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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period
ended March 31, 2004 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
-----------------------------------------------------
(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, 2004
--------------------- -----------------------------
$.01 par value 160,164,056
KEYSPAN CORPORATION AND SUBSIDIARIES
INDEX
-----
Part I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheet -
March 31, 2004 and December 31, 2003 3
Consolidated Statement of Income -
Three Months Ended March 31, 2004 and 2003 5
Consolidated Statement of Cash Flows -
Three Months Ended March 31, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 30
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 57
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 61
Item 6. Exhibits and Reports on Form 8-K 61
Signatures 61
2
CONSOLIDATED BALANCE SHEET
(Unaudited)
- ---------------------------------------------------------------------------------------------------------
(In Thousands of Dollars) March 31, 2004 December 31, 2003
- ---------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 256,940 $ 205,751
Accounts receivable 1,384,598 1,029,459
Unbilled revenue 460,460 505,633
Allowance for uncollectible accounts (91,016) (79,184)
Gas in storage, at average cost 154,072 488,521
Material and supplies, at average cost 118,772 121,415
Other 69,519 115,304
---------------------------- ---------------------
2,353,345 2,386,899
---------------------------- ---------------------
Investments and Other 256,372 248,565
Property
Gas 6,590,421 6,522,251
Electric 2,671,594 2,636,537
Other 429,716 425,576
Accumulated depreciation (2,655,711) (2,610,876)
Gas exploration and production, at cost 3,157,026 3,088,242
Accumulated depletion (1,229,368) (1,167,427)
---------------------------- ---------------------
8,963,678 8,894,303
---------------------------- ---------------------
Deferred Charges
Regulatory assets 554,563 578,383
Goodwill and other intangible assets 1,810,161 1,809,712
Other 741,613 722,320
---------------------------- ---------------------
3,106,337 3,110,415
---------------------------- ---------------------
Total Assets $ 14,679,732 $ 14,640,182
============================ =====================
See accompanying Notes to the Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEET
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------
(In Thousands of Dollars) March 31, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------------------------
LIABILITIES AND CAPITALIZATION
Current Liabilities
Current redemption of long-term debt $ 1,471 $ 1,471
Accounts payable and other liabilities 950,861 1,141,597
Commercial paper 294,150 481,900
Dividends payable 72,070 72,289
Taxes accrued 197,686 46,580
Customer deposits 41,028 40,370
Interest accrued 102,967 64,609
-------------------------- ------------------------
1,660,233 1,848,816
-------------------------- ------------------------
Deferred Credits and Other Liabilities
Regulatory liabilities:
Miscellaneous liabilities 93,110 104,034
Removal cost recovered 462,585 450,034
Deferred income tax 1,250,672 1,278,341
Postretirement benefits and other reserves 1,060,525 961,962
Other 162,713 121,790
-------------------------- ------------------------
3,029,605 2,916,161
-------------------------- ------------------------
Commitments and Contingencies (See Note 6) - -
Capitalization
Common stock 3,492,116 3,487,645
Retained earnings 796,410 621,430
Other comprehensive income (89,309) (59,932)
Treasury stock (366,691) (378,487)
-------------------------- ------------------------
Total common shareholders' equity 3,832,526 3,670,656
Preferred stock 83,433 83,568
Long-term debt 5,537,456 5,611,432
-------------------------- ------------------------
Total Capitalization 9,453,415 9,365,656
-------------------------- ------------------------
Minority Interest in Subsidiary Companies 536,479 509,549
-------------------------- ------------------------
Total Liabilities and Capitalization $ 14,679,732 $ 14,640,182
========================== ========================
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) 2004 2003
- ------------------------------------------------------------------------------------------------------------------
Revenues
Gas Distribution $ 1,927,779 $ 1,832,701
Electric Services 359,136 397,700
Energy Services 129,059 129,065
Gas Exploration and Production 152,419 127,847
Energy Investments 27,180 25,212
----------------------------------------------
Total Revenues 2,595,573 2,512,525
----------------------------------------------
Operating Expenses
Purchased gas for resale 1,226,573 1,196,165
Fuel and purchased power 101,612 97,522
Operations and maintenance 492,466 498,189
Depreciation, depletion and amortization 171,684 144,971
Operating taxes 122,279 124,713
----------------------------------------------
Total Operating Expenses 2,114,614 2,061,560
----------------------------------------------
Income from equity investments 5,717 5,729
----------------------------------------------
Operating Income 486,676 456,694
----------------------------------------------
Other Income and (Deductions)
Interest charges (84,066) (68,939)
Gain on sale of subsidiary stock - 19,020
Cost of debt redemption - (18,194)
Minority interest (20,293) (18,054)
Other 2,761 15,397
----------------------------------------------
Total Other Income and (Deductions) (101,598) (70,770)
----------------------------------------------
Income Taxes
Current 147,702 129,575
Deferred (10,320) 13,258
----------------------------------------------
Total Income Taxes 137,382 142,833
----------------------------------------------
Earnings Before Effect of Change in Accounting Principle 247,696 243,091
Cummulative Effect of Change in Accounting Principle - 174
----------------------------------------------
Net Income 247,696 243,265
Preferred stock dividend requirements 1,461 1,461
----------------------------------------------
Earnings for Common Stock $ 246,235 $ 241,804
==============================================
Basic Earnings Per Share:
Before Change in Accounting Principle,
less preferred stock dividends $ 1.54 $ 1.54
Change in Accounting Principle - -
----------------------------------------------
Basic Earnings Per Share $ 1.54 $ 1.54
==============================================
Diluted Earnings Per Share
Before Change in Accounting Principle,
less preferred stock dividends $ 1.53 $ 1.53
Change in Accounting Principle - -
----------------------------------------------
Diluted Earnings Per Share $ 1.53 $ 1.53
==============================================
Average Common Shares Outstanding (000) 159,892 156,886
Average Common Shares Outstanding - Diluted (000) 161,164 158,045
See accompanying Notes to the Consolidated Financial Statements.
5
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
- ---------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars) 2004 2003
- ---------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 247,696 $ 243,265
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Depreciation, depletion and amortization 171,684 144,971
Deferred income tax (10,320) 13,258
Income from equity investments (5,717) (5,729)
Dividends from equity investments 104 -
Amortization of interest rate swap (2,448) (2,500)
(Gain) on disposal of subsidiary stock - (19,020)
Minority interest 20,293 18,054
Changes in assets and liabilities
Accounts receivable (298,134) (520,062)
Materials and supplies, fuel oil and gas in storage 337,092 201,789
Accounts payable and other liabilities (190,736) 146,311
Taxes accrued 151,106 203,411
Interest accrued 38,357 8,324
Captive insurance 43,214 -
Other 76,895 64,755
----------------------------------------
Net Cash Provided by Operating Activities 579,086 496,827
----------------------------------------
Investing Activities
Construction expenditures (220,224) (220,779)
Cost of removal (6,204) (6,938)
Proceeds from monetization of Houston Exploration - 79,200
Proceeds from sale of property 13,138 -
----------------------------------------
Net Cash Used in Investing Activities (213,290) (148,517)
----------------------------------------
Financing Activities
Treasury stock issued 11,796 26,307
Equity issuance - 473,573
Issuance of long-term debt 20,000 39,161
Payment of long-term debt (94,853) (72,565)
Payment of commercial paper (187,750) (238,365)
Redemption of promissory notes - (447,005)
Preferred stock dividends paid (1,461) (1,461)
Common stock dividends paid (71,474) (63,557)
Other 9,135 9,047
----------------------------------------
Net Cash Used in Financing Activities (314,607) (274,865)
----------------------------------------
Net Increase in Cash and Cash Equivalents $ 51,189 $ 73,445
Cash and Cash Equivalents at Beginning of Period 205,751 170,617
----------------------------------------
Cash and Cash Equivalents at End of Period $ 256,940 $ 244,062
========================================
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 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; underground gas storage; liquefied natural gas storage; retail
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, electric generation 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, 2004, and the results of operations for the three months ended
March 31, 2004 and March 31, 2003, as well as cash flows for the three months
ended March 31, 2004 and March 31, 2003. 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, 2003. The December 31, 2003 financial statement information has
been derived from the 2003 audited financial statements. Income from interim
periods may not be indicative of future results. Certain reclassifications were
made to conform prior period financial statements to 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.
We have approximately 3.6 million common stock options outstanding at March 31,
2004, 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.
7
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) 2004 2003
- ---------------------------------------------------------------------------------------------------------
Earnings for common stock $ 246,235 $ 241,804
Interest savings on convertible preferred stock 129 133
Houston Exploration dilution (81) (87)
- ---------------------------------------------------------------------------------------------------------
Earnings for common stock - adjusted $ 246,283 $ 241,850
- ---------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (000) 159,892 156,886
Add dilutive securities:
Options 1,050 931
Convertible preferred stock 222 228
- ---------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution 161,164 158,045
- ---------------------------------------------------------------------------------------------------------
Basic earnings per share $ 1.54 $ 1.54
- ---------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 1.53 $ 1.53
- ---------------------------------------------------------------------------------------------------------
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 three to eleven years
and power purchase agreements for 23 years. The Electric Services segment also
includes subsidiaries that own, lease and operate the 2,450 megawatt ("MW")
Ravenswood electric generation facility ("Ravenswood facility"), located in
Queens, New York, which includes the recently completed 250 MW combined cycle
electric generating facility located at the Ravenswood site (see below). 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 Electric Services segment also provides retail marketing of electricity to
commercial customers.
8
We are currently in the process of structuring a leveraged lease financing for
the new 250 megawatt electric generating facility located at the existing
Ravenswood site, and are seeking to close this transaction in May to coincide
with the commencement of full commercial operation of the new facility. At the
closing, the new facility will be acquired by the lessor from our subsidiary,
KeySpan Ravenswood, LLC, and simultaneously leased back to it. All obligations
of our subsidiary under the lease will be unconditionally guaranteed by KeySpan.
We anticipate that this lease transaction will generate cash proceeds equivalent
to the fair market value of the facility, as determined by a third-party
appraiser. It is expected that the cash proceeds from this transaction will be
used to redeem outstanding commercial paper. This lease transaction is intended
to qualify as an operating lease under SFAS 98 "Accounting for Leases:
Sale/Leaseback Transactions Involving Real Estate; Sales-Type Leases of Real
Estate; Definition of the Lease Term; an Initial Direct Costs of Direct
Financing Leases, an amendment of FASB Statements No.13, 66, 91 and a rescission
of FASB Statement No. 26 and Technical Bulletin No. 79-11." The lease will have
an initial term of 36 years and operating lease expense is anticipated to be
between $15 million to $17 million per year. Lease payments will fluctuate from
year to year, but are substantially paid over the first 16 years.
The Energy Services segment includes companies that provide energy-related and a
minimal amount of fiber optic services to customers primarily located within the
Northeastern United States, with concentrations in the New York City
metropolitan area, including New Jersey and Connecticut, as well as Rhode
Island, Pennsylvania, Massachusetts and New Hampshire, through the following
lines of business: (i) Home Energy Services, which provides residential and
small commercial customers with service and maintenance of energy systems and
appliances; and (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.
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 55%
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.
Subsidiaries in this segment 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 and a 50% interest in the Premier
Transmission Pipeline in Northern Ireland. At March 31, 2004, we had an
approximate 61% investment in certain midstream natural gas assets in Western
Canada through KeySpan Energy Canada Partnership ("KeySpan Canada"). With the
exception of KeySpan Canada, which is consolidated in our financial statements,
these subsidiaries are accounted for under the equity method.
9
On April 1, 2004, The KeySpan Facilities Income Fund (the "Fund") issued 15.617
million units at a price of $12.60 per unit for gross total proceeds of
approximately CDN$196.8 million. The proceeds of the offering were used to
acquire an additional 35.91% interest in the business of KeySpan Canada from
KeySpan. KeySpan received net proceeds of approximately CDN$186.3 million (or
approximately US$140 million), after commissions and expenses. The Fund's
ownership in KeySpan Canada has now increased from 39.1% to approximately 75%.
KeySpan's ownership of KeySpan Canada is now approximately 25%. KeySpan expects
to record a pre-tax gain of approximately $20 million on this transaction, which
will be reflected in its earnings in the second quarter of 2004. The proceeds
from the transaction will be used to redeem outstanding debt.
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, 2004, the total assets of
each reportable segment have not changed materially from those levels reported
at December 31, 2003. However, in the first quarter of 2004 we reclassified the
operating results of our electric marketing subsidiary from the Energy Services
segment to the Electric Services segment. As a result we restated the financial
results for the first quarter of 2003. 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, 2004
Unaffiliated revenue 1,927,779 359,136 129,059 152,419 27,180 - 2,595,573
Intersegment revenue - - 3,436 - 1,265 (4,701) -
Operating Income 379,653 47,200 (18,474) 62,108 12,922 3,267 486,676
Three Months Ended March 31, 2003
Unaffiliated revenue 1,832,701 397,700 129,065 127,847 25,212 - 2,512,525
Intersegment revenue - 25 1,426 - 1,252 (2,703) -
Operating Income 364,937 39,644 (9,122) 55,590 10,124 (4,479) 456,694
- -----------------------------------------------------------------------------------------------------------------------------------
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 $345.6 million and $334.4 million for the three
months ended March 31, 2004 and 2003 represent approximately 13% of our
consolidated revenues in both periods.
10
3. COMPREHENSIVE INCOME
The table below indicates the components of comprehensive income:
- ------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars) 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
Net Income $ 247,696 $ 243,265
- ------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Net losses (gains) on derivative instruments 11,029 2,354
Foreign currency translation adjustments (1,896) 9,753
Unrealized gains (losses) on marketable securities 513 (3,156)
Settlement of derivative premiums 3,437 -
Unrealized losses on derivative financial instruments (42,458) (14,749)
- ------------------------------------------------------------------------------------------------------------------------
Other comprehensive loss, net of tax (29,375) (5,798)
- ------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 218,321 $ 237,467
- ------------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Net losses (gains) on derivative instruments 5,939 1,267
Foreign currency translation adjustments (1,021) 5,252
Unrealized gains (losses) on marketable securities 274 (1,699)
Settlement of derivative premiums 1,851 -
Unrealized losses on derivative financial instruments (22,862) (7,942)
- ------------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense $ (15,819) $ (3,122)
- ------------------------------------------------------------------------------------------------------------------------
4. HEDGING AND DERIVATIVE FINANCIAL INSTRUMENTS
Financially-Settled Commodity Derivative Instruments - Hedging Activities: From
time to time, KeySpan subsidiaries have utilized derivative financial
instruments, such as futures, options and swaps, for the purpose of hedging the
cash flow variability associated with changes in commodity prices. KeySpan is
exposed to commodity price risk primarily with regard to its gas exploration and
production activities and its electric generating facilities. Derivative
financial instruments are employed by Houston Exploration to hedge cash flow
variability associated with forecasted sales of natural gas. The Ravenswood
facility uses derivative financial instruments to hedge the cash flow
variability associated with the purchase of natural gas and oil that will be
consumed during the generation of electricity. The Ravenswood facility also
hedges the cash flow variability associated with a portion of on-peak electric
energy sales.
The majority of these derivative financial instruments are cash flow hedges that
qualify for hedge accounting under SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS 149 "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," collectively
SFAS 133, and are not considered held for trading purposes as defined by current
accounting literature. Accordingly, we carry the fair market value of our
derivative instruments on the Consolidated Balance Sheet as either a current or
deferred asset or liability, as appropriate, and defer the effective portion of
unrealized gains or losses in accumulated other comprehensive income. Gains and
losses are reclassified from accumulated other comprehensive income to the
Consolidated Statement of Income in the period the hedged transaction effects
earnings. Gains and losses are reflected as a component of either revenue or
fuel and purchased power depending on the hedged transaction. Hedge
ineffectiveness results from changes during the period in the price
differentials between the index price of the derivative contract and the index
price at the point of sale for the cash flow that is being hedged, and is
recorded directly to earnings.
11
Houston Exploration has utilized collars and purchased put options, 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 production. At March 31,
2004, Houston Exploration has hedge positions in place for approximately 70% of
its estimated 2004 gas production, with an effective floor price of $4.26 and an
effective ceiling price of $5.85. Further, Houston Exploration has hedge
positions in place for approximately 60% of its estimated 2005 gas production,
with an effective floor price of $4.57 and an effective ceiling price of $5.46.
Houston Exploration uses standard New York Mercantile Exchange ("NYMEX") futures
prices to value its swap positions and, in addition, uses published volatility
in its Black-Scholes calculation for outstanding options. The maximum length of
time over which Houston Exploration has hedged such cash flow variability is
through December 2005. The fair market value of these derivative instruments at
March 31, 2004 was a liability of $83.8 million. 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 $63.5 million, or approximately $41 million after-tax.
For the first three months of 2004, Houston Exploration recorded an unrealized
loss of $1.0 million ($0.7 million net of tax) representing the ineffective
portion of its derivative instruments.
With respect to price exposure associated with fuel purchases for the Ravenswood
facility, KeySpan employs standard NYMEX natural gas futures contracts to hedge
the cash flow variability for 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 for 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 forecasted purchases
of natural gas and fuel oil is through September 2005. We use standard NYMEX
futures prices to value the gas futures contracts and market quoted forward
prices to value oil swap contracts. The fair market value of these derivative
instruments at March 31, 2004 was an asset of $0.3 million. A substantial
portion of these derivative instruments, which are reported in other
comprehensive income, are expected to be reclassified into earnings over the
next twelve months.
We have also engaged in the use of cash-settled swap instruments to hedge the
cash flow variability associated with a portion of forecasted peak electric
energy sales from the Ravenswood facility. Our hedging strategy is to hedge
approximately 50% of forecasted on-peak summer season electric energy sales and
a portion of forecasted peak electric energy sales for the remainder of the
year. The maximum length of time over which we have hedged cash flow variability
is through December 2005. We use market quoted forward prices to value these
outstanding derivatives. The fair market value of these derivative instruments
at March 31, 2004 was a liability of $1.1 million. 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 $0.6 million, or approximately $0.4 million after-tax.
12
The table below summarizes the fair value of each category of derivative
instrument outstanding at March 31, 2004 and its related line item on the
Consolidated Balance Sheet. Fair value is the amount at which derivative
instruments could be exchanged in a current transaction between willing parties,
other than in a forced liquidation sale.
- --------------------------------------------------------------------------------------------------------
(In Thousands of Dollars) March 31, 2004 December 31, 2003
- --------------------------------------------------------------------------------------------------------
Gas Contracts:
Other current assets $ 47 $ 3,458
Accounts payable and other liabilities (63,535) (35,592)
Other deferred liabilities (20,302) (4,734)
Oil Contracts:
Other current assets 257 -
Other deferred charges 6 385
Electric Contracts:
Accounts payable and other liabilities (572) -
Other deferred liabilities (477) 259
- --------------------------------------------------------------------------------------------------------
$ (84,576) $ (36,224)
- --------------------------------------------------------------------------------------------------------
Financially-Settled Commodity Derivative Instruments that Do Not Qualify for
Hedge Accounting: KeySpan subsidiaries also employ a limited number of financial
derivatives that do not qualify for hedge accounting treatment under SFAS 133.
In 2003, we sold a "swaption" to hedge the cash flow variability associated with
50 MW of forecasted 2004 summer electric energy sales from the Ravenswood
facility. The swaption is an option that gives the counterparty the right, but
not the obligation, to enter into a swap transaction with KeySpan in the future
at a given strike price. This swaption can be converted into a swap, at the
election of the counterparty and has an expiration date of June 1, 2004. The
premium payment KeySpan received was recorded as a current liability on the
Consolidated Balance Sheet. The premium generally will be recorded into income
at the time the swaption is either exercised or expires. An internally developed
option-pricing model is used to value the swaption and at March 31, 2004, the
fair value of the swaption was immaterial.
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 England service territories. The accounting for these derivative instruments
is subject to SFAS 71 "Accounting for the Effects of Certain Types of
Regulation." Therefore, changes in the fair 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. At March 31, 2004, these
derivatives had a net fair market value of $18.4 million and are reflected as a
regulatory liability on the Consolidated Balance Sheet.
13
Physically-Settled Commodity Derivative Instruments: SFAS 133 establishes
criteria that must be satisfied in order for option contracts, forward contracts
with optionality features, or contracts that combine a forward contract and a
purchase option contract to be exempted as normal purchases and sales. Based
upon a continuing review of our physical gas contracts, we determined that
certain contracts for the physical purchase of natural gas associated with our
regulated gas utilities are not exempt as normal purchases from the requirements
of SFAS 133. 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. At March 31, 2004 these contracts had a net negative
fair market value of $5.3 million, and are reflected as a $6.0 million
regulatory asset and $0.7 million regulatory liability on the Consolidated
Balance Sheet.
Interest Rate Derivative Instruments: In May 2003, we entered into interest rate
swap agreements in which we swapped $250 million of 7.25% fixed rate debt to
floating rate debt. Under the terms of the agreements, we received the fixed
coupon rate associated with these bonds and paid our swap counterparties a
variable interest rate based on LIBOR, that was reset on a semi-annual basis.
These swaps were designated as fair-value hedges and qualified for "short-cut"
hedge accounting treatment under SFAS 133. During the three months ended March
31, 2004, we paid our counterparty an average interest rate of 6.44%, and as a
result, we realized interest savings of $0.5 million. The fair market value of
this derivative was $2 million at March 31, 2004.
On April 7, 2004 we terminated these swap agreements and received $1.2 million
from our swap counterparties, of which $0.7 million represented accrued swap
interest. The difference between the termination settlement amount and the
amount of accrued interest, $0.5 million, will be recorded as a reduction to
interest expense over the remaining life of the bond.
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. In October 2003, we entered into heating-degree day call
and put options to mitigate the effect of fluctuations from normal weather on
KEDNE's financial position and cash flows for the 2003/2004 winter heating
season - November 2003 through March 2004. With respect to sold call options,
KeySpan was required to make a payment of $27,500 per heating degree day to its
counterparties when actual weather experienced during this time frame was above
4,440 heating degree days, which equates to approximately 2% colder than normal
weather, based on the most recent 20-year average for normal weather. The
maximum amount KeySpan was required to pay on its sold call options was $5.5
million. With respect to purchased put options, KeySpan would have received a
$27,500 per heating degree day payment from its counterparties when actual
weather was below 4,266 heating degree days, or approximately 2% warmer than
normal. The maximum amount KeySpan would have received on its purchased put
options was $11 million. The net premium cost for these options was $0.4
million. We account for these derivatives pursuant to the requirements of EITF
99-2, "Accounting for Weather Derivatives." In this regard, such instruments are
accounted for using the "intrinsic value method" as set forth in such guidance.
During the first quarter of 2004, weather, as measured in heating degree-days,
was 9.4% colder than normal and, as a result, $4.1 million was recorded as a
reduction to revenues.
14
Derivative contracts are primarily used to manage exposure to market risk
arising from changes in commodity prices and interest rates. In the event of
non-performance by a counterparty to a derivative contract, the desired impact
may not be achieved. The risk of counterparty non-performance is generally
considered a credit risk and is actively managed by assessing each counterparty
credit profile and negotiating appropriate levels of collateral and credit
support. We believe that our credit risk related to the above mentioned
derivative financial instruments is no greater than the risk associated with the
primary contracts which they hedge and that the elimination of a portion of the
price risk reduces volatility in our reported results of operations, financial
position and cash flows and lowers overall business risk.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the Financial Accounting Standards Board ("FASB") issued, as a
proposal, FASB Staff Position ("FSP") 106-b "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003." When issued in final, this guidance will supersede
FSP 106-1 issued in 2003 and will clarify the accounting and disclosure
requirements for employers with postretirement benefit plans that have been or
will be affected by the passage of the Medicare Prescription Drug Improvement
and Modernization Act of 2003 ("the Act"). The Act introduces two new features
to Medicare that an employer needs to consider in measuring its obligation and
net periodic postretirement benefit costs. The effective date for the new
requirements is the first interim or annual period beginning after June 15, 2004
or for KeySpan's purposes the third quarter of 2004.
KeySpan's retiree health benefit plan currently includes a prescription drug
benefit that is provided to retired employees. It is anticipated that
implementation of the new requirements will have a positive impact on KeySpan's
results of operations and cash flows, although the magnitude of the impact can
not be determined with any degree of certainty at this time.
6. FINANCIAL GUARANTEES AND CONTINGENCIES
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, then a 2,200-megawatt electric generating facility
located in Queens, New York, in part, through a variable interest entity from
The Consolidated Edison Company of New York, Inc. ("Consolidated Edison") on
June 18, 1999 for approximately $597 million. In order to reduce the initial
cash requirements, we entered into a lease arrangement ("Master Lease") with a
variable interest, unaffiliated financing entity that acquired a portion of the
facility, or 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 units or the variable interest entity.
KeySpan has guaranteed all payment and performance obligations of our subsidiary
under the Master Lease. Monthly lease payments substantially equal the monthly
interest expense on such debt securities.
15
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. At this time, KeySpan
intends to extend the Master Lease through 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.
We have classified the Master Lease as $412.3 million long-term debt on the
Consolidated Balance Sheet based on our current status as primary beneficiary.
Further, we have an asset on the Consolidated Balance Sheet for an amount
substantially equal to the fair market value of the leased assets at the
inception of the lease, less depreciation since that date, or approximately $385
million. Under the terms of our credit facility, the Master Lease has been
considered debt in the ratio of debt-to-total capitalization since the inception
of the lease. If our subsidiary that leases the Ravenswood facility were 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.
Asset Retirement Obligations: In 2003, KeySpan adopted SFAS 143, "Accounting for
Asset Retirement Obligations." SFAS 143 required us to record a liability and
corresponding asset representing the present value of legal obligations
associated with the retirement of tangible, long-lived assets. At March 31,
2004, the present value of our future asset retirement obligation ("ARO") was
approximately $88.6 million, primarily related to our investment in Houston
Exploration.
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 pursuant to
SFAS 143. KeySpan's ARO will be re-evaluated in future periods until sufficient
information exists to determine a reasonable estimate of fair value.
16
Environmental Matters
New York Sites: Within the State of New York we have identified 43 historical
manufactured gas plant ("MGP") sites and related facilities, which were owned or
operated by KeySpan subsidiaries or such companies' predecessors.
We have identified 28 of these sites as being associated with the historical
operations of KEDNY. One site has been fully remediated. The remaining sites
will be investigated and, if necessary, remediated under the terms and
conditions of Administrative Orders on Consent ("ACO") or Voluntary Cleanup
Agreements ("VCA"). Expenditures incurred to date by us with respect to KEDNY
MGP-related activities total $42.6 million.
The remaining 15 sites have been identified as being associated with the
historical operations of KEDLI. Expenditures incurred to date by us with respect
to KEDLI MGP-related activities total $33.9 million. One site has been fully
investigated and requires no further action. The remaining sites will be
investigated and, if necessary, remediated under the conditions of ACOs or VCAs
We presently estimate the remaining cost of our KEDNY and KEDLI MGP-related
environmental remediation activities will be $220.6 million, which amount has
been accrued by us as a reasonable estimate of probable cost for known sites.
Expenditures incurred to date by us with respect to these MGP-related activities
total $76.5 million.
With respect to remediation costs, the KEDNY and KEDLI rate plans generally
provide for the recovery of investigation and remediation costs in rates charged
to gas distribution customers. At March 31, 2004, we have reflected a regulatory
asset of $240.8 million for our KEDNY/KEDLI MGP sites. In accordance with New
York State Public Service Commission ("NYPSC") policy, KeySpan records a
reduction to regulatory liabilities as costs are incurred for environmental
clean-up activities. At March 31, 2004, these previously deferred regulatory
liabilities totaled $53 million. In October 2003, KEDNY and KEDLI filed a joint
petition with the NYPSC seeking rate treatment for additional environmental
costs that may be incurred in the future.
We are also responsible for environmental obligations associated with the
Ravenswood facility, purchased from Consolidated Edison in 1999, including
remediation activities associated with its historical operations and those of
the MGP facilities that formerly operated at the site. We are not responsible
for liabilities arising from disposal of waste at off-site locations prior to
the acquisition closing and any monetary fines arising from Consolidated
Edison's pre-closing conduct. We presently estimate the remaining environmental
clean up activities for this site will be $3.3 million, which amount has been
accrued by us. Expenditures incurred to date total $1.7 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.
17
Boston Gas Company, Colonial Gas Company and Essex Gas Company may have or share
responsibility under applicable environmental laws for the remediation of 66 of
these sites. 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 8 other
sites. In addition, Boston Gas Company, Colonial Gas Company, and Essex Gas
Company have each assumed responsibility for remediating 3 sites. At this time,
it is uncertain as to whether Boston Gas Company, Colonial Gas Company or Essex
Gas Company have or share responsibility for remediating any of the 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 these Massachusetts KEDNE
MGP-related environmental cleanup activities will be $25.4 million, which amount
has been accrued by us as a reasonable estimate of probable cost for known
sites. Expenditures incurred since November 8, 2000 with respect to these
MGP-related activities total $13.9 million.
We may have or share responsibility under applicable environmental laws for the
remediation of 10 MGP sites and related facilities associated with the
historical operations of EnergyNorth. At four of these sites we have entered
into cost sharing agreements with other parties who share responsibility for
remediation of these sites. EnergyNorth also has entered into an agreement with
the United States Environmental Protection Agency ("EPA") for the contamination
from the Nashua site that was allegedly commingled with asbestos at the Nashua
River Asbestos Site, adjacent to the Nashua MGP site.
We presently estimate the remaining cost of EnergyNorth MGP-related
environmental cleanup activities will be $13.8 million, which amount has been
accrued by us as a reasonable estimate of probable cost for known sites.
Expenditures incurred since November 8, 2000, with respect to these MGP-related
activities total $8 million.
By rate orders, the Massachusetts Department of Telecommunications and Energy
("DTE") and the New Hampshire Public Utility Commission ("NHPUC") provide for
the recovery of site investigation and remediation costs and, accordingly, at
March 31, 2004, we have reflected a regulatory asset of $51.2 million for the
KEDNE MGP sites. Colonial Gas Company and Essex Gas Company are not subject to
the provisions of Statement of Financial Accounting Standard ("SFAS") 71,
"Accounting for the Effects of Certain Types of Regulation" and therefore have
recorded no regulatory asset. However, rate plans currently 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 KeySpan New England, LLC, a successor company to Eastern
Enterprises, for which we may have or share environmental remediation or ongoing
maintenance responsibility. These three sites, located in Philadelphia,
Pennsylvania, New Haven, Connecticut and Everett, Massachusetts, were associated
18
with historical operations involving the production of coke and related
industrial processes. Honeywell International, Inc. and Beazer East, Inc. (both
former owners and/or operators of certain facilities at Everett ("the Everett
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 a portion of that site. KeySpan,
Honeywell and Beazer East have entered into a cost-sharing agreement under which
each company has agreed to pay one-third of the costs of compliance with the
consent order, while preserving any claims it may have against the other
companies for, among other things, reallocation of proportionate liability.
We presently estimate the remaining cost of our environmental cleanup activities
for the three non-utility sites will be approximately $24.3 million, which
amount has been accrued by us as a reasonable estimate of probable costs for
known sites. Expenditures incurred since November 8, 2000, with respect to these
sites total $8.5 million.
We believe that in the aggregate, the accrued liability for these MGP sites and
related facilities identified above are reasonable estimates of the probable
cost for the investigation and remediation of these sites and facilities. As
circumstances warrant, we periodically re-evaluate the accrued liabilities
associated with MGP sites and related facilities. We may be required to
investigate and, if necessary, remediate each site previously noted, 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 cash flows. 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, 2003
Note 7 to those Consolidated Financial Statements "Contractual Obligations,
Financial Guarantees 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, 2003, 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 and certain of its current and former officers and directors are
defendants in a consolidated class action lawsuit filed in the United States
District Court for the Eastern District of New York. This lawsuit alleges, 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. In October
2001, a shareholder's derivative action was commenced in the same court against
19
certain current and former 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. On June 12,
2002, a second derivative action was commenced which asserted similar
allegations. Each of these proceedings seeks 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, plaintiffs filed
an amended complaint and in July 2003 the court denied our motion to dismiss the
amended complaint but did strike certain allegations. On November 20, 2003, the
court granted our motion for reconsideration of the July 2003 order and the
court struck additional allegations from the amended complaint which effectively
limited the potential class period. On December 19, 2003, KeySpan filed a motion
to dismiss the derivative actions. The motion is still pending. KeySpan intends
to vigorously defend each of these proceedings. However, we are unable to
predict the outcome of these proceedings or what 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 ("LILCO") and others. In connection with the May 1998
transaction with LIPA, costs incurred by KeySpan for liabilities for asbestos
exposure arising from the activities of the generating facilities previously
owned by LILCO are recoverable from LIPA through the Power Supply Agreement
("PSA") between LIPA and KeySpan.
KeySpan is unable to determine the outcome of the outstanding asbestos
proceedings, but does not believe that such outcome, if adverse, will have a
material effect on its financial condition, results of operation or cash flows.
KeySpan believes that its cost recovery rights under the PSA, its
indemnification rights against third parties and its insurance coverage (above
applicable deductible limits) cover its exposure for asbestos liabilities
generally.
20
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, 2004, 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:
- -----------------------------------------------------------------------------------------------------------------------
Nature of Guarantee (In Thousands of Dollars) Amount of Expiration
Exposure Dates
- -----------------------------------------------------------------------------------------------------------------------
Medium-Term Notes - KEDLI (i) $ 525,000 2008-2010
Industrial Development Revenue Bonds (ii) 128,000 2027
Master Lease - Ravenswood (iii) 425,000 2004
Surety Bonds (iv) 169,000 Revolving
Commodity Guarantees and Other (v) 51,000 2005
Letters of Credit (vi) 74,000 2004
- -----------------------------------------------------------------------------------------------------------------------
$ 1,372,000
- -----------------------------------------------------------------------------------------------------------------------
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 fully and unconditionally guaranteed the payment obligations of
its subsidiaries with regard to $128 million of Industrial Development
Revenue Bonds issued through the Nassau County and Suffolk County
Industrial Development Authorities for the construction of the Glenwood and
Port Jefferson electric-generation peaking plants. The face value of these
notes are included in long-term debt on the Consolidated Balance Sheet.
(iii)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. The Master Lease is classified as $412.3 million
long-term debt on the Consolidated Balance Sheet.
(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.
21
(v) KeySpan has guaranteed commodity-related payments for certain of its
subsidiaries. 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, 2004.
(vi) KeySpan has arranged for stand-by letters of credit 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.
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 any such defaults may have on our
consolidated results of operations, financial condition or cash flows.
Other Contingencies: We derive a substantial portion of our revenues in our
Electric Services segment from a series of agreements with LIPA pursuant to
which we manage LIPA's transmission and distribution system and supply the
majority of LIPA's customers' electricity needs. The agreements terminate at
various dates between May 28, 2006 and May 28, 2013, and at this time, we can
provide no assurance that any of the agreements will be renewed or extended, or
if they were to be renewed or extended, the terms and conditions thereof. In
addition, given the complexity of these agreements, disputes arise from time to
time between KeySpan and LIPA concerning the rights and obligations of each
party to make and receive payments as required pursuant to the terms of these
agreements. As a result, KeySpan is unable to determine what effect, if any, the
ultimate resolution of these disputes will have on its financial condition,
results of operations or cash flows.
7. 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.
22
(Beginning in 2004, KeySpan officers that serve on the Houston Exploration Board
of Directors will not receive Houston Exploration stock options.) In 2003,
KeySpan and Houston Exploration adopted the prospective method of transition of
accounting for stock option expense 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) 2004 2003
- --------------------------------------------------------------------------------------------------------------------------
Earnings available for common stock:
As reported $ 246,235 $ 241,804
Add: recorded stock-based compensation expense, net of tax 1,512 857
Deduct: total stock-based compensation expense, net of tax (2,967) (2,913)
- --------------------------------------------------------------------------------------------------------------------------
Pro-forma earnings $ 244,780 $ 239,748
- --------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 1.54 $ 1.54
Basic - pro-forma $ 1.53 $ 1.53
Diluted - as reported $ 1.53 $ 1.53
Diluted - pro-forma $ 1.52 $ 1.52
- --------------------------------------------------------------------------------------------------------------------------
8. POSTRETIREMENT BENEFITS
Pension Plans: The following information represents the consolidated net
periodic pension cost for the three months ended March 31, 2004 and 2003 for our
noncontributory defined benefit pension plans which cover substantially all
employees. Benefits are based on years of service and compensation. Funding for
pensions is in accordance with requirements of federal law and regulations.
KEDLI and Boston Gas Company are subject to certain deferral accounting
requirements mandated by the New York Public Service Commission ("NYSPSC") and
the Department of Telecommunications Energy ("DTE"), respectively for pension
costs and other postretirement benefit costs. Further, KeySpan's electric
subsidiaries are subject to certain "true-up" provisions in accordance with the
LIPA service agreements.
23
The calculation of net periodic pension cost is as follows:
- ---------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars) 2004 2003
- ---------------------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 13,079 $ 11,883
Interest cost on projected benefit obligation 36,047 34,568
Expected return on plan assets (36,521) (32,639)
Net amortization and deferral 16,917 16,737
- ---------------------------------------------------------------------------------------------------------------------
Total pension cost $ 29,522 $ 30,549
- ---------------------------------------------------------------------------------------------------------------------
Other Postretirement Benefits: The following information represents the
consolidated net periodic other postretirement benefit cost for the three months
ended March 31, 2004 and 2003 for our noncontributory defined benefit plans
covering certain health care and life insurance benefits for retired employees.
We have been funding a portion of future benefits over employees' active service
lives through Voluntary Employee Beneficiary Association ("VEBA") trusts.
Contributions to VEBA trusts are tax deductible, subject to limitations
contained in the Internal Revenue Code.
Net periodic other postretirement benefit cost included the following
components:
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Thousands of Dollars) 2004 2003
- ------------------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period 5,392 4,706
Interest cost on accumulated
postretirement benefit obligation 18,521 17,451
Expected return on plan assets (7,708) (6,883)
Net amortization and deferral 11,280 8,954
- ------------------------------------------------------------------------------------------------------------------
Other postretirement cost 27,485 24,228
- ------------------------------------------------------------------------------------------------------------------
In 2004, KeySpan is expected to contribute approximately $89 million to its
pension plans and approximately $58 million to its other postretirement benefit
plans, which are the same funding levels as reported in KeySpan's Annual Report
on Form 10K for the Year Ended December 31, 2003.
9. LONG-TERM DEBT
At March 31, 2004, KeySpan had $460 million of MEDS Equity Units outstanding at
8.75% consisting of a three-year forward purchase contract for our common stock
and a six-year note. The purchase contract commits us, three years from the date
of issuance of the MEDS Equity Units, May 2005, to issue and the investors to
purchase, a number of shares of our common stock based on a formula tied to the
market price of our common stock at that time. The 8.75% coupon is composed of
interest payments on the six-year note of 4.9% and premium payments on the
three-year equity forward contract of 3.85%. These instruments have been
recorded as long-term debt on the Consolidated Balance Sheet. Further, upon
issuance of the MEDS Equity Units, we recorded a direct charge to retained
earnings of $49.1 million, which represents the present value of the forward
contract's premium payments.
24
There were 9.2 million MEDS Equity units issued which are subject to conversion
upon execution of the three-year forward purchase contract. The number of shares
to be issued depends on the average closing price of our common stock over the
20 day trading period ending on the third trading day prior to May 16, 2005. If
the average closing price over this time frame is less than or equal to $35.30
of KeySpan's common stock, 13 million shares will be issued. If the average
closing price over this time frame is greater than or equal to $42.36, 10.9
million shares will be issued. The number of shares issued at a price between
$35.30 and $42.36 will be between 10.9 million and 13 million based upon a
sliding scale.
These securities are currently not considered convertible instruments for
purposes of applying SFAS 128 "Earnings Per Share" calculations, unless or until
such time as the market value of our common stock reaches a threshold
appreciation price ($42.36 per share) that is higher than the current per share
market value. Interest payments do, however, reduce net income and earnings per
share.
The Emerging Issues Task Force of the FASB is considering proposals related to
accounting for certain securities and financial instruments, including
securities such as the Equity Units. The current proposals being considered
include the method of accounting discussed above. Alternatively, other proposals
being considered could result in the common shares issuable pursuant to the
purchase contract to be deemed outstanding and included in the calculation of
diluted earnings per share, and could result in periodic "mark to market" of the
purchase contracts, causing periodic charges or credits to income. If this
latter approach were adopted, our basic and diluted earnings per share could
increase and decrease from quarter to quarter to reflect the lesser and greater
number of shares issuable upon satisfaction of the contract, as well as charges
or credits to income.
10. 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.
25
- ---------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ---------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2004
(In Thousands of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 153 $ 471,083 $ 2,124,490 $ (153) $ 2,595,573
-----------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 291,089 935,484 - 1,226,573
Fuel and purchased power - - 101,612 - 101,612
Operations and maintenance 369 33,217 458,880 - 492,466
Intercompany expense - 1,355 (1,355) -
Depreciation and amortization - 29,841 141,843 - 171,684
Operating taxes - 19,543 102,736 - 122,279
-----------------------------------------------------------------------------------------
Total Operating Expenses 369 375,045 1,739,200 - 2,114,614
-----------------------------------------------------------------------------------------
Income from equity investments - - 5,717 - 5,717
-----------------------------------------------------------------------------------------
Operating Income (Loss) (216) 96,038 391,007 (153) 486,676
-----------------------------------------------------------------------------------------
Interest charges (53,488) (15,863) (71,475) 56,760 (84,066)
Other income and (deductions) 297,529 374 (1,960) (313,475) (17,532)
-----------------------------------------------------------------------------------------
Total Other Income and (Deductions) 244,041 (15,489) (73,435) (256,715) (101,598)
-----------------------------------------------------------------------------------------
Income Taxes (Benefit) (5,862) 22,710 120,534 - 137,382
- -
-----------------------------------------------------------------------------------------
Net Income $ 249,687 $ 57,839 $ 197,038 $ (256,868) $ 247,696
=========================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
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
------------------------------------------------------------------------------------
Income from equity investments - - 5,729 - 5,729
------------------------------------------------------------------------------------
Operating Income (Loss) (7,130) 101,009 362,924 (109) 456,694
------------------------------------------------------------------------------------
Interest charges (46,477) (15,006) (52,299) 44,843 (68,939)
Other income and (deductions) 293,453 (7,217) 4,514 (292,581) (1,831)
------------------------------------------------------------------------------------
Total Other Income and (Deductions) 246,976 (22,223) (47,785) (247,738) (70,770)
------------------------------------------------------------------------------------
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 change in accounting principle 174 - 174
------------------------------------------------------------------------------------
Net Income $ 243,265 $ 50,474 $ 197,373 $ (247,847) $ 243,265
====================================================================================
26
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
March 31, 2004
Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
---------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 81,730 $ 59 $ 175,151 $ - $ 256,940
Accounts receivable, net 7,667 274,627 1,471,748 - 1,754,042
Other current assets 2,479 44,457 295,427 - 342,363
---------------------------------------------------------------------------------------
91,876 319,143 1,942,326 - 2,353,345
---------------------------------------------------------------------------------------
Equity Investments 4,740,262 1,043 160,609 (4,645,542) 256,372
---------------------------------------------------------------------------------------
Property
Gas - 1,919,592 4,670,829 - 6,590,421
Other - - 6,258,336 - 6,258,336
Accumulated depreciation and depletion - (316,831) (3,568,248) - (3,885,079)
---------------------------------------------------------------------------------------
- 1,602,761 7,360,917 - 8,963,678
---------------------------------------------------------------------------------------
Intercompany Accounts Receivable 2,977,170 1,212,607 (4,189,777) -
Deferred Charges 375,495 225,589 2,505,253 - 3,106,337
---------------------------------------------------------------------------------------
Total Assets $ 8,184,803 $ 2,148,536 $ 13,181,712 $ (8,835,319) $14,679,732
=======================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 49,113 $ 162,274 $ 740,946 $ - $ 952,333
Commercial paper 294,150 - - 294,150
Other current liabilities 283,634 12,275 117,841 - 413,750
---------------------------------------------------------------------------------------
626,897 174,549 858,787 - 1,660,233
---------------------------------------------------------------------------------------
Intercompany Accounts Payable - 48,291 2,556,920 (2,605,211) -
---------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (48,188) 259,184 1,039,676 - 1,250,672
Other deferred credits and liabilities 571,504 175,547 1,031,882 - 1,778,933
---------------------------------------------------------------------------------------
523,316 434,731 2,071,558 - 3,029,605
---------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 3,901,569 840,061 3,736,438 (4,645,542) 3,832,526
Preferred stock 83,433 - - - 83,433
Long-term debt 3,049,588 650,904 3,421,530 (1,584,566) 5,537,456
---------------------------------------------------------------------------------------
Total Capitalization 7,034,590 1,490,965 7,157,968 (6,230,108) 9,453,415
---------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 536,479 - 536,479
---------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 8,184,803 $ 2,148,536 $ 13,181,712 $ (8,835,319) $14,679,732
=======================================================================================
27
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2003
Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
---------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 97,567 $ 1,554 $ 106,630 $ - $ 205,751
Accounts receivable, net 3,298 209,151 1,243,459 - 1,455,908
Other current assets 3,250 130,994 590,996 - 725,240
---------------------------------------------------------------------------------------
104,115 341,699 1,941,085 - 2,386,899
---------------------------------------------------------------------------------------
Investments and Other 4,475,949 1,123 153,520 (4,382,027) 248,565
---------------------------------------------------------------------------------------
Property
Gas - 1,899,375 4,622,876 - 6,522,251
Other - - 6,150,355 - 6,150,355
Accumulated depreciation and depletion - (312,204) (3,466,099) - (3,778,303)
---------------------------------------------------------------------------------------
- 1,587,171 7,307,132 - 8,894,303
---------------------------------------------------------------------------------------
Intercompany Accounts Receivable 3,105,571 - 1,274,293 (4,379,864) -
Deferred Charges 374,076 237,870 2,498,469 - 3,110,415
---------------------------------------------------------------------------------------
Total Assets $ 8,059,711 $ 2,167,863 $ 13,174,499 $ (8,761,891) $ 14,640,182
=======================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 125,892 $ 165,613 $ 850,092 $ - $ 1,141,597
Commercial paper 481,900 - - - 481,900
Other current liabilities 129,168 16,125 80,026 - 225,319
---------------------------------------------------------------------------------------
736,960 181,738 930,118 - 1,848,816
---------------------------------------------------------------------------------------
Intercompany Accounts Payable - 116,197 2,679,101 (2,795,298) -
---------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (48,059) 256,882 1,069,518 - 1,278,341
Other deferred credits and liabilities 532,062 179,919 925,839 - 1,637,820
---------------------------------------------------------------------------------------
484,003 436,801 1,995,357 - 2,916,161
---------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 3,707,785 782,223 3,562,675 (4,382,027) 3,670,656
Preferred stock 83,568 - - - 83,568
Long-term debt 3,047,395 650,904 3,497,699 (1,584,566) 5,611,432
---------------------------------------------------------------------------------------
Total Capitalization 6,838,748 1,433,127 7,060,374 (5,966,593) 9,365,656
---------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 509,549 - 509,549
---------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 8,059,711 $ 2,167,863 $ 13,174,499 $ (8,761,891) $ 14,640,182
=======================================================================================
28
- -------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- -------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2004
----------------------------------------------------------------------
Guarantor KEDLI Other Subsidiaries Consolidated
----------------------------------------------------------------------
Operating Activities
Net Cash Provided by Operating Activities $ 95,128 $ 91,155 $ 392,803 $ 579,086
----------------------------------------------------------------------
Investing Activities
Capital expenditures - (24,388) (195,836) (220,224)
Cost of removal - (356) (5,848) (6,204)
Proceeds from sale of property - - 13,138 13,138
----------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities - (24,744) (188,546) (213,290)
----------------------------------------------------------------------
Financing Activities
Treasury stock issued 11,796 - - 11,796
Payment of debt, net (187,750) - (74,853) (262,603)
Common and preferred stock dividends paid (72,935) - - (72,935)
Other 9,523 - (388) 9,135
Net intercompany accounts 128,401 (67,906) (60,495) -
-
----------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (110,965) (67,906) (135,736) (314,607)