental Matters
New York Sites. We have identified 28 manufactured gas plant ("MGP") sites and
related facilities in New York State that were historically owned or operated by
KeySpan subsidiaries or such companies' predecessors. Twenty seven of these
former sites, some of which are no longer owned by KeySpan, were associated with
the regulated gas businesses, and have been identified to both the Department of
Environmental Conservation ("DEC") for inclusion on appropriate site inventories
and listing with the New York Public Service Commission ("NYPSC"). The remaining
former MGP site was acquired when the Ravenswood facility was purchased from
Consolidated Edison Company of New York Inc. ("Consolidated Edison"). Fourteen
sites are currently the subjects of Administrative Orders on Consent ("ACOs") or
Voluntary Clean-Up Agreements ("VCAs") with the DEC.
We presently estimate the remaining environmental cleanup costs related to our
New York MGP sites will be $137.9 million, which amount has been accrued as a
reasonable estimate of probable cost for known sites. Expenditures incurred to
date with respect to these MGP-related sites total $53.5 million. The KEDNY and
KEDLI rate plans generally provide for the recovery of MGP related investigation
and remediation costs in rates charged to gas distribution customers. Under
prior rate orders, KEDNY has offset certain refunds due customers against its
estimated environmental cleanup costs for MGP sites. A regulatory asset of
$121.6 million for the New York/Long Island MGP sites is reflected at March 31,
2003.
18
KeySpan is also responsible for environmental obligations associated with the
Ravenswood electric generating facility. Our obligations do not include those
arising from disposal of waste at off-site locations prior to our acquisition of
the Ravenswood facility, or any from Consolidated Edison's post-closing conduct
associated with its transmission facilities at the site. Based on information
currently available, a liability of $3.6 million has been accrued. Expenditures
incurred to date with respect to these environmental obligations total $1.4
million.
New England Sites. Within the Commonwealth of Massachusetts and the State of New
Hampshire, we are aware of 76 former MGP sites and related facilities within the
existing or former service territories of KEDNE.
Boston Gas Company, Colonial Gas Company and Essex Gas Company may have or share
responsibility under applicable environmental laws for the remediation of 66 MGP
sites and related facilities. A subsidiary of National Grid USA ("National
Grid"), formerly New England Electric System, has assumed responsibility for
remediating 11 of these sites, subject to a limited contribution from Boston Gas
Company, and has provided full indemnification to Boston Gas Company with
respect to eight other sites. At this time, there is substantial uncertainty as
to whether Boston Gas Company, Colonial Gas Company or Essex Gas Company have or
share responsibility for remediating any of these other sites. No notice of
responsibility has been issued to us for any of these sites from any
governmental environmental authority.
We presently estimate the remaining cost of New England MGP-related
environmental cleanup activities will be $46.9 million, which amount has been
accrued as a reasonable estimate of probable cost for known sites. Expenditures
incurred since our acquisition of Eastern Enterprises on November 8, 2000 with
respect to these MGP-related activities total $16.7 million.
The Massachusetts Department of Telecommunications and Energy ("DTE") and the
New Hampshire Public Utilities Commission ("NHPUC") have issued rate orders that
provide for the recovery of site investigation and remediation costs in rates
charged to gas distribution customers. Accordingly, a regulatory asset of $58.4
million for the KEDNE MGP sites is reflected at March 31, 2003. Colonial Gas
Company and Essex Gas Company are not subject to the provisions of Statement of
Financial Accounting Standards ("SFAS") 71 "Accounting for the Effects of
Certain Types of Regulation" and therefore have recorded no regulatory asset.
However, rate plans in effect for these subsidiaries provide for the recovery of
investigation and remediation costs.
KeySpan New England LLC Sites. We are aware of three non-utility sites
associated with the historical operations of KeySpan New England, LLC, the
successor company to Eastern Enterprises, for which we may have or share
environmental remediation responsibility or ongoing maintenance: the former
Philadelphia Coke site located in Pennsylvania; the former Connecticut Coke site
located in New Haven, Connecticut; and the Everett site, which includes the
19
former Coal Tar Processing Facility (the "Everett Coal Tar Facility"), Coke
Plant and a by-products facility located in Massachusetts. Honeywell
International, Inc. and Beazer East, Inc. (both former owners or operators of
the Everett Coal Tar Facility) together with KeySpan have entered into an ACO
with the Massachusetts Department of Environmental Protection for the
investigation and development of a remedial response plan for the Everett Coal
Tar Facility.
We presently estimate the remaining cost of our environmental cleanup activities
for the three non-utility sites will be approximately $38.8 million, which
amount has been accrued as a reasonable estimate of probable costs for known
sites. Expenditures incurred since November 8, 2000, with respect to these sites
total $4.5 million.
We believe that in the aggregate, the accrued liability for investigation and
remediation of sites and related facilities identified above are reasonable
estimates of likely cost within a range of reasonable, foreseeable costs. We may
be required to investigate and, if necessary, remediate each of these, or other
currently unknown former sites and related facility sites, the cost of which is
not presently determinable but may be material to our financial position,
results of operations or liquidity. Remediation costs for each site may be
materially higher than noted, depending upon remediation experience, selected
end use for each site, and actual environmental conditions encountered.
See KeySpan's Annual Report on Form 10K for the year ended December 31, 2002
Note 7 to those Consolidated Financial Statements "Contractual Obligations and
Contingencies" for further information on environmental matters.
Legal Matters
From time to time we are subject to various legal proceedings arising out of the
ordinary course of our business. Except as described below, or in KeySpan's
Annual Report on Form 10K for the year ended December 31, 2002, we do not
consider any of such proceedings to be material to our business or likely to
result in a material adverse effect on our results of operations, financial
condition or cash flows.
KeySpan has been cooperating in preliminary inquiries regarding trading in
KeySpan Corporation stock by individual officers of KeySpan prior to the July
17, 2001 announcement that KeySpan was taking a special charge in its Energy
Services business and otherwise reducing its 2001 earnings forecast. These
inquiries are being conducted by the U.S. Attorney's Office, Southern District
of New York and the SEC.
As previously reported, as part of its continuing inquiry, on March 5, 2002, the
SEC issued a formal order of investigation, pursuant to which it will review the
trading activity of certain company insiders from May 1, 2001 to the present, as
well as KeySpan's compliance with its reporting rules and regulations, generally
during the period following the acquisition by KeySpan Services, Inc., a KeySpan
subsidiary, of the Roy Kay companies through the July 17th announcement.
20
KeySpan and certain of its officers and directors are defendants in a number of
class action lawsuits filed in the United States District Court for the Eastern
District of New York after the July 17th announcement. These lawsuits allege,
among other things, violations of Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, as amended ("Exchange Act"), in connection with
disclosures relating to or following the acquisition of the Roy Kay companies
and the announcement of the agreement to acquire Eastern Enterprises and Energy
North Inc.. In October 2001, a shareholder's derivative action was commenced in
the same court against certain officers and directors of KeySpan, alleging,
among other things, breaches of fiduciary duty, violations of the New York
Business Corporation Law and violations of Section 20(a) of the Exchange Act. In
addition, a second derivative action has been commenced asserting similar
allegations. Each of the proceedings seek monetary damages in an unspecified
amount. On March 18, 2003 the court granted our motion to dismiss the class
action complaint. The court's order dismissed certain class allegations with
prejudice, but provided the plaintiffs a final opportunity to file an amended
complaint concerning the remaining allegations. In April 2003, the plaintiff
filed an amended complaint and we intend to file a motion to dismiss the
complaint. We are unable to predict the outcome of these proceedings or effect,
if any, such outcome will have on our financial condition, results of operations
or cash flows.
KeySpan subsidiaries, along with several other parties, have been named as
defendants in numerous proceedings filed by plaintiffs claiming various degrees
of injury from asbestos exposure at generating facilities formerly owned by Long
Island Lighting Company and others. In March 2003, a jury rendered a verdict in
one such proceeding against our subsidiary, KeySpan Generation LLC ("KeySpan
Generation"), and other defendants in the amount of $47 million. KeySpan has
moved to set aside this verdict and, if necessary, will prosecute an appeal, on
the grounds that, among other things, the amount of the verdict is excessive and
unreasonable and the finding of liability against KeySpan Generation is not
supported by the evidence.
In connection with the May 1998 transaction with the Long Island Power Authority
("LIPA"), costs incurred by KeySpan for liabilities for asbestos exposure
arising from the activities of the generating facilities previously owned by the
Long Island Lighting Company, including the facility involved in the case
referred to above, are recoverable from LIPA through the Power Supply Agreement
between LIPA and KeySpan. KeySpan's cost recovery under the Power Supply
Agreement is reduced by any insurance recoveries received by KeySpan Generation
and by amounts received by KeySpan Generation from other indemnification claims
it is pursuing.
KeySpan is unable to determine the outcome of the appeals of the above
referenced action or the outcome of any of these other proceedings, but does not
believe, for the reasons set forth above, that such outcome, if adverse, will
have a material effect on its financial condition or results of operation.
KeySpan believes that its cost recovery rights under the Power Supply Agreement,
its indemnification rights against third parties and its insurance coverage
(above applicable deductible limits) cover its exposure in this case and for
asbestos liabilities generally.
Financial Guarantees
KeySpan has issued financial guarantees in the normal course of business,
primarily on behalf of its subsidiaries, to various third party creditors. At
March 31, 2003, the following amounts would have to be paid by KeySpan in the
event of non-payment by the primary obligor at the time payment is due:
- ------------------------------------------------------------------------------------------------------------
Amount of Expiration
Nature of Guarantee (In Thousands of Dollars) Exposure Dates
- ------------------------------------------------------------------------------------------------------------
Guarantees for Subsidiaries
Medium-Term Notes - KEDLI (i) $ 525,000 2008-2010
Master Lease - Ravenswood (ii) 425,000 2004
Revolving Credit Agreement - KeySpan Canada (iii) 130,000 2004
Surety Bonds (iv) 150,080 Revolving
Commodity Guarantees and Other (v) 99,967 2005
Letters of Credit (vi) 64,822 2003
- ------------------------------------------------------------------------------------------------------------
Guarantees for Non-Affiliates
Third Party Line of Credit (vii) 25,000 2004
Surety Bonds (vii) 8,725 Revolving
- ------------------------------------------------------------------------------------------------------------
$ 1,428,594
- ------------------------------------------------------------------------------------------------------------
21
The following is a description of KeySpan's outstanding subsidiary guarantees:
(i) KeySpan has fully and unconditionally guaranteed $525 million to holders of
Medium-Term Notes issued by KEDLI. These notes are due to be repaid on
January 15, 2008 and February 1, 2010. KEDLI is required to comply with
certain financial covenants under the debt agreements. Currently, KEDLI is
in compliance with all covenants and management does not anticipate that
KEDLI will have any difficulty maintaining such compliance. The face value
of these notes is included in Long-Term Debt on the Consolidated Balance
Sheet.
(ii) KeySpan has guaranteed all payment and performance obligations of KeySpan
Ravenswood, LLC, the lessee under the $425 million Ravenswood Master Lease
(the "Master Lease") associated with the lease of the Ravenswood facility.
The initial term of the lease expires on June 20, 2004 and may be extended
until June 20, 2009. For further information, see Note 9 "Variable Interest
Entity."
(iii)KeySpan has fully and unconditionally guaranteed a US $130 million
revolving credit agreement associated with KeySpan Canada. The term of the
agreement expires January 1, 2004.
(iv) KeySpan has agreed to indemnify the issuers of various surety and
performance bonds associated with certain construction projects currently
being performed by subsidiaries within the Energy Services segment. In the
event that the operating companies in the Energy Services segment fail to
perform their obligations under contract, the injured party may demand that
the surety make payments or provide services under the bond. KeySpan would
then be obligated to reimburse the surety for any expenses or cash outlays
it incurs.
(v) KeySpan has guaranteed commodity-related payments for subsidiaries within
the Energy Services segment, as well as KeySpan Ravenswood, LLC. These
guarantees are provided to third parties to facilitate physical and
financial transactions involved in the purchase of natural gas, oil and
other petroleum products for electric production and marketing activities.
The guarantees cover actual purchases by these subsidiaries that are still
outstanding as of March 31, 2003.
(vi) KeySpan has arranged for stand-by letters of credit in the amount of $64.8
million to be issued to third parties that have extended credit to certain
subsidiaries. Certain vendors require us to post letters of credit to
guarantee subsidiary performance under our contracts and to ensure payment
to our subsidiary subcontractors and vendors under those contracts. Certain
of our vendors also require letters of credit to ensure reimbursement for
amounts they are disbursing on behalf of our subsidiaries, such as to
beneficiaries under our self-funded insurance programs. Such letters of
credit are generally issued by a bank or similar financial institution. The
letters of credit commit the issuer to pay specified amounts to the holder
of the letter of credit if the holder demonstrates that we have failed to
perform specified actions. If this were to occur, KeySpan would be required
to reimburse the issuer of the letter of credit.
22
To date, KeySpan has not had a claim made against it for any of the above
guarantees and we have no reason to believe that our subsidiaries will default
on their current obligations. However, we cannot predict when or if any defaults
may take place or the impact such defaults may have on our consolidated results
of operations, financial condition or cash flows.
The following is a description of KeySpan's outstanding guarantees to
non-affiliates:
(vii)KeySpan has agreed to support a line of credit up to $25 million on behalf
of Hawkeye Construction ("Hawkeye"), a non-affiliated company. It also
assisted Hawkeye in obtaining performance bonds. The guarantees related to
their line of credit extend through 2004. To the extent Hawkeye does not
meet its obligations, KeySpan could be liable for the amount of the
outstanding guarantees. At March 31, 2003, the amount guaranteed was $25
million.
If Hawkeye fails to perform under a contract or to pay subcontractors and
vendors, the counterparty that requested the performance bond may demand
that the surety make payments or provide services under the bond. KeySpan
would then have to reimburse the surety for any expenses or outlays the
surety incurs. To date, we have not had a claim made against either the
guarantee associated with the line of credit or the performance bonds.
KeySpan is presently engaged in a legal action with Hawkeye. (See KeySpan's
Annual Report on form 10K for the year ended December 31, 2002 Note 7
"Contractual Obligations, Financial Guarantees and Contingencies" for
further information on this legal proceeding.)
9. VARIABLE INTEREST ENTITY
KeySpan has an arrangement with a variable interest entity through which we
lease a portion of the Ravenswood facility. We acquired the Ravenswood facility,
in part, through the variable interest entity from Consolidated Edison on June
18, 1999 for approximately $597 million. In order to reduce the initial cash
requirements, we entered into the Master Lease with a variable interest,
unaffiliated financing entity that acquired a portion of the facility, three
steam generating units, directly from Consolidated Edison and leased it to our
subsidiary. The variable interest unaffiliated financing entity acquired the
property for $425 million, financed with debt of $412.3 million (97% of
capitalization) and equity of $12.7 million (3% of capitalization). KeySpan has
no ownership interests in the steam units or in the variable interest entity.
KeySpan has guaranteed all payment and performance obligations of our subsidiary
under the Master Lease. The Master Lease represents approximately $425 million
of the acquisition cost of the facility, which is the amount of debt that would
have been recorded on our Consolidated Balance Sheet had the variable interest
entity not been utilized and conventional debt financing been employed. Further,
we would have recorded an asset in the same amount. Monthly lease payments equal
the monthly interest expense on such debt securities. The Master Lease currently
qualifies as an operating lease for financial reporting purposes.
23
The initial term of the Master Lease expires on June 20, 2004 and may be
extended until June 20, 2009. In June 2004, we have the right to: (i) either
purchase the facility for the original acquisition cost of $425 million, plus
the present value of the lease payments that would otherwise have been paid
through June 2009; (ii) terminate the Master Lease and dispose of the facility;
or (iii) otherwise extend the Master Lease to 2009. If the Master Lease is
terminated in 2004, KeySpan has guaranteed an amount approximately equal to 83%
of the residual value of the original cost of the property, plus the present
value of the lease payments that would have otherwise been paid through June 20,
2009. In June 2009, when the Master Lease terminates, we may purchase the
facility in an amount equal to the original acquisition cost, subject to
adjustment, or surrender the facility to the lessor. If we elect not to purchase
the property, the Ravenswood facility will be sold by the lessor. We have
guaranteed to the lessor 84% of the residual value of the original cost of the
property.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51." FIN 46 requires KeySpan, based upon
its current status as the primary beneficiary, to consolidate this variable
interest entity for the first interim period ending after June 15, 2003. It also
requires that assets, liabilities and non-controlling interests of the variable
interest entity be consolidated at fair value, except to the extent that to do
so would result in a gain to KeySpan. KeySpan believes that the fair market
value of the Ravenswood facility exceeds the fair market value of the lease
obligation.
Prospectively, KeySpan will have a $425 million asset that will be amortized
over the economic life of the leased property. However, upon implementation,
there will be a cumulative catch-up adjustment for a change in accounting policy
as if the asset had been owned from inception, or June 20, 1999. Therefore, at
July 1, 2003, assuming a 35 year economic life, KeySpan will be deemed to have
owned the asset for approximately 4 years and it is anticipated that we will
record a $29.1 million after-tax charge, or $0.18 per share, change in
accounting principle on the Consolidated Statement of Income. Upon
implementation of FIN 46, therefore, we anticipate recording an asset of
approximately $376 million and debt of $425 million.
Based upon expected average outstanding shares, we anticipate the incremental
impact of the additional depreciation expense for the remaining six months of
2003 to be approximately $0.02 per share. In addition, KeySpan is also
conducting a study to determine the fair value of the Ravenswood facility.
Although considered unlikely, to the extent the fair value of the Ravenswood
facility was less than the value of the lease obligation, then a loss would be
recognized upon consolidation.
If our subsidiary that leases the Ravenswood facility was not able to fulfill
its payment obligations with respect to the Master Lease payments, then the
maximum amount KeySpan would be exposed to under its current guarantees would be
$425 million plus the present value of the remaining lease payments through June
20, 2009.
24
10. STOCK OPTIONS
Stock options have been issued to KeySpan officers, directors and certain other
management employees and consultants as approved by the Board of Directors.
These options generally vest over a three-to-five year period and have a
ten-year exercise period. Moreover, under a separate plan, Houston Exploration
has issued stock options to its directors and key Houston Exploration employees.
During 2002, we announced our intention to record stock options as a
compensation expense beginning with those options granted in 2003. In 2003,
KeySpan and Houston Exploration adopted the prospective method of transition in
accordance with SFAS 148 "Accounting for Stock-Based Compensation - Transition
and Disclosure". Accordingly, compensation expense has been recognized by
employing the fair value recognition provisions of SFAS 123 "Accounting for
Stock-Based Compensation" for grants awarded after January 1, 2003.
KeySpan and Houston Exploration continue to apply APB Opinion 25, "Accounting
for Stock Issued to Employees," and related Interpretations in accounting for
grants awarded prior to January 1, 2003. Accordingly, no compensation cost has
been recognized for these fixed stock option plans in the Consolidated Financial
Statements since the exercise prices and market values were equal on the grant
dates. Had compensation cost for these plans been determined based on the fair
value at the grant dates for awards under the plans consistent with SFAS 123,
our net income and earnings per share would have decreased to the pro-forma
amounts indicated below:
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars, Except Per Share Amounts) 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
Earnings available for common stock:
As reported $ 241,804 $ 213,155
Add: recorded stock-based compensation expense, net of tax 857 -
Deduct: total stock-based compensation expense, net of tax (2,913) (1,831)
- ------------------------------------------------------------------------------------------------------------------------------
Pro-forma earnings $ 239,748 $ 211,324
- ------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 1.54 $ 1.52
Basic - pro-forma $ 1.53 $ 1.51
Diluted - as reported $ 1.53 $ 1.51
Diluted - pro-forma $ 1.52 $ 1.50
- ------------------------------------------------------------------------------------------------------------------------------
11. SUBSEQUENT EVENTS
Boston Gas Company's gas rates for local distribution service were governed by a
five-year performance-based rate plan approved by the Department of
Telecommunications and Energy ("DTE") in 1996 (the "Plan"), that expired in
October 2002. Boston Gas Company filed a base rate case and performance based
rate plan on April 16, 2003, to be effective in the fourth quarter of 2003. The
filing requests an annual revenue increase of approximately $61 million and a
performance based rate plan term of five years.
25
In its order approving the acquisition by KeySpan of Eastern Enterprises Inc.,
the SEC reserved jurisdiction on its determination of whether the Energy
Services companies were retainable under existing PUHCA rule or precedent. On
April 24, 2003, the SEC issued an order authorizing the retention of these
companies.
On May 1, 2003, KeySpan's gas and electric marketing subsidiary, KeySpan Energy
Services, assigned a substantial portion of its retail natural gas customers,
consisting mostly of residential and small commercial customers, to ECONnergy
Energy Co., Inc. ("ECONnergy"). ECONnergy is one of the largest deregulated
energy service companies in the Northeast. KeySpan Energy Services will continue
to provided retail natural gas marketing to a small number of customers in New
Jersey and will continue its electric marketing activities.
12. KEYSPAN GAS EAST CORPORATION SUMMARY FINANCIAL INFORMATION
KEDLI is a wholly owned subsidiary of KeySpan. KEDLI was formed on May 7, 1998
and on May 28, 1998 acquired substantially all of the assets related to the gas
distribution business of LILCO. KEDLI established a program for the issuance,
from time to time, of up to $600 million aggregate principal amount of
Medium-Term Notes, which are fully and unconditionally guaranteed by the parent,
KeySpan Corporation. On February 1, 2000, KEDLI issued $400 million of 7.875%
Medium-Term Notes due 2010. In January 2001, KEDLI issued an additional $125
million of Medium-Term Notes at 6.9% due January 2008. The following condensed
financial statements are required to be disclosed by SEC regulations and set
forth those of KEDLI, KeySpan Corporation as guarantor of the Medium-Term Notes
and our other subsidiaries on a combined basis. The March 31, 2002 disclosures
have been revised to separately present our other subsidiaries.
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2003
(In Thousands of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 143 $478,345 $2,034,180 $ (143) $ 2,512,525
Operating Expenses
Purchased gas - 287,009 909,156 - 1,196,165
Fuel and purchased power - - 97,522 - 97,522
Operations and maintenance 7,259 38,220 452,710 - 498,189
Intercompany expense 34 1,182 (1,182) (34) -
Depreciation and amortization (20) 26,920 118,071 - 144,971
Operating taxes - 24,005 100,708 - 124,713
------------------------------------------------------------------------------------
Total Operating Expenses 7,273 377,336 1,676,985 (34) 2,061,560
------------------------------------------------------------------------------------
Operating Income (Loss) (7,130) 101,009 357,195 (109) 450,965
Interest charges (46,477) (15,006) (52,299) 44,843 (68,939)
Other income and (deductions) 293,453 (7,217) 10,243 (292,581) 3,898
------------------------------------------------------------------------------------
Total Other Income and (Deductions) 246,976 (22,223) (42,056) (247,738) (65,041)
Income (Loss) Before Income Taxes 239,846 78,786 315,139 (247,847) 385,924
Income Taxes (3,419) 28,312 117,940 - 142,833
------------------------------------------------------------------------------------
Earnings before Change in Accounting Principle $ 243,265 $ 50,474 $ 197,199 $ (247,847) $ 243,091
Cumulative Effect of Change in Accouting
Principle - - 174 - 174
------------------------------------------------------------------------------------
Net Income $ 243,265 $ 50,474 $ 197,373 $ (247,847) $ 243,265
====================================================================================
26
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2002
(In Thousands of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 104 $ 318,947 $ 1,554,631 $ (104) $ 1,873,578
Operating Expenses
Purchased gas - 142,867 506,493 - 649,360
Fuel and purchased power - - 84,372 - 84,372
Operations and maintenance 1,506 12,001 484,568 - 498,075
Intercompany expense 56 18,209 (18,209) (56) -
Depreciation and amortization - 20,241 105,756 - 125,997
Operating taxes 570 25,386 87,946 - 113,902
--------------------------------------------------------------------------------------
Total Operating Expenses 2,132 218,704 1,250,926 (56) 1,471,706
--------------------------------------------------------------------------------------
Operating Income (Loss) (2,028) 100,243 303,705 (48) 401,872
Interest charges (46,929) (15,202) (67,772) 57,291 (72,612)
Other income and (deductions) 263,251 2,902 17,056 (272,529) 10,680
--------------------------------------------------------------------------------------
Total Other Income and (Deductions) 216,322 (12,300) (50,716) (215,238) (61,932)
Income (Loss) Before Income Taxes 214,294 87,943 252,989 (215,286) 339,940
Income Taxes (337) 37,081 88,565 - 125,309
--------------------------------------------------------------------------------------
Net Income $ 214,631 $ 50,862 $ 164,424 $ (215,286) $ 214,631
======================================================================================
27
- -----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- -----------------------------------------------------------------------------------------------------------------------------------
March 31, 2003
Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
--------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 90,558 $ 14,285 $ 139,219 $ - $ 244,062
Accounts receivable, net 8,206 331,104 1,712,805 - 2,052,115
Other current assets 1,550 13,048 257,578 - 272,176
--------------------------------------------------------------------------------------
100,314 358,437 2,109,602 - 2,568,353
--------------------------------------------------------------------------------------
Investments and Other 3,922,991 2,629 207,382 (3,864,124) 268,878
--------------------------------------------------------------------------------------
Property
Gas - 1,796,884 4,405,849 - 6,202,733
Other - - 4,991,336 - 4,991,336
Accumulated depreciation and depletion - (330,384) (3,487,881) - (3,818,265)
--------------------------------------------------------------------------------------
- 1,466,500 5,909,304 - 7,375,804
--------------------------------------------------------------------------------------
Intercompany Accounts Receivable 3,683,508 13,637 634,910 (4,332,055) -
Deferred Charges 323,858 187,739 2,406,174 - 2,917,771
--------------------------------------------------------------------------------------
Total Assets $ 8,030,671 $ 2,028,942 $ 11,267,372 $ (8,196,179) $ 13,130,806
======================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 74,724 $ 121,056 $ 1,016,626 $ - $ 1,212,406
Commercial paper 677,332 - - - 677,332
Other current liabilities 325,258 163,662 (27,361) - 461,559
--------------------------------------------------------------------------------------
1,077,314 284,718 989,265 - 2,351,297
--------------------------------------------------------------------------------------
Intercompany Accounts Payable - 105,215 2,095,456 (2,200,671) -
--------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (45,924) 142,933 790,699 - 887,708
Other deferred credits and liabilities 509,695 97,609 538,541 - 1,145,845
--------------------------------------------------------------------------------------
463,771 240,542 1,329,240 - 2,033,553
--------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 3,655,742 697,563 3,123,968 (3,864,124) 3,613,149
Preferred stock 83,849 - - - 83,849
Long-term debt 2,749,995 700,904 3,420,716 (2,131,384) 4,740,231
--------------------------------------------------------------------------------------
Total Capitalization 6,489,586 1,398,467 6,544,684 (5,995,508) 8,437,229
--------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 308,727 - 308,727
--------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 8,030,671 $ 2,028,942 $ 11,267,372 $ (8,196,179) $ 13,130,806
======================================================================================
28
- -----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- -----------------------------------------------------------------------------------------------------------------------------------
December 31, 2002
Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
----------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 88,308 $ 6,472 $ 75,837 $ - $ 170,617
Accounts receivable, net 23,982 208,512 1,299,559 - 1,532,053
Other current assets 1,757 79,206 423,596 - 504,559
----------------------------------------------------------------------------------------
114,047 294,190 1,798,992 - 2,207,229
----------------------------------------------------------------------------------------
Investments and Other 3,797,964 2,717 201,675 (3,736,379) 265,977
----------------------------------------------------------------------------------------
Property
Gas - 1,771,780 4,352,501 - 6,124,281
Other - - 4,807,724 - 4,807,724
Accumulated depreciation and depletion - (322,236) (3,392,169) - (3,714,405)
----------------------------------------------------------------------------------------
- 1,449,544 5,768,056 - 7,217,600
----------------------------------------------------------------------------------------
Intercompany Accounts Receivable 3,619,515 54,549 822,725 (4,496,789) -
Deferred Charges 339,443 192,652 2,391,405 - 2,923,500
----------------------------------------------------------------------------------------
Total Assets $ 7,870,969 $ 1,993,652 $ 10,982,853 $ (8,233,168) $ 12,614,306
========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 132,966 $ 68,772 $ 859,911 $ - $ 1,061,649
Commercial paper 915,697 - - - 915,697
Other current liabilities 107,605 104,975 30,302 - 242,882
----------------------------------------------------------------------------------------
1,156,268 173,747 890,213 - 2,220,228
----------------------------------------------------------------------------------------
Intercompany Accounts Payable - 233,392 2,182,013 (2,415,405) -
----------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (43,110) 139,715 780,408 - 877,013
Other deferred credits and liabilities 481,964 98,805 453,353 - 1,034,122
----------------------------------------------------------------------------------------
438,854 238,520 1,233,761 - 1,911,135
----------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 2,983,214 647,089 3,050,668 (3,736,379) 2,944,592
Preferred stock 83,849 - - - 83,849
Long-term debt 3,208,784 700,904 3,395,777 (2,081,384) 5,224,081
----------------------------------------------------------------------------------------
Total Capitalization 6,275,847 1,347,993 6,446,445 (5,817,763) 8,252,522
----------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 230,421 - 230,421
----------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 7,870,969 $ 1,993,652 $ 10,982,853 $ (8,233,168) $ 12,614,306
========================================================================================
29
- -------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- -------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2003
------------------------------------------------------------------------
Guarantor KEDLI Other Subsidiaries Consolidated
------------------------------------------------------------------------
Operating Activities
Net Cash Provided by Operating Activities $ 239,598 $ 121,019 $ 129,272 $ 489,889
------------------------------------------------------------------------
Investing Activities
Capital expenditures - (25,941) (194,838) (220,779)
Proceeds from Monetization of Houston Exploration 79,200 - - 79,200
------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities 79,200 (25,941) (194,838) (141,579)
------------------------------------------------------------------------
Financing Activities
Treasury stock issued 26,307 - - 26,307
Equity Issuance 473,573 - - 473,573
Redemption of Promissory Notes (447,005) - - (447,005)
Payment of debt, net (238,365) - (33,404) (271,769)
Common and preferred stock dividends paid (65,018) - - (65,018)
Other 7,153 - 1,894 9,047
Net intercompany accounts (73,193) (87,265) 160,458 -
-
------------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (316,548) (87,265) 128,948 (274,865)
------------------------------------------------------------------------
Net Increase in Cash and Cash Equivalents $ 2,250 $ 7,813 $ 63,382 $ 73,445
Cash and Cash Equivalents at Beginning of Period 88,308 6,472 75,837 170,617
------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 90,558 $ 14,285 $ 139,219 $ 244,062
========================================================================
- ---------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- ---------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2002
------------------------------------------------------------------------
Guarantor KEDLI Other Subsidiaries Consolidated
------------------------------------------------------------------------
Operating Activities
Net Cash Provided by (Used in) Operating Activities $ 60,515 $ 302,490 $ (30,456) $ 332,549
------------------------------------------------------------------------
Investing Activities
Capital expenditures - (29,168) (214,985) (244,153)
------------------------------------------------------------------------
Net Cash Used in Investing Activities - (29,168) (214,985) (244,153)
------------------------------------------------------------------------
Financing Activities
Treasury stock issued 34,058 - - 34,058
Payment of debt, net (9,947) - (14,955) (24,902)
Common and preferred stock dividends paid