UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-14508
KEYSPAN ENERGY CORPORATION
(Exact name of Registrant as specified in its charter)
New York 11-3344628
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification
No.)
One MetroTech Center, Brooklyn, New York 11201-3851
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including
area code (718) 403-1000
NONE
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class of Common Stock Outstanding at February 13, 1998
$.33 1/3 par value 51,157,142
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES
INDEX
Part I. Financial Information Page No.
Condensed Consolidated Balance Sheet -
December 31, 1997 and 1996, and September 30,
1997 3
Condensed Consolidated Statement of Income -
Three and Twelve Months Ended December 31,
1997 and 1996 4
Condensed Consolidated Statement of Cash Flows -
Three and Twelve Months Ended December 31,
1997 and 1996 5
Notes to Condensed Consolidated Financial
Statements 6
Management's Discussion and Analysis of Results
of Operations and Financial Condition 12
Review of Independent Public Accountants 21
Report of Independent Public Accountants 22
Part II. Other Information
Item 1 - Legal Proceedings 23
Item 5 - Other Information 23
Item 6 - Exhibits and Reports on Form 8-K 24
Signature 25
2
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
===================================================================================================================================
December 31, December 31, September 30,
1997 1996 1997
(UNAUDITED) (UNAUDITED) (AUDITED)
===================================================================================================================================
(Thousands of Dollars)
Assets
Property
Utility, at cost $ 1,855,724 $ 1,786,688 $ 1,848,817
Accumulated depreciation (461,564) (428,445) (458,089)
Gas exploration and production, at cost 683,975 538,551 636,312
Accumulated depletion (237,147) (176,814) (216,423)
- -----------------------------------------------------------------------------------------------------------------------------------
1,840,988 1,719,980 1,810,617
- -----------------------------------------------------------------------------------------------------------------------------------
Equity Investments in Energy Services 98,626 113,183 166,833
- -----------------------------------------------------------------------------------------------------------------------------------
Current Assets
Cash and temporary cash investments 39,803 44,485 36,912
Accounts receivable 335,457 334,106 174,321
Allowance for uncollectible accounts (16,804) (16,781) (14,444)
Gas in storage, at average cost 87,350 81,658 94,695
Materials and supplies, at average cost 11,761 12,691 11,436
Prepaid gas costs 8,474 10,881 11,309
Other 57,645 39,754 33,886
- -----------------------------------------------------------------------------------------------------------------------------------
523,686 506,794 348,115
- -----------------------------------------------------------------------------------------------------------------------------------
Deferred Charges 154,261 120,230 171,625
- -----------------------------------------------------------------------------------------------------------------------------------
$ 2,617,561 $ 2,460,187 $ 2,497,190
===================================================================================================================================
Capitalization and Liabilities
Capitalization
Common stock, $.33 1/3 par value , authorized
210,000,000; outstanding 51,014,498,
50,033,347 and 50,767,041 shares,
respectively stated at $ 580,558 $ 554,907 $ 572,457
Retained earnings 433,545 382,430 396,586
- -----------------------------------------------------------------------------------------------------------------------------------
Total common equity 1,014,103 937,337 969,043
Preferred stock, redeemed - 6,600 -
Long-term debt 760,111 712,031 745,091
- -----------------------------------------------------------------------------------------------------------------------------------
1,774,214 1,655,968 1,714,134
- -----------------------------------------------------------------------------------------------------------------------------------
Current Liabilities
Accounts payable 177,604 179,857 142,725
Dividends payable 19,224 18,924 18,490
Commercial paper and Notes payable 40,300 28,000 64,211
Taxes accrued 37,930 42,456 4,602
Customer deposits 23,208 22,699 22,829
Customer budget plan credits 30,674 26,993 15,956
Interest accrued and other 39,242 32,547 50,629
- -----------------------------------------------------------------------------------------------------------------------------------
368,182 351,476 319,442
- -----------------------------------------------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Federal income tax 291,889 286,818 290,458
Unamortized investment tax credits 18,754 19,738 19,004
Other 76,070 65,755 69,003
- -----------------------------------------------------------------------------------------------------------------------------------
386,713 372,311 378,465
- -----------------------------------------------------------------------------------------------------------------------------------
Minority Interest in Subsidiary Company 88,452 80,432 85,149
- -----------------------------------------------------------------------------------------------------------------------------------
$ 2,617,561 $ 2,460,187 $ 2,497,190
===================================================================================================================================
See accompanying notes to condensed consolidated financial statements.
3
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
================================================================================================================
Three Months Twelve Months
Ended December 31, Ended December 31,
1997 1996 1997 1996
================================================================================================================
(Thousands of Dollars, Except Per Share Data)
Operating Revenues
Gas sales and transportation $ 393,347 $ 405,482 $ 1,301,793 $ 1,362,397
Other retail services 17,936 13,011 55,046 29,717
Gas production and other 40,664 28,233 126,636 84,597
- ----------------------------------------------------------------------------------------------------------------
451,947 446,726 1,483,475 1,476,711
Operating Expenses
Cost of gas 183,221 197,536 579,870 647,287
Operation and maintenance 104,295 101,877 421,350 421,399
Depreciation and depletion 33,787 24,982 119,768 92,601
General taxes 42,409 41,439 154,448 145,912
Federal income tax 27,348 23,434 58,600 41,104
- ----------------------------------------------------------------------------------------------------------------
Operating Income 60,887 57,458 149,439 128,408
Other Income (Expense)
Income from equity investments 2,808 2,290 16,695 12,196
Gain on sale of investments and subsidiary stock 11,417 - 25,172 51,597
Other, net 138 (777) (1,407) 1,440
Federal income tax (4,093) (883) (10,881) (20,155)
Minority interest in earnings of subsidiary (2,964) (1,583) (8,010) (1,583)
- ----------------------------------------------------------------------------------------------------------------
Income Before Interest Charges 68,193 56,505 171,008 171,903
Interest Charges
Long-term debt 9,484 10,545 37,455 43,928
Other 2,162 1,159 7,074 4,972
- ----------------------------------------------------------------------------------------------------------------
Net Income 56,547 44,801 126,479 123,003
Dividends on Preferred Stock - 79 213 320
- ----------------------------------------------------------------------------------------------------------------
Income Applicable to
Common Stock $ 56,547 $ 44,722 $ 126,266 $ 122,683
================================================================================================================
Basic and Diluted Per Share of Common Stock $ 1.11 $ 0.90 $ 2.50 $ 2.47
- ----------------------------------------------------------------------------------------------------------------
Dividends Declared per Share
of Common Stock $ 0.375 $ 0.365 $ 1.470 $ 1.430
- ----------------------------------------------------------------------------------------------------------------
Average Common Shares
Outstanding 50,892,078 49,941,590 50,461,414 49,614,109
================================================================================================================
See accompanying notes to condensed consolidated financial statements.
4
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
====================================================================================================================================
Three Months Twelve Months
Ended December 31, Ended December 31,
1997 1996 1997 1996
====================================================================================================================================
(Thousands of Dollars)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 56,547 $ 44,801 $ 126,479 $ 123,003
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and depletion 34,857 25,911 123,211 90,117
Deferred Federal income tax 5,361 4,558 9,543 29,019
Gain on sale of investments (11,417) - (27,469) (16,160)
Gain on sale of subsidiary stock - - - (35,437)
Income from energy services investments (2,808) (2,290) (16,695) (13,196)
Dividends from energy services investments 4,891 910 16,867 9,633
Change in balance sheet accounts:
Accounts receivable, net (163,780) (152,988) (10,399) 4,268
Accounts payable 30,716 28,188 (7,025) 43,738
Gas inventory and prepayments 10,180 11,219 (3,285) (19,912)
Other 36,733 73,513 22,419 25,821
- ------------------------------------------------------------------------------------------------------------------------------------
Cash provided by operating activities 1,280 33,822 233,646 240,894
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock 7,751 5,061 25,308 25,328
Proceeds from initial public offering of subsidiary stock - - - 101,041
Commercial paper and revolving lines of credit, net (23,911) 28,000 12,300 5,000
Increase in long-term debt 16,000 - 188,000 153,500
Repayment of long-term tax-exempt debt and preferred stock (1,000) - (146,600) (163,523)
Dividends paid (19,130) (18,343) (74,557) (71,819)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) financing activities (20,290) 14,718 4,451 49,527
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FOR INVESTING ACTIVITIES
Capital expenditures (excluding allowance
for equity funds used during construction) (72,272) (49,074) (309,626) (311,266)
Proceeds from sale of investments 101,882 - 125,156 26,938
Partnership (investment) distribution - - (30,000) -
Other (7,709) 3,098 (28,309) 30,810
- ------------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) investing activities 21,901 (45,976) (242,779) (253,518)
- ------------------------------------------------------------------------------------------------------------------------------------
Change in Cash and Temporary Cash Investments 2,891 2,564 (4,682) 36,903
Cash and Temporary Cash Investments at Beginning of Period 36,912 41,921 44,485 7,582
Cash and Temporary Cash Investments at End of Period $ 39,803 $ 44,485 $ 39,803 $ 44,485
- ------------------------------------------------------------------------------------------------------------------------------------
Temporary cash investments are short-term marketable securities purchased with maturities of three months or less that are carried
at cost which approximates their fair value.
Supplemental disclosures of cash flows
Income taxes $ 3,000 $ - $ 51,000 $ 37,053
Interest $ 10,345 $ 12,007 $ 44,003 $ 50,196
====================================================================================================================================
See accompanying notes to condensed consolidated financial statements.
5
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The financial statements presented herein reflect the
reorganization of Brooklyn Union and its subsidiaries into a
holding company structure under the name KeySpan Energy
Corporation on September 29, 1997.
In the opinion of the Company, the accompanying unaudited
Condensed Consolidated Financial Statements contain all
adjustments necessary to present fairly the financial position
of the Company as of December 31, 1997 and 1996, and the
results of operations for the three and 12 month periods ended
December 31, 1997 and 1996, and cash flows for the three and
12 month periods ended December 31, 1997 and 1996. Certain
reclassifications were made to conform prior period financial
statements with the current period financial statement
presentation. All other adjustments were of a normal,
recurring nature.
As permitted by the rules and regulations of the Securities
and Exchange Commission, the Condensed Consolidated Financial
Statements do not include all of the accounting information
normally included with financial statements prepared in
accordance with generally accepted accounting principles.
Accordingly, the Condensed Consolidated Financial Statements
should be read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on
Form 10-K for the fiscal year ended September 30, 1997.
This document contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934.
For any of these statements, the Company claims the protection
of the safe harbor for forward-looking information contained
in the Private Securities Litigation Reform Act of 1995, as
amended.
The gas distribution business is influenced by seasonal
weather conditions. Annual revenues are substantially realized
during the heating season (November 1 to April 30) as a result
of the large proportion of heating sales, primarily
residential, compared with total sales. Accordingly, results
of operations historically are most favorable in the second
quarter (three months ended March 31) of the Company's fiscal
year, with results of operations being next most favorable in
the first quarter. Results for the third quarter are
marginally unprofitable, and losses are usually incurred in
the fourth quarter. Therefore, the interim Condensed
Consolidated Statement of Income should not be taken as a
prediction for any future period.
6
The utility tariff contains a weather normalization adjustment
that largely offsets shortfalls or excesses of firm net
revenues during a heating season due to variations from normal
weather.
2. ENVIRONMENTAL MATTERS
Historically, Brooklyn Union or predecessor entities owned or
operated several former manufactured gas plant (MGP) sites.
These sites have been identified for the New York State
Department of Environmental Conservation (DEC) for inclusion
on appropriate waste site inventories. In certain circum-
stances, former MGP sites can give rise to environmental
cleanup responsibilities for Brooklyn Union.
With respect to one former MGP site located on Brooklyn Union
property, the Brooklyn Borough Works site in Coney Island,
Brooklyn Union executed an administrative consent order (ACO)
with the DEC in 1995 addressing the overall remediation of the
site. In accordance with the ACO, a schedule of investigative
and cleanup activities has been developed, and cleanup over
the next several years is expected.
With respect to another former MGP site also located on
Brooklyn Union property, the Clifton site in Staten Island,
Brooklyn Union has recently completed certain investigations.
Based upon this data and discussions with the DEC, Brooklyn
Union expects to conduct a comprehensive investigation
pursuant to an ACO to be executed with DEC.
Based upon the current estimated range of the costs of
compliance with the Coney Island ACO, and the estimated costs
of investigation of three other sites, the minimum cost of
MGP-related environmental cleanup will be approximately $34
million, the majority of which will be expended for the Coney
Island plant site. This amount includes approximately $7.7
million of costs expended as of December 31, 1997. The actual
MGP-related costs for the Coney Island site may be
substantially higher depending upon remediation experience,
end use of the site and environmental conditions not addressed
in the ACO. Further, additional accruals may be required for
remediation upon completion of current investigative plans.
As of December 31, 1997, the Company had an unpaid liability
of $26.3 million representing costs associated with
investigation and remediation at former manufactured gas plant
sites.
The utility rate plan that became effective on October 1,
1996, provides, among other things, that if the total cost of
investigation and remediation varies from the amount
originally accrued, Brooklyn Union will retain or absorb 10%
7
of the variation. In addition, Brooklyn Union may seek
recovery of any new liability that exceeds three percent of
pretax utility income.
Periodic discussions with insurance carriers and third parties
for reimbursement of some portion of remediation and
investigation cost continues.
3. REGULATORY ASSETS
Brooklyn Union is subject to the provisions of Statement of
Financial Accounting Standards (SFAS) No. 71, "Accounting for
the Effects of Certain Types of Regulation". Regulatory
assets arise from the allocation of costs and revenues to
accounting periods for utility ratemaking purposes differently
from bases generally applied by nonregulated companies.
Regulatory assets are recognized in accordance with SFAS-71.
With the exception of net tax regulatory assets, all other
assets and liabilities created by the ratemaking process are
immaterial. Accordingly, at December 31, 1997, there was a net
tax regulatory asset of $68.7 million compared to a net tax
regulatory asset of $75.3 million at December 31, 1996.
In the event that the provisions of SFAS-71 were no longer
applicable, the Company estimates that the write-off of this
net tax regulatory asset could result in a charge to net
income of approximately $44.7 million which would be
classified as an extraordinary item.
4. COMBINATION WITH LONG ISLAND LIGHTING COMPANY (LILCO
TRANSACTION)
AMENDED AGREEMENT WITH LILCO
On December 29, 1996, Brooklyn Union and LILCO entered into an
Agreement and Plan of Exchange (LILCO Agreement), pursuant to
which the companies would become wholly owned subsidiaries of
a new holding company (LILCO Transaction). The LILCO
Agreement was amended and restated to reflect certain
technical changes as of February 7, 1997 and June 26, 1997.
Further, as the result of Brooklyn Union's reorganization into
holding company form on September 29, 1997, the Company was
assigned all of Brooklyn Union's rights in and to, and assumed
all of the obligations of Brooklyn Union under the Amended
LILCO Agreement.
The LILCO Transaction was approved by both companies' boards
of directors and shareholders of both companies approved the
transaction on August 7, 1997. Under the terms of the LILCO
Transaction, as the result of a merger of the Company with a
newly-formed subsidiary of the new holding company, the
8
Company's common shareholders will receive one share of common
stock of the new holding company for each common share of the
Company that they currently own. Through a share exchange,
LILCO common shareholders will receive 0.803 shares (the
Ratio) of the new holding company's common stock for each
share of LILCO common stock that they currently own. In the
event that the transaction with the Long Island Power
Authority (LIPA Transaction) is consummated, the Ratio will be
0.880. See LILCO Agreement with Long Island Power Authority
(LIPA Transaction). Based on current facts and circumstances,
it is probable that the purchase method of accounting will
apply to the LILCO Transaction with LILCO being the acquiring
company for accounting purposes.
The Amended LILCO Agreement contains certain covenants of the
parties pending the consummation of the LILCO Transaction.
Generally, the parties must carry on their businesses in the
ordinary course consistent with past practice.
The Company and LILCO expect to continue their respective
current dividend policies until completion of the LILCO
Transaction. It is anticipated that the new holding company
will set an initial annual dividend rate of $1.78 per share on
its common stock.
Following the announcement of the LILCO Agreement, Standard &
Poor's Ratings Services placed Brooklyn Union's corporate
credit and senior unsecured debt ratings of A, as well as
Brooklyn Union's A-1 commercial paper rating, on CreditWatch
with negative implications. Similarly, Moody's Investors
Service placed Brooklyn Union's A1 senior unsecured and Prime-
1 short-term ratings on review for possible downgrade.
The LILCO Transaction is conditioned upon the receipt of all
required regulatory approvals and other conditions. On July
17, 1997, the Federal Energy Regulatory Commission (FERC)
approved the LILCO Transaction. By order dated February 5,
1998, the PSC approved the transactions necessary to effect
the combination as well as the transfer of certain utility
assets to the newly-formed holding company and to shared
services organizations being established to provide general
corporate administrative services for the business units and
affiliates of the holding company. (See Management's
Discussion and Analysis of Results of Operations and Financial
Condition, "Utility Rate and Regulatory Matters", for further
information.)
Unaudited pro forma combined condensed financial information
for KeySpan Energy Corporation and Long Island Lighting
Company at December 31, 1997 and for the 12 months ended
December 31, 1997 is contained in the Company's Report on Form
8-K, dated February 13, 1998.
9
LILCO AGREEMENT WITH LONG ISLAND POWER AUTHORITY
(LIPA Transaction)
On June 26, 1997, LILCO and LIPA entered into definitive
agreements pursuant to which, after the transfer of LILCO's
gas distribution assets, non-nuclear electric generation
assets and certain other assets and liabilities (Transferred
Assets and Liabilities) to one or more newly-formed
subsidiaries of the new holding company (Transferee
Subsidiaries), LILCO's common and preferred stock will be sold
to LIPA for $2.4975 billion in cash. The LIPA Transaction was
approved by LILCO's shareholders on August 7, 1997. Upon
consummation of the LIPA Transaction, LIPA will own LILCO's
electric transmission and distribution system, its 18%
interest in the Nine Mile Point 2 Nuclear Power Station, and
its electric regulatory assets and liabilities, and will
assume or refinance approximately $339 million in preferred
stock and approximately $3.6 billion in long term debt. The
common and preferred stock transferred to consummate the LIPA
Transaction will be cancelled and will not represent an
interest in the new holding company or any of its
subsidiaries.
As part of the LIPA Transaction, the definitive agreements
contemplate that one or more subsidiaries of the newly-formed
holding company will enter into agreements with LIPA, pursuant
to which such subsidiaries will provide management and
operations services to LIPA with respect to the electric
transmission and distribution system, sell power generated by
the non-nuclear power plants to LIPA, and manage LIPA's fuel
and electric purchases and any off-system electric sales. In
addition, three years after the LIPA Transaction is
consummated, LIPA will have the right for a one year period to
acquire the non-nuclear generating assets. The purchase price
for such assets would be the fair market value at the time of
the exercise of the right, which value will be determined by
independent appraisers.
On July 16, 1997, the New York State Public Authorities
Control Board (PACB) unanimously approved the definitive
agreements related to the LIPA Transaction subject to the
following conditions: (1) within one year, LIPA must establish
a plan for open access to the electric distribution system;
(2) LIPA may not purchase the generating facilities, as
contemplated in the generation purchase right agreement, at a
price greater than book value; (3) the holding company formed
in connection with the LIPA Transaction (or the LILCO
Transaction) must agree to invest, over a ten year period, at
least $1.3 billion in energy-related and economic development
projects, and natural gas infrastructure projects on Long
Island; (4) LIPA will guarantee that, over a ten year period,
average electric rates will be reduced by no less than 14%
10
when measured against LILCO's rates today. As part of this
guarantee, no less than 2% cost savings to LIPA customers must
result from the savings attributable to the LILCO Transaction;
and (5) LIPA will not increase average customer rates by more
than 2 1/2% over a 12 month period without approval of the
Public Service Commission.
The LIPA Transaction is subject to the approval of the FERC
and other regulatory agencies. In July 1997, the Company,
LILCO and LIPA filed requests for private letter rulings with
the Internal Revenue Service regarding certain federal income
tax issues that require favorable rulings in order for the
LIPA Transaction to close. On January 20, 1998, LILCO filed
an application with the PSC for approval of the transfer of
the Transferred Assets and Liabilities from LILCO to the
Transferee Subsidiaries. At its session held on
February 11, 1998, the FERC approved the LIPA Transaction.
The Company is unable to determine when or if all other
consents and approvals required to consummate the LIPA
Transaction will be obtained.
11
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Operating Results
The following is a summary of items affecting comparative earnings
and a discussion of the material changes in revenues and expenses
during the following periods:
(1) Three Months ended December 31, 1997 vs. Three Months ended
December 31, 1996.
(2) Twelve Months ended December 31, 1997 vs. Twelve Months
ended December 31, 1996.
Earnings
Consolidated earnings for the first quarter ended December 31, 1997
were $56.5 million, or $1.11 per share, compared to $44.7 million,
or 90 cents per share, for the first quarter of last year.
Earnings in this year's first quarter continued to reflect solid
performance from operating subsidiaries and included a gain of $7.4
million, or 14 cents per share, from the sale of our domestic
cogeneration investments and related fuel management operations.
The sale enabled us to realize value from the investment and to
eliminate any potential conflict related to the ownership of these
electric-generation facilities following the LILCO Transaction.
Utility operations contributed $44.2 million, or 87 cents per
share, to consolidated earnings for the first quarter of fiscal
1998, compared to $41.5 million, or 83 cents per share, in last
year's first quarter. The increase reflects continued attainment
of cost efficiency and revenue growth objectives. The results of
the energy-related investment group primarily reflect income from
gas production operations of The Houston Exploration Company
(THEC), investment in the Iroquois Pipeline and the gain from the
cogeneration sale. This group contributed a total of $14.0
million, or 27 cents per share, to consolidated earnings for the
first quarter of fiscal 1998. Excluding the gain from the sale of
our cogeneration investment, earnings from the group were $6.6
million, or 13 cents per share, for the first quarter of fiscal
1998 compared to $4.1 million, or eight cents per share, for last
year's first quarter. The group's results primarily reflected
operating earnings of $5.7 million, or 11 cents per share, from
THEC in this year's first quarter compared to $3.0 million, or six
cents per share, a year ago. THEC's results reflected increased
production and higher prices. The energy-marketing group showed
slight losses in the first quarter of both years, reflecting the
effect of various costs related to market development. We are
12
applying our project development know-how internationally in
pipeline and distribution infrastructure, technology, cogeneration
and marketing in select areas overseas. Major projects under
various stages of development include gas pipeline and distribution
projects in the United Kingdom, and gas cogeneration and
distribution projects in Mexico.
Consolidated earnings for the 12 months ended December 31, 1997
were $126.3 million, or $2.50 per share, compared to $122.7
million, or $2.47 per share, for the 12 months ended December 31,
1996. Earnings in the 12 months ended December 31, 1997 included
gains of $15.2 million, or 30 cents per share, from sales of
various cogeneration investments as well as the sale of residual
interests in Canadian assets. Further, earnings in the 12 months
ended December 31, 1996 included similar but larger net gains of
$25.7 million, or 52 cents per share, from the initial public
offering of THEC's common stock and sale of our investment in a
Canadian processing plant, net of a reorganization charge, all
recorded in September 1996. Otherwise, results for the 12 months
ended December 31, 1997 reflected favorable trends in earnings
growth from major operating groups.
The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS
No. 128) during fiscal 1997. The Company adopted SFAS No. 128
beginning October 1, 1997 and there was no difference between basic
and diluted earnings per share amounts as computed in accordance
with the requirements of SFAS No. 128.
Firm gas and transportation sales for the first quarter of fiscal
1998, which was 4.8% colder than normal, were 43,535 MDTH, compared
to 41,703 MDTH, in last year's first quarter, which had normal
weather. Total gas throughput, which includes gas sales to
interruptible customers primarily within Brooklyn Union's service
territory and transportation services primarily to off-system
customers, was 57,374 MDTH for the first quarter of fiscal 1998,
compared to 55,087 MDTH in last year's first quarter. Total gas
throughput, for the 12 months ended December 31, 1997 was 197,496
MDTH, compared to 187,770 MDTH for the corresponding 12-month
period a year ago.
Net revenues (operating revenues less cost of gas) increased 1% in
the three months ended December 31, 1997 reflecting weather which
was colder than normal, compared to the same period last year which
had normal weather.
A significant market for off-system gas sales, transportation and
other services has developed as a result of deregulation. These
sales and services reflect optimal use of available pipeline
capacity and our New York Market Hub in balancing on-system
requirements to core customers with off-system services to increase
total margins. For the 12 months ended December 31, 1997, gas and
13
transportation sales and services to off-system and interruptible
customers amounted to 59,294 MDTH compared with 47,768 MDTH for the
comparable period in 1996.
Risk Management
The Company's utility and gas exploration and production
subsidiaries employ derivative financial instruments, such as
natural gas and oil futures, options and swaps, for the purpose of
hedging exposure to commodity price risk. The value at risk of the
related positions as measured by the maximum adverse price movement
in a single day is not material.
The utility tariff applicable to certain large-volume customers
permits gas to be sold at prices established monthly within a
specified range expressed as a percentage of prevailing alternate
fuel oil prices. Brooklyn Union uses standard New York Mercantile
Exchange futures contracts to fix profit margins on specified
portions of the sales to this market in line with pricing
objectives.
With respect to natural gas production operations, THEC generally
uses options to establish collars and swaps to hedge the price risk
related to known production plans and capabilities. These
instruments include a fixed price/volume and are structured as both
straight and participating swaps. In all swap instruments, THEC
pays the counterparties the amount by which the floating variable
price (settlement price) exceeds the fixed price and receives the
amount by which the settlement price is below the fixed price.
The Company's subsidiaries are exposed to credit risk in the event
of nonperformance by counterparties to derivative contracts, as
well as nonperformance by the counterparties of the transactions
against which they are hedged. The Company believes that the
credit risk related to the futures, options and swap instruments is
no greater than that associated with the primary commodity
contracts which they hedge, as the instrument contracts are with
major investment grade financial institutions, and that elimination
of the price risk lowers the Company's overall business risk.
Gas Production Revenues
Gas production and other revenues increased in the current periods
as compared with the comparable periods last year, principally due
to the acquisition of gas and oil properties by THEC in July and
September 1996. Gas production for the quarter ended December 31,
1997 was 15.5 BCFe, or 5.0 BCFe above production in the first
quarter last year. For the 12 months ended December 31, 1997, gas
production was 51.3 BCFe, compared with 31.9 BCFe in the 12 months
ended December 31, 1996. The effective price (average wellhead
price received for production including realized gains and losses)
was $2.58 per MCF in the first quarter of fiscal 1998 compared with
14
$2.32 per MCF in the first quarter of 1997. The average wellhead
price was $2.76 per MCF in the current quarter compared with $2.68
per MCF in the first quarter of 1997. The effective prices in the
12 months ended December 31, 1997 and 1996 were $2.25 and $2.00 per
MCF, respectively.
THEC uses the full cost method of accounting for its investment in
natural gas and oil properties. Under the full cost method of
accounting, all costs of acquisition, exploration and development
of natural gas and oil reserves are capitalized into a "full cost
pool" as incurred, and properties in the pool are depleted and
charged to operations using the unit-of-production method based on
the ratio of current production to total proved natural gas and oil
reserves. To the extent that such capitalized costs (net of
accumulated depreciation, depletion and amortization) less deferred
taxes exceed the present value (using a 10% discount rate) of
estimated future net cash flows from proved natural gas and oil
reserves and the lower of cost or fair value of unproved
properties, such excess costs are charged to operations. If a
write-down is required, it would result in a charge to earnings but
would not have an impact on cash flows from operating activities.
Once incurred, a write-down of oil and gas properties is not
reversible at a later date even if oil and gas prices increase.
As of December 31, 1997, THEC estimates, using prices in effect as
of such date, that the ceiling limitation imposed under full cost
accounting rules on total capitalized natural gas and oil property
costs exceeded actual capitalized costs. Natural gas prices
declined substantially in January 1998 from prices in effect on
December 31, 1997. If prices continue to decline, THEC may be
required to write down the carrying value of its natural gas and
oil properties depending upon natural gas prices and the results of
drilling programs during the second quarter of Fiscal 1998.
Consolidated Expenses
Operation and maintenance expense increased 2.4% for the quarter
ended December 31, 1997. The increase principally reflects higher
operating costs related to increased production operations of THEC
and market development costs of energy marketing subsidiaries. The
comparative expense in the 12 months ended December 31, 1997
decreased slightly. The 12 months ended December 31, 1996 included
colder weather and the reorganization charge of $12 million ($7.8
million, after taxes) incurred by THEC.
The increase in depreciation and depletion expense in the current
periods reflects higher depletion charges at THEC due to increased
gas production.
General taxes principally include State and City taxes on utility
revenues and property. The applicable property base generally has
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increased and the related valuations for assessment of utility
franchise taxes was increased. Taxes based on revenues reflect the
variations in utility revenues each year.
Federal income tax expense reflects changes in pre-tax income. The
effective tax rate for the 12 months ended December 31, 1997 was
36%, reflecting the non-deductibility of certain organization
expenses.
Interest charges for the 12 months ended December 31, 1997
primarily reflect lower utility interest costs due to debt
refunding. Other interest charges principally include carrying
charges related to regulatory settlement items, and for the
quarters ended December 31, 1997 and 1996, reflect interest charges
related to commercial paper borrowings for general corporate
purposes.
Other income includes results from investments in energy services
which reflect increased earnings in the current periods, primarily
associated with an increase in the Company's investment in the
Iroquois Gas Transmission System from 11.4% to 19.4% in May 1996.
Other income for the 12 months ended December 31, 1997 reflect the
gains on the sale of our domestic cogeneration investment and the
sale of residual interests in Canadian assets. Other income for
the 12 months ended December 31, 1996 reflect the gains on the sale
of subsidiary stock of $35.4 million ($23 million, after taxes) and
the sale of a Canadian gas processing plant of $16.2 million ($10.5
million, after taxes).
In September 1997, all outstanding shares of 4.60% Cumulative
Preferred Stock were redeemed. Prior to the redemption, dividends
reflect reductions in the number of shares outstanding due to
sinking fund requirements.
Financial Condition and Dividends
Cash flow from operating activities continues to reflect stable
growth notwithstanding differences caused by weather and the timing
of payments of a general corporate nature, which adversely affected
cash flow in the quarter ended December 31, 1997.
At December 31, 1997, the Company had available bank lines of
credit of $100 million, which lines secure the issuance of
commercial paper. The lines of credit are available to the Company
and its principal subsidiary, Brooklyn Union. THEC has an
available line of credit of $130 million. THEC is planning on
issuing $150 million of bonds through a private placement depending
on market conditions and interest rates. The proceeds from such
issuance would be used, in part, to pay down obligations for
borrowings under its revolving loan agreement. The bonds if
issued, would be subordinate to borrowings under the line of
credit.
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In November 1997, the Board of Directors approved an increase in
the annual dividend on common stock to $1.50 per share from $1.46
per share. This increase became effective on February 1, 1998,
when the quarterly dividend was raised to 37 1/2 cents per share
from 36 1/2 cents per share. Common dividends have been increased
in 22 consecutive years and paid continuously for 50 years.
Pursuant to the PSC order dated February 5, 1998 approving the
LILCO Transaction, Brooklyn Union's ability to pay dividends
to the Company is conditioned upon maintenance of a utility
capital structure with debt not exceeding 55% of total utility
capitalization. The principal source of funding for the Company
is dividend payments from Brooklyn Union. The Company and
LILCO expect to continue their respective current dividend policies
until completion of the LILCO Transaction. It is anticipated that
the new holding company, will set an initial dividend rate of $1.78
per share of its common stock. (See Notes to the Condensed
Consolidated Financial Statements, Note 4., "Combination with Long
Island Lighting Company", for additional information.)
Utility Rate and Regulatory Matters
Proposed LILCO Transaction
In 1997, the Company and LILCO filed a joint petition with the New
York State Public Service Commission (PSC or Commission) seeking
PSC approval, under section 70 of the New York Public Service Law,
of the Amended LILCO Agreement by which the Company and LILCO each
would become subsidiaries of a newly-formed holding company. (See
Notes to the Condensed Consolidated Financial Statements, Note 4.,
"Combination with Long Island Lighting Company".) In addition, the
petition called for $1.0 billion of efficiency savings,
excluding gas cost, attributable to operating synergies that are
expected to be realized over the 10 year period following the
combination, be allocated to ratepayers net of transaction costs.
In late December, Brooklyn Union, LILCO, the Staff of the
Department of Public Service and three other parties entered into
a Settlement Agreement (Stipulation) resolving all issues among
them in the proceeding. Hearings on the Stipulation were held in
early January 1998 and, by order dated February 5, 1998, the PSC
approved the Stipulation. Under the Stipulation, effective on the
date of the consummation of the LILCO Transaction, Brooklyn Union's
base rates to core customers will be reduced by $23.866 million
annually. In addition, effective in the fiscal year in which the
LILCO Transaction is consummated, Brooklyn Union will be subject to
an earnings sharing provision pursuant to which it will be required
to credit core customers with 60% of any utility earnings up to 100
basis points above certain threshold returns on equity levels over
the term of the rate plan (other than any earnings associated with
discrete incentives) and 50% of any utility earnings in excess of
100 basis points above such threshold levels. The threshold levels
17
are 13.75% in fiscal year 1998, 13.50% in fiscal years 1999 through
2001, and 13.25% in fiscal year 2002. A safety and reliability
incentive mechanism will be implemented effective on the
consummation date of the LILCO Transaction, with a maximum 12 basis
point pretax return on equity penalty if Brooklyn Union fails to
achieve certain safety and reliability performance standards. With
the exception of the simplification of the customer service
performance standards, the Brooklyn Union rate plan approved by the
PSC in the holding company proceeding remains unchanged. Any gas
cost savings allocable to Brooklyn Union resulting from the LILCO
Transaction will be reflected in rates to utility customers as
those savings are realized. Also under the Stipulation, LILCO's
base gas rates were reduced by $12.175 million annually effective
on February 5, 1998, and further reduced by $6.253 million
effective on the date of consummation of the LILCO Transaction.
The Stipulation defers action on the pending LILCO electric rate
plan until no earlier than July 1, 1998.
The Stipulation also eliminates or relaxes many restrictions
contained in the holding company settlement agreement in such areas
as affiliate transactions; use of the name and reputation of
Brooklyn Union by unregulated affiliates; common officers of the
holding company, the utility subsidiaries and unregulated
subsidiaries; dividend payment restrictions; and the composition of
the Board of Directors of Brooklyn Union.
Appliance Service
On April 4, 1997, the PSC issued its "Order Concerning Gas
Appliance and Repair Service" by which it determined that
non-safety related appliance repair service, other than minor
adjustments, should not be performed by regulated gas utilities.
In compliance with the order, Brooklyn Union filed tariff revisions
with the PSC, which became effective on October 1, 1997, and also
filed an application seeking PSC approval to transfer certain
assets related to the conduct of the non-safety related appliance
repair business to a subsidiary that would conduct and carry on
that business after the PSC's approval is secured. On February 5,
1998, as part of the Settlement Agreement in the proceeding
governing the LILCO Transaction (see above), the Commission
approved the terms of the asset transfers as well as the procedures
by which the Company would assign unexpired service contracts to
the newly-formed appliance repair subsidiary. The Settlement
Agreement calls for the asset transfer and business "spin-off" to
take place no earlier than April 5, 1998 and no later than June 30,
1998.
18
Customer Fixed Price Option
On June 5, 1997, the PSC issued an order entitled "Order Requiring
the Filing of Proposals to Ameliorate Gas Price Volatility and
Requesting Comments" (Order). The Order required each New York
State local distribution company to submit proposals for a fixed
price option to be available for use by customers effective with
the 1997-98 heating season.
As a result of this Order, Brooklyn Union made available to gas
sales customers, except residential non-heating customers, seasonal
off-peak and large volume customers, a fixed price option, for the
period December 1997 through April 1998. Any incremental costs
that may be incurred as a result of the program will be recovered
from customers in the following year.
Industry Restructuring Proceedings
The PSC has set forth a policy framework to guide the transition of
New York State's gas distribution industry in the deregulated gas
industry environment. Beginning on May 1, 1996, customers in the
small-volume market were given the option to purchase their gas
supplies from sources other than Brooklyn Union, the gas
transporter. Large-volume customers had this option for a number
of years. In addition to transporting gas that customers purchase
from marketers, utilities will provide billing, meter reading and
other services for aggregate rates that match the distribution
charge reflected in otherwise applicable sales rates to supply
these customers. The PSC placed a voluntary limit on the amount of
gas a utility would be obligated to transport in its core market
under aggregation programs to 5% of total core sales in each of the
next three years, with no more than 25% of any one service class
permitted to convert to transportation service.
In September, as part of the restructuring proceeding of the gas-
distribution industry in New York, the staff of the Public Service
Commission issued a position paper, "The Future of the Natural Gas
Industry." Its principal recommendations relate to gas supply and
pipeline capacity issues, specifically, the separation of the gas
merchant function from the distribution-transportation function as
the most effective way to establish a more competitive local gas
market. A five-year transition period was suggested in the
Position Paper, during which time local distribution companies
would continue to provide the bulk of the merchant function.
We conceptually support the recommendations made in the Position
Paper but requested flexibility and customer feedback before the
PSC makes a final decision. Our response addressed the need to
establish principles regarding: system reliability, recovery of
prudently incurred costs, the obligation to provide service to all
firm customers, tax disparity among suppliers and the obligation to
be "supplier of last resort". Brooklyn Union also indicated that
19
legislative revisions were required in order for the Staff
recommendations to be implemented. It is anticipated that the PSC
will evaluate all comments to the Position Paper before it makes
specific recommendations.
Environmental Matters
The Company is subject to various Federal, State and local laws and
regulatory programs related to the environment. These
environmental laws govern both the normal, ongoing operations of
the Company as well as the cleanup of historically contaminated
properties. Ongoing environmental compliance activities, which
historically have not been material, are integrated with the
Company's regular operation and maintenance activities. As of
December 31, 1997 the Company had an accrued liability of $26.3
million representing costs associated with investigation and
remediation at former manufactured gas plant sites. (See Notes to
Condensed Consolidated Financial Statements, Note 2.,
"Environmental Matters".)
Computer Software, Year 2000 Issue
The Company has evaluated the extent to which modifications to its
computer software and database will be necessary to accommodate the
year 2000. The Company's computer systems are generally based on
two digits and will require some additional programming to
recognize the start of the new millennium. In 1996, the Emerging
Issues Task Force of the Financial Accounting Standards Board
reached a consensus, EITF Issue No. 96-14, that internal and
external costs specifically associated with modifying internal-use
computer software for the year 2000 should be charged to expense as
incurred. The Company estimates the cost of future modifications,
which are expected to be made over the next two years, to be
approximately $2.5 million.
New Financial Accounting Standards
The Financial Accounting Standards Board issued the following
accounting standards: Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" (SFAS No. 130); and
Statement of Financial Accounting Standards No. 131, "Disclosure
about Segments of an Enterprise and Related Information" (SFAS No.
131). The Company will adopt SFAS No. 130 and SFAS No. 131 in its
next fiscal year. The Company does not expect any material effect
from adoption of these statements.
20
REVIEW OF INDEPENDENT PUBLIC ACCOUNTANTS
Arthur Andersen LLP has performed reviews in accordance with
standards established by the American Institute of Certified Public
Accountants of the Condensed Consolidated Financial Statements for
the periods set forth in their report shown on page 22.
21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To KeySpan Energy Corporation:
We have reviewed the accompanying condensed consolidated balance
sheets of KeySpan Energy Corporation (a New York corporation) and
subsidiaries as of December 31, 1997 and 1996, and the related
condensed consolidated statements of income for the three and
twelve month periods ended December 31, 1997 and 1996, and the
condensed consolidated statements of cash flows for the three and
twelve month periods ended December 31, 1997 and 1996. These
financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by
the American Institute of Certified Public Accountants. A review of
interim financial information consists principally of applying
analytical procedures to financial data and making inquiries of
persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which
is the expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to the financial statements referred to above
for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet and consolidated
statement of capitalization of KeySpan Energy Corporation and
subsidiaries as of September 30, 1997, and the related consolidated
statements of income, retained earnings, and cash flows for the
year then ended (not presented herein) and, in our report dated
October 22, 1997, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information
set forth in the accompanying condensed consolidated balance sheet
as of September 30, 1997 is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which
it has been derived.
ARTHUR ANDERSEN LLP
New York, New York
January 22, 1998
22
Part II. Other Information
Item 1. Legal Proceedings
The Company and/or its subsidiaries have from time to time been
named as defendants in various legal proceedings. In the opinion
of management, the ultimate disposition of currently asserted
claims will not have a materially adverse impact on the Company's
consolidated financial position or results of operations. For
information regarding environmental matters affecting the Company,
see Notes to the Condensed Consolidated Financial Statements, Note
2., "Environmental Matters".
Item 5. Other Information
Annual Shareholders Meeting
Shareholders voted overwhelmingly for the combination with
Long Island Lighting Company at the special meeting held in
August. We anticipate that the business combination will take
place this year, and have postponed the shareholder meeting
originally scheduled for February 5, 1998. KeySpan directors
will continue to serve until a meeting of shareholders is
held. The directors selected for the new holding company will
serve until a meeting of shareholders of the new holding
company is held.
Gas Procurement Matters
On February 10, 1998, Brooklyn Union entered into a series of
agreements with Enron Capital and Trade Resources Corp. (ECT)
and its parent company, Enron Corp. which provide for ECT to
engage in an overall gas supply management arrangement (ECT
Arrangement) on behalf of Brooklyn Union over the course of a
one year term commencing on April 1, 1998 (Contract Period).
Under the ECT Arrangement, Brooklyn Union will assign contract
rights to interstate pipeline transportation and storage field
capacity to ECT (to the extent that Federal law permits such
assignment), and will appoint ECT as its exclusive agent under
gas supply contracts and other interstate pipeline and storage
field capacity contracts (to the extent not assignable under
Federal law). ECT also will satisfy Brooklyn Union's gas
supply requirements during the Contract Period. As
consideration for the various assignments and agency
designations reflected in the ECT Arrangement, ECT will pay
Brooklyn Union a fixed amount that, in Brooklyn Union's
judgment, exceeds the level of margins that it would be able
to generate through the operation of its New York Hub during
the Contract Period. On February 10, 1998, Brooklyn Union
filed with the PSC the ECT agreements and certain tariff
revisions that would permit the ECT Arrangement to take effect
as contemplated in such agreements.
23
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(11) Statement re computation of per share earnings.
(15) Letter re unaudited interim financial information.
(27) Financial data schedule.
(b) Reports on Form 8-K
With the filing of its Form 10-Q Report for the quarter ended
December 31, 1997, the Company filed a report on Form 8-K
providing disclosure applicable to the unaudited pro forma
combined condensed financial information for the Company and
Long Island Lighting Company at December 31, 1997 and for the
12 months ended December 31, 1997. The unaudited pro forma
combined condensed financial information reflects the
condensed consolidated financial information of the Company
and Long Island Lighting Company contained in their respective
Quarterly Reports on Form 10-Q.
There was a Form 8-K filed on December 19, 1997 together with
the Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1997 providing disclosure applicable to
the unaudited pro forma combined condensed financial
information for the Company and Long Island Lighting Company
at September 30, 1997 and for the 12 months ended September
30, 1997. The unaudited pro forma combined condensed
financial information reflects the condensed consolidated
financial information of the Company as reported in its Annual
Report on Form 10-K for its fiscal year ended September 30,
1997 and of Long Island Lighting Company as reported in its
Quarterly Report on Form 10-Q for its period ended September
30, 1997.
24
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
behalf of the undersigned thereunto duly authorized.
KEYSPAN ENERGY CORPORATION
(Registrant)
Date February 13, 1998 s/ V.D. Enright
------------------------
V.D. Enright
Senior Vice President,
Chief Financial Officer
and Chief Accounting
Officer
25