UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
[ ] TRANSITION REPORT PURSUANT
TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period from ___ to ___
Commission file number 1-14161
KEYSPAN CORPORATION
(Exact name of Registrant as specified in its Charter)
New York 11-3431358
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
One MetroTech Center, Brooklyn, New York 11201
175 East Old Country Road, Hicksville, New York 11801
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(Address of principal executive offices) (Zip Code)
(718) 403-1000 (Brooklyn)
(631) 755-6650 (Hicksville)
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.[X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).[X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock Outstanding at October 12, 2005
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$.01 par value 174,361,293
KEYSPAN CORPORATION AND SUBSIDIARIES
INDEX
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Part I. FINANCIAL INFORMATION Page No.
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Item 1. Financial Statements
Consolidated Balance Sheet (Unaudited) -
September 30, 2005 and December 31, 2004 3
Consolidated Statement of Income (Unaudited) -
Three and Nine Months Ended September 30, 2005 and 2004 5
Consolidated Statement of Cash Flows (Unaudited) -
Nine Months Ended September 30, 2005 and 2004 6
Notes to Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 38
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 74
Item 4. Controls and Procedures 77
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 77
Item 5. Other Information 77
Item 6. Exhibits and Reports on Form 8-K 79
Signatures 81
2
CONSOLIDATED BALANCE SHEET
(Unaudited)
- ---------------------------------------------------------------------------------------------------------
(In Millions of Dollars) September 30, 2005 December 31, 2004
- ---------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 84.0 $ 922.0
Restricted cash, margin accounts 256.2 -
Accounts receivable 931.8 788.5
Unbilled revenue 223.0 590.8
Allowance for uncollectible accounts (62.0) (67.8)
Gas in storage, at average cost 756.6 515.5
Material and supplies, at average cost 127.6 123.4
Derivative contracts 483.5 8.3
Other 152.7 162.7
Assets of discontinued operations - 42.9
--------------------------------------------------
2,953.4 3,086.3
--------------------------------------------------
Investments and Other 243.0 272.9
Property
Gas 7,133.2 6,871.2
Electric 2,477.1 2,402.1
Other 416.1 398.6
Accumulated depreciation (2,874.2) (2,702.3)
Gas exploration and production, at cost 183.5 187.1
Accumulated depletion (107.9) (97.5)
Property of discontinued operations - 8.7
--------------------------------------------------
7,227.8 7,067.9
--------------------------------------------------
Deferred Charges
Regulatory assets
Miscellaneous assets 483.8 535.3
Derivative contracts - 20.1
Goodwill and other intangible assets 1,666.4 1,677.6
Derivative contracts 70.7 21.7
Other 669.2 681.2
--------------------------------------------------
2,890.1 2,935.9
--------------------------------------------------
Total Assets $ 13,314.3 $ 13,363.0
==================================================
- ---------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEET
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars) September 30, 2005 December 31, 2004
- ------------------------------------------------------------------------------------------------------------------
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable and other liabilities $ 756.3 $ 905.5
Commercial paper 320.0 912.2
Current redemption of long-term debt 1.5 16.1
Current redemption of preferred stock - 55.3
Taxes accrued 85.1 161.6
Dividends payable 79.3 74.1
Customer deposits 40.5 43.3
Interest accrued 73.4 48.8
Other current liability, margin accounts 256.7 -
Other current liability, derivative contracts 96.1 6.2
Liabilities of discontinued operations - 64.2
-------------------------- ------------------------
1,708.9 2,287.3
-------------------------- ------------------------
Deferred Credits and Other Liabilities
Regulatory liabilities:
Miscellaneous liabilities 41.9 65.2
Removal cost recovered 531.3 496.5
Derivative contracts 544.2 8.7
Deferred income tax 1,130.3 1,124.1
Postretirement benefits and other reserves 927.3 900.4
Derivative contracts 14.6 37.8
Other 98.5 96.2
-------------------------- ------------------------
3,288.1 2,728.9
-------------------------- ------------------------
Commitments and Contingencies (See Note 6) - -
Capitalization
Common stock 3,976.0 3,502.0
Retained earnings 833.2 792.2
Other comprehensive income (117.5) (54.3)
Treasury stock (304.1) (345.1)
-------------------------- ------------------------
Total common shareholders' equity 4,387.6 3,894.8
Preferred stock - 19.7
Long-term debt and capital leases 3,914.5 4,418.7
-------------------------- ------------------------
Total Capitalization 8,302.1 8,333.2
-------------------------- ------------------------
Minority Interest in Subsidiary Companies 15.2 13.6
-------------------------- ------------------------
Total Liabilities and Capitalization $ 13,314.3 $ 13,363.0
========================== ========================
- ------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
4
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
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Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004 2005 2004
- --------------------------------------------------------------------------------------- ------------------------------------------
Revenues
Gas Distribution $ 629.6 $ 419.2 $ 3,476.1 $ 3,023.4
Electric Services 619.9 503.9 1,488.9 1,296.8
Energy Services 45.4 43.7 134.1 129.7
Houston Exploration - - - 268.1
Energy Investments 8.2 8.8 27.0 46.0
----------------- ----------------- ------------------- --------------------
Total Revenues 1,303.1 975.5 5,126.1 4,763.9
----------------- ----------------- ------------------- --------------------
Operating Expenses
Purchased gas for resale 395.7 186.6 2,206.1 1,776.3
Fuel and purchased power 254.6 176.0 546.9 408.0
Operations and maintenance 364.3 344.8 1,143.3 1,143.1
Depreciation, depletion and amortization 92.1 107.2 295.8 467.4
Operating taxes 97.1 89.5 303.0 302.1
----------------- ----------------- ------------------- --------------------
Total Operating Expenses 1,203.8 904.1 4,495.1 4,096.9
Income from equity investments 2.5 16.2 12.5 30.3
Sale of assets 1.0 - 1.2 -
----------------- ----------------- ------------------- --------------------
Operating Income 102.8 87.6 644.7 697.4
----------------- ----------------- ------------------- --------------------
Other Income and (Deductions)
Interest charges (67.4) (88.3) (200.1) (260.8)
Gain on sale of investments - - 4.1 172.9
Cost of debt redemption - (45.9) (20.9) (45.9)
Minority interest (0.2) - (0.3) (37.0)
Other (3.6) 4.1 9.7 25.9
----------------- ----------------- ------------------- --------------------
Total Other Income and (Deductions) (71.2) (130.1) (207.5) (144.9)
----------------- ----------------- ------------------- --------------------
Income Taxes
Current (25.8) (171.8) 119.0 (7.6)
Deferred 34.8 158.1 41.0 210.8
----------------- ----------------- ------------------- --------------------
Total Income Taxes 9.0 (13.7) 160.0 203.2
----------------- ----------------- ------------------- --------------------
Earnings (loss) from continuing operations 22.6 (28.8) 277.2 349.3
Discontinued Operations
Loss from discontinued operations, net of tax - (87.0) (4.1) (86.6)
Gain on disposal, net of tax - - 2.3 -
----------------- ----------------- ------------------- --------------------
Loss from discontinued operations - (87.0) (1.8) (86.6)
----------------- ----------------- ------------------- --------------------
Net Income (Loss) 22.6 (115.8) 275.4 262.7
Preferred stock dividend requirements - 1.3 2.2 4.3
----------------- ----------------- ------------------- --------------------
Earnings (Loss) for Common Stock $ 22.6 $ (117.1) $ 273.2 $ 258.4
================= ================= =================== ====================
Basic Earnings (Loss) Per Share:
Continuing Operations,
less preferred stock dividends $ 0.13 $ (0.19) $ 1.63 $ 2.15
Discontinued Operations - (0.54) (0.01) (0.54)
----------------- ----------------- ------------------- --------------------
Basic Earnings Per Share $ 0.13 $ (0.73) $ 1.62 $ 1.61
================= ================= =================== ====================
Diluted Earnings (Loss) Per Share
Continuing Operations,
less preferred stock dividends $ 0.13 $ (0.19) $ 1.62 $ 2.14
Discontinued Operations - (0.54) (0.01) (0.54)
----------------- ----------------- ------------------- --------------------
Diluted Earnings Per Share $ 0.13 $ (0.73) $ 1.61 $ 1.60
================= ================= =================== ====================
Average Common Shares Outstanding (000) 174,332 160,357 168,465 160,139
Average Common Shares Outstanding - Diluted (000) 175,238 161,346 169,403 161,091
- ----------------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
5
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004
- ---------------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 275.4 $ 262.7
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Depreciation, depletion and amortization 295.8 467.4
Deferred income tax 41.0 62.2
Income from equity investments (12.5) (30.3)
Dividends from equity investments 5.3 4.0
Amortization of deferred fiancing costs and hedging settlements (2.5) (12.5)
Gain on sale of investments and property (5.3) (172.9)
Minority interest 0.3 37.0
Hedging losses 4.8 0.6
Allowance for funds used during construction (4.1) (2.7)
Goodwill impairment charge - 14.4
Loss from discontinued operations 1.8 86.6
Amortization of property tax prepayments 197.6 174.6
Changes in assets and liabilities
Accounts receivable 294.3 277.2
Materials and supplies, fuel oil and gas in storage (245.2) (79.6)
Accounts payable and other liabilities (165.2) (244.4)
Captive insurance - 43.2
Insurance recovery 21.1 -
Property tax prepayment (193.9) (148.6)
Other (36.6) 36.4
------------------ ----------------
Net Cash Provided by Operating Activities 472.1 775.3
------------------ ----------------
Investing Activities
Construction expenditures (372.1) (559.3)
Cost of removal (10.8) (21.2)
Derivative margin calls (63.3) -
Net proceeds from sale of property and investments 46.9 525.2
------------------ ----------------
Net Cash (Used in) Investing Activities (399.3) (55.3)
------------------ ----------------
Financing Activities
Treasury stock issued 41.0 24.3
MEDs equity conversion 460.0 -
Issuance of long-term debt - 49.3
Payment of long-term debt and preferred stock (590.1) (928.5)
Issuance (Payment) of commercial paper (592.2) 93.5
Gain on settlement of treasury lock - 12.7
Net proceeds from sale/leaseback transaction - 383.7
Common and preferred stock dividends paid (229.1) (218.4)
Other 14.0 17.1
------------------ ----------------
Net Cash Used in Financing Activities (896.4) (566.3)
------------------ ----------------
Net Increase (Decrease) in Cash and Cash Equivalents (823.6) 153.7
Cash Flow from Discontinued Operations - Operating Activities (15.1) 2.9
Cash Flow from Discontinued Operations - Investing Activities 0.5 1.2
Cash Flow from Discontinued Operations - Financing Activities 0.2 0.2
Cash and Cash Equivalents at Beginning of Period 922.0 203.3
------------------ ----------------
Cash and Cash Equivalents at End of Period $ 84.0 $ 361.3
================== ================
- ---------------------------------------------------------------------------------------------------------------
Cash equivalents are short-term marketable securities purchased with maturities
of three months or less that were carried at cost which approximates fair value.
See accompanying Notes to the Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
KeySpan Corporation (referred to in the Notes to the Financial Statements as
"KeySpan," "we," "us" and "our") is currently a registered holding company under
the Public Utility Holding Company Act of 1935, as amended ("PUHCA"). KeySpan
operates six regulated utilities that distribute natural gas to approximately
2.6 million customers in New York City, Long Island, Massachusetts and New
Hampshire, making KeySpan the fifth largest gas distribution company in the
United States and the largest in the Northeast. We also own, lease and operate
electric generating plants in Nassau and Suffolk Counties on Long Island and in
Queens County in New York City and are the largest electric generation operator
in New York State. Under contractual arrangements, we provide power, electric
transmission and distribution services, billing and other customer services for
approximately 1.1 million electric customers of the Long Island Power Authority
("LIPA"). KeySpan's other operating subsidiaries are primarily involved in gas
exploration and production; underground gas storage; liquefied natural gas
storage; retail electric marketing; large energy-system ownership, installation
and management; service and maintenance of energy systems; and engineering and
consulting services. We also invest and participate in the development of
natural gas pipelines, electric generation and other energy-related projects.
(See Note 2 "Business Segments" for additional information on each operating
segment.)
1. BASIS OF PRESENTATION
In our opinion, the accompanying unaudited Consolidated Financial Statements
contain all adjustments necessary to present fairly KeySpan's financial position
as of September 30, 2005, and the results of operations for the three and nine
months ended September 30, 2005 and September 30, 2004, as well as cash flows
for the nine months ended September 30, 2005 and September 30, 2004. The
accompanying financial statements should be read in conjunction with the
consolidated financial statements and notes included in KeySpan's Annual Report
on Form 10-K for the year ended December 31, 2004. The December 31, 2004
financial statement information has been derived from the 2004 audited financial
statements. Certain reclassifications were made to conform prior period
financial statements to the current period financial statement presentation.
Consolidated earnings are seasonal in nature primarily due to the significant
contributions to earnings of the gas distribution operations. As a result, we
expect to earn most of our annual earnings in the first and fourth quarters.
Income from interim periods may not be indicative of future results.
Basic earnings per share ("EPS") is calculated by dividing earnings available
for common stock by the weighted average number of shares of common stock
outstanding during the period. No dilution for any potentially anti-dilutive
securities is included. Diluted EPS assumes the conversion of all potentially
dilutive securities and is calculated by dividing earnings available for common
stock, as adjusted, by the sum of the weighted average number of shares of
common stock outstanding plus all potentially dilutive securities.
7
We have approximately 3.1 million common stock options outstanding at September
30, 2005, that were not included in the calculation of diluted EPS since the
exercise price associated with these options was greater than the average market
price of our common stock.
Under the requirements of Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share" our basic and diluted EPS are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) for common stock - adjusted $ 22.6 $ (117.1) $ 273.2 $ 258.4
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (000) 174,332 160,357 168,465 160,139
Add dilutive securities:
Options 906 989 938 952
- ------------------------------------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution 175,238 161,346 169,403 161,091
- ------------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per share $ 0.13 $ (0.73) $ 1.62 $ 1.61
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share $ 0.13 $ (0.73) $ 1.61 $ 1.60
- ------------------------------------------------------------------------------------------------------------------------------------
2. BUSINESS SEGMENTS
We have four reportable segments: Gas Distribution, Electric Services, Energy
Services and Energy Investments.
The Gas Distribution segment consists of six gas distribution subsidiaries.
KeySpan Energy Delivery New York ("KEDNY") provides gas distribution services to
customers in the New York City Boroughs of Brooklyn, Queens and Staten Island.
KeySpan Energy Delivery Long Island ("KEDLI") provides gas distribution services
to customers in the Long Island Counties of Nassau and Suffolk and the Rockaway
Peninsula of Queens County. The remaining gas distribution subsidiaries, Boston
Gas Company, Colonial Gas Company, Essex Gas Company and EnergyNorth Natural
Gas, Inc., collectively referred to as KeySpan Energy Delivery New England
("KEDNE"), provide gas distribution service to customers in Massachusetts and
New Hampshire.
The Electric Services segment consists of subsidiaries that: operate the
electric transmission and distribution system owned by LIPA; own and provide
capacity to and produce energy for LIPA from our generating facilities located
on Long Island; and manage fuel supplies for LIPA to fuel our Long Island
generating facilities. These services are provided in accordance with long-term
service contracts having remaining terms that range from one to seven years and
power purchase agreements with remaining terms that range from seven to
twenty-one years. The Electric Services segment also includes subsidiaries that
own, lease and operate the 2,200 megawatt ("MW") Ravenswood electric generation
facility ("Ravenswood Facility"), located in Queens, New York, as well as a 250
MW combined cycle electric generating facility located at the Ravenswood site
("Ravenswood Expansion"). Collectively, the Ravenswood Facility and Ravenswood
Expansion are referred to as the "Ravenswood Generating Station." The majority
of the energy, capacity and ancillary services related to the Ravenswood
Generating Station are sold to the New York Independent System Operator
("NYISO") energy markets. The Electric Services segment also provides retail
marketing of electricity to commercial customers.
8
The Energy Services segment includes companies that provide primarily
energy-related services to customers located primarily within the Northeastern
United States, with concentrations in the New York City and Boston metropolitan
areas through the following lines of business: (i) Home Energy Services, which
provides residential and small commercial customers with service and maintenance
of energy systems and appliances; and (ii) Business Solutions, which provides
operation and maintenance, design, engineering, consulting and fiber optic
services to commercial, institutional and industrial customers.
In January and February of 2005, KeySpan sold its mechanical contracting
subsidiaries. The operating results and financial position of these companies,
which were previously consolidated within the Energy Services segment, have been
reflected as discontinued operations on the Consolidated Statement of Income,
Consolidated Balance Sheet and Consolidated Statement of Cash Flows.
In regard to the January 2005 transactions, KeySpan received proceeds of
approximately $16 million, including approximately $5 million to be paid within
a three year period. In addition, KeySpan retained a portion of its previously
incurred surety indemnity support obligations related to certain performance and
payment bonds issued for the benefit of KeySpan's former subsidiaries prior to
closing. In June 2005, the balance to be paid over a three year period was fully
collected on a present value basis and a significant portion of the performance
bonds were replaced without any remaining indemnification obligation on the part
of KeySpan. The current estimated cost to complete projects supported by the
remaining indemnity obligations associated with the January 2005 transactions is
approximately $1.0 million. The buyers have agreed to complete the projects for
which such indemnity obligations were incurred and to indemnify and hold KeySpan
harmless with respect to its liabilities in connection with such bonds.
In connection with the February 2005 transaction, KeySpan paid or contributed
approximately $26 million to a former subsidiary prior to closing the sale
transaction in exchange for, among other things, the disposition of outstanding
shares in the former subsidiary and the settlement of intercompany advances and
replacement of a performance and payment bond issued for the benefit of its
former subsidiary with respect to a pending project, which bond had been
supported by a $150 million indemnity obligation of KeySpan. In addition,
KeySpan received from its former subsidiary an indemnity bond issued by a third
party surety company, the purpose of which is to reimburse KeySpan in an amount
up to $80 million in the event it is required to perform under all other
indemnity obligations previously incurred by KeySpan to support the remaining
bonded projects of its former subsidiary as of the closing. As of September 30,
2005, the total cost to complete such remaining bonded projects is estimated to
be approximately $50 million. The aforementioned guarantees are reflected in
Note 6 "Financial Guarantees and Contingencies." KeySpan's former subsidiary has
also agreed to complete the projects for which such indemnity obligations were
incurred and indemnify and hold KeySpan harmless with respect to any liabilities
in connection with such bonds.
9
In the fourth quarter of 2004, KeySpan's investment in its mechanical
contracting subsidiaries was written-down to an estimated fair value. During the
first six months of 2005, operating losses were incurred through the dates of
sale of these companies of $4.1 million after-tax, including but not limited to
costs incurred for employee related benefits. Partially offsetting these losses
was a gain of $2.3 million associated with the related divestitures, reflecting
the difference between the fair value estimates and the financial impact of the
actual sale transactions. The net income impact of the operating losses and the
disposal gain was a loss of $1.8 million, or $0.01 per share for the nine months
ended September 30, 2005.
The Energy Investments segment consists of our gas exploration and production
investments, as well as certain other domestic energy-related investments.
KeySpan's gas exploration and production activities include our wholly-owned
subsidiaries Seneca Upshur Petroleum, Inc. ("Seneca-Upshur") and KeySpan
Exploration and Production, LLC ("KeySpan Exploration"). Seneca-Upshur is
engaged in gas exploration and production activities primarily in West Virginia.
KeySpan Exploration is engaged in a joint venture with The Houston Exploration
Company ("Houston Exploration"), an independent natural gas and oil exploration
company located in Houston, Texas.
During the first five months of 2004, our gas exploration and production
investments also included a 55% equity interest in Houston Exploration, the
operations of which were fully consolidated in KeySpan's Consolidated Financial
Statements. On June 2, 2004, KeySpan exchanged 10.8 million shares of common
stock of Houston Exploration for 100% of the stock of Seneca-Upshur, previously
a wholly owned subsidiary of Houston Exploration. This transaction reduced our
interest in Houston Exploration from 55% to the then current level of 23.5%.
Effective June 1, 2004, Houston Exploration's earnings and our ownership
interest in Houston Exploration were accounted for on the equity method of
accounting. This transaction resulted in a gain to KeySpan of $150.1 million.
The deconsolidation of Houston Exploration required the recognition of certain
deferred taxes on our remaining investment resulting in a net deferred tax
expense of $44.1 million. Therefore, the net gain on the share exchange less the
deferred tax provision was $106 million, or $0.66 per share. In the fourth
quarter of 2004 KeySpan sold its remaining interests in Houston Exploration.
This segment is also engaged in pipeline development activities. KeySpan and
Duke Energy Corporation each own a 50% interest in the Islander East Pipeline
Company, LLC ("Islander East"). Islander East was created to pursue the
authorization and construction of an interstate pipeline from Connecticut,
across Long Island Sound, to a terminus near Shoreham, Long Island. Once in
service, the pipeline is expected to transport up to 260,000 DTH daily to the
Long Island and New York City energy markets. Further, KeySpan has a 21%
interest in the Millennium Pipeline project which is expected to transport up to
525,000 DTH of natural gas a day from Corning to Ramapo, New York, where it will
connect to an existing pipeline. Additionally, subsidiaries in this segment hold
a 20% equity interest in the Iroquois Gas Transmission System LP, a pipeline
that transports Canadian gas supply to markets in the Northeastern United
States. These subsidiaries are accounted for under the equity method.
Accordingly, equity income from these investments is reflected as a component of
operating income in the Consolidated Statement of Income.
10
Through its wholly owned subsidiary, KeySpan LNG, LP, KeySpan owns a liquefied
natural gas storage and receiving facility in Providence, Rhode Island, the
operations of which are fully consolidated.
During the first quarter of 2004, we also had an approximate 61% investment in
certain midstream natural gas assets in Western Canada through KeySpan Energy
Canada Partnership ("KeySpan Canada"). These assets included 14 processing
plants and associated gathering systems that produced approximately 1.5 BCFe of
natural gas daily and provided associated natural gas liquids fractionation.
These operations were fully consolidated in KeySpan's Consolidated Financial
Statements. On April 1, 2004, KeySpan and KeySpan Facilities Income Fund (the
"Fund"), which previously owned a 39.09% interest in KeySpan Canada, consummated
a transaction whereby the Fund sold 15.617 million units of the Fund and
acquired an additional 35.91% interest in KeySpan Canada from KeySpan. As a
result of this transaction, KeySpan's ownership of KeySpan Canada decreased to
25%. KeySpan recorded a gain of $22.8 million ($10.1 million after-tax, or $0.06
per share) at the time of this transaction. Effective April 1, 2004 KeySpan
Canada's earnings and our ownership interest in KeySpan Canada were accounted
for on the equity method of accounting. In the fourth quarter of 2004, KeySpan
sold its remaining interests in KeySpan Canada.
In the first quarter of 2005, KeySpan sold its 50% interest in Premier
Transmission Limited ("PTL"), a gas pipeline from southwest Scotland to Northern
Ireland. On February 25, 2005, KeySpan entered into a Share Sale and Purchase
Agreement with BG Energy Holdings Limited and Premier Transmission Financing
Public Limited Company ("PTFPL"), pursuant to which all of the outstanding
shares of PTL were to be purchased by PTFPL. On March 18, 2005, the sale was
completed and generated cash proceeds of approximately $48.1 million. In the
fourth quarter of 2004, KeySpan recorded a pre-tax non-cash impairment charge of
$26.5 million reflecting the difference between the anticipated cash proceeds
from the sale of PTL compared to its carrying value. The final sale of PTL
resulted in a pre-tax gain of $4.1 million reflecting the difference from
earlier estimates; this gain was recorded in the first quarter of 2005.
The accounting policies of the segments are the same as those used for the
preparation of the Consolidated Financial Statements. The segments are strategic
business units that are managed separately because of their different operating
and regulatory environments. Operating results of our segments are evaluated by
management on an operating income basis. At September 30, 2005, the total assets
of each reportable segment have not changed materially from those levels
reported at December 31, 2004. As mentioned, the mechanical contracting
subsidiaries included in the Energy Services segment are reported as
discontinued operations for all periods. The reportable segment information is
as follows:
11
- ------------------------------------------------------------------------------------------------------------------------------------
Energy Investments
--------------------------
Gas Electric Energy Houston Other Elimi- Consoli-
(In Millions of Dollars) Distribution Service Services Exploration Investments nations dated
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2005
Unaffiliated revenue 629.6 619.9 45.4 - 8.2 - 1,303.1
Intersegment revenue - - 1.7 - 3.7 (5.4) -
Operating Income (loss) (45.5) 149.6 (1.1) - 4.7 (4.9) 102.8
Three Months Ended September 30, 2004
Unaffiliated revenue 419.2 503.9 43.7 - 8.8 - 975.5
Intersegment revenue - - 2.9 - 1.3 (4.2) -
Operating Income (loss) (23.6) 111.2 (19.3) 9.8 6.6 2.9 87.6
- ------------------------------------------------------------------------------------------------------------------------------------
Eliminating items include the elimination of certain intercompany accounts, as
well as activities of our corporate and administrative areas.
Because of the nature of our Electric Services business, electric revenues are
derived from two large customers - the NYISO and LIPA. Electric Services
revenues from these customers of $612.2 million and $473.9 million for the three
months ended September 30, 2005 and 2004, respectively, represent approximately
47% and 49%, respectively, of our consolidated revenues for the respective
periods.
- ------------------------------------------------------------------------------------------------------------------------------------
Energy Investments
-------------------------
Gas Electric Energy Houston Other Elimi- Consoli-
(In Millions of Dollars) Distribution Services Services Exploration Investments nations dated
- ------------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2005
Unaffiliated revenue 3,476.1 1,488.9 134.1 - 27.0 - 5,126.1
Intersegment revenue - 4.6 7.9 - 3.7 (16.2) -
Operating Income (loss) 376.8 266.3 (6.7) - 16.6 (8.3) 644.7
Nine Months Ended September 30, 2004
Unaffiliated revenue 3,023.4 1,296.8 129.7 268.1 46.0 - 4,763.9
Intersegment revenue - - 8.3 - 3.8 (12.1) -
Operating Income (loss) 391.1 226.3 (42.8) 130.8 (22.5) 14.5 697.4
- ------------------------------------------------------------------------------------------------------------------------------------
Eliminating items include the elimination of certain intercompany accounts, as
well as activities of our corporate and administrative areas.
Because of the nature of our Electric Services business, electric revenues are
derived from two large customers - the NYISO and LIPA. Electric Services
revenues from these customers of $1.4 billion and $1.2 billion for the nine
months ended September 30, 2005 and 2004, respectively, represent approximately
28% and 26%, respectively of our consolidated revenues for the respective
periods.
12
3. COMPREHENSIVE INCOME
The table below indicates the components of comprehensive income:
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 22.6 $ (115.8) $ 275.4 $ 262.7
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Settlement of derivative instruments 10.7 (13.9) 18.4 2.6
Deconsolidation of certain subsidiaries - - - (6.7)
Foreign currency translation adjustments - 0.6 (5.0) (16.5)
Unrealized gains (losses) on marketable securities 2.9 (1.3) 1.4 (0.7)
Settlement of derivative premiums - - - 3.4
Unrealized losses on derivative financial instruments (59.8) 12.4 (78.0) 11.3
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Other comprehensive loss, net of tax (46.2) (2.2) (63.2) (6.6)
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income (Loss) $ (23.6) $ (118.0) $ 212.2 $ 256.1
- -----------------------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Settlement of derivative instruments 5.8 (8.6) 9.9 0.3
Deconsolidation of certain subsidiaries - - 5.0
Foreign currency translation adjustments - 0.3 (2.7) (8.9)
Unrealized gains (losses) on marketable securities 1.6 (1.0) 0.8 (0.7)
Settlement of derivative premiums - - - 1.9
Unrealized losses on derivative financial instruments (33.6) 8.1 (44.3) 7.5
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Total Tax (Benefit) Expense $ (26.2) $ (1.2) $ (36.3) $ 5.1
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4. HEDGING AND DERIVATIVE FINANCIAL INSTRUMENTS
Financially-Settled Commodity Derivative Instruments - Hedging Activities: From
time to time, KeySpan subsidiaries have utilized derivative financial
instruments, such as futures, options and swaps, for the purpose of hedging the
cash flow variability associated with changes in commodity prices. KeySpan is
exposed to commodity price risk primarily with regard to its gas distribution
operations, gas exploration and production activities and its electric
generating facilities at the Ravenswood site.
Derivative financial instruments are employed by our gas distribution operations
to reduce the cash flow variability associated with the purchase price for a
portion of future natural gas purchases for our regulated firm gas sales
customers. The accounting for these derivative instruments is subject to
Statement of Financial Accounting Standards ("SFAS") 71 "Accounting for the
Effects of Certain Types of Regulation." See the caption below "Firm Gas Sales
Derivative Instruments - Regulated Utilities" for a further discussion of these
derivatives. Certain derivative instruments employed by our gas distribution
operations, however, are not subject to SFAS 71. Utility tariffs applicable to
certain large-volume customers permit gas to be sold at prices established
monthly, relative to a prevailing alternate fuel price, but limited to the cost
of gas plus the rate for the highest consumption block otherwise applicable to
our firm commercial customers. KEDNY uses over-the-counter ("OTC") natural gas
swaps, with offsetting positions in OTC fuel oil swaps of equivalent energy
value, to hedge the cash-flow variability of specified portions of gas purchases
and sales associated with these customers. The maximum length of time over which
13
we have hedged cash flow variability associated with forecasted purchases and
sales of natural gas is through December 2005. We use standard New York
Mercantile Exchange ("NYMEX") futures prices to value the gas and heating oil
positions. At September 30, 2005, the fair value of gas swap contracts was $14.9
million; the fair value of the oil swap contracts was a liability of $12.4
million. The estimated amount of net gains associated with such derivative
instruments that are reported in other comprehensive income and that are
expected to be reclassified into earnings over the next twelve months is $3.3
million, or $2.1 million after-tax. The ineffective portion of these derivatives
for the nine months ended September 30, 2005 was $0.8 million and has been
recorded as an expense in the Consolidated Statement of Income.
Seneca-Upshur utilizes OTC natural gas swaps to hedge the cash flow variability
associated with forecasted sales of a portion of its natural gas production. At
September 30, 2005, Seneca-Upshur has hedge positions in place for approximately
85% of its estimated 2005 through 2008 gas production, net of gathering costs.
We use market quoted forward prices to value these swap positions. The maximum
length of time over which Seneca-Upshur has hedged such cash flow variability is
through December 2008. The fair value of these derivative instruments at
September 30, 2005 was a liability of $25.7 million. The estimated amount of
losses associated with such derivative instruments that are reported in other
comprehensive income and that are expected to be reclassified into earnings over
the next twelve months is $12.6 million, or $8.2 million after-tax.
The Ravenswood Generating Station uses derivative financial instruments to hedge
the cash flow variability associated with the purchase of natural gas and oil
that will be consumed during the generation of electricity. The Ravenswood
Generating Station also hedges the cash flow variability associated with a
portion of electric energy sales.
With respect to price exposure associated with fuel purchases for the Ravenswood
Generating Station, KeySpan employs the use of financially-settled oil swap
contracts to hedge the cash flow variability for a portion of forecasted
purchases of fuel oil that will be consumed by the Ravenswood Generating
Station. At times, KeySpan also employs natural gas futures contracts to hedge
the cash flow variability for a portion of forecasted purchases of natural gas;
although at September 30, 2005 there no outstanding derivatives associated with
natural gas. We use market quoted forward prices to value oil swap contracts.
The maximum length of time over which we have hedged cash flow variability
associated with forecasted purchases of fuel oil is through April 2006. The fair
value of these derivative instruments at September 30, 2005 was $0.9 million all
of which is reported in other comprehensive income and are expected to be
reclassified into earnings over the next twelve months.
We have also engaged in the use of cash-settled swap instruments to hedge the
cash flow variability associated with a portion of forecasted electric energy
sales from the Ravenswood Generating Station. Our hedging strategy is to hedge
at least 50% of forecasted on-peak summer season electric energy sales and a
portion of forecasted electric energy sales for the remainder of the year. The
maximum length of time over which we have hedged cash flow variability is
through August 2006. We use market quoted forward prices to value these
outstanding derivatives. The fair value of these derivative instruments at
September 30, 2005 was a liability of $71.1 million all of which is expected to
be reclassified into earnings over the next twelve months. The after-tax impact
is anticipated to be $46.2 million.
14
The above noted derivative financial instruments are cash flow hedges that
qualify for hedge accounting under SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS 149 "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," collectively
SFAS 133, and are not considered held for trading purposes as defined by current
accounting literature. Accordingly, we carry the fair value of our derivative
instruments on the Consolidated Balance Sheet as either a current or deferred
asset or liability, as appropriate, and defer the effective portion of
unrealized gains or losses in accumulated other comprehensive income. Gains and
losses are reclassified from accumulated other comprehensive income to the
Consolidated Statement of Income in the period the hedged transaction affects
earnings. Gains and losses are reflected as a component of either revenue or
fuel and purchased power depending on the hedged transaction. As noted, hedge
ineffectiveness was an expense of $0.8 million for the nine months ended
September 30, 2005, and resulted from changes during the period in the price
differentials between the index price of the derivative contract and the price
of the purchase or sale for the cash flow that is being hedged, and was recorded
directly to earnings.
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative
financial instruments to reduce the cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations. Our strategy is to minimize fluctuations in firm
gas sales prices to our regulated firm gas sales customers in our New York and
New England service territories. The accounting for these derivative instruments
is subject to SFAS 71. Therefore, changes in the fair value of these derivatives
have been recorded as a regulatory asset or regulatory liability on the
Consolidated Balance Sheet. Gains or losses on the settlement of these contracts
are initially deferred and then refunded to or collected from our firm gas sales
customers consistent with regulatory requirements. At September 30, 2005, these
derivative instruments had a fair value of $501.1 million and are reflected as a
current asset of $467.8 million and a deferred asset of $33.3 million, with an
offsetting regulatory liability of $501.1 million on the Consolidated Balance
Sheet.
Physically-Settled Commodity Derivative Instruments: SFAS 133 establishes
criteria that must be satisfied in order for option contracts, forward contracts
with optionality features, or contracts that combine a forward contract and a
purchase option contract to be exempted as normal purchases and sales. Certain
contracts for the physical purchase of natural gas associated with our regulated
gas utilities are not exempt as normal purchases from the requirements of SFAS
133. Since these contracts are for the purchase of natural gas sold to regulated
firm gas sales customers, the accounting for these contracts is subject to SFAS
71. Therefore, changes in the market value of these contracts have been recorded
as a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
At September 30, 2005, these derivatives had a fair value of $37.4 million and
are reflected as a deferred assets and regulatory liability on the Consolidated
Balance Sheet.
15
Financially-Settled Commodity Derivative Instruments that Do Not Qualify for
Hedge Accounting: KeySpan subsidiaries also have employed a limited number of
financial derivatives that do not qualify for hedge accounting treatment under
SFAS 133. In 2004, we purchased a series of call options on the spread between
the price of heating oil and the price of natural gas. The options cover the
period February 2005 through December 2005 and further complement our hedging
strategy noted above regarding sales to certain large-volume customers. As
stated, we sell gas to certain large-volume customers at prices established
monthly relative to a prevailing alternate fuel price; however, the cost of gas
plus the rate for the highest consumption block otherwise applicable to our firm
commercial customers (under our applicable New York City and Long Island utility
tariffs) is an upper limit on the price KeySpan can charge for the sale of
natural gas to these customers. These options are intended to limit KeySpan's
exposure to heating oil price spikes. These options do not qualify for hedge
accounting treatment under SFAS 133. We recorded a $1.1 million benefit in other
income and deductions on the Consolidated Statement of Income to reflect the
change in the market value associated with this derivative instrument for the
nine months ended September 30, 2005. In addition, the Ravenswood Generating
Station sold a three year option for 30-day peaking gas service. The 30-day
peaking gas service is for the following three winter seasons: October 2004 -
March 2005, October 2005 - March 2006 and October 2006 - March 2007. For each of
the winter seasons just mentioned, the counterparty can call on the Ravenswood
Generating Station to supply no more than 30,000 Mdth of a gas a day for no more
than 30 days. We recorded a $5.1 million loss in other income and deductions on
the Consolidated Statement of Income to reflect the change in the market value
associated with this derivative instrument for the nine months ended September
30, 2005.
The table below summarizes the fair value of the above outstanding derivative
instruments at September 30, 2005 and December 31, 2004, and the related line
item on the Consolidated Balance Sheet. Fair value is the amount at which
derivative instruments could be exchanged in a current transaction between
willing parties, other than in a forced liquidation sale.
- -----------------------------------------------------------------------------
(In Millions of Dollars) September 30, 2005 December 31, 2004
- -----------------------------------------------------------------------------
Gas Contracts:
Current assets $ 482.6 $ 7.7
Other deferred assets 70.7 21.7
Regulatory asset - 20.1
Current liabilities (12.6) -
Regulatory liabilities (544.2) (8.7)
Other deferred liabilities (14.6) (37.8)
Oil Contracts:
Current assets 0.9 0.3
Current liabilities (12.4) (6.2)
Electric Contracts:
Current assets - 0.3
Current liabilities (71.1) -
- -----------------------------------------------------------------------------
$ (100.7) $ (2.6)
- -----------------------------------------------------------------------------
16
Interest Rate Derivative Instruments: In January 2005, KeySpan redeemed $500
million of outstanding debt - 6.15% Notes due 2006, and accelerated the
amortization of approximately $11.2 million of previously unamortized benefits
associated with an interest rate swap on these notes that was previously
settled. The accelerated amortization was recorded as a reduction to interest
expense. (See Note 9 "Long-term Debt and Commercial Paper" for additional
details regarding the debt redemption.) There were no interest rate derivative
instruments outstanding at September 30, 2005.
Weather Derivatives: The utility tariffs associated with KEDNE's operations do
not contain weather normalization adjustments. As a result, fluctuations from
normal weather may have a significant positive or negative effect on the results
of these operations.
In 2004, we purchased heating-degree day put options to mitigate the effect of
fluctuations from normal weather on KEDNE's financial position and cash flows
for the 2004/2005 winter heating season - November 2004 through March 2005.
These put options would have paid KeySpan up to $40,000 per heating degree day
when the actual temperature was below 4,130 heating degree days, or
approximately 5% warmer than normal, based on the most recent 20-year average
for normal weather. The maximum amount KeySpan would have received on these
purchased put options was $16 million. The net premium cost for these options
was $1.6 million and was amortized over the heating season. Unlike previous
years, if weather was colder than normal KeySpan would have no financial
obligation. Since weather was colder than normal during the first quarter of
2005 there was no earnings impact associated with these financial derivative
instruments other than the premium cost for purchasing the options. We account
for these derivatives pursuant to the requirements of EITF 99-2, "Accounting for
Weather Derivatives." In this regard, such instruments are accounted for using
the "intrinsic value method" as set forth in such guidance.
Derivative contracts are primarily used to manage exposure to market risk
arising from changes in commodity prices and interest rates. In the event of
non-performance by a counterparty to a derivative contract, the desired impact
may not be achieved. The risk of counterparty non-performance is generally
considered a credit risk and is actively managed by assessing each counterparty
credit profile and negotiating appropriate levels of collateral and credit
support. In instances where the counterparties' credit quality has declined, or
credit exposure exceeds certain levels, we may limit our credit exposure by
restricting new transactions with counterparties, requiring additional
collateral or credit support and negotiating the early termination of certain
agreements. At September 30, 2005, KeySpan has received $256.2 million from its
counterparties as collateral associated with outstanding derivative contracts.
This amount has been recorded as restricted cash, with an offsetting position in
current liabilities on the Consolidated Balance Sheet. Further, KeySpan has paid
$63.3 million in margin calls to its counterparties. This amount has been
recorded as an accounts receivable on the September 30, 2005 Consolidated
Balance Sheet.
We believe that our credit risk related to the above mentioned derivative
financial instruments is no greater than the risk associated with the primary
contracts which they hedge and that the elimination of a portion of the price
risk reduces volatility in our reported results of operations, financial
position and cash flows and lowers overall business risk.
17
5. RECENT ACCOUNTING PRONOUNCEMENTS
In 2004, the Financial Accounting Standards Board ("FASB") issued FASB Staff
Position ("FSP") 106-2 "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003." This
guidance clarified the accounting and disclosure requirements for employers with
postretirement benefit plans that have been affected by the passage of the
Medicare Prescription Drug Improvement and Modernization Act of 2003 (the
"Medicare Act"). The Act introduced two new features to Medicare that an
employer needs to consider in measuring its obligation and net periodic
postretirement benefit costs. KeySpan's retiree health benefit plan currently
includes a prescription drug benefit that is provided to retired employees.
KeySpan implemented the requirements of FSP 106-2 in June 2004.
In January 2005, the Department of Health and Human Services/Centers for
Medicare and Medicaid Services ("CMS") released final regulations with regard to
the implementation of the major provisions of the Medicare Act. KeySpan has
reviewed the new provisions and believes that the new guidance will not have a
material impact on its results of operations or cash flows.
In December 2004 the FASB issued SFAS 123 (revised 2004) "Share-Based Payments."
This Statement focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions. This
Statement revises certain provisions of SFAS 123 "Accounting for Stock-Based
Compensation" and supersedes APB Opinion 25 "Accounting for Stock Issued to
Employees." The fair-value-based method in this Statement is similar to the
fair-value-based method in Statement 123 in most respects. However, the
following are key differences between the two: entities are required to measure
liabilities incurred to employees in share-based payment transactions at fair
value as compared to using the intrinsic method allowed under Statement 123;
entities are required to estimate the number of instruments for which the
requisite service is expected to be rendered, as compared to accounting for
forfeitures as they occur under Statement 123; and incremental compensation cost
for a modification of the terms or conditions of an award are also measured
differently under this Statement compared to Statement 123. This Statement also
clarifies and expands Statement 123's guidance in several areas. The effective
date of this Statement is the beginning of the first fiscal year beginning after
June 15, 2005. KeySpan adopted the prospective method of transition for stock
options in accordance with SFAS 148 "Accounting for Stock-Based Compensation -
Transition and Disclosure." Accordingly, compensation expense has been
recognized by employing the fair value recognition provisions of SFAS 123 for
grants awarded after January 1, 2003. KeySpan is currently reviewing the
requirements of this Statement, and believes that implementation of this
Statement will not have a material impact on its results of operations or
financial position and no impact on its cash flows.
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47") "Accounting
for Conditional Asset Retirement Obligations - an interpretation of FASB
Statement No. 143." FIN 47 clarifies that the term conditional asset retirement
obligation as used in SFAS No. 143 "Accounting for Asset Retirement
Obligations," refers to a legal obligation to perform an asset retirement
activity in which the timing and/or method of settlement are conditional on a
18
future event that may or may not be within the control of the entity. The
obligation to perform the asset retirement activity is unconditional even though
uncertainty exists about the timing and/or method of settlement. Accordingly, an
entity is required to recognize a liability for the fair value of a conditional
asset retirement obligation if the fair value of the liability can be reasonably
estimated. Uncertainty about the timing and/or method of settlement of a
conditional asset retirement obligation should be factored into the measurement
of the liability when sufficient information exists. An entity shall recognize
the cumulative effect of initially applying FIN 47 as a change in accounting
principle. The effective date of FIN 47 is December 31, 2005 for calendar-year
enterprises.
At the present time, KeySpan's only recorded asset retirement obligation relates
to its investment in Seneca-Upshur. KeySpan is currently reviewing the
requirements of FIN 47 and at this point in time can not determine the impact,
if any, that implementation of FIN 47 will have on its results of operations or
financial position; cash flows should not be impacted by the implementation of
FIN 47. See Note 6 "Financial Guarantees and Contingencies," for details on
KeySpan's asset retirement obligation.
On July 14, 2005, the FASB issued an Exposure Draft "Accounting for Uncertain
Tax Positions," that would interpret SFAS 109, "Accounting for Income Taxes."
This proposal seeks to reduce the diversity in practice associated with certain
aspects of the recognition and measurement requirements related to accounting
for income taxes. Specifically, the proposal would require that a tax position
meet a "probable recognition threshold" for the benefit of an uncertain tax
position to be recognized in the financial statements. The proposal would
require recognition in the financial statements of the best estimate of the
effect of a tax position only if that position is probable of being sustained on
audit by the appropriate taxing authorities, based solely on the technical
merits of the position.
The original proposed effective date was to be the first fiscal year ending
after December 15, 2005. Any adjustments resulting from the implementation of
the exposure draft would be recognized as a cumulative effect of a change in
accounting principle. The FASB provided a 60-day comment period, which closed
September 12, 2005. The FASB, however, decided to delay implementation of a new
standard until the first quarter of 2006. At this time we are unable to predict
the final action to be taken by the FASB, or what impact, if any, such action
will have on KeySpan's financial condition, results of operations or cash flows.
6. FINANCIAL GUARANTEES AND CONTINGENCIES
Variable Interest Entity: KeySpan has an arrangement with an unaffiliated
variable interest financing entity through which we lease a portion of the
Ravenswood Facility. We acquired the Ravenswood Facility, in part through the
variable interest entity, from Consolidated Edison on June 18, 1999 for
approximately $597 million. In order to reduce the initial cash requirements, we
entered into a Master Lease with the variable interest entity that acquired a
portion of the facility - or three steam generating units - directly from
Consolidated Edison and leased it to our subsidiary. The variable interest
entity acquired the property for $425 million, financed with debt of $412.3
million (97% of capitalization) and equity of $12.7 million (3% of
capitalization). KeySpan has no ownership interests in the units or the variable
interest entity. KeySpan has guaranteed all payment and performance obligations
of our subsidiary under the Master Lease. Monthly lease payments substantially
equal the monthly interest expense on such debt securities.
19
The term of the Master Lease extends through June 20, 2009. On all future
semi-annual payment dates, we have the right to either: (i) purchase the
facility for the original acquisition cost of $425 million, plus the present
value of the lease payments that would otherwise have been paid through June
2009; or (ii) terminate the Master Lease and dispose of the facility. In June
2009, when the Master Lease terminates, we may purchase the facility in an
amount equal to the original acquisition cost, subject to adjustment, or
surrender the facility to the lessor. If we elect not to purchase the property,
the Ravenswood Facility will be sold by the lessor. We have guaranteed to the
lessor 84% of the residual value of the original cost of the property.
We have classified the Master Lease as $412.3 million of long-term debt on the
Consolidated Balance Sheet based on our current status as primary beneficiary.
Further, we have an asset on the Consolidated Balance Sheet for an amount
substantially equal to the fair market value of the leased assets at the
inception of the lease, less depreciation since that date, or approximately $328
million.
If our subsidiary that leases the Ravenswood Facility was not able to fulfill
its payment obligations with respect to the Master Lease payments, then the
maximum amount KeySpan would be exposed to under its current guarantees would be
$425 million plus the present value of the remaining lease payments through June
20, 2009.
Sale/leaseback Transaction: KeySpan also has a leveraged lease financing
arrangement associated with the Ravenswood Expansion. In May 2004, the unit was
acquired by a lessor from our subsidiary, KeySpan Ravenswood, LLC, and
simultaneously leased back to that subsidiary. All the obligations of KeySpan
Ravenswood, LLC under the lease, including future decommissioning costs, have
been unconditionally guaranteed by KeySpan. This lease transaction qualifies as
an operating lease under SFAS 98 "Accounting for Leases: Sale/Leaseback
Transactions Involving Real Estate; Sales-Type Leases of Real Estate; Definition
of the Lease Term; an Initial Direct Costs of Direct Financing Leases, an
amendment of FASB Statements No.13, 66, 91 and a rescission of FASB Statement
No. 26 and Technical Bulletin No. 79-11."
Asset Retirement Obligations: In 2003, KeySpan adopted SFAS 143, "Accounting for
Asset Retirement Obligations." SFAS 143 required us to record a liability and
corresponding asset representing the present value of legal obligations
associated with the retirement of tangible, long-lived assets that existed at
the inception of the obligation. KeySpan's only recorded asset retirement
obligation ("ARO") relates to its investment in Seneca-Upshur and was $1.9
million at September 30, 2005.
20
KeySpan's largest asset base is its gas transmission and distribution system. A
legal obligation exists to perform certain safety requirements at final
abandonment. In addition, a legal obligation may be construed to exist with
respect to KeySpan's liquefied natural gas ("LNG") storage tanks due to clean up
responsibilities upon cessation of use. However, mass assets such as storage,
transmission and distribution assets are believed to operate in perpetuity and,
therefore, have indeterminate cash flow estimates. Since that exposure is in
perpetuity and cannot be measured, no liability has been recorded pursuant to
SFAS 143. As discussed in Note 5 "Recent Accounting Pronouncements," the FASB
recently issued FIN 47 which clarifies certain reporting and measurement issues
for asset retirement obligations. As noted, we are currently reviewing the
requirements of FIN 47, and its potential impact, if any, on KeySpan's financial
position and results of operations.
Environmental Matters
New York Sites: Within the State of New York we have identified 43 historical
manufactured gas plant ("MGP") sites and related facilities, which were owned or
operated by KeySpan subsidiaries or such companies' predecessors. These former
sites, some of which are no longer owned by us, have been identified to the New
York State Public Service Commission ("NYPSC") and the Department of
Environmental Conservation ("DEC") for inclusion on appropriate site
inventories. Administrative Orders on Consent ("ACO") or Voluntary Cleanup
Agreements have been executed with the DEC to address the investigation and
remediation activities associated with certain sites. KeySpan submitted
applications to the DEC for each of the remaining sites in August 2004 under the
DEC's Brownfield Cleanup Program ("BCP"). As a result of a recent United States
Supreme Court decision, KeySpan withdrew its applications in the DEC's BCP
program and will resubmit applications for individual sites under various DEC
cleanup programs on a case-by-case basis.
We have identified 28 of these sites as being associated with the historical
operations of KEDNY. One site has been fully remediated. Subject to the issues
described in the preceding paragraph, the remaining 27 sites either are in the
process of being investigated and remediated or will be investigated and, if
necessary, remediated under the terms and conditions of various types of DEC
cleanup orders. Expenditures incurred to date by us with respect to KEDNY
MGP-related activities total $57.6 million.
The remaining 15 sites have been identified as being associated with the
historical operations of KEDLI. Expenditures incurred to date by us with respect
to KEDLI MGP-related activities total $48.3 million. One site has been fully
investigated and requires no further action. The remaining sites either are in
the process of being investigated and remediated or will be investigated and, if
necessary, remediated under the conditions of various types of DEC cleanup
orders.
We presently estimate the remaining cost of our KEDNY and KEDLI MGP-related
environmental remediation activities will be $191.2 million, which amount has
been accrued by us as a reasonable estimate of probable cost for known sites.
However, remediation costs for each site may be materially higher than noted,
depending upon changing technologies and regulatory standards, selected end use
for each site, and actual environmental conditions encountered.
21
With respect to remediation costs, the KEDNY and KEDLI rate plans approved by
the NYPSC generally provide for the recovery from customers of investigation and
remediation costs of certain sites. At September 30, 2005, we have reflected a
regulatory asset of $221.2 million for our KEDNY/KEDLI MGP sites. In accordance
with NYPSC policy, KeySpan records a reduction to regulatory liabilities as
costs are incurred for environmental cleanup activities. At September 30, 2005,
these previously deferred regulatory liabilities totaled $28.3 million. In
October 2003, KEDNY and KEDLI filed a joint petition with the NYPSC seeking rate
treatment for additional environmental costs that may be incurred at all of our
New York MGP sites. That petition is still pending.
During the nine months ended September 30, 2005, KEDNY and KEDLI received an
aggregate amount of $21.1 million from insurance carriers associated with MGP
related insurance settlements. These proceeds were used to offset other
regulatory items and therefore had no earnings impact.
We are also responsible for environmental obligations associated with the
Ravenswood Facility, purchased from Consolidated Edison in 1999, including
remediation activities associated with its historical operations and those of
the MGP facilities that formerly operated at the site. We are not responsible
for liabilities arising from disposal of waste at off-site locations prior to
the acquisition closing and any monetary fines arising from Consolidated
Edison's pre-closing conduct. We presently estimate the remaining environmental
clean up activities for this site will be $1.8 million, which amount has been
accrued by us. Expenditures incurred to date total $3.2 million.
New England Sites: In the Commonwealth of Massachusetts and the State of New
Hampshire, we are aware of 77 former MGP sites and related facilities within the
existing or former service territories of KEDNE.
Boston Gas Company, Colonial Gas Company and Essex Gas Company may have or share
responsibility under applicable environmental laws for the remediation of 67 of
these sites. A subsidiary of National Grid USA, formerly New England Electric
System, has assumed responsibility for remediating 11 of these sites, subject to
a limited contribution from Boston Gas Company, and has provided full
indemnification to Boston Gas Company with respect to eight other sites. In
addition, Boston Gas Company, Colonial Gas Company, and Essex Gas Company have
assumed responsibility for remediating three sites each. At this time, it is
uncertain as to whether Boston Gas Company, Colonial Gas Company or Essex Gas
Company have or share responsibility for remediating any of the other sites. No
notice of responsibility has been issued to us for any of these sites from any
environmental regulatory authority.
We presently estimate the remaining cost of these Massachusetts KEDNE
MGP-related environmental cleanup activities will be $11.3 million, which amount
has been accrued by us as a reasonable estimate of probable cost for known
sites, however remediation costs for each site may be materially higher than
noted, depending upon changing technologies and regulatory standards, selected
end use for each site, and actual environmental conditions encountered.
Expenditures incurred since November 8, 2000, the date KeySpan acquired the
KEDNE companies, with respect to these MGP-related activities total $26.1
million.
22
We may have or share responsibility under applicable environmental laws for the
remediation of 10 MGP sites and related facilities associated with the
historical operations of EnergyNorth. At four of these sites we have entered
into cost sharing agreements with other parties who share responsibility for
remediation of these sites. EnergyNorth also has entered into an agreement with
the United States Environmental Protection Agency ("EPA") for the contamination
from the Nashua site that was allegedly commingled with asbestos at the
so-called Nashua River Asbestos site, adjacent to the Nashua MGP site.
We presently estimate the remaining cost of EnergyNorth MGP-related
environmental cleanup activities will be $7.1 million, which amount has been
accrued by us as a reasonable estimate of probable cost for known sites however,
remediation costs for each site may be materially higher than noted, depending
upon changing technologies and regulatory standards, selected end use for each
site, and actual environmental conditions encountered. Expenditures incurred
since November 8, 2000, with respect to these MGP-related activities total $15.7
million.
By rate orders, the Massachusetts Department of Telecommunications and Energy
("MADTE") and the New Hampshire Public Utility Commission ("NHPUC") provide for
the recovery of site investigation and remediation costs and, accordingly, at
December 31, 2004, we have reflected a regulatory asset of $38.7 million for the
KEDNE MGP sites. As previously mentioned, Colonial Gas Company and Essex Gas
Company are not subject to the provisions of SFAS 71 and therefore have recorded
no regulatory asset. However, rate orders currently in effect for these
subsidiaries provide for the recovery of investigation and remediation costs.
KeySpan New England, LLC Sites: We are aware of three non-utility sites
associated with KeySpan New England, LLC, a successor company to Eastern
Enterprises, for which we may have or share environmental remediation or ongoing
maintenance responsibility. These three sites, located in Philadelphia,
Pennsylvania, New Haven, Connecticut and Everett, Massachusetts, were associated
with historical operations involving the production of coke and related
industrial processes. Honeywell International, Inc. and Beazer East, Inc. (both
former owners and/or operators of certain facilities at Everett (the "Everett
Facility") together with KeySpan, have entered into an ACO with the
Massachusetts Department of Environmental Protection for the investigation and
development of a remedial response plan for a portion of that site. KeySpan,
Honeywell and Beazer East have entered into a cost-sharing agreement to address
the cost of compliance with the ACO.
We presently estimate the remaining cost of our environmental cleanup activities
for the three non-utility sites will be approximately $16.7 million, which
amount has been accrued by us as a reasonable estimate of probable costs for
known sites however, remediation costs for each site may be materially higher
than noted, depending upon changing technologies and regulatory standards,
selected end use for each site, and actual environmental conditions encountered.
Expenditures incurred since November 8, 2000, with respect to these sites total
$16.1 million.
23
We believe that in the aggregate, the accrued liability for these MGP sites and
related facilities identified above are reasonable estimates of the probable
cost for the investigation and remediation of these sites and facilities. As
circumstances warrant, we periodically re-evaluate the accrued liabilities
associated with MGP sites and related facilities. We may be required to
investigate and, if necessary, remediate each site previously noted, or other
currently unknown former sites and related facility sites, the cost of which is
not presently determinable but may be material to our financial position,
results of operations or cash flows.
See KeySpan's Annual Report on Form 10-K for the year ended December 31, 2004,
Note 7 to those Consolidated Financial Statements "Contractual Obligations,
Financial Guarantees and Contingencies" for further information on environmental
matters.
Legal Matters
From time to time we are subject to various legal proceedings arising out of the
ordinary course of our business. Except as described below, or in KeySpan's
Annual Report on Form 10-K for the year ended December 31, 2004, KeySpan's
quarterly reports on Form 10-Q for the periods ended March 31, 2005 and June 30,
2005 or other periodic reports filed on Form 8-K during 2005, we do not consider
any of such proceedings to be material to our business or likely to result in a
material adverse effect on our results of operations, financial condition or
cash flows.
KeySpan and certain of its current and former officers and directors were
defendants in a consolidated class action lawsuit filed in the United States
District Court for the Eastern District of New York. This lawsuit alleged, among
other things, violations of Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, as amended ("Exchange Act"), in connection with disclosures
relating to or following the acquisition of the Roy Kay companies. In June 2004,
the parties entered into a settlement agreement which provided for the parties
to settle the action for $13.8 million. The court approved the settlement on
September 29, 2005 and the matter is now concluded. The settlement was funded
entirely by insurance.
KeySpan subsidiaries, along with several other parties, have been named as
defendants in numerous proceedings filed by plaintiffs claiming various degrees
of injury from asbestos exposure at generating facilities formerly owned by Long
Island Lighting Company ("LILCO") and others. In connection with the May 1998
transaction with LIPA, costs incurred by KeySpan for liabilities for asbestos
exposure arising from the activities of the generating facilities previously
owned by LILCO are recoverable from LIPA through the Power Supply Agreement
("PSA") between LIPA and KeySpan.
KeySpan is unable to determine the outcome of the outstanding asbestos
proceedings, but does not believe that such outcome, if adverse, will have a
material effect on its financial condition, results of operation or cash flows.
KeySpan believes that its cost recovery rights under the PSA, its
indemnification rights against third parties and its insurance coverage (above
applicable deductible limits) cover its exposure for asbestos liabilities
generally.
24
Financial Guarantees
KeySpan has issued financial guarantees in the normal course of business,
primarily on behalf of its subsidiaries, to various third party creditors. At
September 30, 2005, the following amounts would have to be paid by KeySpan in
the event of non-payment by the primary obligor at the time payment is due:
- -----------------------------------------------------------------------------------------------------------
Amount of Expiration
Nature of Guarantee (In Thousands of Dollars) Exposure Dates
- ---------------------------------------------------------------------------------------------------------
Guarantees for Subsidiaries
Medium-Term Notes - KEDLI (i) $ 525,000 2008-2010
Industrial Development Revenue Bonds (ii) 128,000 2027
Ravenswood - Master Lease (iii) 425,000 2009
Ravenswood - Sale/leaseback (iv) 404,000 2040
Surety Bonds (v) 88,000 2005-2008
Commodity Guarantees and Other (vi) 86,000 2005
Letters of Credit (vii) 74,000 2005
- ---------------------------------------------------------------------------------------------------------
$ 1,730,000
- ---------------------------------------------------------------------------------------------------------
The following is a description of KeySpan's outstanding subsidiary guarantees:
(i) KeySpan has fully and unconditionally guaranteed $525 million to holders of
Medium-Term Notes issued by KEDLI. These notes are due to be repaid on
January 15, 2008 and February 1, 2010. KEDLI is required to comply with
certain financial covenants under the debt agreements. The face value of
these notes is included in long-term debt on the Consolidated Balance
Sheet.
(ii) KeySpan has fully and unconditionally guaranteed the payment obligations of
its subsidiaries with regard to $128 million of Industrial Development
Revenue Bonds issued through the Nassau County and Suffolk County
Industrial Development Authorities for the construction of two
electric-generation peaking plants on Long Island. The face value of these
notes are included in long-term debt on the Consolidated Balance Sheet.
(iii) KeySpan has guaranteed all payment and performance obligations of KeySpan
Ravenswood, LLC, the lessee under the Master Lease. The term of the lease
has been extended to June 20, 2009. The Master Lease is classified as
$412.3 million long-term debt on the Consolidated Balance Sheet.
(iv) KeySpan has guaranteed all payment and performance obligations of KeySpan
Ravenswood, LLC, the lessee under the sale/leaseback transaction associated
with the Ravenswood Expansion, including future decommissioning costs. The
initial term of the lease is for 36 years. As noted previously, this lease
qualifies as an operating lease and is not reflected on the Consolidated
Balance Sheet.
25
(v) KeySpan has agreed to indemnify the issuers of various surety and
performance bonds associated with certain construction projects currently
being performed by certain current and former subsidiaries. In the event
that the current or former subsidiaries fail to perform their obligations
under contracts, the injured party may demand that the surety make payments
or provide services under the bond. KeySpan would then be obligated to
reimburse the surety for any expenses or cash outlays it incurs. Although
KeySpan is not guaranteeing any new bonds for any of the former
subsidiaries, KeySpan's indemnity obligation supports the contractual
obligation of these current and former subsidiaries. KeySpan has also
received from a former subsidiary an indemnity bond issued by a third party
insurance company, the purpose of which is to reimburse KeySpan in an
amount up to $80 million in the event it is required to perform under all
other indemnity obligations previously incurred by KeySpan to support such
company's bonded projects existing prior to divestiture. At September 30,
2005, the total cost to complete such remaining bonded projects is
estimated to be approximately $51 million.
(vi) KeySpan has guaranteed commodity-related payments for subsidiaries within
the Energy Services segment, as well as KeySpan Ravenswood, LLC. These
guarantees are provided to third parties to facilitate physical and
financial transactions involved in the purchase of natural gas, oil and
other petroleum products for electric production and marketing activities.
The guarantees cover actual purchases by these subsidiaries that are still
outstanding as of September 30, 2005.
(vii) KeySpan has arranged for stand-by letters of credit to be issued to third
parties that have extended credit to certain subsidiaries. Certain vendors
require us to post letters of credit to guarantee subsidiary performance
under our contracts and to ensure payment to our subsidiary subcontractors
and vendors under those contracts. Certain of our vendors also require
letters of credit to ensure reimbursement for amounts they are disbursing
on behalf of our subsidiaries, such as to beneficiaries under our
self-funded insurance programs. Such letters of credit are generally issued
by a bank or similar financial institution. The letters of credit commit
the issuer to pay specified amounts to the holder of the letter of credit
if the holder demonstrates that we have failed to perform specified
actions. If this were to occur, KeySpan would be required to reimburse the
issuer of the letter of credit.
To date, KeySpan has not had a claim made against it for any of the above
guarantees and we have no reason to believe that our subsidiaries or former
subsidiaries will default on their current obligations. However, we cannot
predict when or if any defaults may take place or the impact any such
defaults may have on our consolidated results of operations, financial
condition or cash flows.
26
Other Contingencies
We derive a substantial portion of our revenues in our Electric Services segment
from a series of agreements with LIPA pursuant to which we manage LIPA's
transmission and distribution system and supply the majority of LIPA's
customers' electricity needs. The agreements terminate at various dates between
May 28, 2006 and May 28, 2013, and at this time we can provide no assurance that
any of the agreements will be renewed or extended, or if they were to be renewed
or extended, the terms and conditions thereof. In addition, given the complexity
of these agreements, disputes arise from time to time between KeySpan and LIPA
concerning the rights and obligations of each party to make and receive payments
as required pursuant to the terms of these agreements. As a result, KeySpan is
unable to determine what effect, if any, the ultimate resolution of these
disputes will have on its financial condition, results of operations or cash
flows.
In March 2005, LIPA issued a Request for Proposal ("RFP") to provide system
power supply management services beginning May 29, 2006 and fuel management
services for certain of its peaking generating units beginning January 1, 2006.
A KeySpan subsidiary is currently performing these services. KeySpan submitted a
bid in response to the new RFP in April 2005. LIPA was scheduled to select a
service provider in June 2005, but has deferred such decision at this time. We
cannot predict the outcome or the timing of any decisions by LIPA on this matter
at this time.
In addition, LIPA is performing a long-term strategic review of its future
direction. It has engaged a team of advisors and consultants and has conducted
public hearings to develop recommendations to be submitted to the LIPA Trustees.
Some of the strategic options that LIPA is considering include whether LIPA
should continue its operations as they presently exist, fully municipalize or
privatize, or sell some, but not all of its assets. LIPA was initially required
to make a determination by May 2005 as to whether it would exercise its option
to purchase our Long Island generating plants pursuant to the terms of the
Generation Purchase Rights Agreement. KeySpan and LIPA have mutually agreed to
extend the date by which LIPA must make this determination to December 15, 2005.
LIPA and KeySpan are engaged in discussions concerning LIPA's strategic review.
At this time, we are unable to determine what the outcome of this strategic
review will have on our financial condition, results of operations or cash
flows. Any action that may be taken will have to take into consideration the
long-term nature of our existing contracts.
During the year ended December 31, 2002, KeySpan recorded an adjustment to
deferred income taxes of $177.7 million to reflect a decrease in the tax basis
of the assets acquired at the time of the KeySpan/LILCO combination. This
adjustment resulted from a revised valuation study. Concurrent with this
deferred tax adjustment, KeySpan reduced current income taxes payable by $183.2
million, resulting in a net $5.5 million income tax benefit. As reported in
KeySpan's Form 10-K for the year ended December 31, 2004, the Internal Revenue
Service ("IRS") conducted an audit of LILCO's tax returns for the tax years
ended December 31, 1996 through March 31, 1999 and KeySpan's and The Brooklyn
Union Gas Company's tax returns for the tax years ended September 30, 1997
through December 31, 1998, pertaining to the KeySpan/LILCO combination, as well
27
as other return years. The primary issue raised in the conduct of the
examination relates to the valuation of the transferred assets in the
KeySpan/LILCO combination. The IRS has completed its audit and has proposed a
significant adjustment to the valuation of the assets transferred in the
KeySpan/LILCO combination, as well as other adjustments.
KeySpan is pursuing an administrative appeal before the IRS with respect to the
issues raised in the audit. KeySpan believes that its tax positions comply with
applicable tax law and will defend these positions both through administrative
and, if necessary, judicial procedures. At this point in time, we can not
determine what the impact, if any, will be on KeySpan's financial position,
results of operations or cash flows from the resolution of these tax matters.
7. STOCK OPTIONS
Stock options have been issued to KeySpan officers, directors and certain other
management employees and consultants as approved by the Board of Directors.
These options generally vest over a three-to-five year period and have exercise
periods from five to ten years. In 2003, KeySpan adopted the prospective method
of transition of accounting for stock option expense in accordance with SFAS 148
"Accounting for Stock-Based Compensation - Transition and Disclosure."
Accordingly, compensation expense has been recognized by employing the fair
value recognition provisions of SFAS 123 "Accounting for Stock-Based
Compensation" for grants awarded after January 1, 2003.
KeySpan continues to apply APB Opinion 25, "Accounting for Stock Issued to
Employees," and related Interpretations in accounting for grants awarded prior
to January 1, 2003. Accordingly, no compensation cost has been recognized for
these fixed stock option plans in the Consolidated Financial Statements since
the exercise prices and market values were equal on the grant dates. Had
compensation cost for these plans been determined based on the fair value at the
grant dates for awards under the plans consistent with SFAS 123, our net income
and earnings per share would have decreased to the pro-forma amounts indicated
below:
- ---------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) available for common stock:
As reported $ 22.6 $ (117.1) $ 273.2 $ 258.4
Add: recorded stock-based compensation expense, net of tax 1.3 1.3 7.4 4.1
Deduct: total stock-based compensation expense, net of tax (1.8) (1.9) (8.8) (6.9)
- ---------------------------------------------------------------------------------------------------------------------------------
Pro-forma earnings $ 22.1 $ (117.7) $ 271.8 $ 255.6
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic - as reported $ 0.13 $ (0.73) $ 1.62 $ 1.61
Basic - pro-forma $ 0.13 $ (0.73) $ 1.61 $ 1.60
Diluted - as reported $ 0.13 $ (0.73) $ 1.61 $ 1.60
Diluted - pro-forma $ 0.13 $ (0.73) $ 1.60 $ 1.59
- ---------------------------------------------------------------------------------------------------------------------------------
28
8. POSTRETIREMENT BENEFITS
Pension Plans: The following information represents the consolidated net
periodic pension cost for the nine months ended September 30, 2005 and 2004, for
our noncontributory defined benefit pension plans which cover substantially all
employees. Benefits are based on years of service and compensation. Funding for
pensions is in accordance with requirements of federal law and regulations.
KEDLI and Boston Gas Company are subject to certain deferral accounting
requirements mandated by the NYPSC and the MADTE, respectively for pension costs
and other postretirement benefit costs. Further, KeySpan's electric subsidiaries
are subject to certain "true-up" provisions in accordance with the LIPA service
agreements.
The calculation of net periodic pension cost is as follows:
- -----------------------------------------------------------------------------------------------
Nine Months Ended September, 30
(In Millions of Dollars) 2005 2004
- -----------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 42.5 $ 39.7
Interest cost on projected benefit obligation 111.4 108.2
Expected return on plan assets (129.8) (118.7)
Net amortization and deferral 55.4 47.4
- -----------------------------------------------------------------------------------------------
Total pension cost $ 79.5 $ 76.6
- -----------------------------------------------------------------------------------------------
Other Postretirement Benefits: The following information represents the
consolidated net periodic other postretirement benefit cost for the nine months
ended September 30, 2005 and 2004, for our noncontributory defined benefit plans
covering certain health care and life insurance benefits for retired employees.
We have been funding a portion of future benefits over employees' active service
lives through Voluntary Employee Beneficiary Association ("VEBA") trusts.
Contributions to VEBA trusts are tax deductible, subject to limitations
contained in the Internal Revenue Code.
Net periodic other postretirement benefit cost included the following
components:
- ---------------------------------------------------------------------------------------------
Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004
- ---------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 18.3 $ 15.1
Interest cost on accumulated
postretirement benefit obligation 56.8 55.5
Expected return on plan assets (27.1) (25.4)
Net amortization and deferral 44.9 35.1
- ---------------------------------------------------------------------------------------------
Other postretirement cost $ 92.9 $ 80.3
- ---------------------------------------------------------------------------------------------
During the first nine months of 2005, KeySpan contributed $98.5 million to its
pension plans and $18.0 million to its other postretirement benefit plans. At
the present time, KeySpan does not anticipate contributing any additional funds
to its pension plans for the remainder of 2005, but does anticipate contributing
up to an additional $8 million to its other postretirement benefit plans during
29
the remainder of 2005. These estimated contribution levels are subject to change
based on future market returns, interest rates and certain other measurements.
Actual contributions, therefore, may vary from these levels.
9. LONG-TERM DEBT and COMMERCIAL PAPER
On January 14, 2005, KeySpan redeemed $500 million of 6.15% Notes due 2006.
KeySpan incurred $20.9 million in call premiums and wrote-off $1.3 million of
previously deferred costs. Further, KeySpan accelerated the amortization of
approximately $11.2 million of previously unamortized benefits associated with
an interest rate swap on these bonds. The accelerated amortization was recorded
as a reduction to interest expense.
At December 31, 2004, KeySpan had $460 million of MEDS Equity Units outstanding
at 8.75%, consisting of a three-year forward purchase contract for our common
stock and a six-year note. The purchase contract required us, three years from
the date of issuance of the MEDs Equity Units, May 16, 2005, to issue and the
investors to purchase, a number of shares of our common stock based on a formula
tied to the market price of our common stock at that time. The 8.75% coupon was
composed of interest payments on the six-year note of 4.9% and premium payments
on the three-year equity forward contract of 3.85%.
In 2005, KeySpan was required to remarket the note component of the Equity Units
between February 2005 and May 2005 and reset the interest rate to the then
current market rate of interest; however, the reset interest rate could not be
set below 4.9%. In March 2005, KeySpan remarketed the note component of $394.9
million of the Equity Units at the reset interest rate of 4.9% through their
maturity date of May 2008. The balance of the notes ($65.1 million) were held by
the original MEDs equity holders in accordance with their terms and not
remarketed. KeySpan then exchanged $300 million of the remarketed notes for
$307.2 million of new 30 year notes bearing an interest rate of 5.8%. Therefore,
KeySpan now has $160 million of 4.9% notes outstanding with a maturity date of
May 2008 and $307.2 million of 5.8% notes outstanding with a maturity date of
April 2035.
On May 16, 2005 KeySpan issued 12.1 million shares of common stock, at an
issuance price of $37.93 per share, pursuant to the terms of the financial
purchase contract described above. KeySpan received proceeds of approximately
$460 million from the equity conversion. The number of shares issued was
dependent on the average closing price of our common stock over the 20 day
trading period ending on the third trading day prior to May 16, 2005.
In June 2005, KeySpan closed on a $920 million revolving credit facility for
five years due June 24, 2010, which was syndicated among fifteen banks, and an
amended $580 million revolving credit facility due June 24, 2009. These
facilities replace an existing $660 million, 3-year facility due June 2006, and
a 5-year $640 million facility due June 2009. The two credit facilities, which
now total $1.5 billion - $920 million for five years through 2010, and $580
million for the amended facility through 2009, will continue to support
KeySpan's commercial paper program for ongoing working capital needs.
30
The fees for the facilities are based on KeySpan's current credit ratings and
are increased or decreased based on a downgrading or upgrading of our ratings.
The current annual facility fee is 0.07% based on our credit rating of A3 by
Moody's Investor Services and A by Standard & Poor's for each facility. Both
credit facilities allow for KeySpan to borrow using several different types of
loans; specifically, eurodollar loans, ABR loans, or competitively bid loans.
Eurodollar loans are based on the Eurodollar rate plus a margin that is tied to
our applicable credit ratings. ABR loans are based on the higher of the Prime
Rate, the base CD rate plus 1%, or the Federal Funds Effective Rate plus 0.5%.
Competitive bid loans are based on bid results requested by KeySpan from the
lenders. We do not anticipate borrowing against these facilities; however, if
the credit rating on our commercial paper program were to be downgraded, it may
be necessary to do so.
The facilities contain certain affirmative and negative operating covenants,
including restrictions on KeySpan's ability to mortgage, pledge, encumber or
otherwise subject its utility property to any lien, as well as certain financial
covenants that require us to, among other things, maintain a consolidated
indebtedness to consolidated capitalization ratio of no more than 65% at the
last day of any fiscal quarter. Violation of these covenants could result in the
termination of the facilities and the required repayment of amounts borrowed
thereunder, as well as possible cross defaults under other debt agreements. At
September 30, 2005, KeySpan's consolidated indebtedness was 49.1% of its
consolidated capitalization and KeySpan was in compliance with all covenants.
Subject to certain conditions set forth in the credit facility, KeySpan has the
right, at any time, to increase the commitments under the $920 million facility
up to an additional $300 million. In addition, KeySpan has the right to request
that the termination date be extended for an additional period of 365 days prior
to each anniversary of the closing date. This extension option, however,
requires the approval of lenders holding more than 50% of the total commitments
to such extension request. Under the agreements, KeySpan has the ability to
replace non-consenting lenders with other pre-approved banks or financial
institutions.
At September 30, 2005, $320 million of commercial paper was outstanding at a
weighted average annualized interest rate of 3.90%. Based on the level of
authorization granted to us by the Securities and Exchange Commission ("SEC"),
we had the ability to issue up to an additional $1.0 billion of short-term debt
at September 30, 2005, under the commercial paper program.
10. SUBSEQUENT EVENT
On November 1, 2005, KeySpan's gas distribution subsidiary, KEDNY, issued $137
million of tax-exempt Gas Facilities Revenue Bonds ("GFRB") through the New York
State Energy Research and Development Authority ("NYSERDA") in the following
series: (i) $82 million of 4.70% GFRB, 2005 Series A (the "Series A Bonds") and
(ii) $55 million of GFRB, 2005 Series B (the "Series B Bonds"). The interest
rate on the Series B Bonds is re-set every seven days through an auction
process. KEDNY will use the proceeds from these issuances to redeem the
following three series of GFRBs: (i) $41 million Adjustable Rate GFRBs, Series
1989A due February 2024, $41 million Adjustable Rate Gas GFRBs, Series 1989B
February 2024 and (iii) $55 million 5.60% GFRB, Series 1993C due June 2025.
31
On November 1, 2005, the MADTE approved a base rate increase of $7.2 million
under Boston Gas Company's Performance Based Rate Plan that was approved in
2003. Also on November 1, 2005, the MADTE authorized recovery of under-recovered
gas related bad debt expenses for the period January 1, 2004-December 31, 2004
through the gas cost adjustment factor and established a mechanism for future
recovery of such costs. KeySpan is in the process of analyzing the impact of
this order.
11. KEYSPAN ENERGY DELIVERY LONG ISLAND SUMMARY FINANCIAL INFORMATION
KEDLI is a wholly owned subsidiary of KeySpan. KEDLI was formed on May 7, 1998
and on May 28, 1998 acquired substantially all of the assets related to the gas
distribution business of the Long Island Lighting Company. KEDLI established a
program for the issuance, from time to time, of up to $600 million aggregate
principal amount of Medium-Term Notes, which are fully and unconditionally
guaranteed by the parent, KeySpan Corporation. On February 1, 2000, KEDLI issued
$400 million of 7.875% Medium-Term Notes due 2010. In January 2001, KEDLI issued
an additional $125 million of Medium-Term Notes at 6.9% due January 2008. The
following condensed financial statements are required to be disclosed by SEC
regulations and set forth those of KEDLI, KeySpan Corporation as guarantor of
the Medium-Term Notes and our other subsidiaries on a combined basis.
- --------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------
Revenues $ 0.2 $ 185.1 $ 1,118.0 $ (0.2) $ 1,303.1
-----------------------------------------------------------------------------
Operating Expenses
Purchased gas - 136.5 259.2 - 395.7
Fuel and purchased power - - 254.6 - 254.6
Operations and maintenance 3.5 32.6 328.2 - 364.3
Intercompany expense - 1.2 (1.0) (0.2) -
Depreciation and amortization - 14.1 78.0 - 92.1
Operating taxes - 15.5 81.6 - 97.1
-----------------------------------------------------------------------------
Total Operating Expenses 3.5 199.9 1,000.6 (0.2) 1,203.8
-----------------------------------------------------------------------------
Income from equity investments - - 2.5 - 2.5
Gain on Sale of Property - - 1.0 - 1.0
-----------------------------------------------------------------------------
Operating Income (Loss) (3.3) (14.8) 120.9 - 102.8
-----------------------------------------------------------------------------
Interest charges (37.3) (13.7) (22.4) 6.0 (67.4)
Other income and (deductions) 50.4 0.3 (28.3) (26.2) (3.8)
-----------------------------------------------------------------------------
Total Other Income and (Deductions) 13.1 (13.4) (50.7) (20.2) (71.2)
-----------------------------------------------------------------------------
Income Taxes (Benefit) (12.8) (9.9) 31.7 - 9.0
-----------------------------------------------------------------------------
-
Earnings (Loss) from Continuing Operations 22.6 (18.3) 38.5 (20.2) 22.6
Discontinued Operations - - - -
-----------------------------------------------------------------------------
Net Income (Loss) $ 22.6 $ (18.3) $ 38.5 $(20.2) $ 22.6
=============================================================================
- --------------------------------------------------------------------------------------------------------------------------------
32
- ----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2004
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ----------------------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------
Revenues $ 0.2 $ 114.2 $ 861.3 $ (0.2) $ 975.5
----------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 50.0 136.6 - 186.6
Fuel and purchased power - - 176.0 - 176.0
Operations and maintenance 2.1 29.9 312.8 - 344.8
Intercompany expense - 1.3 (1.1) (0.2) -
Depreciation and amortization - 13.8 93.4 - 107.2
Operating taxes - 15.5 74.0 - 89.5
----------------------------------------------------------------------------------
Total Operating Expenses 2.1 110.5 791.7 (0.2) 904.1
----------------------------------------------------------------------------------
Income from equity investments - - 16.2 - 16.2
----------------------------------------------------------------------------------
Operating Income (Loss) (1.9) 3.7 85.8 - 87.6
----------------------------------------------------------------------------------
Interest charges (54.2) (16.3) (67.5) 49.7 (88.3)
Other income and (deductions) (90.1) 0.2 11.3 36.8 (41.8)
----------------------------------------------------------------------------------
Total Other Income and (Deductions) (144.3) (16.1) (56.2) 86.5 (130.1)
----------------------------------------------------------------------------------
Income Taxes (Benefit) (30.4) (2.6) 19.3 - (13.7)
----------------------------------------------------------------------------------
Earnings from Continuing Operations (115.8) (9.8) 10.3 86.5 (28.8)
Discontinued Operations - - (87.0) - (87.0)
----------------------------------------------------------------------------------
Net Income (Loss) $ (115.8) $ (9.8) $ (76.7) $ 86.5 $ (115.8)
==================================================================================
- ----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- -----------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------
Revenues $ 0.5 $ 916.1 $ 4,210.0 $ (0.5) $ 5,126.1
----------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 588.1 1,618.0 - 2,206.1
Fuel and purchased power - - 546.9 - 546.9
Operations and maintenance 10.9 96.4 1,036.0 - 1,143.3
Intercompany expense - 3.7 (3.2) (0.5) -
Depreciation and amortization - 59.1 236.7 - 295.8
Operating taxes - 47.8 255.2 - 303.0
----------------------------------------------------------------------------------
Total Operating Expenses 10.9 795.1 3,689.6 (0.5) 4,495.1
----------------------------------------------------------------------------------
Income from equity investments - - 12.5 - 12.5
Gain on Sale of Property - - 1.2 - 1.2
----------------------------------------------------------------------------------
Operating Income (Loss) (10.4) 121.0 534.1 - 644.7
----------------------------------------------------------------------------------
Interest charges (104.8) (46.1) (64.9) 15.7 (200.1)
Other income and (deductions) 364.8 3.2 (62.4) (313.0) (7.4)
----------------------------------------------------------------------------------
Total Other Income and (Deductions) 260.0 (42.9) (127.3) (297.3) (207.5)
----------------------------------------------------------------------------------
Income Taxes (Benefit) (25.8) 28.2 157.6 - 160.0
----------------------------------------------------------------------------------
-
Earnings from Continuing Operations 275.4 49.9 249.2 (297.3) 277.2
Discontinued Operations - - (1.8) (1.8)
----------------------------------------------------------------------------------
Net Income $ 275.4 $ 49.9 $ 247.4 $ (297.3) $ 275.4
==================================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
33
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- -----------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2004
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------
Revenues $ 0.4 $ 766.7 $ 3,997.2 $ (0.4) $ 4,763.9
----------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 438.0 1,338.3 - 1,776.3
Fuel and purchased power - - 408.0 - 408.0
Operations and maintenance (3.0) 96.8 1,049.2 - 1,143.0
Intercompany expense - 4.1 (3.7) (0.4) -
Depreciation and amortization - 62.1 405.3 - 467.4
Operating taxes - 47.8 254.3 - 302.1
----------------------------------------------------------------------------------
Total Operating Expenses (3.0) 648.8 3,451.4 (0.4) 4,096.8
----------------------------------------------------------------------------------
Income from equity investments - - 30.3 - 30.3
----------------------------------------------------------------------------------
Operating Income (Loss) 3.4 117.9 576.1 - 697.4
----------------------------------------------------------------------------------
Interest charges (161.0) (47.0) (208.4) 155.6 (260.8)
Other income and (deductions) 380.2 0.7 192.8 (457.8) 115.9
----------------------------------------------------------------------------------
Total Other Income and (Deductions) 219.2 (46.3) (15.6) (302.2) (144.9)
----------------------------------------------------------------------------------
Income Taxes (Benefit) (40.1) 22.4 220.9 - 203.2
----------------------------------------------------------------------------------
Earnings from Continuing Operations 262.7 49.2 339.6 (302.2) 349.3
Discontinued Operations - - (86.6) - (86.6)
----------------------------------------------------------------------------------
Net Income $ 262.7 $ 49.2 $ 253.0 $ (302.2) $ 262.7
==================================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
34
- -----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- -----------------------------------------------------------------------------------------------------------------------------------
September 30, 2005
Other Elimina- Consoli-
(In Millions of Dollars) Guarantor KEDLI Subsidiaries tions dated
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ (5.7) $ 1.3 $ 88.4 $ - $ 84.0
Accounts receivable, net 0.2 126.0 966.6 - 1,092.8
Other current assets 2.7 421.2 1,352.7 - 1,776.6
Assets of discontinued operations - - - - -
----------------------------------------------------------------------------------------
(2.8) 548.5 2,407.7 - 2,953.4
----------------------------------------------------------------------------------------
Equity Investments 4,500.4 0.8 128.0 (4,386.2) 243.0
----------------------------------------------------------------------------------------
Property
Property, Plant and Equipment 2,070.8 8,139.0 - 10,209.8
Accumulated depreciation and depletion - (402.3) (2,579.7) - (2,982.0)
Property of discontinued operations - - - - -
----------------------------------------------------------------------------------------
- 1,668.5 5,559.3 - 7,227.8
----------------------------------------------------------------------------------------
Intercompany Accounts Receivable 2,334.5 32.3 75.2 (2,442.0) -
-
Deferred Charges 472.9 247.9 2,169.3 - 2,890.1
----------------------------------------------------------------------------------------
Total Assets $ 7,305.0 $ 2,498.0 $ 10,339.5 $ (6,828.2) $ 13,314.3
========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 28.2 $ 248.3 $ 479.8 $ - $ 756.3
Commercial paper 320.0 - - - 320.0
Other current liabilities 145.0 27.1 460.5 - 632.6
Liabilities of discontinued operations - - - - -
----------------------------------------------------------------------------------------
493.2 275.4 940.3 - 1,708.9
----------------------------------------------------------------------------------------
Intercompany Accounts Payable (62.0) 99.6 890.6 (928.2) -
----------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax 16.8 362.6 750.9 - 1,130.3
Other deferred credits and liabilities 558.9 244.0 1,354.9 - 2,157.8
----------------------------------------------------------------------------------------
575.7 606.6 2,105.8 - 3,288.1
----------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 4,448.2 865.5 3,460.1 (4,386.2) 4,387.6
Long-term debt 1,849.9 650.9 2,927.5 (1,513.8) 3,914.5
----------------------------------------------------------------------------------------
Total Capitalization 6,298.1 1,516.4 6,387.6 (5,900.0) 8,302.1
----------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 15.2 - 15.2
----------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 7,305.0 $ 2,498.0 $ 10,339.5 $ (6,828.2) $ 13,314.3
========================================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
35
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004
Other Elimina- Consoli-
(In Millions of Dollars) Guarantor KEDLI Subsidiaries tions dated
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 580.7 $ (0.9) $ 342.2 $ - $ 922.0
Accounts receivable, net 0.8 223.6 1,087.1 - 1,311.5
Other current assets 4.5 146.5 658.9 - 809.9
Assets of discontinued operations - - 42.9 - 42.9
----------------------------------------------------------------------------------------
586.0 369.2 2,131.1 - 3,086.3
----------------------------------------------------------------------------------------
Investments and Other 4,567.3 2.0 169.1 (4,465.5) 272.9
----------------------------------------------------------------------------------------
Property
Gas - 1,998.5 4,872.7 - 6,871.2
Other - - 2,987.8 - 2,987.8
Accumulated depreciation and depletion - (334.4) (2,465.4) - (2,799.8)
Property of discontinued operations - - 8.7 - 8.7
----------------------------------------------------------------------------------------
- 1,664.1 5,403.8 - 7,067.9
----------------------------------------------------------------------------------------
Intercompany Accounts Receivable 2,485.7 - 1,292.2 (3,777.9) -
Deferred Charges 381.3 221.4 2,333.2 - 2,935.9
----------------------------------------------------------------------------------------
Total Assets $ 8,020.3 $ 2,256.7 $ 11,329.4 $ (8,243.4) $ 13,363.0
========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 48.4 $ 111.6 $ 745.5 $ - $ 905.5
Commercial paper 912.2 - - - 912.2
Other current liabilities 294.7 167.2 (56.5) - 405.4
Liabilities of discontiuned operations - - 64.2 - 64.2
----------------------------------------------------------------------------------------
1,255.3 278.8 753.2 - 2,287.3
----------------------------------------------------------------------------------------
Intercompany Accounts Payable - 101.3 2,147.8 (2,249.1) -
----------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax (83.2) 298.1 909.2 - 1,124.1
Other deferred credits and liabilities 534.5 112.0 958.3 - 1,604.8
----------------------------------------------------------------------------------------
451.3 410.1 1,867.5 - 2,728.9
----------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 3,940.5 815.6 3,604.2 (4,465.5) 3,894.8
Preferred stock 19.7 - - - 19.7
Long-term debt 2,353.5 650.9 2,943.1 (1,528.8) 4,418.7
----------------------------------------------------------------------------------------
Total Capitalization 6,313.7 1,466.5 6,547.3 (5,994.3) 8,333.2
----------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies - - 13.6 - 13.6
----------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 8,020.3 $ 2,256.7 $ 11,329.4 $ (8,243.4) $ 13,363.0
========================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
36
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- ------------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2005
---------------------------------------------------------------------------
Other
(In Millions of Dollars) Guarantor KEDLI Subsidiaries Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash Provided by (Used in )Operating Activities $ (326.2) $ 156.7 $ 641.6 $ 472.1
---------------------------------------------------------------------------
Investing Activities
Capital expenditures - (70.9) (301.2) (372.1)
Cost of removal (1.6) (9.2) (10.8)
Proceeds from sale of property and investments - (2.1) 49.0 46.9
Derivative margin calls - - (63.3) (63.3)
---------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities - (74.6) (324.7) (399.3)
---------------------------------------------------------------------------
Financing Activities
Treasury stock issued 41.0 - - 41.0
Payment of debt, net (1,092.2) - (15.1) (1,107.3)
Redemption of preferred stock (75.0) - - (75.0)
Common and preferred stock dividends paid (229.1) - - (229.1)
MEDs equity conversion 460.0 - - 460.0
Intercompany dividend payments 317.0 - (317.0) -
Other (2.4) - 16.4 14.0
Net intercompany accounts 304.0 (80.0) (224.0) -
-
---------------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (276.7) (80.0) (539.7) (896.4)
---------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ (602.9) $ 2.1 $ (222.8) $ (823.6)
Net Cash Flow from Discontinued Operations - - (14.4) (14.4)
Cash and Cash Equivalents at Beginning of Period 580.7 (0.9) 342.2 922.0
---------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ (22.2) $ 1.2 $ 105.0 $ 84.0
===========================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- -------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2004
----------------------------------------------------------------------
Other
(In Millions of Dollars) Guarantor KEDLI Subsidiaries Consolidated
- -------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash Provided by (Used in) Operating Activities $ (154.5) $ 198.6 $ 731.2 $ 775.3
----------------------------------------------------------------------
Investing Activities
Capital expenditures - (76.3) (483.0) (559.3)
Cost of removal - (4.7) (16.5) (21.2)
Proceeds from sale of property and investments - - 525.2 525.2
----------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities - (81.0) 25.7 (55.3)
----------------------------------------------------------------------
Financing Activities
Treasury stock issued 24.3 - - 24.3
Payment of debt, net (589.4) - (187.8) (777.2)
Common and preferred stock dividends paid (218.4) - - (218.4)
Proceeds from sale/leaseback transaction - - 383.7 383.7
Redemption of preferred stock (8.5) - (8.5)
Gain on settlement of treasury lock 12.7 - 12.7
Other 3.9 - 13.2 17.1
Net intercompany accounts 906.6 (117.1) (789.5) -
-
----------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities 131.2 (117.1) (580.4) (566.3)
----------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (23.3) 0.5 176.5 153.7
Net Cash Flow from Discontinued Operations - - 4.3 4.3
Cash and Cash Equivalents at Beginning of Period 97.6 1.5 104.2 203.3
----------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 74.3 $ 2.0 $ 285.0 $ 361.3
======================================================================
- -------------------------------------------------------------------------------------------------------------------------------
37
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Executive Summary of Results
The following is a summary of transactions affecting comparative earnings for
the three and nine months ended September 30, 2005, compared to the three and
nine months ended September 30, 2004. Capitalized terms used in the following
discussion, but not otherwise defined, have the same meaning as when used in the
Notes to the Consolidated Financial Statements included under Item 1. References
to "KeySpan," "we," "us," and "our" mean KeySpan Corporation, together with its
consolidated subsidiaries.
The table below summarizes the KeySpan's earnings for the periods indicated.
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended
(In Millions of Dollars, September 30, 2005 September 30, 2004 September 30, 2005 September 30, 2004
Except Per Share Amounts) Earnings E.P.S. Earnings E.P.S. Earnings E.P.S. Earnings E.P.S.
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) from continuing
operations, less preferred stock
dividends $ 22.6 $ 0.13 $ (30.1) $ (0.19) $ 275.0 $ 1.63 $345.0 $ 2.15
Discontinued operations - - (87.0) (0.54) (1.8) (0.01) (86.6) (0.54)
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (Loss) for Common Stock $ 22.6 $ 0.13 $(117.1) $ (0.73) $ 273.2 $ 1.62 $258.4 $ 1.61
- ------------------------------------------------------------------------------------------------------------------------------------
Components of Continuing Operations
Core operations $ 22.6 $ 0.13 $ 4.9 $ 0.03 $ 281.8 $ 1.67 $248.6 $ 1.55
Ceiling test write-down - - - - - - (31.1) (0.19)
Debt redemption costs - - (29.3) (0.18) (6.8) (0.04) (29.3) (0.18)
Impairment charges - - (12.6) (0.08) - - (12.6) (0.08)
Non-core operations - - 6.9 0.04 - - 53.3 0.33
Asset sales - - - - - - 116.1 0.72
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) from continuing
operations, less preferred stock
dividends $22.6 $ 0.13 $ (30.1) $ (0.19) $ 275.0 $ 1.63 $345.0 $ 2.15
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings from Continuing Operations
KeySpan's earnings from continuing operations, less preferred stock dividends
for the three months ended September 30, 2005 were $22.6 million, or $0.13 per
share, compared to a loss of $30.1 million or $0.19 per share incurred during
the corresponding quarter last year. KeySpan's earnings from continuing
operations, less preferred stock dividends for the nine months ended September
30, 2005 were $275.0 million, or $1.63 per share, compared to $345.0 million or
$2.15 per share realized during the same period last year. KeySpan's financial
results for all periods reflect the following items that had a significant
impact on comparative results: (i) asset sales of non-core subsidiaries recorded
in 2004 and their respective results for 2004; (ii) impairment charges recorded
in 2004; and (iii) debt redemption charges recorded in 2005 and 2004.
38
For the first five months of 2004, KeySpan's non-core subsidiaries included its
55% equity ownership interest in The Houston Exploration Company ("Houston
Exploration"), an independent natural gas and oil exploration company based in
Houston, Texas. Further, for the first three months of 2004, KeySpan also held
an approximate 61% investment in certain midstream natural gas assets in Western
Canada through KeySpan Energy Canada Partnership ("KeySpan Canada").
On June 2, 2004, KeySpan exchanged 10.8 million shares of common stock of
Houston Exploration for 100% of the stock of Seneca-Upshur, previously a wholly
owned subsidiary of Houston Exploration. This transaction reduced our interest
in Houston Exploration from 55% to the then current level of 23.5%. The net gain
on the share exchange less deferred tax provisions was $106 million ($150.1
million pre-tax), or $0.66 per share.
On April 1, 2004, KeySpan and KeySpan Facilities Income Fund (the "Fund"), which
previously owned a 39.09% interest in KeySpan Canada, consummated a transaction
whereby the Fund sold 15.617 million units of the Fund and acquired an
additional 35.91% interest in KeySpan Canada from KeySpan. As a result of this
transaction, KeySpan's ownership of KeySpan Canada decreased to 25%. KeySpan
recorded a gain of $22.8 million ($10.1 million after-tax, or $0.06 per share)
on the transaction.
The operations of Houston Exploration were fully consolidated in KeySpan's
Consolidated Financial Statements during the first five months of 2004 and
KeySpan Canada's operations were fully consolidated during the first three
months of 2004. The operations of these companies were accounted for on the
equity method of accounting after the respective stock transactions reduced our
ownership interest in these companies to below 50%. During the three and nine
months ended September 30, 2004, KeySpan's share of the combined earnings of
Houston Exploration and KeySpan Canada, including the gains from the stock
transactions, were $6.9 million or $0.04 per share, and $169.4 million, or $1.05
per share, respectively. KeySpan sold its remaining ownership interest in these
non-core operations in the fourth quarter of 2004.
KeySpan recorded two significant impairment charges during the nine months ended
September 30, 2004 (a goodwill impairment charge recorded in the Energy Services
segment and a ceiling test write-down associated with our gas exploration and
production activities) that resulted in after-tax charges to continuing
operations of $12.6 million, or $0.08 per share for the three months ended
September 30, 2004 and $43.7 million, or $0.27 per share for the nine months
ended September 30, 2004.
In the third quarter of 2004, the Energy Services segment recorded an after-tax
non-cash goodwill impairment charge of $12.6 million, or $0.08 per share in
continuing operations as a result of an evaluation of the carrying value of
goodwill recorded in this segment. That evaluation resulted in a total
impairment charge of $90.4 million after-tax, or $0.56 per share - $12.6 million
of this charge is attributable to continuing operations, while the remaining
$77.8 million, or $0.48 per share, was reflected in discontinued operations.
(See the discussion below under the caption "Earnings Available for Common
Stock" for additional details on discontinued operations.)
39
Also, KeySpan's wholly owned gas exploration and production subsidiaries that
have remained with KeySpan after the Houston Exploration transaction, recorded a
non-cash impairment charge of $48.2 million ($31.1 million after-tax, or $0.19
per share) to recognize the reduced valuation of proved reserves which is
reflected in the nine months ended September 30, 2004.
On January 14, 2005 KeySpan redeemed $500 million 6.15% Series notes due 2006.
KeySpan incurred $20.9 million in call premiums and wrote-off $1.3 million of
previously deferred financing costs. Further, KeySpan accelerated the
amortization of approximately $11.2 million of previously unamortized gains
associated with an interest rate swap on these bonds. The accelerated
amortization of the interest rate swap and the write-off of previously deferred
financing costs were recorded to interest expense on the Consolidated Statement
of Income. The net after-tax charge associated with this transaction was $6.8
million, or $0.04 per share.
In August 2004, KeySpan redeemed approximately $758 million of outstanding
long-term debt. KeySpan incurred $54.5 million in call premiums associated with
this redemption, of which $45.9 was expensed and recorded in other income and
deductions on the Consolidated Statement of Income. The remaining amount of the
call premiums were deferred for future recovery. Further, KeySpan wrote-off $8.2
million of previously deferred financing costs which have been reflected in
interest expense. The total after-tax expense of the debt redemption was $29.3
million or $0.18 per share.
The net impact of the above mentioned items resulted in a decrease to earnings
from continuing operations of $35.0 million, or $0.22 per share for the third
quarter of 2004. For the nine months ended September 30, 2005 the net impact of
the above mentioned items resulted in a decrease to earnings from continuing
operations of $6.8 million, or $0.04 per share compared to gain of $96.4 million
or $0.60 per share for the same period of 2004.
The remaining item impacting comparative earnings from continuing operations is
KeySpan's core operations. As indicated in the above table, KeySpan's earnings
from core operations increased $17.7 million or $0.10 per share in the third
quarter of 2005, primarily reflecting higher earnings from our electric services
operations as well as lower interest charges, offset by lower earnings from our
gas distribution operations. Electric services operations reflect the favorable
results from an increase in net electric revenues principally as a result of
improved pricing due, in part, to the warm weather during the third quarter of
2005.
The decrease in interest expense resulted from the benefits attributable to
lower outstanding debt resulting from debt redemptions in 2004 and the first
quarter of 2005, as well as from the sale of Houston Exploration and KeySpan
Canada. Gas distribution results were impacted by higher operating expenses,
primarily due to an increase in the provision for uncollectible accounts as a
result of increasing gas costs and the adverse impact from recent collection
experience, as well as from an increase in property taxes.
40
For the nine months ended September 30, 2005, KeySpan's earnings from core
operations, less preferred stock dividends, increased $33.2 million, or $0.12
per share compared to the same period of 2004, primarily reflecting higher
earnings from the Electric Services segment, improved results from the Energy
Services segment, and a decrease in interest charges. As noted, KeySpan's
electric services operations benefited from higher pricing due, in part, to the
warm summer weather. Lower operating losses were incurred at the Energy Services
segment as a result of lower operating expenses. These favorable results were
somewhat offset by a decrease in operating income from KeySpan's gas
distribution operations as a result of higher operating expenses, primarily due
to an increase in the provision for uncollectible accounts as a result of
increasing gas costs and the adverse impact from recent collection experience,
as well as from an increase in property taxes.
The full benefit of the favorable operating results of the Electric Services and
Energy Services segments, as well the decrease in interest charges was also
mitigated by the higher level of common shares outstanding. On May 16, 2005,
KeySpan issued 12.1 million shares of common stock upon the conversion of the
MEDs Equity Units. The dilutive effect of this issuance on earnings per share
for the nine months ended September 30, 2005, was approximately $0.07. (See Note
9 to the Consolidated Financial Statements "Long-term Debt and Commercial Paper"
for additional details on the MEDs Equity Units.)
Earnings Available for Common Stock
Earnings available for common stock also include losses from discontinued
operations. For all periods, we have reclassified the operations of KeySpan's
former mechanical contracting subsidiaries as discontinued operations because
these companies were discontinued in the fourth quarter of 2004 and sold in
early 2005. In the fourth quarter of 2004, KeySpan's investment in its
mechanical contracting subsidiaries was written-down to fair value. During the
nine months ended September 30, 2005, operating losses amounting to $4.1 million
after-tax were incurred through the dates of sale of these companies, including,
but not limited to, costs incurred for employee related benefits. Partially
offsetting these losses was a gain of $2.3 million associated with the related
divestitures, reflecting the difference between the fair value estimates and the
financial impact of the actual sale transactions. The net income impact of the
operating losses and the disposal gain was a loss of $1.8 million, or $0.01 per
share for the nine months ended September 30, 2005.
As noted, in the third quarter of 2004, KeySpan conducted an evaluation of the
carrying value of its investments in the Energy Services segment. As a result of
this evaluation, KeySpan recorded a loss in discontinued operations of $87.0
million, or $0.54 per share. This loss reflects the $77.8 million after-tax
impairment charges to reflect a reduction to the carrying value of assets
associated with mechanical contracting activities and operating losses of $9.2
million. For the nine months ended September 30, 2005, KeySpan recorded a loss
in discontinued operations of $86.6 million, or $0.54 per share. This loss
reflects the $77.8 million after-tax impairment charges and operating losses of
$8.8 million.
41
See the discussion under the caption "Review of Operating Segments" for
additional details on KeySpan's operating results.
Consolidated Review of Results
Operating income by segment, as well as consolidated earnings for common stock
is set forth in the following table for the periods indicated.
- --------------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars, Except per Share)
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Gas Distribution $ (45.5) $ (23.6) $ 376.8 $ 391.1
Electric Services 149.6 111.2 266.3 226.3
Energy Services -
Operations (1.1) (4.9) (6.7) (28.4)
Goodwill impairment charge - (14.4) - (14.4)
Energy Investments -
Operations of entities sold - 11.2 - 143.1
Operations of remaining entities 4.7 5.2 16.6 13.4
Ceiling test write-down - - - (48.2)
Eliminations and other (4.9) 2.9 (8.3) 14.5
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 102.8 87.6 644.7 697.4
- --------------------------------------------------------------------------------------------------------------------------------
Other Income and (Deductions)
Interest charges (67.4) (88.3) (200.1) (260.8)
Gain on sale of investments - - 4.1 172.9
Cost of debt redemption - (45.9) (20.9) (45.9)
Minority interest (0.2) - (0.3) (37.0)
Other income and (deductions) (3.6) 4.1 9.7 25.9
- --------------------------------------------------------------------------------------------------------------------------------
(71.2) (130.1) (207.5) (144.9)
- --------------------------------------------------------------------------------------------------------------------------------
Income taxes 9.0 (13.7) 160.0 203.2
- --------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) from continuing operations 22.6 (28.8) 277.2 349.3
Discontinued operations - (87.0) (1.8) (86.6)
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) 22.6 (115.8) 275.4 262.7
Preferred stock dividend requirements - 1.3 2.2 4.3
- --------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) for Common Stock $ 22.6 $ (117.1) $ 273.2 $ 258.4
- --------------------------------------------------------------------------------------------------------------------------------
Basic Earnings (Loss) per Share
Continuing operations, less preferred
stock dividends $ 0.13 $ (0.19) $ 1.63 $ 2.15
Discontinued operations - (0.54) (0.01) (0.54)
- --------------------------------------------------------------------------------------------------------------------------------
$ 0.13 $ (0.73) $ 1.62 $ 1.61
- --------------------------------------------------------------------------------------------------------------------------------
As indicated in the above table, operating income increased $15.2 million, or
17%, for the third quarter of 2005, compared to the third quarter of last year.
The comparative operating results reflect the following two items that had a
significant impact on results: (i) operating results of non-core subsidiaries
recorded in 2004; and (ii) a goodwill impairment charge recorded in 2004. As
noted earlier, during 2004 KeySpan held equity ownership interests in Houston
Exploration and KeySpan Canada. For the three months ended September 30, 2004,
KeySpan's share of the combined operating income of Houston Exploration and
KeySpan Canada was $11.2 million. KeySpan sold its ownership interest in these
42
non-core operations in the fourth quarter of 2004. Also as noted earlier, in the
third quarter of 2004 the Energy Services segment recorded a $14.4 million
non-cash goodwill impairment charge ($12.6 million, or $0.08 per share
after-tax) in continuing operations as a result of an evaluation of the carrying
value of goodwill recorded in this segment. The combined impact of these two
items was a reduction to operating income in the third quarter of 2004 of $3.2
million. KeySpan's core businesses, therefore, posted an increase in operating
income of $12 million for the third quarter of 2005 compared to the third
quarter of 2004 primarily reflecting an increase of $38.4 million in the
Electric Services segment partially offset by a $21.9 million decrease in the
Gas Distribution segment. As mentioned, the favorable results from KeySpan's
electric services operations were due to an increase in net electric revenues as
a result of higher electric prices that were due, in part, to the warm weather
during the third quarter of 2005. Gas distribution results, however, were
adversely impacted by higher operating expenses, primarily due to an increase in
the provision for uncollectible accounts, as well as from an increase in
property taxes.
For the nine months ended September 30, 2005, operating income decreased $52.7
million, or 8% compared to the nine months ended September 30, 2004. Similar to
the analyses of the quarterly results, the comparative operating results for the
nine months ended September 30, 2005, compared to the nine months ended
September 30, 2004 reflect, in part,: (i) operating results of non-core
subsidiaries recorded in 2004; and (ii) the non-cash impairment charges recorded
in 2004. For the nine months ended September 30, 2004, the combined operating
income of Houston Exploration and KeySpan Canada was $143.1 million. Offsetting
this income, to some extent was the non-cash impairment charge of $48.2 million
recorded in June 2004 to recognize the reduced valuation of proved reserves as
previously noted. Also as noted, in the third quarter of 2004, the Energy
Services segment recorded a $14.4 million non-cash goodwill impairment charge.
The combined impact of these items was a benefit to operating income in the nine
months ended September 30, 2004 of $80.5 million.
KeySpan's core businesses, therefore, posted an increase in operating income of
$27.8 million for the nine months ended September 30, 2005 compared to the
corresponding period of 2004 primarily reflecting an increase of $40 million in
the Electric Services segment partially offset by a $14.3 million decrease in
the Gas Distribution segment. As mentioned, the favorable results from KeySpan's
electric services operations reflect an increase in net electric revenues due to
higher electric prices partially as a result of warm weather during the third
quarter of 2005. Gas distribution results, however, were adversely impacted by
higher operating expenses, primarily due to an increase in the provision for
uncollectible accounts receivable, as well as from an increase in property
taxes. (See the discussion under the caption "Review of Operating Segments" for
further details on each segment.)
Other income and (deductions) reflects interest charges, costs associated with
debt redemptions, income from subsidiary stock transactions, minority interest
charges and other miscellaneous items. For the third quarter of 2005 other
income and deductions reflects an expense of $71.2 million compared to an
expense of $130.1 million for the third quarter of 2004. This favorable
variation of $58.9 million is due to lower interest charges of $20.9 million or
43
24%, as well as to debt redemption costs recorded in 2004. As noted earlier, in
August 2004 KeySpan redeemed approximately $758 million of outstanding long-term
debt and incurred $54.5 million in call premiums associated with this
redemption, of which $45.9 million was expensed and recorded in other income and
(deductions) on the Consolidated Statement of Income. The remaining amount of
the call premiums was deferred for future recovery. Further, KeySpan wrote-off
$8.2 million of previously deferred financing costs which have been reflected in
interest expense. Other income and (deductions) for the third quarter of 2005
also reflects a $8.5 million non-cash loss associated with the fair value of
outstanding derivative financial instruments that do not qualify for hedge
accounting treatment. (See Note 4 to the Consolidated Financial Statements,
"Hedging and Derivative Financial Instruments" for additional details on the
non-cash loss associated with the derivative financial instruments.)
For the nine months ended September 30, 2005 other income and (deductions)
reflects an expense of $207.5 million compared to an expense of $144.9 million
for the nine months ended September 30, 2004. This unfavorable variation of
$62.6 is due to significantly smaller gains from asset sales recorded in 2005
compared to 2004, offset by a decrease in interest charges, lower debt
redemption costs and the absence of minority interest charges. In the first
quarter of 2005, KeySpan sold its 50% interest in Premier Transmission Limited
("PTL"), a gas pipeline from southwest Scotland to Northern Ireland and realized
cash proceeds of approximately $48.1 million. In the fourth quarter of 2004,
KeySpan recorded a pre-tax non-cash impairment charge of $26.5 million
reflecting the difference between the anticipated cash proceeds from the sale of
PTL compared to its carrying value. The final sale of PTL resulted in a pre-tax
gain of $4.1 million reflecting the difference from earlier estimates and what
was recorded in the first quarter of 2005.
For the nine months ended September 30, 2004, KeySpan realized $172.9 million
from subsidiary stock transactions. As noted earlier, in June 2004, KeySpan
exchanged 10.8 million shares of common stock of Houston Exploration for 100% of
the stock of Seneca-Upshur, previously a wholly owned subsidiary of Houston
Exploration. The net gain on the share exchange less deferred tax provisions was
$150.1 million ($106 million after-tax, or $0.66 per share). Further, in April
2004, KeySpan sold 35.91% of its interest in KeySpan Canada that resulted in a
gain of $22.8 million ($10.1 million after-tax, or $0.06 per share).
Interest expense decreased $60.7 million, or 23%, for the nine months ended
September 30, 2005, compared to the same period of 2004, reflecting the benefits
attributable to lower outstanding debt resulting from recent debt redemptions,
as well as the sale of Houston Exploration and KeySpan Canada. At September 30,
2005, KeySpan had $3.9 billion of long-term debt outstanding compared to $5.2
billion outstanding at September 30, 2004.
In addition, on January 14, 2005, KeySpan redeemed $500 million 6.15% Series
notes due 2006. KeySpan incurred $20.9 million in call premiums and wrote-off
$1.3 million of previously deferred financing costs. Further, KeySpan
accelerated the amortization of approximately $11.2 million of previously
unamortized benefits associated with an interest rate swap on these bonds. The
accelerated amortization of the interest rate swap and the write-off of
previously deferred financing costs reduced interest expense in 2005 by $9.9
million. As previously noted, in 2004 KeySpan wrote-off $8.2 million of
previously deferred financing costs associated with debt redemptions. Therefore,
the net impact of the 2005 and 2004 debt redemptions lowered comparative
interest expense by $18.1 million.
44
Further, as noted, the call premium associated with the 2005 debt redemption was
$20.9 million compared to $45.9 million associated with the 2004 debt
redemption.
Other income and (deductions) for the nine months ended September 30, 2005, also
reflects a $4.8 million non-cash loss associated with the fair value of
outstanding derivative financial instruments that do not qualify for hedge
accounting treatment. For the nine months ended September 30, 2004 other income
and (deductions) also reflects a $12.6 million gain recorded on the settlement
of a derivative financial instrument entered into in connection with the
sale/leaseback transaction associated with the Ravenswood Expansion. Finally,
other income and (deductions) includes the effects of minority interest of $37.0
million for the nine months ended September 30, 2004 related to our previous
majority ownership interests in Houston Exploration and KeySpan Canada.)
Income tax expense for all periods of 2005 and 2004 generally reflects the level
of pre-tax income. Further, income tax expense for the nine months ended
September 30, 2004, reflects the beneficial tax treatment afforded the stock
transaction with Houston Exploration, as well as a $6.0 million benefit from a
revised appraisal associated with property that was disposed of in 2003.
Earnings from continuing operations for the three months ended September 30,
2005 increased $51.4 million compared to the same period last year, reflecting
the items previously noted - primarily higher operating income associated with
electric service operations, a decrease in interest charges and debt redemption
costs, offset by lower operating income from gas distribution operations. The
increase in earnings available for common stock of $139.7 million, or $0.86 per
share, also reflects losses of $87.0 million incurred in 2004 from discontinued
operations.
Earnings from continuing operations for the nine months ended September 30, 2005
decreased $72.1 million compared to the corresponding period in 2004, reflecting
the items previously noted - the impact from the sale of Houston Exploration and
KeySpan Canada in 2004 and lower earnings from our gas distribution operations,
partially offset by higher earnings from our electric services operations, a
decrease in interest charges and debt redemption costs, and the absence of
non-cash impairment charges recorded in 2004. However, earnings available for
common stock increased $14.8 million, or $0.01 per share reflecting losses of
$86.6 million incurred in 2004 from discontinued operations.
Consistent with our prior earnings guidance, KeySpan's consolidated earnings for
2005 are forecasted to be in the range of $2.30 to $2.40 per share, excluding
special items. Since we sold the majority of our non-core assets in 2004, the
earnings forecast represents earnings from all continuing operations less
preferred stock dividends. Further, the earnings forecast included the dilutive
impact from the conversion of the MEDs Equity Units.
45
Consolidated earnings are seasonal in nature due to the significant contribution
to earnings of our gas distribution operations. As a result, we expect to earn
most of our annual earnings in the first and fourth quarters of our fiscal year.
Review of Operating Segments
- ----------------------------
KeySpan reports its segment results on an Operating Income basis. Management
believes that this Generally Accepted Accounting Principle (GAAP) based measure
provides a reasonable indication of KeySpan's underlying performance associated
with its operations. The following is a discussion of financial results achieved
by KeySpan's operating segments presented on an operating income basis.
Gas Distribution
KeySpan Energy Delivery New York ("KEDNY") provides gas distribution service to
customers in the New York City Boroughs of Brooklyn, Staten Island and a portion
of Queens, and KeySpan Energy Delivery Long Island ("KEDLI") provides gas
distribution service to customers in the Long Island counties of Nassau and
Suffolk and the Rockaway Peninsula of Queens County. Four gas distribution
companies - Boston Gas Company, Colonial Gas Company, Essex Gas Company, and
EnergyNorth Natural Gas Inc., each doing business under the name KeySpan Energy
Delivery New England ("KEDNE"), provide gas distribution service to customers in
Massachusetts and New Hampshire.
The table below highlights certain significant financial data and operating
statistics for the Gas Distribution segment for the periods indicated.
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------
Revenues $ 629.6 $ 419.2 $ 3,476.1 $ 3,023.4
Cost of gas 399.8 186.6 2,214.9 1,776.3
Revenue taxes 7.8 7.2 43.0 52.3
- ------------------------------------------------------------------------------------------------------------------------------
Net Revenues 222.0 225.4 1,218.2 1,194.8
- ------------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 162.9 148.8 519.8 489.4
Depreciation and amortization 63.5 63.4 207.4 207.1
Operating taxes 41.1 36.8 114.2 107.2
- ------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 267.5 249.0 841.4 803.7
- ------------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) $ (45.5) $ (23.6) $ 376.8 $ 391.1
- ------------------------------------------------------------------------------------------------------------------------------
Firm gas sales and transportation (MDTH) 28,020 26,576 228,260 229,360
Transportation - Electric Generation (MDTH) 9,756 13,304 21,188 26,077
Other Sales (MDTH) 47,937 30,454 142,398 111,123
Warmer (Colder) than Normal - New York N/A N/A (2.5%) (3%)
Warmer (Colder) than Normal - New England N/A N/A (11.5%) (9%)
- ------------------------------------------------------------------------------------------------------------------------------
A MDTH is 10,000 therms (British Thermal Units) and reflects the heating content
of approximately one million cubic feet of gas. A therm reflects the heating
content of approximately 100 cubic feet of gas. One billion cubic feet (BCF) of
gas equals approximately 1,000 MDTH.
46
Executive Summary
The Gas Distribution segment incurred a seasonal operating loss of $45.5 million
in the third quarter of 2005 compared to loss of $23.6 million incurred last
year. The decrease in comparative operating results of $21.9 million primarily
reflects higher operating expenses of $18.5 million. The increase in operating
expenses was mainly due to an increase in the provision for uncollectible
accounts as a result of higher gas costs and the adverse impact from recent
collection experience, as well as from higher property taxes.
Operating income decreased $14.3 million for the nine months ended September 30,
2005 compared to the same period last year, again due to higher operating
expenses. Operating expenses increased $37.7 million reflecting an increase in
the provision for uncollectible accounts, as well as higher property taxes.
Partially offsetting the higher operating expenses was an increase of $23.4
million in net gas revenues (revenues less the cost of gas and associated
revenue taxes) resulting from customer additions and oil-to-gas conversions in
our firm gas sales market, as well as from higher net gas revenues in our
large-volume heating markets.
Net Revenues
Net gas revenues from our gas distribution operations increased by $23.4
million, or 2%, for the nine months ended September 30, 2005 compared to the
same period last year. Net gas revenues benefited from customer additions and
oil-to-gas conversions in our firm gas sales market (residential, commercial and
industrial customers), as well as from higher net gas revenues in our
large-volume heating and interruptible (non-firm) markets. As measured in
heating degree days, weather for the nine months ended September 30, 2005 in our
New York and New England service territories was approximately 2.5% and 11.5%
colder than normal, respectively. Compared to last year, weather was
approximately 1.6% warmer than last year in KeySpan's New York service
territory, but 2.3% colder than last year in KeySpan's New England service
territory.
Net revenues from firm gas customers increased $6.1 million for the nine months
ended September 30, 2005 compared to the same period last year. Customer
additions and oil-to-gas conversions, net of attrition and conservation, added
$11.9 million to net gas revenues. Further, we realized a benefit of $3.5
million as a result of the Boston Gas Company's Performance Based Rate Plan (the
"Plan") that was approved by the Massachusetts Department of Telecommunications
and Energy ("MADTE") in 2003. The Plan provides for firm gas sales rates to be
adjusted each year based on an inflation factor offset by a productivity factor.
(See the caption under "Regulation and Rate Matters" for further information
regarding the rate filing.)
Offsetting, to some extent, the beneficial impact of the customer additions and
oil-to-gas conversions was the adverse impact to comparative net gas revenues
from the additional billing day last year due to the leap year. In 2004, KeySpan
realized $5.9 million in additional net gas revenues from the additional billing
day. Further, KeySpan earned $8.9 million less in regulatory incentives for the
nine months ended September 30, 2005 compared to the same period last year.
47
Also included in net revenues is the recovery of certain regulatory items and
certain taxes that combined added $5.1 million to net revenues. However, the
recovery of these items through revenues does not impact net income since we
expense a similar amount as amortization charges and income taxes, as
appropriate on the Consolidated Statement of Income. Firm gas distribution rates
for KEDNY, KEDLI and KEDNE in 2005, other than for the recovery of gas costs and
as noted, have remained substantially unchanged from rates charged in 2004.
KEDNY and KEDLI each operate under a utility tariff that contains a weather
normalization adjustment that significantly offsets variations in firm net
revenues due to fluctuations in normal weather. However, the gas distribution
operations of our New England based subsidiaries do not have a weather
normalization adjustment. To mitigate the effect of fluctuations in normal
weather patterns on KEDNE's results of operations and cash flows, weather
derivatives were in place for the 2004/2005 winter heating season. These
financial derivatives afforded KeySpan some protection against warmer than
normal weather. As a result of the weather normalization adjustments and
financial weather derivatives, weather had an immaterial impact on comparative
net gas revenues. (See Note 4 to the Consolidated Financial Statements "Hedging
and Derivative Financial Instruments" for further information on derivative
transactions.)
In our large-volume heating and interruptible (non-firm) markets, which include
large apartment houses, government buildings and schools, gas service is
provided under rates that are designed to compete with prices of alternative
fuel, including No. 2 and No. 6 grade heating oil. These "dual-fuel" customers
can consume either natural gas or fuel oil for heating purposes. Net revenues in
these markets increased $17.3 million during the nine months ended September 30,
2005, compared to the same period last year, primarily reflecting higher
pricing. Further, since weather during January 2004 was significantly colder
than normal, KeySpan discontinued sales service to a segment of its dual-fuel
customers for a number of days during the month, as permitted under its tariff,
to ensure reliable service to firm customers. The majority of interruptible
profits earned by KEDNE and KEDLI are returned to firm customers as an offset to
gas costs.
Firm Sales, Transportation and Other Quantities
Firm gas sales and transportation quantities for the nine months ended September
30, 2005 decreased slightly from the same period of 2004. Net revenues are not
affected by customers opting to purchase their gas supply from other sources,
since delivery rates charged to transportation customers generally are the same
as delivery rates charged to full sales service customers. Transportation
quantities related to electric generation reflect the transportation of gas to
our electric generating facilities located on Long Island. Net revenues from
transportation services are not material.
Other sales quantities include on-system interruptible quantities, off-system
sales quantities (sales made to customers outside of our service territories)
and related transportation. We had an agreement with Coral Resources, L.P.
("Coral"), a subsidiary of Shell Oil Company, under which Coral assisted in the
origination, structuring, valuation and execution of energy-related transactions
48
on behalf of KEDNY and KEDLI. This agreement expired on March 31, 2005 and these
services are now performed by KeySpan employees. We also have a portfolio
management contract with Merrill Lynch Trading, under which Merrill Lynch
Trading provides all of the city gate supply requirements at market prices and
manages certain upstream capacity, underground storage and term supply contracts
for KEDNE. This agreement expires on March 31, 2006, and we are exploring
options with respect to the services currently provided under this contract.
Purchased Gas for Resale
The increase in gas costs for the nine months ended September 30, 2005, compared
to the same period of 2004, of $438.6 million, or 25%, reflects an increase of
12% in the price per dekatherm of gas purchased for firm gas sales customers, as
well as an increase in the quantity of gas purchased for large-volume heating
and interruptible (non-firm) customers. The current gas rate structure of each
of our gas distribution utilities includes a gas adjustment clause, pursuant to
which variations between actual gas costs incurred for resale to firm sales
customers and gas costs billed to firm sales customers are deferred and refunded
to or collected from customers in a subsequent period.
Operating Expenses
Operating expenses during the third quarter of 2005 compared to the same quarter
last year increased $18.5 million, or 7%. Operations and maintenance expense
increased $14.1 million, or 9%, in 2005 compared to 2004 primarily due to an
increase of $8.1 million in the provision for uncollectible accounts as a result
of increasing gas costs and the adverse impact from recent collection
experience. Further, in 2004 KeySpan recognized a benefit of approximately $2
million, net of amounts subject to regulatory deferral treatment, associated
with the implementation of the Medicare Prescription Drug Improvement and
Modernization Act of 2003 ("Medicare Act") and implementation of Financial
Accounting Standards Board Staff Position ("FSP") 106-2. In addition, in
September 2004, Boston Gas Company reached an agreement with an insurance
carrier for recovery of previously incurred environmental expenditures. Under a
previously issued MADTE rate order, insurance and third-party recoveries, after
deducting legal fees, are shared between Boston Gas and its firm gas customers.
As a result of the insurance agreement, in September 2004 Boston Gas recorded a
$5 million benefit to operations and maintenance expense. The comparative
increase in operating taxes was due to the expiration, in July 2005, of a
five-year property tax assessment agreement with New York City.
For the nine months ended September 30, 2005, operating expenses increased $37.7
million, or 5% compared to the same period last year. Operations and maintenance
expense increased $30.4 million, or 6%, in 2005 compared to 2004 primarily due
to an increase of $20.0 million in the provision for uncollectible accounts as a
result of increasing gas costs and the adverse impact from recent collection
experience. In addition, as noted above, in 2004 KeySpan recognized a $2 million
benefit associated with the implementation of the Medicare Act and a $5 million
benefit associated with environmental insurance recoveries. Further, the gas
distribution operations realized an increase in insurance and regulatory fees in
49
2005 compared to 2004. Comparative operating taxes increased $7.0 million due to
the expiration of a five-year property tax assessment agreement with New York
City, as noted, as well as to a $2.5 million property tax refund received in
2004. Higher depreciation charges of $4.3 million reflecting the continued
expansion of the gas distribution system were offset by lower regulatory
amortization charges of $4.1 million
Gas Supply and Pricing
KeySpan anticipates having enough gas supply to fully meet its gas load demand
in its service territories for this coming winter heating season. KeySpan's gas
storage is on target to be 100% full by the start of the 2005/2006 winter
heating season. The current gas rate structure of each of our gas distribution
utilities includes a gas adjustment clause, pursuant to which gas costs are
recovered in billed sales to regulated firm gas sales customers. Although
KeySpan is allowed to "pass through" the cost of gas to its customers,
management is concerned with the rising natural gas prices and the related
impact on customers' gas bills and recovery of customer accounts receivable. As
noted, KeySpan has already experienced an increase in bad debt expense and an
increase in collection lag. Also, it is likely that the high gas prices will
lead to an increase in price elasticity possibly resulting in an increase in
customer conservation measures and attrition. With our strategy of having
KeySpan's storage facilities 100% full by the start of the heating season and
the financial derivatives KeySpan currently has in place, KeySpan has
effectively hedged the price of approximately two-thirds of the gas supply
needed to serve its customers during the upcoming 2005/2006 winter. This will
help mitigate the full impact from rising natural gas prices on customers'
winter-heating gas bills. Further, KeySpan has programs in place to help
customers manage their gas bills, such as balanced billing plans, deferred
payment arrangements and the Low Income Home Energy Assistance Program, which we
worked to expand through the Energy Policy Act of 2005. Management believes that
these measures will mitigate the full impact of rising gas prices on customers'
bills.
Other Matters
We remain committed to our ongoing gas system expansion strategies. We believe
that significant growth opportunities exist on Long Island and in our New
England service territories as well as continued growth in the New York service
territory, despite the rising gas prices. We estimate that on Long Island
approximately 37% of the residential and multi-family markets, and approximately
55% of the commercial market, currently use natural gas for space heating.
Further, we estimate that in our New England service territories approximately
50% of the residential and multi-family markets, as well as the commercial
market, currently use natural gas for space heating purposes. We will continue
to seek growth, in all our market segments, through the expansion of our gas
distribution system for new construction and to penetrate existing communities
where no distribution system exists, as well as through the conversion of
residential homes from oil-to-gas for space heating purposes where natural gas
is already in the home for other uses and the pursuit of opportunities to grow
multi-family, industrial and commercial markets.
50
In order to serve the anticipated market requirements in our New York service
territories, KeySpan and Duke Energy Corporation formed Islander East Pipeline
Company, LLC ("Islander East") in 2000. Once in service, the pipeline is
expected to transport up to 260,000 DTH daily to the Long Island and New York
City energy markets, enough natural gas to heat 600,000 homes. In addition, in
2004 KeySpan acquired a 21% interest in the Millennium Pipeline development
project which is anticipated to transport up to 525,000 DTH of natural gas a day
to the Algonquin pipeline. Once constructed, KeySpan anticipates contracting for
150,000 DTH per day of transportation capacity from the Millennium Pipeline
system. These pipeline projects will also allow KeySpan to diversify the
geographic sources of its gas supply. See the discussion under the caption
"Energy Investments" for additional information regarding these pipeline
projects.
Electric Services
The Electric Services segment primarily consists of subsidiaries that own and
operate oil and gas fired electric generating plants in the Borough of Queens
(including the "Ravenswood Generating Station") and the counties of Nassau and
Suffolk on Long Island. In addition, through long-term contracts of varying
lengths, we manage the electric transmission and distribution ("T&D") system,
the fuel and electric purchases, and the off-system electric sales for LIPA. The
Electric Services segment also provides retail marketing of electricity to
commercial customers.
Selected financial data for the Electric Services segment is set forth in the
table below for the periods indicated.
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------
Revenues $ 619.9 $ 503.9 $ 1,493.5 $ 1,296.8
Purchased fuel 254.2 175.9 546.0 407.6
- --------------------------------------------------------------------------------------------------------------------
Net Revenues 365.7 328.0 947.5 889.2
- --------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 150.6 153.7 480.8 472.9
Depreciation 21.5 21.6 67.6 65.6
Operating taxes 45.0 41.5 133.8 124.4
- --------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 217.1 216.8 682.2 662.9
- --------------------------------------------------------------------------------------------------------------------
Sale of Property 1.0 - 1.0 -
- --------------------------------------------------------------------------------------------------------------------
Operating Income $ 149.6 $ 111.2 $ 266.3 $ 226.3
- --------------------------------------------------------------------------------------------------------------------
Electric sales (MWH)* 2,351,722 2,177,030 4,798,239 4,807,667
Capacity(MW)* 2,450 2,450 2,450 2,450
Cooling degree days 1,125 751 1,438 1,051
- --------------------------------------------------------------------------------------------------------------------
*Reflects the operations of the Ravenswood Generating Station only.
Executive Summary
Operating income increased $38.4 million, or 35% for the three months ended
September 30, 2005, compared to the same quarter last year, due to an increase
in net revenues from the Ravenswood Generating Station of $39.1 million
principally as a result of improved pricing.
51
For the nine months ended September 30, 2005, operating income increased $40.0
million compared to the same period last year, due primarily to an increase in
net revenues from the Ravenswood Generating Station of $56.3 million primarily
as a result of improved pricing, partially offset by an increase in operating
lease costs associated with Ravenswood Expansion of $7.5 million, as well as
lower net revenues associated with KeySpan's retail electric marketing
activities of $7.2 million
Net Revenues
Total electric net revenues realized during the third quarter of 2005 were $37.7
million, or 12% higher than such revenues realized during the corresponding
quarter last year. For the nine months ended September 30, 2005, total electric
net revenues were $58.3 million, or 7% higher than such revenues realized during
the same period of 2004.
Net revenues from the Ravenswood Generating Station increased $39.1 million, or
31% for the three months ended September 30, 2005, compared to the same period
last year reflecting higher energy margins of $34.1 million, as well as
increased capacity revenues of $5.0 million. The increase in capacity revenues
primarily reflects load growth in New York City and slightly higher summer
pricing.
The increase in energy margins for the third quarter of 2005, reflects an
increase of 56% in realized "spark-spreads" (the selling price of electricity
less the cost of fuel, plus hedging gains or losses), as well as from an
increase of 8% in the level of megawatt hours ("MWh") sold into the New York
Independent System Operator ("NYISO") energy market. Management believes these
favorable energy results were primarily driven by the warm summer weather, as
well as the pricing differential between number 6-grade fuel oil and natural gas
used in the Ravenswood Generating Station in the third quarter of 2005. Weather
for the third quarter of 2005, as measured in cooling degree days, was 50%
warmer than last year. Due to the duel-fuel nature of the Ravenswood Generating
Station, KeySpan's generating units were able to take advantage of their ability
to switch to cheaper fuel as the gap between oil and gas prices spread during
the latter part of the 2005 summer. The two hurricanes experienced this past
summer in the Gulf Coast of the United States contributed to the current gap
between number 6-grade fuel oil and natural gas prices.
For the nine months ended September 30, 2005, net revenues from the Ravenswood
Generating Station increased $56.3 million, or 20%, compared to the same period
last year reflecting higher energy margins of $41.0 million, as well as
increased capacity revenues of $15.3 million. The increase in capacity revenues
primarily reflects the operation of the Ravenswood Expansion which went into
full commercial operation in May 2004, as well as load growth in New York City.
The increase in energy margins for the nine months ended September 30, 2005,
reflects an increase of 42% in realized spark-spreads. The level of megawatt
hours ("MWh") sold into the NYISO energy market during the nine months ended
September 30, 2005 was essentially the same as last year. Weather for the nine
months ended September 30, 2005, as measured in cooling degree days, was 37%
warmer than last year. Again, these favorable energy results were primarily
52
driven by the warm summer weather, as well as the pricing differential between
number 6-grade fuel oil and natural gas used in the Ravenswood Generating
Station in 2005. However, in the second quarter of 2005, the Ravenswood
Generating Station experienced a comparative decrease in electric sales
quantities between the second quarter of 2005 and the second quarter of 2004 due
to the extremely cool weather for the month of May. The comparative decrease in
sales quantities for the second quarter of 2005 was not fully recovered by the
increase in comparative sales quantities experienced in the third quarter of
2005.
We employ derivative financial hedging instruments to hedge the cash flow
variability for a portion of forecasted purchases of natural gas and fuel oil
consumed at the Ravenswood Generating Station. Further, we have engaged in the
use of derivative financial hedging instruments to hedge the cash flow
variability associated with a portion of forecasted electric energy sales from
the Ravenswood Generating Station. These derivative instruments resulted in
hedging losses, which are reflected in net electric margins, of $11.8 million
during the third quarter of 2005 compared to hedging gains of $21.4 million for
the third quarter of 2004. For the nine months ended September 30, 2005,
derivative instruments resulted in hedging losses of $4.5 million compared to
hedging gains of $18.6 million for the corresponding period of 2004. The results
derived from KeySpan's hedging strategy are reflected in the calculation of
realized spark-spreads. (See Note 4 to the Consolidated Financial Statements
"Hedging and Derivative Financial Instruments" for further information on
KeySpan's hedging strategy.)
The rules and regulations for capacity, energy sales and the sale of certain
ancillary services to the NYISO energy markets continue to evolve and there are
several matters pending with the Federal Energy Regulatory Commission ("FERC").
See the discussion under the caption "Market and Credit Risk Management
Activities" for further details on these matters.
Net revenues for the third quarter of 2005 from the service agreements with
LIPA, including the power purchase agreements associated with two electric
peaking facilities, were generally in-line with the third quarter of 2004.
For the nine months ended September 30, 2005, net revenues from the service
agreements with LIPA, including the power purchase agreements associated with
two electric peaking facilities, increased $9.2 million compared to the
corresponding period of 2004. The increase is due, in part, to recovery of
depreciation charges and property taxes of approximately $7.0 million. The
remaining increase primarily reflects the timing of certain incentives earned on
these agreements and an increase in emission credits earned.
(For a description of the LIPA Agreements and power purchase agreements, see
KeySpan's 2004 Annual Report on Form 10-K for the Year Ended December 31, 2004
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations under the caption "Electric Services - Revenue Mechanisms.")
53
Net revenues associated with KeySpan's curtailed retail electric marketing
activities decreased $0.7 million and $7.2 million for the three and nine months
ended September 30, 2005, respectively, compared to the same periods in 2004.
Operating Expenses
Operating expenses in total were essentially the same for the third quarter of
2005 compared to the third quarter of 2004. Operations and maintenance expense
was $3.1 million, or 2% below last year, reflecting the timing of repair and
maintenance work performed on LIPA's behalf. The higher operating taxes
primarily reflect an increase in property taxes, which are fully recoverable
from LIPA. (See Note 6 to the Consolidated Financial Statements "Financial
Guarantees and Contingencies" for additional information regarding the financing
arrangement for the Ravenswood Expansion.)
For the nine months ended September 30, 2005, operating expenses increased $19.3
million, or 3%, compared to the same period last year. Operations and
maintenance expense increased $7.9 million, or 2% over last year reflecting an
increase of $7.5 million in operating lease costs associated with our financing
arrangement for the Ravenswood Expansion. The increase in depreciation expense
is associated with KeySpan's Long Island based electric generating units and is
fully recoverable from LIPA. The higher operating taxes primarily reflect an
increase in property taxes which are also fully recoverable from LIPA.
Other Matters
In 2003, the New York State Board on Electric Generation Siting and the
Environment issued an opinion and order which granted a certificate of
environmental capability and public need for a 250 MW combined cycle electric
generating facility in Melville, Long Island, which is now final and
non-appealable. Also in 2003, LIPA issued a Request for Proposal ("RFP") seeking
bids from developers to either build and operate a Long Island generating
facility, and/or a new cable that will link Long Island to dedicated off-Long
Island power of between 250 to 600 MW of electricity by no later than the summer
of 2007. KeySpan filed a proposal in response to LIPA's RFP. In 2004, LIPA
selected proposals submitted by two other bidders in response to the RFP.
KeySpan remains committed to the Melville project and the benefits to Long
Island's energy future that this project would supply. The project has received
New York State Article X approval by having met all operational and
environmental permitting requirements. Further, the project is strategically
located in close proximity to both the high voltage power transmission grid and
the high pressure gas distribution network. At September 30, 2005, total
capitalized costs associated with the siting, permitting and procurement of
equipment for the Melville facility were $60.6 million.
LIPA is in the process of performing a long-term strategic review of its future
direction. Some of the options that LIPA is considering include whether LIPA
should continue its operations as they presently exist, fully municipalize or
privatize, or sell some, but not all of its assets. LIPA was initially required
to make a determination by May 2005 as to whether it would exercise its option
54
to purchase our Long Island generating plants pursuant to the terms of the
Generation Purchase Rights Agreement. KeySpan and LIPA have mutually agreed to
extend the date by which LIPA must make this determination to December 15, 2005.
LIPA and KeySpan are engaged in discussions concerning LIPA's strategic review.
At this time, we are unable to determine what the outcome of this strategic
review will have on the Melville project, or more broadly, our Electric Services
segment.
In March 2005, the New York Power Authority ("NYPA") issued a RFP for long-term
New York City capacity and energy to meet the needs of its customers at prices
that are economical, stable and predictable over the long run. In June 2005,
KeySpan submitted a non-binding bid in response to NYPA's RFP in which we
proposed to construct a 500 MW, combined cycle, natural gas fired power plant to
be located in New York City which could provide energy and capacity to NYPA. The
proposed facility could be in commercial operation by June 2009. We cannot
predict the outcome or the timing of any decisions by NYPA on this matter at
this time.
As part of our growth strategy, we continually evaluate the possible acquisition
and development of additional generating facilities in the Northeast, as well as
other assets to complement our core operations. However, we are unable to
predict when or if any such facilities will be acquired and the effect any such
acquired facilities will have on our financial condition, results of operations
or cash flows.
The NYISO's New York City local reliability rules currently require that 80% of
the electric capacity needs of New York City be provided by "in-City"
generators. Our Ravenswood Facility is an "in-City" generator. As the electric
infrastructure develops and the demand for electric power increases over time in
New York City and the surrounding areas, the requirement that 80% of in-City
load be served by the in-City generators could be modified. Construction of new
transmission and generation facilities could also cause significant changes to
the market for sales of capacity, energy and ancillary services from our
Ravenswood generating facility. KeySpan currently anticipates that approximately
1,000 MW of new capacity may be available during 2006 as a result of the
completion of in-City generation projects currently under construction. We can
not, however, be certain as to when the new power plants will be in operation or
the nature of future New York City energy, capacity or ancillary services market
requirements or design. Accordingly, we are unable to determine the impact, if
any, the foregoing could have on our financial condition or results of
operation.
Energy Services
The Energy Services segment includes companies that provide energy-related
services to customers located primarily within the Northeastern United States,
with concentrations in the New York City and Boston metropolitan areas through
the following lines of business: (i) Home Energy Services, which provides
residential and small commercial customers with service and maintenance of
energy systems and appliances; and (ii) Business Solutions, which provides
operation and maintenance, design, engineering, consulting and fiber optic
services to commercial, institutional and industrial customers.
55
In January and February of 2005, KeySpan sold its mechanical contracting
subsidiaries. The operating results and financial position of these companies,
which were previously consolidated within the Energy Services segment, have been
reflected as discontinued operations on the Consolidated Statement of Income,
Consolidated Balance Sheet and Consolidated Statement of Cash Flows.
In the fourth quarter of 2004, KeySpan's investment in its mechanical
contracting subsidiaries was written-down to an estimated fair value. During the
nine months ended September 30, 2005, operating losses were incurred through the
dates of sale of these companies of $4.1 million after-tax, including, but not
limited to, costs incurred for employee related benefits. Partially offsetting
these losses was a gain of $2.3 million associated with the related
divestitures, reflecting the difference between the fair value estimates and the
financial impact of the actual sale transactions. The net income impact of the
operating losses and the disposal gain was a loss of $1.8 million, or $0.01 per
share for the nine months ended September 30, 2005. (See Note 2 to the
Consolidated Financial Statements "Business Segments" for additional details on
the sale of the mechanical companies.)
The table below highlights selected financial information associated with Energy
Service's continuing businesses.
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 47.1 $ 46.6 $ 142.0 $ 138.0
Operating expenses 48.2 51.5 148.7 166.4
Goodwill impairment charge - 14.4 - 14.4
- --------------------------------------------------------------------------------------------------------------------------------
Operating (Loss) $ (1.1) $ (19.3) $ (6.7) $ (42.8)
- --------------------------------------------------------------------------------------------------------------------------------
The Energy Services segment incurred an operating loss of $1.1 million for the
third quarter of 2005 compared to a loss of $19.3 million for the same quarter
last year. For the nine months ended September 30, 2005, the Energy Services
segment incurred operating losses of $6.7 million compared to $42.8 million for
the same period last year. As noted earlier, in September 2004, KeySpan recorded
a non-cash goodwill impairment charge of $122.2 million ($90.4 million after -
tax or $0.56 per share) as a result of an evaluation of the carrying value of
goodwill recorded in this segment - $14.4 million of this charge was recorded in
continuing operations, with the remaining $107.8 impairment charge recorded as
discontinued operations.
The improved performance for the third quarter of 2005 compared to the third
quarter of 2004, excluding the goodwill impairment charge is attributable to:
(i) an increase in gross profit margins at Business Solutions; (ii) lower
operating costs at Home Energy Services; and (iii) generally lower
administrative costs.
56
For the nine months ended September 30, 2005, the improved performance over last
year, excluding the goodwill impairment charge, primarily reflects a reduction
in operating expenses. In 2004, the Home Energy Services operations incurred
charges associated with the write-off of accounts receivable and contract
revenues on certain projects that were determined to be uncollectible, as well
as the write-down of inventory balances. Further, the Business Solutions
companies have experienced an increase in gross profit margins and the segment
has incurred generally lower administrative costs in 2005.
Energy Investments
The Energy Investments segment consists of our gas exploration and production
investments, as well as certain other domestic energy-related investments.
KeySpan's gas exploration and production activities include its wholly-owned
subsidiaries Seneca Upshur Petroleum, Inc. ("Seneca-Upshur") and KeySpan
Exploration and Production, LLC ("KeySpan Exploration"). Seneca-Upshur is
engaged in gas exploration and production activities primarily in West Virginia.
KeySpan Exploration is primarily engaged in a joint venture with Houston
Exploration.
This segment is also engaged in pipeline development activities. KeySpan
and Duke Energy Corporation each own a 50% interest in Islander East. Islander
East was created to pursue the authorization and construction of an interstate
pipeline from Connecticut, across Long Island Sound, to a terminus near
Shoreham, Long Island. Further, KeySpan has a 21% interest in the Millennium
Pipeline project which is expected to transport up to 525,000 DTH of natural gas
a day from Corning to Ramapo, New York, where it will connect to an existing
pipeline. Additionally, subsidiaries in this segment hold a 20% equity interest
in the Iroquois Gas Transmission System LP, a pipeline that transports Canadian
gas supply to markets in the Northeastern United States. These subsidiaries are
accounted for under the equity method of accounting. Accordingly, equity income
from these investments is reflected as a component of operating income in the
Consolidated Statement of Income. KeySpan also owns a 600,000 barrel liquefied
natural gas storage and receiving facility in Providence, Rhode Island, through
its wholly owned subsidiary KeySpan LNG, the operations of which are fully
consolidated. KeySpan LNG is re-evaluating its plans to upgrade its LNG facility
in Providence, Rhode Island in light of the FERC decision in June 2005 to deny
KeySpan LNG's application for FERC authorization to expand the facility to
accept marine deliveries and triple vaporization capacity. KeySpan filed its
rehearing request with the FERC in August 2005. On September 6, 2005, the FERC
issued an order granting rehearing for the purpose of further consideration. As
of September 30, 2005, our investment in this project was $14.2 million.
During the first quarter of 2004, we also had an approximate 61% investment in
certain midstream natural gas assets in Western Canada through KeySpan Energy
Canada Partnership ("KeySpan Canada"). These assets included 14 processing
plants and associated gathering systems that produced approximately 1.5 BCFe of
natural gas daily and provided associated natural gas liquids fractionation.
These operations were fully consolidated in KeySpan's Consolidated Financial
Statements. On April 1, 2004, KeySpan reduced its ownership interest in KeySpan
Canada to 25%. The transaction resulted in a gain of $22.8 million ($10.1
million after-tax, or $0.06 per share). Effective April 1, KeySpan Canada's
earnings and our ownership interest in KeySpan Canada were accounted for on the
equity method of accounting. In the fourth quarter of 2004 KeySpan, sold its
remaining interests in KeySpan Canada. (See Note 2 to the Consolidated Financial
Statements "Business Segments" for additional details regarding this
transaction.)
57
Selected financial data and operating statistics for these energy-related
investments are set forth in the following table for the periods indicated.
These results exclude the results of Houston Exploration.
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 11.9 $ 10.1 $ 30.7 $ 49.8
Less: Operation and maintenance expense 7.0 7.0 19.0 29.5
Ceiling test write-down - - - 48.2
Other operating expenses 2.7 2.9 7.7 12.0
Add: Equity earnings 2.5 6.4 12.5 17.4
Sale of assets - - 0.1 -
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) $ 4.7 $ 6.6 $ 16.6 $ (22.5)
- --------------------------------------------------------------------------------------------------------------------------------
Operating income above reflects 100% of KeySpan Canada's results from
January 1, 2004 through April 1, 2004.
As indicated in the above table, operating income for the Energy Investments
segment decreased $1.9 million in the third quarter of 2005 compared to the
corresponding quarter last year primarily reflecting the sale of KeySpan Canada
in 2004. Operating income for the three months ended September 30, 2004 includes
$1.4 million in earnings from KeySpan Canada.
For the nine months ended September 30, 2005 operating income for this segment
increased $39.1 million compared to the same period of 2004, reflecting the
$48.2 million non-cash impairment charge recorded last year. As noted earlier,
in June 2004, KeySpan's wholly owned gas exploration and production subsidiaries
that have remained with KeySpan after the Houston Exploration sale, recorded a
non-cash impairment charge of $48.2 million ($31.1 million after-tax, or $0.19
per share) to recognize the reduced valuation of proved reserves.
Operating income for the nine months ended September 30, 2004, also includes
$12.3 million in earnings from KeySpan Canada. The remaining activities
reflected an increase in operating income of $3.2 million primarily associated
with lower overhead costs, operating income from Seneca-Upshur and higher
earnings from our investment in the Iroquois Gas Transmission System LP.
In the first quarter of 2005, KeySpan sold its 50% interest in Premier
Transmission Limited ("PTL"), a gas pipeline from southwest Scotland to Northern
Ireland. In February 2005, KeySpan entered into a Share Sale and Purchase
Agreement with BG Energy Holdings Limited and Premier Transmission Financing
Public Limited Company ("PTFPL"), pursuant to which all of the outstanding
shares of PTL were to be purchased by PTFPL. On March 18, 2005, the sale was
completed and generated cash proceeds of $48.1 million. In the fourth quarter of
2004, KeySpan recorded a pre-tax non-cash impairment charge of $26.5 million
reflecting the difference between the anticipated cash proceeds from the sale of
PTL compared to its carrying value. The final sale of PTL resulted in a pre-tax
gain of $4.1 million reflecting the difference from earlier estimates. This gain
was recorded in other income and (deductions) on the Consolidated Statement of
Income.
58
During the first five months of 2004, our gas exploration and production
investments also included a 55% equity interest in Houston Exploration, the
operations of which were fully consolidated in KeySpan's Consolidated Financial
Statements. On June 2, 2004, KeySpan exchanged 10.8 million shares of common
stock of Houston Exploration for 100% of the stock of Seneca-Upshur, previously
a wholly owned subsidiary of Houston Exploration. This transaction reduced our
interest in Houston Exploration from 55% to the then current level of 23.5%.
Effective June 1, 2004, Houston Exploration's earnings and our ownership
interest in Houston Exploration were accounted for on the equity method of
accounting. This transaction resulted in a gain to KeySpan after deferred tax
provisions of $106 million, or $0.66 per share. In the fourth quarter of 2004
KeySpan sold its remaining interests in Houston Exploration.
Selected financial data and operating statistics for Houston Exploration are set
forth in the following table.
- ---------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended Ended
(In Millions of Dollars) September 30, 2004 September 30, 2004
- ---------------------------------------------------------------------------------------------------
Revenues $ - $ 268.1
Depletion and amortization expense - 104.6
Other operating expenses - 45.6
Add: Equity Earnings 9.8 12.9
- ---------------------------------------------------------------------------------------------------
Operating Income $ 9.8 $ 130.8
- ---------------------------------------------------------------------------------------------------
Other Matters
In order to serve the anticipated market requirements in our New York service
territories, KeySpan and Duke Energy Corporation formed Islander East Pipeline
Company, LLC ("Islander East") in 2000. Islander East is owned 50% by KeySpan
and 50% by Duke Energy, and was created to pursue the authorization and
construction of an interstate pipeline from Connecticut, across Long Island
Sound, to a terminus near Shoreham, Long Island. Applications for all necessary
regulatory authorizations were filed in 2000 and 2001. Islander East has
received a final certificate from FERC which is non-appealable and all necessary
permits from the State of New York. The State of Connecticut denied Islander
East's request for a consistency determination under the Coastal Zone Management
Act ("CZMA") and application for a permit under Section 401 of the Clean Water
Act. Islander East appealed the State of Connecticut's determination on the CZMA
issue to the United States Department of Commerce. In 2004, the Department of
Commerce overrode Connecticut's denial and granted the CZMA authorization.
Islander East's petition for a declaratory order overriding the denial of the
Clean Water Act permit is pending with Connecticut's State Superior Court.
Pursuant to the Energy Act, Islander East has appealed the denial of the Clean
Water Act permit directly to the United States Court of Appeals for the Second
59
Circuit. The State of Connecticut has filed a motion to challenge the
constitutionality of the provisions of the Energy Act providing this appeal
right. (For additional information on the Energy Act, see the discussion on
"Regulation and Rate Matters.") Various options for the financing of this
pipeline construction are being evaluated. At September 30, 2005, our investment
in this project was $23.5 million.
In 2004 KeySpan acquired a 21% interest in the Millennium Pipeline Company, L.P.
(`the "Partnership") which is developing a natural gas pipeline project which
will have the capacity to transport up to 525,000 DTH of natural gas a day,
interconnecting with the pipeline systems of various other utilities in New
York. The project received a FERC certificate to construct, acquire and operate
the facilities in 2002. On August 1, 2005, the project filed an amended
application with FERC requesting, among other things, approval of a reduction in
capacity and maximum allowable operating pressure, minor route modifications,
the addition of certain facilities and the acquisition of certain facilities
from Columbia Gas Transmission Corporation. Additionally, on August 1, 2005, Con
Edison, KEDLI and Columbia Gas Transmission Corporation each entered into
precedent agreements to purchase capacity on the pipeline. As a result of the
failure of certain conditions precedent to be achieved, these agreements are no
longer in effect. The Partnership is engaged in negotiations with these parties
concerning modification to and renewal of these agreements. Subject to, among
other things, the renegotiations of the precedent agreements, the receipt of
necessary regulatory approvals and financing, it is anticipated that
construction could begin in the Spring of 2006, with service beginning in 2007.
At September 30, 2005, our investment in this project was $9.2 million.
In addition to the proceeding at FERC noted above, KeySpan LNG is involved in
seeking other required regulatory approvals and the resolution of certain
litigation regarding such approvals. In February 2005, KeySpan LNG filed an
action in Federal District Court in Rhode Island seeking a declaratory judgment
that it is not required to obtain a "Category B Assent" from the State of Rhode
Island and an injunction preventing the Rhode Island Coastal Resources
Management Council ("CRMC") from enforcing the Category B assent requirements.
In March 2005, the Rhode Island Attorney General answered the complaint and
moved to substitute the State of Rhode Island as the defendant and filed a
counterclaim seeking a declaratory judgment that the expansion requires a
Category B Assent. In April, the parties filed cross motions for summary
judgment with respect to all issues presented to the Court. On April 14, 2005,
the Attorney General also filed on behalf of the State a complaint against
KeySpan LNG in Rhode Island State Superior Court raising substantially the same
issues as the federal court action. KeySpan LNG removed that action to federal
court and moved for summary judgment. The Attorney General subsequently withdrew
both the motion to substitute defendants and the counterclaim. Although the
Court had indicated its intention to issue a decision in the pending cases by
August 2005, the Court has now indicated that it will stay the litigation
pending resolution of the FERC rehearing and/or appeal process discussed above.
60
Allocated Costs
We are currently subject to the jurisdiction of the SEC under PUHCA. As part of
the regulatory provisions of PUHCA, the SEC currently regulates various
transactions among affiliates within a holding company system. In accordance
with the current PUHCA regulations and state regulatory agencies, we have
service companies that provide: (i) traditional corporate and administrative
services; (ii) gas and electric transmission and distribution system planning,
marketing, and gas supply planning and procurement; and (iii) engineering and
surveying services to subsidiaries. As discussed above, the Energy Act will
result in the repeal of PUHCA and the elimination of the SEC's regulatory
oversight over affiliate transactions. However, certain of KeySpan's affiliate
transactions will remain subject to the regulations of the NYPSC, MADTE and
NHPUC. In addition, pursuant to the Energy Act, the FERC will now also have
authority over certain affiliate transaction matters and is currently in the
process of developing cost allocation and other related rules.
The operating income variation as reflected in "elimination and other" is due
primarily to costs residing at KeySpan's holding company level such as corporate
advertising and strategic review costs, as well as to the timing of certain
corporate expenses and allocated costs associated with these service companies.
Liquidity
Cash flow from operations decreased $303.2 million for the nine months ended
September 30, 2005 compared to last year, primarily reflecting the absence of
Houston Exploration and KeySpan Canada which combined contributed approximately
$230 million to consolidated operating cash flow in 2004. Further, the one time
benefit of $43 million from the start-up of the insurance captive last year, as
well as the timing and amount of property tax payments contributed to the
variation in cash flow. It should be noted that in prior years Houston
Exploration funded their gas exploration and development activities, in part,
from available cash flow from operations.
At September 30, 2005, we had cash and temporary cash investments of $84.0
million. During the nine months ended September 30, 2005, we repaid $592.2
million of commercial paper and, at September 30, 2005, $320 million of
commercial paper was outstanding at a weighted-average annualized interest rate
of 3.9%. Based on the level of authorization granted to us by the SEC, we had
the ability to issue up to an additional $1.0 billion of short-term debt at
September 30, 2005 under the commercial paper program.
In June 2005, KeySpan closed on a $920 million revolving credit facility for
five years due June 24, 2010, which was syndicated among fifteen banks, and an
amended $580 million revolving credit facility due June 24, 2009. These
facilities replaced an existing $660 million, 3-year facility due June 2006, and
a 5-year $640 million facility due June 2009. The two credit facilities, which
now total $1.5 billion - $920 million for five years through 2010, and $580
million for the amended facility through 2009, will continue to support
KeySpan's commercial paper program for ongoing working capital needs.
61
The fees for the facilities are based on KeySpan's current credit ratings and
are increased or decreased based on a downgrading or upgrading of our ratings.
The current annual facility fee is 0.07% based on our credit rating of A3 by
Moody's Investor Services and A by Standard & Poor's for each facility. Both
credit facilities allow for KeySpan to borrow using several different types of
loans; specifically, eurodollar loans, ABR loans, or competitively bid loans.
Eurodollar loans are based on the Eurodollar rate plus a margin that is tied to
our applicable credit ratings. ABR loans are based on the higher of the Prime
Rate, the base CD rate plus 1%, or the Federal Funds Effective Rate plus 0.5%.
Competitive bid loans are based on bid results requested by KeySpan from the
lenders. We do not anticipate borrowing against these facilities; however, if
the credit rating on our commercial paper program were to be downgraded, it may
be necessary to do so.
The facilities contain certain affirmative and negative operating covenants,
including restrictions on KeySpan's ability to mortgage, pledge, encumber or
otherwise subject its utility property to any lien, as well as certain financial
covenants that require us to, among other things, maintain a consolidated
indebtedness to consolidated capitalization ratio of no more than 65% as at the
last day of any fiscal quarter. Violation of these covenants could result in the
termination of the facilities and the required repayment of amounts borrowed
thereunder, as well as possible cross defaults under other debt agreements. At
September 30, 2005, KeySpan's consolidated indebtedness was 49.1% of its
consolidated capitalization and KeySpan was in compliance with all covenants.
Subject to certain conditions set forth in the credit facility, KeySpan has the
right, at any time, to increase the commitments under the $920 million facility
up to an additional $300 million. In addition, KeySpan has the right to request
that the termination date be extended for an additional period of 365 days prior
to each anniversary of the closing date. This extension option, however,
requires the approval of lenders holding more than 50% of the total commitments
to such extension request. Under the agreements, KeySpan has the ability to
replace non-consenting lenders with other pre-approved banks or financial
institutions.
A substantial portion of consolidated revenues are derived from the operations
of businesses within the Electric Services segment, that are largely dependent
upon two large customers - LIPA and the NYISO. Accordingly, our cash flows are
dependent upon the timely payment of amounts owed to us by these counterparties.
We satisfy our seasonal working capital requirements primarily through
internally generated funds and the issuance of commercial paper. We believe that
these sources of funds are sufficient to meet our seasonal working capital
needs.
62
Capital Expenditures and Financing
Construction Expenditures
The table below sets forth our construction expenditures by operating segment
for the periods indicated:
- ----------------------------------------------------------------------------
Nine Months Ended September 30,
(In Millions of Dollars) 2005 2004
- ----------------------------------------------------------------------------
Gas Distribution $ 270.1 $ 294.1
Electric Services 72.8 103.7
Energy Investments 17.8 150.6
Energy Services and other 11.4 10.9
- ----------------------------------------------------------------------------
$ 372.1 $ 559.3
- ----------------------------------------------------------------------------
Construction expenditures related to the Gas Distribution segment are primarily
for the renewal, replacement and expansion of the distribution system.
Construction expenditures for the Electric Services segment reflect costs to
maintain our generating facilities and, for 2004, expand the Ravenswood
Generating Station. Construction expenditures related to the Energy Investments
segment for 2004 primarily reflect costs associated with gas exploration and
production activities of Houston Exploration, as well as costs related to
KeySpan Canada's gas processing facilities.
The decrease in capital expenditures for the nine months ended September 30,
2005, compared to the same period last year of $187.2 million mainly reflects a
decrease in the Gas Distribution segment of $24.0 million and a decrease in the
Energy Investments segment of $132.8 million. The decrease in the Gas
Distribution segment is due to more efficient repair and maintenance processes,
as well as to an improved process related to billing New York City for costs
associated with city/state construction projects. The decrease in Energy
Investments reflects the absence of Houston Exploration's gas exploration and
development activities.
Financing
On November 1, 2005, KeySpan's gas distribution subsidiary, KEDNY, issued $137
million of tax-exempt Gas Facilities Revenue Bonds ("GFRB") through the New York
State Energy Research and Development Authority ("NYSERDA") in the following
series: (i) $82 million of 4.70% GFRB, 2005 Series A (the "Series A Bonds") and
(ii) $55 million of GFRB, 2005 Series B (the "Series B Bonds"). The interest
rate on the Series B Bonds is re-set every seven days through an auction
process. KEDNY will use the proceeds from these issuances to redeem the
following three series of GFRBs: (i) $41 million Adjustable Rate GFRBs, Series
1989A due February 2024, $41 million Adjustable Rate Gas GFRBs, Series 1989B
February 2024 and (iii) $55 million 5.60% GFRB, Series 1993C due June 2025.
KEDNY incurred $1.0 million in call premiums, all of which have been deferred
for future rate recovery. Further, in December 2005, KeySpan intends to
refinance $50 million 5.64% GFRB, Series D1 and D2 due 2026 .
63
In January 2005, KeySpan redeemed $500 million of outstanding debt - 6.15% notes
due 2006. KeySpan incurred $20.9 million in call premiums and wrote-off $1.3
million of previously deferred costs. Further, we accelerated the amortization
of approximately $11.2 million of previously unamortized benefits associated
with an interest rate swap on these bonds. The accelerated amortization, as well
as the write-off of previously deferred costs was recorded to interest expense.
In addition, during the first quarter of 2005, $15 million of 8.87% notes of a
KeySpan subsidiary were redeemed at maturity.
Further, $55.3 million of 7.07% Series B preferred stock was redeemed in May
2005 on its scheduled redemption date. Additionally, also in May 2005, KeySpan
called for optional redemption $19.7 million of 7.17% Series C of preferred
stock due 2008. KeySpan no longer has outstanding preferred stock.
At December 31, 2004, KeySpan had 9.2 million MEDs Equity Units issued which
were subject to conversion upon execution of the three-year forward purchase
contract. In 2005, KeySpan was required to remarket the note component of the
Equity Units between February 2005 and May 2005 and reset the interest rate to
the then current market rate of interest; however, the reset interest rate could
not be set below 4.9%. In March 2005, KeySpan remarketed the note component of
$394.9 million of the Equity Units at the reset interest rate of 4.9% through
their maturity date of May 2008. The balance of the notes ($65.1 million) were
held by the original MEDs Equity Unit holders in accordance with their terms and
not remarketed. KeySpan then exchanged $300 million of the remarketed notes for
$307.2 million of new 30 year notes bearing an interest rate of 5.8%. Therefore,
KeySpan now has $160 million of 4.9% notes outstanding with a maturity date of
May 2008 and $307.2 million of 5.8% notes outstanding with a maturity date of
April 2035.
On May 16, 2005 KeySpan issued 12.1 million shares of common stock, at an
issuance price of $37.93 per share pursuant to the terms of the forward purchase
contract. KeySpan received proceeds of approximately $460 million from the
equity conversion. The number of shares issued was dependent on the average
closing price of our common stock over the 20 day trading period ending on the
third trading day prior to May 16, 2005.
The following table represents the ratings of our long-term debt at September
30, 2005. During the fourth quarter of 2004 Standard & Poor's reaffirmed its
ratings on KeySpan's and its subsidiaries' long-term debt and removed its
negative outlook. Further in the second quarter of 2005, Fitch Ratings revised
its ratings on KeySpan's and its subsidiaries' long-term debt to positive
outlook. Moody's Investor Services, however, continues to maintain its negative
outlook ratings on KeySpan's and its subsidiaries' long-term debt.
64
- --------------------------------------------------------------------------------------------------
Moody's Investor Standard
Services & Poor's FitchRatings
- --------------------------------------------------------------------------------------------------
KeySpan Corporation A3 A A-
KEDNY N/A A+ A+
KEDLI A2 A+ A-
Boston Gas A2 A N/A
Colonial Gas A2 A+ N/A
KeySpan Generation A3 A N/A
- --------------------------------------------------------------------------------------------------
Off-Balance Sheet Arrangements
Guarantees
KeySpan has a number of financial guarantees with its subsidiaries at September
30, 2005. KeySpan has fully and unconditionally guaranteed: (i) $525 million of
medium-term notes issued by KEDLI; (ii) the obligations of KeySpan Ravenswood,
LLC, which is the lessee under the $425 million Master Lease associated with the
Ravenswood Facility and the lessee under the $385 million sale/leaseback
transaction for the Ravenswood Expansion including future decommission costs of
$19 million; and (iii) the payment obligations of our subsidiaries related to
$128 million of tax-exempt bonds issued through the Nassau County and Suffolk
County Industrial Development Authorities for the construction of two
electric-generation peaking facilities on Long Island. The medium-term notes,
the Master Lease and the tax-exempt bonds are reflected on the Consolidated
Balance Sheet; the sale/leaseback transaction is not recorded on the
Consolidated Balance Sheet. Further, KeySpan has guaranteed: (i) up to $88
million of surety bonds associated with certain construction projects currently
being performed by current and former subsidiaries; (ii) certain supply
contracts, margin accounts and purchase orders for certain subsidiaries in an
aggregate amount of $86 million; and (iii) $74 million of subsidiary letters of
credit. These guarantees are not recorded on the Consolidated Balance Sheet.
KeySpan's guarantees on certain performance bonds relating to current
construction projects of the discontinued mechanical contracting companies will
remain in place throughout the construction period for these projects. KeySpan
has received an indemnity bond issued by a third party to offset potential
exposure related to a significant portion of the continuing guarantee. At this
time, we have no reason to believe that our subsidiaries or former subsidiaries
will default on their current obligations. However, we cannot predict when or if
any defaults may take place or the impact such defaults may have on our
consolidated results of operations, financial condition or cash flows. (See Note
6 to the Consolidated Financial Statements, "Financial Guarantees and
Contingencies" for additional information regarding KeySpan's guarantees.)
Contractual Obligations
KeySpan has certain contractual obligations related to its outstanding long-term
debt, outstanding credit facility borrowings, outstanding commercial paper
borrowings, operating and capital leases, and demand charges associated with
certain commodity purchases. These obligations have remained substantially
unchanged since December 31, 2004. (For additional details regarding these
65
obligations see KeySpan's Annual Report on Form 10-K for the Year Ended December
31, 2004, Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations, Note 6 "Long-Term Debt," as well as Note 7 to those
Consolidated Financial Statements "Contractual Obligations, Financial Guarantees
and Contingencies.")
Discussions of Critical Accounting Policies and Assumptions
In preparing our financial statements, the application of certain accounting
policies requires difficult, subjective and/or complex judgments. The
circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the impact of matters that are
inherently uncertain. Actual effects on our financial position and results of
operations may vary significantly from expected results if the judgments and
assumptions underlying the estimates prove to be inaccurate.
KeySpan continually evaluates its critical accounting policies. Based upon
current facts and circumstances KeySpan has decided that certain accounting
policies that were considered "critical" at December 31, 2004 should no longer
be considered as critical accounting policies. The accounting policies that are
no longer considered critical are as follows: (i) Percentage-of-completion
accounting is a method of accounting for long-term construction type contracts
in accordance with Generally Accepted Accounting Principles. This accounting
policy was used for engineering and mechanical contracting revenue recognition
by the Energy Services segment. However, since KeySpan has sold its mechanical
contracting subsidiaries, contracting revenue recognition is no longer a
significant accounting issue; and (ii) The full cost accounting method is used
by our gas exploration and production subsidiaries to account for their natural
gas and oil properties. Seneca-Upshur and KeySpan Exploration continue to apply
this accounting treatment. However, since KeySpan has sold its ownership
interest in Houston Exploration, KeySpan's gas exploration and production
activities are not a significant aspect of its overall business operations and
therefore, full cost accounting is no longer a significant accounting policy.
Below is a discussion of KeySpan's critical accounting policies and assumptions
at September 30, 2005. For a more detailed discussion of these policies and
assumptions see KeySpan's Annual Report on Form 10-K for the Year Ended December
31, 2004, Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations "Discussion of Critical Accounting Policies and
Assumptions."
Valuation of Goodwill
KeySpan records goodwill on purchase transactions, representing the excess of
acquisition cost over the fair value of net assets acquired. In testing for
goodwill impairment under Statement of Financial Accounting Standards ("SFAS")
142 "Goodwill and Other Intangible Assets," significant reliance is placed upon
a number of estimates regarding future performance that require broad
assumptions and significant judgment by management. A change in the fair value
of our investments could cause a significant change in the carrying value of
goodwill. The assumptions used to measure the fair value of our investments are
66
the same as those used by us to prepare annual operating segment and
consolidated earnings and cash flow forecasts. In addition, these assumptions
are used to set annual budgetary guidelines. At September 30, 2005, KeySpan has
$1.7 billion of recorded goodwill and has concluded that the fair value of the
business units that have recorded goodwill exceed their carrying value.
Accounting for the Effects of Rate Regulation on Gas Distribution Operations
The financial statements of the Gas Distribution segment reflect the ratemaking
policies and orders of the New York Public Service Commission ("NYPSC"), the New
Hampshire Public Utilities Commission ("NHPUC"), and the Massachusetts
Department of Telecommunications and Energy ("MADTE").
Four of our six regulated gas utilities (KEDNY, KEDLI, Boston Gas Company and
EnergyNorth Natural Gas, Inc.) are subject to the provisions of SFAS 71,
"Accounting for the Effects of Certain Types of Regulation." This statement
recognizes the actions of regulators, through the ratemaking process, to create
future economic benefits and obligations affecting rate-regulated companies.
In 2003, the MADTE approved a base revenue increase for the Boston Gas Company,
as well as a Performance Based Rate Plan (the "Plan") for up to ten years.
EnergyNorth Natural Gas, Inc.'s base rates continue as set by the NHPUC in 1993.
In separate orders issued by the MADTE relating to the acquisition by Eastern
Enterprises of Colonial Gas Company and Essex Gas Company, the base rates
charged by these companies have been frozen at their current levels for a
ten-year period ending 2009. Due to the length of these base rate freezes, the
Colonial and Essex Gas Companies had previously discontinued the application of
SFAS 71.
As is further discussed under the caption "Regulation and Rate Matters," the
rate plans previously in effect for KEDNY and KEDLI have expired. The continued
application of SFAS 71 to record the activities of these subsidiaries is
contingent upon the actions of regulators with regard to future rate plans. We
are currently evaluating various options that may be available to us including,
but not limited to, proposing new plans for KEDNY and KEDLI. The ultimate
resolution of any future rate plans could have a significant impact on the
application of SFAS 71 to these entities and, accordingly, on our financial
position, results of operations and cash flows. However, management believes
that currently available facts support the continued application of SFAS 71 and
that all regulatory assets and liabilities are recoverable or refundable through
the regulatory environment.
Pension and Other Postretirement Benefits
KeySpan participates in both non-contributory defined benefit pension plans, as
well as other post-retirement benefit ("OPEB") plans (collectively
"postretirement plans"). KeySpan's reported costs of providing pension and OPEB
benefits are dependent upon numerous factors resulting from actual plan
experience and assumptions of future experience. Pension and OPEB costs
(collectively "postretirement costs") are impacted by actual employee
67
demographics, the level of contributions made to the plans, earnings on plan
assets, and health care cost trends. Changes made to the provisions of these
plans may also impact current and future postretirement costs. Postretirement
costs may also be significantly affected by changes in key actuarial
assumptions, including anticipated rates of return on plan assets and the
discount rates used in determining the postretirement costs and benefit
obligations. Actual results that differ from our assumptions are accumulated and
amortized over ten years.
Historically, we have funded our qualified pension plans in excess of the amount
required to satisfy minimum ERISA funding requirements. At September 30, 2005,
we had a funding credit balance in excess of the ERISA minimum funding
requirements. Although we have presently exceeded ERISA funding requirements,
our pension plans, on an actuarial basis, are currently underfunded. Therefore,
for 2005, KeySpan expects to contribute up to a total of $124.5 million to its
funded and unfunded postretirement plans, $116.5 million of which had been
contributed by the end of the third quarter. Future funding requirements are
heavily dependent on actual return on plan assets and prevailing interest rates.
(In addition to Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations in KeySpan's Annual Report on Form 10-K for
the Year Ended December 31, 2004, see also Note 4 of those Consolidated
Financial Statements, "Postretirement Benefits.")
Regulation and Rate Matters
The Energy Policy Act of 2005
The Energy Act, which was enacted in August 2005, is a broad energy bill that
places an increased emphasis on the production of energy and promotes the
development of new technology and alternative energy sources and provides tax
credits to companies that produce natural gas, oil, coal, electricity and
renewable energy.
One of the more significant provisions of the Energy Act is the repeal of PUHCA,
effective six months from the effective date of the Act which will be on
February 8, 2006. Upon repeal, our corporate and financial activities and those
of our subsidiaries will no longer be subject to regulation by the SEC. However,
we will remain subject to certain regulations of the NYPSC, MADTE and NHPUC and
the authority of the FERC will be expanded to cover a limited number of holding
company activities. In particular, FERC approval will likely be required for
KeySpan to acquire securities of, or directly or indirectly merge with, another
electric utility or electric utility holding company. The FERC will also have
authority to review and authorize costs charged by service companies to electric
utilities in the same holding company system. The FERC and state regulators will
be granted access to the books and records of all companies within any utility
holding company system, similar to the access granted to the SEC under PUHCA. On
September 16, 2005, FERC issued a notice of proposed rulemaking with respect to
how it will implement its expanded jurisdiction. The FERC will finalize its
rules during the next few months and implement them by February 2006. We
continue to review the provisions of the Energy Act in order to assess its
impact on us, and ultimately the effects of many of these changes will be
subject to FERC rulemaking and further interpretation.
68
Securities and Exchange Commission Regulation Under PUHCA
Currently, KeySpan and certain of its subsidiaries are subject to the
jurisdiction of the SEC under PUHCA. The rules and regulations under PUHCA
generally limit the operations of a registered holding company to a single
integrated public utility system, plus additional energy-related businesses. In
addition, the principal regulatory provisions of PUHCA: (i) regulate certain
transactions among affiliates within a holding company system including the
payment of dividends by such subsidiaries to a holding company; (ii) govern the
issuance, acquisition and disposition of securities and assets by a holding
company and its subsidiaries; (iii) limit the entry by registered holding
companies and their subsidiaries into businesses other than electric and/or gas
utility businesses; and (iv) require SEC approval for certain utility mergers
and acquisitions.
KeySpan has financing authorization under PUHCA to do the following through
December 31, 2006 (the "Authorization Period"): (a) to issue and sell up to an
additional amount of $3.0 billion of common stock, preferred stock, preferred
and equity-linked securities, and long-term debt securities (the "Long-Term
Financing Limit") in accordance with certain defined parameters; (b) in addition
to the Long-Term Financing Limit, to issue and sell up to an aggregate amount of
$1.3 billion of short-term debt; (c) to issue up to 13 million shares of common
stock under dividend reinvestment and stock-based management incentive and
employee benefit plans; (d) to maintain existing and enter into additional
hedging transactions with respect to outstanding indebtedness in order to manage
and minimize interest rate costs; (e) to issue guarantees and other forms of
credit support in an aggregate principal amount not to exceed $4.0 billion
outstanding at any one time; (f) to refund, repurchase (through open market
purchases, tender offers or private transactions), replace or refinance debt or
equity securities outstanding during the Authorization Period through the
issuance of similar or any other type of authorized securities; (g) to pay
dividends out of capital and unearned surplus as well as paid-in-capital with
respect to certain subsidiaries, subject to certain limitations; (h) to engage
in preliminary development activities and administrative and management
activities in connection with anticipated investments in exempt wholesale
generators, foreign utility companies and other energy-related companies; (i) to
organize and/or acquire the equity securities of entities that will serve the
purpose of facilitating authorized financings; (j) to invest up to $3.0 billion
in exempt wholesale generators and foreign utility companies; (k) to create
and/or acquire the securities of entities organized for the purpose of
facilitating investments in other non-utility subsidiaries; and (l) to enter
into certain types of affiliate transactions between certain non-utility
subsidiaries involving cost structures above the typical "at-cost" limit.
In addition, we have committed that during the Authorization Period, our common
equity will be at least 30% of our consolidated capitalization and each of our
utility subsidiaries' common equity will be at least 30% of such entity's
capitalization. At September 30, 2005, KeySpan's consolidated common equity was
50.9% of its consolidated capitalization, including commercial paper, and each
of its utility subsidiaries common equity was at least 49% of its respective
capitalization.
As noted previously, the Energy Policy Act of 2005 resulted in the repeal of
PUHCA, and the elimination of the financing, investment and operating
limitations discussed earlier. Although, KeySpan would no longer be subject to
the limitations under PUHCA, it remains subject to regulation by the NYPSC,
MADTE and NHPUC and will become subject to the additional regulatory
requirements of the FERC.
69
Gas Matters
As of September 30, 2005, the rate agreements for KEDNY and KEDLI have expired.
Under the terms of the KEDNY and KEDLI rate agreements, gas distribution rates
and all other provisions will remain in effect until changed by the NYPSC. At
this time, we are currently evaluating various options that may be available to
us regarding the KEDNY and KEDLI rate plans, including but not limited to,
proposing new rate plans.
Regarding the Boston Gas Company, in 2003 the MADTE approved a $25.9 million
increase in base revenues with an allowed return on equity of 10.2% assuming an
equal balance of debt and equity. On January 27, 2004 the MADTE issued orders on
Boston Gas Company's Motion for Recalculation, Reconsideration and Clarification
that granted an additional $1.1 million in base revenues, for a total of $27
million. The MADTE also approved a Performance Based Rate Plan (the "Plan") for
up to ten years. On November 1, 2005, the MADTE approved a base rate increase of
$7.2 million under the Plan. Also on November 1, 2005, the MADTE authorized
recovery of under-recovered gas related bad debt expenses for the period January
1, 2004-December 31, 2004 through the gas cost adjustment factor and established
a mechanism for future recovery of such costs. KeySpan is in the process of
analyzing the impact of this order.
For an additional discussion of our current gas distribution rate agreements,
see KeySpan's Annual Report on Form 10-K for the Year Ended December 31, 2004,
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operations "Regulation and Rate Matters."
Electric Matters
KeySpan sells to LIPA all of the capacity and, to the extent requested, energy
conversion services from our existing Long Island based oil and gas-fired
generating plants. Sales of capacity and energy conversion services are made
under rates approved by the FERC in accordance with the Power Supply Agreement
("PSA") entered into between KeySpan and LIPA in 1998. The original FERC
approved rates, which had been in effect since May 1998, expired on December 31,
2003. On October 1, 2004 the FERC approved a settlement reached between KeySpan
and LIPA to reset rates effective January 1, 2004. Under the new Settlement
Agreement, KeySpan's rates reflect a cost of equity of 9.5% with no revenue
increase in the first year. The FERC approved updated operating and maintenance
expense levels and recovery of certain other costs as agreed to by the parties.
Environmental Matters
KeySpan is subject to various federal, state and local laws and regulatory
programs related to the environment. Through various rate orders issued by the
NYPSC, MADTE and NHPUC, we anticipate that costs related to MGP environmental
cleanup activities will be recovered in rates charged to gas distribution
customers and, as a result, adjustments to these reserve balances do not impact
earnings. However, environmental cleanup activities related to the three
non-utility sites are not subject to rate recovery.
70
We estimate that the remaining cost of our MGP related environmental cleanup
activities, including costs associated with the Ravenswood Facility, will be
approximately $211.4 million and we have recorded a related liability for such
amount. We have also recorded an additional $16.7 million liability,
representing the estimated environmental cleanup costs related to a former coal
tar processing facility. As of September 30, 2005, we have expended a total of
$167.0 million on environmental investigation and remediation activities. (See
Note 6 to the Consolidated Financial Statements, "Financial Guarantees and
Contingencies.")
Market and Credit Risk Management Activities
Market Risk: KeySpan is exposed to market risk arising from potential changes in
one or more market variables, such as energy commodity prices, interest rates,
volumetric risk due to weather or other variables. Such risk includes any or all
changes in value whether caused by commodity positions, asset ownership,
business or contractual obligations, debt covenants, exposure concentration,
currency, weather, and other factors regardless of accounting method. We manage
our exposure to changes in market prices using various risk management
techniques for non-trading purposes, including hedging through the use of
derivative instruments, both exchange-traded and over-the-counter contracts,
purchase of insurance and execution of other contractual arrangements.
KeySpan is exposed to price risk due to investments in equity and debt
securities held to fund benefit payments for various employee pension and other
postretirement benefit plans. To the extent that the value of investments held
change, or long-term interest rates change, the effect will be reflected in
KeySpan's recognition of periodic cost of such employee benefit plans and the
determination of contributions to the employee benefit plans.
Credit Risk: KeySpan is exposed to credit risk arising from the potential that
our counterparties fail to perform on their contractual obligations. Our credit
exposures are created primarily through the sale of gas and transportation
services to residential, commercial, electric generation, and industrial
customers and the provision of retail access services to gas marketers, by our
regulated gas businesses; the sale of commodities and services to LIPA and the
NYISO; the sale of power and services to our retail customers by our unregulated
energy service businesses; entering into financial and energy derivative
contracts with energy marketing companies and financial institutions; and the
sale of gas, oil and processing services to energy marketing and oil and gas
production companies.
We have regional concentration of credit risk due to receivables from
residential, commercial and industrial customers in New York, New Hampshire and
Massachusetts, although this credit risk is spread over a diversified base of
residential, commercial and industrial customers. Customers' payment records are
monitored and action is taken, when appropriate and in accordance with various
regulatory requirements.
We also have credit risk from LIPA, our largest customer, and from other energy
and financial services companies. Counterparty credit risk may impact overall
exposure to credit risk in that our counterparties may be similarly impacted by
changes in economic, regulatory or other considerations. We actively monitor the
credit profile of our wholesale counterparties in derivative and other
71
contractual arrangements, and manage our level of exposure accordingly. In
instances where counterparties' credit quality has declined, or credit exposure
exceeds certain levels, we may limit our credit exposure by restricting new
transactions with the counterparty, requiring additional collateral or credit
support and negotiating the early termination of certain agreements.
Regulatory Issues and Competitive Environment: We are subject to various other
risk exposures and uncertainties associated with our gas and electric
operations. The most significant contingency involves the evolution of the gas
distribution and electric industries towards more competitive and deregulated
environments. The risks associated with KeySpan's gas distribution activities
have not changed substantially since December 31, 2004. For additional
information regarding these risks see KeySpan's Annual Report on Form 10-K for
the Year Ended December 31, 2004, Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations "Market and Credit Risk Management
Activities." The following is an update to certain matters related KeySpan's
electric operations.
Due to volatility in the market clearing price of 10-minute spinning and
non-spinning reserves during the first quarter of 2000, the NYISO requested that
FERC approve a bid cap on such reserves, as well as requiring a refunding of so
called alleged "excess payments" received by sellers, including the Ravenswood
Facility. On May 31, 2000, FERC issued an order that granted approval of a $2.52
per MWh bid cap for 10 minute non-spinning reserves, plus payments for the
opportunity cost of not making energy sales. The NYISO's other requests, such as
a bid cap for spinning reserves, retroactive refunds, recalculation of reserve
prices, etc., were rejected.
The NYISO, Con Edison, Niagara Mohawk Power Corporation and Rochester Gas and
Electric each individually appealed FERC's order in federal court. The appeals
were consolidated into one case and on November 7, 2003, the United States Court
of Appeals for the District of Columbia (the "Court") issued its decision in the
case of Consolidated Edison Company of New York, Inc., v. Federal Energy
Regulatory Commission ("Decision"). Essentially, the Court found errors in
FERC's order and remanded some issues back to FERC for further explanation and
action.
On June 25, 2004, the NYISO submitted a motion to FERC seeking refunds as a
result of the Decision. KeySpan and others submitted statements of opposition
opposing the refunds. On March 4, 2005, FERC issued an order upholding its
original decision not to order refunds. FERC also provided the further
explanation requested by the Court as to why refunds were not being ordered. The
NYISO and other market participants have requested rehearing of FERC's latest
order and that decision is still pending.
In a related case, on March 4, 2005, FERC issued a second order requiring the
NYISO to reinstate the original prices for May 8 and 9, 2000 and to pay
suppliers, including the Ravenswood Facility, accordingly. In 2000, the NYISO
revised prices downward after it determined a market design flaw existed which
caused prices to be higher than what would occur in a competitive market. FERC
originally agreed with the NYISO, but reversed its original decision on renewal
from the Court of Appeals.
72
The NYISO and other market participants have requested a rehearing of this March
4, 2005 order. FERC has not issued an order in response to the rehearing or stay
request.
We cannot predict the final outcome of these proceedings or what effect, if any,
the outcome may have on our financial position, results of operations or cash
flows.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q concerning
expectations, beliefs, plans, objectives, goals, strategies, future events or
performance and underlying assumptions and other statements that are other than
statements of historical facts, are "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Without limiting the foregoing, all statements under the captions "Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Item 3. Quantitative and Qualitative Disclosures About Market
Risk" relating to our future outlook, anticipated capital expenditures, future
cash flows and borrowings, pursuit of potential future acquisition opportunities
and sources of funding, are forward-looking statements. Such forward-looking
statements reflect numerous assumptions and involve a number of risks and
uncertainties and actual results may differ materially from those discussed in
such statements.
Among the factors that could cause actual results to differ materially are:
- volatility of energy prices used to generate electricity;
- fluctuations in weather and in gas and electric prices;
- general economic conditions, especially in the Northeast United
States;
- our ability to successfully manage our cost structure and operate
efficiently;
- our ability to successfully contract for natural gas supplies required
to meet the needs of our customers;
- implementation of new accounting standards or changes in accounting
standards or GAAP which may require adjustments to financial
statements;
- inflationary trends and interest rates;
- the ability of KeySpan to identify and make complementary
acquisitions, as well as the successful integration of such
acquisitions;
- available sources and cost of fuel;
- creditworthiness of counterparties to derivative instruments and
commodity contracts;
- the resolution of certain disputes with LIPA concerning each party's
rights and obligations under various agreements;
73
- retention of key personnel;
- federal and state regulatory initiatives that threaten cost and
investment recovery, and place limits on the type and manner in which
we invest in new businesses and conduct operations;
- the impact of federal, state and local utility regulatory policies,
legislation and orders on our regulated and unregulated businesses;
- potential write-down of our investment in natural gas properties when
natural gas prices are depressed or if we have significant downward
revisions in our estimated proved gas reserves;
- competition facing our unregulated Energy Services businesses;
- the degree to which we develop unregulated business ventures, as well
as federal, state and local regulatory policies affecting our ability
to retain and operate such business ventures profitably;
- a change in the fair value of our investments that could cause a
significant change in the carrying value of such investments or the
carrying value of related goodwill;
- timely receipts of payments from our two largest customers LIPA and
the NYISO; and
- the outcome of LIPA's strategic business options study, pertaining to
its long-term future which include, as stated by LIPA, whether or not
LIPA will continue its operations as they presently exist, fully
municipalize or privatize, or sell some, but not all of its assets. In
addition, LIPA must make a determination by December 15, 2005, as to
whether it will purchase our interest in KeySpan Generation LLC, the
owner of our Long Island (excluding the Glenwood and Port Jefferson
Energy Center units) generating assets, pursuant to the terms of the
Generation Purchase Rights Agreement; and
- other risks detailed from time to time in other reports and other
documents filed by KeySpan with the SEC.
For any of these statements, KeySpan claims the protection of the safe harbor
for forward-looking information contained in the Private Securities Litigation
Reform Act of 1995, as amended. For additional discussion on these risks,
uncertainties and assumptions, see "Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Financially-Settled Commodity Derivative Instruments - Hedging Activities: From
time to time, KeySpan subsidiaries have utilized derivative financial
instruments, such as futures, options and swaps, for the purpose of hedging the
cash flow variability associated with changes in commodity prices. KeySpan is
exposed to commodity price risk primarily with regard to its gas distribution
operations, gas exploration and production activities and its electric
generating facilities. Our gas distribution operations utilize over-the-counter
("OTC") natural gas and fuel oil swaps to hedge the cash-flow variability of
specified portions of gas purchases and sales associated with certain
large-volume customers. Seneca-Upshur utilizes OTC natural gas swaps to hedge
cash flow variability associated with forecasted sales of natural gas. The
Ravenswood Generating Station uses derivative financial instruments to hedge the
74
cash flow variability associated with the purchase of a portion of natural gas
and oil that will be consumed during the generation of electricity. The
Ravenswood Generating Station also hedges the cash flow variability associated
with a portion of electric energy sales using OTC electricity swaps.
KeySpan uses standard NYMEX futures prices to value gas futures and market
quoted forward prices to value OTC swap contracts.
The following tables set forth selected financial data associated with these
derivative financial instruments noted above that were outstanding at September
30, 2005.
- -------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Current Fair Value
Type of Contract Maturity mmcf Price $ Price $ (In $ Millions)
- -------------------------------------------------------------------------------------------------------------------------------
Gas
Swaps/Futures - Long Natural Gas 2005 2,226 7.31 - 7.81 11.41 - 14.43 14.9
OTC Swaps - Short Natural Gas 2005 493 6.58 - 6.70 14.68 - 15.19 (4.0)
2006 1,827 6.17 - 6.29 10.95 - 15.70 (11.0)
2007 1,679 5.86 - 5.97 9.34 - 12.56 (7.3)
2008 1,539 6.77 - 6.85 8.22 - 10.86 (3.4)
- -------------------------------------------------------------------------------------------------------------------------------
7,764 (10.8)
- -------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Current Fair Value
Type of Contract Maturity Barrels Price $ Price $ (In $ Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
Oil
Swaps - Long Fuel Oil 2005 20,000 30.80 - 37.16 60.49 0.5
2006 12,000 34.40 62.20 0.3
Swaps - Short Heating Oil 2005 212 62.77 - 63.59 89.44 - 90.51 (12.4)
- ---------------------------------------------------------------------------------------------------------------------------------
32,212 (11.6)
- ---------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
Year of Fixed Margin/ Current Fair Value
Type of Contract Maturity MWh Price $ Price $ (In $ Millions)
- ------------------------------------------------------------------------------------------------------------------------------
Electricity
Swaps - Energy 2005 656,400 66.50 - 150.00 141.50 - 155.00 (21.0)
2006 953,600 76.00 - 208.00 141.01 - 207.00 (50.1)
- ------------------------------------------------------------------------------------------------------------------------------
1,610,000 (71.1)
- ------------------------------------------------------------------------------------------------------------------------------
75
- ----------------------------------------------------------------------------
2005
Change in Fair Value of Derivative Instruments (In $ Millions)
- ----------------------------------------------------------------------------
Fair value of contracts at January 1, 2005 1.3
Net losses (gains) on contracts realized 28.3
(Decrease) in fair value of all open contracts (123.1)
- ----------------------------------------------------------------------------
Fair value of contracts outstanding at September 30, (93.5)
- ----------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------
(In Millions of Dollars)
- ---------------------------------------------------------------------------------------
Fair Value of Contracts
- ---------------------------------------------------------------------------------------
Mature Within Total
Sources of Fair Value 12 Months Thereafter Fair Value
- ---------------------------------------------------------------------------------------
Prices actively quoted $ (10.1) $ (13.2) $ (23.3)
Local published indicies (70.2) - (70.2)
- ---------------------------------------------------------------------------------------
$ (80.3) $ (13.2) $ (93.5)
- ---------------------------------------------------------------------------------------
We measure the commodity risk of our derivative hedging instruments (indicated
in the above table) using a sensitivity analysis. Based on a sensitivity
analysis as of September 30, 2005, a 10% increase/decrease in heating oil and
natural gas prices would decrease/increase the value of derivative instruments
maturing in one year by $3.0 million. Further, a 10% increase/decrease in
electricity and fuel prices would decrease/increase the value of derivative
instruments maturing in one year by $16.1 million.
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative
financial instruments to reduce the cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
gas distribution operations. The accounting for these derivative instruments is
subject to SFAS 71 "Accounting for the Effects of Certain Types of Regulation."
Therefore, changes in the fair value of these derivatives have been recorded as
a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
Gains or losses on the settlement of these contracts are initially deferred and
then refunded to or collected from our firm gas sales customers consistent with
regulatory requirements.
The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at September 30, 2005.
- ------------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Floor Ceiling Fixed Current Fair Value
Type of Contract Maturity mmcf ($) ($) Price ($) Price ($) (In $ Millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Options 2005 3,370 5.50 - 6.40 5.50 - 8.70 - 13.92 - 14.43 22.7
2006 7,070 5.50 - 6.40 5.50 - 8.70 - 10.56 - 14.43 46.3
Swaps 2005 22,807 - - 5.95 - 13.45 13.92 - 14.43 140.8
2006 53,253 - - 5.43 - 13.74 10.56 - 14.77 271.4
2007 9,350 6.94 - 11.34 8.39 - 11.78 19.9
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95,850 501.1
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See Note 4 to the Consolidated Financial Statements "Hedging and Derivative
Financial Instruments" for a further description of all our derivative
instruments.
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Item 4. Controls and Procedures
We maintain disclosure controls and procedures (as defined under Exchange Act
Rule 13a-15(e) and 15d-15(e)) that are designed to ensure that information
required to be disclosed by us in the reports we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms,
and that such information is accumulated and communicated to KeySpan's
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosure. Any
control system, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives. Our
management, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of our disclosure controls and procedures as of September 30, 2005. Based upon
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that the design and operation of our disclosure controls and
procedures provided reasonable assurance that the disclosure controls and
procedures are effective to accomplish their objectives.
Furthermore, there has been no change in KeySpan's internal control over
financial reporting identified in connection with the evaluation of such control
that occurred during KeySpan's last fiscal quarter, which has materially
affected, or is reasonably likely to materially affect, KeySpan's internal
control over financial reporting.
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings
See Note 6 to the Consolidated Financial Statements "Financial Guarantees and
Contingencies."
Item 5. Other Information
The following disclosure regarding the recent refinancing conducted by KEDNY
would otherwise have been filed on Form 8-K under the heading "Item 101 - Entry
into a Material Definitive Agreement" and "Item 2.03 - Creation of a Direct
Financial Obligation or an Off-Sheet Balance Arrangement of a Registrant."
On November 1, 2005, KEDNY, issued $82,000,000 aggregate principal amount of
4.70% Gas Facilities Revenue Bonds, 2005 Series A (KEDNY Project) (the "Series A
Refunding Bonds"). The Series A Refunding Bonds were issued to refund within 90
days NYSERDA's $41,000,000 outstanding principal amount of Adjustable Rate Gas
Facilities Revenue Bonds, Series 1989A (KEDNY project) due 2024 and $41,000,000
outstanding principal amount of Adjustable Rate Gas Facilities Revenue Bonds,
Series 1989B (KEDNY project) due 2024.
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The Series A Refunding Bonds bear interest at a rate per annum of 4.70% and
mature on February 1, 2024. Interest on the bonds is payable on February 1 and
August 1 of each year, commencing on February 1, 2006. These bonds are subject
to certain redemption provisions, including optional redemption at any time
after February 1, 2016 by NYSERDA, at the direction of KEDNY, at a redemption
price equal to the principal amount thereof; and extraordinary optional
redemption by NYSERDA, at the direction of KEDNY, at a redemption price equal to
100% of the aggregate principal amount thereof plus accrued and unpaid interest
to the redemption date under certain limited circumstances.
The Series A Refunding Bonds are issued pursuant to and secured by an Indenture
of Trust dated as of November 1, 2005 (the "Indenture") between NYSERDA and
Citibank, N.A, as trustee (the "Trustee"). KEDNY also entered into a
Participation Agreement, dated as of November 1, 2005 with NYSERDA. Pursuant to
the terms of the Participation Agreement, KEDNY issued a Promissory Note related
to the Series A Refunding Bonds under which it is obligated to pay to the
trustee amounts sufficient for, together with other amounts held by the Trustee
and available under the Indenture for application to, the payment of principal
of and premium, if any, and interest on the Series A Refunding Bonds as the same
become due and payable. The payment of the principal of, and interest on these
bonds is unconditionally guaranteed by a Municipal Bond Insurance Policy issued
by Financial Guaranty Insurance Company.
This description of the Indenture of Trust, Participation Agreement and
Promissory Note related are subject to, and qualified in their entirety by,
reference to the Indenture of Trust, Participation Agreement and Promissory Note
attached hereto as Exhibits 10.1, 10.2 and 10.3, respectively, copies of which
(including the form of the Promissory Note) are included as exhibits to this
Form 10-Q.
On November 1, 2005, KEDNY, also issued $55,000,000 aggregate principal amount
of Gas Facilities Revenue Bonds, 2005 Series B (KEDNY Project) (the "Series B
Refunding Bonds"). The Series B Refunding Bonds were issued to refund within 90
days NYSERDA's $55,000,000 outstanding principal amount of Gas Facilities
Revenue Bonds, Series C (KEDNY project) due 2025.
The Series B Refunding Bonds bear interest at an auction rate which is reset
every seven days and mature on June 1, 2025. These bonds are subject to certain
redemption provisions, including optional redemption at any time after February
1, 2016 by NYSERDA, at the direction of KEDNY, at a redemption price equal to
the principal amount thereof; and extraordinary optional redemption by NYSERDA,
at the direction of KEDNY, at a redemption price equal to 100% of the aggregate
principal amount thereof plus accrued and unpaid interest to the redemption date
under certain limited circumstances.
The Series B Refunding Bonds are issued pursuant to and secured by an Indenture
of Trust dated as of November 1, 2005 (the "Indenture") between NYSERDA and
Citibank, N.A, as trustee (the "Trustee"). KEDNY also entered into a
Participation Agreement, dated as of November 1, 2005 with NYSERDA. Pursuant to
the terms of the Participation Agreement, KEDNY issued a Promissory Note related
to the Series B Refunding Bonds under which it is obligated to pay to the
trustee amounts sufficient for, together with other amounts held by the Trustee
and available under the Indenture for application to, the payment of principal
of, and premium, if any, and interest on the Series A Refunding Bonds as the
same become due and payable. The payment of the principal of and interest on
these bonds is unconditionally guaranteed by a Municipal Bond Insurance Policy
issued by Financial Guaranty Insurance Company.
78
This description of the Indenture of Trust, Participation Agreement and
Promissory Note related are subject to, and qualified in their entirety by,
reference to the Indenture of Trust, Participation Agreement and Promissory Note
attached hereto as Exhibits 10.4, 10.5 and 10.6, respectively, copies of which
(including the form of the Promissory Note) are included as exhibits to this
Form 10-Q.
Item 6. Exhibits
10.1* Indenture of Trust between New York State Energy Research and
Development Authority and Citibank, N.A. for the issuance of $82
million GFRB, 2005 Series A, 4.7% due February 2024 dated as of
November 1, 2005
10.2* Participation Agreement between New York State Energy Research and
Development Authority and The Brooklyn Union Gas Company d/b/a KeySpan
Energy Delivery New York for the issuance of $82 million GFRB, 2005
Series A, 4.7% due February 2024 dated as of November 1, 2005
10.3* Promissory Note executed by The Brooklyn Union Gas Company d/b/a
KeySpan Energy Delivery New York for $82 million GFRB, 2005 Series A,
4.7% due February 2024 dated as of November 1, 2005
10.4* Indenture of Trust between New York State Energy Research and
Development Authority and Citibank, N.A. for the issuance of $55
million GFRB, 2005 Series B due June 2025 dated as of November 1, 2005
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10.5* Participation Agreement between New York State Energy Research and
Development Authority and The Brooklyn Union Gas Company d/b/a KeySpan
Energy Delivery New York for the issuance of $55 million GFRB, 2005
Series due June 2025 dated as of November 1, 2005
10.6* Promissory Note executed by The Brooklyn Union Gas Company d/b/a
KeySpan Energy Delivery New York for for the issuance of $55 million
GFRB, 2005 Series B due June 2025 dated as of November 1, 2005
31.1* Certification of the Chairman and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2* Certification of the Executive Vice President and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of the Chairman and Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2* Certification of the Executive Vice President and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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*Filed Herewith
80
KEYSPAN CORPORATION AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf of the undersigned
there unto duly authorized.
KEYSPAN CORPORATION
(Registrant)
Date: November 4, 2005 /s/ Gerald Luterman
-----------------------------
Gerald Luterman
Executive Vice President and
Chief Financial Officer
81