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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30, 2001 Commission File Number 1-4928
DUKE ENERGY CORPORATION
(Exact name of Registrant as Specified in its Charter)
North Carolina 56-0205520
(State or Other Jurisdiction (IRS Employer
of Incorporation) Identification No.)
526 South Church Street
Charlotte, NC 28202-1904
(Address of Principal Executive Offices)
(Zip code)
704-594-6200
(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 and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of Common Stock, without par value, outstanding at October 31,
2001......776,143,500
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DUKE ENERGY CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2001
INDEX
Item Page
- ---- ----
PART I. FINANCIAL INFORMATION
1. Financial Statements......................................................1
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 2001 and 2000................................2
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2001 and 2000................................3
Consolidated Balance Sheets as of September 30, 2001 and
December 31, 2000................................................4
Consolidated Statements of Comprehensive Income for the Three
and Nine Months Ended September 30, 2001 and 2000................5
Notes to Consolidated Financial Statements............................6
2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.............................................18
PART II. OTHER INFORMATION
1. Legal Proceedings........................................................31
4. Submission of Matters to a Vote of Security Holders......................31
5. Other Information........................................................31
6. Exhibits and Reports on Form 8-K.........................................32
Signatures...............................................................33
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
From time to time, Duke Energy's reports, filings and other public announcements
may include assumptions, projections, expectations, intentions or beliefs about
future events. These statements are intended as "forward-looking statements"
under the Private Securities Litigation Reform Act of 1995. Duke Energy cautions
that assumptions, projections, expectations, intentions or beliefs about future
events may and often do vary from actual results and the differences between
assumptions, projections, expectations, intentions or beliefs and actual results
can be material. Accordingly, there can be no assurance that actual results will
not differ materially from those expressed or implied by the forward-looking
statements. Some of the factors that could cause actual achievements and events
to differ materially from those expressed or implied in such forward-looking
statements include state, federal and foreign legislative and regulatory
initiatives that affect cost and investment recovery, have an impact on rate
structures and affect the speed and degree at which competition enters the
electric and natural gas industries; industrial, commercial and residential
growth in the service territories of Duke Energy and its subsidiaries; the
weather and other natural phenomena; the timing and extent of changes in
commodity prices, interest rates and foreign currency exchange rates; changes in
environmental and other laws and regulations to which Duke Energy and its
subsidiaries are subject or other external factors over which Duke Energy has no
control; the results of financing efforts, including Duke Energy's ability to
obtain financing on favorable terms, which can be affected by Duke Energy's
credit rating and general economic conditions; level of creditworthiness of
counterparties to transactions; growth in opportunities for Duke Energy's
business units; and the effect of accounting policies issued periodically by
accounting standard-setting bodies.
i
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In millions, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Operating Revenues
Sales, trading and marketing of natural gas
and petroleum products $ 7,428 $ 7,441 $ 26,688 $ 18,277
Trading and marketing of electricity 7,015 5,731 15,523 9,484
Generation, transmission and distribution of electricity 1,402 1,562 4,560 4,077
Transportation and storage of natural gas 253 253 732 779
Gain on sale of equity investment - 407 - 407
Other 620 297 1,286 883
---------- ---------- ---------- ----------
Total operating revenues 16,718 15,691 48,789 33,907
---------- ---------- ---------- ----------
Operating Expenses
Natural gas and petroleum products purchased 6,998 7,195 25,677 17,504
Net interchange and purchased power 6,264 5,461 14,427 9,047
Fuel used in electric generation 261 215 726 583
Other operation and maintenance 1,218 908 3,059 2,487
Depreciation and amortization 375 300 1,017 864
Property and other taxes 110 111 329 315
---------- ---------- ---------- ----------
Total operating expenses 15,226 14,190 45,235 30,800
---------- ---------- ---------- ----------
Operating Income 1,492 1,501 3,554 3,107
Other Income and Expenses 52 55 176 145
Interest Expense 206 257 651 670
Minority Interests 62 31 267 151
---------- ---------- ---------- ----------
Earnings Before Income Taxes 1,276 1,268 2,812 2,431
Income Taxes 480 498 1,043 939
---------- ---------- ---------- ----------
Income Before Cumulative Effect of Change
in Accounting Principle 796 770 1,769 1,492
Cumulative Effect of Change in Accounting Principle,
Net of Tax - - (96) -
---------- ---------- ---------- ----------
Net Income 796 770 1,673 1,492
Preferred and Preference Stock Dividends 4 4 12 14
---------- ---------- ---------- ----------
Earnings Available For Common Stockholders $ 792 $ 766 $ 1,661 $ 1,478
========== ========== ========== ==========
Common Stock Data
Weighted average shares outstanding 775 736 765 735
Earnings per share (before cumulative effect of change
in accounting principle)
Basic $ 1.02 $ 1.04 $ 2.30 $ 2.01
Diluted $ 1.01 $ 1.03 $ 2.28 $ 2.00
Earnings per share
Basic $ 1.02 $ 1.04 $ 2.17 $ 2.01
Diluted $ 1.01 $ 1.03 $ 2.16 $ 2.00
Dividends per share $ - $ - $ 0.825 $ 0.825
See Notes to Consolidated Financial Statements.
1
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)
Nine Months Ended
September 30,
-------------------------
2001 2000
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES $ 3,923 $ 1,887
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, net of cash acquired (4,049) (3,498)
Investment expenditures (1,066) (1,099)
Proceeds from sale of equity interest - 400
Other 460 310
---------- ----------
Net cash used in investing activities (4,655) (3,887)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from
Long-term debt issuances 2,025 2,755
Common stock issuances and stock option exercises 1,382 130
Payments for the redemption of
Long-term debt (1,086) (844)
Preferred and preference stock (20) (20)
Net change in notes payable and commercial paper (913) 1,189
Distributions to minority interests - (1,217)
Contributions from minority interests - 741
Dividends paid (651) (621)
Other (10) 35
---------- ----------
Net cash provided by financing activities 727 2,148
---------- ----------
Net (decrease) increase in cash and cash equivalents (5) 148
Cash and cash equivalents at beginning of period 622 613
---------- ----------
Cash and cash equivalents at end of period $ 617 $ 761
========== ==========
Supplemental Disclosures
Cash paid for interest, net of amount capitalized $ 635 $ 611
Cash paid for income taxes $ 115 $ 758
See Notes to Consolidated Financial Statements.
2
CONSOLIDATED BALANCE SHEETS
(In millions)
September 30, December 31,
2001 2000
(Unaudited)
---------- ----------
ASSETS
Current Assets
Cash and cash equivalents $ 617 $ 622
Receivables, net of allowance for doubtful accounts 8,447 8,293
Inventory 872 736
Unrealized gains on trading and hedging transactions 2,311 11,038
Other 878 1,466
---------- ----------
Total current assets 13,125 22,155
---------- ----------
Investments and Other Assets
Investments in affiliates 1,293 1,370
Nuclear decommissioning trust funds 643 717
Pre-funded pension costs 310 304
Goodwill, net 1,625 1,566
Notes receivable 501 462
Unrealized gains on trading and hedging transactions 2,853 4,218
Other 2,070 1,445
---------- ----------
Total investments and other assets 9,295 10,082
---------- ----------
Property, Plant and Equipment
Cost 37,729 34,615
Less accumulated depreciation and amortization 10,902 10,146
---------- ----------
Net property, plant and equipment 26,827 24,469
---------- ----------
Regulatory Assets and Deferred Debits 1,216 1,470
---------- ----------
Total Assets $ 50,463 $ 58,176
========== ==========
See Notes to Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEETS
(In millions)
September 30, December 31,
2001 2000
(Unaudited)
---------- ----------
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 7,065 $ 7,375
Notes payable and commercial paper 951 1,826
Taxes accrued 1,049 261
Interest accrued 210 208
Current maturities of long-term debt and preferred stock 260 470
Unrealized losses on trading and hedging transactions 1,885 11,070
Other 2,106 1,769
---------- ----------
Total current liabilities 13,526 22,979
---------- ----------
Long-term Debt 12,130 11,019
---------- ----------
Deferred Credits and Other Liabilities
Deferred income taxes 4,401 3,851
Nuclear decommissioning costs externally funded 643 717
Unrealized losses on trading and hedging transactions 1,249 3,581
Other 1,831 1,885
---------- ----------
Total deferred credits and other liabilities 8,124 10,034
---------- ----------
Commitments and Contingencies
Guaranteed Preferred Beneficial Interests in Subordinated
Notes of Duke Energy Corporation or Subsidiaries 1,407 1,406
---------- ----------
Minority Interests 2,528 2,435
---------- ----------
Preferred and Preference Stock
Preferred and preference stock with sinking fund requirements 38 38
Preferred and preference stock without sinking fund requirements 209 209
---------- ----------
Total preferred and preference stock 247 247
---------- ----------
Common Stockholders' Equity
Common stock, no par, 2 billion shares authorized; 776 million and 739 million
shares outstanding at September 30, 2001 and December 31, 2000, respectively 6,173 4,797
Retained earnings 6,354 5,379
Accumulated other comprehensive loss (26) (120)
---------- ----------
Total common stockholders' equity 12,501 10,056
---------- ----------
Total Liabilities and Common Stockholders' Equity $ 50,463 $ 58,176
========== ==========
See Notes to Consolidated Financial Statements.
4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In millions)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Net Income $ 796 $ 770 $ 1,673 $ 1,492
Other Comprehensive Income (Loss), Net of Tax
Cumulative effect of change in accounting principle - - (921) -
Foreign currency translation adjustment (125) (12) (313) (60)
Net unrealized (losses) gains on cash flow hedges (14) - 1,139 -
Reclassification into earnings (290) - 189 -
--------- --------- --------- ---------
Total other comprehensive (loss) income (429) (12) 94 (60)
--------- --------- --------- ---------
Total Comprehensive Income $ 367 $ 758 $ 1,767 $ 1,432
========= ========= ========= =========
See Notes to Consolidated Financial Statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
Duke Energy Corporation (collectively with its subsidiaries, "Duke Energy") is
an integrated energy and energy services provider with the ability to offer
physical delivery and management of both electricity and natural gas throughout
the U.S. and abroad. Duke Energy provides these and other services through seven
business segments.
Franchised Electric generates, transmits, distributes and sells electric energy
in central and western North Carolina and the western portion of South Carolina.
Its operations are conducted primarily through Duke Power and Nantahala Power
and Light. These electric operations are subject to the rules and regulations of
the Federal Energy Regulatory Commission (FERC), the North Carolina Utilities
Commission and the Public Service Commission of South Carolina.
Natural Gas Transmission provides interstate transportation and storage of
natural gas for customers primarily in the Mid-Atlantic, New England and
southeastern states. Its operations are conducted primarily through Duke Energy
Gas Transmission Corporation. The interstate natural gas transmission and
storage operations are subject to the rules and regulations of the FERC.
Field Services gathers, processes, transports, markets and stores natural gas
and produces, transports, markets and stores natural gas liquids (NGLs). Its
operations are conducted primarily through Duke Energy Field Services, LLC
(DEFS), a limited liability company that is approximately 30% owned by Phillips
Petroleum. Field Services operates gathering systems in western Canada and 11
contiguous states that serve major natural gas-producing regions in the Rocky
Mountain, Permian Basin, Mid-Continent, East Texas-Austin Chalk-North Louisiana,
as well as onshore and offshore Gulf Coast areas.
North American Wholesale Energy's (NAWE's) activities include asset development,
operation and management, primarily through Duke Energy North America, LLC
(DENA), and commodity sales and services related to natural gas and power,
primarily through Duke Energy Trading and Marketing, LLC (DETM). DETM is a
limited liability company that is approximately 40% owned by Exxon Mobil
Corporation. NAWE also includes Duke Energy Merchants, which develops new
business lines in the evolving energy commodity markets. NAWE conducts its
business throughout the U.S. and Canada.
International Energy conducts its operations through Duke Energy International,
LLC. International Energy's activities include asset development, operation and
management of natural gas and power facilities and energy trading and marketing
of natural gas and electric power. This activity is targeted in the Latin
American, Asia-Pacific and European regions.
Other Energy Services is a combination of businesses that provide engineering,
consulting, construction and integrated energy solutions worldwide, primarily
through Duke Engineering & Services, Inc., Duke/Fluor Daniel (D/FD) and
DukeSolutions, Inc. D/FD is a 50/50 partnership between Duke Energy and Fluor
Enterprises, Inc.
Duke Ventures is comprised of other diverse businesses, primarily operating
through Crescent Resources, LLC (Crescent), DukeNet Communications, LLC
(DukeNet) and Duke Capital Partners, LLC (DCP). Crescent develops high-quality
commercial, residential and multi-family real estate projects and manages land
holdings primarily in the southeastern U.S. DukeNet provides fiber optic
networks for industrial, commercial and residential customers. DCP, a wholly
owned merchant finance company, provides financing, investment banking and asset
management services to wholesale and commercial energy markets.
6
2. Summary of Significant Accounting Policies
Consolidation. The Consolidated Financial Statements include the accounts of
Duke Energy and all majority-owned subsidiaries after the elimination of
significant intercompany transactions and balances. These Consolidated Financial
Statements reflect all normal recurring adjustments that are, in the opinion of
management, necessary to present fairly the financial position and results of
operations for the respective periods. Amounts reported in the Consolidated
Statements of Income are not necessarily indicative of amounts expected for the
respective annual periods due to the effects of seasonal temperature variations
on energy consumption and the timing of maintenance of certain electric
generating units.
Earnings Per Common Share. Basic earnings per share is based on a simple
weighted average of common shares outstanding. Diluted earnings per share
reflects the potential dilution that could occur if securities or other
agreements to issue common stock, such as stock options, were exercised or
converted into common stock. The numerator for the calculation of basic and
diluted earnings per share is earnings available for common stockholders.
- ----------------------------------------------------------------------------------------
Denominator for Earnings per Share (In millions)
- ----------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------
2001 2000 2001 2000
----------------------------------------
Denominator for basic earnings per share
(weighted average shares outstanding) 775.2 736.4 764.5 734.9
Assumed exercise of dilutive stock options 5.5 4.6 5.6 2.8
----------------------------------------
Denominator for diluted earnings per share 780.7 741.0 770.1 737.7
- ----------------------------------------------------------------------------------------
Prior year common stock amounts and per share data have been adjusted to reflect
the two-for-one common stock split effective January 26, 2001.
Accounting for Hedges and Commodity Trading Activities. All derivatives are
recorded on the Consolidated Balance Sheets at their fair value as Unrealized
Gains or Unrealized Losses on Trading and Hedging Transactions, as appropriate.
On the date swaps, futures, forwards or option contracts are entered into, Duke
Energy either designates the derivative as held for trading (trading
instruments); as a hedge of a forecasted transaction or future cash flows (cash
flow hedges); as a hedge of a recognized asset, liability, or firm commitment
(fair value hedge); as a normal purchase or sale contract; or leaves the
derivative undesignated for contracts not afforded special hedge accounting.
Duke Energy also formally assesses, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items. The time value of options of $3 million was excluded in the assessment of
hedge effectiveness for the three months ended September 30, 2001.
Commodity Trading. Prior to settlement of any energy contract held for trading
purposes, favorable or unfavorable price movement is reported as Natural Gas and
Petroleum Products Purchased, or Net Interchange and Purchased Power, as
appropriate, in the Consolidated Statements of Income. An offsetting amount is
recorded on the Consolidated Balance Sheets as Unrealized Gains or Unrealized
Losses on Trading and Hedging Transactions. When a contract to sell energy is
physically settled, the fair value entries are reversed and the gross amount
invoiced to the customer is included as Sales, Trading and Marketing of Natural
Gas and Petroleum Products, or Trading and Marketing of Electricity, as
appropriate, in the Consolidated Statements of Income. Similarly, when a
contract to purchase energy is physically settled, the purchase price is
included as Natural Gas and Petroleum Products Purchased, or Net Interchange and
Purchased Power, as appropriate, in the Consolidated Statements of Income. If a
contract is not physically settled, the unrealized gain or loss on the
Consolidated Balance Sheets is reversed and reclassified to a receivable or
payable account. For income statement purposes, the contract is treated as a
pure financial instrument, so financial settlement has no effect on the
Consolidated Statements of Income.
7
Cash Flow Hedges. Changes in the fair value of a derivative that is designated
and qualifies as a cash flow hedge are included in the Consolidated Statements
of Comprehensive Income as Other Comprehensive Income (OCI) until earnings are
affected by the hedged item. Settlement amounts and ineffective portions of cash
flow hedges are removed from OCI and recorded in the Consolidated Statements of
Income in the same accounts as the item being hedged. Duke Energy discontinues
hedge accounting prospectively when it is determined that the derivative no
longer qualifies as an effective hedge, or when it is no longer probable that
the hedged transaction will occur. When hedge accounting is discontinued, the
derivative will continue to be carried on the Consolidated Balance Sheets at its
fair value with subsequent changes in its fair value recognized in
current-period earnings. Gains and losses related to discontinued hedges that
were accumulated in OCI will remain in OCI until earnings are affected by the
hedged item, unless it is no longer probable that the hedged transaction will
occur. Under these circumstances, gains and losses that were accumulated in OCI
will be recognized in current-period earnings.
Fair Value Hedges. Duke Energy enters into interest rate swaps to convert some
of its fixed-rate long-term debt to floating-rate debt and designates such
interest rate swaps as fair value hedges. Duke Energy also enters into
electricity derivative instruments such as swaps, futures and forwards to manage
the fair value risk associated with certain of its unrecognized firm commitments
to sell generated power due to changes in the market price of power. Upon
designation of such derivatives as fair value hedges, prospective changes in
fair value of the derivative and the hedged item are recognized in current
earnings. All components of each derivative gain or loss are included in the
assessment of hedge effectiveness, unless otherwise noted.
Cumulative Effect of Change in Accounting Principle. Duke Energy adopted
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities," on January 1, 2001. In
accordance with the transition provisions of SFAS No. 133, Duke Energy recorded
a net-of-tax cumulative effect adjustment of $96 million, or $0.13 per basic
share, as a reduction in earnings. The net-of-tax cumulative effect adjustment
reducing OCI and Common Stockholders' Equity was $921 million. For the nine
months ended September 30, 2001, Duke Energy reclassified as earnings $504
million of losses from OCI for derivatives included in the transition adjustment
related to hedge transactions that settled. The amount reclassified out of OCI
will be different from the amount included in the transition adjustment due to
market price changes since January 1, 2001.
Currently, there are ongoing discussions surrounding the implementation and
interpretation of SFAS No. 133 by the Financial Accounting Standards Board's
(FASB) Derivative Implementation Group. In June 2001, the FASB approved Issue
C15, "Scope Exceptions: Normal Purchases and Normal Sales Exception for
Option-Type Contracts and Forwards Contracts in Electricity." Under the guidance
of Issue C15, buyers and sellers of electricity are not required to
mark-to-market contracts meeting certain criteria. Option-type contracts include
capacity contracts that allow the electric industry to meet volatile demand by
providing the option to purchase electricity as needed. The FASB concluded if
such contracts meet the criteria outlined in Issue C15, they could qualify as a
normal purchase or sale under SFAS No. 133. This new SFAS No. 133 implementation
guidance became effective July 1, 2001. For contracts previously designated as
hedges, Duke Energy treated the change as a de-designation under SFAS No. 133,
and the fair value for each qualifying contract on July 1 became the contract's
net carrying amount. On October 10, 2001 the FASB approved revisions to the
qualifying criteria outlined in Issue C15. The revised guidance becomes
effective January 1, 2002. Duke Energy is continuing to determine the impact on
its future results of the revision.
New Accounting Standards. In June 2001, the FASB issued SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets."
8
SFAS No. 141 requires all business combinations initiated (as defined by the
standard) after June 30, 2001 to be accounted for using the purchase method.
Companies may no longer use the pooling method of accounting for future
combinations.
SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 and
will be adopted by Duke Energy as of January 1, 2002. SFAS No. 142 requires that
goodwill no longer be amortized over an estimated useful life, as previously
required. Instead, goodwill amounts will be subject to a fair-value-based
annual impairment assessment. The standard also requires acquired intangible
assets to be recognized separately and amortized as appropriate. Duke Energy
expects that the adoption of SFAS No. 142 will have an impact on future
financial statements due to the discontinuation of goodwill amortization
expense. For the nine months ended September 30, 2001, amortization expense for
goodwill was $108 million. The FASB and the Emerging Issues Task Force continue
to field questions surrounding the transition provisions and clarification of
key aspects of the standard. Duke Energy is preparing to implement the new
standard and has not yet determined the impact on its consolidated results of
operations, cash flows or financial position.
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 provides the accounting requirements for retirement
obligations associated with tangible long-lived assets. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002, and early adoption is
permitted. Duke Energy is currently assessing the new standard and has not yet
determined the impact on its consolidated results of operations, cash flows or
financial position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The new rules supersede SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." The new rules retain many of the fundamental recognition and
measurement provisions, but significantly change the criteria for classifying an
asset as held-for-sale. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001. Duke Energy is currently assessing the new standard and
has not yet determined the impact on its consolidated results of operations,
cash flows or financial position.
Reclassifications. Certain prior period amounts have been reclassified in the
Consolidated Financial Statements and in Note 4 to conform to the current
presentation.
Excise and Other Pass Through Taxes. Duke Energy generally presents revenues net
of pass through taxes on the Consolidated Statements of Income.
3. Derivative Instruments, Hedging Activities and Credit Risk
Commodity Cash Flow Hedges. Certain subsidiaries of Duke Energy are exposed to
market fluctuations in the prices of various commodities related to their
ongoing power generating and natural gas gathering, processing and marketing
activities. Duke Energy closely monitors the potential impacts of commodity
price changes, and where appropriate, uses various instruments to lock in
margins for a portion of its future sales and generation revenues. These
commodity instruments, consisting of swaps, futures, forwards and collared
options, serve as cash flow hedges for natural gas, electricity and NGL
transactions. The maximum term over which Duke Energy is hedging exposures to
the price variability of these commodities is 12 years.
For the nine months ended September 30, 2001, the ineffective portion of
commodity cash flow hedges and the amount recognized for transactions that no
longer qualified as cash flow hedges were not material. As of September 30,
2001, $47 million of after-tax deferred net losses on derivative instruments
accumulated in OCI are expected to be reclassified to earnings during the next
three months as the hedged transactions occur. These losses will generally be
more than offset by the related sales and generation revenues. However, due to
the volatility of the commodities markets, the value of the derivative
instrument is subject to change prior to its reclassification into earnings.
9
Commodity Fair Value Hedges. Certain subsidiaries of Duke Energy are exposed to
changes in fair value of certain if its unrecognized firm commitments to sell
generated power due to market fluctuations of the underlying commodity prices.
Duke Energy actively evaluates such changes in fair value of such unrecognized
firm commitments due to commodity price changes, and where appropriate, uses
various instruments to hedge its market risk associated with those firm
commitments. These commodity instruments, consisting of swaps, futures and
forwards, serve as fair value hedges for the firm commitments associated with
generated power sales. The maximum term over which Duke Energy is hedging
exposures to the market risk of such items is ten years. For the nine months
ended September 30, 2001, the ineffective portion of commodity fair value hedges
was not material.
Energy Trading Contracts. Duke Energy provides energy supply, structured
origination, trading and marketing, risk management and commercial optimization
services to large energy customers, energy aggregators and other wholesale
companies. These services require Duke Energy to utilize natural gas,
electricity, NGL and transportation derivatives and contracts that expose it to
a variety of market risks. Duke Energy manages its trading exposure with strict
policies that limit its market risk and require daily reporting to management of
potential financial exposure. These policies include statistical risk tolerance
limits using historical price movements to calculate a daily earnings at risk
measurement.
Interest Rate (Fair Value or Cash Flow) Hedges. Duke Energy is exposed to risk
resulting from changes in interest rates as a result of its issuance of
variable-rate debt, fixed-rate securities, commercial paper and auction market
preferred stock, as well as interest rate swaps and interest rate lock
agreements. Duke Energy manages its interest rate exposure by limiting its
variable-rate and fixed-rate exposures to certain percentages of total
capitalization, as set by policy, and by monitoring the effects of market
changes in interest rates. For the nine months ended September 30, 2001, Duke
Energy's existing interest rate derivative instruments and related
ineffectiveness were not material to its results of operations, cash flows or
financial position.
Foreign Currency (Fair Value or Cash Flow) Hedges. Duke Energy is exposed to
foreign currency risk that arises from investments in international affiliates
and businesses owned and operated in foreign countries. To mitigate risks
associated with foreign currency fluctuations, when possible, contracts are
denominated in or indexed to the U.S. dollar, or investments may be hedged
through debt denominated in the foreign currency. Duke Energy also uses foreign
currency derivatives, where possible, to manage its risk related to foreign
currency fluctuations. For the nine months ended September 30, 2001, the impact
of Duke Energy's existing foreign currency derivative instruments were not
material to its results of operations, cash flows or financial position.
Market and Credit Risk. Duke Energy's principal markets for power and natural
gas marketing services are industrial end-users and utilities located throughout
the U.S., Canada, Asia Pacific, Europe and Latin America. Duke Energy has
concentrations of receivables from natural gas and electric utilities and their
affiliates, as well as industrial customers throughout these regions. These
concentrations of customers may affect Duke Energy's overall credit risk in that
certain customers may be similarly affected by changes in economic, regulatory
or other factors. Where exposed to credit risk, Duke Energy analyzes the
counterparties' financial condition prior to entering into an agreement,
establishes credit limits and monitors the appropriateness of these limits on an
ongoing basis. As of September 30, 2001, Duke Energy had a pre-tax provision of
$90 million related to energy sales in California. See Note 8 for further
information regarding credit exposure.
The change in market value of New York Mercantile Exchange-traded futures and
options contracts requires daily cash settlement in margin accounts with
brokers. Physical forward contracts and financial derivatives are generally
settled at the expiration of the contract term or each delivery period; however,
these transactions are also generally subject to margin agreements with the
majority of Duke Energy's counterparties.
10
4. Business Segments
Duke Energy's reportable segments are strategic business units that offer
different products and services and are each managed separately. Management
evaluates segment performance based on earnings before interest and taxes (EBIT)
after deducting minority interests. EBIT is calculated as follows:
- ------------------------------------------------------------------------
Reconciliation of Operating Income to EBIT (In millions)
- ------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------
2001 2000 2001 2000
--------------------------------------
Operating income $ 1,492 $ 1,501 $ 3,554 $ 3,107
Other income and expenses 52 55 176 145
--------------------------------------
EBIT $ 1,544 $ 1,556 $ 3,730 $ 3,252
- ------------------------------------------------------------------------
EBIT should not be considered as an alternative to, or more meaningful than, net
income or cash flow as determined in accordance with generally accepted
accounting principles as an indicator of Duke Energy's operating performance or
liquidity. Duke Energy's EBIT is not necessarily comparable to a similarly
titled measure of another company.
Beginning January 1, 2001, Duke Energy discontinued allocating corporate
governance costs for its business segment analysis. Certain reclassifications
have been made to information for the period ended September 30, 2000 to conform
to the current year presentation.
11
- --------------------------------------------------------------------------------------------------------------------
Business Segment Data (In millions)
- --------------------------------------------------------------------------------------------------------------------
Depreciation Capital and
Unaffiliated Intersegment Total and Investment
Revenues Revenues Revenues EBIT/a/ Amortization Expenditures/c/
-------------------------------------------------------------------------------
Three Months Ended
September 30, 2001
Franchised Electric $ 1,431 $ - $ 1,431 $ 607 $ 147 $ 298
Natural Gas Transmission 238 33 271 143 35 238
Field Services 1,331 373 1,704 75 81 148
NAWE 12,995 95 13,090 618 40 1,115
International Energy 390 5 395 74 24 106
Other Energy Services 75 68 143 (22) 34 2
Duke Ventures 258 - 258 51 6 192
Other Operations/b/ - (2) (2) (39) 8 24
Eliminations and
Minority interests - (572) (572) 37 - -
-----------------------------------------------------------------------------
Total consolidated $ 16,718 $ - $ 16,718 $ 1,544 $ 375 $ 2,123
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended
September 30, 2000
Franchised Electric $ 1,435 $ - $ 1,435 $ 616 $ 141 $ 166
Natural Gas Transmission 247 32 279 132 33 447
Field Services 2,087 440 2,527 85 67 53
NAWE 11,143 43 11,186 235 20 558
International Energy 270 - 270 83 25 99
Other Energy Services (29) 105 76 (69) 3 6
Duke Ventures 538 - 538 445 4 253
Other Operations/b/ - (66) (66) (16) 7 206
Eliminations and
Minority interests - (554) (554) 45 - -
-----------------------------------------------------------------------------
Total consolidated $ 15,691 $ - $ 15,691 $ 1,556 $ 300 $ 1,788
- --------------------------------------------------------------------------------------------------------------------
/a/ EBIT includes intersegment sales accounted for at prices representative of unaffiliated party transactions.
/b/ Includes certain unallocated corporate items, as discussed above.
/c/ Capital and Investment Expenditures are gross of cash received from acquisitions.
12
- -------------------------------------------------------------------------------------------------------------------------
Business Segment Data (In millions)
- ---------------------------------------------------------------------------------------------------------------------------
Depreciation Capital and
Unaffiliated Intersegment Total and Investment
Revenues Revenues Revenues EBIT/a/ Amortization Expenditures/c/
---------------------------------------------------------------------------------
Nine Months Ended
September 30, 2001
Franchised Electric $ 3,742 $ - $ 3,742 $ 1,428 $ 439 $ 750
Natural Gas Transmission 712 105 817 460 106 524
Field Services 6,202 1,438 7,640 282 219 455
NAWE 36,223 388 36,611 1,217 101 2,480
International Energy 1,286 10 1,296 218 72 264
Other Energy Services 231 162 393 (9) 41 10
Duke Ventures 393 - 393 94 15 555
Other Operations/b/ - 119 119 (152) 24 83
Eliminations and
Minority interests - (2,222) (2,222) 192 - -
-------------------------------------------------------------------------------
Total consolidated $ 48,789 $ - $ 48,789 $ 3,730 $ 1,017 $ 5,121
- --------------------------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30, 2000
Franchised Electric $ 3,708 $ - $ 3,708 $ 1,476 $ 423 $ 457
Natural Gas Transmission 748 98 846 418 94 914
Field Services 5,231 917 6,148 229 176 268
NAWE 22,586 235 22,821 427 55 1,384
International Energy 725 2 727 274 74 929
Other Energy Services 300 189 489 (52) 9 22
Duke Ventures 609 - 609 478 12 417
Other Operations/b/ - (56) (56) (126) 21 306
Eliminations and
Minority interests - (1,385) (1,385) 128 - -
-------------------------------------------------------------------------------
Total consolidated $ 33,907 $ - $ 33,907 $ 3,252 $ 864 $ 4,697
- --------------------------------------------------------------------------------------------------------------------------
/a/ EBIT includes intersegment sales accounted for at prices representative of unaffiliated party transactions.
/b/ Includes certain unallocated corporate items.
/c/ Capital and Investment Expenditures are gross of cash received from acquisitions.
Segment assets in the accompanying table are net of intercompany advances,
intercompany notes receivable and investments in subsidiaries.
- --------------------------------------------------------------------------
Segment Assets (In millions)
- --------------------------------------------------------------------------
September 30, December 31,
2001 2000
-----------------------
Franchised Electric $ 12,901 $ 12,819
Natural Gas Transmission 4,960 4,995
Field Services 7,040 6,266
NAWE 17,203 28,213
International Energy 4,226 4,551
Other Energy Services 192 543
Duke Ventures 1,842 1,967
Other Operations and eliminations/a/ 2,099 (1,178)
-----------------------
Total consolidated $ 50,463 $ 58,176
- --------------------------------------------------------------------------
/a/ Includes certain unallocated corporate items.
13
5. Debt
In February 2001, DEFS issued $250 million of 6.875% Senior Unsecured Notes due
2011. The proceeds were used to repay DEFS' remaining balance of commercial
paper that was issued in connection with the March 2000 combination of Field
Services' natural gas gathering, processing and marketing business with Phillips
Petroleum's gas gathering, processing and marketing unit. In addition, in
November 2001 DEFS issued $300 million of 5.75% Senior Unsecured Notes due 2006.
The proceeds will be used to repay short-term debt.
In July 2001, Duke Energy redeemed seven issues of its first and refunding
mortgage bonds. The redemption was completed to take advantage of the general
decline in interest rates. The total face value of the redeemed bonds was $386
million with interest rates ranging from 5.875% to 8.30%. Fees paid in
connection with these redemptions totaled approximately $15 million and are not
shown separately in the accompanying financial statements.
Duke Energy's wholly-owned subsidiary, Duke Capital Corporation, had a $141
million note payable to D/FD as of December 31, 2000. As of September 30, 2001,
the note had increased $412 million to $553 million. The weighted average
interest rates were 3.87% and 4.44% for the quarter and nine months ended
September 30, 2001, respectively.
6. Equity Offerings
In March 2001, Duke Energy completed an offering of 25 million shares of common
stock, at a price of $38.98 per share, before underwriting discount and other
offering expenses. In addition, Duke Energy completed an offering of
approximately 31 million units of mandatorily convertible securities (Equity
Units) at a price of $25 per unit before underwriting discount and other
offering expenses. The Equity Units consist of senior notes of Duke Capital
Corporation, and purchase contracts obligating the investors to purchase shares
of Duke Energy's common stock in 2004. The number of shares to be issued in 2004
will be based on the stock price at conversion. Also in March 2001, the
underwriters exercised options granted to them to purchase an additional 3.75
million shares of common stock and four million Equity Units at the original
issue prices, less underwriting discounts, to cover over-allotments made during
the offerings. Total net proceeds from the offerings were approximately $1.94
billion and were used to repay short-term debt and for other corporate purposes.
7. Common Stock
At Duke Energy's annual meeting of shareholders held on April 26, 2001,
shareholders approved an amendment to the Articles of Incorporation to increase
the authorized common stock from one billion to two billion shares.
8. Commitments and Contingencies
Environmental Matters. In October 1998, the Environmental Protection Agency
(EPA) issued a final rule on regional ozone control that required 22 eastern
states and the District of Columbia to revise their State Implementation Plans
(SIPs) to significantly reduce emissions of nitrogen oxide by May 1, 2003. The
EPA's rule was challenged in court by various states, industry and other
interests, including Duke Energy and the states of North Carolina and South
Carolina. In March 2000, the court upheld most aspects of the EPA's rule. The
same court subsequently issued a decision that extended the compliance deadline
for implementation of emission reductions to May 31, 2004.
In January 2000, the EPA finalized another ozone-related rule under Section 126
of the Clean Air Act that has virtually identical emission control requirements
as its October 1998 action, but with a May 1, 2003 compliance date. This rule
was challenged in court and on May 14, 2001 the U.S. Court of Appeals for the DC
Circuit sided with the EPA on all issues except one. The court remanded the
electric generating unit (EGU) growth rate factor determinations used to
establish each state's emission cap until the EPA could
14
engage in decision making on how to set the EGU growth rate factors. On August
24, 2001, the DC Circuit suspended the implementation schedule for EGUs until
the EPA completes a rulemaking in response to the court's May 14 remand order.
This ruling prevents the EPA from implementing the Section 126 program beginning
May 1, 2003. Possible new implementation dates range from mid July of 2003 to
May 31, 2004. Management estimates that Duke Energy will spend from $500 million
to $900 million in capital costs for additional emission controls through 2007
to comply with the new EPA rules.
In response to the EPA's October 1998 rule, both North Carolina and South
Carolina have revised their SIPs and are awaiting legislative and EPA approval.
Legislation was recently introduced in the North Carolina General Assembly that
would require North Carolina electric utilities, including Duke Energy, to make
significant reductions in emissions of sulfur dioxide and nitrogen oxides from
its coal-fired power plants over the next eight to 12 years. Management
estimates the cost to Duke Energy of achieving the specified emission reductions
in the proposed legislation to be approximately $1.5 billion. The proposed North
Carolina legislation includes a provision that allows Duke Energy to recover
some or all of these costs from customers. The provisions of the final
legislation, if passed into law, could be significantly different from the
proposal.
Emission control retrofits needed to comply with the new rules are large
technical, design and construction projects. These projects will be managed
closely to ensure the continuation of reliable electric service to Duke Energy's
customers throughout the projects and upon their completion.
California Issues. Duke Energy, certain of its subsidiaries, and three current
or former executives have been named as defendants, among numerous other
corporate and individual defendants, in one or more of a total of six lawsuits
brought by or on behalf of electricity consumers in the State of California who
seek damages as a result of the defendants' alleged unlawful manipulation of the
California wholesale electricity markets. Duke Energy North America (DENA) and
DETM have been named among 16 defendants in a class action lawsuit (the Gordon
lawsuit) filed against companies identified as "generators and traders" of
electricity in California markets. DETM also was named as one of numerous
defendants in four additional lawsuits, including two class actions (the
Hendricks and Pier 23 Restaurant lawsuits), filed against generators, marketers
and traders and other unnamed providers of electricity in California markets. A
sixth lawsuit (the Bustamante lawsuit), was brought by the Lieutenant Governor
of the State of California and a State Assemblywoman, and includes Duke Energy,
certain of its subsidiaries and three current or former executives of Duke
Energy among the numerous other corporate and individual defendants. The Gordon
and Hendricks class action lawsuits were filed in the Superior Court of the
State of California, San Diego County, in November 2000. Three other lawsuits
were filed in January 2001, one in Superior Court, San Diego County, and the
other two in Superior Court, County of San Francisco. The Bustamante lawsuit was
filed in May 2001 in Superior Court, Los Angeles County. These lawsuits
generally allege that the defendants manipulated the wholesale electricity
markets in violation of state laws against unfair and unlawful business
practices and state antitrust laws. Plaintiffs in these lawsuits seek aggregate
damages of billions of dollars. The lawsuits each seek the disgorgement of
alleged unlawfully obtained revenues for sales of electricity and, in four
lawsuits, an award of treble damages. While these matters referenced above are
in their earliest stages, management believes, based on its analysis to date of
the factual background and the claims asserted in these matters, that their
resolution will not have a material adverse effect on Duke Energy's consolidated
results of operations, cash flows or financial position.
In addition to the lawsuits described in the preceding paragraph, several
investigations and regulatory proceedings have commenced at the state and
federal levels into the causes of the high wholesale electricity prices in the
western U.S. At the federal level, there are numerous proceedings before the
FERC. Some parties to those proceedings have made claims for billions of dollars
of refunds from sellers of wholesale electricity, including DETM. Some parties
have also sought to revoke the authority of DETM and other DENA-affiliated
electricity marketers to sell electricity at market-based rates. The FERC is
also conducting its own investigation to determine the causes of the high
wholesale electricity prices. As a result of these proceedings, the FERC has
ordered some sellers, including DETM, to refund, or offset against outstanding
accounts receivable, certain amounts billed for sales of electricity in excess
of a FERC established proxy
15
price. The proxy price is intended to represent what the FERC believes would
have been the market-clearing price in a perfectly competitive market. In June
2001, DETM offset approximately $20 million against amounts owed to it by the
California Independent System Operator and the California Power Exchange for
sales of electricity during January and February 2001. This offset reduced the
$110 million reserve established in the fourth quarter of 2000 to $90 million.
Proceedings are ongoing to determine, among other things, the amount of any
refunds or offsets for periods prior to January 2001 and the method to be used
to determine the proxy price in future months.
At the state level, the California Public Utilities Commission has formal and
informal investigations in place primarily to determine if power plant operators
in California, including DENA, have improperly "withheld," either economically
or physically, generation output from the market to manipulate market prices. In
addition, the California State Senate formed a Select Committee to Investigate
Price Manipulation of the Wholesale Energy Market (Select Committee). The Select
Committee has served a subpoena on several Duke Energy subsidiaries seeking data
concerning their California market activities. The Select Committee has heard
testimony from several witnesses but no one from Duke Energy has been called to
testify to date.
The California Attorney General also has an investigation under way to determine
if any market participants engaged in illegal activity, including antitrust
activity, in the course of their sales of electricity into the wholesale markets
in the western U.S. The Attorneys General of Washington and Oregon have joined
the California Attorney General in a joint investigation of the electricity
markets.
The California Attorney General has also convened a grand jury to determine
whether criminal charges should be brought against any market participants. To
date, no Duke Energy employee has been called to testify before the grand jury
nor have any criminal charges been filed against Duke Energy or any of its
officers, directors or employees in connection with the wholesale electricity
markets in the western U.S.
Throughout 2001, Duke Energy has conducted its business in California to supply
the maximum possible electricity to meet the needs of the state while limiting
its exposure to non-creditworthy counterparties and managing the output
limitations on its power plants imposed by applicable permits and laws. Since
December 31, 2000, Duke Energy has closely managed the balance of questionable
receivables, and believes that the current pre-tax provision of $90 million is
appropriate. No additional provisions for California receivables have been
recorded in 2001. Management believes, based on its analysis to date of the
factual background and the claims asserted in these matters, that their
resolution will not have a material adverse effect on Duke Energy's consolidated
results of operations, cash flows or financial position.
Litigation. Exxon Mobil Corporation Arbitration. In December 2000, three
subsidiaries of Duke Energy initiated binding arbitration against three
subsidiaries of the Exxon Mobil Corporation (collectively, the "Exxon Mobil
entities") concerning the parties' joint ownership of DETM and certain related
affiliates (collectively, the "Ventures"). At issue is a buy-out right provision
in the parties' agreement. The agreements governing the ownership of the
Ventures contain provisions giving Duke Energy the right to purchase the Exxon
Mobil entities' 40% interest in the Ventures in the event material business
disputes arise between the Ventures' owners. Such disputes have arisen, and
consequently, Duke Energy exercised its right to buy the Exxon Mobil entities'
interest in the Ventures. Duke Energy claims that refusal by the Exxon Mobil
entities to honor the exercise is a breach of the buy-out right provision, and
seeks specific performance of the provision. Duke Energy has also asserted
various additional claims against the Exxon Mobil entities for breach of the
agreements governing the Ventures.
In January 2001, the Exxon Mobil entities asserted counterclaims in the
arbitration and claims in a separate Texas State court action alleging that Duke
Energy breached its obligations to the Ventures and to the Exxon Mobil entities.
In April 2001, the state court entered an order staying the state court action,
and compelling the Exxon Mobil entities to arbitrate their state court claims.
To date, the Exxon Mobil entities have not sought to challenge this order in an
appellate court. In early October, a hearing was held before an arbitration
panel regarding the buyout right and the various claims of Duke Energy and Exxon
Mobil against each other. Although the hearing is complete from an evidentiary
standpoint, both parties are
16
submitting final briefs, and oral arguments will take place before the panel in
November 2001. Duke Energy expects a final decision from the panel before the
end of the year. Management believes that the final disposition of this action
will not have a material adverse effect on Duke Energy's consolidated results of
operations, cash flows or financial position.
Duke Energy and its subsidiaries are involved in other legal, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding performance, contracts and other matters arising in the
ordinary course of business, some of which involve substantial amounts.
Management believes that the final disposition of these proceedings will not
have a material adverse effect on consolidated results of operations, cash flows
or financial position.
Proposed Acquisition of Westcoast Energy. In September 2001, Duke Energy
announced the proposed acquisition of Westcoast Energy Inc. (Westcoast) for $8.5
billion, including assumed debt of approximately $5 billion. Westcoast,
headquartered in Vancouver, British Columbia, is a North American energy company
with interests in natural gas gathering, processing, transmission, storage and
distribution, as well as power generation, international energy businesses, and
financial, information technology, and energy services businesses. The proposed
transaction provides for the acquisition of all outstanding common shares of
Westcoast in exchange for a combination of cash, Duke Energy common shares and
exchangeable shares of a Canadian subsidiary of Duke Energy such that 50% of the
consideration will be paid in cash and 50% will be paid in stock. The
transaction is expected to close by the end of the first quarter 2002, subject
to approval of Westcoast's shareholders and regulatory approvals. The
transaction will be accounted for using the purchase method of accounting.
Further details about the proposed acquisition are in Duke Energy's report on
Form 8-K, filed with the Securities and Exchange Commission on September 21,
2001.
17
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Introduction
- ------------
Duke Energy Corporation (collectively with its subsidiaries, "Duke Energy") is
an integrated energy and energy services provider with the ability to offer
physical delivery and management of both electricity and natural gas throughout
the U.S. and abroad. Duke Energy provides these and other services through seven
business segments. See Note 1 for descriptions of Duke Energy's business
segments.
Management's Discussion and Analysis should be read in conjunction with the
Consolidated Financial Statements.
RESULTS OF OPERATIONS
For the quarter ended September 30, 2001, earnings available for common
stockholders were $792 million, or $1.02 per basic share. For the comparable
2000 period, earnings available for common stockholders were $766 million, or
$1.04 per basic share. The increase was primarily due to earnings from business
expansion and growth that occurred during 2001, and decreased interest expense.
Partially offsetting these items were the prior year pre-tax gain of $407
million, or an after-tax gain of $0.34 per basic share, on the sale of Duke
Energy's 20% interest in BellSouth Carolina PCS and increased minority interest
expense. Earnings per share information for 2000 has been restated to reflect
the two-for-one common stock split that was effective January 26, 2001.
For the nine months ended September 30, 2001, earnings available for common
stockholders were $1,661 million, or $2.17 per basic share. For the comparable
2000 period, earnings available for common stockholders were $1,478 million, or
$2.01 per basic share. The increase was primarily due to earnings from business
expansion and growth that occurred during 2001, and decreased interest expense,
partially offset by the prior year gain on the sale of Duke Energy's interest in
BellSouth Carolina PCS, increased minority interest expense, and a current year
one-time net-of-tax charge of $96 million, or $0.13 per basic share. This
one-time charge was the cumulative effect of a change in accounting principle
for the January 1, 2001 adoption of Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities."
Operating income decreased $9 million to $1,492 million for the quarter, and
increased $447 million to $3,554 million for the nine months ended September 30,
2001. Earnings before interest and taxes (EBIT) decreased $12 million to $1,544
million for the quarter, and increased $478 million to $3,730 million for the
nine months ended September 30, 2001. Operating income and EBIT are affected by
the same fluctuations for Duke Energy and each of its business segments. Prior
year business segment EBIT amounts have been restated to conform to the current
year presentation of corporate cost allocations. See Note 4 for additional
information on business segments.
EBIT is calculated as follows:
- ------------------------------------------------------------------------
Reconciliation of Operating Income to EBIT (In millions)
- ------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------
2001 2000 2001 2000
--------------------------------------
Operating income $ 1,492 $ 1,501 $ 3,554 $ 3,107
Other income and expenses 52 55 176 145
--------------------------------------
EBIT $ 1,544 $ 1,556 $ 3,730 $ 3,252
- ------------------------------------------------------------------------
EBIT should not be considered as an alternative to, or more meaningful than, net
income or cash flow as determined in accordance with generally accepted
accounting principles as an indicator of Duke Energy's
18
operating performance or liquidity. Duke Energy's EBIT may not be comparable to
a similarly titled measure of another company.
Business segment EBIT is summarized in the following table and is discussed
thereafter.
- ------------------------------------------------------------------------------------------------
EBIT by Business Segment (In millions)
- ------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------
Franchised Electric $ 607 $ 616 $ 1,428 $ 1,476
Natural Gas Transmission 143 132 460 418
Field Services 75 85 282 229
North American Wholesale Energy 618 235 1,217 427
International Energy 74 83 218 274
Other Energy Services (22) (69) (9) (52)
Duke Ventures 51 445 94 478
Other Operations (39) (16) (152) (126)
EBIT attributable to minority interests 37 45 192 128
----------------------------------------------
Consolidated EBIT $ 1,544 $ 1,556 $ 3,730 $ 3,252
- ------------------------------------------------------------------------------------------------
Other Operations primarily include certain unallocated corporate costs. Included
in the amounts discussed hereafter are intercompany transactions that are
eliminated in the Consolidated Financial Statements.
Franchised Electric
- ------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------
(In millions, except where noted) 2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------
Operating revenues $ 1,431 $ 1,435 $ 3,742 $ 3,708
Operating expenses 840 838 2,367 2,290
----------------------------------------------
Operating income 591 597 1,375 1,418
Other income, net of expenses 16 19 53 58
----------------------------------------------
EBIT $ 607 $ 616 $ 1,428 $ 1,476
=============================================
Sales - GWh/a/ 22,566 22,639 62,149 63,854
- ------------------------------------------------------------------------------------------------
/a/ Gigawatt-hours
Franchised Electric's EBIT decreased $9 million for the quarter ended September
30, 2001, compared to the same period in 2000. The decrease was primarily due to
reclassifying approximately $33 million in mutual insurance distributions to a
suspense account as required by the North Carolina Utilities Commission (NCUC),
pending the outcome of a regulatory audit that will determine the treatment for
these distributions (see "Management's Discussion and Analysis of Results of
Operations and Financial Condition, Current Issues - Regulatory Matters" for
additional information). Offsetting this reserve were lower operating costs,
resulting primarily from decreased nuclear outage costs. For the nine months
ended September 30, 2001, Franchised Electric's EBIT decreased $48 million. The
decrease was primarily the result of the approximately $33 million reserve and
increased operating costs, due to increased nuclear outage costs in the first
six months of 2001.
Decreased sales to industrial customers, which were impacted by the slowing
economy, affected both the quarter and nine-month period. These decreased sales
were offset by growth in sales to general service and residential customers, due
mainly to an increase in the average number of customers in Franchised
Electric's service territory. The following table details the changes in GWh
sales and average number of customers compared to the prior year.
19
- ------------------------------------------------------------------------------
Increase (decrease) over prior year Three Months Ended Nine Months Ended
- ------------------------------------------------------------------------------
Residential sales 2.7 % 4.4 %
General service sales 6.2 % 4.5 %
Industrial sales (12.8)% (9.6)%
Total Franchised Electric sales (0.3)% (2.7)%
Average number of customers 1.5% 1.9 %
- ------------------------------------------------------------------------------
Natural Gas Transmission
- --------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------
(In millions, except where noted) 2001 2000 2001 2000
- --------------------------------------------------------------------------------------
Operating revenues $ 271 $ 279 $ 817 $ 846
Operating expenses 131 144 363 439
------ ------ ------ -------
Operating income 140 135 454 407
Other income, net of expenses 3 (3) 6 11
------ ------ ------ -------
EBIT $ 143 $ 132 $ 460 $ 418
====== ====== ====== =======
Throughput - TBtu/a/ 376 346 1,221 1,223
- --------------------------------------------------------------------------------------
/a/ Trillion British thermal units
For the quarter and nine months ended September 30, 2001, EBIT for Natural Gas
Transmission increased $11 million and $42 million, respectively, compared to
the same periods in 2000. The quarterly results benefited from earnings of
Market Hub Partners, which was acquired in September 2000, increased earnings
from other miscellaneous projects, and lower operating expenses. The nine-month
period also benefited from earnings of Market Hub Partners as well earnings from
East Tennessee Natural Gas Company (East Tennessee), which was acquired in March
2000, and increased earnings from other miscellaneous projects.
For both the quarter and nine months ended September 30, 2001, the decrease in
operating revenues, which was offset by a decrease in operating expenses,
resulted from reduced rates that went into effect in December 2000. These
reduced rates reflect lower recovery requirements for operating costs at Texas
Eastern Transmission, LP, primarily system fuel and Federal Energy Regulatory
Commission (FERC) Order 636 transition costs.
20
Field Services
- -----------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------
(In millions, except where noted) 2001 2000 2001 2000
- ----------------------------------------------------------------------------------------
Operating revenues $ 1,704 $ 2,527 $ 7,640 $ 6,148
Operating expenses 1,588 2,405 7,213 5,835
-------- -------- -------- --------
Operating income 116 122 427 313
Other income, net of expenses (5) 9 (5) 5
Minority interest expense 36 46 140 89
---------------------------------------
EBIT $ 75 $ 85 $ 282 $ 229
=======================================
Natural gas gathered and
processed/transported, TBtu/d /a/ 8.8 8.2 8.5 7.4
Natural gas liquids (NGL)
production, MBbl/d /b/ 412.8 417.0 396.9 349.9
Natural gas marketed, TBtu/d 1.6 0.5 1.6 0.5
Average natural gas price per MMBtu /c/ $ 2.88 $ 4.27 $ 4.88 $ 3.42
Average NGL price per gallon /d/ $ 0.39 $ 0.55 $ 0.49 $ 0.51
- ----------------------------------------------------------------------------------------
/a/ Trillion British thermal units per day
/b/ Thousand barrels per day
/c/ Million British thermal units
/d/ Does not reflect results of commodity hedges
EBIT for Field Services decreased $10 million for the quarter ended September
30, 2001, compared to the same period in 2000, primarily due to commodity
prices. The decease in revenues was driven by a $1.39 decrease in the average
natural gas price per MMBtu and a $0.16 decrease in the average NGL price per
gallon. The decrease in expenses resulted primarily from the interaction of
Field Services' natural gas and NGL purchase contracts with lower commodity
prices, and increased cost reduction efforts and plant consolidation.
Field Services' EBIT increased $53 million for the nine months ended September
30, 2001. The increase was primarily due to the addition of Phillips Petroleum's
gas gathering, processing and marketing unit's midstream natural gas business in
March 2000, which accounted for the majority of the 13% increase in NGL
production. A $1.46 increase in the average natural gas price per MMBtu,
slightly offset by a $0.02 decrease in the average NGL price per gallon, also
contributed to increased revenues. Expenses also increased from the interaction
of Field Services' natural gas and NGL purchase contracts with higher natural
gas prices, but were slightly offset by increased cost reductions efforts and
plant consolidation.
21
North American Wholesale Energy (NAWE)
- --------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------------
(In millions, except where noted) 2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------
Operating revenues $ 13,090 $ 11,186 $ 36,611 $ 22,821
Operating expenses 12,471 10,955 35,363 22,365
-------------------------------------------------------
Operating income 619 231 1,248 456
Other income, net of expenses (5) (4) 3 (8)
Minority interest (benefit) expense (4) (8) 34 21
-------------------------------------------------------
EBIT $ 618 $ 235 $ 1,217 $ 427
=======================================================
Natural gas marketed, TBtu/d 12.5 12.0 12.4 11.7
Electricity marketed and traded, GWh 88,801 89,967 199,643 198,518
Proportional megawatt capacity in
operation 6,799 5,115
Proportional megawatt capacity owned/a/ 13,119 7,925
- --------------------------------------------------------------------------------------------------------
/a/ Includes under construction or under contract at period end
For the quarter and nine months ended September 30, 2001, EBIT for NAWE
increased $383 million and $790 million, respectively, compared with the same
periods in 2000. The increases were a result of enhanced performance in natural
gas and electricity trading and services and increased earnings from generation
assets, resulting primarily from a 33% increase in proportional megawatt
capacity in operation. In addition, when compared to the prior year, EBIT
increased $60 million for the quarter and $78 million for the nine months from
the sale of interests in generating facilities as a result of NAWE executing its
portfolio management strategy.
Losses at Duke Energy Trading and Marketing, LLC (DETM) resulted in a minority
interest benefit for the quarter ended September 30, 2001 while year-to-date
earnings resulted in a $13 million increase in minority interest expense when
compared to the prior year.
International Energy
- --------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------------
(In millions, except where noted) 2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------
Operating revenues $ 395 $ 270 $ 1,296 $ 727
Operating expenses 331 187 1,093 470
-------------------------------------------------------
Operating income 64 83 203 257
Other income, net of expenses 15 7 33 35
Minority interest expense 5 7 18 18
-------------------------------------------------------
EBIT $ 74 $ 83 $ 218 $ 274
=======================================================
Proportional megawatt capacity in
operation 4,370 4,306
Proportional megawatt capacity owned /a/ 4,925 4,394
Proportional maximum pipeline
capacity in operation, MMcf/d /b/ 255 255
Proportional maximum pipeline
capacity owned /a/,
MMcf/d 363 255
- --------------------------------------------------------------------------------------------------------
/a/ Includes under construction or under contract at period end
/b/ Million cubic feet per day
22
International Energy's EBIT decreased $9 million for the quarter and $56 million
for the nine months ended September 30, 2001, compared to the same periods in
2000. The decrease for the nine months was due primarily to a $54 million gain
recognized in the first quarter of 2000 from the sale of liquefied natural gas
ships. The decrease for both periods includes the effects of reduced power
consumption in Brazil due to the government's mandatory energy rationing, which
started during the second quarter of 2001, caused by a period of severe drought
conditions. Both periods were also affected by the negative impact of foreign
currency devaluation on the earnings of the Latin American operations. The
effects of the water rationing in Brazil and the foreign currency devaluation
associated with Latin America investments were partially offset by inflation
adjustment clauses in certain Brazilian power contracts and stronger operational
results from other country operations in Latin America, Asia Pacific and Europe.
Other Energy Services
- ------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------
(In millions) 2001 2000 2001 2000
- ------------------------------------------------------------------
Operating revenues $ 143 $ 76 $ 393 $ 489
Operating expenses 165 145 402 541
-------------------------------------
EBIT $ (22) $ (69) $ (9) $ (52)
- ------------------------------------------------------------------
EBIT for Other Energy Services improved $47 million for the quarter and $43
million for the nine months ended September 30, 2001, compared to the same
periods in 2000. The current year quarterly results included approximately $29
million of charges at Duke Engineering & Services, Inc. (DE&S) for goodwill
impairment. These charges were offset by the prior year's quarterly loss on a
Duke/Fluor Daniel (D/FD) project of approximately $42 million and an
approximately $27 million charge at DE&S to reflect a more conservative revenue
recognition approach on its projects. Year-to-date results were driven by the
same items that effected the quarter. Year-to-date operating revenues and
expenses also decreased compared to 2000 due to cessation of retail commodity
trading activity at DukeSolutions, Inc.
Duke Ventures
- ------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------
(In millions) 2001 2000 2001 2000
- ------------------------------------------------------------------
Operating revenues $ 258 $ 538 $ 393 $ 609
Operating expenses 207 93 299 131
-------------------------------------
EBIT $ 51 $ 445 $ 94 $ 478
- ------------------------------------------------------------------
Duke Ventures EBIT decreased $394 million for the quarter and $384 million for
the nine months ended September 30, 2001, compared with the same periods in
2000. The decrease for both periods was primarily attributable to DukeNet
Communications' 2000 sale of its 20% interest in BellSouth Carolina PCS to
BellSouth Corporation for a pre-tax gain of $407 million. This decrease was
minimally offset by increased earnings at Crescent Resources, LLC, related
primarily to increased commercial project sales, and the absence of losses
related to DukeNet Communications' BellSouth PCS investment. Excluding the gain
on sale from the prior year results, operating revenues and expenses increased
due to Duke Capital Partners, which commenced operations in late 2000.
Other Impacts on Earnings Available for Common Stockholders
For the quarter and nine months ended September 30, 2001, interest expense
decreased $51 million and $19 million, respectively, compared to the prior year.
The decrease was primarily due to lower interest rates, and the redemption of
first and refunding mortgage bonds in July as well as the repayment of
short-term borrowings following the equity offering in March.
23
Minority interest expense increased $31 million for the quarter and $116 million
for the nine months ended September 30, 2001 compared to the same periods in
2000. Minority interest expense related to joint ventures increased $20 million
for the quarter and $72 million for the nine-month period. The increase for both
periods was primarily attributable to increased minority interest expense
resulting from Field Services' joint venture. Minority interest expense also
increased $11 million for the quarter and $44 million for the nine-month period
due to the formation of Catawba River Associates, LLC in September 2000.
During the first quarter of 2001, Duke Energy recorded a one time net-of-tax
charge of $96 million related to the cumulative effect of change in accounting
principle for the January 1, 2001 adoption of SFAS No. 133. This charge related
to contracts that either did not meet the definition of a derivative under
previous accounting guidance or do not qualify as hedges under new accounting
requirements. See Notes 2 and 3 for further discussion.
The net aggregate change in unrealized gains and losses since December 31, 2000
is due primarily to the implementation of SFAS No. 133 for hedge positions, as
well as price volatility and the magnitude of trading activity that Duke Energy
has entered into to take advantage of that volatility.
LIQUIDITY AND CAPITAL RESOURCES
Operating Cash Flows
During the nine months ended September 30, 2001 cash flows from operating
activities increased $2,036 million over the same period in 2000. This increase
is due primarily to price risk management activities, including reduced margin
deposit requirements compared to 2000. Operating cash flows were also higher in
2001 due to tax payments made in 2000 related to the 1999 sale of the midwest
pipelines.
Investing Cash Flows
Net cash used in investing activities was $4,655 million for the nine months
ended September 30, 2001 compared to $3,887 million for the same period in 2000.
The increase in investing activities reflects additional expansion and
development expenditures, especially related to NAWE's generating facilities,
refurbishment and upgrades to existing assets and minor acquisitions of various
businesses and assets. These increases were partially offset by the $390 million
acquisition of East Tennessee, the $280 million tender offer for Companhia de
Geracao de Energia Eletrica Paranapanema and the $250 million acquisition of
Market Hub Partners in 2000. The prior year expenditures were also offset by
cash proceeds from the 2000 sale of Duke Energy's 20% interest in BellSouth
Carolina PCS to BellSouth Corporation for approximately $400 million.
In February 2001, Duke Energy and The Williams Companies, Inc. completed their
purchase of Gulfstream Natural Gas System, LLC from Coastal Corporation. The
proposed Gulfstream pipeline will be able to deliver approximately 1.1 billion
cubic feet of natural gas per day and will extend from Mobile, Alabama, across
the Gulf of Mexico and into Florida. The target in-service date for the $1.6
billion project, of which Duke Energy owns half, is June 2002.
Financing Cash Flows
Duke Energy's consolidated capital structure at September 30, 2001, including
short-term debt, was 44% debt, 50% common equity and minority interests, 5%
trust preferred securities and 1% preferred stock. Fixed charges coverage,
calculated using the Securities and Exchange Commission (SEC) guidelines, was
4.7 times and 4.3 times for the nine months ended September 30, 2001 and 2000,
respectively.
Duke Energy's growth opportunities, along with dividends, debt repayments and
operating requirements, are expected to be funded by cash from operations,
external financing, common stock issuances and the proceeds from certain asset
sales. Growth opportunities are dependent upon favorable market conditions.
Management believes Duke Energy has adequate financial resources to meet its
future needs.
In February 2001, Duke Energy Field Services, LLC (DEFS) issued $250 million of
6.875% Senior Unsecured Notes due 2011. The proceeds were used to repay DEFS'
remaining balance of commercial paper that was issued in connection with the
March 2000 combination of Field Services' natural gas
24
gathering, processing and marketing business and Phillips Petroleum's gas
gathering, processing and marketing unit. In addition, in November 2001 DEFS
issued $300 million of 5.75% Senior Unsecured Notes due 2006. The proceeds will
be used to repay short-term debt.
Duke Energy's wholly-owned subsidiary, Duke Capital Corporation, had a $141
million note payable to D/FD as of December 31, 2000. As of September 30, 2001,
the note had increased $412 million to $553 million. The weighted average
interest rates were 3.87% and 4.44% for the quarter and nine months ended
September 30, 2001, respectively.
In March 2001, Duke Energy completed an offering of 25 million shares of common
stock, at a price of $38.98 per share, before underwriting discount and other
offering expenses. In addition, Duke Energy completed an offering of
approximately 31 million units of mandatorily convertible securities (Equity
Units) at a price of $25 per unit before underwriting discount and other
offering expenses. The Equity Units consist of senior notes of Duke Capital
Corporation and purchase contracts obligating the investors to purchase shares
of Duke Energy's common stock in 2004. The number of shares to be issued in 2004
will be based on the stock price at conversion. Also in March 2001, the
underwriters exercised options granted to them to purchase an additional 3.75
million shares of common stock and four million Equity Units at the original
issue prices, less underwriting discounts, to cover over-allotments made during
the offerings. Total net proceeds from the offerings were approximately $1.94
billion and were used to repay short-term debt and for other corporate purposes.
In July 2001, Duke Energy redeemed seven issues of its first and refunding
mortgage bonds. The redemption was completed to take advantage of the general
decline in interest rates. The total face value of the redeemed bonds was $386
million with interest rates ranging from 5.875% to 8.30%.
Under its commercial paper facilities and extendable commercial notes programs
(ECNs), Duke Energy had the ability to borrow up to $5.3 billion and $5.7
billion at September 30, 2001 and December 31, 2000, respectively. These
facilities do not have termination dates.
A summary of the available commercial paper and ECNs as of September 30, 2001 is
as follows:
- ---------------------------------------------------------------------------------------------
Duke Duke Duke Energy Duke
Energy Capital Field Energy
(In billions) Corporation/a/ Services International Total
- ---------------------------------------------------------------------------------------------
Commercial Paper $ 1.25 $ 1.55 $ 0.68 $ 0.37/b/ $ 3.85
ECNs 0.50 1.00 - - 1.50
----------------------------------------------------------------
Total $ 1.75 $ 2.55 $ 0.68 $ 0.37 $ 5.35
- ---------------------------------------------------------------------------------------------
/a/ Duke Capital Corporation is a wholly owned subsidiary of Duke Energy that
provides financing and credit enhancement services for its subsidiaries.
/b/ Includes ability to issue medium term notes.
Severe price movement in the energy markets for trading and hedging activities
may result in a rapid change in the availability of cash. To meet these demands,
in April 2001, Duke Energy entered into a $1.075 billion unsecured bank credit
facility that allows it to issue letters of credit in lieu of actual cash
deposits to meet margin requirements. Half of this facility matures in 2002 and
the remainder matures in 2004.
The total amount of Duke Energy's bank credit and construction facilities
available at September 30, 2001 and December 31, 2000, was approximately $4.3
billion and $4.2 billion, respectively. Certain of the credit facilities support
the issuance of commercial paper; therefore, the issuance of commercial paper
reduces the amount available under these credit facilities. At September 30,
2001, approximately $2.4 billion was outstanding under the commercial paper and
ECN programs, and approximately $38 million of borrowings were outstanding under
the bank credit and construction facilities. These facilities expire from 2001
to 2004 and the credit facilities are not subject to minimum cash requirements.
25
As of September 30, 2001, Duke Energy and its subsidiaries had effective SEC
shelf registrations for up to $5.3 billion in gross proceeds from debt and other
securities. Such securities may be issued as Senior Notes, First and Refunding
Mortgage Bonds, Subordinated Notes, Trust Preferred Securities, Duke Energy
Common Stock, Stock Purchase Contracts or Stock Purchase Units.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Policies. Duke Energy is exposed to market risks associated with interest
rates, commodity prices, equity prices, counterparty credit and foreign currency
exchange rates. Management has established comprehensive risk management
policies to monitor and manage these market risks. Duke Energy's Policy
Committee is responsible for the overall approval of market risk management
policies and the delegation of approval and authorization levels. The Policy
Committee is comprised of senior executives who receive periodic updates from
the Chief Risk Officer (CRO) on market risk positions, corporate exposures,
credit exposures and overall results of Duke Energy's risk management
activities. The CRO has responsibility for the overall management of interest
rate risk, foreign currency risk, credit risk and energy risk, including
monitoring of exposure limits. There have been no material changes in Duke
Energy's market risk since December 31, 2000.
CURRENT ISSUES
Electric Retail Competition. In 1999 and 2000, the FERC issued its Order 2000
and Order 2000-A regarding Regional Transmission Organizations (RTOs). In these
orders, the FERC stressed the voluntary nature of RTO participation by utilities
and set minimum characteristics and functions that must be met by utilities that
participate in an RTO, including exclusive and independent authority to propose
rates, terms and conditions of transmission service provided over the facilities
it operates. The order provides for an open, flexible structure for RTOs to meet
the needs of the market and provides for the possibility of incentive ratemaking
and other benefits for utilities that participate in an RTO.
As a result of these rulemakings, Duke Energy and two other investor-owned
utilities, Carolina Power & Light Company and South Carolina Electric & Gas,
planned to establish GridSouth Transco, LLC (GridSouth), as a for-profit,
independent transmission company (or RTO), responsible for operating and
planning the companies' combined transmission systems. In March 2001, GridSouth
received provisional approval from the FERC. However, in July of 2001, the FERC
issued orders recommending that utilities throughout the U.S. combine their
transmission systems to create four large independent regional operators, one
each in the Northeast, Southeast, Midwest and West. The FERC ordered GridSouth
and other utilities in the Southeast to join in 45 days of mediation to
negotiate terms of a Southeast RTO. Those mediations are complete and the
administrative law judge that presided over the proceedings has issued a report
to the FERC, but the FERC has yet to issue an order based on the results. The
actual structure of GridSouth and the date that it will become operational
depends upon the outcome of the mediation and resolution of all regulatory
approvals and technical issues. Management believes that the result of this
process, and the establishment and operation of GridSouth or an alternative
combined transmission system structure will not have a material adverse effect
on Duke Energy's future consolidated results of operations, cash flows or
financial position.
Environmental Matters. In October 1998, the Environmental Protection Agency
(EPA) issued a final rule on regional ozone control that required 22 eastern
states and the District of Columbia to revise their State Implementation Plans
(SIPs) to significantly reduce emissions of nitrogen oxide by May 1, 2003. The
EPA's rule was challenged in court by various states, industry and other
interests, including Duke Energy and the states of North Carolina and South
Carolina. In March 2000, the court upheld most aspects of the EPA's rule. The
same court subsequently issued a decision that extended the compliance deadline
for implementation of emission reductions to May 31, 2004.
In January 2000, the EPA finalized another ozone-related rule under Section 126
of the Clean Air Act that has virtually identical emission control requirements
as its October 1998 action, but with a May 1, 2003 compliance date. This rule
was challenged in court and on May 14, 2001 the U.S. Court of Appeals for the
26
DC Circuit sided with the EPA on all issues except one. The court remanded the
electric generating unit (EGU) growth rate factor determinations used to
establish each state's emission cap until the EPA could engage in decision
making on how to set the EGU growth rate factors. On August 24, 2001, the DC
Circuit suspended the implementation schedule for EGUs until the EPA completes a
rulemaking in response to the court's May 14 remand order. This ruling prevents
the EPA from implementing the Section 126 program beginning May 1, 2003.
Possible new implementation dates range from mid July of 2003 to May 31, 2004.
Management estimates that Duke Energy will spend from $500 million to $900
million in capital costs for additional emission controls through 2007 to comply
with the new EPA rules.
In response to the EPA's October 1998 rule, both North Carolina and South
Carolina have revised their SIPs and are awaiting legislative and EPA approval.
Legislation was introduced in the North Carolina General Assembly that would
require North Carolina electric utilities, including Duke Energy, to make
significant reductions in emissions of sulfur dioxide and nitrogen oxides from
its coal-fired power plants over the next eight to 12 years. Management
estimates the cost to Duke Energy of achieving the specified emission reductions
in the proposed legislation to be approximately $1.5 billion. The proposed North
Carolina legislation includes a provision that allows Duke Energy to recover
some or all of these costs from customers. The provisions of the final
legislation, if passed into law, could be significantly different from the
proposal.
Emission control retrofits needed to comply with the new rules are large
technical, design and construction projects. These projects will be managed
closely to ensure the continuation of reliable electric service to Duke Energy's
customers throughout the projects and upon their completion.
Notice of Proposed Rulemaking (NOPR). On September 27, 2001 the FERC issued a
NOPR announcing that the FERC is considering new regulations regarding standards
of conduct that would apply uniformly to natural gas pipelines and transmitting
public utilities that are currently subject to different gas or electric
standards. The proposed standards would change how companies and their
subsidiaries interact and share information by broadening the definition of
"affiliate" covered by the standards of conduct, from the more narrow definition
in the existing regulations. The NOPR also seeks comment on whether the
standards of conduct should be broadened to include the separation of those
involved in the bundled retail electric sales function from those in the
transmission function. The current electric standards apply only to those
involved in the wholesale activities. Duke Energy is currently evaluating the
impact this NOPR may have on the company and will file comments with the FERC
suggesting appropriate revisions to the proposal.
Regulatory Matters. Duke Energy was notified on August 3, 2001, that the NCUC
and the Public Service Commission of South Carolina (PSCSC) had undertaken a
joint investigation, along with the North Carolina Public Staff, regarding
certain regulatory accounting entries for 1998 at Duke Power. In its internal
review of the fourteen entries in question, Duke Energy concluded that nine of
the fourteen items were correctly classified for regulatory accounting
treatment. Four of the items were incorrectly classified for regulatory purposes
for 1998 only but did not recur thereafter. The classification of the remaining
item, distributions from mutual insurance companies, is subject to differing
interpretations for regulatory treatment. Duke Energy believes that it
appropriately classified this item but is evaluating its classification for
future years. As part of their investigation, the NCUC and PSCSC have notified
Duke Energy that they will jointly engage an independent firm to conduct an
audit of Duke Power's accounting records for reporting periods from 1998 through
June 30, 2001. Duke Energy has fully cooperated with the Commissions in their
investigation. The NCUC has requested that Duke Energy place the amount of the
2001 mutual insurance distribution, approximately $33 million, in a deferred
credit account, pending final outcome of the independent audit.
Energy Trading Marketplace. As described in Note 3 to the Consolidated Financial
Statements, Duke Energy has receivables and other exposures concentrated from
natural gas and electric industry counterparties. With recent changes in energy
industry market conditions, including recent developments regarding one of the
industry's largest traders and market makers, Enron Corporation, Duke Energy has
continued to monitor exposures to credit and market risk using established
policies and procedures. Duke Energy has both collateralized and
non-collateralized exposures to its counterparties, including Enron Corporation.
Duke Energy will continue to monitor the situation closely.
California Issues. Duke Energy, certain of its subsidiaries, and three current
or former executives have been named as defendants, among numerous other
corporate and individual defendants, in one or more of a total of six lawsuits
brought by or on behalf of electricity consumers in the State of California who
seek damages as a result of the defendants' alleged unlawful manipulation of the
California wholesale electricity markets. DENA and DETM have been named among 16
defendants in a class action lawsuit (the Gordon lawsuit) filed against
companies identified as "generators and traders" of electricity in California
markets.
27
DETM also was named as one of numerous defendants in four additional lawsuits,
including two class actions (the Hendricks and Pier 23 Restaurant lawsuits),
filed against generators, marketers and traders and other unnamed providers of
electricity in California markets. A sixth lawsuit (the Bustamante lawsuit), was
brought by the Lieutenant Governor of the State of California and a State
Assemblywoman, and includes Duke Energy, certain of its subsidiaries and three
current or former executives of Duke Energy among the numerous other corporate
and individual defendants. The Gordon and Hendricks class action lawsuits were
filed in the Superior Court of the State of California, San Diego County, in
November 2000. Three other lawsuits were filed in January 2001, one in Superior
Court, San Diego County, and the other two in Superior Court, County of San
Francisco. The Bustamante lawsuit was filed in May 2001 in Superior Court, Los
Angeles County. These lawsuits generally allege that the defendants manipulated
the wholesale electricity markets in violation of state laws against unfair and
unlawful business practices and state antitrust laws. Plaintiffs in these
lawsuits seek aggregate damages of billions of dollars. The lawsuits each seek
the disgorgement of alleged unlawfully obtained revenues for sales of
electricity and, in four lawsuits, an award of treble damages. While these
matters referenced above are in their earliest stages, management believes,
based on its analysis to date of the factual background and the claims asserted
in these matters, that their resolution will not have a material adverse effect
on Duke Energy's consolidated results of operations, cash flows or financial
position.
In addition to the lawsuits described in the preceding paragraph, several
investigations and regulatory proceedings have commenced at the state and
federal levels into the causes of the high wholesale electricity prices in the
western U.S. At the federal level, there are numerous proceedings before the
FERC. Some parties to those proceedings have made claims for billions of dollars
of refunds from sellers of wholesale electricity, including DETM. Some parties
have also sought to revoke the authority of DETM and other DENA-affiliated
electricity marketers to sell electricity at market-based rates. The FERC is
also conducting its own investigation to determine the causes of the high
wholesale electricity prices. As a result of these proceedings, the FERC has
ordered some sellers, including DETM, to refund, or offset against outstanding
accounts receivable, certain amounts billed for sales of electricity in excess
of a FERC established proxy price. The proxy price is intended to represent what
the FERC believes would have been the market- clearing price in a perfectly
competitive market. In June 2001, DETM offset approximately $20 million against
amounts owed to it by the California Independent System Operator and the
California Power Exchange for sales of electricity during January and February
2001. This offset reduced the $110 million reserve established in the fourth
quarter of 2000 to $90 million. Proceedings are ongoing to determine, among
other things, the amount of any refunds or offsets for periods prior to January
2001 and the method to be used to determine the proxy price in future months.
At the state level, the California Public Utilities Commission has formal and
informal investigations in place primarily to determine if power plant operators
in California, including DENA, have improperly "withheld," either economically
or physically, generation output from the market to manipulate market prices. In
addition, the California State Senate formed a Select Committee to Investigate
Price Manipulation of the Wholesale Energy Market (Select Committee). The Select
Committee has served a subpoena on several Duke Energy subsidiaries seeking data
concerning their California market activities. The Select Committee has heard
testimony from several witnesses but no one from Duke Energy has been called to
testify to date.
The California Attorney General also has an investigation under way to determine
if any market participants engaged in illegal activity, including antitrust
activity, in the course of their sales of electricity into the wholesale markets
in the western U.S. The Attorneys General of Washington and Oregon have joined
the California Attorney General in a joint investigation of the electricity
markets.
The California Attorney General has also convened a grand jury to determine
whether criminal charges should be brought against any market participants. To
date, no Duke Energy employee has been called to testify before the grand jury
nor have any criminal charges been filed against Duke Energy or any of its
officers, directors or employees in connection with the wholesale electricity
markets in the western U.S.
28
Throughout 2001, Duke Energy has conducted its business in California to supply
the maximum possible electricity to meet the needs of the state while limiting
its exposure to non-creditworthy counterparties and managing the output
limitations on its power plants imposed by applicable permits and laws. Since
December 31, 2000, Duke Energy has closely managed the balance of questionable
receivables, and believes that the current pre-tax provision of $90 million is
appropriate. No additional provisions for California receivables have been
recorded in 2001. Management believes, based on its analysis to date of the
factual background and the claims asserted in these matters, that their
resolution will not have a material adverse effect on Duke Energy's consolidated
results of operations, cash flows or financial position.
Litigation. Exxon Mobil Corporation Arbitration. In December 2000, three
subsidiaries of Duke Energy initiated binding arbitration against three
subsidiaries of the Exxon Mobil Corporation (collectively, the "Exxon Mobil
entities") concerning the parties' joint ownership of DETM and certain related
affiliates (collectively, the "Ventures"). At issue is a buy-out right provision
in the parties' agreement. The agreements governing the ownership of the
Ventures contain provisions giving Duke Energy the right to purchase the Exxon
Mobil entities' 40% interest in the Ventures in the event material business
disputes arise between the Ventures' owners. Such disputes have arisen, and
consequently, Duke Energy exercised its right to buy the Exxon Mobil entities'
interest in the Ventures. Duke Energy claims that refusal by the Exxon Mobil
entities to honor the exercise is a breach of the buy-out right provision, and
seeks specific performance of the provision. Duke Energy has also asserted
various additional claims against the Exxon Mobil entities for breach of the
agreements governing the Ventures.
In January 2001, the Exxon Mobil entities asserted counterclaims in the
arbitration and claims in a separate Texas State court action alleging that Duke
Energy breached its obligations to the Ventures and to the Exxon Mobil entities.
In April 2001, the state court entered an order staying the state court action,
and compelling the Exxon Mobil entities to arbitrate their state court claims.
To date, the Exxon Mobil entities have not sought to challenge this order in an
appellate court. In early October, a hearing was held before an arbitration
panel regarding the buyout right and the various claims of Duke Energy and Exxon
Mobil against each other. Although the hearing is complete from an evidentiary
standpoint, both parties are submitting final briefs, and oral arguments will
take place before the panel in November 2001. Duke Energy expects a final
decision from the panel before the end of the year. Management believes that the
final disposition of this action will not have a material adverse effect on Duke
Energy's consolidated results of operations, cash flows or financial position.
Duke Energy and its subsidiaries are involved in other legal, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding performance, contracts and other matters arising in the
ordinary course of business, some of which involve substantial amounts.
Management believes that the final disposition of these proceedings will not
have a material adverse effect on consolidated results of operations, cash flows
or financial position.
New Accounting Standards. In June 2001, the Financial Accounting Standards Board
(FASB) issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill
and Other Intangible Assets."
SFAS No. 141 requires all business combinations initiated (as defined by the
standard) after June 30, 2001 to be accounted for using the purchase method.
Companies may no longer use the pooling method of accounting for future
combinations.
SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 and
will be adopted by Duke Energy as of January 1, 2002. SFAS No. 142 requires that
goodwill no longer be amortized over an estimated useful life, as previously
required. Instead, goodwill amounts will be subject to a fair-value-based annual
impairment assessment. The standard also requires acquired intangible assets to
be recognized separately and amortized as appropriate. Duke Energy expects that
the adoption of SFAS No. 142 will have an impact on future financial statements
due to the discontinuation of goodwill amortization expense. For the nine months
ended September 30, 2001, amortization expense for goodwill was $108 million.
The FASB and the Emerging Issues Task Force continue to field questions
surrounding the transition provisions
29
and clarification of key aspects of the standard. Duke Energy is preparing to
implement the new standard and has not yet determined the impact on its
consolidated results of operations, cash flows or financial position.
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 provides the accounting requirements for retirement
obligations associated with tangible long-lived assets. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002, and early adoption is
permitted. Duke Energy is currently assessing the new standard and has not yet
determined the impact on its consolidated results of operations, cash flows or
financial position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The new rules supersede SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." The new rules retain many of the fundamental recognition and
measurement provisions, but significantly change the criteria for classifying an
asset as held-for-sale. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001. Duke Energy is currently assessing the new standard and
has not yet determined the impact on its consolidated results of operations,
cash flows or financial position.
Proposed Acquisition of Westcoast Energy Inc. In September 2001, Duke Energy
announced the proposed acquisition of Westcoast Energy Inc. (Westcoast) for $8.5
billion, including assumed debt of approximately $5 billion. Westcoast,
headquartered in Vancouver, British Columbia, is a North American energy company
with interests in natural gas gathering, processing, transmission, storage and
distribution, as well as power generation, international energy businesses, and
financial, information technology, and energy services businesses. The proposed
transaction provides for the acquisition of all outstanding common shares of
Westcoast in exchange for a combination of cash, Duke Energy common shares and
exchangeable shares of a Canadian subsidiary of Duke Energy such that 50% of the
consideration will be paid in cash and 50% will be paid in stock. The
transaction is expected to close by the end of the first quarter 2002, subject
to approval of Westcoast's shareholders and regulatory approvals. The
transaction will be accounted for using the purchase method of accounting.
Further details about the proposed acquisition are in Duke Energy's report on
Form 8-K, filed with the SEC on September 21, 2001.
30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Duke Energy's subsidiary, Duke Energy Field Services, LLC (DEFS), has resolved
its issues with the Colorado Air Pollution Control Division disclosed in Duke
Energy's last Form 10-K regarding various asserted non-compliance issues arising
from agency inspections of DEFS' Colorado facilities in 2000 and 1999, and
arising from compliance issues disclosed to the agency pursuant to permit
requirements or voluntarily disclosed to the agency in 2000. These items relate
to various specific and detailed terms of the Title V Operating Permits at seven
gas plants and two compressor stations in Colorado, including, for example,
record keeping requirements, parametric monitoring requirements, delayed
filings, and operations inconsistent with throughput limits on particular pieces
of equipment. In October 2001, DEFS entered into a Compliance Order and Consent
which requires DEFS to pay a penalty of $97,000 and undertake supplemental
environmental projects totaling $388,000.
In June 2001, DEFS received two administrative Compliance Orders from the New
Mexico Environment Department (NMED) seeking civil penalties primarily for
historic air permit matters. One order alleges specific permit non-compliance at
eleven facilities that occurred periodically between 1996 and 1999. Allegations
under this order relate primarily to emissions from certain compressor engines
in excess of what were then new operating permit limits. The other order alleges
numerous unexcused excursions from an hourly permit limit arising from upset
events at one facility's sulfur recovery unit between 1997 and 2001. The NMED
applied its civil penalty policy to the alleged violations and calculated the
penalties to be approximately $10 million in the aggregate. The NMED has
initiated settlement discussions and offered to resolve these matters for an
amount lower than the calculated penalties. DEFS is continuing its discussions
with the NMED and anticipates that it will resolve all issues relating to the
alleged violations.
In September 2001, DEFS received a Proposed Agreed Order from the Texas Natural
Resource Conservation Commission to settle allegations reflected in a June 2001
notice from the agency relating to DEFS' Port Arthur natural gas processing
plant. The Proposed Agreed Order seeks penalties of $278,000 for various items
of alleged-noncompliance relating to the facility's air permit and state air
regulations, including valve monitoring and repair requirements under 40 CFR 60,
subpart KKK. DEFS is discussing settlement terms with the agency.
For additional information concerning litigation and other contingencies, see
Note 8 to the Consolidated Financial Statements, "Commitments and
Contingencies," and Item 3, "Legal Proceedings," included in Duke Energy's Form
10-K for December 31, 2000, which are incorporated herein by reference.
Management believes that the resolution of these matters discussed and referred
to above will not have a material adverse effect on consolidated results of
operations, cash flows or financial position.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of the security holders of Duke Energy
during the third quarter of 2001.
Item 5. Other Information.
- -------------------------
As previously announced, on September 20, 2001, Duke Energy, two wholly owned
subsidiaries of Duke Energy and Westcoast Energy Inc. (Westcoast) entered into a
combination agreement (the "Combination Agreement") providing for the
acquisition of all outstanding common shares of Westcoast in exchange for a
combination of cash, Duke Energy common shares and exchangeable shares of a
Canadian subsidiary of Duke Energy. The material terms of the Combination
Agreement are set forth in the Form 8-K as filed by Duke Energy with the
Securities and Exchange Commission on September 21, 2001.
31
On November 5, 2001, the parties to the Combination Agreement entered into an
amended and restated combination agreement (the "Amended and Restated
Combination Agreement"). The Amended and Restated Combination Agreement made
certain changes to the Combination Agreement and related agreements, including
the Plan of Arrangement. The changes include changes to the Westcoast
shareholder election date and measurement periods for determining the exchange
ratio, refinements of other timing considerations in connection with the
expected consummation of the transaction by the end of the first quarter of
2002, and other technical amendments and clarifications. A full description of
the Amended and Restated Combination Agreement is set forth in the Westcoast
proxy circular dated November 8, 2001 which is being mailed to Westcoast
shareholders on November 16, 2001. This description of provisions of the Amended
and Restated Combination Agreement is qualified in its entirety by reference to
the Amended and Restated Combination Agreement, a copy of which is attached
hereto as Exhibit 10.7 and incorporated by reference herein.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number
- -------
10.1 $537,500,000 364-Day Credit Agreement dated as of April 19, 2001, among
Duke Capital Corporation, the Banks listed therein and Bank One, NA, as
Administrative Agent.
10.2 $537,500,000 Three-Year Credit Agreement dated as of April 19, 2001,
among Duke Capital Corporation, the Banks listed therein and Bank One,
NA, as Administrative Agent.
10.3 $550,000,000 364-Day Credit Agreement dated as of August 20, 2001,
among Duke Capital Corporation, the Banks listed therein and The Chase
Manhattan Bank, as Administrative Agent.
10.4 $550,000,000 Three-Year Credit Agreement dated as of August 20, 2001,
among Duke Capital Corporation, the Banks listed therein and The Chase
Manhattan Bank, as Administrative Agent.
10.5 $475,000,000 364-Day Credit Agreement dated as of August 29, 2001,
among Duke Energy Corporation, the Banks listed therein and The Chase
Manhattan Bank, as Administrative Agent
10.6 $475,000,000 Three-Year Credit Agreement dated as of August 29, 2001,
among Duke Energy Corporation, the Banks listed therein and The Chase
Manhattan Bank, as Administrative Agent
10.7 Amended and Restated Combination Agreement dated as of September 20,
2001, among Duke Energy Corporation, 3058368 Nova Scotia Company,
3946509 Canada Inc. and Westcoast Energy Inc.
(b) Reports on Form 8-K
A Current Report on Form 8-K filed on September 21, 2001 contained
disclosures under Item 5, Other Events; Item 7, Financial Statements and
Exhibits; and Item 9, Regulation FD Disclosure.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DUKE ENERGY CORPORATION
November 13, 2001 /s/ ROBERT P. BRACE
------------------------------------
Robert P. Brace
Executive Vice President and
Chief Financial Officer
November 13, 2001 /s/ KEITH G. BUTLER
------------------------------------
Keith G. Butler
Senior Vice President and
Controller
33