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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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
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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 July 14, 2004
--------------------- ----------------------------
$.01 par value 160,176,033
KEYSPAN CORPORATION AND SUBSIDIARIES
INDEX
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Part I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheet -
June 30, 2004 and December 31, 2003 3
Consolidated Statement of Income - Three and
Six Months Ended June 30, 2004 and 2003 5
Consolidated Statement of Cash Flows -
Six Months Ended June 30, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 33
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 62
Item 4. Controls and Procedures 65
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 65
Item 4. Submission of Matters to a Vote of Security Holders 65
Item 5. Other Events 66
Item 6. Exhibits and Reports on Form 8-K 67
Signatures 69
2
CONSOLIDATED BALANCE SHEET
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------
(In Thousands of Dollars) June 30, 2004 December 31, 2003
- -----------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 818,127 $ 205,751
Accounts receivable 977,499 1,029,459
Unbilled revenue 272,890 505,633
Allowance for uncollectible accounts (82,219) (79,184)
Gas in storage and prepaid gas 371,781 488,521
Material and supplies at average cost 117,884 121,415
Other 44,783 115,304
----------------------------- ----------------------------
2,520,745 2,386,899
----------------------------- ----------------------------
Investments and Other 499,157 248,565
Property
Gas 6,688,175 6,522,251
Electric 2,323,247 2,636,537
Other 434,329 425,576
Accumulated depreciation (2,649,641) (2,610,876)
Gas exploration and production, at cost 181,927 3,088,242
Accumulated depletion (102,588) (1,167,427)
----------------------------- ----------------------------
6,875,449 8,894,303
----------------------------- ----------------------------
Deferred Charges
Regulatory assets 544,393 578,383
Goodwill and other intangible assets 1,811,243 1,809,712
Other 707,869 722,320
----------------------------- ----------------------------
3,063,505 3,110,415
----------------------------- ----------------------------
Total Assets $ 12,958,856 $ 14,640,182
============================= ============================
See accompanying Notes to the Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEET
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------
June 30, 2004 December 31, 2003
- --------------------------------------------------------------------------------------------------------------------
Current redemption of long-term debt $ 16,474 $ 1,471
Accounts payable and other liabilities 738,145 1,141,597
Commercial paper 40,000 481,900
Dividends payable 72,054 72,289
Taxes accrued 90,460 46,580
Customer deposits 41,251 40,370
Interest accrued 62,328 64,609
------------------------------ ----------------------------
1,060,712 1,848,816
------------------------------ ----------------------------
Regulatory liabilities:
Miscellaneous liabilities 104,824 104,034
Removal cost recovered 473,720 450,034
Deferred income tax 1,092,322 1,278,341
Postretirement benefits and other reserves 915,603 961,962
Other 113,738 121,790
------------------------------ ----------------------------
2,700,207 2,916,161
------------------------------ ----------------------------
- -
Common stock 3,490,056 3,487,645
Retained earnings 854,559 621,430
Accumulated other comprehensive loss (64,370) (59,932)
Treasury stock (363,861) (378,487)
------------------------------ ----------------------------
Total common shareholders' equity 3,916,384 3,670,656
Preferred stock 83,342 83,568
Long-term debt 5,182,652 5,611,432
------------------------------ ----------------------------
9,182,378 9,365,656
------------------------------ ----------------------------
15,559 509,549
------------------------------ ----------------------------
$ 12,958,856 $ 14,640,182
============================== ============================
See accompanying Notes to the Consolidated Financial Statements.
4
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
- -----------------------------------------------------------------------------------------------------------------------------------
(In Thousands of Dollars, Except Per Share Amounts) 2004 2003 2004 2003
-------------------------------------------------------------------------------
Revenues
Gas Distribution $ 676,363 $ 732,036 $ 2,604,142 $ 2,564,737
Electric Services 433,763 392,345 792,899 790,045
Energy Services 129,877 132,268 258,936 261,333
Energy Investments 125,768 151,503 305,367 304,562
-------------------------------------------------------------------------------
Total Revenues 1,365,771 1,408,152 3,961,344 3,920,677
-------------------------------------------------------------------------------
Operating Expenses
Purchased gas for resale 363,130 424,300 1,589,703 1,620,465
Fuel and purchased power 130,347 102,476 231,959 199,998
Operations and maintenance 477,511 509,636 969,977 1,007,825
Depreciation, depletion and amortization 189,403 142,290 361,088 287,261
Operating taxes 90,484 95,251 212,763 219,964
-------------------------------------------------------------------------------
Total Operating Expenses 1,250,875 1,273,953 3,365,490 3,335,513
-------------------------------------------------------------------------------
Income from Equity Investments 8,416 4,030 14,132 9,759
-------------------------------------------------------------------------------
Operating Income 123,312 138,229 609,986 594,923
-------------------------------------------------------------------------------
Other Income and (Deductions)
Interest charges (88,475) (79,198) (172,540) (148,137)
Gain (loss) on subsidiary stock transactions 172,894 (30,345) 172,894 (11,325)
Cost of debt redemption - (5,900) - (24,094)
Minority interest (16,661) (13,000) (36,954) (30,358)
Other 19,382 (246) 22,143 14,455
-------------------------------------------------------------------------------
Total Other Income and (Deductions) 87,140 (128,689) (14,457) (199,459)
-------------------------------------------------------------------------------
Income Taxes
Current 8,364 4,017 163,503 133,592
Deferred 71,351 11,461 53,592 24,719
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Total Income Taxes 79,715 15,478 217,095 158,311
-------------------------------------------------------------------------------
Earnings (Loss) Before Change in Accounting Principle 130,737 (5,938) 378,434 237,153
Cummulative Change in Accounting Principle - - - 174
--------------------------------------------------------------------------------
Net Income (Loss) 130,737 (5,938) 378,434 237,327
Preferred stock dividend requirements 1,459 1,461 2,920 2,922
-------------------------------------------------------------------------------
Earnings (Loss) for Common Stock $ 129,278 $ (7,399) $ 375,514 $ 234,405
===============================================================================
Basic Earnings (Loss) Per Share:
Before Change in Accounting Principle 0.81 (0.05) 2.35 1.49
Change in Accounting Principle - - - -
-------------------------------------------------------------------------------
Basic Earnings (Loss) Per Share $ 0.81 $ (0.05) $ 2.35 $ 1.49
===============================================================================
Diluted Earnings (Loss) Per Share:
Before Change in Accounting Principle 0.80 (0.05) 2.33 1.48
Change in Accounting Principle - - - -
-------------------------------------------------------------------------------
Diluted Earnings (Loss) Per Share $ 0.80 $ (0.05) $ 2.33 $ 1.48
===============================================================================
Average Common Shares Outstanding (000) 160,167 157,943 160,030 157,414
Average Common Shares Outstanding - Diluted (000) 161,433 158,757 161,256 158,464
- -----------------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
5
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
- -------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 378,434 $ 237,327
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Depreciation, depletion and amortization 361,088 287,261
Deferred income tax 53,592 24,719
Income from equity investments (14,132) (9,759)
Dividends from equity investments 104 -
Amortization of interest rate swap (4,895) (4,930)
(Gain) Loss on subsidiary stock transactions (172,894) 15,048
(Gain) on settlement of treasury lock (12,656) -
Amortization of prepayments 46,489 46,706
Minority interest 36,954 30,358
Changes in assets and liabilities
Accounts receivable 85,087 54,237
Materials and supplies, fuel oil and gas in storage 112,806 18,231
Accounts payable and other liabilities (112,166) 7,292
Interest accrued (2,281) (17,865)
Captive insurance reserve 43,214 -
Property tax prepayments - (47,478)
Other (12,411) (63,130)
-----------------------------------------------
Net Cash Provided by Operating Activities 786,333 578,017
-----------------------------------------------
Investing Activities
Construction expenditures (413,247) (434,052)
Cost of removal (14,606) (12,640)
Proceeds from sale of property 13,138 -
Net proceeds from sale/leaseback transaction 383,716 -
Net proceeds from subsidiary stock transactions 512,065 198,553
-----------------------------------------------
Net Cash Provided by (Used In) Investing Activities 481,066 (248,139)
-----------------------------------------------
Financing Activities
Treasury stock issued 14,626 57,441
Equity issuance - 473,573
Issuance of long-term debt 49,142 599,684
Payment of long-term debt (153,884) (377,174)
Payment of commercial paper (441,900) (484,697)
Redemption of promissory notes - (447,005)
Gain on settlement of treasury lock 12,656 -
Preferred stock dividends paid (2,920) (2,922)
Common stock dividends paid (142,622) (133,435)
Other 9,879 9,708
-----------------------------------------------
Net Cash (Used in) Financing Activities (655,023) (304,827)
-----------------------------------------------
Net Increase in Cash and Cash Equivalents $ 612,376 $ 25,051
Cash and Cash Equivalents at Beginning of Period 205,751 170,617
-----------------------------------------------
Cash and Cash Equivalents at End of Period $ 818,127 $ 195,668
===============================================
Cash equivalents are short-term marketable securities purchased with maturities
of six 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; and engineering and consulting services. We also
invest and participate in the development of natural gas pipelines, electric
generation and other energy-related projects. (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 June 30, 2004, and the results of operations for the three and six months
ended June 30, 2004 and June 30, 2003, as well as cash flows for the six months
ended June 30, 2004 and June 30, 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 10-K 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.
Consolidated earnings are seasonal in nature primarily due to the significant
contribution to earnings of the gas distribution operations. As a result, we
expect to earn most of our annual earnings in the first and fourth quarters of
the fiscal year.
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 June 30,
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 June 30, Six Months Ended June 30,
(In Thousands of Dollars, Except Per Share Amounts) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) for common stock $ 129,278 $ (7,399) $ 375,514 $ 234,405
Interest savings on convertible preferred stock 129 - 514 265
Houston Exploration dilution (76) (57) (158) (144)
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) for common stock - adjusted $ 129,331 $ (7,456) $ 375,870 $ 234,526
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (000) 160,167 157,943 160,030 157,414
Add dilutive securities:
Options 1,045 814 1,005 822
Convertible preferred stock 221 - 221 228
- ------------------------------------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution 161,433 158,757 161,256 158,464
- ------------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss )per share $ 0.81 $ (0.05) $ 2.35 $ 1.49
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share $ 0.80 $ (0.05) $ 2.33 $ 1.48
- ------------------------------------------------------------------------------------------------------------------------------------
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 six to eleven years and
power purchase agreements having remaining terms of 23 years. The Electric
Services segment also includes subsidiaries that own or 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 unit located at the Ravenswood site
("Ravenswood Expansion"). 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 conducts
retail marketing of electricity to commercial customers.
8
The Energy Services segment includes companies that provide energy-related
services to customers primarily located within the Northeastern United States,
with concentrations in the New York City metropolitan area, including New
Jersey, 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 include our 23.5%
interest in The Houston Exploration Company ("Houston Exploration") an
independent natural gas and oil exploration company, as well as our wholly-owned
subsidiaries KeySpan Exploration and Production, LLC ("KeySpan Exploration and
Production"), which is engaged in a joint venture with Houston Exploration, as
well as Seneca-Upshur Petroleum, Inc ("Seneca-Upshur").
On June 2, 2004, KeySpan exchanged 10.8 million shares of common stock of
Houston Exploration for 100% of the stock of Seneca-Upshur, previously a wholly
owned subsidiary of Houston Exploration. This transaction reduced our interest
in Houston Exploration from 55% to the current level of 23.5%. As part of this
transaction, Houston Exploration retired 4.6 million of its common shares and
issued 6.8 million new shares in a public offering. Based on Houston
Exploration's announced offering price of $48.00 per share, Seneca-Upshur's
shares were valued at the equivalent of $449 million, or $41.57 per share.
Seneca-Upshur's assets consist of West Virginia gas producing properties valued
at $60 million, and $389 million in cash. This transaction resulted in a gain to
KeySpan of $150.1 million. Effective June 1, Houston Exploration's earnings and
our ownership interest in Houston Exploration have been accounted for on the
equity basis of accounting. The deconsolidation of Houston Exploration required
the recognition of certain deferred taxes on our remaining investment resulting
in a net deferred tax expense of $44.1 million. Therefore, the net gain on the
share exchange less the deferred tax provision was $106 million, or $0.66 per
share.
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. Further, KeySpan has a 17.4%
ownership interest in KeySpan Canada, a subsidiary with natural gas processing
plants and gathering facilities in Western Canada.
On April 1, 2004, KeySpan and KeySpan Facilities Income Fund (the "Fund"), which
previously owned a 39.09% interest in KeySpan Canada, consummated a transaction
whereby the Fund sold 15.617 million units of the Fund at a price of CDN$12.60
per unit for gross total proceeds of approximately CDN$196.8 million. The
proceeds of the offering were used by the Fund to acquire an additional 35.91%
interest in KeySpan Canada from KeySpan. We received net proceeds of
approximately CDN$186.3 million (or approximately US$135 million), after
9
commissions and expenses. The Fund's ownership in KeySpan Canada increased from
39.1% to 75%, and KeySpan's ownership of KeySpan Canada decreased to 25%.
KeySpan recorded a gain of $22.8 million ($10.1 million after-tax, or $0.06 per
share) on this transaction. Effective April 1, KeySpan Canada's earnings and our
ownership interest in KeySpan Canada have been accounted for on the equity basis
of accounting.
On July 2, 2004, the Fund issued an additional 10.7 million units, the proceeds
of which were used to fund the acquisition of the midstream assets of Chevron
Canada Midstream Inc. This transaction had the effect of further diluting
KeySpan's ownership of KeySpan Canada to 17.4%.
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. As a result of the Houston Exploration
stock transaction, the total assets associated with our gas exploration and
production operations, including cash from the transaction, were $640 million at
June 30, 2004, compared to $1.5 billion at December 31, 2003. Total assets
associated with KeySpan's other energy-related investments were approximately
$600 million at June 30, 2004 compared to $900 million at December 31, 2003, as
a result of the KeySpan Canada transaction.
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 reclassified the financial results for all
periods of 2003. The reportable segment information is as follows:
- ----------------------------------------------------------------------------------------------------------------------------------
Energy Investments
--------------------------
Gas
Gas Electric Energy Exploration Other
(InThousands of Dollars) Distribution Services Services and Production Investments Eliminations Consolidated
- ----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2004
Unaffiliated revenue 676,363 433,763 129,877 118,926 6,842 - 1,365,771
Intersegment revenue - - 4,147 - 1,278 (5,425) -
Operating income (Loss) 35,065 67,912 (4,906) 11,388 5,480 8,373 123,312
Three Months Ended June 30, 2003
Unaffiliated revenue 732,036 392,345 132,268 122,875 28,628 - 1,408,152
Intersegment revenue - 26 1,542 - 1,252 (2,820) -
Operating income (Loss) 31,616 52,100 (10,463) 50,148 9,074 5,754 138,229
- ----------------------------------------------------------------------------------------------------------------------------------
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 for the three months ended June 30, 2004 and 2003
represent approximately 15% of our consolidated revenues in both periods.
10
- ------------------------------------------------------------------------------------------------------------------------------------
Energy Investments
---------------------------
Gas
Gas Electric Energy Exploration Other
(In Thousands of Dollars) Distribution Services Services and Production Investments Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2004
Unaffiliated revenue 2,604,142 792,899 258,936 271,345 34,022 - 3,961,344
Intersegment revenue - - 7,583 - 2,543 (10,126) -
Operating income (Loss) 414,717 115,111 (23,380) 73,496 18,402 11,640 609,986
Six Months Ended June 30, 2003
Unaffiliated revenue 2,564,737 790,045 261,333 250,722 53,840 - 3,920,677
Intersegment revenue - 51 2,968 - 2,504 (5,523) -
Operating income (Loss) 396,554 91,744 (19,585) 105,738 19,198 1,274 594,923
- ------------------------------------------------------------------------------------------------------------------------------------
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 for the six months ended June 30, 2004 and 2003
represent approximately 10% of our consolidated revenues for both periods.
3. COMPREHENSIVE INCOME
The table below indicates the components of comprehensive income:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) for common stock $ 129,278 $ (7,399) $ 375,514 $ 234,405
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Reclassification adjustments for loss (gains) realized in net income 5,502 8,817 16,531 11,171
Foreign currency translation adjustments (15,167) 17,773 (17,063) 27,526
Unrealized gains (losses) on marketable securities 29 5,405 542 2,249
Premiums on derivative financial instruments - (3,437) 3,437 (3,437)
Deconsolidation of certain subsidiaries (6,711) - (6,711) -
Unrealized gain (losses) on derivative financial instruments 41,285 (6,184) (1,173) (20,933)
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 24,938 22,374 (4,437) 16,576
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 154,216 $ 14,975 $ 371,077 $ 250,981
- ------------------------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Reclassification adjustments for loss (gains) realized in net income 2,963 4,748 8,902 6,015
Foreign currency translation adjustments (8,167) 9,570 (9,188) 14,822
Unrealized gains (losses) on marketable securities 16 2,910 290 1,211
Premiums on derivative financial instruments - (1,851) 1,851 (1,851)
Deconsolidation of certain subsidiaries 5,016 - 5,016 -
Unrealized gain (losses) on derivative financial instruments 22,231 (3,329) (631) (11,271)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense $ 22,059 $ 12,048 $ 6,240 $ 8,926
- ------------------------------------------------------------------------------------------------------------------------------------
11
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 at the Ravenswood
site. 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. Since
Houston Exploration is no longer a consolidated subsidiary, the fair market
value of their outstanding derivative instruments are not reflected on the June
30, 2004 Consolidated Balance Sheet. Gains and losses are reclassified from
accumulated other comprehensive income to the Consolidated Statement of Income
in the period the hedged transaction affects 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.
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 April 2006. 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 June 30, 2004 was $0.4 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.
12
We have also engaged in the use of cash-settled swap instruments to hedge the
cash flow variability associated with a portion of forecasted 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 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 June 30, 2004 was $1.4 million. 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 $1.5 million, or approximately $1.0 million after-tax.
The table below summarizes the fair value of outstanding financially-settled
commodity derivative instruments that qualify for hedge accounting at June 30,
2004 and the related line item on the Consolidated Balance Sheet. As noted
earlier, derivative instruments employed by Houston Exploration are no longer
reflected on KeySpan's 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) June 30, 2004 December 31, 2003
- -----------------------------------------------------------------------------------------------------
Gas Contracts:
Other current assets $ 12 $ 3,458
Accounts payable and other liabilities - (35,592)
Other deferred liabilities (16) (4,734)
Oil Contracts:
Other current assets 382 -
Other deferred charges (20) 385
Electric Contracts:
Other current assets 1,501 -
Other deferred liabilities (123) 259
- ----------------------------------------------------------------------------------------------------
$ 1,736 $ (36,224)
- ----------------------------------------------------------------------------------------------------
Financially-Settled Commodity Derivative Instruments that Do Not Qualify for
Hedge Accounting: KeySpan subsidiaries also have employed a limited number of
financial derivatives that did 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 was converted into a swap at
the election of the counterparty in June 2004. The resulting premium payment
KeySpan received was recorded into income at the time the swaption was
exercised. The swap qualifies for hedge accounting treatment and its market
value at June 30, 2004 is reflected in the above table.
13
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 June 30, 2004, these
derivatives had a net fair market value of $28 million and are reflected as a
regulatory liability on the Consolidated Balance Sheet.
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 June 30, 2004 these contracts had a net negative
fair market value of $3.5 million, and are reflected as a $3.9 million
regulatory asset and $0.4 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. In the first quarter of 2004, we paid
our counterparty an average interest rate of 6.44%, and as a result, we realized
interest savings of $0.5 million.
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 bonds.
KeySpan has a leveraged lease financing arrangement associated with the
Ravenswood Expansion. In May 2004, the facility was acquired by a lessor from
our subsidiary, KeySpan Ravenswood, LLC, and simultaneously leased back to that
subsidiary. In connection with this sale/leaseback transaction, KeySpan utilized
a $275 million treasury lock (at 4.2%) to hedge the 10-year US Treasury
component of the underlying notes issued by the lessor to purchase the facility.
The treasury lock was in effect for a five-week period during which time the
10-year US Treasury increased 70 basis points. KeySpan did not designate the
14
derivative instrument as a hedge for accounting purposes. The treasury lock
settled in May 2004 and KeySpan received cash proceeds of $12.6 million which
was recorded in other income and (deductions) in the Consolidated Statement of
Income. (See Note 6. "Financial Guarantees and Contingencies" for additional
information regarding the sale/leaseback transaction.)
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 then 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.
Derivative contracts are primarily used to manage exposure to market risk
arising from changes in commodity prices, interest rates and weather. 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
15
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. The implementation of the new
requirements is not expected to have a material impact on KeySpan's results of
operations and cash flows
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
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 six 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.
The initial term of the Master Lease expired on June 20, 2004 and was
automatically extended until June 20, 2009 pursuant to the terms of the Master
Lease. On all future semi-annual payment dates, 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; or (ii) terminate the Master Lease and dispose of the
facility. 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 of 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 $383
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.
16
Sale/leaseback Transaction: KeySpan has a leveraged lease financing arrangement
associated with the Ravenswood Expansion. In May 2004, the unit was acquired by
a lessor from our subsidiary, KeySpan Ravenswood, LLC, and simultaneously leased
back to that subsidiary. All the obligations of KeySpan Ravenswood, LLC have
been unconditionally guaranteed by KeySpan. This lease transaction generated
cash proceeds of $385 million, which approximates the fair market value of the
facility, as determined by a third-party appraiser. The cash proceeds from this
transaction were initially used to redeem outstanding commercial paper. This
lease transaction qualifies 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 has an
initial term of 36 years and the yearly operating lease expense will be
approximately $17 million per year. Lease payments will fluctuate from year to
year, but are substantially paid over the first 16 years.
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 that existed at
the inception of the obligation. At the time of implementation, KeySpan recorded
an asset retirement obligation related to its investment in Houston Exploration.
Since Houston Exploration's operations are no longer consolidated in KeySpan's
financial statements, this liability is no longer reflected on KeySpan's
Consolidated Balance Sheet.
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 was 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 such obligation.
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 27 sites
will be investigated and, if necessary, remediated under the terms and
conditions of Administrative Orders on Consent ("ACO"), Voluntary Cleanup
Agreements ("VCA") or Brownfield Cleanup Agreements ("BCA"). Expenditures
incurred to date by us with respect to KEDNY MGP-related activities total $44.8
million.
17
We have identified 15 of these sites as being associated with the historical
operations of KEDLI. Expenditures incurred to date by us with respect to KEDLI
MGP-related activities total $35.3 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, VCAs or BCAs.
We presently estimate the remaining cost of our KEDNY and KEDLI MGP-related
environmental remediation activities will be $217.0 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 $80.1 million.
With respect to remediation costs, the KEDNY and KEDLI rate plans generally
provide for the recovery from customers of investigation and remediation costs.
At June 30, 2004, we have reflected a regulatory asset of $237.7 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 June
30, 2004, these previously deferred regulatory liabilities totaled $49.1
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 $3.2 million, which amount has been
accrued by us. Expenditures incurred to date total $1.8 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 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.
18
We presently estimate the remaining cost of these Massachusetts KEDNE
MGP-related environmental cleanup activities will be $22.8 million, which amount
has been accrued by us as a reasonable estimate of probable cost for known
sites. Expenditures incurred by KeySpan with respect to these MGP-related
activities total $15.8 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 $12.5 million, which amount has been
accrued by us as a reasonable estimate of probable cost for known sites.
Expenditures incurred by KeySpan, with respect to these MGP-related activities
total $8.5 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
June 30, 2004, we have reflected a regulatory asset of $49.6 million for the
KEDNE MGP sites. Colonial Gas Company and Essex Gas Company are not subject to
the provisions of SFAS 71 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 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 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.
19
We presently estimate the remaining cost of our environmental cleanup activities
for the three non-utility sites will be approximately $24.1 million, which
amount has been accrued by us as a reasonable estimate of probable costs for
known sites. Expenditures incurred by KeySpan with respect to these sites total
$8.7 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 10-K 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 10-K 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.
As previously reported, 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 June 2004, the parties reached an agreement in principle to settle the
consolidated class action lawsuit. The proposed settlement provides for KeySpan
to make certain payments to plaintiffs, all of which is to be funded by the
insurance carrier providing liability coverage for KeySpan's directors and
officers. While KeySpan continues to deny any wrongdoing, we believe the
proposed settlement is in the best interest of KeySpan and its shareholders. The
settlement is subject to court approval and finalization of all necessary
documentation, the timing of which cannot be determined.
Also, as previously reported two shareholder derivative actions were commenced
in the same court as the class action lawsuit against 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
20
violations of Section 20(a) of the Exchange Act. Each of these proceedings
sought monetary damages in an unspecified amount. In April 2004, the court
dismissed both derivative actions without prejudice following the withdrawal of
such actions by the plaintiffs.
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.
Financial Guarantees
KeySpan has issued financial guarantees in the normal course of business, on
behalf of its subsidiaries, to various third party creditors. At June 30, 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:
- --------------------------------------------------------------------------------------------------------------------------
Amount of
Nature of Guarantee (In Thousands of Dollars) Exposure Expiration Dates
- --------------------------------------------------------------------------------------------------------------------------
Medium-Term Notes - KEDLI (i) $ 525,000 2008-2010
Industrial Development Revenue Bonds (ii) 128,000 2027
Ravenswood - Master Lease (iii) 425,000 2019
Ravenswood - Sale/leaseback (iv) 385,000 2040
Surety Bonds (v) 269,000 Revolving
Commodity Guarantees and Other (vi) 64,000 2005
Letters of Credit (vii) 74,000 2005
- --------------------------------------------------------------------------------------------------------------------------
$ 1,870,000
- --------------------------------------------------------------------------------------------------------------------------
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.
21
(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 two
electric-generation peaking plants on Long Island. 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 Master Lease. The initial term of the
Master Lease expired on June 20, 2004 and was automatically 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 guaranteed all payment and performance obligations of KeySpan
Ravenswood, LLC, the lessee under the sale/leaseback transaction associated
with the 250 MW Ravenswood Expansion site. The initial term of the lease is
for 36 years. As noted previously, this lease qualifies as an operating
lease and is therefore not reflected on the Consolidated Balance Sheet.
(v) 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.
(vi) 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 June 30, 2004.
(vii)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.
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 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 December 31, 2008 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.
(Beginning in 2004, KeySpan officers that serve on the Houston Exploration Board
of Directors do 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,
net income and earnings per share would have decreased to the pro-forma amounts
indicated below. The 2004 pro-forma impact of Houston Exploration's stock
options are reflected for the five month period ended May 31, 2004.
23
- ----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Thousands of Dollars, Except Per Share Amounts) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings available for common stock: $ 129,278 $ (7,399) $ 375,514 $ 234,405
As reported
Add: recorded stock-based compensation expense, net of tax 1,390 1,132 2,794 1,990
Deduct: total stock-based compensation expense, net of tax (2,371) (2,969) (4,959) (6,070)
- ----------------------------------------------------------------------------------------------------------------------------------
Pro-forma earnings $ 128,297 $ (9,236) $ 373,349 $ 230,325
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 0.81 $ (0.05) $ 2.35 $ 1.49
Basic - pro-forma $ 0.80 $ (0.06) $ 2.33 $ 1.46
Diluted - as reported 0.80 $ (0.05) $ 2.33 $ 1.48
Diluted - pro-forma 0.79 $ (0.06) $ 2.32 $ 1.45
- ----------------------------------------------------------------------------------------------------------------------------------
8. POSTRETIREMENT BENEFITS
Pension Plans: The following information represents the consolidated net
periodic pension cost for the six months ended June 30, 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 NYPSC and 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.
The calculation of net periodic pension cost is as follows:
- -------------------------------------------------------------------------------------------------------------
Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003
- -------------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 26,454 $ 23,766
Interest cost on projected benefit obligation 72,121 69,135
Expected return on plan assets (79,134) (65,278)
Net amortization and deferral 31,654 33,475
- -------------------------------------------------------------------------------------------------------------
Total pension cost $ 51,095 $ 61,097
- -------------------------------------------------------------------------------------------------------------
Other Postretirement Benefits: The following information represents the
consolidated net periodic other postretirement benefit cost for the six months
ended June 30, 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.
24
Net periodic other postretirement benefit cost included the following
components:
- -----------------------------------------------------------------------------------------------------------
Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003
- -----------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 10,060 $ 9,413
Interest cost on accumulated
postretirement benefit obligation 37,006 34,902
Expected return on plan assets (16,946) (13,765)
Net amortization and deferral 23,398 17,908
- -----------------------------------------------------------------------------------------------------------
Other postretirement cost $ 53,518 $ 48,457
- -----------------------------------------------------------------------------------------------------------
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 10-K for the Year Ended December 31, 2003. For the six months ended June
30, 2004, $115.4 million has been contributed.
9. LONG-TERM DEBT and COMMERCIAL PAPER
At June 30, 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, in May 2005, three years
after the date of issuance of the MEDS Equity Units, 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.
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 KeySpan's 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 shares
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 KeySpan's 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.
25
In June 2004, KeySpan completed the restructuring of its credit facilities. We
entered into a new $640 million five year revolving credit facility to replace
the $450 million, 364 day facility which expired in June. We also amended our
existing three year $850 million facility due June 2006 to reduce commitments
thereunder by $190 million to a new level of $660 million. The two credit
facilities total $1.3 billion and are each syndicated among sixteen banks. These
facilities continue to support KeySpan's commercial paper program for working
capital needs.
The fees for these facilities are subject to a ratings-based grid, with an
annual fee of 0.08% on the new five-year facility and 0.125% on the existing
three-year facility. Both credit agreements allow for KeySpan to borrow using
several different types of loans; specifically, Eurodollar loans, Adjustable
Bank Rate (ABR) loans, or competitively bid loans. Eurodollar loans in the
five-year facility are based on the Eurodollar rate plus a margin of 0.40% for
loans up to 33% of the total five-year facility, and an additional 0.125% for
loans over 33% of the total five-year facility. In the three-year facility
Eurodollar loans are based on the Eurodollar rate plus a margin of 0.625% for
loans up to 33% of the total three-year facility, and an additional 0.125% for
loans over 33% of the total three-year facility. ABR loans are based on the
highest of the Prime Rate, the base CD rate plus 1%, or the Federal Funds
Effective Rate plus 0.5%. Competitive bid loans are based on bid results
requested by KeySpan from the lenders. We do not anticipate borrowing against
these facilities; however, if the credit rating on our commercial paper program
were to be downgraded, it may be necessary to do so.
The facilities contain certain affirmative and negative operating covenants,
including restrictions on KeySpan's ability to mortgage, pledge, encumber or
otherwise subject its property to any lien, as well as certain financial
covenants that require us to, among other things, maintain a consolidated
indebtedness to consolidated capitalization ratio of no more than 64% until the
expiration of the existing three-year facility in 2006, at which time it will be
lowered to 62%. Violation of this covenant could result in the termination of
the facilities and the required repayment of amounts borrowed thereunder, as
well as possible cross defaults under other debt agreements.
10. GAS EXPLORATION and PRODUCTION PROPERTY - DEPLETION
As described in Note 2 "Business Segments", KeySpan's investments in gas
exploration and production activities consists of its 23.5% ownership interest
in Houston Exploration, as well as KeySpan's wholly-owned subsidiary KeySpan
Exploration and Production, which is engaged in a joint drilling program with
Houston Exploration. Further KeySpan's investments in these activities also
includes its wholly owned subsidiary Seneca-Upshur. These assets are accounted
for under the full cost method of accounting. Under the full cost method, costs
of acquisition, exploration and development of natural gas and oil reserves are
capitalized into a "full cost pool" as incurred. Unproved properties and related
costs are excluded from the depletion and amortization base until a
determination as to the existence of proved reserves. Properties are depleted
and charged to operations using the unit of production method using proved
reserve quantities.
26
To the extent that such capitalized costs (net of accumulated depletion) less
deferred taxes exceed the present value (using a 10% discount rate) of estimated
future net cash flows from proved natural gas and oil reserves and the lower of
cost or fair value of unproved properties, less deferred taxes, such excess
costs are charged to operations, but would not have an impact on cash flows.
Once incurred, such impairment of gas properties is not reversible at a later
date even if gas prices increase. The ceiling test is calculated using natural
gas and oil prices in effect as of the balance sheet date, held flat over the
life of the reserves.
As a result of the stock transaction previously mentioned, KeySpan now accounts
for its investment in Houston Exploration on the equity method, i.e. Houston
Exploration's operations are not consolidated with KeySpan's other subsidiaries.
Therefore, we are now required to calculate the ceiling test on KeySpan
Exploration and Production's and Seneca-Uphsur's assets independently of Houston
Exploration's assets. Based on a report furnished by an indpendent reservoir
engineer, it was determined that the remaining proved undeveloped oil reserves
held in the joint venture required a substantial investment in order to develop.
Therefore, KeySpan and Houston Exploration elected not to develop these oil
reserves. As a result, in the second quarter of 2004 we recorded a $48.2 million
non-cash impairment charge to write down our wholly-owned gas exploration and
production subsidiaries' assets. This charge was recorded in depreciation,
depletion and amortization on the Consolidated Statement of Income.
11. 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.
27
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2004
(In Thousands of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues $ 160 $ 181,373 $ 1,184,398 $ (160) $ 1,365,771
--------------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 96,907 266,223 - 363,130
Fuel and purchased power - - 130,347 - 130,347
Operations and maintenance (3,429) 33,724 447,216 - 477,511
Intercompany expense - 1,432 (1,432) -
Depreciation and amortization - 18,408 170,995 - 189,403
Operating taxes - 12,733 77,751 - 90,484
--------------------------------------------------------------------------------------------
Total Operating Expenses (3,429) 163,204 1,091,100 - 1,250,875
--------------------------------------------------------------------------------------------
Income from equity investments - - 8,416 - 8,416
--------------------------------------------------------------------------------------------
Operating Income (Loss) 3,589 18,169 101,714 (160) 123,312
--------------------------------------------------------------------------------------------
Interest charges (53,278) (14,833) (69,486) 49,122 (88,475)
Other income and (deductions) 177,853 159 175,732 (178,129) 175,615
--------------------------------------------------------------------------------------------
Total Other Income and (Deductions) 124,575 (14,674) 106,246 (129,007) 87,140
--------------------------------------------------------------------------------------------
Income Taxes (Benefit) (4,573) 2,343 81,945 - 79,715
--------------------------------------------------------------------------------------------
Net Income $ 132,737 $ 1,152 $ 126,015 $(129,167) $ 130,737
============================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2003
(In Thousands of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues $ 34 $ 177,340 $ 1,230,812 $ (34) $ 1,408,152
------------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 90,611 333,689 - 424,300
Fuel and purchased power - - 102,476 - 102,476
Operations and maintenance (5,424) 32,760 482,300 - 509,636
Intercompany expense 31 735 (735) (31) -
Depreciation and amortization (20) 18,064 124,246 - 142,290
Operating taxes (1,824) 16,954 80,121 - 95,251
------------------------------------------------------------------------------------------
Total Operating Expenses (7,237) 159,124 1,122,097 (31) 1,273,953
------------------------------------------------------------------------------------------
Income from Equity Investments 36 - 3,994 - 4,030
------------------------------------------------------------------------------------------
Operating Income (Loss) 7,307 18,216 112,709 (3) 138,229
------------------------------------------------------------------------------------------
Interest charges (53,403) (16,104) (56,720) 47,029 (79,198)
Other income and (deductions) 34,630 (1,809) (46,030) (36,282) (49,491)
------------------------------------------------------------------------------------------
Total Other Income and (Deductions) (18,773) (17,913) (102,750) 10,747 (128,689)
------------------------------------------------------------------------------------------
Income Taxes (Benefit) (5,528) 1,221 19,785 - 15,478
------------------------------------------------------------------------------------------
Net Income (Loss) $ (5,938) $ (918) $ (9,826) $ 10,744 $ (5,938)
==========================================================================================
28
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2004
(In Thousands of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 313 $ 652,456 $ 3,308,888 $ (313) $ 3,961,344
------------------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 387,996 1,201,707 - 1,589,703
Fuel and purchased power - - 231,959 - 231,959
Operations and maintenance (3,060) 66,941 906,096 - 969,977
Intercompany expense - 2,787 (2,787) - -
Depreciation and amortization - 48,249 312,839 - 361,088
Operating taxes - 32,276 180,487 - 212,763
------------------------------------------------------------------------------------------------
Total Operating Expenses (3,060) 538,249 2,830,301 - 3,365,490
------------------------------------------------------------------------------------------------
Income from equity investments - 14,132 - 14,132
------------------------------------------------------------------------------------------------
Operating Income (Loss) 3,373 114,207 492,719 (313) 609,986
------------------------------------------------------------------------------------------------
Interest charges (106,766) (30,696) (140,960) 105,882 (172,540)
Other income and (deductions) 475,382 533 173,782 (491,614) 158,083
------------------------------------------------------------------------------------------------
Total Other Income and (Deductions) 368,616 (30,163) 32,822 (385,732) (14,457)
------------------------------------------------------------------------------------------------
Income Taxes (Benefit) (10,435) 25,053 202,477 - 217,095
------------------------------------------------------------------------------------------------
Net Income $ 382,424 $ 58,991 $ 323,064 $ (386,045) $ 378,434
================================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2003
(In Thousands of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 177 $655,685 $ 3,264,992 $ (177) $ 3,920,677
-------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 377,620 1,242,845 - 1,620,465
Fuel and purchased power - - 199,998 - 199,998
Operations and maintenance 1,835 70,980 935,010 - 1,007,825
Intercompany expense 65 1,917 (1,917) (65) -
Depreciation and amortization (40) 44,984 242,317 - 287,261
Operating taxes (1,824) 40,959 180,829 - 219,964
-------------------------------------------------------------------------------------
Total Operating Expenses 36 536,460 2,799,082 (65) 3,335,513
-------------------------------------------------------------------------------------
Income from Equity Investment 108 - 9,651 - 9,759
-------------------------------------------------------------------------------------
Operating Income (Loss) 249 119,225 475,561 (112) 594,923
-------------------------------------------------------------------------------------
Interest charges (99,880) (31,110) (109,019) 91,872 (148,137)
Other income and (deductions) 328,011 (9,026) (41,444) (328,863) (51,322)
-------------------------------------------------------------------------------------
Total Other Income and (Deductions) 228,131 (40,136) (150,463) (236,991) (199,459)
-------------------------------------------------------------------------------------
Income Taxes (Benefit) (8,947) 29,533 137,725 - 158,311
-------------------------------------------------------------------------------------
Earnings before Change in Accounting Principle 237,327 49,556 187,373 (237,103) 237,153
Cumulative Effect of Change in Accounting
Principle - - 174 - 174
-------------------------------------------------------------------------------------
Net Income (Loss) $237,327 $ 49,556 $ 187,547 $(237,103) $ 237,327
=====================================================================================
29
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
June 30, 2004
Other
Guarantor KEDLI Subsidiaries Eliminations Consolidated
------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 526,211 $ (1,164) $ 293,080 $ - $ 818,127
Accounts receivable, net 1,226 140,688 1,026,256 - 1,168,170
Other current assets 3,281 101,074 430,093 - 534,448
------------------------------------------------------------------------------------------
530,718 240,598 1,749,429 - 2,520,745
------------------------------------------------------------------------------------------
Investments 4,771,429 963 405,526 (4,678,761) 499,157
------------------------------------------------------------------------------------------
Property
Gas - 1,946,261 4,741,914 - 6,688,175
Other - - 2,939,503 - 2,939,503
Accumulated depreciation and
depletion - (324,889) (2,427,340) - (2,752,229)
------------------------------------------------------------------------------------------
- 1,621,372 5,254,077 - 6,875,449
------------------------------------------------------------------------------------------
Intercompany Accounts Receivable 2,118,880 - 1,802,882 (3,921,762) -
Deferred Charges 375,350 224,180 2,463,975 - 3,063,505
------------------------------------------------------------------------------------------
Total Assets $ 7,796,377 $ 2,087,113 $ 11,675,889 $ (8,600,523) $ 12,958,856
==========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 40,108 $ 146,882 $ 567,629 $ - $ 754,619
Commercial paper 40,000 - - - 40,000
Other current liabilities 166,453 (2,304) 101,944 - 266,093
------------------------------------------------------------------------------------------
246,561 144,578 669,573 - 1,060,712
------------------------------------------------------------------------------------------
Intercompany Accounts Payable - 12,626 2,397,570 (2,410,196) -
------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (46,080) 265,495 872,907 - 1,092,322
Other deferred credits and liabilities 499,905 172,296 935,684 - 1,607,885
------------------------------------------------------------------------------------------
453,825 437,791 1,808,591 - 2,700,207
------------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 3,962,536 841,214 3,791,395 (4,678,761) 3,916,384
Preferred stock 83,342 - - 83,342
Long-term debt 3,050,113 650,904 2,993,201 (1,511,566) 5,182,652
------------------------------------------------------------------------------------------
Total Capitalization 7,095,991 1,492,118 6,784,596 (6,190,327) 9,182,378
------------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 15,559 - 15,559
------------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 7,796,377 $ 2,087,113 $ 11,675,889 $ (8,600,523) $ 12,958,856
==========================================================================================
30
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2003
Other
Guarantor KEDLI Subsidiaries Eliminations Consolidated
----------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and 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
========================================================================================
31
- ----------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- ----------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2004
---------------------------------------------------------------
Guarantor KEDLI Other Subsidiaries Consolidated
---------------------------------------------------------------
Operating Activities
Net Cash Provided by Operating Activities $ (8,282) $ 152,747 $ 641,868 $ 786,333
---------------------------------------------------------------
Investing Activities
Capital expenditures - (51,212) (362,035) (413,247)
Proceeds from the sale of subsidiary investments - (682) (13,924) (14,606)
Net proceeds from subsidiary stock transactions - 512,065 512,065
Net proceeds from sale/leaseback transaction - 383,716 383,716
Proceeds from sale of property - 13,138 13,138
---------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities - (51,894) 532,960 481,066
---------------------------------------------------------------
Financing Activities
Treasury stock issued 14,626 - - 14,626
Payment of debt, net (441,900) - (104,742) (546,642)
Common and preferred stock dividends paid (145,542) - - (145,542)
Gain on settlement of treasury lock 12,656 - - 12,656
Other 10,389 - (510) 9,879
Net intercompany accounts 986,691 (103,571) (883,120) -
-
---------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities 436,920 (103,571) (988,372) (655,023)
---------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ 428,638 $ (2,718) $ 186,456 $ 612,376
Cash and Cash Equivalents at Beginning of Period 97,567 1,554 106,630 205,751
---------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 526,205 $ (1,164) $ 293,086 $ 818,127
===============================================================
- -------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- -------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2003
-----------------------------------------------------------------------
Guarantor KEDLI Other Subsidiaries Consolidated
-----------------------------------------------------------------------
Operating Activities
Net Cash Provided by Operating Activities $ 138,174 $ 88,770 $ 351,073 $ 578,017
-----------------------------------------------------------------------
Investing Activities
Capital expenditures - (49,875) (384,177) (434,052)
Cost of removal - (1,039) (11,601) (12,640)
Proceeds from the sale of subsidiary investments 79,200 - 119,353 198,553
-----------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities 79,200 (50,914) (276,425) (248,139)
-----------------------------------------------------------------------
Financing Activities
Treasury stock issued 57,441 - - 57,441
Equity issuance 473,573 - - 473,573
Redemption of promissory notes (447,005) - - (447,005)
Payment of debt, net (184,697) - (77,490) (262,187)
Common and preferred stock dividends paid (136,357) - - (136,357)
Other 13,065 - (3,357) 9,708
Net intercompany accounts (66,266) (38,834) 105,100 -
-
-----------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (290,246) (38,834) 24,253 (304,827)
-----------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ (72,872) $ (978) $ 98,901 $ 25,051
Cash and Cash Equivalents at Beginning of Period 88,308 6,472 75,837 170,617
-----------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 15,436 $ 5,494 $ 174,738 $ 195,668
=======================================================================
32
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Consolidated Review of Results
- ------------------------------
The following is a summary of transactions affecting comparative earnings and a
discussion of material changes in revenues and expenses during the three and six
months ended June 30, 2004, compared to the three and six months ended June 30,
2003. Capitalized terms used in the following discussion, but not otherwise
defined, have the same meaning as when used in the Notes to the Consolidated
Financial Statements included under Item 1. References to "KeySpan," "we," "us,"
and "our" mean KeySpan Corporation, together with its consolidated subsidiaries.
Operating income by segment, as well as consolidated earnings available for
common stock is set forth in the following table for the periods indicated.
- ----------------------------------------------------------------------------------------------------------------------------------
(In Thousands of Dollars, Except per Share)
- ----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------------
Gas Distribution $ 35,065 $ 31,616 $ 414,717 $ 396,554
Electric Services 67,912 52,100 115,111 91,744
Energy Services (4,906) (10,463) (23,380) (19,585)
Energy Investments -
Operations 65,058 59,222 140,088 124,936
Ceiling test write-down (48,190) - (48,190) -
Eliminations and other 8,373 5,754 11,640 1,274
- ----------------------------------------------------------------------------------------------------------------------------------
Operating Income 123,312 138,229 609,986 594,923
Interest charges (88,475) (79,198) (172,540) (148,137)
Gain on Houston Exploration transaction 150,070 - 150,070 19,020
Gain (loss) on sale of KeySpan Canada 22,824 (30,345) 22,824 (30,345)
Other income and (deductions) 2,721 (19,146) (14,811) (39,997)
Income taxes 79,715 15,478 217,095 158,311
- ----------------------------------------------------------------------------------------------------------------------------------
Income (Loss) before change in accounting principle 130,737 (5,938) 378,434 237,153
Cumulative effect of a change
in accounting principle - - - 174
- ----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) 130,737 (5,938) 378,434 237,327
Preferred stock dividend requirements 1,459 1,461 2,920 2,922
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings (Loss) for Common Stock $ 129,278 $ (7,399) $ 375,514 $ 234,405
- ----------------------------------------------------------------------------------------------------------------------------------
Basic Earnings per Share
Income (loss) before change in accounting principle $ 0.81 $ (0.05) $ 2.35 $ 1.49
Change in accounting principle - - - -
- ----------------------------------------------------------------------------------------------------------------------------------
$ 0.81 $ (0.05) $ 2.35 $ 1.49
- ----------------------------------------------------------------------------------------------------------------------------------
33
KeySpan's financial results for the three and six months ended June 30, 2004 and
2003 reflect a number of events that had a significant impact on earnings. On
June 2, 2004, KeySpan exchanged 10.8 million shares of The Houston Exploration
Company common stock ("Houston Exploration"- our previously 55% owned gas
exploration and production subsidiary) for 100% of the stock of Seneca-Upshur
Petroleum, Inc., a wholly owned subsidiary of Houston Exploration. This
transaction reduced our interest in Houston Exploration to 23.5% and resulted in
a gain to KeySpan of $150.1 million. Effective June 1, 2004, Houston
Exploration's earnings and our ownership interest in Houston Exploration have
been accounted for on the equity method of accounting. The deconsolidation of
Houston Exploration required the recognition of certain deferred taxes on our
remaining investment resulting in a deferred tax expense of $44.1 million.
Therefore, the net gain on the share exchange, less the deferred tax on the
remaining investment, was $106.0 million, or $0.66 per share. (See Note 2 to the
Consolidated Financial Statements "Business Segments" for a detailed discussion
of this transaction.)
On April 1, 2004, KeySpan and KeySpan Facilities Income Fund (the "Fund"), which
previously owned a 39.09% interest in KeySpan Canada (a KeySpan subsidiary with
natural gas processing plants and gathering facilities in Western Canada),
consummated a transaction whereby the Fund sold 15.617 million units of the
Fund. The Fund used the proceeds of the offering to acquire an additional 35.91%
interest in KeySpan Canada from KeySpan. As a result of the transaction, the
Fund's ownership in KeySpan Canada increased from 39.1% to 75% and KeySpan's
ownership of KeySpan Canada decreased to 25%. KeySpan recorded a gain of $22.8
million ($10.1 million after-tax, or $0.06 per share) on this transaction.
Effective April 1, 2004, KeySpan Canada's earnings and our ownership interest in
KeySpan Canada have been accounted for on the equity method of accounting.
On July 2, 2004, the Fund issued an additional 10.7 million units, the proceeds
of which were used to fund the acquisition of the midstream assets of Chevron
Canada Midstream Inc. This transaction had the effect of further diluting
KeySpan's ownership of KeySpan Canada to 17.4%. (See Note 2 to the Consolidated
Financial Statements "Business Segments" for a detailed discussion of this
transaction.)
In addition, asset transactions completed in 2003 had a significant impact on
comparative earnings. These transactions included the monetization of a portion
of our ownership interests in Houston Exploration and KeySpan Canada. In
February 2003, we reduced our ownership interest in Houston Exploration from 66%
to approximately 55% following the repurchase, by Houston Exploration, of six
million shares of common stock owned by KeySpan. We recorded a gain of $19.0
million on this transaction, or $0.12 per share. Income taxes were not provided
on this transaction, since the transaction was structured as a return of
capital.
In June 2003, we sold 39.09% of our interest in KeySpan Canada and recorded a
pre-tax loss of $30.3 million ($34.1 million after applying applicable taxes or
$0.22 per share). Additionally, we sold our 20% interest in Taylor NGL LP that
owns and operates two extraction plants also in Canada.
34
As a result of these asset transactions, net income for the quarter and six
months ended June 30, 2004 reflects a combined after-tax gain of $116.1 million
or $0.72 per share. Net income for the quarter and six months ended June 30,
2003 reflects after-tax losses of $34.1 million or $0.22 per share and $15.1
million or $0.10 per share, respectively.
In June 2004, KeySpan's wholly owned gas exploration and production
subsidiaries, recorded a non-cash impairment charge of $48.2 million ($31.1
million after-tax, or $0.19 per share) to recognize the reduced valuation of
proved reserves. (See Note 10 to the Consolidated Financial Statements "Gas
Exploration and Production Property - Depletion for additional details on this
transaction.)
Operating income, as indicated in the above table, decreased $14.9 million, or
11%, for the three months ended June 30, 2004, compared to the corresponding
period last year primarily as a result of the non-cash impairment charge of
$48.2 million. For the six months ended June 30, 2004, operating income
increased $15.1 million or 3% including the non-cash impairment charge. Aside
from this charge, operating income in both periods reflects higher earnings from
the Gas Distribution, Energy Investments and Electric Services segments. The Gas
Distribution segment benefited from customer additions and oil-to-gas
conversions throughout our service territories, as well as from a rate increase
resulting from the Boston Gas Company rate proceeding concluded last fall. In
the Energy Investments segment, higher gas production volumes and higher
realized gas prices resulted in an increase in operating income associated with
gas exploration and production activities, while the Electric Services segment
benefited from higher net electric margins associated with the Ravenswood
facility. For the three months ended June 30, 2004, the Energy Services segment
benefited from a slightly better business climate, improved project profit
margins and cost reduction measures. However, for the six months ended June 30,
2004, the Energy Services segment experienced higher operating expenses compared
to the same period last year. (See the discussion under the caption "Review of
Operating Segments" for further details on each segment.)
The increase in interest expense of $9.3 million, or 12%, and $24.4 million, or
16% for the three and six months ended June 30, 2004, respectively, compared to
the same periods last year, reflects in part, the implementation of FASB
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51." This Interpretation required us to, among
other things, consolidate the Ravenswood Master Lease and classify the lease
obligation as long-term debt on the Consolidated Balance Sheet based on our
current status as primary beneficiary. As a result of implementing FIN 46,
beginning January 1, 2004 lease payments have been reflected as interest expense
on the Consolidated Statement of Income resulting in an increase to interest
expense of $7.5 million and $15 million for the quarter and six months ended
June 30, 2004, respectively. (See Note 6 "Financial Guarantees and Contingencies
for further information on the Master Lease".)
Further, comparative interest expense for the six months reflects the benefits
realized in 2003 associated with interest rate swaps. In February 2003, we
terminated an interest rate swap agreement with a notional amount of $270
million. This swap was used to hedge a portion of outstanding promissory notes
that were issued to the Long Island Power Authority ("LIPA") in connection with
35
the KeySpan/Long Island Lighting Company ("LILCO") business combination
completed in May 1998. In March 2003, we called approximately $447 million of
the outstanding promissory notes and recorded debt redemption charges of $18.2
million in other income and (deductions). The cash proceeds from the termination
of the interest rate hedge were $18.4 million, of which $8.1 million represented
accrued swap interest. The difference between the termination settlement amount
and the amount of accrued swap interest, $10.3 million, was recorded to earnings
(as an adjustment to interest expense) in the first quarter of 2003 and
effectively offset a portion of the redemption charges.
In addition to the asset sales previously noted, other income and (deductions)
for the three and six months ended June 30, 2004 reflects a $12.6 million gain
recorded on the settlement of a derivative financial instrument entered into in
connection with the sale/leaseback transaction associated with the Ravenswood
Expansion. (See Note 6 and Note 4 to the Consolidated Financial Statements,
"Financial Guarantees and Contingencies" and "Hedging and Derivative Financial
Instruments", for additional information regarding this financing arrangement
and derivative financial instrument.) Other income and (deductions) also
includes the effects of minority interest of $16.7 million and $37.0 million for
the three and six months ended June 30, 2004 respectively, related to our
previous majority ownership interests in Houston Exploration and KeySpan Canada.
In addition to the items noted above, other income and (deductions) for the six
months ended June 30, 2003 also includes a $10.6 million severance tax refund
for severance taxes paid in 2002 and earlier periods. The effects of minority
interest of $13.0 million and $30.4 million for the three and six months ended
June 30, 2003 respectively, are also reflected in other income and (deductions).
Income tax expense generally reflects the level of pre-tax income and, for the
six months ended June 30, 2004, a $6.0 million benefit to income taxes resulting
from a revised appraisal associated with property that was disposed of in 2003.
Earnings available for common stock for the three and six months ended June 30,
2004, increased by $136.7 million and $141.1 million, respectively, compared to
the same periods last year. Earnings per share increased by $0.86 per share for
both the three and six months ended June 30, 2004, compared to the same periods
last year. Average common shares outstanding for the quarter and six months
ended June 30, 2004 increased 1% and 2%, respectively, reflecting the
re-issuance of shares held in treasury pursuant to dividend reinvestment and
employee benefit plans.
Consistent with our prior earnings guidance, KeySpan's consolidated earnings for
2004 are forecasted to be in the range of $2.55 to $2.75 per share, excluding
special items. Earnings from continuing core operations (defined for this
purpose as all continuing operations other than exploration and production, less
preferred stock dividends) are forecasted to be in the range of $2.20 to $2.30
per share. Earnings from gas exploration and production operations, excluding
the impact of the gain on the sale of Houston Exploration and the impact of the
non-cash impairment charge, are forecasted to be in the range of $0.35 to $0.45
per share. The original non-core earnings forecast for gas exploration and
production activities remains in effect, as the favorable impact of higher
realized gas prices and production levels are offsetting the lower ownership
interest.
36
Consolidated earnings are seasonal in nature due to the significant contribution
to earnings of the gas distribution operations. As a result, we expect to earn
most of our annual earnings in the first and fourth quarters of the fiscal year.
Review of Operating Segments
- ----------------------------
KeySpan's segment results are reported on an Operating Income basis. Management
believes that this Generally Accepted Accounting Principle (GAAP) based measure
provides a reasonable indication of KeySpan's underlying performance associated
with its operations. The following is a discussion of financial results achieved
by KeySpan's operating segments presented on an operating income basis.
Gas Distribution
KeySpan Energy Delivery New York ("KEDNY") provides gas distribution service to
customers in the New York City Boroughs of Brooklyn, Staten Island and a portion
of Queens, and KeySpan Energy Delivery Long Island ("KEDLI") provides gas
distribution service to customers in the Long Island counties of Nassau and
Suffolk and the Rockaway Peninsula of Queens County. Four gas distribution
companies - Boston Gas Company, Colonial Gas Company, Essex Gas Company, and
EnergyNorth Natural Gas Inc., each doing business under the name KeySpan Energy
Delivery New England ("KEDNE"), provide gas distribution service to customers in
Massachusetts and New Hampshire.
The table below highlights certain significant financial data and operating
statistics for the Gas Distribution segment for the periods indicated.
37
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 676,363 $ 732,036 $ 2,604,142 $ 2,564,737
Cost of gas 363,130 417,484 1,589,703 1,571,616
Revenue taxes 10,294 17,269 45,048 55,886
- ------------------------------------------------------------------------------------------------------------------------------------
Net Revenues 302,939 297,283 969,391 937,235
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 168,141 163,124 340,541 329,214
Depreciation and amortization 66,810 66,192 143,750 137,009
Operating taxes 32,923 36,351 70,383 74,458
- ------------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 267,874 265,667 554,674 540,681
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Income $ 35,065 $ 31,616 $ 414,717 $ 396,554
- ------------------------------------------------------------------------------------------------------------------------------------
Firm gas sales and transportation (MDTH) 57,152 56,048 211,467 211,714
Transportation - Electric Generation (MDTH) 8,634 9,145 12,773 14,148
Other Sales (MDTH) 19,029 24,482 71,986 78,151
Warmer (Colder) than Normal - New York 14% (30%) (3%) (13%)
Warmer (Colder) than Normal - New England (8%) (45%) (9%) (17%)
- ------------------------------------------------------------------------------------------------------------------------------------
A MDTH is 10,000 therms (British Thermal Units) and reflects the heating content
of approximately one million cubic feet of gas. A therm reflects the heating
content of approximately 100 cubic feet of gas. One billion cubic feet (BCF) of
gas equals approximately 1,000 MDTH.
Net Revenues
Net gas revenues (revenues less the cost of gas and associated revenue taxes)
from our gas distribution operations increased by $32.2 million, or 3%, for the
six months ended June 30, 2004 compared to the same period last year. Net gas
revenues benefited from customer additions and oil-to-gas conversions, as well
as from a rate increase resulting from the Boston Gas Company's rate proceeding
that was concluded in the fourth quarter of 2003. As measured in heating degree
days, weather for the six months ended June 30, 2004 in our New York and New
England service territories was approximately 3% and 9% colder than normal,
respectively, compared to approximately 13% and 17% colder than normal last
year, respectively. Weather was approximately 7% warmer than last year across
KeySpan's service territories.
Net revenues from firm gas customers (residential, commercial and industrial
customers) in our New York service territory increased by $5.4 million for the
six months ended June 30, 2004 compared to the same period last year. Customer
additions and oil-to-gas conversions, net of attrition and conservation, added
$4.6 million to net gas revenues. Further, we realized a $3.5 million benefit to
net gas revenues as a result of an additional billing day in the leap year.
Weather, which was warmer than last year, resulted in an adverse impact to
comparative net gas revenues of $3.6 million. KEDNY and KEDLI each operate under
a utility tariff that contains a weather normalization adjustment that
significantly offsets variations in firm net revenues due to fluctuations in
normal weather. Since weather was colder than normal we refunded to firm
customers $8.7 million through the weather normalization adjustment. Also
included in net gas revenues is the recovery of property taxes that added $1.0
million to net revenues during the period. These revenues, however, do not
38
impact net income since the taxes they are designed to recover are expensed as
amortization charges on the Consolidated Statement of Income. Firm gas
distribution rates for KEDNY and KEDLI during the first six months of 2004,
other than for the recovery of gas costs, have remained substantially unchanged
from rates charged last year.
Net revenues from firm gas customers in our New England service territory
increased by $25.7 million during the first six months of 2004 compared to the
same period last year. Customer additions and oil-to-gas conversions, net of
attrition and conservation, added $4.8 million to net gas revenues. Further, we
realized a $2.2 million benefit in net gas revenues as a result of an additional
billing day for leap year. As mentioned, the Massachusetts Department of
Telecommunications and Energy ("DTE") approved a $27 million base rate increase
for the Boston Gas Company, which became effective November 1, 2003. This rate
increase resulted in a benefit to net gas revenues of $20.7 million during the
six months ended June 30, 2004. (See the caption under "Regulation and Rate
Matters" for further information regarding the rate filing.) The gas
distribution operations of our New England based subsidiaries do not have a
weather normalization adjustment. Weather, which was warmer than last year,
resulted in an adverse impact to comparative net gas revenues of $9.9 million.
To mitigate the effect of fluctuations in normal weather patterns on KEDNE's
results of operations and cash flows, weather derivatives were in place for the
2003/2004 winter heating season (November through March). Since weather during
the first quarter of 2004 was approximately 9% colder than normal in the New
England service territories, we recorded a $4.1 million reduction to revenues to
reflect the loss on these derivative transactions. Similarly, in 2003 we
recorded an $11.9 million reduction to revenues. As a result of these
transactions, comparative net revenues were favorably impacted by $7.8 million
(See Note 4 to the Consolidated Financial Statements "Hedging and Derivative
Financial Instruments" for further information).
In our large-volume heating and other interruptible (non-firm) markets, which
include large apartment houses, government buildings and schools, gas service is
provided under rates that are designed to compete with prices of alternative
fuel, including No. 2 and No. 6 grade heating oil. These "dual-fuel" customers
can consume either natural gas or fuel oil for heating purposes. Net revenues in
these markets increased slightly during the first six months of 2004 compared to
the same period last year. The majority of interruptible profits earned by KEDNE
and KEDLI are returned to firm customers as an offset to gas costs.
We are committed to our expansion strategies initiated during the past few
years. We believe that significant growth opportunities exist on Long Island and
in our New England service territories. We estimate that on Long Island
approximately 36% of the residential and multi-family markets, and approximately
58% of the commercial market, currently use natural gas for space heating.
Further, we estimate that in our New England service territories approximately
53% of the residential and multi-family markets, and approximately 63% of the
commercial market, currently use natural gas for space heating purposes. We will
continue to seek growth, in our market segments, through the expansion of our
gas distribution system, as well as through the conversion of residential homes
from oil-to-gas for space heating purposes and the pursuit of opportunities to
grow multi-family, industrial and commercial markets.
39
Firm Sales, Transportation and Other Quantities
Firm gas sales and transportation quantities for the six months ended June 30,
2004, were consistent with such quantities for same period in 2003. Net revenues
are not affected by customers opting to purchase their gas supply from other
sources, since delivery rates charged to transportation customers generally are
the same as delivery rates charged to full sales service customers.
Transportation quantities related to electric generation reflect the
transportation of gas to our electric generating facilities located on Long
Island. Net revenues from these services are not material.
Other sales quantities include on-system interruptible quantities, off-system
sales quantities (sales made to customers outside of our service territories)
and related transportation. We have an agreement with Coral Resources, L.P.
("Coral"), a subsidiary of Shell Oil Company, under which Coral assists in the
origination, structuring, valuation and execution of energy-related transactions
on behalf of KEDNY and KEDLI. We also have a portfolio management contract with
Entergy Koch Trading, LP ("EKT"), under which EKT provides all of the city gate
supply requirements at market prices and manages certain upstream capacity,
underground storage and term supply contracts for KEDNE. These agreements expire
on March 31, 2006.
Purchased Gas for Resale
The increase in gas costs for the six months ended June 30, 2004 compared to the
same period of 2003 of $18.1 million, or 1%, reflects an increase of 8% in the
price per dekatherm of gas purchased, and a 5% decrease in the quantity of gas
purchased. The current gas rate structure of each of our gas distribution
utilities includes a gas adjustment clause, pursuant to which variations between
actual gas costs incurred for resale to firm sales customers and gas costs
billed to firm sales customers are deferred and refunded to or collected from
customers in a subsequent period.
Operating Expenses
Operating expenses during the second quarter of 2004 were relatively constant
with the same quarter last year. Higher employee benefit costs, primarily
related to employee severance costs, were significantly offset by lower
operating taxes resulting from a recent property tax refund in our New York
service territory.
The increase in operating expenses of $14.0 million or 3% for the first six
months of 2004, compared to the same period last year, is attributable, in part,
to higher employee benefit costs principally pension and other postretirement
benefits and employee severance costs. The cost of pension and other
postretirement benefits, net of amounts subject to regulatory deferral
treatment, has risen primarily as a result of increased health care costs.
Higher depreciation and amortization expense reflects the continued expansion of
the gas distribution system. These increases to operating expenses were
partially offset by lower operating taxes resulting from the recent property tax
refund noted earlier.
40
Other Matters
In order to serve the anticipated market requirements in our New York service
territories, KeySpan and Duke Energy Corporation formed Islander East Pipeline
Company, LLC ("Islander East") in 2000. Islander East is owned 50% by KeySpan
and 50% by Duke Energy, and was created to pursue the authorization and
construction of an interstate pipeline from Connecticut, across Long Island
Sound, to a terminus near Shoreham, Long Island. Applications for all necessary
regulatory authorizations were filed in 2000 and 2001. To date, Islander East
has received a final certificate from the Federal Energy Regulatory Commission
("FERC") and all necessary permits from the State of New York. The State of
Connecticut denied Islander East's applications for coastal zone management and
Section 401 of the Clean Water Act authorizations. Islander East appealed the
State of Connecticut's determination on the coastal zone management issue to the
United States Department of Commerce. On May 6, 2004, the Department of Commerce
overrode Connecticut's denial and granted the coastal zone management
authorization. Islander East's petition for a declaratory order challenging the
denial of the Section 401 authorization is pending with Connecticut's State
Superior Court. Once in service, the pipeline is expected to transport up to
260,000 DTH daily to the Long Island and New York City energy markets, enough
natural gas to heat 600,000 homes. The pipeline will also allow KeySpan to
diversify the geographic sources of its gas supply. Various options for the
financing of this pipeline construction are currently being evaluated. At June
30, 2004, total capitalized costs associated with the siting and permitting of
the Islander East pipeline were $18.2 million.
Electric Services
The Electric Services segment primarily consists of subsidiaries that own and
operate oil and gas fired electric generating plants in the Borough of Queens
(including the "Ravenswood facility") and the counties of Nassau and Suffolk on
Long Island. In addition, through long-term contracts of varying lengths, we
manage the electric transmission and distribution ("T&D") system, the fuel and
electric purchases, and the off-system electric sales for LIPA. The Electric
Services segment also provides retail marketing of electricity to commercial
customers, the earnings of which were previously reported in the Energy Services
segment. Financial results for 2003 have been reclassified to reflect these
activities in the Electric Services segment.
41
Selected financial data for the Electric Services segment is set forth in the
table below for the periods indicated.
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 433,763 $ 392,371 $ 792,899 $ 790,096
Purchased fuel 130,218 109,175 231,707 248,596
- --------------------------------------------------------------------------------------------------------------------------------
Net Revenues 303,545 283,196 561,192 541,500
- --------------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 172,071 179,794 319,256 344,195
Depreciation 22,359 16,188 43,965 32,808
Operating taxes 41,203 35,114 82,860 72,753
- --------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 235,633 231,096 446,081 449,756
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income $ 67,912 $ 52,100 $ 115,111 $ 91,744
- --------------------------------------------------------------------------------------------------------------------------------
Electric sales (MWH)* 1,647,531 995,433 2,630,637 1,762,782
Capacity(MW)* 2,450 2,200 2,450 2,200
Cooling degree days 300 176 300 176
- --------------------------------------------------------------------------------------------------------------------------------
*Reflects the operations of the Ravenswood facility only.
Net Revenues
Total electric net revenues realized during the second quarter of 2004 were
$20.3 million, or 7% higher than such revenues realized during the second
quarter of 2003. For the six months ended June 30, 2004, total electric net
revenues were $19.7 million, or 4% higher than the same period last year. The
increase in both the quarter and six months ended June 30, 2004, is attributable
to the operations of the Ravenswood facility.
Net revenues from the Ravenswood facility increased $25.0 million, or 38% in the
second quarter of 2004 compared to the second quarter of 2003. Comparative net
revenues reflect higher energy margins of $17.5 million, as well as higher
capacity revenues of $7.5 million.
For the six months ended June 30, 2004, net revenues from the Ravenswood
facility reflects a $25.1 million, or 20% increase over the same period last
year. Comparative net revenues reflect higher energy margins of $20.9 million,
as well as higher capacity revenues of $4.2 million.
The increase in energy margins for both the quarter and six months of 2004
reflects a higher level of megawatt hours ("MWh") sold into the New York
Independent System Operator ("NYISO") energy market, as well as higher
"spark-spreads" (the selling price of electricity less the cost of fuel, plus
hedging gains or losses). The increase in energy sales quantities reflects, in
part, the operations of the Ravenswood Expansion. (See discussion under the
caption "Other Matters" for additional information regarding the new facility.)
In addition, energy sales quantities were favorably impacted by warmer weather
in the second quarter of 2004 compared to the same quarter of 2003. As measured
in cooling degree-days, weather was approximately 70% warmer than last year.
Further, energy sales quantities in 2003 were adversely impacted by the
scheduled major overhaul of our largest electric generating unit during the
first quarter of 2003.
42
We employ derivative financial hedging instruments to hedge the cash flow
variability for a portion of forecasted purchases of natural gas and fuel oil
consumed at the Ravenswood facility. Further, we have engaged in the use of
derivative financial hedging instruments to hedge the cash flow variability
associated with a portion of forecasted peak electric energy sales from the
Ravenswood facility. These derivative instruments resulted in hedging gains,
which are reflected in net electric margins, of $1.5 million for the quarter
ended June 30, 2004, compared to hedging gains of $1.8 million for the quarter
ended June 30, 2003. For the six months ended June 30, 2004 derivative
instruments resulted in hedging losses of $2.9 million compared to hedging gains
of $3.5 million for the same period in 2003. (See Note 4 to the Consolidated
Financial Statements "Hedging and Derivative Financial Instruments" as well as
Item 3. Quantitative and Qualitative Disclosures about Market Risk for further
information).
The increase in capacity revenues for both the quarter and the first six months
of 2004 reflects the operations of the Ravenswood Expansion, as well as a
revision to the NYISO's capacity market procurement design. In 2003, the FERC
approved a revised capacity market procurement design with an effective date of
May 21, 2003. This revised capacity market procurement design is based on a
demand curve rather than relying on deficiency auctions to procure necessary
capacity. The deficiency auction with its associated fixed minimum capacity
requirements was replaced with a spot market auction that pays gradually
declining prices as additional capacity is offered and gradually increasing
prices as capacity offers decrease. This new market design recognizes the value
of capacity in excess of the minimum requirement and reduces price spikes during
periods of shortage. Essentially, the demand curve design eliminates the high
and low cycles inherent in the deficiency auction market design. This new market
design also established seasonal electric generator specific price caps. Price
caps establish the maximum price per MW that capacity can be sold into the NYISO
by generating units like those at Ravenswood (other than the new unit) divested
by Consolidated Edison Company of New York, Inc. Prior to this design change,
one price cap was established for the entire year and was effective for all
electric generators. Since the revised capacity market procurement design did
not take effect until late in the second quarter of 2003 Ravenswood's structured
price cap for the second quarter of 2004 was higher than the price cap effective
during most of the second quarter of 2003, resulting in higher capacity
revenues.
The rules and regulations for capacity, energy sales and the sale of certain
ancillary services to the NYISO energy markets continue to evolve and the FERC
has adopted several price mitigation measures that have adversely impacted
earnings from the Ravenswood facility over time. Certain of these mitigation
measures are still subject to rehearing and possible judicial review. The final
resolution of these issues and their effect on our financial position, results
of operations and cash flows cannot be fully determined at this time. (See the
caption "Market and Credit Risk Management Activities" for a further discussion
of these matters. Also see KeySpan's 2003 Annual Report on Form 10-K for the
Year Ended December 31, 2003 Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations under the caption "Market and
Credit Risk Management Activities.)
43
Net revenues from the service agreements with LIPA, including the power purchase
agreements associated with two electric peaking facilities, decreased $3.2
million, or 2% and $3.8 million, or 1% for the three and six months ended June
30, 2004, respectively, compared to the same periods last year. These decreases
reflect adjustments to the cost recovery mechanisms in the service agreements to
better align actual costs incurred with recovery of such costs. These
adjustments to revenues had little impact on operating income since actual
operating costs decreased by a like amount. (For a description of the LIPA
Agreements and power purchase agreements, see KeySpan's 2003 Annual Report on
Form 10-K for the Year Ended December 31, 2003 Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations under the caption
"Electric Services - Revenue Mechanisms.")
The remaining decrease in total electric net revenues reflects the operations of
our electric retail-marketing subsidiary, which has reduced its customer base
from last year.
Operating Expenses
Operating expenses increased $4.5 million, or 2%, in the second quarter of 2004
compared to the same quarter of 2003. This increase primarily reflects higher
property taxes on our Long Island based generating units (which are fully
recoverable from LIPA), partially offset by the implementation of FIN 46 and
lower operating costs associated with the LIPA service agreements.
Implementation of FIN 46 required KeySpan to, among other things, consolidate
the Ravenswood Master Lease and classify the lease obligation as long-term debt
on the Consolidated Balance Sheet. Further, an asset was recorded 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. As a result of implementing FIN 46, beginning January 1, 2004,
lease payments have been reflected as interest expense on the Consolidated
Statement of Income and the leased assets are being depreciated. The
reclassification of lease payments to interest expense, partially offset by the
higher depreciation expense, resulted in a comparative decrease to operating
expense of approximately $2.2 million. (See Note 6 to the Consolidated Financial
Statements "Financial Guarantees and Contingencies" for additional information
regarding the Ravenswood leasing arrangement.)
Operating expenses decreased $3.7 million, or 1%, during the six months ended
June 30, 2004 compared to the same period of 2003. This decrease reflects in
part the impact of implementing FIN 46. The reclassification of lease payments
to interest expense, partially offset by the higher depreciation expense,
resulted in a comparative decrease to operating expense of approximately $5.4
million. Further, comparative operating expenses reflect lower costs associated
with the LIPA Service Agreements. These benefits to operating expenses were
offset, in part, by higher property taxes on our Long Island based generating
units
Other Matters
The Ravenswood Expansion, a 250 MW combined cycle generating facility, was
synchronized to the electric grid in December 2003 and commenced operational
testing in January 2004. In March, the facility completed full load Dependable
Maximum Net Capacity testing and in May 2004 the facility began full commercial
operations. The entire capacity and energy produced from this plant is being
sold into the NYISO markets.
44
To finance this facility, KeySpan entered into a leveraged lease financing
arrangement. In May 2004, the facility was acquired by a lessor from our
subsidiary, KeySpan Ravenswood, LLC, and simultaneously leased back to it. All
the obligations of our subsidiary under the lease have been unconditionally
guaranteed by KeySpan. This lease transaction generated cash proceeds of $385
million, which approximates the fair market value of the facility, as determined
by a third-party appraiser. The lease has an initial term of 36 years and the
yearly operating lease expense will be approximately $17 million per year. Lease
payments will fluctuate from year to year, but are substantially paid over the
first 16 years. (See Note 6 to the Consolidated Financial Statements, "Financial
Guarantees and Contingencies" for additional information regarding this
financing arrangement.)
In 2003, the New York State Board on Electric Generation Siting and the
Environment issued an opinion and order which granted a certificate of
environmental capability and public need for a 250 MW combined cycle electric
generating facility in Melville, Long Island, which is now final and
non-appealable. Also in 2003, LIPA issued a Request for Proposal ("RFP") seeking
bids from developers to either build and operate a Long Island generating
facility, and/or a new cable that will link Long Island to dedicated off-Long
Island power of between 250 to 600 MW of electricity by no later than the summer
of 2007. KeySpan and American National Power Inc. ("ANP") filed a joint proposal
in response to LIPA's RFP. Under the proposal, KeySpan and ANP would have
jointly owned and operated two 250 MW electric generating facilities to be
located on Long Island, one of which is the Melville site and the other in the
town of Brookhaven which also has received all permits and approvals. In May
2004, LIPA tentatively selected proposals submitted by two other bidders in
response to the RFP. KeySpan remains committed to the Melville project and the
benefits to Long Island's energy future that this project would supply. We will
continue to explore all of our options for this facility. At June 30, 2004,
total capitalized costs associated with the siting, permitting and procurement
of equipment for the Melville facility were approximately $57.4 million.
Energy Services
The Energy Services segment includes subsidiaries that provide energy-related
services to customers primarily located within the Northeastern United States,
with concentrations in the New York City metropolitan area including New Jersey,
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; (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.
45
The table below highlights selected financial information for the Energy
Services segment.
- ---------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------
Revenues $ 134,024 $ 133,810 $ 266,519 $ 264,301
Less: cost of sales 104,761 113,459 210,631 218,604
- ---------------------------------------------------------------------------------------------------------------
Gross profit 29,263 20,351 55,888 45,697
Operating expenses (34,169) (30,814) (79,268) (65,282)
- ---------------------------------------------------------------------------------------------------------------
Operating (Loss) $ (4,906) $ (10,463) $ (23,380) $ (19,585)
- ---------------------------------------------------------------------------------------------------------------
The Energy Services segment realized operating losses of $4.9 million compared
to losses of $10.5 million last year. The results reflect slightly better
business conditions, improved project profit margins and cost reduction
measures.
For the six months ended June 30, 2004, the Energy Services segment realized
operating losses of $23.4 million compared to $19.6 million for the same period
last year, primarily due to an increase in operating expenses. The higher
expenses principally reflect the write-off of accounts receivable and contract
revenues on certain projects that were determined to be uncollectible, as well
as the write-down of inventory balances. Total backlog for the Energy Services
group of companies increased to $635 million at June 30, 2004 compared to $469
million at June 30, 2003, due in part to the recent award of a significant
long-term contract, as well as from the Bard, Rao + Athanas Consulting
Engineering acquisition completed in the third quarter of 2003.
The operating results of this segment continue to be below expectations.
Management will continue to monitor the operating performance of this segment
and will take appropriate action as determined necessary. In addition,
management will conduct a review of the carrying value of goodwill during the
remainder of the year. The recorded goodwill for this segment is approximately
$173 million. At this point in time, we are unable to predict what effect, if
any, the outcome of this review will have on the carrying value of our goodwill
or on financial position or our results of operations.
Energy Investments
The Energy Investment segment consists of our gas exploration and production
operations, as well as certain other domestic and international energy-related
investments. Our gas exploration and production subsidiaries include our 23.5%
ownership interest in The Houston Exploration Company ("Houston Exploration"),
as well as our wholly-owned subsidiaries KeySpan Exploration and Production LLC
("KeySpan Exploration and Production") and Seneca-Upshur Petroleum, Inc. These
companies are engaged in gas and oil exploration and production, and the
development and acquisition of domestic natural gas and oil properties.
As mentioned earlier, on June 2, 2004, KeySpan exchanged 10.8 million shares of
Houston Exploration common stock for 100% of the stock of Seneca-Upshur
Petroleum, Inc., then a wholly owned subsidiary of Houston Exploration. This
transaction reduced our interest in Houston Exploration from 55% to the current
level of 23.5%. As part of this transaction, Houston Exploration, retired 4.6
million of its common shares and issued 6.8 million new shares in a public
offering. Based on Houston Exploration's announced offering price of $48.00 per
46
share, Seneca-Upshur's shares were valued at the equivalent of $449 million, or
$41.57 per share. Seneca-Upshur's assets consist of West Virginia producing
properties valued at $60 million, and $389 million in cash. This transaction
resulted in a gain to KeySpan of $150.1 million. Effective June 1, 2004, Houston
Exploration's earnings and our ownership interest in Houston Exploration have
been accounted for on the equity method of accounting. The deconsolidation of
Houston Exploration required the recognition of certain deferred taxes on our
remaining investment resulting in a deferred tax expense of $44.1 million.
Therefore, the net gain on the share exchange, less the deferred tax provision
on the remaining investment, was $106.0 million, or $0.66 per share.
Selected financial data and operating statistics for our gas exploration and
production activities are set forth in the following table for the periods
indicated. Operating income below represents 100% of our gas exploration and
production subsidiaries' results for the five months ended May 31, 2004 and one
month of equity earnings for our 23.5% interest in Houston Exploration.
- -------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Revenues $ 118,926 $ 122,875 $ 271,345 $ 250,722
Less: Depletion and amortization expense 44,538 49,475 106,459 96,918
Full cost ceiling test write-down 48,190 - 48,190 -
Other operating expenses 17,355 23,252 45,745 48,066
Plus: Equity earnings 2,545 - 2,545 -
- -------------------------------------------------------------------------------------------------------------------------------
Operating Income $ 11,388 $ 50,148 $ 73,496 $ 105,738
- -------------------------------------------------------------------------------------------------------------------------------
Natural gas and oil production (Mmcf) 32,076 27,119 62,449 53,205
Natural gas (per Mcf) realized $ 5.39 $ 4.55 $ 5.19 $ 4.73
Natural gas (per Mcf) unhedged $ 5.85 $ 5.16 $ 5.65 $ 5.76
- -------------------------------------------------------------------------------------------------------------------------------
Gas reserves and production volumes are stated in BCFe and Mmcfe, which includes
equivalent oil reserves.
The decline in operating income of $38.8 million for the three months ended June
30, 2004 and $32.2 million for the six months ended June 30, 2004, compared to
the same periods of 2003, is attributable to the $48.2 million non-cash
impairment charge recorded by KeySpan's wholly-owned gas exploration and
production subsidiaries to reflect the reduced valuation of proved reserves.
Excluding this non-cash charge, operating income for the second quarter of 2004
benefited from an 18% increase in both production volumes and average realized
gas prices (average wellhead price received for production including hedging
gains and losses). Operating income for the six months ended June 30, 2004
benefited from a 17% increase in production volumes and a 10% increase in
average realized gas prices. (See Note 10 to the Consolidated Financial
Statements "Gas Exploration and Production Property - Depletion" for further
details on the impairment charge.)
Derivative financial hedging instruments are employed by Houston Exploration to
provide more predictable cash flow, as well as to reduce its exposure to
fluctuations in natural gas prices. The average realized gas price for the three
months ended June 30, 2004 was 92% of the average unhedged natural gas price,
resulting in revenues that were $13.9 million lower than revenues that would
have been achieved if derivative financial instruments had not been in place.
Houston Exploration has hedge positions in place for slightly less than 70% of
its estimated 2004 production, principally through the use of costless collars.
The average realized gas price for the second quarter of 2003 was 88% of the
47
average unhedged natural gas price, resulting in revenues that were $15.4
million lower than revenues that would have been achieved if derivative
financial instruments had not been in place. Houston Exploration hedged almost
70% of its 2003 production, principally through the use of costless collars.
The average realized gas price for the six months ended June 30, 2004 was 92% of
the average unhedged natural gas price, resulting in revenues that were $26.5
million lower than revenues that would have been achieved if derivative
financial instruments had not been in place. The average realized gas price for
the six months ended June 30, 2003 was 82% of the average unhedged natural gas
price, resulting in revenues that were $50.4 million lower than revenues that
would have been achieved if derivative financial instruments had not been in
place.
The decrease in depletion expense during the three months ended June 30, 2004,
primarily reflects the deconsolidation of Houston Exploration. The increase in
depletion for the six months ended June 30, 2004 is primarily due to a higher
depletion rate experienced. For the six months ended June 30, 2004 the depletion
rate was $2.06 per Mcf, compared to $1.78 per Mcf experienced during the
corresponding period in 2003. The increase in the depletion rate is the result
of additional costs to the depreciation base with fewer additions for reserves.
This segment also consists of KeySpan Canada; our 20% interest in Iroquois Gas
Transmission System LP ("Iroquois"); our wholly owned 600,000 barrel liquefied
natural gas ("LNG") storage and receiving facility located in Rhode Island
("KeySpan LNG"); and our 50% interest in Premier Transmission Limited located in
Northern Ireland.
On April 1, 2004, KeySpan and KeySpan Facilities Income Fund, which previously
owned a 39.09% interest in KeySpan Canada, (the "Fund") entered into a
transaction whereby the Fund sold 15.617 million units of the Fund at a price of
CDN$12.60 per unit for gross total proceeds of approximately CDN$196.8 million.
The proceeds of the offering were used by the Fund to acquire an additional
35.91% interest in KeySpan Canada (a KeySpan subsidiary with natural gas
processing plants and gathering facilities in Western Canada) from KeySpan. We
received net proceeds of approximately CDN$186.3 million (or approximately
US$135 million), after commissions and expenses. As a result of the transaction
the Fund's ownership in KeySpan Canada was increased from 39.1% to 75% and
KeySpan's ownership of KeySpan Canada decreased to 25%. KeySpan recorded a gain
of $22.8 million ($10.1 million after-tax, or $0.06 per share) on this
transaction. Effective April 1, 2004, KeySpan Canada's earnings and our
ownership interest in KeySpan Canada have been accounted for on the equity
method of accounting.
On July 2, 2004, the Fund issued an additional 10.7 million units, the proceeds
of which were used to fund the acquisition of the midstream assets of Chevron
Canada Midstream Inc. This transaction had the effect of further diluting
KeySpan's ownership of KeySpan Canada to 17.4%.
Selected financial data and operating statistics for these energy-related
investments are set forth in the following table for the periods indicated.
Operating income below represents 100% of KeySpan Canada's results for three
months ended March 31, 2004 and three months of equity earnings since April 1,
2004.
48
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June30,
(In Thousands of Dollars) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------
Revenues $ 8,120 $ 29,880 $ 36,565 $ 56,344
Operation and maintenance expense 6,927 19,390 22,315 36,034
Other operating expenses 1,584 5,410 7,436 10,763
Equity earnings 5,871 3,994 11,588 9,651
- ----------------------------------------------------------------------------------------------------------------------------
Operating Income $ 5,480 $ 9,074 $ 18,402 $ 19,198
- ----------------------------------------------------------------------------------------------------------------------------
The decrease in comparative operating income for both the quarter and six months
ended June 30, 2004 compared to same periods last year reflects our lower
ownership interest in KeySpan Canada. Operating income from our other
energy-related investments in 2004 is substantially the same as 2003.
We have stated in the past that we may sell or otherwise dispose of certain
Energy Investments assets. Based on current market conditions, however, we
cannot predict when, or if, additional sales or dispositions of these assets may
take place, or the effect that any such additional sale or disposition may have
on our financial position, results of operations or cash flows.
Allocated Costs
We are subject to the jurisdiction of the Securities and Exchange Commission
("SEC") under the Public Utility Holding Company Act ("PUHCA") as amended. As
part of the regulatory provisions of PUHCA, the SEC regulates various
transactions among affiliates within a holding company system. In accordance
with the SEC's regulations under PUHCA and the New York State Public Service
Commission, we have service companies that provide: (i) traditional corporate
and administrative services; (ii) gas and electric transmission and distribution
systems planning, marketing, and gas supply planning and procurement; and (iii)
engineering and surveying services to subsidiaries. Operating income variations
reflected in "elimination and other" associated with these non-operating
subsidiaries reflect expenses incurred in 2003 related to costs associated with
the implementation of the Sarbanes-Oxley Act of 2002 that were not allocated to
the various operating subsidiaries. Further, operating income variations are
also due to the timing of certain corporate expenses.
Liquidity
Cash flow from operating activities increased $208.3 million, or 36%, for the
first half of 2004 compared to the same time last year, reflecting generally
higher cash earnings and higher cash flow from gas exploration and production
activities. In addition, during the first quarter of 2004, we consolidated our
newly created "captive" insurance company, which included $43.2 million of cash
and short-term marketable securities. Comparative cash flow from operating
activities also reflects the favorable impact of the timing of certain property
tax payments.
49
At June 30, 2004, we had cash and temporary cash investments of $818 million.
During the six months ended June 30, 2004, we repaid $441.9 million of
commercial paper and, at June 30, 2004, $40 million of commercial paper was
outstanding at a weighted-average annualized interest rate of 1.2%. We had the
ability to borrow up to an additional $1.3 billion at June 30, 2004, under the
terms of our credit facility.
In June 2004, KeySpan completed the restructuring of its credit facilities. We
entered into a new $640 million five year revolving credit facility to replace
the $450 million, 364 day facility which expired in June. We also amended our
existing three year $850 million facility due June 2006 to reduce commitments
thereunder by $190 million to a new level of $660 million. The two credit
facilities total $1.3 billion and are each syndicated among sixteen banks. These
facilities continue to support KeySpan's commercial paper program for working
capital needs.
The fees for these facilities are subject to a ratings-based grid, with an
annual fee of 0.08% on the new five-year facility and 0.125% on the existing
three-year facility. Both credit agreements allow for KeySpan to borrow using
several different types of loans; specifically, Eurodollar loans, Adjustable
Bank Rate (ABR) loans, or competitively bid loans. Eurodollar loans in the
five-year facility are based on the Eurodollar rate plus a margin of 0.40% for
loans up to 33% of the total five-year facility, and an additional 0.125% for
loans over 33% of the total five-year facility. In the three-year facility
Eurodollar loans are based on the Eurodollar rate plus a margin of 0.625% for
loans up to 33% of the total three-year facility, and an additional 0.125% for
loans over 33% of the total three-year facility. ABR loans are based on the
highest of the Prime Rate, the base CD rate plus 1%, or the Federal Funds
Effective Rate plus 0.5%. Competitive bid loans are based on bid results
requested by KeySpan from the lenders. We do not anticipate borrowing against
these facilities; however, if the credit rating on our commercial paper program
were to be downgraded, it may be necessary to do so.
The facilities contain certain affirmative and negative operating covenants,
including restrictions on KeySpan's ability to mortgage, pledge, encumber or
otherwise subject its property to any lien, as well as certain financial
covenants that require us to, among other things, maintain a consolidated
indebtedness to consolidated capitalization ratio of no more than 64% until the
expiration of the existing three-year facility in 2006, at which time it will be
lowered to 62%. Violation of this covenant could result in the termination of
the facilities and the required repayment of amounts borrowed thereunder, as
well as possible cross defaults under other debt agreements.
Under the terms of the credit agreements, KeySpan's debt-to-total capitalization
ratio reflects 80% equity treatment for the MEDS Equity Units issued in May
2002. At June 30, 2004, consolidated indebtedness, as calculated under the terms
of the credit agreements was 52.7% of consolidated capitalization
50
Houston Exploration and KeySpan Canada also have revolving credit facilities
with commercial banks. During the time period that Houston Exploration's results
were consolidated with KeySpan's (the five months ended May 31, 2004) Houston
Exploration borrowed $49 million under its credit facility and repaid $136
million. KeySpan Canada repaid $17.7 million under its facility during the first
three months of 2004 (the time period in which its results were consolidated
with KeySpan's). These borrowings and repayments are included in the
Consolidated Cash Flow Statement. Cash borrowings and repayments under Houston
Exploration's and KeySpan Canada's credit facilities after the date of the stock
transactions are not reflected in the Consolidated Cash Flow Statement.
A substantial portion of consolidated revenues are derived from the operations
of businesses within the Electric Services segment, that are largely dependent
upon two large customers - LIPA and the NYISO. Additionally, our KEDNE gas
supply is concentrated with Entergy-Koch Trading. Accordingly, our cash flows
are dependent upon the timely payment or delivery of amounts or commodity owed
to us by these counterparties.
We satisfy our seasonal working capital requirements primarily through
internally generated funds and the issuance of commercial paper. We believe that
these sources of funds are sufficient to meet our seasonal working capital
needs.
Capital Expenditures and Financing
Construction Expenditures
The table below sets forth our construction expenditures by operating segment
for the periods indicated:
- -------------------------------------------------------------------------------
Six Months Ended June 30,
(In Thousands of Dollars) 2004 2003
- -------------------------------------------------------------------------------
Gas Distribution $ 180,799 $ 165,690
Electric Services 73,732 113,880
Energy Investments 148,302 149,009
Energy Services and other 10,414 5,473
- -------------------------------------------------------------------------------
$ 413,247 $ 434,052
- -------------------------------------------------------------------------------
Construction expenditures related to the Gas Distribution segment are primarily
for the renewal, replacement and expansion of the distribution system.
Construction expenditures for the Electric Services segment reflect costs: (i)
to maintain our generating facilities; and (ii) to complete the Ravenswood
Expansion. Construction expenditures related to the Energy Investments segment
primarily reflect costs associated with gas exploration and production
activities, including those of Houston Exploration through May 31, 2004, as well
as costs related to KeySpan Canada's gas processing facilities through April 1,
2004.
51
Financing
During the second quarter of 2004, KeySpan entered into a leveraged lease
financing arrangement associated with the Ravenswood Expansion. In May 2004, the
facility was acquired by a lessor from our subsidiary, KeySpan Ravenswood, LLC,
and simultaneously leased back to that subsidiary. All of the obligations of our
subsidiary under the lease have been unconditionally guaranteed by KeySpan. This
lease transaction generated cash proceeds of $385 million, which approximates
fair market value of the facility, as determined by a third-party appraiser. The
cash proceeds from this transaction were initially used to redeem outstanding
commercial paper. (See Note 6 to the Consolidated Financial Statements,
"Financial Guarantees and Contingencies" for additional information regarding
this financing arrangement.)
In August 2004, KeySpan and certain of its subsidiaries intend to redeem
approximately $758 million of outstanding debt ahead of scheduled maturities.
Included in this redemption are $700 million of medium-term notes scheduled to
mature in 2005. The remaining debt was scheduled to mature in 2009 through 2027.
It is anticipated that we will incur approximately $52 million in call premiums
and $9 million in accelerated amortization of previously recorded and deferred
debt discounts and expenses. We will continue to evaluate our capital structure
and financing strategy for the remainder of 2004 and beyond. We believe that our
current sources of funding (i.e., internally generated funds and the
availability of commercial paper) are sufficient to meet our anticipated capital
needs for the foreseeable future.
The following table represents the ratings of our long-term debt at June 30,
2004. Currently, Standard & Poor's and Moody's Investor Services ratings on
KeySpan's and its subsidiaries' long-term debt are on negative outlook.
Moody's Investor Standard
Services & Poor's FitchRatings
- ------------------------------------------------------------------------------------------------------------------
KeySpan Corporation A3 A A-
KEDNY N/A A+ A+
KEDLI A2 A+ A-
Boston Gas A2 A N/A
Colonial Gas A2 A+ N/A
Electric Generation A3 A N/A
- ------------------------------------------------------------------------------------------------------------------
Off-Balance Sheet Arrangements
Guarantees
KeySpan has a number of financial guarantees with its subsidiaries that have
remained substantially unchanged since December 31, 2003. At June 30, 2004,
KeySpan had fully and unconditionally guaranteed: (i) $525 million of
medium-term notes issued by KEDLI; (ii) the obligations of KeySpan Ravenswood
LLC, which is the lessee under the $425 million Master Lease associated with the
Ravenswood facility and the lessee under the sale/leaseback transaction; and
(iii) the payment obligations of our subsidiaries related to $128 million of
52
tax-exempt bonds issued through the Nassau County and Suffolk County Industrial
Development Authorities for the construction of two electric-generation peaking
facilities on Long Island. The medium-term notes, the Master Lease and the
tax-exempt bonds are reflected on the Consolidated Balance Sheet; the
sale/leaseback transaction is not recorded on the Consolidated Balance Sheet.
Further, KeySpan has guaranteed: (i) up to $269 million of surety bonds
associated with certain construction projects currently being performed by
subsidiaries within the Energy Services segment; (ii) certain supply contracts,
margin accounts and purchase orders for certain subsidiaries in an aggregate
amount of $64 million; and (iii) $74 million of subsidiary letters of credit.
These guarantees are not recorded on the Consolidated Balance Sheet. At this
time, 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. (See Note 6 to the Consolidated
Financial Statements, "Financial Guarantees and Contingencies" for additional
information regarding KeySpan's guarantees.)
Contractual Obligations
KeySpan has certain contractual obligations related to its outstanding long-term
debt, outstanding credit facility borrowings, outstanding commercial paper
borrowings, operating and capital leases, and demand charges associated with
certain commodity purchases. Except for the recent sale/leaseback transaction
previously noted, these obligations have remained substantially unchanged since
December 31, 2003. Cash obligations associated with the sale/leaseback
transaction are anticipated to be: (i) $2.7 million for the remainder of 2004;
(ii) $69.4 million for fiscal years 2005 through 2007; (iii) $73.4 million for
fiscal years 2008 and 2009; and (iv) $465.1 million thereafter. (For additional
details regarding these obligations see KeySpan's Annual Report on Form 10-K for
the Year Ended December 31, 2003, Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations, Note 6 "Long-Term Debt," as well
as Note 7 to those Consolidated Financial Statements "Contractual Obligations,
Financial Guarantees and Contingencies.")
Discussions of Critical Accounting Policies and Assumptions
In preparing our financial statements, the application of certain accounting
policies requires difficult, subjective and/or complex judgments. The
circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the impact of matters that are
inherently uncertain. Actual effects on our financial position and results of
operations may vary significantly from expected results if the judgments and
assumptions underlying the estimates prove to be inaccurate. At June 30, 2004,
KeySpan's critical accounting policies and assumptions have remained
substantially unchanged since December 31, 2003. Below is a brief discussion of
those critical accounting policies requiring such subjectivity. For a more
detailed discussion of these policies and assumptions see KeySpan's Annual
Report on Form 10-K for the Year Ended December 31, 2003, Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations
"Discussion of Critical Accounting Policies and Assumptions."
53
Percentage of Completion Accounting
Percentage-of-completion accounting is a method of accounting for long-term
construction type contracts in accordance with Generally Accepted Accounting
Principles and, accordingly, the method used for engineering and mechanical
contracting revenue recognition by the Energy Services segment. Due to
uncertainties inherent within estimates employed to apply
percentage-of-completion accounting, it is possible that estimates will be
revised as project work progresses. Changes in estimates resulting in additional
future costs to complete projects can result in reduced margins or loss
contracts.
Valuation of Goodwill
KeySpan records goodwill on purchase transactions, representing the excess of
acquisition cost over the fair value of net assets acquired. In testing for
goodwill impairment under Statement of Financial Accounting Standards ("SFAS")
142 "Goodwill and Other Intangible Assets", significant reliance is placed upon
a number of estimates regarding future performance that require broad
assumptions and significant judgment by management. A change in the fair value
of our investments could cause a significant change in the carrying value of
goodwill. The assumptions used to measure the fair value of our investments are
the same as those used by us to prepare annual operating segment and
consolidated earnings and cash flow forecasts. In addition, these assumptions
are used to set annual budgetary guidelines.
Although management determined that the fair value of KeySpan's assets
adequately exceeded their carrying value for the year ended December 31, 2003,
the operating performance of the Energy Services segment continues to be below
expectations. Management will continue to monitor the operating performance of
this segment and will conduct a review of the carrying value of goodwill during
the remainder of the year. The recorded goodwill for this segment, as a result
of prior acquisitions, is approximately $173 million. At this point in time, we
are unable to predict what effect, if any, the outcome of this review will have
on the carrying value of our goodwill or on our financial position or results of
operations.
Management will continue to review and focus on its overall strategy for each of
KeySpan's business units and accordingly will continue to evaluate the carrying
value of goodwill. While we believe that our assumptions are reasonable, actual
results, however, may differ from our projections.
Accounting for the Effects of Rate Regulation on Gas Distribution Operations
The financial statements of the Gas Distribution segment reflect the ratemaking
policies and orders of the New York State Public Service Commission ("NYPSC"),
the New Hampshire Public Utility Commission ("NHPUC"), and the DTE.
54
Four of our six regulated gas utilities (KEDNY, KEDLI, Boston Gas Company and
EnergyNorth Natural Gas, Inc.) are subject to the provisions of SFAS 71,
"Accounting for the Effects of Certain Types of Regulation." This statement
recognizes the actions of regulators, through the ratemaking process, to create
future economic benefits and obligations affecting rate-regulated companies.
In separate merger-related orders issued by the DTE, the base rates charged by
Colonial Gas Company and Essex Gas Company have been frozen at their current
levels for a ten-year period ending 2009. Due to the length of these base rate
freezes, the Colonial and Essex Gas Companies had previously discontinued the
application of SFAS 71.
As is further discussed under the caption "Regulation and Rate Matters," the
rate plans previously in effect for KEDNY and KEDLI have expired. The continued
application of SFAS 71 to record the activities of these subsidiaries is
contingent upon the actions of regulators with regard to future rate plans. We
are currently evaluating various options that may be available to us including,
but not limited to, proposing new plans for KEDNY and KEDLI. The ultimate
resolution of any future rate plans could have a significant impact on the
application of SFAS 71 to these entities and, accordingly, on our financial
position, results of operations and cash flows. However, management believes
that currently available facts support the continued application of SFAS 71 and
that all regulatory assets and liabilities are recoverable or refundable through
the regulatory environment. It should be noted that the DTE approved a base
revenue increase for the Boston Gas Company in the fourth quarter of 2003. (See
the discussion under the caption "Regulation and Rate Matters" for additional
information regarding the DTE's rate decision.)
Rate regulation is undergoing significant change as regulators and customers
seek lower prices for utility service and greater competition among energy
service providers. In the event that regulation significantly changes the
opportunity for us to recover costs in the future, all or a portion of our
regulated operations may no longer meet the criteria for the application of SFAS
71. In that event, a write-down of our existing regulatory assets and
liabilities could result. In management's opinion, our regulated subsidiaries
that currently are subject to the provisions of SFAS 71 will continue to be
subject to SFAS 71 for the foreseeable future.
Pension and Other Postretirement Benefits
KeySpan participates in both non-contributory defined benefit pension plans, as
well as other post-retirement benefit ("OPEB") plans (collectively
"postretirement plans"). KeySpan's reported costs of providing pension and OPEB
benefits are dependent upon numerous factors resulting from actual plan
experience and assumptions of future experience. Pension and OPEB costs
(collectively "postretirement costs") are impacted by actual employee
demographics, the level of contributions made to the plans, earnings on plan
assets, and health care cost trends. Changes made to the provisions of these
plans may also impact current and future postretirement costs. Postretirement
costs may also be significantly affected by changes in key actuarial
assumptions, including anticipated rates of return on plan assets and the
discount rates used in determining the postretirement costs and benefit
obligations. Actual results that differ from our assumptions are accumulated and
amortized over ten years.
55
Historically, we have funded our qualified pension plans in excess of the amount
required to satisfy minimum ERISA funding requirements. At June 30, 2004, we had
a funding credit balance in excess of the ERISA minimum funding requirements.
Although we have presently exceeded ERISA funding requirements, our pension
plans, on an actuarial basis, are currently underfunded. Therefore, for 2004,
KeySpan expects to contribute a total of $147 million to its funded and unfunded
post-retirement plans. Future funding requirements are heavily dependent on
actual return on plan assets and prevailing interest rates. (In addition to Item
7 Management's Discussion and Analysis of Financial Condition and Results of
Operations in KeySpan's Annual Report on Form 10-K for the Year Ended December
31, 2003, see also Note 4 of those Consolidated Financial Statements,
"Postretirement Benefits.")
Full Cost Accounting
Our gas exploration and production subsidiaries use the full cost method to
account for their natural gas and oil properties. Under full cost accounting,
all costs incurred in the acquisition, exploration, and development of natural
gas and oil reserves are capitalized into a "full cost pool." Capitalized costs
include costs of all unproved properties, internal costs directly related to
natural gas and oil activities, and capitalized interest.
Under full cost accounting rules, total capitalized costs are limited to a
ceiling equal to the present value of future net revenues, discounted at 10%,
plus the lower of cost or fair value of unproved properties less income tax
effects (the "ceiling limitation"). A quarterly ceiling test is performed to
evaluate whether the net book value of the full cost pool exceeds the ceiling
limitation. If capitalized costs (net of accumulated depreciation, depletion and
amortization) less deferred taxes are greater than the discounted future net
revenues or ceiling limitation, a write-down or impairment of the full cost pool
is required. At June 30, 2004 such a write-down was required for our
wholly-owned gas exploration and production subsidiaries' full cost pool and we
recorded a non-cash impairment charge of $48.2 million. (See Note 10 to the
Consolidated Financial Statements "Gas Exploration and Production Property -
Depletion" for additional details regarding this charge.)
Natural gas and oil reserve quantities represent estimates only. Under full cost
accounting, reserve estimates are used to determine the full cost ceiling
limitation as well as the depletion rate. Our gas exploration and production
subsidiaries estimate proved reserves and future net revenues using sales prices
estimated to be in effect as of the date it makes the reserve estimates.
Further, our subsidiaries employ independent petroleum engineers in the
preparation of estimated reserve quantities. Natural gas prices, which have
fluctuated widely in recent years, affect estimated quantities of proved
reserves and future net revenues. Any estimates of natural gas and oil reserves
and their values are inherently uncertain, including many factors beyond our
control.
Accounting for Sales of Stock by a Subsidiary
KeySpan applies the accounting principle of income recognition for gains or
losses associated with the sale of stock by its subsidiaries. As provided for in
Staff Accounting Bulletin Topic 5-H ("SAB 51"), the SEC allows for income
recognition of gains or losses on subsidiary stock transactions in instances
56
where the transaction is not part of a broader corporate reorganization
contemplated by the parent. Provided that no other capital transactions are
contemplated with regard to the shares issued, income statement treatment in
consolidation for issuance of stock by a subsidiary is appropriate. SAB 51
requires that this accounting treatment, if elected by the parent, must be
consistently applied to all subsidiary stock transactions that meet the
conditions for income statement recognition. As noted earlier, KeySpan has
appropriately applied this accounting treatment to its recent subsidiary stock
transactions.
Regulation and Rate Matters
Gas Matters
As of June 30, 2004, the rate agreements for KEDNY and KEDLI have expired. Under
the terms of the KEDNY and KEDLI rate agreements, gas distribution rates and all
other provisions will remain in effect until changed by the NYPSC. At this time,
we are currently evaluating various options that may be available to us
regarding the KEDNY and KEDLI rate plans, including but not limited to,
proposing new rate plans.
Effective November 1, 2003, the DTE approved a $25.9 million increase in base
revenues for the Boston Gas Company with an allowed return on equity of 10.2%
reflecting an equal balance of debt and equity. On January 27, 2004 the DTE
issued its order on Boston Gas Company's Motion for Recalculation,
Reconsideration and Clarification that granted an additional $1.1 million in
base revenues, for a total of $27 million. The DTE also approved a Performance
Based Rate Plan (the "Plan") for up to ten years.
For an additional discussion of our current gas distribution rate agreements,
see KeySpan's Annual Report on Form 10-K for the Year Ended December 31, 2003,
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operations "Regulation and Rate Matters."
Electric Matters
KeySpan sells to LIPA all of the capacity and, to the extent requested, energy
conversion services from our existing Long Island based oil and gas-fired
generating plants. Sales of capacity and energy conversion services are made
under rates approved by the Federal Energy Regulatory Commission ("FERC") in
accordance with the Power Supply Agreement ("PSA") entered into between KeySpan
and LIPA in 1998. The prior FERC approved rates, which had been in effect since
May 1998, expired on December 31, 2003. KeySpan filed with the FERC an updated
cost of service for the Long Island based generating plants in October 2003. The
rate filing included, among other things, an annual revenue increase of 2.1% or
approximately $6.4 million, a return on equity of 11%, updated operating and
maintenance expense levels and recovery of certain other costs. FERC approved
implementation of new rates starting January 1, 2004, subject to refund.
Settlement negotiations with LIPA are currently ongoing.
57
Securities and Exchange Commission Regulation
KeySpan and certain of its subsidiaries are subject to the jurisdiction of the
SEC under PUHCA. The rules and regulations under PUHCA generally limit the
operations of a registered holding company to a single integrated public utility
system, plus additional energy-related businesses. In addition, the principal
regulatory provisions of PUHCA: (i) regulate certain transactions among
affiliates within a holding company system including the payment of dividends by
such subsidiaries to a holding company; (ii) govern the issuance, acquisition
and disposition of securities and assets by a holding company and its
subsidiaries; (iii) limit the entry by registered holding companies and their
subsidiaries into businesses other than electric and/or gas utility businesses;
and (iv) require SEC approval for certain utility mergers and acquisitions. As a
result of the recent transactions with Houston Exploration and KeySpan Canada
these entities are no longer subject to SEC jurisdiction under PUHCA
KeySpan has the authorization, under PUHCA to do the following through December
31, 2006 (the "Authorization Period"): (a) to issue and sell up to an additional
amount of $3.0 billion of common stock, preferred stock, preferred and
equity-linked securities, and long-term debt securities (the "Long-Term
Financing Limit") in accordance with certain defined parameters; (b) in addition
to the Long-Term Financing Limit, to issue and sell up to an aggregate amount of
$1.3 billion of short-term debt; (c) to issue up to 13 million shares of common
stock under dividend reinvestment and stock-based management incentive and
employee benefit plans; (d) to maintain existing and enter into additional
hedging transactions with respect to outstanding indebtedness in order to manage
and minimize interest rate costs; (e) to issue guarantees and other forms of
credit support in an aggregate principal amount not to exceed $4.0 billion
outstanding at any one time; (f) to refund, repurchase (through open market
purchases, tender offers or private transactions), replace or refinance debt or
equity securities outstanding during the Authorization Period through the
issuance of similar or any other type of authorized securities; (g) to pay
dividends out of capital and unearned surplus as well as paid-in-capital with
respect to certain subsidiaries, subject to certain limitations; (h) to engage
in preliminary development activities and administrative and management
activities in connection with anticipated investments in exempt wholesale
generators, foreign utility companies and other energy-related companies; (i) to
organize and/or acquire the equity securities of entities that will serve the
purpose of facilitating authorized financings; (j) to invest up to $3.0 billion
in exempt wholesale generators and foreign utility companies; (k) to create
and/or acquire the securities of entities organized for the purpose of
facilitating investments in other non-utility subsidiaries; and (l) to enter
into certain types of affiliate transactions between certain non-utility
subsidiaries involving cost structures above the typical "at-cost" limit.
In addition, we have committed that during the Authorization Period, our common
equity will be at least 30% of our consolidated capitalization and each of our
utility subsidiaries' common equity will be at least 30% of such entity's
capitalization. At June 30, 2004, KeySpan's consolidated common equity was 43%
of its consolidated capitalization, including commercial paper, and each of its
utility subsidiaries common equity was at least 31% of its respective
capitalization.
58
Environmental Matters
KeySpan is subject to various federal, state and local laws and regulatory
programs related to the environment. We estimate that the remaining cost of our
manufactured gas plant ("MGP") related environmental cleanup activities,
including costs associated with the Ravenswood facility, will be approximately
$255.5 million and we have recorded a related liability for such amount. We have
also recorded an additional $24.1 million liability representing the estimated
environmental cleanup costs related to a former coal tar processing facility.
Further, as of June 30, 2004, we have expended a total of $114.9 million on
environmental remediation. (See Note 6 to the Consolidated Financial Statements,
"Financial Guarantees and Contingencies".)
Market and Credit Risk Management Activities
Market Risk: KeySpan is exposed to market risk arising from potential changes in
one or more market variables, such as energy commodity prices, interest rates,
foreign currency exchange rates, volumetric risk due to weather or other
variables. Such risk includes any or all changes in value whether caused by
commodity positions, asset ownership, business or contractual obligations, debt
covenants, exposure concentration, currency, weather, and other factors
regardless of accounting method. We manage our exposure to changes in market
prices using various risk management techniques for non-trading purposes,
including hedging through the use of derivative instruments, both
exchange-traded and over-the-counter contracts, purchase of insurance and
execution of other contractual arrangements.
Credit Risk: KeySpan is exposed to credit risk arising from the potential that
our counterparties fail to perform on their contractual obligations. Our credit
exposures are created primarily through the sale of gas and transportation
services to residential, commercial, electric generation, and industrial
customers and the provision of retail access services to gas marketers, by our
regulated gas businesses; the sale of commodities and services to LIPA and the
NYISO; the sale of gas, power and services to our retail customers by our
unregulated energy service businesses; entering into financial and energy
derivative contracts with energy marketing companies and financial institutions;
and the sale of gas, natural gas liquids, oil and processing services to energy
marketing and oil and gas production companies.
We have regional concentration of credit risk due to receivables from
residential, commercial and industrial customers in New York, New Hampshire and
Massachusetts, although this credit risk is spread over a diversified base of
residential, commercial and industrial customers. Customers' payment records are
monitored and action is taken, when appropriate. Companies within the Energy
Services segment have a concentration of credit risk to large customers and to
the governmental and healthcare industries.
We also have concentrations of credit risk from LIPA, our largest customer, and
from other energy companies. Concentration of energy company counterparties may
impact overall exposure to credit risk in that our counterparties may be
similarly impacted by changes in economic, regulatory or other considerations.
We actively monitor the credit profile of our wholesale counterparties in
59
derivative and other contractual arrangements, and manage our level of exposure
accordingly. In instances where counterparties' credit quality has declined, we
may limit our credit exposure by restricting new transactions with the
counterparty, requiring additional collateral or credit support and negotiating
the early termination of certain agreements.
Equity and Debt Securities Risk: KeySpan is exposed to price risk due to
investments in equity and debt securities held to fund benefit payments for
various employee pension and other postretirement benefit plans. To the extent
that the values of investments held decline, the effect will be reflected in
KeySpan's recognition of periodic cost of such employee benefit plans and the
determination of the amount of cash to be contributed to the employee benefit
plans.
Regulatory Issues and Competitive Environment: We are subject to various other
risk exposures and uncertainties associated with our gas and electric
operations. The most significant contingency involves the evolution of the gas
distribution and electric industries towards more competitive and deregulated
environments. These risks have not changed substantially since December 31,
2003. Nevertheless, the rules and regulations for capacity, energy sales and the
sale of certain ancillary services to the NYISO market continue to evolve.
Certain of these mitigation measures are still subject to rehearing and possible
judicial review. The following discussion is an update to the ongoing judicial
review that has previously been discussed in KeySpan's Annual Report on Form
10-K for the Year Ended December 31, 2003.
Due to volatility in the market clearing price of 10-minute spinning and
non-spinning reserves during the first quarter of 2000, the NYISO requested that
FERC approve a bid cap on reserves as well as requiring a refunding of so called
alleged "excess payments" received by sellers, including Ravenswood. On May 31,
2000, FERC issued an order that granted approval of a $2.52 per MWh bid cap for
10 minute non-spinning reserves, plus payments for the opportunity cost of not
making energy sales. The other requests, such as a bid cap for spinning
reserves, retroactive refunds, recalculation of reserve prices for March 2000,
and convening a technical conference and settlement proceeding, were rejected.
The NYISO, Con Edison, Niagara Mohawk Power Corporation and Rochester Gas and
Electric each individually appealed FERC's order to Federal court. The appeals
were consolidated into one case by the court. On November 7, 2003 the United
States Court of Appeals for the District of Columbia (the "Court") issued its
decision in the case of Consolidated Edison Company of New York, Inc., v.
Federal Energy Regulatory Commission ("Decision"). Essentially, the Court found
errors in the Commission's decision and remanded some issues in the case back to
the Commission for further explanation and action. The FERC has not acted on the
remand.
On June 25, 2004, the NYISO submitted a motion to FERC seeking refunds as a
result of the Decision. KeySpan and others submitted statements of opposition
opposing the refunds. FERC has not acted on the remand or the NYISO's refund
motion and we cannot predict the outcome of these proceedings.
60
For additional information regarding these risks see KeySpan's Annual Report on
Form 10-K for the Year Ended December 31, 2003, Item 7 Management's Discussion
and Analysis of Financial Condition and Results of Operations "Market and Credit
Risk Management Activities."
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q concerning
expectations, beliefs, plans, objectives, goals, strategies, future events or
performance and underlying assumptions and other statements that are other than
statements of historical facts, are "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Without limiting the foregoing, all statements under the captions "Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Item 3. Quantitative and Qualitative Disclosures About Market
Risk" relating to our future outlook, anticipated capital expenditures, future
cash flows and borrowings, pursuit of potential future acquisition opportunities
and sources of funding, are forward-looking statements. Such forward-looking
statements reflect numerous assumptions and involve a number of risks and
uncertainties and actual results may differ materially from those discussed in
such statements.
Among the factors that could cause actual results to differ materially are:
- - volatility of energy prices used to generate electricity;
- - fluctuations in weather and in gas and electric prices;
- - general economic conditions, especially in the Northeast United States;
- - our ability to successfully manage our cost structure and operate
efficiently;
- - our ability to successfully contract for natural gas supplies required to
meet the needs of our customers;
- - implementation of new accounting standards;
- - inflationary trends and interest rates;
- - the ability of KeySpan to identify and make complementary acquisitions, as
well as the successful integration of recent and future acquisitions;
- - available sources and cost of fuel;
- - creditworthiness of counterparties to derivative instruments and commodity
contracts;
- - the resolution of certain disputes with LIPA concerning each party's rights
and obligations under various agreements;
- - retention of key personnel;
61
- - federal and state regulatory initiatives that increase competition,
threaten cost and investment recovery, and place limits on the type and
manner in which we invest in new businesses and conduct operations;
- - the impact of federal and state utility regulatory policies and orders on
our regulated and unregulated businesses;
- - potential write-down of our investment in natural gas properties when
natural gas prices are depressed or if we have significant downward
revisions in our estimated proved gas reserves;
- - competition facing our unregulated Energy Services businesses, including
but not limited to competition from other mechanical, plumbing, heating,
ventilation and air conditioning, and engineering companies, as well as,
other utilities and utility holding companies that are permitted to engage
in such activities;
- - the degree to which we develop unregulated business ventures, as well as
federal and state regulatory policies affecting our ability to retain and
operate such business ventures profitably;
- - changes in political conditions, acts of war or terrorism;
- - changes in rates of return on overall debt and equity markets could have an
adverse impact on the value of pension assets;
- - changes in accounting standards or GAAP which may require adjustment to
financial statements;
- - a change in the fair value of our investments that could cause a
significant change in the carrying value of goodwill;
- - timely receipts of payments from our two largest customers LIPA and the
NYISO; and
- - other risks detailed from time to time in other reports and other documents
filed by KeySpan with the SEC.
For any of these statements, KeySpan claims the protection of the safe harbor
for forward-looking information contained in the Private Securities Litigation
Reform Act of 1995, as amended. For additional discussion on these risks,
uncertainties and assumptions, see "Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Financially-Settled Commodity Derivative Instruments - Non-Regulated 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
62
cash flow variability associated with forecasted sales of natural gas. However,
since Houston Exploration is no longer a consolidated subsidiary its derivative
financial instruments are not reflected on the June 30, 2004 Consolidated
Balance Sheet. 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 peak
electric energy sales.
KeySpan uses standard NYMEX futures prices to value gas futures contracts and
market quoted forward prices to value oil swap and natural gas basis swap
contracts associated with its Ravenswood facility. We also use market quoted
forward prices to value electric derivatives associated with the Ravenswood
facility.
The following tables set forth selected financial data associated with these
derivative financial instruments noted above that were outstanding at June 30,
2004.
- -----------------------------------------------------------------------------------------------------------------------------------
Year of Fair Value
Type of Contract not updated Maturity Volumes mmcf Fixed Price $ Current Price $ ($000)
- -----------------------------------------------------------------------------------------------------------------------------------
Gas
Swaps/Futures - Long Natural Gas 2004 40 5.11 - 6.75 6.16 - 6.17 15
2005 60 4.95 - 6.42 5.82 - 5.89 (19)
- -----------------------------------------------------------------------------------------------------------------------------------
100 (4)
- -----------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Price Current Price Fair Value
Type of Contract Maturity Barrels $ $ ($000)
- ---------------------------------------------------------------------------------------------------------------------------------
Oil
Swaps - Long Fuel Oil 2004 67,000 24.85 - 34.40 31.70 - 33.44 195
2005 84,000 24.65 - 34.40 32.89 - 34.67 210
2006 12,000 34.40 34.40 (43)
- ---------------------------------------------------------------------------------------------------------------------------------
163,000 362
- ---------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
Year of Fixed Margin/ Fair Value
Type of Contract Maturity MWh Price $ Current Price $ ($000)
- -----------------------------------------------------------------------------------------------------------------------------
Electricity
Swaps - Energy 2004 1,084,800 16.00 - 102.35 19.77 - 100.50 2,770
2005 684,800 16.64 - 72.00 20.74 - 72.71 (1,392)
- -----------------------------------------------------------------------------------------------------------------------------
1,769,600 1,378
- -----------------------------------------------------------------------------------------------------------------------------
63
- ------------------------------------------------------------------------------
2004
Change in Fair Value of Derivative Instruments ($000)
- ------------------------------------------------------------------------------
Fair value of contracts at January 1, $(36,224)
Losses on contracts realized 25,433
Derivative balance that has been de-consolidated 14,331
(Decrease) in fair value of all open contracts (1,804)
- ------------------------------------------------------------------------------
Fair value of contracts outstanding at March 31, $ 1,736
- ------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
(In Thousands of Dollars)
- ---------------------------------------------------------------------------------------------------------------
Fair Value of Contracts
- ---------------------------------------------------------------------------------------------------------------
Mature Within Total
Sources of Fair Value 12 Months Thereafter Fair Value
- ---------------------------------------------------------------------------------------------------------------
Prices actively quoted $ 12 (16) $ (4)
Prices based on models and
other valuation methods - - -
Local published indicies 1,883 (143) 1,740
- ---------------------------------------------------------------------------------------------------------------
$ 1,895 $ (159) $ 1,736
- ---------------------------------------------------------------------------------------------------------------
We measure the commodity risk of our derivative hedging instruments using a
sensitivity analysis. Based on a sensitivity analysis as of June 30, 2004, a 10%
increase in electricity and fuel prices would reduce the value of derivative
instruments maturing in 2004 by $1.8 million, while the value of expected
physical power production for the remainder of 2004 would be enhanced $5.6
million (net benefit to KeySpan of $3.8 million). A 10% decrease in electricity
and fuel prices would enhance the value of derivative instruments maturing in
2004 by $1.9 million, while the value of expected physical power production
would be reduced $6.6 million (net cost to KeySpan of $4.7 million).
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative
financial instruments to reduce the cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations. The accounting for these derivative instruments is
subject to SFAS 71 "Accounting for the Effects of Certain Types of Regulation."
Therefore, changes in the fair value of these derivatives have been recorded as
a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
Gains or losses on the settlement of these contracts are initially deferred and
then refunded to or collected from our firm gas sales customers consistent with
regulatory requirements.
64
The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at June 30, 2004.
- ------------------------------------------------------------------------------------------------------------------------------
Fair
Type of Year of Volumes Floor Ceiling Fixed Price Current Value
Contract Maturity mmcf ($) ($) ($) Price ($) ($000)
- ------------------------------------------------------------------------------------------------------------------------------
Options 2004 4,500 5.00 - 6.00 5.00 - 7.00 - 6.16 - 6.68 562
2005 5,160 5.00 - 6.00 5.00 - 7.00 - 5.82 - 6.81 1,138
Swaps 2004 14,760 - - 5.60 - 5.99 6.16 - 6.68 10,345
2005 24,000 - - 5.81 - 6.01 5.82 - 6.81 16,135
2006 1,030 - - 6.03 - 6.16 5.28 - 6.33 (50)
- ------------------------------------------------------------------------------------------------------------------------------
49,450 28,130
- ------------------------------------------------------------------------------------------------------------------------------
See Note 4 to the Consolidated Financial Statements "Hedging and Derivative
Financial Instruments" for a further description of all our derivative
instruments.
Item 4. Controls and Procedures
KeySpan maintains "disclosure controls and procedures", as such term is defined
under Exchange Act Rule 13a-15(e), that are designed to ensure that information
required to be disclosed by KeySpan in the reports it files or submits under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and that such information
is accumulated and communicated to KeySpan's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.
An evaluation of the effectiveness of KeySpan's disclosure controls and
procedures as of June 30, 2004 was conducted under the supervision and with the
participation of KeySpan's Chief Executive Officer and Chief Financial Officer.
Based on that evaluation, KeySpan's Chief Executive Officer and Chief Financial
Officer have concluded that KeySpan's disclosure controls and procedures were
adequate and designed to ensure that material information relating to KeySpan
and its consolidated subsidiaries would be made known to the Chief Executive
Officer and Chief Financial Officer by others within those entities,
particularly during the periods when periodic reports under the Exchange Act are
being prepared. Furthermore, there has been no change in KeySpan's internal
control over financial reporting, identified in connection with the evaluation
of such control, that occurred during KeySpan's last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, KeySpan's
internal control over financial reporting. Refer to the Certifications by
KeySpan's Chief Executive Officer and Chief Financial Officer filed as exhibits
31.1 and 31.2 to this report.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Note 6 to the Consolidated Financial Statements "Financial Guarantees and
Contingencies".
65
Item 4. Submission of Matters to a Vote of Security Holders
We held our Annual Meeting of Shareholders on May 20, 2004, at 10:00 a.m.
Eastern Time, at KeySpan's Auditorium located at our corporate headquarters at
One MetroTech Center, Brooklyn, New York to consider and take action on the
following items:
1. Election of Ten Directors
The names of the persons who received a plurality of the votes cast by the
holders of shares entitled to vote thereon, and who were accordingly elected
Directors of KeySpan for a one year term or until their successors are duly
elected or chosen and qualified are as follows:
DIRECTOR VOTES VOTES TOTAL
FOR WITHHELD VOTES
Robert B. Catell 128,233,166 4,407,512 132,640,678
Andrea S. Christensen 128,614,745 4,025,933 132,640,678
Alan H. Fishman 127,658,738 4,981,940 132,640,678
J. Atwood Ives 127,607,605 5,033,073 132,640,678
James R. Jones 128,359,642 4,281,036 132,640,678
James L. Larocca 128,597,354 4,043,324 132,640,678
Gloria C. Larson 129,358,881 3,281,797 132,640,678
Stephen W. McKessy 127,968,342 4,672,336 132,640,678
Edward D. Miller 128,868,484 3,772,194 132,640,678
Vikki L. Pryor 129,343,203 3,297,475 132,640,678
2. Ratification of Deloitte & Touche LLP, as Independent Public Accountants
Deloitte & Touche LLP received a majority of the votes cast by the holders of
shares entitled to vote thereon, and were accordingly ratified as the
Independent Public Accountants of KeySpan for the fiscal year ending December
31, 2004.
DELOITTE & TOUCHE LLP VOTES CAST
FOR 128,736,744
AGAINST 2,505,960
ABSTAIN 1,397,974
TOTAL 132,640,678
66
3. Shareholder Proposal
The shareholder proposal on the Shareholder Rights Plan received a majority of
the votes cast by the holders of shares entitled to vote thereon, and was
accordingly approved.
SHAREHOLDER PROPOSAL VOTES CAST
FOR 63,212,949
AGAINST 33,534,579
NON-VOTES 32,493,890
ABSTAIN 3,399,260
TOTAL 132,640,678
Item 5. Other Information
KeySpan had adopted a Shareholder Right Plan (the "Plan") on March 30, 1999 with
a ten year expiration date. In June 2004, KeySpan's Board determined to amend
the Plan to provide for it to terminate effective September 30, 2004.
Additionally, the Board also adopted a policy whereby the Corporation will not
adopt and implement a new Plan (or similar type of plan), unless it submits such
Plan to a vote of the shareholders; provided, however, that the Board reserved
the right to adopt and implement such a Plan without shareholder approval, if,
under the circumstances then existing, the Board in the exercise of its
fiduciary responsibilities deems it to be in the best interest of the
Corporation and its shareholders to immediately adopt such a Plan without the
delay associated with seeking shareholder approval. In such case, the Board will
seek shareholder ratification of the Plan no later than 12 months from the date
of adoption of any new Plan.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
4.1* Credit Agreement among KeySpan Corporation, the several Lenders, ABN AMRO
Bank N.V. and Citibank, N.A., as co-syndication agents, The Bank of New
York and The Royal Bank of Scotland plc, as co-documentation agents, and
JPMorgan Chase Bank, as administrative agent for $640 million, dated as of
June 30, 2004.
4.2* First Amendment to Credit Agreement dated as of June 27, 2003 among KeySpan
Corporation, the several Lenders, Citibank N.A., as Syndication Agent, The
Bank of New York and The Royal Bank of Scotland plc, as co-documentation
agents, and JPMorgan Chase Bank, as administrative agent to reduce the
amount from $850 million to $660 million, dated as of June 25, 2004.
10.1*KeySpan Guaranty dated May 25, 2005 relating to the 250 MW Ravenswood
expansion plant.
10.2*Facility Lease Agreement dated as of May 25, 2004 between SE Ravenswood
Trust, a Delaware statutory trust and KeySpan-Ravenswood, LLC relating to
the 250 MW Ravenswood expansion plant.
10.3*Site Lease and Easement Agreement dated as of May 25, 2004 between
KeySpan-Ravenswood, LLC and SE Ravenswood Trust relating to the 250 MW
Ravenswood expansion plant.
10.4*Site Sublease dated as of May 25, 2004 between SE Ravenswood Trust and
KeySpan-Ravenswood, LLC relating to the 250 MW Ravenswood expansion plant.
67
10.5 Distribution Agreement dated June 2, 2004 by and among The Houston
Exploration Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp. and
KeySpan Corporation (filed as Exhibit 99.2 to The Houston Exploration
Company's Form 8-K dated as of June 3, 2004).
10.6 Asset Contribution Agreement dated June 2, 2004 between The Houston
Exploration Company and Seneca-Upshur Petroleum, Inc. (filed as Exhibit
99.3 to The Houston Exploration Company's Form 8-K dated as of June 3,
2004).
10.7 Tax Matters Agreement dated June 2, 2004 by and among The Houston
Exploration Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp. and
KeySpan Corporation (filed as Exhibit 99.4 to The Houston Exploration
Company's Form 8-K dated as of June 3, 2004).
10.8 Amended and Restated Registration Rights Agreement dated June 2, 2004
between The Houston Exploration Company, THEC Holdings Corp. and KeySpan
Corporation (filed as Exhibit 99.2 to The Houston Exploration Company's
Form 8-K dated as of June 3, 2004).
31.1*Certification of the Chairman and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*Certification of the Executive Vice President and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*Certification of the Chairman and Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*Certification of the Executive Vice President and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
On April 30, 2004, the Company reported that it had issued a press release
concerning, among other things, its consolidated earnings for the quarter ended
March 31, 2004. It also reported that it would be hosting an earnings conference
call at 10:30 A.M. EST on April 30, 2004 to discuss its consolidated earnings
for the quarter ended March 31, 2004.
On April 30, 2004, the Company reported that beginning on May 2, 2004, the
Company would give a series of presentations at the American Gas Association
("AGA") Financial Forum.
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On May 24, 2004, the Company reported that it had issued a press release
disclosing that it planned to enter into an agreement to exchange thirty one
percent of its shares of common stock of The Houston Exploration Company
("THEC") for a THEC subsidiary.
On May 27, 2004, the Company reported that it had issued a press release
announcing the successful pricing of an exchange transaction with The Houston
Exploration Company.
On June 2, 2004, the Company reported that it had issued a press release
announcing the successful completion of an exchange transaction with The Houston
Exploration Company.
- ----------------------
*Filed Herewith
KEYSPAN CORPORATION AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf of the undersigned
there unto duly authorized.
KEYSPAN CORPORATION
(Registrant)
Date: August 5, 2004 /s/ Gerald Luterman
-----------------------------
Gerald Luterman
Executive Vice President and
Chief Financial Officer
69