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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 March 31, 2005
[ ] 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
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(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)
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.[X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).[X}
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock Outstanding at April 13, 2005
--------------------- -------------------------------
$.01 par value 161,614,217
KEYSPAN CORPORATION AND SUBSIDIARIES
INDEX
Part I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheet -
March 31, 2005 and December 31, 2004 3
Consolidated Statement of Income -
Three Months Ended March 31, 2005 and 2004 5
Consolidated Statement of Cash Flows -
Three Months Ended March 31, 2005 and 2004 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 34
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 59
Item 4. Controls and Procedures 62
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 62
Item 6. Exhibits and Reports on Form 8-K 62
Signatures 63
2
CONSOLIDATED BALANCE SHEET
(Unaudited)
- --------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars) March 31, 2005 December 31, 2004
- --------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 223.0 $ 922.0
Accounts receivable 1,160.3 788.5
Unbilled revenue 500.9 591.4
Allowance for uncollectible accounts (85.5) (67.8)
Gas in storage, at average cost 212.2 515.5
Material and supplies, at average cost 127.6 123.4
Other 130.9 162.7
Assets of discontinued operations 3.4 42.9
------------------------------ ---------------------------
2,272.8 3,078.6
------------------------------ ---------------------------
Investments and Other 236.6 272.9
Property
Gas 6,938.7 6,871.2
Electric 2,433.7 2,402.1
Other 403.2 398.6
Accumulated depreciation (2,757.2) (2,702.3)
Gas exploration and production, at cost 181.3 187.1
Accumulated depletion (105.7) (97.5)
Property of discontinued operations 3.2 8.7
------------------------------ ---------------------------
7,097.2 7,067.9
------------------------------ ---------------------------
Deferred Charges
Regulatory assets 537.9 555.4
Goodwill and other intangible assets 1,666.7 1,677.6
Other 770.2 711.7
------------------------------ ---------------------------
2,974.8 2,944.7
------------------------------ ---------------------------
Total Assets $ 12,581.4 $ 13,364.1
============================== ===========================
- --------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEET
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars) March 31, 2005 December 31, 2004
- ----------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable and other liabilities $ 777.9 $ 906.7
Commercial paper 470.9 912.2
Current redemption of long-term debt 1.5 16.1
Current redemption of preferred stock 75.0 55.3
Taxes accrued 247.4 161.6
Dividends payable 72.7 74.1
Customer deposits 41.7 43.3
Interest accrued 63.9 48.8
Liabilities of discontinued operations 4.6 64.2
------------------------------ -----------------------------
1,755.6 2,282.3
------------------------------ -----------------------------
Deferred Credits and Other Liabilities
Regulatory liabilities:
Miscellaneous liabilities 145.7 74.0
Removal cost recovered 509.5 496.5
Deferred income tax 1,117.9 1,124.1
Postretirement benefits and other reserves 938.0 901.3
Other 119.8 139.1
------------------------------ -----------------------------
2,830.9 2,735.0
------------------------------ -----------------------------
Commitments and Contingencies (See Note 6) - -
Capitalization
Common stock 3,509.5 3,502.0
Retained earnings 953.3 792.2
Other comprehensive income (73.3) (54.3)
Treasury stock (322.2) (345.1)
------------------------------ -----------------------------
Total common shareholders' equity 4,067.3 3,894.8
Preferred stock - 19.7
Long-term debt and capital leases 3,914.2 4,418.7
------------------------------ -----------------------------
Total Capitalization 7,981.5 8,333.2
------------------------------ -----------------------------
Minority Interest in Subsidiary Companies 13.4 13.6
------------------------------ -----------------------------
Total Liabilities and Capitalization $ 12,581.4 $ 13,364.1
============================== =============================
- ---------------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
4
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
- -------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004
- --------------------------------------------------------------------------------------------------- ------------------
Revenues
Gas Distribution $ 2,025.5 $ 1,927.8
Electric Services 400.4 359.1
Energy Services 44.5 44.1
Gas Exploration and Production - 152.4
Energy Investments 10.1 27.2
---------------------- ------------------
Total Revenues 2,480.5 2,510.6
---------------------- ------------------
Operating Expenses
Purchased gas for resale 1,308.8 1,226.6
Fuel and purchased power 133.1 101.6
Operations and maintenance 387.2 407.0
Depreciation, depletion and amortization 106.1 171.2
Operating taxes 111.9 122.3
---------------------- ------------------
Total Operating Expenses 2,047.1 2,028.7
---------------------- ------------------
Income from equity investments 5.3 5.7
---------------------- ------------------
Operating Income 438.7 487.6
---------------------- ------------------
Other Income and (Deductions)
Interest charges (60.0) (84.1)
Gain on sale of investments 4.1 -
Cost of debt redemption (20.9) -
Minority interest - (20.3)
Other 9.1 2.6
---------------------- ------------------
Total Other Income and (Deductions) (67.7) (101.8)
---------------------- ------------------
Income Taxes
Current 128.8 154.5
Deferred 6.5 (16.8)
---------------------- ------------------
Total Income Taxes 135.3 137.7
---------------------- ------------------
Earnings from continuing operations 235.7 248.1
Discontinued Operations
Loss from discontinued operations, net of tax (2.2) (0.4)
Gain on disposal, net of tax 2.2 -
---------------------- ------------------
Loss from discontinued operations - (0.4)
---------------------- ------------------
Net Income 235.7 247.7
Preferred stock dividend requirements 1.3 1.5
---------------------- ------------------
Earnings for Common Stock $ 234.4 $ 246.2
====================== ==================
Basic Earnings Per Share:
Continuing Operations,
less preferred stock dividends $ 1.45 $ 1.54
Discontinued Operations - -
---------------------- ------------------
Basic Earnings Per Share $ 1.45 $ 1.54
====================== ==================
Diluted Earnings Per Share
Continuing Operations,
less preferred stock dividends 1.44 $ 1.53
Discontinued Operations - -
---------------------- ------------------
Diluted Earnings Per Share $ 1.44 $ 1.53
====================== ==================
Average Common Shares Outstanding (000) 161,125 159,892
Average Common Shares Outstanding - Diluted (000) 162,245 161,164
- -------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
5
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- ------------------------------------------------------------------------------------------------- -------------------
Operating Activities
Net income $ 235.7 $ 247.7
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Depreciation, depletion and amortization 106.1 171.2
Deferred income tax 6.5 (16.8)
Income from equity investments (5.3) (5.7)
Dividends from equity investments - 0.1
Amortization of interest rate swap (11.7) (2.4)
(Gain) on sale of investment (4.1) -
Minority interest - 20.3
Loss from discontinued operations - 0.4
Changes in assets and liabilities
Accounts receivable (262.3) (305.5)
Materials and supplies, fuel oil and gas in storage 297.8 336.3
Accounts payable and other liabilities (126.5) (183.6)
Taxes accrued 85.7 151.1
Interest accrued 15.0 38.4
Captive insurance - 43.2
Other 46.5 83.6
--------------------- -------------------
Net Cash Provided by Operating Activities 383.4 578.3
--------------------- -------------------
Investing Activities
Construction expenditures (111.8) (219.0)
Cost of removal (4.8) (6.2)
Net proceeds from sale of property and investments 48.1 13.1
--------------------- -------------------
Net Cash Used in Investing Activities (68.5) (212.1)
--------------------- -------------------
Financing Activities
Treasury stock issued 22.9 11.8
Issuance of long-term debt - 20.0
Payment of long-term debt (515.0) (94.9)
Payment of commercial paper (441.4) (187.8)
Preferred stock dividends paid (1.3) (1.5)
Common stock dividends paid (74.6) (71.4)
Other 10.5 9.2
--------------------- -------------------
Net Cash Used in Financing Activities (998.9) (314.6)
--------------------- -------------------
Net Increase (Decrease) in Cash and Cash Equivalents (684.0) 51.6
Net Cash Flow from Discontinued Operations (15.0) 1.9
Cash and Cash Equivalents at Beginning of Period 922.0 203.4
--------------------- -------------------
Cash and Cash Equivalents at End of Period $ 223.0 $ 256.9
===================== ===================
- -----------------------------------------------------------------------------------------------------------------------
Cash equivalents are short-term marketable securities purchased with
maturities of three months or less that were carried at cost which
approximates fair value.
See accompanying Notes to the Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
KeySpan Corporation (referred to in the Notes to the Financial Statements as
"KeySpan," "we," "us" and "our") is a registered holding company under the
Public Utility Holding Company Act of 1935, as amended ("PUHCA"). KeySpan
operates six regulated utilities that distribute natural gas to approximately
2.6 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, lease 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 1.1 million electric customers of the Long Island Power Authority
("LIPA"). KeySpan's other operating subsidiaries are primarily involved in gas
exploration and production; underground gas storage; liquefied natural gas
storage; retail electric marketing; large energy-system ownership, installation
and management; service and maintenance of energy systems; 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 March 31, 2005, and the results of operations for the three months ended
March 31, 2005 and March 31, 2004, as well as cash flows for the three months
ended March 31, 2005 and March 31, 2004. The accompanying financial statements
should be read in conjunction with the consolidated financial statements and
notes included in KeySpan's Annual Report on Form 10K for the year ended
December 31, 2004. The December 31, 2004 financial statement information has
been derived from the 2004 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
contributions 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.
Basic earnings per share ("EPS") is calculated by dividing earnings available
for common stock by the weighted average number of shares of common stock
outstanding during the period. No dilution for any potentially dilutive
securities is included. Diluted EPS assumes the conversion of all potentially
dilutive securities and is calculated by dividing earnings available for common
stock, as adjusted, by the sum of the weighted average number of shares of
common stock outstanding plus all potentially dilutive securities.
7
We have approximately 1.7 million common stock options outstanding at March 31,
2005, that were not included in the calculation of diluted EPS since the
exercise price associated with these options was greater than the average market
price of our common stock.
Under the requirements of Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share" our basic and diluted EPS are as follows:
- --------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004
- --------------------------------------------------------------------------------------------------------------------------
Earnings for common stock $ 234.4 $ 246.2
Interest savings on convertible preferred stock - 0.1
Houston Exploration dilution - (0.1)
- --------------------------------------------------------------------------------------------------------------------------
Earnings for common stock - adjusted $ 234.4 $ 246.2
- --------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (000) 161,125 159,892
Add dilutive securities:
Options 1,120 1,050
Convertible preferred stock - 222
- --------------------------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution 162,245 161,164
- --------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 1.45 $ 1.54
- --------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 1.44 $ 1.53
- --------------------------------------------------------------------------------------------------------------------------
2. BUSINESS SEGMENTS
We have four reportable segments: Gas Distribution, Electric Services, Energy
Services and Energy Investments.
The Gas Distribution segment consists of six gas distribution subsidiaries.
KeySpan Energy Delivery New York ("KEDNY") provides gas distribution services to
customers in the New York City Boroughs of Brooklyn, Queens and Staten Island.
KeySpan Energy Delivery Long Island ("KEDLI") provides gas distribution services
to customers in the Long Island Counties of Nassau and Suffolk and the Rockaway
Peninsula of Queens County. The remaining gas distribution subsidiaries, Boston
Gas Company, Colonial Gas Company, Essex Gas Company and EnergyNorth Natural
Gas, Inc., collectively referred to as KeySpan Energy Delivery New England
("KEDNE"), provide gas distribution service to customers in Massachusetts and
New Hampshire.
The Electric Services segment consists of subsidiaries that: operate the
electric transmission and distribution system owned by LIPA; own and provide
capacity to and produce energy for LIPA from our generating facilities located
on Long Island; and manage fuel supplies for LIPA to fuel our Long Island
generating facilities. These services are provided in accordance with long-term
service contracts having remaining terms that range from three to eight years
and power purchase agreements with remaining terms that range from eight to 22
years. The Electric Services segment also includes subsidiaries that own, lease
and operate the 2,200 megawatt ("MW") Ravenswood electric generation facility
("Ravenswood Facility"), located in Queens, New York, as well as a 250 MW
combined cycle electric generating facility located at the Ravenswood site
("Ravenswood Expansion"). Collectively, the Ravenswood Facility and Ravenswood
Expansion are referred to as the "Ravenswood Generating Station." All of the
8
energy, capacity and ancillary services related to the Ravenswood Generating
Station are sold to the New York Independent System Operator ("NYISO") energy
markets. The Electric Services segment also provides retail marketing of
electricity to commercial customers.
The Energy Services segment includes companies that provide primarily
energy-related services to customers located primarily within the Northeastern
United States, with concentrations in the New York City and Boston metropolitan
areas 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
operation and maintenance, design, engineering, consulting and fiber optic
services to commercial, institutional and industrial customers.
In January and February of 2005, KeySpan sold its mechanical contracting
subsidiaries. The operating results and financial position of these companies,
which were previously consolidated within the Energy Services segment, have been
reflected as discontinued operations on the Consolidated Statement of Income,
Consolidated Balance Sheet and Consolidated Statement of Cash Flows.
In regard to the January 2005 transactions, KeySpan received proceeds of
approximately $16 million, approximately $5 million of which is to be paid
within a three year period. In addition, KeySpan retained a portion of its
previously incurred surety indemnity support obligations related to certain
performance and payment bonds issued for the benefit of KeySpan's former
subsidiaries prior to closing. The current estimated cost to complete projects
supported by such indemnity obligations is approximately $20 million. The buyers
have agreed to complete the projects for which such indemnity obligations were
incurred and to indemnify and hold KeySpan harmless with respect to its
liabilities in connection with such bonds.
In connection with the February 2005 transaction, KeySpan paid or contributed
approximately $26 million to its former subsidiary prior to closing the sale
transaction in exchange for, among other things, the disposition of outstanding
shares in the former subsidiary and the settlement of intercompany advances and
replacement of a performance and payment bond issued for the benefit of its
former subsidiary with respect to a pending project, which bond had been
supported by a $150 million indemnity obligation of KeySpan. In addition,
KeySpan received from its former subsidiary an indemnity bond issued by a third
party surety company, the purpose of which is to reimburse KeySpan in an amount
up to $80 million in the event it is required to perform under all other
indemnity obligations previously incurred by KeySpan to support the remaining
bonded projects of its former subsidiary as of the closing. As of March 31,
2005, the total cost to complete such remaining bonded projects is estimated to
be approximately $65 million. The aforementioned guarantees are reflected in
Note 6 "Financial Guarantees and Contingencies." KeySpan's former subsidiary has
also agreed to complete the projects for which such indemnity obligations were
incurred and indemnify and hold KeySpan harmless with respect to any liabilities
in connection with such bonds.
9
In the fourth quarter of 2004, KeySpan's investment in its mechanical
contracting subsidiaries was written-down to fair value.
The Energy Investments segment consists of our gas exploration and production
investments, as well as certain other domestic energy-related investments.
KeySpan's gas exploration and production activities include its wholly-owned
subsidiaries Seneca Upshur Petroleum, Inc. ("Seneca-Upshur") and KeySpan
Exploration and Production, LLC ("KeySpan Exploration"). Seneca-Upshur is
engaged in gas exploration and production activities primarily in West Virginia.
KeySpan Exploration is engaged in a joint venture with The Houston Exploration
Company ("Houston Exploration"), an independent natural gas and oil exploration
company located in Houston, Texas. During the first quarter of 2004, our gas
exploration and production investments also included a 55% equity interest in
Houston Exploration, the operations of which were fully consolidated in
KeySpan's Consolidated Financial Statements. Houston Exploration's revenues and
operating income were $152.4 million and $62.1 million, respectively, for the
first quarter of 2004. In the fourth quarter of 2004 KeySpan sold its remaining
interests in Houston Exploration.
This segment is also engaged in pipeline development activities. KeySpan and
Duke Energy Corporation each own a 50% interest in the Islander East Pipeline
Company, LLC ("Islander East"). Islander East 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. 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. Further, KeySpan has a 21%
interest in the Millennium Pipeline project which is expected to transport up to
500,000 DTH of natural gas a day from Corning to Ramapo, New York, where it will
connect to an existing pipeline. Additionally, subsidiaries in this segment 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. These subsidiaries are accounted for under the equity method.
Accordingly, equity income from these investments is reflected as a component of
operating income in the Consolidated Statement of Income.
Through its wholly owned subsidiary, KeySpan LNG, KeySpan owns a 600,000 barrel
liquefied natural gas storage and receiving facility in Providence, Rhode
Island, the operations of which are fully consolidated.
During the first quarter of 2004, we also had an approximate 61% investment in
certain midstream natural gas assets in Western Canada through KeySpan Energy
Canada Partnership ("KeySpan Canada"). These assets included 14 processing
plants and associated gathering systems that produced approximately 1.5 BCFe of
natural gas daily and provided associated natural gas liquids fractionation.
These operations were fully consolidated in KeySpan's Consolidated Financial
Statements. KeySpan Canada's revenues and operating income were $22.2 million
and $8.6 million, respectively, for the first quarter of 2004. In the fourth
quarter of 2004 KeySpan sold its remaining interests in KeySpan Canada.
10
In the first quarter of 2005, KeySpan sold its 50% interest in Premier
Transmission Limited ("PTL"), a gas pipeline from southwest Scotland to Northern
Ireland. On February 25, 2005, KeySpan entered into a Share Sale and Purchase
Agreement with BG Energy Holdings Limited and Premier Transmission Financing
Public Limited Company ("PTFPL"), pursuant to which all of the outstanding
shares of PTL were to be purchased by PTFPL. On March 18, 2005 the sale was
completed and generated cash proceeds of approximately $48.1 million. In the
fourth quarter of 2004, KeySpan recorded a pre-tax non-cash impairment charge of
$26.5 million reflecting the difference between the anticipated cash proceeds
from the sale of PTL compared to its carrying value. The final sale of PTL
resulted in a pre-tax gain of $4.1 million reflecting the difference from
earlier estimates.
The accounting policies of the segments are the same as those used for the
preparation of the Consolidated Financial Statements. The segments are strategic
business units that are managed separately because of their different operating
and regulatory environments. Operating results of our segments are evaluated by
management on an operating income basis. At March 31, 2005, the total assets of
each reportable segment have not changed materially from those levels reported
at December 31, 2004. As mentioned, the mechanical contracting subsidiaries,
included in Energy Services, are reported as discontinued operations for March
31, 2004. The reportable segment information is as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
Energy Investments
------------------------
Gas
Exploration
Gas Electric Energy and Other
(In Millions of Dollars) Distribution Service Services Production Investments Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2005
Unaffiliated revenue 2,025.5 400.4 44.5 - 10.1 - 2,480.5
Intersegment revenue - 4.6 2.6 - - (7.2) -
Operating Income 391.9 51.0 (2.8) - 6.4 (7.8) 438.7
Three Months Ended March 31, 2004
Unaffiliated revenue 1,927.8 359.1 44.1 152.4 27.2 - 2,510.6
Intersegment revenue - - 2.5 - 1.3 (3.8) -
Operating Income 379.7 47.2 (17.5) 62.1 12.9 3.2 487.6
- -----------------------------------------------------------------------------------------------------------------------------------
Eliminating items include intercompany interest income and expense, the
elimination of certain intercompany accounts, as well as activities of our
corporate and administrative areas.
Because of the nature of our Electric Services business, electric revenues are
derived from two large customers - the NYISO and LIPA. Electric Services
revenues from these customers of $371.0 million and $345.6 million for the three
months ended March 31, 2005 and 2004, respectively, represent approximately15%
and 13%, respectively of our consolidated revenues in both periods.
11
3. COMPREHENSIVE INCOME
The table below indicates the components of comprehensive income:
- ------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- ------------------------------------------------------------------------------------------------------------------------
Net Income $ 235.7 $ 247.7
- ------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Net losses (gains) on derivative instruments (4.8) 11.0
Foreign currency translation adjustments (5.0) (1.8)
Unrealized gains (losses) on marketable securities (1.8) 0.5
Settlement of derivative premiums - 3.4
Unrealized losses on derivative financial instruments (7.3) (42.5)
- ------------------------------------------------------------------------------------------------------------------------
Other comprehensive loss, net of tax (18.9) (29.4)
- ------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 216.8 $ 218.3
- ------------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Net losses (gains) on derivative instruments (0.5) 5.9
Foreign currency translation adjustments (2.7) (1.0)
Unrealized gains (losses) on marketable securities (1.0) 0.3
Settlement of derivative premiums - 1.9
Unrealized losses on derivative financial instruments (6.7) (22.9)
- ------------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense $ (10.9) $ (15.8)
- ------------------------------------------------------------------------------------------------------------------------
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 distribution
operations, gas exploration and production activities and its electric
generating facilities at the Ravenswood site.
Derivative financial instruments are employed by our gas distribution operations
to reduce the cash flow variability associated with the purchase price for a
portion of future natural gas purchases for our regulated firm gas sales
customers. The accounting for these derivative instruments is subject to
Statement of Financial Accounting Standards ("SFAS") 71 "Accounting for the
Effects of Certain Types of Regulation." See the caption below "Firm Gas Sales
Derivative Instruments - Regulated Utilities" for a further discussion of these
derivatives. Certain derivative instruments employed by our gas distribution
operations are not subject to SFAS 71. Utility tariffs applicable to certain
large-volume customers permit gas to be sold at prices established monthly
relative to a prevailing alternate fuel price but limited to the cost of gas
plus the tail block rate. KEDNY uses over-the-counter ("OTC") natural gas swaps,
with offsetting positions in OTC fuel oil swaps of equivalent energy value, to
hedge the cash-flow variability of specified portions of gas purchases and sales
associated with these customers. The maximum length of time over which we have
hedged cash flow variability associated with forecasted purchases and sales of
natural gas is through October 2005. We use standard New York Mercantile
12
Exchange ("NYMEX") futures prices to value the gas and heating oil positions. At
March 31, 2005, the fair value of gas swap contracts was $4.4 million; the fair
value of the oil swap contracts was a liability of $13.8 million. These
derivative balances are expected to be reclassified from other comprehensive
income into earnings over the next twelve months.
Seneca-Upshur utilizes OTC natural gas swaps to hedge the cash flow variability
associated with forecasted sales of a portion of its natural gas production. At
March 31, 2005, Seneca-Upshur has hedge positions in place for approximately 85%
of its estimated 2005 through 2007 gas production, net of gathering costs. We
use market quoted forward prices to value these swap positions. The maximum
length of time over which Seneca-Upshur has hedged such cash flow variability is
through December 2007. The fair value of these derivative instruments at March
31, 2005 was a liability of $8.3 million. The estimated amount of losses
associated with such derivative instruments that are reported in other
comprehensive income and that are expected to be reclassified into earnings over
the next twelve months is $3.8 million, or approximately $2.5 million after-tax.
The Ravenswood Generation Station 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
Generation Station also hedges the cash flow variability associated with a
portion of electric energy sales.
With respect to price exposure associated with fuel purchases for the Ravenswood
Generation Station, KeySpan employs 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 by the Ravenswood Generation Station. We use standard NYMEX
futures prices to value the gas futures contracts and market quoted forward
prices to value oil swap contracts. The maximum length of time over which we
have hedged cash flow variability associated with forecasted purchases of
natural gas is through September 2005. The fair value of these derivative
instruments at March 31, 2005 was negligible. The maximum length of time over
which we have hedged cash flow variability associated with forecasted purchases
of fuel oil is through April 2006. The fair value of these derivative
instruments at March 31, 2005 was $1.0 million. A substantial portion of these
derivative instruments, which are reported in other comprehensive income, are
expected to be reclassified into earnings over the next twelve months.
We have also engaged in the use of cash-settled swap instruments to hedge the
cash flow variability associated with a portion of forecasted electric energy
sales from the Ravenswood Generation Station. Our hedging strategy is to hedge
at least 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 March 2006. We use market quoted forward prices to value these
outstanding derivatives. The fair value of these derivative instruments at March
31, 2005 was a liability of $2.0 million all of which is expected to be
13
reclassified into earnings over the next twelve months. The after-tax impact is
anticipated to be $1.3 million.
The above noted 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 value of our derivative
instruments on the Consolidated Balance Sheet as either a current or deferred
asset or liability, as appropriate, and defer the effective portion of
unrealized gains or losses in accumulated other comprehensive income. Gains and
losses are reclassified from accumulated other comprehensive income to the
Consolidated Statement of Income in the period the hedged transaction 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, which was negligible during the first quarter of 2005, results
from changes during the period in the price differentials between the index
price of the derivative contract and the price of the purchase or sale for the
cash flow that is being hedged, and is recorded directly to earnings.
The table below summarizes the fair value of outstanding financially-settled
commodity derivative instruments that qualify for hedge accounting at March 31,
2005 and December 31, 2004 and the related line item on the Consolidated Balance
Sheet. Fair value is the amount at which derivative instruments could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale.
- --------------------------------------------------------------------------------------------------------
(In Millions of Dollars) March 31, 2005 December 31, 2004
- --------------------------------------------------------------------------------------------------------
Gas Contracts:
Other current assets $ 4.5 $ 0.2
Accounts payable and other liabilities (3.8) (6.2)
Other deferred liabilities (4.5) (0.8)
Oil Contracts:
Other current assets 1.0 7.7
Accounts payable and other liabilities (13.8) -
Electric Contracts:
Other current assets - 0.4
Accounts payable and other liabilities (2.0) -
- --------------------------------------------------------------------------------------------------------
$ (18.6) $ 1.3
- --------------------------------------------------------------------------------------------------------
Financially-Settled Commodity Derivative Instruments that Do Not Qualify for
Hedge Accounting: KeySpan subsidiaries also have employed a limited number of
financial derivatives that do not qualify for hedge accounting treatment under
SFAS 133. In 2004, we purchased a series of call options on the spread between
the price of heating oil and the price of natural gas. The options cover the
period February 2005 through October 2005 and further complement our hedging
strategy noted above regarding sales to certain large-volume customers. As
stated, we sell gas to certain large-volume customers at prices established
14
monthly relative to a prevailing alternate fuel price but limited to the cost of
gas plus the tail block rate. Utility tariffs, however, establish an upper limit
on the price KeySpan can charge for the sale of natural gas to these customers.
These options are intended to limit KeySpan's exposure to heating oil price
spikes. These options do not qualify for hedge accounting treatment under SFAS
133. We recorded a $3.1 million benefit in other income and deductions on the
Consolidated Statement of Income to reflect the change in the market value
associated with this derivative instrument for the first quarter of 2005. In
addition, the Ravenswood Generation Station sold a three year option for 30-day
peaking gas service. The 30-day peaking gas service is for the following three
winter seasons: October 2004 - March 2005, October 2005 - March 2006 and October
2006 - March 2007. For each of the winter seasons just mentioned, the
counterparty can call on the Ravenswood Generation Station to supply no more
than 30,000 Mdth of a gas a day for no more than 30 days. We recorded a $3.3
million benefit in other income and deductions on the Consolidated Statement of
Income to reflect the change in the market value associated with this derivative
instrument for the first quarter of 2005.
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. Therefore, changes in the fair value of these derivatives
have been recorded as a regulatory asset or regulatory liability on the
Consolidated Balance Sheet. Gains or losses on the settlement of these contracts
are initially deferred and then refunded to or collected from our firm gas sales
customers consistent with regulatory requirements. At March 31, 2005, these
derivatives had a fair value of $78.6 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. Certain
contracts for the physical purchase of natural gas associated with our regulated
gas utilities are not exempt as normal purchases from the requirements of SFAS
133. Since these contracts are for the purchase of natural gas sold to regulated
firm gas sales customers, the accounting for these contracts is subject to SFAS
71. Therefore, changes in the market value of these contracts have been recorded
as a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
At March 31, 2005, these derivatives had a net negative fair value of $3.2
million and are reflected as a regulatory liability of $4.8 million and a
regulatory asset of $8.0 on the Consolidated Balance Sheet.
Interest Rate Derivative Instruments: In January 2005, KeySpan redeemed $500
million of outstanding debt - 6.15% Notes due 2006, and accelerated the
amortization of approximately $11.2 million of previously unamortized benefits
associated with an interest rate swap on these bonds that was previously
settled. The accelerated amortization was recorded as a reduction to interest
expense. (See Note 9 "Long-term Debt and Commercial Paper for additional details
15
regarding the debt redemption.) There were no interest rate derivative
instruments outstanding at March 31, 2005.
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 2004, we entered into heating-degree day put options to mitigate the effect
of fluctuations from normal weather on KEDNE's financial position and cash flows
for the 2004/2005 winter heating season - November 2004 through March 2005.
These put options would have paid KeySpan up to $40,000 per heating degree day
when the actual temperature was below 4,130 heating degree days, or
approximately 5% warmer than normal, based on the most recent 20-year average
for normal weather. The maximum amount KeySpan would have received on these
purchased put options is $16 million. The net premium cost for these options was
$1.6 million and was amortized over the heating season. Unlike previous years if
weather was colder than normal KeySpan would have no financial obligation. Since
weather was colder than normal during the first quarter of 2005 there was no
earnings impact associated with these financial derivative instruments. 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.
Derivative contracts are primarily used to manage exposure to market risk
arising from changes in commodity prices and interest rates. In the event of
non-performance by a counterparty to a derivative contract, the desired impact
may not be achieved. The risk of counterparty non-performance is generally
considered a credit risk and is actively managed by assessing each counterparty
credit profile and negotiating appropriate levels of collateral and credit
support. In instances where counterparties' credit quality has declined, or
credit exposure exceeds certain levels, we may limit our credit exposure by
restricting new transactions with counterparties, requiring additional
collateral or credit support and negotiating the early termination of certain
agreements. 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 2004, the Financial Accounting Standards Board ("FASB") issued FASB Staff
Position ("FSP") 106-2 "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003." This
guidance clarified the accounting and disclosure requirements for employers with
postretirement benefit plans that have been affected by the passage of the
Medicare Prescription Drug Improvement and Modernization Act of 2003 ("the
Act"). The Act introduced two new features to Medicare that an employer needs to
consider in measuring its obligation and net periodic postretirement benefit
costs. KeySpan's retiree health benefit plan currently includes a prescription
16
drug benefit that is provided to retired employees. KeySpan implemented the
requirements of FSP 106-2 in September 2004.
In January 2005, the Department of Health and Human Services/Centers for
Medicare and Medicaid Services (CMS) released final regulations with regard to
the implementation of the major provisions of the Medicare Act. KeySpan is
currently reviewing the new provisions and believes that the new guidance will
not have a material impact on its results of operations or cash flows.
In December 2004 the FASB issued SFAS 123 (revised 2004) "Share-Based Payment."
This Statement focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions. This
Statement revises certain provisions of SFAS 123 "Accounting for Stock-Based
Compensation" and supersedes APB Opinion 25 "Accounting for Stock Issued to
Employees." The fair-value-based method in this Statement is similar to the
fair-value-based method in Statement 123 in most respects. However, the
following are key differences between the two: Entities are required to measure
liabilities incurred to employees in share based payment transactions at fair
value as compared to using the intrinsic method allowed under Statement 123.
Entities are required to estimate the number of instruments for which the
requisite service is expected to be rendered, as compared to accounting for
forfeitures as they occur under Statement 123. Incremental compensation cost for
a modification of the terms or conditions of an award are also measured
differently under this Statement compared to Statement 123. This Statement also
clarifies and expands Statement 123's guidance in several areas. The effective
date of this Statement is the beginning of the first fiscal year beginning after
June 15, 2005. KeySpan adopted the prospective method of transition for stock
options 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 for
grants awarded after January 1, 2003. KeySpan is currently reviewing the
requirements of this Statement, and believes that implementation of this
Statement will not have a material impact on its results of operations or
financial position and no impact on its 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, a 2,200-megawatt electric generating facility located
in Queens, New York, in part, through the variable interest entity from
Consolidated Edison on June 18, 1999 for approximately $597 million. In order to
reduce the initial cash requirements, we entered into the Master Lease with a
variable interest, unaffiliated financing entity that acquired a portion of the
facility, or three steam generating units, directly from Consolidated Edison and
leased it to our subsidiary. The variable interest unaffiliated financing entity
acquired the property for $425 million, financed with debt of $412.3 million
(97% of capitalization) and equity of $12.7 million (3% of capitalization).
KeySpan has no ownership interests in the units or the variable interest entity.
KeySpan has guaranteed all payment and performance obligations of our subsidiary
under the Master Lease. Monthly lease payments substantially equal the monthly
interest expense on such debt securities.
17
The term of the Master Lease extends through June 20, 2009. 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 $336
million.
If our subsidiary that leases the Ravenswood Facility was not able to fulfill
its payment obligations with respect to the Master Lease payments, then the
maximum amount KeySpan would be exposed to under its current guarantees would be
$425 million plus the present value of the remaining lease payments through June
20, 2009.
Sale/leaseback Transaction: KeySpan also 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 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."
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. KeySpan's only asset retirement obligation
("ARO") relates to its investment in Seneca-Upshur and was approximately $1.9
million at March 31, 2005.
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
18
perpetuity and cannot be measured, no liability has been 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. These former
sites, some of which are no longer owned by us, have been identified to the New
York State Public Service Commission ("NYPSC") and the Department of
Environmental Conservation ("DEC") for inclusion on appropriate site
inventories. Administrative Orders on Consent ("ACO") or Voluntary Cleanup
Agreements have been executed with the DEC to address the investigation and
remediation activities associated with certain sites. KeySpan submitted
applications to the DEC for each of the remaining sites in August 2004 under the
DEC's Brownfield Cleanup Program ("BCP"). As a result of a recent United States
Supreme Court decision, KeySpan withdrew its applications in the DEC's BCP
program and will resubmit applications for individual sites under various DEC
cleanup programs on a case-by-case basis.
We have identified 28 of these sites as being associated with the historical
operations of KEDNY. One site has been fully remediated. Subject to the issues
described in the preceding paragraph, the remaining 27 sites will be
investigated and, if necessary, remediated under the terms and conditions of
various types of DEC cleanup orders. Expenditures incurred to date by us with
respect to KEDNY MGP-related activities total $50.0 million.
The remaining 15 sites have been identified as being associated with the
historical operations of KEDLI. Expenditures incurred to date by us with respect
to KEDLI MGP-related activities total $44.7 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 various types
of DEC cleanup orders.
We presently estimate the remaining cost of our KEDNY and KEDLI MGP-related
environmental remediation activities will be $202.4 million, which amount has
been accrued by us as a reasonable estimate of probable cost for known sites.
However, remediation costs for each site may be materially higher than noted,
depending upon changing technologies and regulatory standards, selected end use
for each site, and actual environmental conditions encountered.
With respect to remediation costs, the KEDNY and KEDLI rate plans generally
provide for the recovery from customers of investigation and remediation costs
of certain sites. At March 31, 2005, we have reflected a regulatory asset of
$225.8 million for our KEDNY/KEDLI MGP sites. In accordance with NYPSC policy,
KeySpan records a reduction to regulatory liabilities as costs are incurred for
environmental cleanup activities. At March 31, 2005, these previously deferred
regulatory liabilities totaled $31.2 million. In October 2003, KEDNY and KEDLI
19
filed a joint petition with the NYPSC seeking rate treatment for additional
environmental costs that may be incurred at all of our New York MGP sites. That
petition is still pending.
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 $2.3 million, which amount has been
accrued by us. Expenditures incurred to date total $2.7 million.
New England Sites: Within the Commonwealth of Massachusetts and the State of New
Hampshire, we are aware of 77 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 67 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 eight other
sites. In addition, Boston Gas Company, Colonial Gas Company, and Essex Gas
Company have assumed responsibility for remediating three sites each. At this
time, it is uncertain as to whether Boston Gas Company, Colonial Gas Company or
Essex Gas Company have or share responsibility for remediating any of the other
sites. No notice of responsibility has been issued to us for any of these sites
from any governmental environmental authority.
We presently estimate the remaining cost of these Massachusetts KEDNE
MGP-related environmental cleanup activities will be $14.9 million, which amount
has been accrued by us as a reasonable estimate of probable cost for known
sites, however remediation costs for each site may be materially higher than
noted, depending upon changing technologies and regulatory standards, selected
end use for each site, and actual environmental conditions encountered.
Expenditures incurred since November 8, 2000, the date KeySpan acquired Eastern
Enterprises, with respect to these MGP-related activities total $24.1 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
so-called Nashua River Asbestos Site, adjacent to the Nashua MGP site.
20
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 however,
remediation costs for each site may be materially higher than noted, depending
upon changing technologies and regulatory standards, selected end use for each
site, and actual environmental conditions encountered. Expenditures incurred
since November 8, 2000, with respect to these MGP-related activities total $10.3
million.
By rate orders, the Massachusetts Department of Telecommunications and Energy
("MADTE") and the New Hampshire Public Utility Commission ("NHPUC") provide for
the recovery of site investigation and remediation costs and, accordingly, at
December 31, 2004, we have reflected a regulatory asset of $44.0 million for the
KEDNE MGP sites. As previously mentioned, 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 orders currently in effect for these
subsidiaries provide for the recovery of investigation and remediation costs.
KeySpan New England, LLC Sites: We are aware of three non-utility sites
associated with KeySpan New England, LLC, a successor company to Eastern
Enterprises, for which we may have or share environmental remediation or ongoing
maintenance responsibility. These three sites, located in Philadelphia,
Pennsylvania, New Haven, Connecticut and Everett, Massachusetts, were associated
with historical operations involving the production of coke and related
industrial processes. Honeywell International, Inc. and Beazer East, Inc. (both
former owners and/or operators of certain facilities at Everett ("the Everett
Facility") together with KeySpan, have entered into an ACO with the
Massachusetts Department of Environmental Protection for the investigation and
development of a remedial response plan for a portion of that site. KeySpan,
Honeywell and Beazer East have entered into a cost-sharing agreement under which
each company has agreed to pay one-third of the costs of compliance with the
consent order, while preserving any claims it may have against the other
companies for, among other things, reallocation of proportionate liability.
We presently estimate the remaining cost of our environmental cleanup activities
for the three non-utility sites will be approximately $18.9 million, which
amount has been accrued by us as a reasonable estimate of probable costs for
known sites however, remediation costs for each site may be materially higher
than noted, depending upon changing technologies and regulatory standards,
selected end use for each site, and actual environmental conditions encountered.
Expenditures incurred since November 8, 2000, with respect to these sites total
$13.9 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.
21
See KeySpan's Annual Report on Form 10K for the year ended December 31, 2004
Note 7 to those Consolidated Financial Statements "Contractual Obligations,
Financial Guarantees and Contingencies" for further information on environmental
matters.
Legal Matters
From time to time we are subject to various legal proceedings arising out of the
ordinary course of our business. Except as described below, or in KeySpan's
Annual Report on Form 10K for the year ended December 31, 2004, 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.
On February 9, 2005, KeySpan was served with a shareholder derivative action
asserting claims on behalf of KeySpan based upon breach of fiduciary duty. The
complaint, which was filed in the New York State Supreme Court for the County of
Kings, relates to the 2001 Roy Kay related losses and alleges that KeySpan's
directors and certain senior officers breached their fiduciary duties when they
placed their own personal interests above the interests of KeySpan by using
material non-public information (the losses at Roy Kay) to sell securities at
artificially inflated prices.
This new complaint asserts essentially the same allegations as contained in two
prior federal shareholder derivative actions which were commenced in October
2001 and June 2002. On March 15, 2004, KeySpan and the individual defendants
filed a motion to dismiss those earlier federal complaints. On April 14, 2004,
the plaintiffs filed a notice of voluntary withdrawal of their actions. On April
23, 2004, the federal court dismissed both actions without prejudice. KeySpan
intends to file a motion to dismiss this new complaint. While KeySpan denies any
wrongdoing, the outcome of this proceeding cannot be determined as yet.
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.
22
Financial Guarantees
KeySpan has issued financial guarantees in the normal course of business,
primarily on behalf of its subsidiaries, to various third party creditors. At
March 31, 2005, the following amounts would have to be paid by KeySpan in the
event of non-payment by the primary obligor at the time payment is due:
- -----------------------------------------------------------------------------------------------------------------------------
Nature of Guarantee (In Thousands of Dollars) Amount of Exposure Expiration Dates
- -----------------------------------------------------------------------------------------------------------------------------
Guarantees for Subsidiaries
Medium-Term Notes - KEDLI (i) $ 525,000 2008-2010
Industrial Development Revenue Bonds (ii) 128,000 2027
Ravenswood - Master Lease (iii) 425,000 2009
Ravenswood - Sale/leaseback (iv) 385,000 2040
Surety Bonds (v) 126,000 2005 - 2008
Commodity Guarantees and Other (vi) 58,000 2005
Letters of Credit (vii) 74,000 2005
- --------------------------------------------------------------------------------------------------------------------------
$ 1,721,000
- --------------------------------------------------------------------------------------------------------------------------
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. The face value of
these notes is included in long-term debt on the Consolidated Balance
Sheet.
(ii) KeySpan has fully and unconditionally guaranteed the payment obligations of
its subsidiaries with regard to $128 million of Industrial Development
Revenue Bonds issued through the Nassau County and Suffolk County
Industrial Development Authorities for the construction of 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 term of the lease
has been extended to 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 Ravenswood Expansion. The initial term of the lease is for 36
years. As noted previously, this lease qualifies as an operating lease and
is not reflected on the Consolidated Balance Sheet.
23
(v) KeySpan has agreed to indemnify the issuers of various surety and
performance bonds associated with certain construction projects currently
being performed by certain current and former subsidiaries within the
Energy Services segment. In the event that the current or former
subsidiaries fail to perform their obligations under contracts, 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. Although KeySpan is not guaranteeing
any new bonds for any of the former subsidiaries, KeySpan's indemnity
obligation supports the contractual obligations of these current and former
subsidiaries. It is contemplated that the majority of the current contracts
will be completed by the end of 2005. In addition, a performance and
payment bond issued for the benefit of a former subsidiary with respect to
a pending project, which bond had been supported by a $150 million
indemnity obligation, has been replaced. KeySpan has also received from a
former subsidiary an indemnity bond issued by a third party insurance
company, the purpose of which is to reimburse KeySpan in an amount up to
$80 million in the event it is required to perform under all other
indemnity obligations previously incurred by KeySpan to support such
company's bonded projects existing prior to divestiture.
(vi) KeySpan has guaranteed commodity-related payments for subsidiaries within
the Energy Services segment, as well as KeySpan Ravenswood, LLC. These
guarantees are provided to third parties to facilitate physical and
financial transactions involved in the purchase of natural gas, oil and
other petroleum products for electric production and marketing activities.
The guarantees cover actual purchases by these subsidiaries that are still
outstanding as of March 31, 2005.
(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.
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 or former
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.
24
Other Contingencies
We derive a substantial portion of our revenues in our Electric Services segment
from a series of agreements with LIPA pursuant to which we manage LIPA's
transmission and distribution system and supply the majority of LIPA's
customers' electricity needs. The agreements terminate at various dates between
May 28, 2006 and May 28, 2013, and at this time we can provide no assurance that
any of the agreements will be renewed or extended, or if they were to be renewed
or extended, the terms and conditions thereof. In addition, given the complexity
of these agreements, disputes arise from time to time between KeySpan and LIPA
concerning the rights and obligations of each party to make and receive payments
as required pursuant to the terms of these agreements. As a result, KeySpan is
unable to determine what effect, if any, the ultimate resolution of these
disputes will have on its financial condition, results of operations or cash
flows.
In addition, LIPA is in the process of performing a long-term strategic review
initiative regarding its future direction. It has engaged a team of advisors and
consultants and has been conducting public hearings to develop recommendations
to be submitted to the LIPA Trustees. Some of the strategic options that LIPA is
considering include whether LIPA should continue its operations as they
presently exist, fully municipalize or privatize, sell some, but not all of
their assets and become a regulator of rates and services. LIPA was initially
required to make a determination by May 2005 as to whether it would exercise its
option to purchase our Long Island generating plants pursuant to the terms of
the Generation Purchase Rights Agreement. KeySpan and LIPA have mutually agreed
to extend the date by which LIPA must make this determination to December 15,
2005. At the time, we are unable to determine what the outcome of this strategic
review will have on our financial condition, results of operations or cash
flows. Any action that may be taken will have to take into consideration the
long-term nature of our existing contracts.
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 exercise
periods from five to ten years. In 2003, KeySpan 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 continues 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
25
grant dates for awards under the plans consistent with SFAS 123, our net income
and earnings per share would have decreased to the pro-forma amounts indicated
below:
- ------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Earnings available for common stock:
As reported $ 234.4 $ 246.2
Add: recorded stock-based compensation expense, net of tax 2.9 1.5
Deduct: total stock-based compensation expense, net of tax (3.4) (2.9)
- ------------------------------------------------------------------------------------------------------------------
Pro-forma earnings $ 233.9 $ 244.8
- ------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 1.45 $ 1.54
Basic - pro-forma $ 1.45 $ 1.53
Diluted - as reported $ 1.44 $ 1.53
Diluted - pro-forma $ 1.44 $ 1.52
- ------------------------------------------------------------------------------------------------------------------
8. POSTRETIREMENT BENEFITS
Pension Plans: The following information represents the consolidated net
periodic pension cost for the three months ended March 31, 2005 and 2004 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 the MADTE, 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:
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 15.0 $ 13.1
Interest cost on projected benefit obligation 37.4 36.0
Expected return on plan assets (42.9) (36.5)
Net amortization and deferral 18.9 16.9
- --------------------------------------------------------------------------------------------------------------------------------
Total pension cost $ 28.4 $ 29.5
- --------------------------------------------------------------------------------------------------------------------------------
Other Postretirement Benefits: The following information represents the
consolidated net periodic other postretirement benefit cost for the three months
ended March 31, 2005 and 2004 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.
26
Contributions to VEBA trusts are tax deductible, subject to limitations
contained in the Internal Revenue Code.
Net periodic other postretirement benefit cost included the following
components:
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 6.3 $ 5.4
Interest cost on accumulated
postretirement benefit obligation 19.9 18.5
Expected return on plan assets (9.1) (7.7)
Net amortization and deferral 16.5 11.3
- ------------------------------------------------------------------------------------------------------------------------------
Other postretirement cost $33.6 $27.5
- ------------------------------------------------------------------------------------------------------------------------------
>
During the first quarter of 2005, KeySpan has contributed $4.0 million to its
pension plans and $9.0 million to its other postretirement benefit plans.
Subsequent to March 31, 2005, KeySpan contributed an additional $94.5 million to
its pension plans. At the present time, KeySpan does not anticipate contributing
any additional funds to its pension plans for the remainder of 2005. However,
KeySpan anticipates contributing an additional $17 million to its other
postretirement benefit plans during the remainder of 2005. These estimated
contribution levels are subject to change based on future market returns,
interest rates and certain other measurements. Actual contributions, therefore,
may vary from these levels.
9. LONG-TERM DEBT and COMMERCIAL PAPER
On January 14, 2005, KeySpan redeemed $500 million of outstanding debt - 6.15%
Notes due 2006. KeySpan incurred $20.9 million in call premiums and wrote-off
$1.3 million of previously deferred costs. Further, we accelerated the
amortization of approximately $11.2 million of previously unamortized benefits
associated with an interest rate swap on these bonds. The accelerated
amortization was recorded as a reduction to interest expense.
At December 31, 2004, KeySpan had $460 million of MEDS Equity Units outstanding
at 8.75% consisting of a three-year forward purchase contract for our common
stock and a six-year note. The purchase contract required us, three years from
the date of issuance of the MEDS Equity Units, May 16, 2005, to issue and the
investors to purchase, a number of shares of our common stock based on a formula
tied to the market price of our common stock at that time. The 8.75% coupon was
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%.
There were 9.2 million MEDS Equity units issued which are subject to conversion
upon execution of the three-year forward purchase contract. The number of shares
to be issued depends on the average closing price of our common stock over the
20 day trading period ending on the third trading day prior to May 16, 2005. If
the average closing price of KeySpan's common stock over this time frame is less
than or equal to $35.30, then 13 million shares will be issued. If the average
27
closing price over this time frame is greater than or equal to $42.36, then 10.9
million shares will be issued. The number of shares issued at a price between
$35.30 and $42.36 will be between 10.9 million and 13 million based upon a
sliding scale.
In 2005, KeySpan was required to remarket the note component of the Equity Units
between February 2005 and May 2005 and reset the interest rate to the then
current market rate of interest; however, the reset interest rate could not be
set below 4.9%. In March 2005, KeySpan remarketed the note component of $394.9
million of the Equity Units at the reset interest rate of 4.9% through their
maturity date of May 2008. The balance of the notes ($65.1 million) were held by
the original MEDS equity holders in accordance with their terms and not
remarketed. KeySpan then exchanged $300 million of the remarketed notes for
$307.2 million of new 30 year notes bearing an interest rate of 5.8%. Therefore,
at March 31, 2005 KeySpan had $160 million of 4.9% notes outstanding with a
maturity date of May 2008 and $307.2 million of 5.8% notes outstanding with a
maturity date of April 2035.
The cash proceeds generated by the remarketing have been deposited in a special
trust that will be used by the original MEDS Equity Units holders to purchase
KeySpan common stock on May 16, 2005 under the formula described earlier. The
note holders who did not remarket their notes were required to post treasury
securities into the special trust as well. The funds in the trust will accrete
to $460 million which will be provided to KeySpan on May 16, 2005 to satisfy the
MEDS purchase contracts. Currently, KeySpan has no legal right to the funds
currently deposited in the special trust and therefore has not reflected this
cash on its Consolidated Balance Sheet.
KeySpan applied the accounting requirements of Emerging Issues Task Force
("EITF") 96-19 "Debtor's Accounting for a Modification or Exchange of Debt
Instruments" to account for these transactions and, as a result, recorded
charges of $4.1 million representing the remaining balance of prior unamortized
issuance costs, as well as fees paid to the prior note holders. KeySpan also
deferred $2.7 million of issuance costs associated with the exchange.
The MEDS Equity Units were 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 reached a threshold
appreciation price of $42.36 per share, which did not occur.
KeySpan currently has two credit facilities totaling $1.3 billion - a $640
million five year revolving credit facility due June 2009 and a three year $660
million facility due June 2006. 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 five-year facility and 0.125% on the three-year
facility. Both credit agreements allow for KeySpan to borrow using several
different types of loans; specifically, Eurodollar loans, 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 facility,
and an additional 0.125% for loans over 33% of the 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 facility, and an additional 0.125% for loans
over 33% of the facility. ABR loans are based on the highest of the Prime Rate,
28
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.
At March 31, 2005, consolidated indebtedness was 51.4% of consolidated
capitalization. Assuming the equity issuance expected to occur on May 16, 2005
as noted above, the consolidated indebtedness at March 31, 2005 would have been
48.8%.
At March 31, 2005, $470.9 million of commercial paper was outstanding at a
weighted average annualized interest rate of 2.83%. We had the ability to borrow
up to an additional $829.1 million at March 31, 2004 under the commercial paper
program.
10. KEYSPAN GAS EAST CORPORATION SUMMARY FINANCIAL INFORMATION
KEDLI is a wholly owned subsidiary of KeySpan. KEDLI was formed on May 7, 1998
and on May 28, 1998 acquired substantially all of the assets related to the gas
distribution business of the Long Island Lighting Company. 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.
29
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 0.2 $ 503.6 $ 1,976.9 $ (0.2) $ 2,480.5
----------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 314.1 994.7 - 1,308.8
Fuel and purchased power - - 133.1 - 133.1
Operations and maintenance 6.3 32.5 348.4 - 387.2
Intercompany expense - 1.3 (1.3) -
Depreciation and amortization - 26.5 79.6 - 106.1
Operating taxes - 17.0 94.9 - 111.9
----------------------------------------------------------------------------------------
Total Operating Expenses 6.3 391.4 1,649.4 - 2,047.1
----------------------------------------------------------------------------------------
Income from equity investments - - 5.3 - 5.3
----------------------------------------------------------------------------------------
Operating Income (Loss) (6.1) 112.2 332.8 (0.2) 438.7
----------------------------------------------------------------------------------------
Interest charges (29.7) (14.8) (63.3) 47.8 (60.0)
Other income and (deductions) 261.7 0.1 13.4 (282.9) (7.7)
----------------------------------------------------------------------------------------
Total Other Income and (Deductions) 232.0 (14.7) (49.9) (235.1) (67.7)
----------------------------------------------------------------------------------------
Income Taxes (Benefit) (9.8) 34.1 111.0 - 135.3
Discontinued Operations - - - - -
------------------------------------------------------------------------------------------
Net Income $ 235.7 $ 63.4 $ 171.9 $ (235.3) $ 235.7
==========================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2004
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues $ 0.2 $ 471.1 $ 2,039.5 $ (0.2) $ 2,510.6
------------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 291.1 935.5 - 1,226.6
Fuel and purchased power - - 101.6 - 101.6
Operations and maintenance 0.4 33.2 373.4 - 407.0
Intercompany expense - 1.4 (1.4) -
Depreciation and amortization - 29.8 141.4 - 171.2
Operating taxes - 19.6 102.7 - 122.3
------------------------------------------------------------------------------------------
Total Operating Expenses 0.4 375.1 1,653.2 - 2,028.7
------------------------------------------------------------------------------------------
Income from equity investments - - 5.7 - 5.7
------------------------------------------------------------------------------------------
Operating Income (Loss) (0.2) 96.0 392.0 (0.2) 487.6
------------------------------------------------------------------------------------------
Interest charges (53.5) (15.9) (71.5) 56.8 (84.1)
Other income and (deductions) 297.5 0.4 (2.1) (313.5) (17.7)
---------------------------------------------------------------
Total Other Income and (Deductions) 244.0 (15.5) (73.6) (256.7) (101.8)
------------------------------------------------------------------------------------------
Income Taxes (Benefit) (5.9) 22.7 120.9 - 137.7
------------------------------------------------------------------------------------------
Earnings from Continuing Operations 249.7 57.8 197.5 (256.9) 248.1
Discontinued Operations - - (0.4) - (0.4)
------------------------------------------------------------------------------------------
Net Income $ 249.7 $ 57.8 $ 197.1 $ (256.9) $ 247.7
==========================================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
30
- -----------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- -----------------------------------------------------------------------------------------------------------------------------
March 31, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 82.7 $ (5.2) $ 145.5 $ - $ 223.0
Accounts receivable, net 1.5 202.9 1,371.3 - 1,575.7
Other current assets 3.2 138.8 328.7 - 470.7
Assets of discontinued operations - - 3.4 - 3.4
------------------------------------------------------------------------------
87.4 336.5 1,848.9 - 2,272.8
------------------------------------------------------------------------------
Equity Investments 4,510.1 0.8 138.0 (4,412.3) 236.6
------------------------------------------------------------------------------
Property
Gas - 2,015.3 4,923.4 - 6,938.7
Other - - 3,018.2 - 3,018.2
Accumulated depreciation and depletion - (391.0) (2,471.9) - (2,862.9)
Property of discontinued operations - - 3.2 - 3.2
------------------------------------------------------------------------------
- 1,624.3 5,472.9 - 7,097.2
------------------------------------------------------------------------------
Intercompany Accounts Receivable 2,349.5 24.5 1,774.2 (4,148.2) -
-
Deferred Charges 376.9 231.6 2,366.3 - 2,974.8
------------------------------------------------------------------------------
Total Assets $ 7,323.9 $ 2,217.7 $ 11,600.3 $ (8,560.5) $ 12,581.4
==============================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 47.0 $ 92.6 $ 638.3 $ - $ 777.9
Commercial paper 470.9 - - - 470.9
Other current liabilities 322.1 108.4 71.7 - 502.2
Liabilities of discontinued operations - - 4.6 - 4.6
------------------------------------------------------------------------------
840.0 201.0 714.6 - 1,755.6
------------------------------------------------------------------------------
Intercompany Accounts Payable 51.3 57.3 1,906.8 (2,015.4) -
------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (78.6) 301.8 894.7 - 1,117.9
Other deferred credits and liabilities 574.3 127.7 1,011.0 - 1,713.0
------------------------------------------------------------------------------
495.7 429.5 1,905.7 - 2,830.9
------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 4,087.5 879.0 3,513.1 (4,412.3) 4,067.3
Long-term debt 1,849.4 650.9 3,546.7 (2,132.8) 3,914.2
------------------------------------------------------------------------------
Total Capitalization 5,936.9 1,529.9 7,059.8 (6,545.1) 7,981.5
------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 13.4 - 13.4
------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 7,323.9 $ 2,217.7 $ 11,600.3 $ (8,560.5) $ 12,581.4
==============================================================================
- -----------------------------------------------------------------------------------------------------------------------------
31
- -----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- -----------------------------------------------------------------------------------------------------------------------------------
December 31, 2004
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 580.7 $ (0.9) $ 342.2 $ - $ 922.0
Accounts receivable, net 0.8 223.6 1,087.7 - 1,312.1
Other current assets 4.5 146.5 650.6 - 801.6
Assets of discontinued operations - - 42.9 - 42.9
------------------------------------------------------------------------------------------
586.0 369.2 2,123.4 - 3,078.6
------------------------------------------------------------------------------------------
Investments and Other 4,567.3 2.0 169.1 (4,465.5) 272.9
------------------------------------------------------------------------------------------
Property
Gas - 1,998.5 4,872.7 - 6,871.2
Other - - 2,987.8 - 2,987.8
Accumulated depreciation
and depletion - (334.4) (2,465.4) - (2,799.8)
Property of discontinued
operations - - 8.7 - 8.7
------------------------------------------------------------------------------------------
- 1,664.1 5,403.8 - 7,067.9
------------------------------------------------------------------------------------------
Intercompany Accounts Receivable 2,485.7 - 1,292.2 (3,777.9) -
Deferred Charges 381.3 221.4 2,342.0 - 2,944.7
------------------------------------------------------------------------------------------
Total Assets $ 8,020.3 $ 2,256.7 $ 11,330.5 $ (8,243.4) $ 13,364.1
===========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 48.4 $ 111.6 $ 746.7 $ - $ 906.7
Commercial paper 912.2 - - - 912.2
Other current liabilities 294.7 167.2 (62.7) - 399.2
Liabilities of discontiuned operation - - 64.2 - 64.2
-------------------------------------------------------------------------------------------
1,255.3 278.8 748.2 - 2,282.3
-------------------------------------------------------------------------------------------
Intercompany Accounts Payable - 101.3 2,147.8 (2,249.1) -
-------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (83.2) 298.1 909.2 - 1,124.1
Other deferred credits and liabilities 534.5 112.0 964.4 - 1,610.9
-------------------------------------------------------------------------------------------
451.3 410.1 1,873.6 - 2,735.0
-------------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 3,940.5 815.6 3,604.2 (4,465.5) 3,894.8
Preferred stock 19.7 - - - 19.7
Long-term debt 2,353.5 650.9 2,943.1 (1,528.8) 4,418.7
-------------------------------------------------------------------------------------------
Total Capitalization 6,313.7 1,466.5 6,547.3 (5,994.3) 8,333.2
-------------------------------------------------------------------------------------------
Minority Interest in
Subsidiary Companies - - 13.6 - 13.6
-------------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 8,020.3 $ 2,256.7 $ 11,330.5 $ (8,243.4) $ 13,364.1
===========================================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
32
- ------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2005
----------------------------------------------------------------------
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Consolidated
- ------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash Provided by Operating Activities $ 33.4 $ 81.6 $ 268.4 $ 383.4
----------------------------------------------------------------------
Investing Activities
Capital expenditures - (17.0) (94.8) (111.8)
Cost of removal - (0.3) (4.5) (4.8)
Proceeds from sale of investment - - 48.1 48.1
----------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities - (17.3) (51.2) (68.5)
----------------------------------------------------------------------
Financing Activities
Treasury stock issued 22.9 - - 22.9
Payment of debt, net (941.4) - (15.0) (956.4)
Common and preferred stock dividends paid (75.9) - - (75.9)
Other 10.5 - - 10.5
Intercompany dividend payments 265.0 (265.0) -
Net intercompany accounts 187.5 (68.6) (118.9) -
----------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (531.4) (68.6) (398.9) (998.9)
----------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ (498.0) $ (4.3) $ (181.7) $ (684.0)
Net Cash Flow from Discontinued Operations - - (15.0) (15.0)
Cash and Cash Equivalents at Beginning of Period 580.7 (0.9) 342.2 922.0
----------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 82.7 $ (5.2) $ 145.5 $ 223.0
======================================================================
- ------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2004
----------------------------------------------------------------------
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash Provided by (Used in) Operating Activities $ 95.1 $ 91.2 $ 392.0 $ 578.3
----------------------------------------------------------------------
Investing Activities
Capital expenditures - (24.4) (194.6) (219.0)
Cost of removal - (0.4) (5.8) (6.2)
Proceeds from sale of property - - 13.1 13.1
----------------------------------------------------------------------
Net Cash Used in Investing Activities - (24.8) (187.3) (212.1)
----------------------------------------------------------------------
Financing Activities
Treasury stock issued 11.8 - - 11.8
Payment of debt, net (187.8) - (74.9) (262.7)
Common and preferred stock dividends paid (72.9) - - (72.9)
Other 9.5 - (0.3) 9.2
Net intercompany accounts 128.4 (67.9) (60.5) -
-
----------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (111.0) (67.9) (135.7) (314.6)
----------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (15.9) (1.5) 69.0 51.6
Net Cash Flow from Discontinued Operations - - 1.9 1.9
Cash and Cash Equivalents at Beginning of Period 97.6 1.6 104.2 203.4
----------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 81.7 $ 0.1 $ 175.1 $ 256.9
======================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
33
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Executive Summary of Results
The following is a summary of transactions affecting comparative earnings for
the three months ended March 31, 2005, compared to the three months ended March
31, 2004. 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.
The table below summarizes the KeySpan's results of operations for the periods
indicated.
- ---------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended
(In Millions of Dollars, March 31, 2005 March 31, 2004
Except Per Share Amounts) Earnings E.P.S. Earnings E.P.S.
- ---------------------------------------------------------------------------------------------------------------------------
Earnings from core operations,
less preferred stock dividends $ 234.4 $ 1.45 $ 222.8 $ 1.39
Non-core earnings - - 23.8 0.15
Discontinued operations - - (0.4) -
- ---------------------------------------------------------------------------------------------------------------------------
Earnings for common stock $ 234.4 $ 1.45 $ 246.2 $ 1.54
- ---------------------------------------------------------------------------------------------------------------------------
KeySpan's earnings for common stock for the three months ended March 31, 2005
were $234.4 million, or $1.45 per share, compared to $246.2 million or $1.54 per
share realized during the corresponding period last year. In the first quarter
of 2004, KeySpan held a 55% equity ownership interest in The Houston Exploration
Company ("Houston Exploration"), an independent natural gas and oil exploration
company located in Houston, Texas. Further, KeySpan held an approximate 61%
investment in certain midstream natural gas assets in Western Canada through
KeySpan Energy Canada Partnership ("KeySpan Canada"). The operations of both
Houston Exploration and KeySpan Canada were fully consolidated in KeySpan's
Consolidated Financial Statements during the first quarter of 2004. KeySpan sold
its ownership interest in these non-core operations in the fourth quarter of
2004. During the three months ended March 31, 2004, the combined earnings of
Houston Exploration and KeySpan Canada were $23.8 million or $0.15 per share.
Additionally, for March 31, 2004 we have reclassified the operations of
KeySpan's former mechanical contracting subsidiaries as discontinued operations
as these companies were discontinued in the fourth quarter of 2004 and sold in
early 2005. In the fourth quarter of 2004, KeySpan's investment in its
mechanical contracting subsidiaries was written-down to fair value.
34
As indicated in the above table, KeySpan's earnings from core operations, less
preferred stock dividends increased $11.5 million or $0.06 per share in the
first quarter of 2005, primarily reflecting higher earnings from our gas
distribution operations, as well as lower interest charges. Gas distribution
earnings were favorably impacted by customer additions and oil-to-gas
conversions, net of attrition and conservation, as well as from higher revenues
associated with the large volume heating market. The decrease in interest
expense resulted from the benefits attributable to lower outstanding debt
resulting from debt redemptions in the fourth quarter of 2004 and the first
quarter of 2005, as well as from the sale of Houston Exploration and KeySpan
Canada. See the discussion under the caption "Review of Operating Segments " for
additional details on KeySpan's operating results.
Consolidated Review of Results
Operating income by segment, as well as consolidated earnings for common stock
is set forth in the following table for the periods indicated.
- ----------------------------------------------------------------------------------------------------
(In Millions of Dollars, Except per Share)
- ----------------------------------------------------------------------------------------------------
Quarter Ended March 31, 2005 2004
- ----------------------------------------------------------------------------------------------------
Gas Distribution $ 391.9 $ 379.7
Electric Services 51.0 47.2
Energy Services (2.8) (17.5)
Energy Investments 6.4 75.0
Eliminations and other (7.8) 3.2
- ----------------------------------------------------------------------------------------------------
Operating Income 438.7 487.6
Interest charges (60.0) (84.1)
Other income and (deductions) (7.7) (17.7)
Income taxes 135.3 137.7
- ----------------------------------------------------------------------------------------------------
Earnings from continuing operations 235.7 248.1
Discontinued operations - (0.4)
- ----------------------------------------------------------------------------------------------------
Net Income 235.7 247.7
Preferred stock dividend requirements 1.3 1.5
- ----------------------------------------------------------------------------------------------------
Earnings for Common Stock $ 234.4 $ 246.2
- ----------------------------------------------------------------------------------------------------
Basic Earnings per Share
Continuing operations, less preferred
stock dividends $ 1.45 $ 1.54
Discontinued operations - -
- ----------------------------------------------------------------------------------------------------
$ 1.45 $ 1.54
- ----------------------------------------------------------------------------------------------------
As indicated in the above table, operating income decreased $49.0 million, or
10% for the quarter ended March 31, 2005, compared to the corresponding period
last year. The decrease in operating income primarily reflects lower operating
results associated with the Energy Investments segment of $68.6 million. As
noted earlier, during the first quarter of 2004 KeySpan held a 55% ownership
interest in Houston Exploration and an approximate 61% ownership interest in
KeySpan Canada. For the three months ended March 31, 2004, the combined
operating income of Houston Exploration and KeySpan Canada was approximately $71
35
million. KeySpan sold its ownership interest in these non-core operations in the
fourth quarter of 2004.
KeySpan's continuing businesses posted an increase in operating income of $22
million primarily as a result of higher earnings from the Gas Distribution
segment of $12.2 million and better results from the Energy Services segment.
The Gas Distribution results reflect an increase in net gas revenues (revenues
less the cost of gas and associated revenue taxes) while the operating results
of the Energy Services segment benefited from lower operating expenses. (See the
discussion under the caption "Review of Operating Segments" for further details
on each segment.)
Interest expense decreased $24.0 million, or 29% reflecting the benefits
attributable to lower outstanding debt resulting from recent debt redemptions,
as well as the sale of Houston Exploration and KeySpan Canada. In addition to
debt redemptions in 2004, on January 14, 2005, KeySpan redeemed $500 million
6.15% Series due 2006 of outstanding debt. KeySpan incurred $20.9 million in
call premiums and wrote-off $1.3 million of previously deferred financing costs.
Further, KeySpan accelerated the amortization of approximately $11.2 million of
previously unamortized benefits associated with an interest rate swap on these
bonds. The accelerated amortization of the interest rate swap and the write-off
of previously deferred financing costs were recorded to interest expense. At
March 31, 2005 KeySpan had $3.9 billion of debt outstanding compared to $5.5
billion outstanding at March 31, 2004.
In addition to the debt redemption charge noted above, other income and
(deductions) for the first quarter of 2005 includes a number of other items. In
the first quarter of 2005, KeySpan sold its 50% interest in Premier Transmission
Limited ("PTL"), a gas pipeline from southwest Scotland to Northern Ireland and
realized cash proceeds of approximately $48.1 million. In the fourth quarter of
2004, KeySpan recorded a pre-tax non-cash impairment charge of $26.5 million
reflecting the difference between the anticipated cash proceeds from the sale of
PTL compared to its carrying value. The final sale of PTL resulted in a pre-tax
gain of $4.1 million reflecting the difference from earlier estimates. (See Note
2 to the Consolidated Financial Statements "Business Segments" for additional
details.) Further, other income and (deductions) reflects a $6.4 million non
cash gain reflecting the fair value of outstanding derivative financial
instruments that do not qualify for hedge accounting treatment. (See Note 4 to
the Consolidated Financial Statements, "Hedging and Derivative Financial
Instruments" for additional details.) For the quarter ended March 31, 2004,
other income and (deductions) included the minority interest impact associated
with our ownership interests in Houston Exploration and KeySpan Canada of $20.3
million.
Income tax expense for the first quarter of 2005 and 2004 generally reflects the
level of pre-tax income. Further, income tax expense for the first quarter of
2004 includes a $6.0 million benefit from a revised appraisal associated with
property that was disposed of in 2003.
Earnings for common stock for the three months ended March 31, 2005, decreased
36
$11.9 million, or $0.09 per share compared to the same period last year
reflecting the items previously noted - specifically the comparative adverse
impact to earnings from the sale of Houston Exploration and KeySpan Canada in
2004, offset by higher earnings from the Gas Distribution segment and lower
interest charges.
Consistent with our prior earnings guidance, KeySpan's consolidated earnings for
2005 are forecasted to be in the range of $2.30 to $2.40 per share, excluding
special items. Since we sold the majority of our non-core assets in 2004, the
earnings forecast represents earnings from all continuing operations less
preferred stock dividends. Further, the earnings forecast includes the
anticipated dilutive impact from the conversion of the MEDS Equity Units
scheduled for May of this year. (See Note 9 to the Consolidated Financial
Statements "Long-Term Debt and Commercial Paper" for an explanation of the MEDS
Equity Units.)
Consolidated earnings are seasonal in nature due to the significant contribution
to earnings of our gas distribution operations. As a result, we expect to earn
most of our annual earnings in the first and fourth quarters of our fiscal year.
Review of Operating Segments
KeySpan reports its segment results 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.
37
The table below highlights certain significant financial data and operating
statistics for the Gas Distribution segment for the periods indicated.
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------
Revenues $ 2,025.5 $ 1,927.8
Cost of gas 1,313.4 1,226.6
Revenue taxes 24.8 34.8
- ----------------------------------------------------------------------------------------------------------------------------
Net Revenues 687.3 666.4
- ----------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 181.8 172.4
Depreciation and amortization 76.8 76.9
Operating taxes 36.8 37.4
- ----------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 295.4 286.7
- ----------------------------------------------------------------------------------------------------------------------------
Operating Income $ 391.9 $ 379.7
- ----------------------------------------------------------------------------------------------------------------------------
Firm gas sales and transportation (MDTH) 152,556 154,316
Transportation - Electric Generation (MDTH) 2,840 4,139
Other Sales (MDTH) 56,540 52,956
Warmer (Colder) than Normal - New York (2.7)% (6.0)%
Warmer (Colder) than Normal - New England (6.6)% (9.4)%
- ----------------------------------------------------------------------------------------------------------------------------
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.
Executive Summary
Operating income increased $12.2 million for the three months ended March 31,
2005 compared to the same period last year, primarily due to an increase in net
gas revenues (revenues less the cost of gas and associated revenue taxes) of
$20.9 million resulting from customer additions and oil-to-gas conversions in
our firm gas sales market, as well as from higher net gas revenues in our
large-volume heating markets. Partially offsetting the increase in net revenues
were higher operating expenses of $8.7 million, primarily due to an increase of
$5.2 million in the provision for uncollectible accounts receivable as a result
of higher gas costs.
Net Revenues
Net gas revenues from our gas distribution operations increased by $20.9
million, or 3.1%, in the first quarter of 2005 compared to the same quarter last
year. Net gas revenues benefited from customer additions and oil-to-gas
conversions in our firm gas sales market (residential, commercial and industrial
customers), as well as from higher net gas revenues in our large-volume heating
and other interruptible (non-firm) markets. As measured in heating degree days,
weather for the first quarter of 2005 in our New York and New England service
territories was approximately 2.7% and 6.6% colder than normal, respectively,
and was approximately 2% - 5% warmer than last year across KeySpan's service
territories.
38
Net revenues from firm gas customers increased $9.3 million for the first
quarter of 2005 compared to the same period last year. Customer additions and
oil-to-gas conversions, net of attrition and conservation, added $15.2 million
to net gas revenues. Further, we realized a benefit of $1.0 million as a result
of the Boston Gas Company's Performance Based Rate Plan (the "Plan") that was
approved by the Massachusetts Department of Telecommunications and Energy
("MADTE") in 2003. The Plan provides for firm gas sales rates to be adjusted
each year based on an inflation factor offset by a productivity factor. (See the
caption under "Regulation and Rate Matters" for further information regarding
the rate filing.)
Offsetting, to some extent, the beneficial impact of the customer additions and
oil-to-gas conversions was the adverse impact to comparative net gas revenues
from the additional billing day last year due to the leap year. For the first
quarter of 2004, KeySpan realized $5.7 million in additional net gas revenues
from the additional billing day.
Weather, which was warmer than last year, resulted in an adverse impact to
comparative net gas revenues of $5.3 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 $4.8 million through the weather normalization adjustment. However,
the gas distribution operations of our New England based subsidiaries do not
have a weather normalization adjustment. 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 2004/2005 winter heating season. These
financial derivatives afforded KeySpan some protection against warmer than
normal weather. Unlike in prior years, however, KeySpan had no financial
obligation to its counterparties if weather was colder than normal during the
2004/2005 winter heating season. Since weather during the first quarter of 2005
was colder than normal in the New England service territories there was no
earnings impact associated with these derivative instruments. However, in the
first quarter of 2004, we recorded a $4.1 million reduction to revenues to
reflect the loss on derivative positions that were settled. Therefore,
comparative first quarter 2005 net revenues reflect a favorable $4.1 million
variation. (See Note 4 to the Consolidated Financial Statements "Hedging and
Derivative Financial Instruments" for further information).
Firm gas distribution rates for KEDNY, KEDLI and KEDNE in 2005, other than for
the recovery of gas costs and as noted, have remained substantially unchanged
from rates charged in 2004.
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 $11.6 million during the first quarter of 2005 compared
to the same period last year reflecting primarily higher pricing. Further, since
weather during January 2004 was significantly colder than normal, KeySpan
discontinued sales service to a segment of its dual-fuel customers for a number
of days during the month, as permitted under its tariff and directed by the New
York State Public Service Commission to ensure reliable service to firm
39
customers. 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 as well as continued growth in the New
York service territory. We estimate that on Long Island approximately 37% of the
residential and multi-family markets, and approximately 55% of the commercial
market, currently use natural gas for space heating. Further, we estimate that
in our New England service territories approximately 50% of the residential and
multi-family markets, as well as the commercial market, currently use natural
gas for space heating purposes. We will continue to seek growth, in all 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.
Firm Sales, Transportation and Other Quantities
Firm gas sales and transportation quantities for the quarter ended March 31,
2005 decreased slightly (1%) compared to the same period in 2004 due primarily
to the warmer weather this year compared to last year. Customer additions and
oil-to-gas conversions offset the full impact of the warmer weather. 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 had an agreement with Coral Resources, L.P.
("Coral"), a subsidiary of Shell Oil Company, under which Coral assisted in the
origination, structuring, valuation and execution of energy-related transactions
on behalf of KEDNY and KEDLI. This agreement expired on March 31, 2005 and these
services are now performed by KeySpan employees. We also have a portfolio
management contract with Merrill Lynch Trading, under which Merrill Lynch
Trading provides all of the city gate supply requirements at market prices and
manages certain upstream capacity, underground storage and term supply contracts
for KEDNE. This agreement expires on March 31, 2006, and we are exploring
options with respect to the services under this contract.
Purchased Gas for Resale
The increase in gas costs for the first quarter of 2005 compared to the first
quarter of 2004 of $86.8 million, or 7%, reflects an increase of 8% in the price
per dekatherm of gas purchased, and a slight 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
40
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 first quarter of 2005 compared to the same quarter
last year increased $8.7 million, or 3%. Operations and maintenance expense
increased $9.4 million, or 5%, in 2005 compared to 2004 primarily due to an
increase of $5.2 million in the provision for uncollectible accounts as a result
of increasing gas costs. Further, the timing of the incurrence of certain
insurance costs and regulatory fees resulted in a comparative increase to
operations and maintenance expense. Higher depreciation charges of $3.6 million
reflecting the continued expansion of the gas distribution system were offset by
lower regulatory amortization charges of $3.8 million.
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. Islander East has
received a final certificate from the Federal Energy Regulatory Commission
("FERC") which are non-appealable 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. In 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 being evaluated. At March
31, 2004, our investment in the Islander East pipeline was $21 million.
In addition, in 2004 KeySpan acquired a 21% interest in the Millennium Pipeline
development project which is anticipated to transport up to 500,000 DTH of
natural gas a day to the Algonquin pipeline. The project has been approved by
the FERC and, pending an amendment to the project's FERC certificate,
construction could begin in the Spring of 2006, with service beginning in 2007.
Once constructed, KeySpan anticipates contracting for 150,000 DTH per day of
transportation capacity from the Millennium Pipeline system. As of March 31,
2005, our investment in this project was $8 million.
41
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 Generation Station") 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.
Selected financial data for the Electric Services segment is set forth in the
table below for the periods indicated.
- ------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- ------------------------------------------------------------------------------------------
Revenues $ 405.0 $ 359.1
Purchased fuel 133.0 101.5
- ------------------------------------------------------------------------------------------
Net Revenues 272.0 257.6
- ------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 153.6 147.1
Depreciation 22.8 21.6
Operating taxes 44.6 41.7
- ------------------------------------------------------------------------------------------
Total Operating Expenses 221.0 210.4
- ------------------------------------------------------------------------------------------
Operating Income $ 51.0 $ 47.2
- ------------------------------------------------------------------------------------------
Electric sales (MWH)* 1,001,408 983,106
Capacity(MW)* 2,450 2,200
Cooling degree days N/A N/A
- ------------------------------------------------------------------------------------------
*Reflects the operations of the Ravenswood facility only.
Executive Summary
Operating income increased $3.8 million for the three months ended March 31,
2005, compared to the same period last year, due primarily to an increase in net
revenues from the Ravenswood Generation Station of $8.8 million as a result of
improved pricing, as well as $3.5 million of incentives earned on the LIPA
Service agreements. These benefits to operating income were partially offset by
operating lease costs associated with Ravenswood Expansion of $4.5 million and
an increase of $3.6 million in plant overhauls for the Ravenswood Generation
Station.
42
Net Revenues
Total electric net revenues realized during the first quarter of 2005 were $14.4
million, or 6% higher than such revenues realized during the corresponding
period last year.
Net revenues from the Ravenswood Generation Station increased $8.8 million, or
15% for the three months ended March 31, 2005, compared to the same period last
year reflecting increased capacity revenues of $5.6 million, as well as higher
energy margins of $3.2 million. The increase in capacity revenues primarily
reflects the operation of the Ravenswood Expansion, a 250 MW combined cycle
generating facility that began full commercial operations in May 2004.
The increase in energy margins for the first quarter of 2005, reflects a 2%
increase in the level of megawatt hours ("MWh") sold into the New York
Independent System Operator ("NYISO") energy market, as well as an increase of
13% in realized "spark-spreads" (the selling price of electricity less the cost
of fuel, plus hedging gains or losses). The increase in energy sales quantities
primarily reflects the operations of the Ravenswood Expansion.
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 Generation Station. Further, we have engaged in the
use of derivative financial hedging instruments to hedge the cash flow
variability associated with a portion of forecasted electric energy sales from
the Ravenswood Generation Station. These derivative instruments resulted in
hedging gains, which are reflected in net electric margins, of $2.9 million for
the first quarter of 2005 compared to hedging losses of $4.6 million for the
first quarter of 2004. The benefits derived from KeySpan's hedging strategy
contributed to the increase in realized spark-spreads. (See Note 4 to the
Consolidated Financial Statements "Hedging and Derivative Financial Instruments"
for further information on KeySpan's hedging strategy.)
The rules and regulations for capacity, energy sales and the sale of certain
ancillary services to the NYISO energy markets continue to evolve and there are
several matters pending with the Federal Energy Regulatory Commission ("FERC").
See the discussion under the caption "Market and Credit Risk Management
Activities" for further details on these matters.
Net revenues for the first quarter of 2005 from the service agreements with
LIPA, including the power purchase agreements associated with two electric
peaking facilities, increased approximately $8.3 million compared to the first
quarter of 2004. This increase reflects, primarily, the timing of certain
incentives earned on these agreements of $3.5 million. KeySpan currently
anticipates earning approximately the same level of incentives in 2005 as it
earned in 2004. The remaining increase is due, for the most part, to recovery of
depreciation costs and property taxes. (For a description of the LIPA Agreements
and power purchase agreements, see KeySpan's 2004 Annual Report on Form 10K for
the Year Ended December 31, 2004 Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations under the caption "Electric
Services - Revenue Mechanisms.")
43
Offsetting, to some extent, these benefits to electric net revenues was a
decrease of $2.7 million in revenues associated with KeySpan's electric
marketing activities.
Operating Expenses
Operating expenses increased $10.6 million, or 5%, for the first quarter of 2005
compared to the first quarter of 2004. Operations and maintenance expense posted
an increase of $6.5 million, or 4% over last year reflecting $4.5 million in
operating lease costs associated with our financing arrangement for the
Ravenswood Expansion, as well as an increase in overhaul costs at the Ravenswood
Generation Station of $3.6 million, partially offset by lower postretirement
costs. The increase in overhaul costs are primarily timing related, since we
anticipate incurring the same level of overhaul expenses at the Ravenswood
Generation Station in 2005 as we incurred in 2004. (See Note 6 to the
Consolidated Financial Statements "Financial Guarantees and Contingencies" for
additional information regarding the financing arrangement for the Ravenswood
Expansion.) The increase in depreciation expense is associated with KeySpan's
Long Island based electric generating units and is fully recoverable from LIPA.
The higher operating taxes primarily reflect an increase in property taxes which
are also fully recoverable from LIPA.
Other Matters
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 filed a proposal in response to LIPA's RFP. In 2004, LIPA
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. The project has received
New York State Article X approval by having met all operational and
environmental permitting requirements. Further, the project is strategically
located in close proximity to both the high voltage power transmission grid and
the high pressure gas distribution network. At March 31, 2005, total capitalized
costs associated with the siting, permitting and procurement of equipment for
the Melville facility were approximately $63 million.
LIPA is in the process of performing a long-term strategic review initiative
regarding its future direction. Some of the strategic options that LIPA is
considering include whether LIPA should continue its operations as they
presently exist, fully municipalize or privatize, sell some, but not all of
their assets and become a regulator of rates and services. LIPA was initially
required to make a determination by May 2005 as to whether it would exercise its
option to purchase our Long Island generating plants pursuant to the terms of
the Generation Purchase Rights Agreement. KeySpan and LIPA have mutually agreed
44
to extend the date by which LIPA must make this determination to December 15,
2005. At this time, we are unable to determine what the outcome of this
strategic review will have on the Melville project, or more broadly, our
Electric Services segment. As part of our growth strategy, we continually
evaluate the possible acquisition and development of additional generating
facilities in the Northeast. However, we are unable to predict when or if any
such facilities will be acquired and the effect any such acquired facilities
will have on our financial condition, results of operations or cash flows.
Energy Services
The Energy Services segment includes companies that provide energy-related
services to customers located primarily within the Northeastern United States,
with concentrations in the New York City and Boston metropolitan areas 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
operation and maintenance, design, engineering, consulting and fiber optic
services to commercial, institutional and industrial customers.
In January and February of 2005, KeySpan sold its mechanical contracting
subsidiaries. The operating results and financial position of these companies,
which were previously consolidated within the Energy Services segment, have been
reflected as discontinued operations on the Consolidated Statement of Income,
Consolidated Balance Sheet and Consolidated Statement of Cash Flows.
In the fourth quarter of 2004, KeySpan's investment in its mechanical
contracting subsidiaries was written-down to fair value and, therefore, there
was no earnings impact from the final sale of these companies in the first
quarter of 2005. (See Note 2 to the Consolidated Financial Statements "Business
Segments" for additional details on the sale of the mechanical companies.)
The table below highlights selected financial information associated with Energy
Service's continuing businesses.
- -----------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- -----------------------------------------------------------------------------------------------
Revenues $ 47.1 $ 46.6
Operating expenses 49.9 64.1
- -----------------------------------------------------------------------------------------------
Operating (Loss) $ (2.8) $(17.5)
- -----------------------------------------------------------------------------------------------
The Energy Services segment incurred an operating loss of $2.8 million for the
first quarter of 2005 compared to an operating loss of $17.5 million incurred in
the first quarter of 2004. The improved performance reflects a reduction in
operating expenses. In the first quarter of 2004, the Home Energy Services
operations incurred charges associated with 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. Except for the
charges incurred in 2004, the operations of the remaining businesses in the
45
Energy Services segment have remained consistent between the first quarter of
2005 and the first quarter of 2004.
Energy Investments
The Energy Investments segment consists of our gas exploration and production
investments, as well as certain other domestic energy-related investments.
KeySpan's gas exploration and production activities include its wholly-owned
subsidiaries Seneca Upshur Petroleum, Inc. ("Seneca-Upshur") and KeySpan
Exploration and Production, LLC ("KeySpan Exploration"). Seneca-Upshur is
engaged in gas exploration and production activities primarily in West Virginia.
KeySpan Exploration is primarily engaged in a joint venture with Houston
Exploration.
This segment is also engaged in pipeline development activities. KeySpan and
Duke Energy Corporation each own a 50% interest in Islander East. Islander East
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. Further, KeySpan has a 21% interest in the Millennium
Pipeline project which will transport up to 500,000 DTH of natural gas a day
from Corning to Ramapo, New York, where it will connect to an existing pipeline.
Additionally, subsidiaries in this segment 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. These subsidiaries are
accounted for under the equity method of accounting. Accordingly, equity income
from these investments is reflected as a component of operating income in the
Consolidated Statement of Income. KeySpan also owns a 600,000 barrel liquefied
natural gas storage and receiving facility in Providence, Rhode Island, through
its wholly owned subsidiary KeySpan LNG, the operations of which are fully
consolidated. The LNG facility is being upgraded to accept marine deliveries and
triple its vaporization capacity, pending regulatory approvals and the
resolution of certain litigations with respect to such approvals.
During the first quarter of 2004, we also had an approximate 61% investment in
certain midstream natural gas assets in Western Canada through KeySpan Energy
Canada Partnership ("KeySpan Canada"). In the fourth quarter of 2004 KeySpan
sold its remaining interests in KeySpan Canada.
46
Selected financial data and operating statistics for these energy-related
investments are set forth in the following table for the periods indicated.
- --------------------------------------------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- --------------------------------------------------------------------------------------------------------------
Revenues $ 10.1 $ 28.5
Less: Operation and maintenance expense 6.5 15.4
Other operating expenses 2.5 5.9
Add: Equity earnings 5.3 5.7
- --------------------------------------------------------------------------------------------------------------
Operating Income $ 6.4 $ 12.9
- --------------------------------------------------------------------------------------------------------------
Operating income above reflects 100% of KeySpan's Canada's results for
the first quarter of 2004.
As indicated in the above table, operating income for the Energy Investments
segment decreased $6.5 million in the first quarter of 2005 compared to the
corresponding period last year primarily reflecting the sale of KeySpan Canada
in 2004. During the first quarter of 2004, KeySpan Canada realized operating
income of $8.6 million. The remaining activities reflected an increase in
operating income of $2.1 million primarily associated with lower overhead costs
and operating income from Seneca-Upshur.
In the first quarter of 2005, KeySpan sold its 50% interest in Premier
Transmission Limited ("PTL"), a gas pipeline from southwest Scotland to Northern
Ireland. In February 2005, KeySpan entered into a Share Sale and Purchase
Agreement with BG Energy Holdings Limited and Premier Transmission Financing
Public Limited Company ("PTFPL"), pursuant to which all of the outstanding
shares of PTL were to be purchased by PTFPL. On March 18, 2005 the sale was
completed and generated cash proceeds of approximately $48.1 million. In the
fourth quarter of 2004, KeySpan recorded a pre-tax non-cash impairment charge of
$26.5 million reflecting the difference between the anticipated cash proceeds
from the sale of PTL compared to its carrying value. The final sale of PTL
resulted in a pre-tax gain of $4.1 million reflecting the difference from
earlier estimates. This gain was recorded in other income and (deductions) on
the Consolidated Statement of Income.
During the first quarter of 2004, our gas exploration and production investments
also included a 55% equity interest in Houston Exploration, the operations of
which were fully consolidated in KeySpan's Consolidated Financial Statements. In
the fourth quarter of 2004, KeySpan sold its remaining interests in Houston
Exploration.
47
Selected financial data and operating statistics for Houston Exploration are set
forth in the following table for the first quarter of 2004.
- ----------------------------------------------------------------
Three Months Ended
March 31,2004
(In Millions of Dollars)
- ----------------------------------------------------------------
Revenues $ 152.4
Depletion and amortization expense 61.9
Other operating expenses 28.4
- ----------------------------------------------------------------
Operating Income $ 62.1
- ----------------------------------------------------------------
Other Matters
As noted above, KeySpan's LNG facility is being upgraded to accept marine
deliveries and triple its vaporization capacity pending regulatory approvals and
the resolution of certain litigation regarding such approvals. In February 2005,
KeySpan LNG filed an action in Federal District Court in Rhode Island seeking a
declaratory judgment that it is not required to obtain a "Category B Assent"
from the state of Rhode Island and an injunction preventing the Rhode Island
Costal Resource Management Council ("CRMC") from enforcing the Category B assent
requirements. In March 2005, the Rhode Island Attorney General answered the
complaint and moved to substitute the State of Rhode Island as the defendant and
filed a counterclaim seeking a declaratory judgment that the expansion requires
a Category B Assent. In April, the parties filed cross motions for summary
judgment with respect to all issues presented to the Court, and the Court has
indicated its intention to issue a decision by August 2005. On April 14, 2005,
the Attorney General also filed on behalf of the State a complaint against
KeySpan LNG in Rhode Island State Superior Court raising substantially the same
issues as the federal court action. KeySpan LNG intends to vigorously pursue a
favorable outcome of both court actions.
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
system planning, marketing, and gas supply planning and procurement; and (iii)
engineering and surveying services to subsidiaries. The operating income
variation as reflected in "elimination and other" is due primarily to the timing
of certain corporate expenses.
48
Liquidity
Cash flow from operations decreased of $194.9 million in the first quarter of
2005 compared to last year primarily reflecting the absence of Houston
Exploration which contributed approximately $130 million to consolidated
operating cash flow in 2004 and the one time benefit of $43 million from the
start-up of the insurance captive last year. It should be noted that in prior
years Houston Exploration funded their gas exploration and development
activities, in part, from available cash flow from operations.
At March 31, 2005, we had cash and temporary cash investments of $223 million.
During the first quarter of 2005, we repaid $441.4 million of commercial paper
and, at March 31, 2005, $470.9 million of commercial paper was outstanding at a
weighted-average annualized interest rate of 2.83%. We had the ability to borrow
up to an additional $829.1 million at March 31, 2005, under the terms of our
credit facility.
KeySpan currently has two credit facilities totaling $1.3 billion - a $640
million five year revolving credit facility due June 2009 and a three year $660
million facility due June 2006. 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 five-year facility and 0.125% on the three-year
facility. Both credit agreements allow for KeySpan to borrow using several
different types of loans; specifically, Eurodollar loans, 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.
At March 31, 2005, consolidated indebtedness was 51.4% of consolidated
capitalization. Assuming the equity issuance expected to occur on May 16, 2005
as mentioned in Note 9 to the Consolidated Financial Statements "Long-term Debt
and Commercial Paper," the consolidated indebtedness at March 31, 2005 would
have been 48.8%.
49
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. Accordingly, our cash flows are
dependent upon the timely payment of amounts 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:
- ------------------------------------------------------------------------
Three Months Ended March 31,
(In Millions of Dollars) 2005 2004
- ------------------------------------------------------------------------
Gas Distribution $ 71.6 $ 82.2
Electric Services 31.1 36.6
Energy Investments 6.6 97.2
Energy Services and other 2.5 3.0
- ------------------------------------------------------------------------
$ 111.8 $ 219.0
- ------------------------------------------------------------------------
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 to
maintain our generating facilities and, for 2004, expand the Ravenswood
Generating Station. Construction expenditures related to the Energy Investments
segment for 2004 primarily reflect costs associated with gas exploration and
production activities of Houston Exploration, as well as costs related to
KeySpan Canada's gas processing facilities.
The decrease in capital expenditures for the three months ended March 31, 2005
compared to the same period last year of $107 million mainly reflects a decrease
in the Gas Distribution segment of over $10 million and a decrease in the Energy
Investments segment of over $90 million. The decrease in the Gas Distribution
segment is due to a lower capital budget this year, more efficient repair and
maintenance processes, as well as to an improved, more timely billing process
related to billing New York City for costs associated with city/state
construction projects. The decrease in Energy Investments reflects the absence
of Houston Exploration's gas exploration and development activities.
50
Financing
On January 14, 2005, KeySpan redeemed $500 million of outstanding debt - 6.15%
Notes due 2006. KeySpan incurred $20.9 million in call premiums and wrote-off
$1.3 million of previously deferred costs. Further, we accelerated the
amortization of approximately $11.2 million of previously unamortized benefits
associated with an interest rate swap on these bonds. The accelerated
amortization, as well as the write-off of previously deferred costs was recorded
to interest expense. Further, $55.3 million of 7.07% Series B preferred stock is
scheduled to be redeemed in May 2005. Additionally, KeySpan intends to call for
optional redemption $19.7 million of 7.17% Series C of preferred stock due 2008
during the second quarter. After this redemption, KeySpan will have no
outstanding preferred stock.
There are 9.2 million MEDS Equity units issued which are subject to conversion
upon execution of the three-year forward purchase contract. In 2005, KeySpan was
required to remarket the note component of the Equity Units between February
2005 and May 2005 and reset the interest rate to the then current market rate of
interest; however, the reset interest rate could not be set below 4.9%. In March
2005, KeySpan remarketed the note component of $394.9 million of the Equity
Units at the reset interest rate of 4.9% through their maturity date of May
2008. The balance of the notes ($65.1 million) were held by the original MEDS
equity holders in accordance with their terms, and not remarketed. KeySpan then
exchanged $300 million of the remarketed notes for $307.2 million of new 30 year
notes bearing an interest rate of 5.8%. Therefore, at March 31, 2005 KeySpan had
$160 million of 4.9% notes outstanding with a maturity date of May 2008 and
$307.2 million of 5.8% notes outstanding with a maturity date of April 2035.
The cash proceeds generated by the remarketing have been deposited in a special
trust that will be used by the original MEDS Equity Units holders to purchase
KeySpan common stock on May 16, 2005 under the formula described earlier. The
note holders who held their notes and did not remarket them were required to
post treasury securities into the special trust as well. The funds in the trust
will accrete to $460 million which will be provided to KeySpan on May 16, 2005
to satisfy the MEDS purchase contracts. Currently, KeySpan has no legal right to
the funds currently deposited in the special trust and therefore has not
reflected this cash on its Consolidated Balance Sheet. (See Note 9 to the
Consolidated Financial Statements "Long-term Debt and Commercial Paper" for
additional details on the MEDs Equity Units.)
The following table represents the ratings of our long-term debt at March 31,
2005. During the fourth quarter of 2004 Standard & Poor's reaffirmed its ratings
on KeySpan's and its subsidiaries' long-term debt and removed its negative
outlook. Moody's Investor Services, however, continues to maintain its negative
outlook ratings on KeySpan's and its subsidiaries' long-term debt.
- --------------------------------------------------------------------------------
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
KeySpan Generation A3 A N/A
- --------------------------------------------------------------------------------
51
Off-Balance Sheet Arrangements
Guarantees
KeySpan has a number of financial guarantees with its subsidiaries at March 31,
2005. KeySpan has 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 $385 million sale/leaseback
transaction for the Ravenswood Expansion; and (iii) the payment obligations of
our subsidiaries related to $128 million of 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
$126 million of surety bonds associated with certain construction projects
currently being performed by current and former subsidiaries within the Energy
Services segment; (ii) certain supply contracts, margin accounts and purchase
orders for certain subsidiaries in an aggregate amount of $58 million; and (iii)
$74 million of subsidiary letters of credit. These guarantees are not recorded
on the Consolidated Balance Sheet. KeySpan's guarantees on certain performance
bonds relating to current construction projects of the discontinued mechanical
contracting companies will remain in place throughout the construction period
for these projects. It is contemplated that the majority of the current
contracts will be completed by the end of 2005. KeySpan has received an
indemnity bond issued by a third party to offset potential exposure related to a
significant portion of the continuing guarantee. At this time, we have no reason
to believe that our subsidiaries or former 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. These obligations have remained substantially
unchanged since December 31, 2004. (For additional details regarding these
obligations see KeySpan's Annual Report on Form 10K for the Year Ended December
31, 2004, 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.")
52
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.
KeySpan continually evaluates its critical accounting policies. Based upon
current facts and circumstances KeySpan has decided that certain accounting
policies that were considered "critical" at December 31, 2004 should no longer
be considered as critical accounting policies. The accounting policies that are
no longer considered critical are as follows: (i) Percentage-of-completion
accounting is a method of accounting for long-term construction type contracts
in accordance with Generally Accepted Accounting Principles. This accounting
policy was used for engineering and mechanical contracting revenue recognition
by the Energy Services segment. However, since KeySpan has sold its mechanical
contracting subsidiaries, contracting revenue recognition is no longer a
significant accounting issue; (ii) The full cost accounting method is used by
our gas exploration and production subsidiaries to account for their natural gas
and oil properties. Seneca-Upshur and KeySpan Exploration continue to apply this
accounting treatment. However, since KeySpan has sold its ownership interest in
Houston Exploration, KeySpan's gas exploration and production activities are not
a significant aspect of its overall business operations and therefore, full cost
accounting is no longer a significant accounting policy.
Below is a discussion of KeySpan's critical accounting policies and assumptions
at March 31, 2005. For a more detailed discussion of these policies and
assumptions see KeySpan's Annual Report on Form 10K for the Year Ended December
31, 2004, Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations "Discussion of Critical Accounting Policies and
Assumptions."
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
53
consolidated earnings and cash flow forecasts. In addition, these assumptions
are used to set annual budgetary guidelines. At March 31, 2005, KeySpan has $1.7
billion of recorded goodwill and has concluded that the fair value of the
business units that have recorded goodwill exceed their carrying value.
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 Public Service Commission ("NYPSC"), the New
Hampshire Public Utilities Commission ("NHPUC"), and the Massachusetts
Department of Telecommunications and Energy ("MADTE").
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 2003, the MADTE approved a base revenue increase for the Boston Gas Company,
as well as a Performance Based Rate Plan (the "Plan") for up to ten years.
EnergyNorth Natural Gas, Inc.'s base rates continue as set by the NHPUC in 1993.
In separate orders issued by the MADTE relating to the Eastern Enterprise
acquisition in 2000, 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.
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
54
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.
Historically, we have funded our qualified pension plans in excess of the amount
required to satisfy minimum ERISA funding requirements. At March 31, 2005, 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 2005, KeySpan expects to contribute a total of $125 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 10K for the Year
Ended December 31, 2004, see also Note 4 of those Consolidated Financial
Statements, "Postretirement Benefits.")
Regulation and Rate Matters
Gas Matters
As of March 31, 2005, 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.
Regarding the Boston Gas Company, in 2003 the DTE approved a $25.9 million
increase in base revenues with an allowed return on equity of 10.2% assuming an
equal balance of debt and equity. On January 27, 2004 the DTE issued orders 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. On October 29, 2004, the MADTE approved a base rate increase of
$4.6 million under the Plan. In addition, an increase of $7.9 million in the
local distribution adjustment clause was approved to recover pension and other
postretirement costs. The DTE also approved a true-up mechanism for pension and
other postretirement benefit costs under which variations between actual pension
and other postretirement benefit costs and amounts used to establish rates are
deferred and collected from or refunded to customers in subsequent periods.
For an additional discussion of our current gas distribution rate agreements,
see KeySpan's Annual Report on Form 10K for the Year Ended December 31, 2004,
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operations "Regulation and Rate Matters."
55
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 FERC in accordance with the Power Supply Agreement
("PSA") entered into between KeySpan and LIPA in 1998. The original FERC
approved rates, which had been in effect since May 1998, expired on December 31,
2003. On October 1, 2004 the FERC approved a settlement reached between KeySpan
and LIPA. Under the new Settlement Agreement, KeySpan's rates reflect a cost of
equity of 9.5% with no revenue increase in the first year. The FERC approved
updated operating and maintenance expense levels and recovery of certain other
costs as agreed to by the parties.
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.
KeySpan has 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.
56
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 March 31, 2005, KeySpan's consolidated common equity was
47.7% of its consolidated capitalization, including commercial paper, and each
of its utility subsidiaries common equity was at least 48% of its respective
capitalization.
Environmental Matters
KeySpan is subject to various federal, state and local laws and regulatory
programs related to the environment. Through various rate orders issued by the
NYPSC, MADTE and NHPUC, costs related to MGP environmental cleanup activities
are recovered in rates charged to gas distribution customers and, as a result,
adjustments to these reserve balances do not impact earnings. However,
environmental cleanup activities related to the three non-utility sites are not
subject to rate recovery.
We estimate that the remaining cost of our MGP related environmental cleanup
activities, including costs associated with the Ravenswood Facility, will be
approximately $232.1 million and we have recorded a related liability for such
amount. We have also recorded an additional $18.9 million liability,
representing the estimated environmental cleanup costs related to a former coal
tar processing facility. As of March 31, 2005, we have expended a total of
$145.7 million on environmental investigation and remediation activities. (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,
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.
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 value of investments held
change, or long-term interest rates change, the effect will be reflected in
KeySpan's recognition of periodic cost of such employee benefit plans and the
determination of contributions to the employee benefit plans.
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 power and services to our retail customers by our unregulated
57
energy service businesses; entering into financial and energy derivative
contracts with energy marketing companies and financial institutions; and the
sale of gas, 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 and in accordance with various
regulatory requirements.
We also have credit risk from LIPA, our largest customer, and from other energy
and financial services companies. Counterparty credit risk 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 derivative and other
contractual arrangements, and manage our level of exposure accordingly. In
instances where counterparties' credit quality has declined, or credit exposure
exceeds certain levels, 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.
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. The risks associated with KeySpan's gas distribution activities
have not changed substantially since December 31, 2004. For additional
information regarding these risks see KeySpan's Annual Report on Form 10K for
the Year Ended December 31, 2004, Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations "Market and Credit Risk Management
Activities." The following is an update to certain matters related KeySpan's
electric operations.
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 such reserves, as well as requiring a refunding of so
called alleged "excess payments" received by sellers, including the Ravenswood
Facility. 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 NYISO's other requests, such as
a bid cap for spinning reserves, retroactive refunds, recalculation of reserve
prices, etc. were rejected.
The NYISO, Con Edison, Niagara Mohawk Power Corporation and Rochester Gas and
Electric each individually appealed FERC's order in federal court. The appeals
were consolidated into one case and 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
FERC's order and remanded some issues back to FERC for further explanation and
action.
58
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. On March 4, 2005 FERC issued an order upholding its
original decision and denied the NYISO's motion for refunds. FERC also provided
the further explanation requested by the Court and why refunds were not being
ordered. The NYISO and other market participants have requested rehearing of
FERC's latest order and that decision is still pending.
In a related case, on March 4, 2005, FERC issued a second order requiring the
NYISO to reinstate the original prices from May 8 and 9, 2000 and to pay
suppliers, including the Ravenswood Facility, accordingly. In 2000, the NYISO
revised prices downward after it determined a market design flaw existed which
caused prices to be higher than what would occur in a competitive market. FERC
originally agreed with the NYISO, but reversed its original decision.
The NYISO and other market participants have requested a rehearing of this March
4, 2005 order. In addition, the NYISO and Consolidated Edison Solutions have
requested that FERC stay the payment of refunds claiming it will cause
irreparable harm. FERC has not issued an order in response to the rehearing or
stay request.
We cannot predict the final outcome of these proceedings or what effect, if any,
the outcome may have on our financial position, results of operations or cash
flows.
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;
59
- implementation of new accounting standards or changes in accounting
standards or GAAP which may require adjustments to financial
statements;
- inflationary trends and interest rates;
- the ability of KeySpan to identify and make complementary
acquisitions, as well as the successful integration of such
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;
- federal and state regulatory initiatives that 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, state and local utility regulatory policies,
legislation 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;
- the degree to which we develop unregulated business ventures, as well
as federal, state and local regulatory policies affecting our ability
to retain and operate such business ventures profitably;
- a change in the fair value of our investments that could cause a
significant change in the carrying value of such investments or the
carrying value of related goodwill;
- timely receipts of payments from our two largest customers LIPA and
the NYISO; and
- the outcome of LIPA's strategic business options study, pertaining to
its long-term future which include, as stated by LIPA, whether or not
LIPA will continue its operations as they presently exist, fully
municipalize or privatize, sell some, but not all of its assets and/or
become a regulator of rates and services. In addition, LIPA must make
a determination by December 15, 2005, as to whether it will purchase
our interest in KeySpan Generation LLC, the owner of our Long Island
(excluding the Glenwood and Port Jefferson Energy Center units)
generating assets, pursuant to the terms of the Generation Purchase
Rights Agreement; and
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- 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 - 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 distribution
operations, gas exploration and production activities and its electric
generating facilities. Our gas distribution operations utilize over-the-counter
("OTC") natural gas and fuel oil swaps to hedge the cash-flow variability of
specified portions of gas purchases and sales associated with certain
large-volume customers. Seneca-Upshur utilizes OTC natural gas swaps to hedge
cash flow variability associated with forecasted sales of natural gas. The
Ravenswood Generation Station uses derivative financial instruments to hedge the
cash flow variability associated with the purchase of a portion of natural gas
and oil that will be consumed during the generation of electricity. The
Ravenswood Generation Station also hedges the cash flow variability associated
with a portion of electric energy sales using OTC electricity swaps.
KeySpan uses standard NYMEX futures prices to value gas futures and market
quoted forward prices to value OTC swap contracts.
The following tables set forth selected financial data associated with these
derivative financial instruments noted above that were outstanding at March 31,
2005.
- ------------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Fair Value
Type of Contract Maturity mmcf Fixed Price $ Current Price $ (In $ Millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Gas
Swaps/Futures - Long Natural Gas 2005 6,076 7.11 7.32 - 7.91 4.5
OTC Swaps - Short Natural Gas 2005 1,320 6.58 - 6.70 7.96 - 8.85 (2.2)
2006 1,884 6.17 - 6.29 7.50 - 9.10 (3.4)
2007 1,812 5.86 - 5.97 6.95 - 8.38 (2.7)
- ------------------------------------------------------------------------------------------------------------------------------------
11,092 (3.8)
- ------------------------------------------------------------------------------------------------------------------------------------
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- ---------------------------------------------------------------------------------------------------------------------------
Year of Volumes Fair Value
Type of Contract Maturity Barrels Fixed Price $ Current Price $ (In $ Millions)
- ---------------------------------------------------------------------------------------------------------------------------
Oil
Swaps - Long Fuel Oil 2005 78,000 24.65 - 37.21 43.24 - 45.13 0.9
2006 12,000 34.40 43.86 0.1
Swaps - Short Heating Oil 2005 1,035,102 54.79 67.29 - 69.62 (13.8)
- ---------------------------------------------------------------------------------------------------------------------------
1,125,102 (12.8)
- ---------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Year of Fixed Margin/ Fair Value
Type of Contract Maturity MWh Price $ Current Price $ (In $ Millions)
- -------------------------------------------------------------------------------------------------------------------
Electricity
Swaps - Energy 2005 1,299,200 29.95 - 113.50 36.60 - 118.42 (2.4)
2006 173,600 42.24 - 108.75 45.24 - 99.54 0.4
- -------------------------------------------------------------------------------------------------------------------
1,472,800 (2.0)
- -------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
2005
Change in Fair Value of Derivative Instruments (In $ Millions)
- ----------------------------------------------------------------------------------------
Fair value of contracts at January 1, 2004 1.3
Net (gains) on contracts realized (7.4)
(Decrease) in fair value of all open contracts (12.5)
- ----------------------------------------------------------------------------------------
Fair value of contracts outstanding at March 31, (18.6)
- ----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
(In Millions of Dollars)
- -----------------------------------------------------------------------------------------------------
Fair Value of Contracts
- -----------------------------------------------------------------------------------------------------
Mature Within Total
Sources of Fair Value 12 Months Thereafter Fair Value
- -----------------------------------------------------------------------------------------------------
Prices actively quoted $ (9.3) $ - $ (9.3)
Local published indicies (4.8) (4.5) (9.3)
- -----------------------------------------------------------------------------------------------------
$(14.1) $(4.5) $(18.6)
- -----------------------------------------------------------------------------------------------------
62
We measure the commodity risk of our derivative hedging instruments (indicated
in the above table) using a sensitivity analysis. Based on a sensitivity
analysis as of March 31, 2005, a 10% increase in heating oil and natural gas
prices would decrease the value of derivative instruments maturing in one year
by $1.6 million, while the value of expected physical deliveries for one year
would be enhanced $2.1 million (net benefit to KeySpan of $0.5 million). A 10%
decrease in heating oil and natural gas prices would enhance the value of
derivative instruments maturing in one year by $1.6 million, while the value of
expected physical deliveries for one year would be decreased $2.1 million (net
cost to KeySpan of $0.5 million).
Based on a sensitivity analysis as of March 31, 2005, a 10% increase in
electricity and fuel prices would decrease the value of derivative instruments
maturing in one year by $6.0 million, while the value of expected physical power
production for one year would be enhanced $14.2 million (net benefit to KeySpan
of $8.2 million). A 10% decrease in electricity and fuel prices would have a
$6.2 million favorable impact on the value of derivative instruments maturing in
one year, while the value of expected physical power production would be reduced
$14.2 million (net cost to KeySpan of $8.0 million).
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative
financial instruments to reduce the cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations. The accounting for these derivative instruments is
subject to SFAS 71 "Accounting for the Effects of Certain Types of Regulation."
Therefore, changes in the fair value of these derivatives have been recorded as
a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
Gains or losses on the settlement of these contracts are initially deferred and
then refunded to or collected from our firm gas sales customers consistent with
regulatory requirements.
The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at March 31, 2005.
- -----------------------------------------------------------------------------------------------------------------------------------
Year of Volunes Floor Ceiling Fixed Current Fair Value
Type of Contract Maturity mmcf ($) ($) Price ($) Price ($) (In $ Millions)
- -----------------------------------------------------------------------------------------------------------------------------------
Options 2005 13,990 5.50 - 6.40 5.50 - 8.50 - 7.65 - 8.55 1.6
2006 7,910 5.50 - 6.40 5.50 - 8.50 - 7.18 - 7.87 5.5
Swaps 2005 26,320 - - 6.54 - 6.68 7.65 - 8.55 37.1
2006 25,870 - - 6.90 - 7.23 7.18 - 7.87 34.4
- -----------------------------------------------------------------------------------------------------------------------------------
74,090 78.6
- -----------------------------------------------------------------------------------------------------------------------------------
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
We maintain disclosure controls and procedures (as defined under Exchange Act
Rule 13a-15(e) and 15d-15(e)) that are designed to ensure that information
required to be disclosed by us in the reports we file or submit under 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 our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosure. Any
control system, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives. Our
management, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of our disclosure controls and procedures as of March 31, 2005. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that the design and operation of our disclosure controls and procedures provided
reasonable assurance that the disclosure controls and procedures are effective
to accomplish their objectives.
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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, which has materially
affected, or is reasonably likely to materially affect, KeySpan's internal
control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Note 6 to the Consolidated Financial Statements "Financial Guarantees and
Contingencies".
Item 6. Exhibits
10.1* Purchase Rights Extension Agreement between KeySpan and the Long Island
Power Authority dated March 28, 2005.
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
* filed herewith
- ----------------------
*Filed Herewith
64
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: April 29, 2005 /s/ Gerald Luterman
----------------------------
Gerald Luterman
Executive Vice President and
Chief Financial Officer
65