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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 March 31, 2002 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 of Incorporation) (IRS Employer 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 April 30,
2002......829,808,849
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DUKE ENERGY CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2002
INDEX
Item Page
- ---- ----
PART I. FINANCIAL INFORMATION
1. Financial Statements................................................................................................1
Consolidated Statements of Income for the Three Months Ended March 31, 2002 and 2001.............................1
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2002 and 2001.........................2
Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001...........................................3
Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2002 and 2001........5
Notes to Consolidated Financial Statements.......................................................................6
2. Management's Discussion and Analysis of Results of Operations and Financial Condition..............................16
PART II. OTHER INFORMATION
1. Legal Proceedings..................................................................................................32
4. Submission of Matters to a Vote of Security Holders................................................................32
6. Exhibits and Reports on Form 8-K...................................................................................32
Signatures.........................................................................................................33
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Duke Energy's reports, filings and other public announcements may include
statements that reflect 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.
Generally, the words "may," "could," "project," "believe," "anticipate,"
"expect," "estimate," "plan," "forecast," "intend" and similar words identify
forward-looking statements, which generally are not historical in nature. All
such statements (other than statements of historical facts), including
statements regarding operating performance, financial position, business
strategy, budgets, projected costs, plans and objectives of management for
future operations and events or developments that we expect or anticipate will
occur in the future, are forward looking. Forward-looking statements are subject
to certain risks and uncertainties that could, and often do, cause actual
results to differ from Duke Energy's historical experience and our present
expectations or projections. Accordingly, there can be no assurance that actual
results will not differ materially from those expressed or implied by the
forward-looking statements. Caution should be taken not to place undue reliance
on any such forward-looking statements.
Factors that could cause actual results to differ materially from the
expectations expressed or implied in such forward-looking statements include,
but are not limited to: 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 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
March 31,
------------------
2002 2001
------- -------
Operating Revenues
Sales, trading and marketing of natural gas
and petroleum products $ 5,629 $11,451
Trading and marketing of electricity 4,027 3,303
Generation, transmission and distribution of electricity 1,703 1,260
Transportation and storage of natural gas 326 246
Other 200 231
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Total operating revenues 11,885 16,491
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Operating Expenses
Natural gas and petroleum products purchased 5,462 11,080
Net interchange and purchased power 4,194 2,679
Fuel used in electric generation 215 242
Other operation and maintenance 852 877
Depreciation and amortization 344 316
Property and other taxes 127 115
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Total operating expenses 11,194 15,309
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Operating Income 691 1,182
Other Income and Expenses 70 72
Interest Expense 189 213
Minority Interest Expense 32 160
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Earnings Before Income Taxes 540 881
Income Taxes 158 327
------- -------
Income Before Cumulative Effect of Change in Accounting Principle 382 554
Cumulative Effect of Change in Accounting Principle, net of tax -- (96)
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Net Income 382 458
Preferred and Preference Stock Dividends 3 4
------- -------
Earnings Available For Common Stockholders $ 379 $ 454
======= =======
Common Stock Data
Weighted-average shares outstanding 788 745
Earnings per share (before cumulative effect of change in accounting principle)
Basic $ 0.48 $ 0.74
Diluted $ 0.48 $ 0.73
Earnings per share
Basic $ 0.48 $ 0.61
Diluted $ 0.48 $ 0.60
Dividends per share $ 0.275 $ 0.275
See Notes to Consolidated Financial Statements
1
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)
Three Months Ended
March 31,
------------------
2002 2001
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 382 $ 458
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization 379 357
Cumulative effect of change in accounting principle -- 96
Deferred income taxes (53) 214
Purchased capacity levelization 67 38
(Increase) decrease in
Net unrealized mark-to-market and hedging transactions 179 (609)
Receivables 1,021 (112)
Inventory 30 103
Other current assets (200) (486)
Increase (decrease) in
Accounts payable (444) 178
Taxes accrued 176 (27)
Interest accrued 1 7
Other current liabilities (647) (161)
Other, assets 73 83
Other, liabilities (144) (120)
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Net cash provided by operating activities 820 19
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CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, net of cash acquired (1,274) (723)
Investment expenditures (320) (324)
Acquisition of Westcoast Energy, Inc., net of cash acquired (1,690) --
Other 8 117
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Net cash used in investing activities (3,276) (930)
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CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the issuance of
Long-term debt 2,346 1,339
Common stock and stock options 77 1,193
Payments for the redemption of long-term debt (407) (64)
Net change in notes payable and commercial paper 650 (1,415)
Distributions to minority interests (84) --
Dividends paid (222) (208)
Other (43) (67)
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Net cash provided by financing activities 2,317 778
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Net decrease in cash and cash equivalents (139) (133)
Cash and cash equivalents at beginning of period 290 622
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Cash and cash equivalents at end of period $ 151 $ 489
======= =======
Supplemental Disclosures
Cash paid for interest, net of amount capitalized $ 135 $ 204
Cash paid for income taxes $ 12 $ 105
Acquisition of Westcoast Energy, Inc.
Fair value of assets acquired $ 9,487
Liabilities assumed, including debt and minority interests 8,382
Issuance of common stock 1,797
See Notes to Consolidated Financial Statements
2
CONSOLIDATED BALANCE SHEETS
(In millions)
March 31, December 31,
2002 2001
(Unaudited)
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ASSETS
Current Assets
Cash and cash equivalents $ 151 $ 290
Receivables 5,647 5,301
Inventory 1,149 1,017
Current portion of purchased capacity costs 170 160
Unrealized gains on mark-to-market and hedging transactions 3,918 2,326
Other 659 451
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Total current assets 11,694 9,545
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Investments and Other Assets
Investments in affiliates 2,067 1,480
Nuclear decommissioning trust funds 696 716
Pre-funded pension costs 334 313
Goodwill, net of accumulated amortization 4,085 1,730
Notes receivable 628 576
Unrealized gains on mark-to-market and hedging transactions 4,490 3,117
Other 1,385 1,299
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Total investments and other assets 13,685 9,231
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Property, Plant and Equipment
Cost 46,921 39,464
Less accumulated depreciation and amortization 11,617 11,049
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Net property, plant and equipment 35,304 28,415
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Regulatory Assets and Deferred Debits
Purchased capacity costs 112 189
Deferred debt expense 229 203
Regulatory asset related to income taxes 543 510
Other 979 282
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Total regulatory assets and deferred debits 1,863 1,184
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Total Assets $62,546 $48,375
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See Notes to Consolidated Financial Statements
3
CONSOLIDATED BALANCE SHEETS
(In millions)
March 31, December 31,
2002 2001
----------- ------------
(Unaudited)
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 4,234 $ 4,231
Notes payable and commercial paper 2,615 1,603
Taxes accrued 670 443
Interest accrued 288 239
Current maturities of long-term debt and preferred stock 566 274
Unrealized losses on mark-to-market and hedging transactions 3,186 1,519
Other 1,373 2,118
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Total current liabilities 12,932 10,427
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Long-term Debt 18,323 12,321
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Deferred Credits and Other Liabilities
Deferred income taxes 4,544 4,307
Investment tax credit 185 189
Nuclear decommissioning costs externally funded 696 716
Environmental cleanup liabilities 84 85
Unrealized losses on mark-to-market and hedging transactions 3,434 2,212
Other 3,175 1,542
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Total deferred credits and other liabilities 12,118 9,051
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Commitments and Contingencies
Guaranteed Preferred Beneficial Interests in Subordinated
Notes of Duke Energy Corporation or Subsidiaries 1,407 1,407
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Minority Interests in Financing Subsidiary 1,025 1,025
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Minority Interests 1,641 1,221
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Preferred and Preference Stock
Preferred and preference stock with sinking fund requirements 25 25
Preferred and preference stock without sinking fund requirements 209 209
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Total preferred and preference stock 234 234
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Common Stockholders' Equity
Common stock, no par, 2 billion shares authorized; 829 million and 777 million
shares outstanding at March 31, 2002 and December 31, 2001, respectively 8,084 6,217
Retained earnings 6,475 6,292
Accumulated other comprehensive income 307 180
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Total common stockholders' equity 14,866 12,689
------- -------
Total Liabilities and Common Stockholders' Equity $62,546 $48,375
======= =======
See Notes to Consolidated Financial Statements.
4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In millions)
Three Months Ended
March 31,
------------------
2002 2001
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Net Income $ 382 $ 458
Other comprehensive income, net of tax
Cumulative effect of change in accounting principle -- (921)
Foreign currency translation adjustment (24) (141)
Net unrealized gains (losses) on cash flow hedges 263 (356)
Reclassification into earnings (112) 178
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Total other comprehensive income 127 (1,240)
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Total Comprehensive Income (Loss) $ 509 $ (782)
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See Notes to Consolidated Financial Statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
Duke Energy Corporation (collectively with its subsidiaries, Duke Energy), an
integrated provider of energy and energy services, offers physical delivery and
management of both electricity and natural gas throughout the U.S. and abroad.
Duke Energy provides these and other services through the seven business
segments described below.
Franchised Electric generates, transmits, distributes and sells electricity in
central and western North Carolina and western South Carolina. It conducts
operations 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 transportation, storage and distribution of
natural gas for customers throughout the east coast and southern portion of the
U.S. and Canada. Natural Gas Transmission provides gas gathering, processing and
transportation services to customers located in British Columbia, Canada and in
the Pacific northwest region of the U.S. Natural Gas Transmission does business
primarily through Duke Energy Gas Transmission Corporation. Duke Energy acquired
Westcoast Energy, Inc. (Westcoast) on March 14, 2002 (see Note 3). Interstate
natural gas transmission and storage operations in the U.S. are subject to the
FERC's rules and regulations while natural gas gathering, processing,
transmission, distribution and storage operations in Canada are subject to the
National Energy Board, Ontario Energy Board and British Columbia Utilities
Commission rules and regulations.
Field Services gathers, processes, transports, markets and stores natural gas
and produces, transports, markets and stores natural gas liquids (NGLs). It
conducts operations primarily through Duke Energy Field Services, LLC, which is
approximately 30% owned by Phillips Petroleum. Field Services operates gathering
systems in western Canada and 11 contiguous states in the U.S. Those systems
serve major natural gas-producing regions in the Rocky Mountain, Permian Basin,
Mid-Continent, East Texas-Austin Chalk-North Louisiana, and onshore and offshore
Gulf Coast areas.
North American Wholesale Energy (NAWE) develops, operates and manages merchant
generation facilities and engages in commodity sales and services related to
natural gas and electric power. NAWE conducts these operations primarily through
Duke Energy North America, LLC (DENA) and Duke Energy Trading and Marketing, LLC
(DETM). DETM is approximately 40% owned by Exxon Mobil Corporation. NAWE also
includes Duke Energy Merchants Holdings, LLC, which develops new business lines
in the evolving energy commodity markets other than natural gas and power. NAWE
conducts business primarily throughout the U.S. and Canada.
International Energy develops, operates and manages natural gas transportation
and power generation facilities and engages in energy trading and marketing of
natural gas and electric power. It conducts operations primarily through Duke
Energy International, LLC and its activities target 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. (DE&S), Duke/Fluor Daniel (D/FD) and
DukeSolutions, Inc. (DukeSolutions). D/FD is a 50/50 partnership between Duke
Energy and Fluor Enterprises, Inc., a wholly owned subsidiary of Fluor
Corporation. On April 30, 2002, Duke Energy completed the sale of DE&S to
Framatome ANP, Inc. and, on May 1, 2002, Duke Energy completed the sale of
DukeSolutions to Ameresco, Inc. (See Note 3).
Duke Ventures is composed of other diverse businesses, operating primarily
through Crescent Resources, LLC (Crescent), DukeNet Communications, LLC
(DukeNet) and Duke Capital Partners, LLC (DCP).
6
Crescent develops high-quality commercial, residential and multi-family real
estate projects and manages land holdings primarily in the southeastern and
southwestern U.S. DukeNet provides fiber optic networks for industrial,
commercial and residential customers. DCP, a wholly owned merchant banking
company, provides debt and equity capital and financial advisory services to the
energy industry.
2. Summary of Significant Accounting Policies
Consolidation. The Consolidated Financial Statements include the accounts of
Duke Energy and all majority-owned subsidiaries, after eliminating 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 on 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 and equity units, were
exercised or converted into common stock. The numerator for the calculation of
both basic and diluted earnings per share is earnings available for common
stockholders. The following table shows the denominator for basic and diluted
earnings per share.
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Denominator for Earnings per Share (in millions)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
------------------
2002 2001
------------------
Denominator for basic earnings per share
(weighted average shares outstanding)/a/ 787.7 745.3
Assumed exercise of dilutive securities or
other agreements to issue common stock 3.9 6.7
------------------
Denominator for diluted earnings per share 791.6 752.0
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/a/ Increase in shares due primarily to Westcoast acquisition (See Note 3)
Options, restricted stock awards, performance awards and phantom stock awards to
purchase 19 million shares of common stock as of March 31, 2002, and 6 million
as of March 31, 2001, were not included in the computation of diluted earnings
per share because the option exercise prices were greater than the average
market price of the common shares during the periods.
Accounting for Hedges and Trading Activities. All derivatives not qualifying for
the normal purchases and sales exemption under Statement of Financial Accounting
Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities," are recorded on the Consolidated Balance Sheets at their fair value
as Unrealized Gains or Unrealized Losses on Mark-to-Market and Hedging
Transactions. On the date that swaps, futures, forwards or option contracts are
entered into, Duke Energy designates the derivative as either held for trading
(trading instrument); as a hedge of a forecasted transaction or future cash
flows (cash flow hedge); 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 and marks it to market.
For hedge contracts, Duke Energy formally assesses, both at the hedge contract's
inception and on an ongoing basis, whether the hedge contract is highly
effective in offsetting changes in fair values or cash flows of hedged items. A
loss on the time value of options of $2 million was excluded in the assessment
and measurement of hedge effectiveness for the three months ended March 31,
2002.
When available, quoted market prices or prices obtained through external sources
are used to verify a contract's fair value. For contracts with a delivery
location or duration for which quoted market prices are
7
not available, fair value is determined based on pricing models developed
primarily from historical and expected correlations with quoted market prices.
Values are adjusted to reflect the potential impact of liquidating the positions
held in an orderly manner over a reasonable time period under current
conditions. Changes in market price and management estimates directly affect the
estimated fair value of these contracts. Accordingly, it is reasonably possible
that such estimates may change in the near term.
Trading. Prior to settlement of any energy contract held for trading purposes, a
favorable or unfavorable price movement is reported as Natural Gas and Petroleum
Products Purchased, or Net Interchange and Purchased Power, in the Consolidated
Statements of Income. An offsetting amount is recorded on the Consolidated
Balance Sheets as Unrealized Gains or Unrealized Losses on Mark-to-Market and
Hedging Transactions. When a contract to sell 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, in the Consolidated Statements of
Income. Similarly, when a contract to purchase is physically settled, the
purchase price is included as Natural Gas and Petroleum Products Purchased, or
Net Interchange and Purchased Power, in the Consolidated Statements of Income.
If a contract is not financially 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, financial settlement has no
revenue presentation effect on the Consolidated Statements of Income.
Cash Flow Hedges. Changes in the fair value of a derivative designated and
qualified 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 because
the derivative no longer qualifies as an effective hedge, the derivative
continues 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 previously 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. Gains and
losses that were accumulated in OCI will be immediately recognized in
current-period earnings in those instances.
Fair Value Hedges. Duke Energy enters into interest rate swaps to convert some
of its fixed-rate long-term debt to floating-rate long-term 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 some 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 the
fair value of the derivative and the hedged item are recognized in current
earnings in a manner consistent with the earnings effect of the hedged risk. All
components of each derivative gain or loss are included in the assessment of
hedge effectiveness, unless otherwise noted.
New Accounting Standards. Duke Energy adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," 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 are subject to a fair-value-based annual impairment
assessment. Duke Energy did not recognize any material impairment due to the
implementation of SFAS No. 142. The standard also requires certain identifiable
intangible assets to be recognized separately and amortized as appropriate upon
reassessment. No adjustments to intangibles were identified at Duke Energy at
transition.
The following table shows what net income and earnings per share would have been
if amortization (including any related tax effects) related to goodwill that is
no longer being amortized had been excluded from prior periods.
8
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Goodwill - Adoption of SFAS No. 142
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Three Months Ended
March 31,
------------------
(in millions, except per share amounts) 2002 2001
- --------------------------------------------------------------------------------
Net Income
Reported net income $ 382 $ 458
Add back: Goodwill amortization, net of tax -- 14
----- -----
Adjusted net income $ 382 $ 472
Basic earnings per share
Reported earnings per share $0.48 $0.61
Goodwill amortization -- 0.02
Adjusted earnings per share 0.48 0.63
Diluted earnings per share
Reported earnings per share $0.48 $0.60
Goodwill amortization -- 0.02
Adjusted earnings per share 0.48 0.62
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The changes in the carrying amount of goodwill for the three months ended March
31, 2002 and March 31, 2001 are as follows:
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Goodwill (in millions)
- --------------------------------------------------------------------------------
Balance Balance
December 31, Acquired March 31,
2001 Goodwill Other 2002
--------------------------------------------
Natural Gas Transmission $ 481 $2,459 $ -- $2,940
Field Services 571 -- (106) 465
North American Wholesale
Energy 92 -- 9 101
International Energy 427 -- (4) 423
Other Energy Services 5 -- (3) 2
Other Operations 154 -- -- 154
--------------------------------------------
Total consolidated $1,730 $2,459 $(104) $4,085
================================================================================
Balance Balance
December 31, Acquired March 31,
2000 Goodwill Other 2001
--------------------------------------------
Natural Gas Transmission $ 299 $-- $ 5 $ 304
Field Services 507 -- (15) 492
North American Wholesale
Energy 74 -- (2) 72
International Energy 457 6 (37) 426
Other Energy Services 46 -- (1) 45
Other Operations 183 -- (8) 175
--------------------------------------------
Total consolidated $1,566 $ 6 $(58) $1,514
================================================================================
Duke Energy adopted SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" on January 1, 2002. 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. Adoption of the new standard had no material adverse
effect on Duke Energy's consolidated results of operations or financial
position.
9
Reclassifications. Certain prior period amounts have been reclassified in the
Consolidated Financial Statements and Note 5 to conform to the current
presentation.
3. Business Acquisitions and Dispositions
Business Acquisitions. Using the purchase method for acquisitions, Duke Energy
consolidates assets and liabilities as of the purchase date, and includes
earnings from acquisitions in consolidated earnings after the purchase date.
Assets acquired and liabilities assumed are recorded at estimated fair values on
the date of acquisition. The purchase price minus the estimated fair value of
the acquired assets and liabilities is recorded as goodwill. The allocation of
the purchase price may be adjusted if additional information on asset and
liability valuations becomes available within one year after the acquisition.
Acquisition of Westcoast Energy Inc. On March 14, 2002, Duke Energy acquired
Westcoast for approximately $8 billion, including the assumption of $4.7 billion
of debt. The assumed debt consists of debt of Westcoast, Union Gas Limited (a
wholly-owned subsidiary of Westcoast) and various project entities that are
wholly-owned or consolidated by Duke Energy. The interest rates on the assumed
debt range from 2.53% to 15.0%, with maturity dates ranging from 2002 through
2027. 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 and
international energy businesses. In the transaction, a Duke Energy subsidiary
acquired all of the outstanding common shares of Westcoast in exchange for
approximately 49.9 million shares of Duke Energy common stock (including
exchangeable shares of a Duke Energy Canadian subsidiary that are substantially
equivalent to and exchangeable on a one-for-one basis for Duke Energy common
stock), and approximately $1.8 billion in cash. Under prorating provisions that
ensured that approximately 50% of the total consideration was paid in cash and
50% in stock, each common share of Westcoast entitled the holder to elect to
receive 43.80 in Canadian dollars, 0.7711 of a share of Duke Energy common stock
or of an exchangeable share of a Duke Energy Canadian subsidiary, or a
combination thereof. The cash portion of the consideration was funded with the
proceeds from the issuance of $750 million in mandatory convertible securities
in November 2001 along with incremental commercial paper. Duke Energy plans to
retire the commercial paper later in 2002 and replace it with permanent capital
in the form of mandatory convertible equity. The timing for the mandatory
convertible equity financing will be dependent on the market opportunities
presented and favorable market conditions. The Westcoast acquisition was
accounted for using the purchase method of accounting, and goodwill totaling
approximately $2.5 billion was recorded in the transaction.
The following unaudited pro forma consolidated financial results for the period
ended March 31, 2002 and March 31, 2001 are presented as if the acquisition had
taken place at the beginning of the periods presented.
- --------------------------------------------------------------------------------
Westcoast Pro Forma Consolidated Results (in millions, except per share amounts)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
------------------------
2002 2001
------------------------
Income Statement Data
Operating revenues $ 13,167 $ 19,871
Income before cumulative effect of change in
accounting principle 419 607
Cumulative effect of change in accounting
principle, net of tax - (96)
Preferred and preference stock dividends 3 4
Earnings available to common stockholders 416 507
Common Stock Data
Weighted-average shares outstanding 828 795
Earnings per share (before cumulative effect of
change in accounting principle)
Basic $ 0.50 $ 0.76
Diluted $ 0.50 $ 0.75
Earnings per share
Basic $ 0.50 $ 0.64
Diluted $ 0.50 $ 0.63
- --------------------------------------------------------------------------------
Dispositions. DE&S. On April 30, 2002, Duke Energy completed the sale of
portions of its DE&S business unit to Framatome ANP, Inc. (a nuclear supplier).
Two components of DE&S are not part of the sale and will remain as components of
Other Energy Services. Duke Energy will establish Duke Energy - Energy Delivery
Services, formed by the power delivery services component of DE&S, which will
continue to supply power delivery solutions to customers. Leadership of the U.S.
Department of Energy Mixed Oxide Fuel project will also remain with Duke Energy.
DukeSolutions. On May 1, 2002, Duke Energy completed the sale of portions of
DukeSolutions to Ameresco. Inc. The remaining portions will remain as a
component of Other Energy Services. During the first quarter of 2002, Duke
Energy recorded a reserve of $15 million for the expected loss associated with
the sale of DukeSolutions.
10
4. Derivative Instruments, Hedging Activities and Credit Risk
Commodity Cash Flow Hedges. Some Duke Energy subsidiaries 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, enters into contracts to protect margins for a portion of its
future sales and generation revenues. Duke Energy uses commodity instruments,
consisting of swaps, futures, forwards and collared options, as cash flow hedges
for natural gas, electricity and NGL transactions. Duke Energy is hedging
exposures to the price variability of these commodities for a maximum of 20
years.
For the three months ended March 31, 2002, 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 March 31, 2002, $370
million of after-tax deferred net gains on derivative instruments were
accumulated on the balance sheet in a separate component of stockholders equity,
OCI, and are expected to be recognized in earnings during the next 12 months as
the hedged transactions occur. However, due to the volatility of the commodities
markets, the corresponding value in OCI will likely change prior to its
reclassification into earnings.
Commodity Fair Value Hedges. Some Duke Energy subsidiaries are exposed to
changes in the fair value of some unrecognized firm commitments to sell
generated power or natural gas due to market fluctuations in the underlying
commodity prices. Duke Energy actively evaluates changes in the fair value of
such unrecognized firm commitments due to commodity price changes and, where
appropriate, uses various instruments to hedge its market risk. These commodity
instruments, consisting of swaps, futures and forwards, serve as fair value
hedges for the firm commitments associated with generated power and natural gas
sales. Duke Energy is hedging exposures to the market risk of such items for a
maximum of 23 years. For the three months ended March 31, 2002, the ineffective
portion of commodity fair value hedges was not material.
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 use 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 of potential financial exposure to
management. 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. Changes in interest rates expose
Duke Energy to risk as a result of its issuance of variable-rate debt,
fixed-to-floating interest rate swaps, commercial paper and auction rate
preferred stock. Duke Energy manages its interest rate exposure by limiting its
variable-rate and fixed-rate exposures to percentages of total capitalization,
as set by policy, and by monitoring the effects of market changes in interest
rates. Duke Energy also enters into financial derivative instruments, including,
but not limited to, interest rate swaps, options, swaptions and lock agreements
to manage and mitigate interest rate risk exposure. For the three months ended
March 31, 2002 and 2001, Duke Energy's existing interest rate derivative
instruments and related ineffectiveness were not material to its consolidated
results of operations, cash flows or financial position.
Foreign Currency (Fair Value or Cash Flow) Hedges. Duke Energy is exposed to
foreign currency risk 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 and/or local inflation rates, or investments may
be hedged through debt denominated or issued in the foreign currency. Duke
Energy also uses foreign currency derivatives, where possible, to manage its
risk related to foreign currency fluctuations. For the three months ended March
31, 2002 and 2001, the impact of Duke Energy's foreign currency derivative
instruments was not material to its consolidated results of operations, cash
flows or financial position.
11
Credit Risk. Duke Energy's principal customers 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
some 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 those limits on an
ongoing basis. Duke Energy frequently uses master collateral agreements to
mitigate credit exposure. The collateral agreement provides for a counterparty
to post cash or letters of credit for exposure in excess of the established
threshold. The threshold amount represents an open credit limit, determined in
accordance with the corporate credit policy. The collateral agreement also
provides that the inability to post collateral is sufficient cause to terminate
a contract and liquidate all positions.
The change in market value of New York Mercantile Exchange-traded futures and
options contracts requires daily cash settlement in margin accounts with
brokers. Financial derivatives are generally cash settled periodically
throughout the contract term. However, these transactions are also generally
subject to margin agreements with many of Duke Energy's counterparties.
As of March 31, 2002, Duke Energy had a pre-tax bad debt provision of $90
million related to receivables for energy sales in California. Following the
bankruptcy of Enron Corporation, Duke Energy terminated substantially all
contracts with Enron Corporation and its affiliated companies (collectively,
Enron). As a result, in 2001 Duke Energy recorded, as a charge, a
non-collateralized accounting exposure of $43 million. The $43 million
non-collateralized accounting exposure was composed of charges of $36 million at
NAWE, $3 million at International Energy, $3 million at Field Services and $1
million at Natural Gas Transmission. These amounts were stated on a pre-tax
basis as charges against the reporting segment's earnings in 2001.
Duke Energy's determination of its bankruptcy claims against Enron is still
under review, and its claims made in the bankruptcy case are likely to exceed
$43 million. Any bankruptcy claims that exceed this amount would primarily
relate to termination and settlement rights under contracts and transactions
with Enron that would have been recognized in future periods, and not in the
historical periods covered by the financial statements to which the $43 million
charge relates.
Substantially all contracts with Enron were completed or terminated prior to
December 31, 2001. Duke Energy has continuing contractual relationships with
certain Enron affiliates, which are not in bankruptcy. In Brazil, a power
purchase agreement between a Duke Energy affiliate, Companhia de Geracao de
Energia Electrica Paranapanema (Paranapanema), and Elektro Eletricidade e
Servicos S/A (Elektro), a distribution company 40% owned by Enron, will expire
December 31, 2005. The contract was executed by Duke Energy's predecessor in
interest in Paranapanema, and obligates Paranapanema to provide energy to
Elektro on an irrevocable basis for the contract period. In addition, a
purchase/sale agreement expiring September 1, 2005 between a Duke Energy
affiliate and Citrus Trading Corporation (Citrus), a 50/50 joint venture between
Enron and El Paso Corporation, continues to be in effect. The contract requires
the Duke Energy affiliate to provide liquefied natural gas to Citrus. Citrus has
provided a letter of credit in favor of Duke Energy to cover its exposure.
5. Business Segments
Duke Energy's reportable segments offer different products and services and are
managed separately as strategic business units. Their accounting policies are
the same as those described in Note 2. Management evaluates segment performance
based on earnings before interest and taxes (EBIT) after deducting minority
interests. The following table shows how EBIT is calculated.
12
====================================================================
Reconciliation of Operating Income to EBIT (in millions)
- --------------------------------------------------------------------
Three Months Ended
March 31,
------------------
2002 2001
------------------
Operating income $691 $1,182
Plus: Other income and expenses 70 72
------------------
EBIT $761 $1,254
====================================================================
EBIT is the main performance measure used by management to evaluate segment
performance. As an indicator of Duke Energy's operating performance or
liquidity, EBIT should not be considered an alternative to, or more meaningful
than, net income or cash flow as determined in accordance with generally
accepted accounting principles. Duke Energy's EBIT may not be comparable to a
similarly titled measure of another company.
In the accompanying table, EBIT includes intersegment sales at prices
representative of unaffiliated party transactions. Capital and investment
expenditures are gross of cash received from acquisitions.
========================================================================================================
Business Segment Data (in millions)
- --------------------------------------------------------------------------------------------------------
Depreciation Capital and
Unaffiliated Intersegment Total and Investment
Revenues Revenues Revenues EBIT Amortization Expenditures
-----------------------------------------------------------------------------
Three Months Ended
March 31, 2002
Franchised Electric $ 1,113 $ -- $ 1,113 $ 385 $153 $ 244
Natural Gas Transmission 456 28 484 268 54 2,020
Field Services 1,336 230 1,566 35 74 110
North American Wholesale
Energy 7,914 50 7,964 67 32 744
International Energy 984 2 986 67 23 81
Other Energy Services 43 93 136 (2) 1 1
Duke Ventures 39 -- 39 6 4 125
Other Operations /a/ -- (35) (35) (79) 3 36
Eliminations and
minority interests -- (368) (368) 14 -- --
-----------------------------------------------------------------------------
Total consolidated $11,885 $ -- $11,885 $ 761 $344 $3,361
- --------------------------------------------------------------------------------------------------------
Three Months Ended
March 31, 2001
Franchised Electric $ 1,157 $ -- $ 1,157 $ 460 $146 $ 177
Natural Gas Transmission 245 37 282 175 35 79
Field Services 2,616 782 3,398 123 68 46
North American Wholesale
Energy 11,858 157 12,015 348 27 518
International Energy 497 5 502 76 25 23
Other Energy Services 81 37 118 4 3 5
Duke Ventures 37 -- 37 7 4 174
Other Operations /a/ -- 91 91 (70) 8 25
Eliminations and
minority interests -- (1,109) (1,109) 131 -- --
-----------------------------------------------------------------------------
Total consolidated $16,491 $ -- $16,491 $1,254 $316 $1,047
========================================================================================================
/a/ Other operations primarily includes certain unallocated corporate costs.
13
Segment assets in the accompanying table are net of intercompany advances,
intercompany notes receivable, intercompany current assets, intercompany
derivative assets and investments in subsidiaries.
================================================================================
Segment Assets (in millions)
- --------------------------------------------------------------------------------
March 31, December 31,
2002 2001
------------------------
Franchised Electric $13,238 $12,964
Natural Gas Transmission 15,394 5,027
Field Services 6,636 7,113
North American Wholesale
Energy 19,242 14,562
International Energy 5,665 5,115
Other Energy Services 234 145
Duke Ventures 2,062 1,926
Other Operations and eliminations /a/ 75 1,523
------------------------
Total consolidated $62,546 $48,375
================================================================================
/a/ Other operations primarily includes certain unallocated corporate costs.
6. Debt
In January 2002, Duke Energy issued $750 million of 6.25% senior unsecured bonds
due in 2012 and $250 million of floating rate (based on the three-month London
Interbank Offered Rate (LIBOR) plus 0.35%) senior unsecured bonds due in 2005.
The proceeds from these issuances were used to manage working capital needs.
In February 2002, Duke Capital Corporation, a wholly owned subsidiary of Duke
Energy issued $500 million of 6.25% senior unsecured bonds due in 2013 and $250
million of 6.75% senior unsecured bonds due in 2032. In addition, Duke Capital
Corporation, through a private placement transaction, issued $500 million of
floating rate (based on the one-month LIBOR plus 0.65%) senior unsecured bonds
due in 2003. The proceeds from these issuances were used to manage working
capital needs and to fund a portion of the cash consideration for the Westcoast
acquisition.
In March 2002, a wholly owned subsidiary of Duke Energy, Duke Australia Pipeline
Finance Pty Ltd., closed a syndicated bank debt facility for $450 million with
various banks to fund its pipeline business in Australia. The facility is split
between a Duke Capital Corporation-guaranteed tranche and a non-recourse project
finance tranche that is secured by liens over existing Australian pipeline
assets. Proceeds from the project finance tranche were used to repay
inter-company loans.
In April 2002, Duke Energy issued $250 million of 6.60% retail bonds due in
2022. The senior unsecured bonds were insured to obtain an `AAA' credit rating.
Duke Energy subsequently swapped the bonds to a floating rate (based on the
three-month LIBOR). The proceeds from this issuance were used for general
corporate purposes. In addition, Duke Capital Corporation, through a private
placement transaction, issued $100 million of floating rate (based on the
one-month LIBOR plus 0.85%) senior unsecured bonds due in 2004. The proceeds
from this issuance were used to repay commercial paper.
On March 14, 2002, Duke Energy acquired Westcoast for approximately $8 billion,
including the assumption of $4.7 billion of debt. The assumed debt consists of
debt of Westcoast, Union Gas Limited (a wholly-owned subsidiary of Westcoast)
and various project entities that are wholly-owned or consolidated by Duke
Energy. The interest rates on the assumed debt range from 2.53% to 15.0%, with
maturity dates ranging from 2002 through 2027. (See Note 3.)
7. Commitments and Contingencies
Environmental. In 2001, 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 North Carolina coal-fired power plants over the next
seven to 11 years. Management estimates the cost to Duke Energy of achieving the
specified emission reductions in
14
the proposed legislation to be approximately $1.5 billion. The proposed North
Carolina legislation included a provision that allows Duke Energy to recover
some or all of these costs from customers through an environmental compliance
expenditure-recovery factor that would have been separate from the utility's
base rates.
In April 2002, Governor Easley of North Carolina announced his Clean Air
Initiative which is intended to supersede the proposed legislation introduced in
2001. Through discussions with Duke Energy and other stakeholders, the Governor
developed a plan to implement the emission reductions introduced in 2001, but
without any increase in costs to consumers. Instead, North Carolina electric
utilities would freeze their rates for five years and use the money collected
during that period to pay for controls to meet the required emission reductions.
This plan has not yet been introduced as legislation, but is expected to be
introduced and acted upon quickly in late May 2002 or early June 2002. The final
legislation, if passed into law, could differ significantly from the Governor's
announced initiative.
California Issues. Duke Energy, some of its subsidiaries and three current or
former executives have been named as defendants, among 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. The plaintiffs
seek damages as a result of the defendants' alleged unlawful manipulation of the
California wholesale electricity markets. DENA and DETM are among 16 defendants
in a class-action lawsuit (the Gordon lawsuit) filed against generators and
traders of electricity in California markets. DETM was also 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, 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, on their own
behalf as citizens and on behalf of the general public, and includes Duke
Energy, some of its subsidiaries and three current or former executives of Duke
Energy among 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. The plaintiffs seek aggregate damages of billions of dollars. The lawsuits
seek the refund of alleged unlawfully obtained revenues for electricity sales
and, in four lawsuits, an award of treble damages. These suits have been
consolidated before a state court judge in San Diego. The plaintiffs in the six
lawsuits filed a joint Master Amended Complaint on March 8, 2002, which adds
additional defendants. The claims against the defendants are similar to those in
the original complaints. The court has approved a schedule which calls for class
certification motions to be filed by October 1, 2002 in the class action
lawsuits. Trial has been scheduled for March 1, 2004. While these matters are in
their earliest stages, management believes, based on its analysis of the facts
and the asserted claims, that their resolution will have no 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 and regulatory
proceedings and investigations related to activities in California. These other
activities were disclosed in Duke Energy's Form 10-K for the year ended December
31, 2001, and there have been no new material developments in relation to these
issues.
Regulatory Matters. In November 2001, Nevada Power Company and Sierra Pacific
Power Company (collectively, the Companies) filed a complaint with the FERC
against DETM. The complaint requests the FERC to mitigate prices in sales
contracts between Duke Energy and Nevada Power, and Duke Energy and Sierra
Pacific that were entered into between December 7, 2000 and June 20, 2001. The
Companies allege that the contract prices are unjust and unreasonable because
they were entered into during a period that the FERC determined the California
market to be dysfunctional and uncompetitive, and that the California market
influenced the contract prices. In April 2002, the FERC issued an order which
provides for an evidentiary hearing, establishes refund dates, and requires the
parties to participate in settlement negotiations. In the order, the FERC also
estimated a final decision by July 2003. While this matter is in its
15
earliest stages, management believes, based on its analysis of facts and the
asserted claims, that the resolution will have no material adverse effect on
Duke Energy's consolidated results of operations, cash flows or financial
position.
8. Subsequent Event
On April 17, 2002, Duke Energy completed the sale of the Anderson Water Company
to the Anderson County Joint Municipal Water System and the City of Anderson.
The agreements for closing are two-fold. The first part represents the sale of
the water treatment facility and the related water transmission system to the
traditional wholesale customers forming the Anderson County Joint Municipal
Water System. The second relates to the sale of the retail water system to the
City of Anderson. As a result, the City of Anderson becomes a wholesale customer
participant in and a member of the joint system.
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Introduction
Duke Energy Corporation (collectively with its subsidiaries, Duke Energy), an
integrated provider of energy and energy services, offers 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 to the Consolidated Financial Statements 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 three months ended March 31, 2002, earnings available for common
stockholders were $379 million, or $0.48 per basic share. For the comparable
2001 period, earnings available for common stockholders were $454 million, or
$0.61 per basic share. The decrease was due primarily to a 39% decrease in
earnings before interest and taxes (EBIT), as described below. The current-year
EBIT decrease on a comparative basis was partially offset by the prior year's
one-time net-of-tax charge of $96 million, or $0.13 per basic share. This
one-time charge was the cumulative effect of 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."
Also offsetting the comparative decrease in EBIT was a $128 million decrease in
minority interest expense, as discussed in the following sections, and a
decrease in the effective tax rate due to tax savings initiatives.
Operating income was $691 million and EBIT was $761 million for the three months
ended March 31, 2002. This compares to operating income of $1,182 million and
EBIT of $1,254 million for the same period in 2001. Operating income and EBIT
are affected by the same fluctuations for Duke Energy and each of its business
segments. The following table shows the components of EBIT and reconciles EBIT
to net income.
16
==============================================================
Reconciliation of Operating Income to Net Income (in millions)
- --------------------------------------------------------------
Three Months Ended
March 31,
------------------
2002 2001
------------------
Operating income $691 $1,182
Other income and expenses 70 72
------------------
EBIT 761 1,254
Interest expense 189 213
Minority interest expense 32 160
------------------
Earnings before income taxes 540 881
Income taxes 158 327
------------------
Income before cumulative effect of
change in accounting Principle 382 554
Cumulative effect of change in accounting
principle, net of tax -- (96)
------------------
Net income $382 $ 458
==============================================================
EBIT is the main performance measure used by management to evaluate segment
performance. As an indicator of Duke Energy's operating performance or
liquidity, EBIT should not be considered an alternative to, or more meaningful
than, net income or cash flow as determined in accordance with generally
accepted accounting principles. 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 detailed discussions follow.
==============================================================
EBIT by Business Segment (in millions)
- --------------------------------------------------------------
Three Months Ended
March 31,
------------------
2002 2001
------------------
Franchised Electric $385 $ 460
Natural Gas Transmission 268 175
Field Services 35 123
North American Wholesale Energy 67 348
International Energy 67 76
Other Energy Services (2) 4
Duke Ventures 6 7
Other Operations (79) (70)
EBIT attributable to minority interests 14 131
------------------
Consolidated EBIT $761 $1,254
==============================================================
Other Operations primarily includes certain unallocated corporate costs. The
amounts discussed below include intercompany transactions that are eliminated in
the Consolidated Financial Statements.
17
Franchised Electric
================================================================
Three Months Ended
March 31,
------------------
(in millions, except where noted) 2002 2001
- ----------------------------------------------------------------
Operating revenues $ 1,113 $ 1,157
Operating expenses 746 748
------------------
Operating income 367 409
Other income, net of expenses 18 51
------------------
EBIT $ 385 $ 460
==================
Sales, GWh /a/ 19,521 19,362
================================================================
/a/ Gigawatt-hours
Franchised Electric's EBIT decreased $75 million for the three months ended
March 31, 2002 as compared to the same period in 2001. The decrease was due
primarily to $33 million in mutual insurance distributions recorded as income in
the first quarter of 2001 and the favorable settlement of forward power sales
contracts used to manage price risk for Franchised Electric's wholesale
market-rate sales in first quarter of 2001. Since the third quarter of 2001, the
mutual insurance distributions have been reclassified from earnings to a
deferred credit account as required by the North Carolina Utilities Commission,
pending final outcome of a regulatory audit which will likely determine the
treatment of those distributions. Earnings also decreased as a result of lower
sales, primarily in the industrial class, due to the slowing economy and warmer
weather in the first quarter of 2002, partially offset by continued growth in
the average number of customers in Franchised Electric's service territory.
The following table shows the changes in GWh sales and average number of
customers.
==============================================================
Increase (decrease) over prior year Three Months Ended
- --------------------------------------------------------------
Residential sales (6.0)%
General service sales (0.8)%
Industrial sales (9.5)%
Total Franchised Electric sales 0.8%
Average number of customers 1.3%
==============================================================
Natural Gas Transmission
==============================================================
Three Months Ended
March 31,
------------------
(in millions, except where noted) 2002 2001
- --------------------------------------------------------------
Operating revenues $484 $282
Operating expenses 218 107
------------------
Operating income 266 175
Other income, net of expenses 5 --
Minority interest expense 3 --
------------------
EBIT $268 $175
==================
Proportional throughput, TBtu /a/ 759 548
==============================================================
/a/ Trillion British thermal units
For the three months ended March 31, 2002, EBIT for Natural Gas Transmission
increased $93 million compared to the same period in 2001. This increase
primarily resulted from $62 million in earnings from the natural gas
transmission and distribution assets acquired as a part of the acquisition of
Westcoast
18
Energy, Inc. (Westcoast) in March 2002. (See Note 3 to the Consolidated
Financial Statements.) Also contributing to the increase in EBIT was a $14
million gain on the sale of a portion of Natural Gas Transmission's limited
partnership interest in Northern Border Partners, LP, which owns a general
partnership interest in Northern Border Pipeline Company.
Field Services
===============================================================================
Three Months Ended
March 31,
------------------
(in millions, except where noted) 2002 2001
- -------------------------------------------------------------------------------
Operating revenues $1,566 $3,398
Operating expenses 1,523 3,219
------------------
Operating income 43 179
Other income, net of expenses -- --
Minority interest expense 8 56
------------------
EBIT $ 35 $ 123
==================
Natural gas gathered and processed/transported, TBtu/d /a/ 8.4 8.2
Natural gas liquid (NGL) production, MBbl/d /b/ 388.6 371.1
Natural gas marketed, TBtu/d 1.6 1.6
Average natural gas price per MMBtu /c/ $ 2.32 $ 7.09
Average NGL price per gallon /d/ $ 0.31 $ 0.60
===============================================================================
/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 $88 million for the three months ended March
31, 2002 compared to the same period in 2001, due primarily to the decrease in
commodity prices. The decrease was driven by a $4.77 per MMBtu decrease in the
average natural gas prices and a $0.29 per gallon decrease in the average NGL
prices. Partially offsetting the decrease in commodity prices were increased
contributions of approximately $15 million from the 2001 acquisitions of
Canadian Midstream Services, Ltd., northeast propane terminal and marketing
assets, and additional interests in three offshore Gulf of Mexico partnerships.
North American Wholesale Energy (NAWE)
================================================================
Three Months Ended
March 31,
------------------
(in millions, except where noted) 2002 2001
- ----------------------------------------------------------------
Operating revenues $ 7,964 $12,015
Operating expenses 7,897 11,589
------------------
Operating income 67 426
Other income (loss), net of expenses (1) (10)
Minority interest (benefit) expense (1) 68
------------------
EBIT $ 67 $ 348
==================
Natural gas marketed, TBtu/d 13.8 13.6
Electricity marketed and traded, GWh 108,220 44,617
Proportional megawatt capacity in operation 7,515 5,064
Proportional megawatt capacity owned /a/ 18,605 10,054
================================================================
/a/ Includes under construction or under contract at period end
19
For the three months ended March 31, 2002, NAWE's EBIT decreased $281 million
compared to the same period in 2001. Increases of 48% in the proportional
megawatt capacity of generation assets in operation and 143% in the marketing
and trading of electricity volumes were significantly offset by decreased
origination activities and trading margins. Last year's results were driven by
unusually high natural gas and power prices and volatility levels, especially in
the western U.S. This year's results reflect a return to more normal commodity
pricing and volatility. In 2002, NAWE also held several short positions during a
period of rising market prices (contracts under which a trader has agreed to
sell a commodity at a future date for a specific price) which also contributed
to the decrease in EBIT. Partially offsetting these decreases were lower
variable compensation costs related to the trading activities. Changes in the
ownership percentage of NAWE's waste-to-energy plants and decreased earnings at
Duke Energy Trading and Marketing, LLC (DETM) resulted in a $69 million decrease
in minority interest expense compared to the prior year.
International Energy
================================================================================
Three Months Ended
March 31,
------------------
(in millions, except where noted) 2002 2001
- -------------------------------------------------------------------------------
Operating revenues $ 986 $ 502
Operating expenses 927 428
------------------
Operating income 59 74
Other income, net of expenses 13 9
Minority interest expense 5 7
------------------
EBIT $ 67 $ 76
==================
Proportional megawatt capacity in operation 4,705 4,199
Proportional megawatt capacity owned /a/ 5,748 4,847
Proportional maximum pipeline capacity in operation /a/,
MMcf/d /b/ 363 255
Proportional maximum pipeline capacity owned /a/, MMcf/d /b/ 363 363
================================================================================
/a/ Includes under construction or under contract at period end
/b/ Million cubic feet per day
International Energy's EBIT decreased $9 million for the three months ended
March 31, 2002 compared to the same period in 2001, due primarily to decreased
earnings from Latin America investments and European operations. The Latin
American operations were affected by lower demand in Brazil due to the
government's mandatory energy rationing, which was in effect until mid-March
2002. The European operations were affected by lower trading margins and lower
product prices. The corresponding increases in International Energy's operating
revenues and expenses for 2002 are due primarily to its increased trading and
marketing activities in Europe.
Other Energy Services
=====================================================================
Three Months Ended
March 31,
------------------
(in millions) 2002 2001
- ---------------------------------------------------------------------
Operating revenues $136 $118
Operating expenses 138 114
------------------
EBIT $ (2) $ 4
=====================================================================
20
For the three months ended March 31, 2002, EBIT for Other Energy Services
decreased $6 million compared to the same period in 2001. On April 30, 2002,
Duke Energy completed the sale of Duke Engineering & Services, Inc. to Framatome
ANP, Inc. and, on May 1, 2002, Duke Energy completed the sale of DukeSolutions,
Inc. to Ameresco, Inc. (See Note 3 to the Consolidated Financial Statements).
The decrease in EBIT as compared to the prior year was due primarily to a
current-year $15 million reserve for the expected loss associated with the sale
of DukeSolutions, Inc. This loss was partially offset by project income at
Duke/Fluor Daniel.
Duke Ventures
================================================================================
Three Months Ended
March 31,
-------------------
(in millions) 2002 2001
- --------------------------------------------------------------------------------
Operating revenues $39 $37
Operating expenses 34 30
-------------------
Operating income 5 7
Minority interest benefit (1) --
-------------------
EBIT $ 6 $ 7
================================================================================
EBIT for Duke Ventures decreased $1 million for the three months ended March 31,
2002 compared to the same period in 2001. On April 17, 2002, Duke Energy
completed the sale of Anderson Water Company to Anderson County Joint Municipal
Water System and the City of Anderson. (See Note 8 to the Consolidated Financial
Statements.)
Other Impacts on Earnings Available for Common Stockholders
For the three months ended March 31, 2002, interest expense decreased $24
million compared to the same period in 2001, due primarily to lower interest
rates on commercial paper.
Minority interest expense decreased $128 million for the three months ended
March 31, 2002 compared to the same period in 2001. Minority interest expense
includes expense related to regular distributions on preferred securities of
Duke Energy and its subsidiaries. This expense decreased $11 million for the
three months ended March 31, 2002 due to lower distributions related to Catawba
River Associates, LLC (Catawba). Catawba is a fully consolidated financing
entity formed by Duke Energy in September 2000 and is managed by a Duke Energy
subsidiary.
Minority interest expense as shown and discussed in the preceding business
segment EBIT discussions includes only minority interest expense related to EBIT
of Duke Energy's joint ventures. It does not include minority interest expense
related to interest and taxes of the joint ventures. Total minority interest
expense related to the joint ventures (including the portion related to interest
and taxes) decreased $117 million for the three month period due to decreased
income from Field Services' joint venture with Phillips Petroleum, changes in
the ownership percentage of NAWE's waste-to-energy plants and decreased earnings
at DETM, NAWE's joint venture with Exxon Mobil Corporation.
A state tax settlement finalized during the three months ended March 31, 2002,
as well as the optimization of tax savings benefits, resulted in an effective
tax rate of 29%, compared to 37% for the same period in 2001. Duke Energy's
overall effective tax rate for 2002 is expected to be in the range of 35%-36%.
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.
21
LIQUIDITY AND CAPITAL RESOURCES
Operating Cash Flows
Net cash provided by operations increased $801 million in 2002 when compared to
the same period in 2001. The increase is due primarily to the change in the net
unrealized mark-to-market and hedging transactions resulting from increased cash
earnings in first quarter 2002 versus the same period in 2001. As a result of
the increased volatility and higher prices in the western U.S. for power in the
first quarter 2001, Duke Energy experienced a higher level of non-cash earnings
from mark-to-market transactions as compared to first quarter 2002.
Investing Cash Flows
Net cash used in investing activities increased $2,346 million in 2002 when
compared to the same period in 2001, primarily due to the acquisition of
Westcoast for $1,690 million in cash, net of cash acquired (see Note 3 to the
Consolidated Financial Statements). Capital and investment expenditures
increased $547 million in 2002 compared to 2001. The increase reflects
additional expansion and development expenditures (especially related to NAWE's
generating facilities), refurbishment and upgrades to existing assets and minor
acquisitions of businesses and assets.
Financing Cash Flows
Duke Energy's consolidated capital structure at March 31, 2002, including
short-term debt, was 53% debt, 36% common equity, 7% minority interests, 3%
trust preferred securities and 1% preferred stock. Fixed charges coverage,
calculated using the Securities and Exchange Commission (SEC) guidelines, was
2.7 for the three months ended March 31, 2002 and 4.3 times for the three months
ended March 31, 2001. The decrease in the fixed charges coverage is attributed
primarily to decreased net income and decreased tax expenses.
Duke Energy's growth initiatives, along with dividends, debt repayments and
operating requirements are expected to be funded by cash from operations, debt
and capital market financings, project financings, common stock issuances
through its InvestorDirect Choice Plan and employee benefit plans, and proceeds
from the sale of assets. These financing opportunities are dependent upon the
market opportunities presented and favorable market conditions. Additionally,
internal cash generation should fund approximately half of the capital needs.
Management believes Duke Energy has adequate financial resources to meet its
future needs.
In January 2002, Duke Energy issued $750 million of 6.25% senior unsecured bonds
due in 2012 and $250 million of floating rate (based on the three-month London
Interbank Offered Rate (LIBOR) plus 0.35%) senior unsecured bonds due in 2005.
The proceeds from these issuances were used to manage working capital needs.
In February 2002, Duke Capital Corporation, a wholly owned subsidiary of Duke
Energy, issued $500 million of 6.25% senior unsecured bonds due in 2013 and $250
million of 6.75% senior unsecured bonds due in 2032. In addition, Duke Capital
Corporation, through a private placement transaction, issued $500 million of
floating rate (based on the one-month LIBOR plus 0.65%) senior unsecured bonds
due in 2003. The proceeds from these issuances were used to manage working
capital needs and to fund a portion of the cash consideration for the Westcoast
acquisition.
In March 2002, a wholly owned subsidiary of Duke Energy, Duke Australia Pipeline
Finance Pty Ltd., closed a syndicated bank debt facility for $450 million with
various banks to fund its pipeline business in Australia. The facility is split
between a Duke Capital Corporation-guaranteed tranche and a non-recourse project
finance tranche that is secured by liens over existing Australian pipeline
assets. Proceeds from the project finance tranche were used to repay
inter-company loans.
In April 2002, Duke Energy issued $250 million of 6.60% retail bonds due in
2022. The senior unsecured bonds were insured to obtain an `AAA' credit rating.
Duke Energy subsequently swapped the bonds to a floating rate (based on the
three-month LIBOR). The proceeds from this issuance were used for general
corporate purposes. In addition, Duke Capital Corporation, through a private
placement transaction, issued
22
$100 million of floating rate (based on the one-month LIBOR plus 0.85%) senior
unsecured bonds due in 2004. The proceeds from this issuance were used to repay
commercial paper.
On March 14, 2002, Duke Energy acquired Westcoast for approximately $8 billion,
including the assumption of $4.7 billion of debt. The assumed debt consists of
debt of Westcoast. Union Gas Limited (a wholly-owned subsidiary of Westcoast)
and various project entities that are wholly-owned or consolidated by Duke
Energy. The interest rates on the assumed debt range from 2.53% to 15.0%, with
maturity dates ranging from 2002 through 2027. In addition to the debt assumed,
Westcoast and Union Gas Limited have operating credit facilities of 600 million
Canadian dollars and 715 million Canadian dollars, respectively. Borrowings
under each of these facilities are subject to and dependent upon the senior
unsecured ratings of Westcoast (currently rated A for Dominion Bond Rating
Service (DBRS) and A+ for Standard & Poor's) and Union Gas (currently rated
A(low) for DBRS and A+ for Standard & Poor's). For the Westcoast credit
facility, a material adverse change could occur if the ratings for Westcoast
fall below a BBB(low) at DBRS or a BB+ at Standard & Poor's, although a change
in ratings is not in and of itself a material adverse change. For Union Gas
Limited's facility, no material adverse change can be declared if Union Gas
Limited maintains a rating of BBB or greater by either DBRS or Standard &
Poor's. For both facilities, any outstanding debt would not become due and
payable as a result of the change in ratings. 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 and international energy businesses. In the
transaction, a Duke Energy subsidiary acquired all of the outstanding common
shares of Westcoast in exchange for approximately 49.9 million shares of Duke
Energy common stock (including exchangeable shares of a Duke Energy Canadian
subsidiary that are substantially equivalent to and exchangeable on a
one-for-one basis for Duke Energy common stock), and approximately $1.8 billion
in cash. Under prorating provisions of the acquisition agreement that ensured
that approximately 50% of the total consideration was paid in cash and 50% in
stock, each common share of Westcoast entitled the holder to elect to receive
43.80 in Canadian dollars, 0.7711 of a share of Duke Energy common stock or of
an exchangeable share of a Duke Energy Canadian subsidiary, or a combination
thereof. The cash portion of the consideration was funded with the proceeds from
the issuance of $750 million in mandatory convertible securities in November
2001 along with incremental commercial paper. Duke Energy plans to retire the
commercial paper later in 2002 and replace it with permanent capital in the form
of mandatory convertible market equity. The timing for the mandatory convertible
equity will be dependent on the market opportunities presented and favorable
market conditions. The Westcoast acquisition was accounted for using the
purchase method of accounting, and goodwill totaling approximately $2.5 billion
was recorded in the transaction.
Under its commercial paper, medium-term notes and extendible commercial notes
(ECNs) programs, Duke Energy had the ability to borrow up to $7,917 million at
March 31, 2002 compared with $5,358 million at December 31, 2001. These programs
do not have termination dates. The following table summarizes the commercial
paper, medium-term notes and ECNs as of March 31, 2002.
==============================================================================================================
Duke
Duke Duke Capital Duke Energy Energy Westcoast Union Gas
(in millions) Energy Corporationa/a/ Field Services International Energy Limited Total
- --------------------------------------------------------------------------------------------------------------
Commercial Paper $1,250 $2,550 $650 $400/b/ $376 $470 $5,696
Medium-term notes -- -- -- -- 470 251 721
ECNs 500 1,000 -- -- -- -- 1,500
------------------------------------------------------------------------------------------
Total $1,750 $3,550 $650 $400 $846 $721 $7,917
==============================================================================================================
/a/ Duke Capital Corporation provides financing and credit enhancement services
for its subsidiaries.
/b/ Includes ability to issue medium term notes
The total amount of Duke Energy's bank credit facilities was $7,136 million as
of March 31, 2002 compared with $4,606 million as of December 31, 2001. Some of
the credit facilities support the issuance of commercial paper and as a result,
the issuance of commercial paper reduces the amount available under these credit
facilities. As of March 31, 2002, $4,460 million was outstanding in the form of
commercial paper, medium-term notes and ECNs, and $40 million of borrowings were
outstanding under the bank credit facilities. The credit facilities expire from
2002 to 2005 and are not subject to minimum cash requirements.
As of March 31, 2002, Duke Energy and its subsidiaries had effective SEC shelf
registrations for up to $1,750 million in gross proceeds from debt and other
securities. Effective April 2002, the amount available was increased by $1,750
million. 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. In addition,
Westcoast and its subsidiaries had $439 million of unused Canadian debt
capacity.
23
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk and Accounting Policies
Duke Energy is exposed to market risks associated with commodity prices, credit
exposure, interest rates, equity prices 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 composed of senior
executives who receive periodic updates from the Chief Risk Officer (CRO) on
market risk positions, corporate exposures, credit exposures and overall risk
management activities. The CRO is responsible for the overall management of
credit risk and commodity price risk, including monitoring exposure limits.
Mark-to-Market Accounting (MTM accounting). Under the MTM accounting method, an
asset or liability is recognized at fair value and the change in the fair value
of that asset or liability is recognized in earnings during the current period.
This accounting method has been used by other industries for many years, and in
1998 the Financial Accounting Standards Board's (FASB) Emerging Issues Task
Force (EITF) issued guidance that required MTM accounting for energy trading
contracts. MTM accounting reports contracts at their "fair value," (the value a
willing third party would pay for the particular contract at the time a
valuation is made).
When available, quoted market prices are used to record a contract's fair value.
However, market values for energy trading contracts may not be readily
determinable because the duration of the contracts exceeds the liquid activity
in a particular market. If no active trading market exists for a commodity or
for a contract's duration, holders of these contracts must calculate fair value
using pricing models or matrix pricing based on contracts with similar terms and
risks. This is validated by an internal group independent of Duke Energy's
trading area. Holders of thinly traded securities or investments (mutual funds,
for example) use similar techniques to price such holdings. Correlation and
volatility are two significant factors used in the computation of fair values.
Duke Energy validates its internally developed fair values by comparing
locations/durations that are highly correlated, using market intelligence and
mathematical extrapolation techniques. While Duke Energy uses industry best
practices to develop its pricing models, changes in Duke Energy's pricing
methodologies or the underlying assumptions could result in significantly
different fair values, income recognition and realization in future periods.
Hedge Accounting. Hedging typically refers to the mechanism that Duke Energy
uses to mitigate the impact of volatility associated with price fluctuations.
Hedge accounting treatment is used when Duke Energy contracts to buy or sell a
commodity such as natural gas or electricity at a fixed price for future
delivery corresponding with anticipated physical sales or purchases of natural
gas and power (cash flow hedge). In addition, hedge accounting treatment is used
when Duke Energy holds firm commitments or asset positions, and enters into
transactions that "hedge" the risk that the price of natural gas or power may
change between the contract's inception and the physical delivery date of the
commodity ultimately affecting the underlying value of the firm commitment or
position (fair value hedge). While the majority of Duke Energy's hedging
transactions are used to protect the value of future cash flows related to its
physical assets, to the extent the hedge is effective, Duke Energy recognizes in
earnings the value of the contract when the commodity is purchased or sold, or
the hedged transaction occurs or settles.
Normal Purchases and Normal Sales, Special Exemption. A unique characteristic of
the electric power industry is that electricity cannot be readily stored in
significant quantities. As a result, some of the contracts to buy and sell
electricity allow the buyer some flexibility in determining when to take
electricity and in what quantity to match fluctuating demand. These contracts
would normally meet the definition of a derivative requiring MTM or hedge
accounting. However, because electricity cannot be readily stored in significant
quantities and an entity engaged in selling electricity is obligated to maintain
sufficient capacity to meet the electricity needs of its customer base, an
option contract for the purchase of electricity qualifies
24
for the normal purchases and sales exemption described in Paragraph 10 of SFAS
No. 133 and Derivative Implementation Group (DIG) Issue No. C15, "Scope
Exceptions: Normal Purchases and Normal Sales Exception for Option-Type
Contracts and Forward Contracts in Electricity." Therefore, contracts that Duke
Energy holds for the sale of power in future periods that meet the criteria in
DIG Issue No. C15 have been designated as "normal purchases, normal sales"
contracts, and are exempted from recognition in the Consolidated Financial
Statements until power is delivered. Duke Energy tracks these contracts
separately in its hedge portfolio, but no value for these contracts is included
in the Consolidated Financial Statements until power is actually delivered.
North American Merchant Generation
Duke Energy's wholesale energy portfolio in North America includes the merchant
generation facilities and trading contracts held for power, natural gas, crude
oil and petroleum products. Of the total estimated value of this portfolio,
approximately 80% is attributed to the anticipated value of merchant generation
facility capacity owned or controlled by Duke Energy. This portion of the value
of the merchant generation portfolio is anticipated to be realized in future
periods as the generation facilities are dispatched. A portion of this future
value is secured by hedge contracts. Of the unhedged capacity, dispatch
performance, and in some cases price, has been further secured through contracts
designated as normal purchases and normal sales. Only the contracts designated
and effective as qualifying hedges are reflected on Duke Energy's Consolidated
Balance Sheets at fair value. Changes in the fair value of qualifying hedging
contracts do not affect current-period earnings. Normal purchases and normal
sales contracts are not subject to accounting recognition until contract
performance occurs. The remaining percentage of the total estimated value of the
merchant generation portfolio is attributed to the current value of trading
contracts. These contracts are subject to MTM accounting and changes in the
contract fair value are recorded as part of current-period earnings. The table
below represents the value by year of Duke Energy's North American merchant
generation portfolio. It does not include the value of trading positions, or
hedges of other commodity risks or exposures.
=============================================================================================
North American Merchant Generation Portfolio Value as of March 31, 2002 (in millions)
- ---------------------------------------------------------------------------------------------
Maturity in 2005 Total
Maturity in 2002 Maturity in 2003 Maturity in 2004 and Thereafter /a/ Portfolio Value
- ---------------------------------------------------------------------------------------------
$747 $785 $895 $4,378 $6,805
=============================================================================================
/a/ For purposes of calculating total portfolio value, model valuations were
calculated through March 2010.
As of March 31, 2002, the portion hedged of NAWE's expected output of its
merchant generation portfolio was 74% for 2003, 60% for 2004 and 59% for 2005,
through derivative contracts such as forward natural gas purchases and forward
power sales.
Commodity Price Risk
Duke Energy, substantially through its subsidiaries, is exposed to the impact of
market fluctuations in the price of natural gas, electricity and other
energy-related products marketed and purchased. Duke Energy employs established
policies and procedures to manage its risks associated with these market
fluctuations using various commodity derivatives, including forward contracts,
futures, swaps and options for trading purposes and for activity other than
trading activity (primarily hedge strategies). (See Notes 2 and 4 to the
Consolidated Financial Statements.)
Trading. The risk in the trading portfolio is measured and monitored on a daily
basis utilizing a Value-at-Risk base model to determine the potential one-day
favorable or unfavorable Daily Earnings at Risk (DER) as described below. DER is
monitored daily in comparison to established thresholds. Other measures are also
used to limit and monitor risk in the trading portfolio (which includes all
trading contracts not designated as hedge positions) on monthly and annual
bases. These measures include limits on the nominal size of positions and
periodic loss limits.
25
DER computations are based on historical simulation, which uses price movements
over a specified period (generally ranging from seven to 14 days) to simulate
forward price curves in the energy markets to estimate the potential favorable
or unfavorable impact of one day's price movement on the existing portfolio. The
historical simulation emphasizes the most recent market activity, which is
considered the most relevant predictor of immediate future market movements for
natural gas, electricity and other energy-related products. DER computations use
several key assumptions, including a 95% confidence level for the resultant
price movement and the holding period specified for the calculation. Duke
Energy's DER amounts for instruments held for trading purposes are shown in the
following table.
=======================================================================================================
Daily Earnings at Risk (in millions)
- -------------------------------------------------------------------------------------------------------
Estimated Average Estimated Average
One-Day Impact on One-Day Impact on High One-Day Impact Low One-Day Impact
EBIT for 1st Quarter EBIT for 1st Quarter on EBIT for 1st on EBIT for 1st
2002 /a/ 2001 Quarter 2002 Quarter 2002
- -------------------------------------------------------------------------------------------------------
Calculated DER $17 $30 $24 $10
=======================================================================================================
/a/ Amount does not include the impact of Westcoast's trading activity.
DER is an estimate based on historical price volatility. Actual volatility can
exceed assumed results. DER also assumes a normal distribution of price changes;
thus, if the actual distribution is not normal, the DER may understate or
overstate actual results. DER is used to estimate the risk of the entire
portfolio, and for locations that do not have daily trading activity, it may not
accurately estimate risk due to limited price information. Stress tests are
employed in addition to DER to measure risk where market data information is
limited. In the current DER methodology, options are modeled in a manner
equivalent to forward contracts which may understate the risk.
Duke Energy's exposure to commodity price risk is influenced by a number of
factors, including contract size, length, market liquidity, location and unique
or specific contract terms. The following table illustrates the movements in the
fair value of Duke Energy's trading instruments during the first quarter of
2002.
=======================================================================================
Changes in Fair Value of Trading Contracts (in millions)
- ---------------------------------------------------------------------------------------
Fair value of contracts outstanding at the beginning of the year $1,069
Contracts realized or otherwise settled during the period (93)
Fair value of contracts entered into during the period 70
Changes in fair value amounts attributable to changes in valuation techniques 36
Other changes in fair values (63)
-------
Fair value of contracts outstanding at the end of the period $1,019
=======================================================================================
For the quarter ended March 31, 2002, the unrealized net loss recognized in
operating income was $68 million, compared to a $557 million gain for the first
quarter of 2001. The fair value of these contracts is expected to be realized in
future periods, as detailed in the following table. The amount of cash
ultimately realized for these contracts will differ from the amounts shown in
the following table due to factors such as market volatility, counterparty
default and other unforeseen events that could impact the amount and/or
realization of these values. At March 31, 2002, Duke Energy held cash or letters
of credit of $798 million to secure such future performance, and had deposited
with counterparties $96 million of such collateral to secure its obligations to
provide such future services. Collateral amounts held or posted vary depending
on the value of the underlying contracts and cover trading, normal purchases and
normal sales, and hedging contracts outstanding. Duke Energy may be required to
return held collateral and post additional collateral should price movements
adversely impact the value of open contracts or positions.
When available, Duke Energy uses observable market prices for valuing its
trading instruments. When quoted market prices are not available, management
uses established guidelines for the valuation of these contracts. Management may
use a variety of reasonable methods to assist in determining the valuation of a
trading instrument, including analogy to reliable quotations of similar trading
instruments, pricing models,
26
matrix pricing and other formula-based pricing methods. These methodologies
incorporate factors for which published market data may be available. All
valuation methods employed by Duke Energy are approved by an independent
internal corporate risk management organization.
The following table shows the fair value of Duke Energy's trading portfolio as
of March 31, 2002.
=========================================================================================================
Fair Value of Trading Contracts as of March 31, 2002 (in millions)
- ---------------------------------------------------------------------------------------------------------
Maturity in
Maturity in Maturity in Maturity in 2005 and Total Fair
Sources of Fair Value 2002 2003 2004 Thereafter Value
- ---------------------------------------------------------------------------------------------------------
Prices supported by quoted market
prices and other external sources $210 $148 $ 83 $ 32 $ 473
Prices based on models and other
valuation methods 27 20 63 436 546
- ---------------------------------------------------------------------------------------------------------
Total $237 $168 $146 $468 $1,019
=========================================================================================================
The "prices supported by quoted market prices and other external sources"
category includes Duke Energy's New York Mercantile Exchange (NYMEX) futures
positions in natural gas and crude oil. The NYMEX has currently quoted prices
for the next 32 months. In addition, this category includes Duke Energy's
forward positions and options in natural gas and power and natural gas basis
swaps at points for which over-the-counter (OTC) broker quotes are available. On
average, OTC quotes for natural gas and power forwards and swaps extend 22 and
32 months into the future, respectively. OTC quotes for natural gas and power
options extend 12 months into the future, on average. Duke Energy values these
positions against internally developed forward market price curves that are
constantly validated and recalibrated against OTC broker quotes. This category
also includes "strip" transactions whose prices are obtained from external
sources and then modeled to daily or monthly prices as appropriate.
The "prices based on models and other valuation methods" category includes (i)
the value of options not quoted by an exchange or OTC broker, (ii) the value of
transactions for which an internally developed price curve was constructed as a
result of the long dated nature of the transaction or the illiquidity of the
market point, and (iii) the value of structured transactions. It is important to
understand that in certain instances structured transactions can be decomposed
and modeled by Duke Energy as simple forwards and options based on prices
actively quoted. Although the valuation of the simple structures might not be
different from the valuation of contracts in other categories, the effective
model price for any given period is a combination of prices from two or more
different instruments and therefore have been included in this category due to
the complex nature of these transactions.
The value of Duke Energy's trading portfolio valuation adjustments for
liquidity, credit and cost of service is reflected in the above amounts.
Hedging Strategies. Some Duke Energy subsidiaries are exposed to market
fluctuations in the prices of energy commodities related to their power
generating and natural gas gathering, processing and marketing activities. Duke
Energy closely monitors the risks associated with these commodity price changes
on its future operations and, where appropriate, uses various commodity
instruments such as electricity, natural gas, crude oil and NGL contracts to
hedge the value of its assets and operations from such price risks. In
accordance with SFAS No. 133, Duke Energy's primary use of energy commodity
derivatives is to hedge the output and production of assets it physically owns.
Contract terms are up to 23 years; however, since these contracts are designated
and qualify as effective hedge positions of future cash flows, or fair values of
assets owned by Duke Energy, to the extent that the hedge relationships are
effective, their market value change impacts are not recognized in current
earnings. The unrealized gains or losses on these contracts are deferred in
Other Comprehensive Income (OCI) for cash flow hedges or included in Other
Current or
27
Noncurrent Assets or Liabilities on the Consolidated Balance Sheets for fair
value hedges of firm commitments, in accordance with SFAS No. 133. Amounts
deferred in OCI are realized in earnings concurrently with the transaction being
hedged. (See Notes 2 and 4 to the Consolidated Financial Statements.) However,
in instances where the hedging contract no longer qualifies for hedge
accounting, amounts included in OCI through the date of de-designation remain in
OCI until the underlying transaction actually occurs. The derivative contract
(if continued as an open position) will be marked to market currently through
earnings. Several factors influence the effectiveness of a hedge contract,
including counterparty credit risk and using contracts with different
commodities or unmatched terms. Hedge effectiveness is monitored regularly and
measured each month.
The following table shows when gains and losses deferred on the Consolidated
Balance Sheets for derivative instruments qualifying as effective hedges of firm
commitments or anticipated future transactions will be recognized into earnings.
Contracts with terms extending several years are generally valued using models
and assumptions developed internally or by industry standards. However, as
mentioned previously, the gains and losses for these contracts are not
recognized in earnings until settlement at their then market price. Therefore,
assumptions and valuation techniques for these contracts have no impact on
reported earnings prior to settlement.
The fair value of Duke Energy's qualifying hedge positions at a point in time is
not necessarily indicative of the value realized when such contracts settle.
==========================================================================================
Fair Value of Hedge Position Contracts as of March 31, 2002 (in millions)
- ------------------------------------------------------------------------------------------
Maturity in 2005 Total
Maturity in 2002 Maturity in 2003 Maturity in 2004 and Thereafter Contract Value
- ------------------------------------------------------------------------------------------
$408 $136 $100 $150 $794
==========================================================================================
In addition to the hedge contracts described above and recorded on the
Consolidated Balance Sheets, Duke Energy enters into other contracts that
qualify for the normal purchases and sales exemption described in Paragraph 10
of SFAS No. 133 and DIG Issue No. C15. These contracts, generally forward
agreements to sell power, bear the same counterparty credit risk as the hedge
contracts described above. Under the same risk reduction guidelines used for
other contracts, normal purchases and sales contracts are also subject to
collateral requirements. Income recognition and realization related to these
contracts coincide with the physical delivery of power.
Credit Risk
Duke Energy's principal customers 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 some 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 those limits on an ongoing basis. Duke Energy
frequently uses master collateral agreements to mitigate credit exposure. The
collateral agreement provides for a counterparty to post cash or letters of
credit for exposure in excess of the established threshold. The threshold amount
represents an open credit limit, determined in accordance with the corporate
credit policy. The collateral agreement also provides that the inability to post
collateral is sufficient cause to terminate a contract and liquidate all
positions.
The change in market value of New York Mercantile Exchange-traded futures and
options contracts requires daily cash settlement in margin accounts with
brokers. Financial derivatives are generally cash settled periodically
throughout the contract term. However, these transactions are also generally
subject to margin agreements with many of Duke Energy's counterparties.
28
As of March 31, 2002, Duke Energy had a pre-tax bad debt provision of $90
million related to receivables for energy sales in California. Following the
bankruptcy of Enron Corporation, Duke Energy terminated substantially all
contracts with Enron Corporation and its affiliated companies (collectively,
Enron). As a result, in 2001Duke Energy recorded, as a charge, a
non-collateralized accounting exposure of $43 million. The $43 million
non-collateralized accounting exposure was composed of charges of $36 million at
NAWE, $3 million at International Energy, $3 million at Field Services and $1
million at Natural Gas Transmission. These amounts were stated on a pre-tax
basis as charges against the reporting segment's earnings in 2001.
Duke Energy's determination of its bankruptcy claims against Enron is still
under review, and its claims made in the bankruptcy case are likely to exceed
$43 million. Any bankruptcy claims that exceed this amount would primarily
relate to termination and settlement rights under contracts and transactions
with Enron that would have been recognized in future periods, and not in the
historical periods covered by the financial statements to which the $43 million
charge relates.
Substantially all contracts with Enron were completed or terminated prior to
December 31, 2001. Duke Energy has continuing contractual relationships with
certain Enron affiliates, which are not in bankruptcy. In Brazil, a power
purchase agreement between a Duke Energy affiliate, Companhia de Geracao de
Energia Electrica Paranapanema (Paranapanema), and Elektro Eletricidade e
Servicos S/A (Elektro), a distribution company 40% owned by Enron, will expire
December 31, 2005. The contract was executed by Duke Energy's predecessor in
interest in Paranapanema, and obligates Paranapanema to provide energy to
Elektro on an irrevocable basis for the contract period. In addition, a
purchase/sale agreement expiring September 1, 2005 between a Duke Energy
affiliate and Citrus Trading Corporation (Citrus), a 50/50 joint venture between
Enron and El Paso Corporation, continues to be in effect. The contract requires
the Duke Energy affiliate to provide liquefied natural gas to Citrus. Citrus has
provided a letter of credit in favor of Duke Energy to cover its exposure.
Interest Rate Risk
Duke Energy is exposed to risk resulting from changes in interest rates as a
result of its issuance of variable-rate debt, fixed-to-floating interest rate
swaps, commercial paper and auction rate preferred stock. Duke Energy manages
its interest rate exposure by limiting its variable-rate and fixed-rate
exposures to percentages of total capitalization, as set by policy, and by
monitoring the effects of market changes in interest rates. Duke Energy also
enters into financial derivative instruments, including, but not limited to,
interest rate swaps, options, swaptions and lock agreements to manage and
mitigate interest rate risk exposure. (See Notes 2, 4, and 6 to the Consolidated
Financial Statements.)
Equity Price Risk
Duke Energy maintains trust funds, as required by the Nuclear Regulatory
Commission (NRC), to fund certain costs of nuclear decommissioning. As of
December 31, 2001 and 2000, these funds were invested primarily in domestic and
international equity securities, fixed-rate, fixed-income securities and cash
and cash equivalents. Duke Energy has an agreement with the NRC that these funds
will only be used for activities relating to nuclear decommissioning. Because
the accounting for nuclear decommissioning recognizes that costs are recovered
through Franchised Electric's rates, fluctuations in equity prices or interest
rates do not affect consolidated results of operations, cash flows or financial
position.
Foreign Currency Risk
Duke Energy is exposed to foreign currency risk from investments in
international affiliates and businesses owned and operated in foreign countries.
To mitigate risks associated with foreign currency fluctuations, when possible,
transactions are denominated in or indexed to the U.S. dollar and/or local
inflation rates, or investments may be hedged through debt denominated or issued
in the foreign currency. Duke Energy also uses foreign currency derivatives,
where possible, to manage its risk related to foreign currency fluctuations. To
monitor its currency exchange rate risks, Duke Energy uses sensitivity analysis,
which measures the impact of devaluation of the foreign currencies to which it
has exposure.
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Since 1991, the Argentine peso had been pegged to the U.S. dollar at a fixed 1:1
exchange ratio. In December 2001, the Argentine government imposed a restriction
that limited cash withdrawals above a certain amount and foreign money
transfers. Financial institutions were allowed to conduct limited activity as a
bank and exchange holiday was announced, and currency exchange activity was
essentially halted. In January 2002, the Argentine government announced the
creation of a dual-currency system. Subsequently, however, the Argentine
government has decided to use a free-floating currency.
Duke Energy's investment in Argentina was U.S. dollar functional as of December
31, 2001. Once a functional currency determination has been made, that
determination must be adhered to consistently, unless significant changes in
economic factors indicate that the entity's functional currency has changed. The
events in Argentina required a change. In January 2002, the functional currency
of Duke Energy's investment in Argentina changed from the U.S. dollar to the
Argentine peso. In compliance with SFAS No. 52, "Foreign Currency Translation,"
the change in functional currency will be made prospectively. Management
believes that the events in Argentina will have no material adverse effect on
Duke Energy's future consolidated results of operations, cash flows or financial
position.
CURRENT ISSUES
Environmental. In 2001, 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 North Carolina coal-fired power plants over the next
seven to 11 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 included a provision that
allows Duke Energy to recover some or all of these costs from customers through
an environmental compliance expenditure-recovery factor that would have been
separate from the utility's base rates.
In April 2002, Governor Easley of North Carolina announced his Clean Air
Initiative which is intended to supersede the proposed legislation introduced in
2001. Through discussions with Duke Energy and other stakeholders, the Governor
developed a plan to implement the emission reductions introduced in 2001, but
without any increase in costs to consumers. Instead, North Carolina electric
utilities would freeze their rates for five years and use the money collected
during that period to pay for controls to meet the required emission reductions.
This plan has not yet been introduced as legislation, but is expected to be
introduced and acted upon quickly in late May 2002 or early June 2002. The final
legislation, if passed into law, could differ significantly from the Governor's
announced initiative.
California Issues. Duke Energy, some of its subsidiaries and three current or
former executives have been named as defendants, among 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. The plaintiffs
seek damages as a result of the defendants' alleged unlawful manipulation of the
California wholesale electricity markets. Duke Energy North America, LLC (DENA)
and DETM are among 16 defendants in a class-action lawsuit (the Gordon lawsuit)
filed against generators and traders of electricity in California markets. DETM
was also 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, 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, on their own behalf as citizens and on behalf of the general
public, and includes Duke Energy, some of its subsidiaries and three current or
former executives of Duke Energy among 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. The plaintiffs seek aggregate
damages of billions of
30
dollars. The lawsuits seek the refund of alleged unlawfully obtained revenues
for electricity sales and, in four lawsuits, an award of treble damages. These
suits have been consolidated before a state court judge in San Diego. The
plaintiffs in the six lawsuits filed a joint Master Amended Complaint on March
8, 2002, which adds additional defendants. The claims against the defendants are
similar to those in the original complaints. The court has approved a schedule
which calls for class certification motions to be filed by October 1, 2002 in
the class action lawsuits. Trial has been scheduled for March 1, 2004. While
these matters are in their earliest stages, management believes, based on its
analysis of the facts and the asserted claims, that their resolution will have
no 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 and regulatory
proceedings and investigations related to activities in California. These other
activities were disclosed in Duke Energy's Form 10-K for the year ended December
31, 2001, and there have been no new material developments in relation to these
issues.
Regulatory Matters. In November 2001, Nevada Power Company and Sierra Pacific
Power Company (collectively, the Companies) filed a complaint with the Federal
Energy Regulatory Commission (FERC) against DETM. The complaint requests the
FERC to mitigate prices in sales contracts between Duke Energy and Nevada Power,
and Duke Energy and Sierra Pacific that were entered into between December 7,
2000 and June 20, 2001. The Companies allege that the contract prices are unjust
and unreasonable because they were entered into during a period that the FERC
determined the California market to be dysfunctional and uncompetitive, and that
the California market influenced the contract prices. In April 2002, the FERC
issued an order which provides for an evidentiary hearing, establishes refund
dates, and requires the parties to participate in settlement negotiations. In
the order, the FERC also estimated a final decision by July 2003. While this
matter is in its earliest stages, management believes, based on its analysis of
facts and the asserted claims, that the resolution will have no material adverse
effect on Duke Energy's consolidated results of operations, cash flows or
financial position.
Subsequent Event. On April 17, 2002, Duke Energy completed the sale of the
Anderson Water Company to the Anderson County Joint Municipal Water System and
the City of Anderson. The agreements for closing are two-fold. The first part
represents the sale of the water treatment facility and the related water
transmission system to the traditional wholesale customers forming the Anderson
County Joint Municipal Water System. The second relates to the sale of the
retail water system to the City of Anderson. As a result, the City of Anderson
becomes a wholesale customer participant in and a member of the joint system.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
For information concerning litigation and other contingencies, see Note 7 to the
Consolidated Financial Statements, "Commitments and Contingencies," and Item 3,
"Legal Proceedings," included in Duke Energy's Form 10-K for December 31, 2001,
which are incorporated herein by reference.
Management believes that the final disposition of these proceedings will have no
material adverse effect on Duke Energy's 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 first quarter of 2002.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number
- -------
3 Articles of Amendment to Restated Articles of Incorporation of
registrant.
10 $500,000,000 364-Day Credit Agreement dated as of April 18, 2002,
among Duke Capital Corporation, the Banks listed therein and Bank One,
NA, as Administrative Agent.
(b) Reports on Form 8-K
A Current Report on Form 8-K filed on January 9, 2002 contained
disclosures under Item 9, Regulation FD Disclosure.
A Current Report on Form 8-K filed on March 29, 2002 contained
disclosures under Item 2, Acquisition or Disposition of Assets and Item 7,
Financial Statements, Pro forma Financial Information and Exhibits.
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
May 15, 2002 /s/ Robert P. Brace
-----------------------------------
Robert P. Brace
Executive Vice President and
Chief Financial Officer
May 15, 2002 /s/ Keith G. Butler
-----------------------------------
Keith G. Butler
Senior Vice President and
Controller
33