UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
[ ] 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
(State or Other Jurisdiction of Incorporation or (I.R.S. Employer
Organization) Identification No.)
One MetroTech Center, Brooklyn, New York 11201
175 East Old Country Road, Hicksville, New York 11801
(Address of Principal Executive Offices) (Zip Code)
(718) 403-1000 (Brooklyn)
(516) 755-6650 (Hicksville)
(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.
Yes[X] No[ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).
Yes[X] No[ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock Outstanding at July 18, 2006
--------------------- ----------------------------
$.01 par value 175,022,851
KEYSPAN CORPORATION AND SUBSIDIARIES
INDEX
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Part I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheet -
June 30, 2006 and December 31, 2005 3
Consolidated Statement of Income -
Three and Six Months Ended June 30, 2006 and 2005 5
Consolidated Statement of Cash Flows -
Six Months Ended June 30, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 42
Item 3. Quantitative and Qualitative Disclosures About Market Risk 70
Item 4. Controls and Procedures 72
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 73
Item 1A.Risk Factors 73
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds 75
Item 3. Defaults Upon Senior Securities 75
Item 4. Submission of Matters to a Vote of Security Holders 75
Item 5. Other Information 75
Item 6. Exhibits 75
Signatures 76
2
CONSOLIDATED BALANCE SHEET
(Unaudited)
- ------------------------------------------------------------------------------------------
(In Millions of Dollars) June 30, 2006 December 31, 2005
- ------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 40.1 $ 124.5
Restricted cash 6.3 13.2
Accounts receivable 934.5 1,035.6
Unbilled revenue 236.6 685.6
Allowance for uncollectible accounts (77.4) (62.8)
Gas in storage, at average cost 690.7 766.9
Material and supplies, at average cost 127.0 140.5
Derivative contracts 24.9 142.8
Other 126.0 173.8
---------------------- --------------------
2,108.7 3,020.1
---------------------- --------------------
Investments and Other 251.3 242.4
Property
Gas 7,444.9 7,275.9
Electric 2,533.4 2,492.3
Other 423.0 416.3
Accumulated depreciation (3,035.5) (2,922.6)
Gas exploration and production, at cost 185.3 184.2
Accumulated depletion (119.8) (109.2)
---------------------- --------------------
7,431.3 7,336.9
---------------------- --------------------
Deferred Charges
Regulatory assets:
Miscellaneous assets 710.9 688.3
Derivative contracts 50.8 30.9
Goodwill and other intangible assets 1,666.3 1,666.3
Derivative contracts 69.9 75.2
Other 771.0 752.5
---------------------- --------------------
3,268.9 3,213.2
---------------------- --------------------
Total Assets $ 13,060.2 $ 13,812.6
====================== ====================
- ------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEET
(Unaudited)
- --------------------------------------------------------------------------------------------------
(In Millions of Dollars) June 30, 2006 December 31, 2005
- --------------------------------------------------------------------------------------------------
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable and other liabilities $ 683.2 $ 1,087.0
Commercial paper 190.0 657.6
Current redemption of long-term debt 13.4 13.0
Taxes accrued 161.3 176.3
Dividends payable 81.4 81.1
Customer deposits 36.5 39.1
Interest accrued 55.9 53.8
Derivative contracts 68.4 47.3
---------------------- ---------------------
1,290.1 2,155.2
---------------------- ---------------------
Deferred Credits and Other Liabilities
Regulatory liabilities:
Miscellaneous liabilities 56.2 69.9
Removal cost recovered 538.0 516.4
Derivative contracts 53.0 175.4
Asset retirement obligations 48.8 47.4
Deferred income tax 1,178.5 1,157.9
Postretirement benefits and other reserves 1,216.2 1,118.4
Derivative contracts 36.9 44.3
Other 120.0 127.5
---------------------- ---------------------
3,247.6 3,257.2
---------------------- ---------------------
Commitments and Contingencies (See Note 6) - -
Capitalization
Common stock - 184,864 shares issued, 175,018
shares outstanding, par value $0.01 3,983.2 3,975.9
Retained earnings 961.6 866.9
Other comprehensive (loss) (72.5) (74.8)
Treasury stock (285.0) (303.9)
---------------------- ---------------------
Total common shareholders' equity 4,587.3 4,464.1
Long-term debt and capital leases 3,919.8 3,920.8
---------------------- ---------------------
Total Capitalization 8,507.1 8,384.9
---------------------- ---------------------
Minority Interest in Subsidiary Companies 15.4 15.3
---------------------- ---------------------
Total Liabilities and Capitalization $ 13,060.2 $ 13,812.6
====================== =====================
- ---------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
4
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Millions of Dollars, Except Per Share Amounts) 2006 2005 2006 2005
- -------------------------------------------------------------------------------------- --------------------------------------------
Revenues
Gas Distribution $ 873.2 $ 821.1 $ 3,053.3 $ 2,846.5
Electric Services 444.2 468.5 869.0 869.1
Energy Services 50.4 44.2 98.7 88.6
Energy Investments 9.9 8.7 17.8 18.8
--------------- ------------------- ------------------ ----------------------
Total Revenues 1,377.7 1,342.5 4,038.8 3,823.0
--------------- ------------------- ------------------ ----------------------
Operating Expenses
Purchased gas for resale 539.8 501.6 2,051.2 1,810.5
Fuel and purchased power 115.7 159.2 245.7 292.3
Operations and maintenance 420.6 391.8 826.7 779.0
Depreciation, depletion and
amortization 101.2 97.5 211.4 203.6
Operating taxes 95.8 94.0 214.0 205.8
--------------- ------------------- ------------------ ----------------------
Total Operating Expenses 1,273.1 1,244.1 3,549.0 3,291.2
Income from equity investments 2.9 4.7 6.3 10.0
Sale of assets - 0.1 0.5 0.1
--------------- ------------------- ------------------ ----------------------
Operating Income 107.5 103.2 496.6 541.9
--------------- ------------------- ------------------ ----------------------
Other Income and (Deductions)
Interest charges (59.4) (72.6) (125.6) (132.7)
Gain on sale of investments - - - 4.1
Cost of debt redemption - - - (20.9)
Other 6.2 4.1 17.6 13.2
--------------- ------------------- ------------------ ----------------------
Total Other Income and (Deductions) (53.2) (68.5) (108.0) (136.3)
--------------- ------------------- ------------------ ----------------------
Income Taxes
Current (37.3) 16.0 122.2 144.8
Deferred 42.2 (0.2) 9.0 6.2
--------------- ------------------- ------------------ ----------------------
Total Income Taxes 4.9 15.8 131.2 151.0
--------------- ------------------- ------------------ ----------------------
Earnings from continuing operations 49.4 18.9 257.4 254.6
Discontinued Operations
Income (loss) from discontinued
operations, net of tax - (1.9) - (4.1)
Gain on disposal, net of tax - 0.1 - 2.3
--------------- ------------------- ------------------ ----------------------
Loss from discontinued operations - (1.8) - (1.8)
--------------- ------------------- ------------------ ----------------------
Net Income 49.4 17.1 257.4 252.8
Preferred stock dividend requirements - 0.9 - 2.2
--------------- ------------------- ------------------ ----------------------
Earnings for Common Stock $ 49.4 $ 16.2 $ 257.4 $ 250.6
=============== =================== ================== ======================
Basic Earnings Per Share:
Continuing Operations,
less preferred stock dividends $ 0.28 $ 0.11 $ 1.47 $ 1.52
Discontinued Operations - (0.01) - (0.01)
--------------- ------------------- ------------------ ----------------------
Basic Earnings Per Share $ 0.28 $ 0.10 $ 1.47 $ 1.51
=============== =================== ================== ======================
Diluted Earnings Per Share
Continuing Operations,
less preferred stock dividends $ 0.28 $ 0.10 $ 1.46 $ 1.52
Discontinued Operations - (0.01) - (0.01)
--------------- ------------------- ------------------ ----------------------
Diluted Earnings Per Share $ 0.28 $ 0.09 $ 1.46 $ 1.51
=============== =================== ================== ======================
Average Common Shares Outstanding (000) 174,989 169,933 174,846 165,529
Average Common Shares Outstanding - Diluted (000) 176,121 170,878 175,848 166,507
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
5
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
- -----------------------------------------------------------------------------------------------
Six Months Ended June 30,
(In Millions of Dollars) 2006 2005
- -----------------------------------------------------------------------------------------------
Operating Activities
Net income $ 257.4 $ 252.8
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Depreciation, depletion and amortization 211.4 203.6
Deferred income tax 9.0 6.2
Income from equity investments (6.3) (10.0)
Dividends from equity investments 6.5 1.0
Amortization of interest rate swap 4.1 (12.2)
(Gain) on sale of investment - (4.1)
Loss from discontinued operations - 1.8
Amortization of property tax prepayments 66.7 56.7
Net pension and other postretirement expense / cash payment 83.2 (17.9)
Changes in assets and liabilities
Accounts receivable 524.3 210.0
Materials and supplies, fuel oil and gas in storage 89.6 48.7
Accounts payable and other liabilities (399.0) (219.6)
Taxes accrued (15.1) (14.4)
Interest accrued 2.2 5.8
Insurance recovery and regulatory settlements, net - 8.5
Property tax prepayment - (24.9)
Other (44.5) (26.9)
---------------- --------------
Net Cash Provided by Operating Activities 789.5 465.1
---------------- --------------
Investing Activities
Construction expenditures (247.0) (231.0)
Cost of removal (15.7) (10.3)
Net proceeds from sale of property and investments - 48.1
---------------- --------------
Net Cash Used in Investing Activities (262.7) (193.2)
---------------- --------------
Financing Activities
Treasury stock issued 18.8 36.2
MEDs equity conversion - 460.0
Payment of long-term debt - (514.6)
Redemption of preferred stock - (75.0)
Payment of commercial paper (467.6) (628.3)
Common and preferred stock dividends paid (162.4) (149.8)
Other - 16.0
---------------- --------------
Net Cash Used in Financing Activities (611.2) (855.5)
---------------- --------------
Net Decrease in Cash and Cash Equivalents (84.4) (583.6)
Cash Flow from Discontinued Operations - Operating - (3.8)
Cash Flow from Discontinued Operations - Investing - (10.6)
Cash and Cash Equivalents at Beginning of Period 124.5 922.0
---------------- --------------
Cash and Cash Equivalents at End of Period $ 40.1 $ 324.0
================ ==============
- -----------------------------------------------------------------------------------------------
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 THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
INTRODUCTION TO THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
KeySpan Corporation (referred to in the Notes to the Financial Statements as
"KeySpan," "we," "us" and "our") is a holding company under the Public Holding
Company Act of 2005 ("PUHCA 2005"). 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.)
On February 25, 2006, KeySpan entered into an Agreement and Plan of Merger (the
"Merger Agreement"), with National Grid plc, a public limited company
incorporated under the laws of England and Wales ("Parent") and National Grid
US8, Inc., a New York Corporation ("Merger Sub"), pursuant to which Merger Sub
will merge with and into KeySpan (the "Merger"), with KeySpan continuing as the
surviving company and thereby becoming an indirect wholly-owned subsidiary of
the Parent. Pursuant to the Merger Agreement, at the effective time of the
Merger, each outstanding share of KeySpan common stock, par value $0.01 per
share of KeySpan (the "Shares"), other than treasury shares and shares held by
the Parent and its subsidiaries, shall be canceled and shall be converted into
the right to receive $42.00 in cash, without interest.
Consummation of the Merger is subject to various closing conditions, including
but not limited to the adoption of the Merger Agreement by the stockholders of
KeySpan and the Parent and the receipt of requisite regulatory approvals from
certain United States federal and state public utility, antitrust and other
regulatory authorities, many of which have been filed or obtained. Specifically,
we filed our application for approval of the Merger pursuant to the Federal
Power Act in May 2006. In early July 2006, we cleared review by the Federal
Trade Commission under the Hart-Scott-Rodino Antitrust Improvement Act and
received notification that the Committee on Foreign Investment in the U.S. has
determined that there are no issues of national security sufficient to warrant
an investigation of the transaction. On July 20, 2006 we filed an application
for approval of the transaction with the New York Public Service Commission and
intend to seek approval from the New Hampshire Public Utility Commission and the
State of New Jersey Board of Public Utilities within the next several weeks. In
addition, approval of the Merger by our shareholders will be sought at our
Annual Meeting scheduled for August 17, 2006. Shareholders of National Grid plc
approved the transaction at a meeting held on July 31, 2006.
7
In addition to seeking approval of the Merger, the application filed with the
NYPSC also contained a proposed ten-year rate plan for KEDNY and KEDLI, as well
as proposals concerning corporate structure, affiliate rules and transactions
and the rate treatment for contemplated synergy savings. Specifically, the rate
plan proposal provides for, among other things, a freeze of base delivery rates
for KEDNY and KEDLI for 18 months. Thereafter, KEDNY's and KEDLI's gas
adjustment clause would be increased to recover, on a prospective basis, gas
commodity-related costs of $68.6 million for KEDNY and $28.7 million for KEDLI
that would no longer be included in base rates. In addition, KEDNY and KEDLI
base delivery rates would be increased by an average of 2.7% ($63.8 million) and
2.45% ($46.9 million), respectively in years 3, 5, 7 and 9 of the rate plan. The
proposed rate plan also contemplates an allowed return on equity of 11.0% for
each entity. Cumulative earnings above 11.75% would be shared between gas sales
customers and KeySpan over the rate plan period.
Assuming receipt of all required approvals, it is currently anticipated that the
Merger will be consummated in 2007. However, we are unable to predict the
outcome of the regulatory proceedings and no assurance can be given that the
Merger will occur or the timing of its completion
At December 31, 2005, KeySpan was a holding company under the Public Utility
Holding Company Act of 1935, as amended ("PUHCA 1935"). In August 2005, the
Energy Policy Act of 2005 (the "Energy Act") was enacted. The Energy Act is a
broad energy bill that places an increased emphasis on the production of energy
and promotes the development of new technologies and alternative energy sources
and provides tax credits to companies that produce natural gas, oil, coal,
electricity and renewable energy. For KeySpan, one of the more significant
provisions of the Energy Act was the repeal of PUHCA 1935, which became
effective on February 8, 2006. Since that time, the jurisdiction of the
Securities and Exchange Commission ("SEC") over certain holding company
activities, including the regulation of our affiliate transactions and service
companies, has been transferred to the Federal Energy Regulatory Commission
("FERC") pursuant to PUHCA 2005. (For additional information on the Energy Act
and PUHCA 2005 see KeySpan's Annual Report on Form 10-K for the year ended
December 31, 2005, Item 7. Management's Discussion and Analyses of Financial
Condition and Results of Operations - "Regulation and Rate Matters.")
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 June 30, 2006, and the results of operations for the three and six months
ended June 30, 2006 and June 30, 2005, as well as cash flows for the six months
ended June 30, 2006 and June 30, 2005. 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, 2005. The December 31, 2005 financial statement information has
been derived from the 2005 audited financial statements. Income from interim
periods may not be indicative of future results. Certain reclassifications were
made to conform prior period financial statements to the current period
financial statement presentation.
8
Consolidated earnings are seasonal in nature primarily due to the significant
contributions to earnings of the gas distribution operations. As a result, we
expect to earn most of our annual earnings in the first and fourth quarters.
Basic earnings per share ("EPS") is calculated by dividing earnings available
for common stock by the weighted average number of shares of common stock
outstanding during the period. No dilution for any potentially dilutive
securities is included. Diluted EPS assumes the conversion of all potentially
dilutive securities and is calculated by dividing earnings available for common
stock, as adjusted, by the sum of the weighted average number of shares of
common stock outstanding plus all potentially dilutive securities.
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 June 30, Six Months Ended June 30,
(In Millions of Dollars, Except Per Share Amounts) 2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------------------------------
Earnings for common stock $ 49.4 $ 16.2 $ 257.4 $ 250.6
Weighted average shares outstanding (000) 174,989 169,933 174,846 165,529
Add dilutive securities:
Options 1,038 945 933 978
Performance shares 94 - 69 -
- ---------------------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution 176,121 170,878 175,848 166,507
- ---------------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 0.28 $ 0.10 $ 1.47 $ 1.51
- ---------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 0.28 $ 0.09 $ 1.46 $ 1.51
- ---------------------------------------------------------------------------------------------------------------------
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 existing long-term
service contracts having remaining terms that range from one to seven years and
9
power purchase agreements having remaining terms that range from seven to 21
years. On February 1, 2006, KeySpan and LIPA agreed to extend, amend and restate
these contractual arrangements. (See Note 10, "2006 LIPA Settlement" for a
further discussion of these agreements.) The Electric Services segment also
includes subsidiaries that own or lease and operate the 2,200 MW Ravenswood
Facility located in Queens, New York, and the 250 MW combined-cycle Ravenswood
Expansion. Collectively the Ravenswood Facility and Ravenswood Expansion are
referred to as the "Ravenswood Generating Station." All of the energy, capacity
and ancillary services related to the Ravenswood Generating Station are sold to
the New York Independent Systems Operator ("NYISO") energy markets. To finance
the purchase and/or construction of the Ravenswood Generating Station, KeySpan
entered into a leasing arrangement for each facility. The Electric Services
segment also conducts retail marketing of electricity to commercial customers.
(See Note 6 "Financial Guarantees and Contingencies" for further details on the
leasing arrangements.)
The Energy Services segment includes companies that provide energy-related
services to customers located primarily within the Northeastern United States.
Subsidiaries in this segment provide residential and small commercial customers
with service and maintenance of energy systems and appliances, as well as
operation and maintenance, design, engineering, consulting and fiber optic
services to commercial, institutional and industrial customers.
In 2005, KeySpan sold its mechanical contracting subsidiaries. The operating
results and financial position of these companies have been reflected as
discontinued operations on the Consolidated Statement of Income and Consolidated
Statement of Cash Flows for 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 its wholly-owned
subsidiaries Seneca Upshur Petroleum, Inc. ("Seneca-Upshur") and KeySpan
Exploration and Production, LLC ("KeySpan Exploration"). Seneca-Upshur is
engaged in gas exploration and production activities primarily in West Virginia.
KeySpan Exploration is engaged in a joint venture with The Houston Exploration
Company ("Houston Exploration"), an independent natural gas and oil exploration
company located in Houston, Texas. Houston Exploration, formerly a KeySpan
subsidiary, was sold in 2004.
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 26.3%
interest in the Millennium Pipeline Company LLC, the developer of 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 investments 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, KeySpan owns a 600,000 barrel
liquefied natural gas storage and receiving facility in Providence, Rhode
Island, the operations of which are fully consolidated.
In the first quarter of 2005, KeySpan sold its 50% interest in Premier
Transmission Limited ("Premier"), a gas pipeline from southwest Scotland to
Northern Ireland. The sale generated cash proceeds of approximately $48.1
million. In the fourth quarter of 2004, KeySpan reduced its carrying value in
Premier to an amount approximating the anticipated cash proceeds from the sale.
The final sale of Premier 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 June 30, 2006, the total assets of
each reportable segment have not changed materially from those levels reported
at December 31, 2005. The reportable segment information is as follows:
- -------------------------------------------------------------------------------------------------------------------------
Gas Electric Energy Energy
(In Millions of Dollars) Distribution Services Services Investments Eliminations Consolidated
- -------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2006
Unaffiliated revenue 873.2 444.2 50.4 9.9 - 1,377.7
Intersegment revenue - - 2.2 1.3 (3.5) -
Operating Income 39.5 62.4 2.0 3.7 (0.1) 107.5
Three Months Ended June 30, 2005
Unaffiliated revenue 821.1 468.5 44.2 8.7 - 1,342.5
Intersegment revenue - - 3.7 - (3.7) -
Operating Income 30.4 65.7 (2.8) 5.5 4.4 103.2
- ------------------------------------------------------------------------------------------------------------------------
Eliminating items include intercompany interest income and expense, the
elimination of certain intercompany accounts, as well as activities of our
corporate and administrative areas.
Because of the nature of our Electric Services business, electric revenues are
derived from two large customers - the NYISO and LIPA. Electric Services
revenues from these customers of $439.3 million and $440.6 million for the three
months ended June 30, 2006 and 2005, respectively, represent approximately 32%
and 33%, respectively of our consolidated revenues in these periods.
11
- ------------------------------------------------------------------------------------------------------------------------------------
Gas Electric Energy Energy
(In Millions of Dollars) Distribution Services Services Investments Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2006
Unaffiliated revenue 3,053.3 869.0 98.7 17.8 - 4,038.8
Intersegment revenue - - 4.7 2.6 (7.3) -
Operating Income 376.0 127.3 1.6 6.7 (15.0) 496.6
Six Months Ended June 30, 2005
Unaffiliated revenue 2,846.5 869.1 88.6 18.8 - 3,823.0
Intersegment revenue - 4.6 6.3 - (10.9) -
Operating Income 422.3 116.7 (5.6) 11.9 (3.4) 541.9
- ------------------------------------------------------------------------------------------------------------------------------------
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 $862.0 million and $816.3 million for the six
months ended June 30, 2006 and 2005, respectively, represent approximately 21%,
of our consolidated revenues in both periods.
3. COMPREHENSIVE INCOME
The table below indicates the components of comprehensive income:
- --------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Millions of Dollars) 2006 2005 2006 2005
- --------------------------------------------------------------------------------------------------------------------------------
Net Income $ 49.4 $ 17.1 $ 257.4 $ 252.8
- --------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Reclassification of (gains) losses included in net income (3.2) 12.5 (38.9) 7.7
Foreign currency translation adjustments - - - (5.0)
Unrealized gains (losses) on marketable securities (0.1) 0.3 0.3 (1.5)
Unrealized (losses) gains on derivative financial instruments (5.0) (10.9) 40.9 (18.3)
- --------------------------------------------------------------------------------------------------------------------------------
Other comprehensive loss, net of tax (8.3) 1.9 2.3 (17.1)
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 41.1 $ 19.0 $ 259.7 $ 235.7
- --------------------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Reclassification of (gains) losses included in net income (1.7) 5.2 (20.9) 4.7
Foreign currency translation adjustments - - - (2.7)
Unrealized gains (losses) on marketable securities (0.1) 0.2 0.2 (0.8)
Unrealized (losses) gains on derivative financial instruments (2.4) (4.5) 22.9 (11.2)
- --------------------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense $ (4.2) $ 0.9 $ 2.2 $ (10.0)
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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 Generating Station site.
12
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 certain of these derivative instruments is subject
to SFAS 71 "Accounting for the Effects of Certain Types of Regulation."
Therefore, the fair value of these derivatives are recorded as current or
deferred assets and liabilities, with offsetting positions recorded as
regulatory assets and regulatory liabilities 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. 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 and thus are not subject to deferral
accounting treatment. 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 natural gas swaps qualify for hedge
accounting treatment, but the fuel oil swaps do not qualify for hedge accounting
treatment and are discussed below under the caption "Financially-Settled
Commodity Derivative Instruments that Do Not Qualify for Hedge Accounting." The
maximum length of time over which we have hedged cash flow variability
associated with forecasted purchases and sales of natural gas is through October
2006. We use standard New York Mercantile Exchange ("NYMEX") futures prices to
value the gas positions. At June 30, 2006, the fair value of gas swap contracts
was a liability of $3.1 million; such amount is reported in accumulated other
comprehensive income and is expected to be reclassified into earnings over the
next twelve months. The ineffective portion of these derivatives for the six
months ended June 30, 2006 was immaterial.
Our Energy Investments subsidiary, 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 June 30, 2006, Seneca-Upshur has hedge
positions in place for approximately 80% of its estimated 2006 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 June 30, 2006 was a liability of $11.2 million.
The estimated amount of losses associated with such derivative instruments that
are reported in accumulated other comprehensive income and that are expected to
be reclassified into earnings over the next twelve months is $4.4 million.
Ineffectiveness associated with these outstanding derivative financial
instruments was immaterial for the six months ended June 30, 2006.
13
The Ravenswood Generating Station hedges the cash flow variability associated
with a portion of electric energy sales. Our strategy is to hedge up to 50% of
the on-peak capability of the Ravenswood Generating Station. The maximum length
of time over which we have hedged cash flow variability is through March 2007.
To accomplish our stated hedging strategy, KeySpan employs financially-settled
electric-power swap contracts with offsetting financially-settled oil swap
contracts and OTC natural gas swaps. We use market quoted forward prices to
value the electric-power swap contracts. The fair value of these derivative
instruments at June 30, 2006 was $16.2 million, $15.8 million of which is
reported in accumulated other comprehensive income and is expected to be
reclassified into earnings within the next twelve months. We use market quoted
forward prices to value the oil swap contracts. The fair value of these
derivative instruments at June 30, 2006, was a liability of $1.2 million of
which $1.0 million is reported in accumulated other comprehensive income and is
expected to be reclassified into earnings within the next twelve months. We use
market quoted forward prices to value the gas swap contracts. The fair value of
these derivative instruments at June 30, 2006, was a liability of $13.1 million,
of which $12.4 million is reported in accumulated other comprehensive income and
is expected to be reclassified into earnings within the next twelve months.
Ineffectiveness associated with these outstanding derivative financial
instruments was immaterial for the six months ended June 30, 2006.
The above noted derivative financial instruments are cash flow hedges that
qualify for hedge accounting under SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS 149 "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," collectively
SFAS 133, and are not considered held for trading purposes as defined by current
accounting literature. Accordingly, we carry the fair value of our derivative
instruments on the Consolidated Balance Sheet as either a current or deferred
asset or liability, as appropriate, and defer the effective portion of
unrealized gains or losses in accumulated other comprehensive income. Gains and
losses are reclassified from accumulated other comprehensive income to the
Consolidated Statement of Income in the period the hedged transaction affects
earnings. Gains and losses are reflected as a component of either revenue or
fuel and purchased power depending on the hedged transaction. Hedge
ineffectiveness results from changes during the period in the price
differentials between the index price of the derivative contract and the price
of the purchase or sale for the cash flow that is being hedged, and is recorded
directly to earnings.
Firm Gas Sales Financial 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 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, the fair value of these
derivatives are recorded as current or deferred assets and liabilities, with
offsetting positions recorded as regulatory assets and regulatory liabilities 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 June 30, 2006
the fair value of these derivative instruments was a liability of $54.5 million.
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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 qualify for the normal purchases and sales
exception. Certain contracts for the physical purchase of natural gas associated
with our regulated gas utilities do not qualify for normal purchases under 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. At June 30, 2006, these derivatives had a net fair value of $62.7 million.
Financially-Settled Commodity Derivative Instruments that Do Not Qualify for
Hedge Accounting: KeySpan subsidiaries also have employed financial derivatives
that do not qualify for hedge accounting treatment under SFAS 133. In 2006, we
purchased a series of call options on the spread between the price of heating
oil and the price of natural gas. The remaining options cover the period July
2006 through October 2006 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, but limited to the cost of gas plus the tail
block rate. Utility tariffs, however, establish an upper limit on the price
KeySpan can charge for the sale of natural gas to these customers. These options
are intended to limit KeySpan's exposure to spikes in heating oil prices
relative to the price of natural gas. These options do not qualify for hedge
accounting treatment under SFAS 133. The fair value of these options at June 30,
2006 was $3.5 million and has been recorded as a deferred asset on the
Consolidated Balance Sheet. Further, KeySpan recorded a $3.5 million benefit in
other income and deductions on the Consolidated Statement of Income to reflect
the change in the market value associated with these derivative instruments for
the six months ended June 30, 2006.
As noted earlier, OTC fuel oil swaps associated with our hedging strategy
regarding sales to large-volume customers do not qualify for hedge accounting
treatment. The fair value of these derivative instruments at June 30, 2006 was a
liability of $3.0 million and has been recorded as a current liability on the
Consolidated Balance Sheet. During the six months ended June 30, 2006, $1.6
million was charged to expense on the Consolidated Statement of Income.
Further, the Ravenswood Generating Station has also employed a limited number of
financial derivatives that do not qualify for hedge accounting treatment under
SFAS 133 that were originally executed to hedge the cash flow variability for a
portion of forecasted purchases of natural gas and fuel oil that will be
consumed during the generation of electricity. The fair value of these
derivative instruments at June 30, 2006 was a liability of $3.7 million and has
been recorded as a current liability on the Consolidated Balance Sheet. KeySpan
recorded a $3.7 million charge to expense in the Consolidated Statement of
Income to reflect the change in the market value associated with these
derivative instruments for the six months ended June 30, 2006; $2.3 million of
which was transferred from accumulated other comprehensive income since it is no
longer probable that the forecasted transactions will occur.
15
KeySpan has employed a limited number of financial derivatives that do not
qualify for hedge accounting treatment under SFAS 133 to hedge the cash flow
variability for a portion of forecasted purchases of fleet fuel. The fair value
of these derivative instruments at June 30, 2006 was $0.6 million and has been
recorded as a deferred asset on the Consolidated Balance Sheet.
On January 18, 2006, KeySpan entered into an International SWAP Dealers
Association Master Agreement for a fixed for float unforced capacity financial
swap (the "Agreement") with Morgan Stanley Capital Group Inc. ("Morgan
Stanley"). The Agreement has a three year term that began on May 1, 2006. The
notional quantity is 1,800,000kW (the "Notional Quantity") of In-City Unforced
Capacity and the fixed price is $7.57/kW-month ("Fixed Price"), subject to
adjustment upon the occurrence of certain events. Cash settlement occurs on a
monthly basis based on the In-City Unforced Capacity price determined by the
relevant New York Independent System Operator ("NYISO") Spot Demand Curve
Auction Market ("Floating Price"). For each monthly settlement period, the price
difference equals the Fixed Price minus the Floating Price. If such price
difference is less than zero, Morgan Stanley will pay KeySpan an amount equal to
the product of (a) the Notional Quantity and (b) the absolute value of such
price difference. Conversely, if such price difference is greater than zero,
KeySpan will pay Morgan Stanley an amount equal to the product of (a) the
Notional Quantity and (b) the absolute value of such price difference. This
derivative instrument does not qualify for hedge accounting treatment under SFAS
133 and is subject to fair value accounting treatment; although currently there
is no observable market reference to value this derivative instrument. As noted,
this is a financial derivative instrument and is unrelated to any physical
production of electricity.
Additionally, KeySpan has a management contract with Merrill Lynch Trading,
under which KeySpan and Merrill Lynch Trading will share the responsibilities
for managing KeySpan's upstream gas distribution assets associated with its
Massachusetts gas distribution subsidiaries, as well as providing city-gate
delivered supply. This contract, which replaces the prior arrangement with
Merrill Lynch Trading, allows for both KeySpan and Merrill Lynch Trading to
employ derivative instruments to maximize the profitability of KeySpan's
portfolio of gas distribution assets. Profits associated with these activities
are shared between KeySpan, Merrill Lynch Trading and KeySpan's Massachusetts
ratepayers. At June 30, 2006, KeySpan's proportionate share of the fair value
associated with these derivative instruments amounted to $4.4 million and is
reflected on the Consolidated Balance Sheet as a deferred asset of $4.4 million
with an offsetting regulatory liability of $2.5 million and deferred liability
of $1.1 million; the remaining amount was recorded as a benefit to revenues.
KeySpan provides these services internally for its New York and New Hampshire
gas distribution subsidiaries.
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The table below summarizes the fair value of all of the above outstanding
derivative instruments at June 30, 2006 and December 31, 2005, 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.
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(In Millions of Dollars) June 30, 2006 December 31, 2005
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Gas Contracts:
Other current assets $ 9.0 $ 132.1
Other deferred charges 69.1 75.2
Regulatory asset 50.8 30.9
Other current liabilities (61.9) (39.8)
Other deferred liabilities (36.9) (44.3)
Regulatory liability (53.0) (175.4)
Oil Contracts:
Other current assets - 0.5
Other current liabilities (6.5) (6.8)
Electric Contracts:
Other current assets 15.8 10.2
Other deferred charges 0.8 -
Other current liabilities - (0.7)
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$ (12.8) $ (18.1)
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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 2005, we entered into heating-degree day put options to mitigate the effect
of fluctuations from normal weather on KEDNE's financial position and cash flows
for the 2005/2006 winter heating season - November 2005 through March 2006.
These put options would have paid KeySpan up to $40,000 per heating degree day
when the actual temperature was below 4,169 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 $1.2 million and was amortized over the heating season. Weather for the
entire primary winter heating season -November 2005 through March 2006 - was
slightly colder than normal. Therefore, there was no earnings impact associated
with these weather derivatives, except for the amortization of the net premium
cost. 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.
17
Credit and Collateral: 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 June 30, 2006, KeySpan has received $6.3
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. At
June 30, 2006, KeySpan has no outstanding margin calls to its counterparties.
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 the reported results of operations, financial
position and cash flows and lowers overall business risk.
5. RECENT ACCOUNTING PRONOUNCEMENTS
On July 13, 2006, the FASB issued Interpretation No. 48 "Accounting for
Uncertainty In Income Taxes." The FASB, in its interpretation of SFAS 109,
"Accounting for Income Taxes," seeks to reduce the diversity in practice
associated with certain aspects of the recognition and measurement requirements
related to accounting for income taxes. The Interpretation requires application
for fiscal years beginning after December 15, 2006. KeySpan anticipates that
implementation of this Interpretation will have minimal impact on its results of
operations, financial position or cash flows.
On March 31, 2006, the Financial Accounting Standards Board ("FASB") issued an
Exposure Draft of proposed rules on employers' accounting for defined benefit
pensions and other postretirement benefit plans that would require employers to
fully recognize the plan's funded status on the balance sheet. If adopted as
proposed, the new rules would be applied retroactively to prior financial
statements presented and be effective for fiscal years ending after December 15,
2006. KeySpan is currently evaluating the Exposure Draft and believes that the
new rules, if adopted as proposed, may significantly increase KeySpan's recorded
pension and other postretirement liabilities and reduce its shareholders'
equity. The comment period on this Exposure Draft ended on May 31, 2006.
In December 2004 the FASB issued SFAS 123 (revised 2004 "SFAS 123R")
"Share-Based Payment." SFAS 123R focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS 123R 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 SFAS 123R is similar to the
fair-value-based method in SFAS 123 in most respects. However, the following are
key differences between the two: entities are now required to measure
liabilities incurred to employees in share-based payment transactions at fair
value as compared to using the intrinsic method allowed under SFAS 123; entities
18
are now 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 SFAS 123; and incremental compensation cost for a modification
of the terms or conditions of an award are also measured differently under SFAS
123R compared to Statement 123. SFAS 123R also clarifies and expands SFAS 123's
guidance in several areas. The effective date of SFAS 123R was 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. Therefore implementation of SFAS 123R in January 2006 did not have a
material impact on KeySpan's results of operations or financial position and no
impact on its cash flows.
6. FINANCIAL GUARANTEES AND CONTINGENCIES
Variable Interest Entity: KeySpan has an arrangement with a variable interest
entity through which we lease a portion of the Ravenswood Facility. We acquired
the Ravenswood Facility, a 2,200-megawatt electric generating facility located
in Queens, New York, in part, through the variable interest entity from
Consolidated Edison on June 18, 1999 for approximately $597 million. In order to
reduce the initial cash requirements, we entered into a lease agreement (the
"Master Lease") with a variable interest, unaffiliated financing entity that
acquired a portion of the facility, or three steam generating units, directly
from Consolidated Edison and leased it to our subsidiary. The variable interest
unaffiliated financing entity acquired the property for $425 million, financed
with debt of $412.3 million (97% of capitalization) and equity of $12.7 million
(3% of capitalization). KeySpan has no ownership interests in the units or the
variable interest entity. KeySpan has guaranteed all payment and performance
obligations of our subsidiary, KeySpan Ravenswood, LLC, under the Master Lease.
Monthly lease payments substantially equal the monthly interest expense on such
debt securities.
The term of the Master Lease extends through June 20, 2009. On all future
semi-annual payment dates, we have the right to: (i) either purchase the
facility for the original acquisition cost of $425 million, plus the present
value of the lease payments that would otherwise have been paid through June
2009; or (ii) terminate the Master Lease and dispose of the facility. In June
2009, when the Master Lease terminates, we may purchase the facility in an
amount equal to the original acquisition cost, subject to adjustment, or
surrender the facility to the lessor. If we elect not to purchase the property,
the Ravenswood Facility will be sold by the lessor. We have guaranteed to the
lessor, as residual value, 84% of the acquisition 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
$315.2 million.
19
If our subsidiary that leases the Ravenswood Facility, KeySpan Ravenswood LLC,
was not able to fulfill its payment obligations with respect to the Master Lease
payments, then the maximum amount KeySpan would be exposed to under its current
guarantees would be $425 million plus the present value of the remaining lease
payments through June 20, 2009.
Sale/leaseback Transaction: KeySpan also has a leveraged lease financing
arrangement associated with the Ravenswood Expansion. In May 2004, the unit was
acquired by a lessor from our subsidiary, KeySpan Ravenswood, LLC, and
simultaneously leased back to that subsidiary. All the obligations of KeySpan
Ravenswood, LLC have been unconditionally guaranteed by KeySpan. This lease
transaction qualifies as an operating lease under SFAS 98 "Accounting for
Leases: Sale/Leaseback Transactions Involving Real Estate; Sales-Type Leases of
Real Estate; Definition of the Lease Term; an Initial Direct Costs of Direct
Financing Leases, an amendment of FASB Statements No.13, 66, 91 and a rescission
of FASB Statement No. 26 and Technical Bulletin No. 79-11."
Asset Retirement Obligations: KeySpan has various asset retirement obligations
primarily associated with its gas distribution and electric generation
activities. These obligations have remained substantially unchanged from
December 31, 2005, except for accretion adjustments. Generally, KeySpan's
largest asset retirement obligations relate to: (i) legal requirements to cut
(disconnect from the gas distribution system), purge (clean of natural gas and
PCB contaminants) and cap gas mains within its gas distribution and transmission
system when mains are retired in place; or dispose of sections of gas main when
removed from the pipeline system; (ii) cleaning and removal requirements
associated with storage tanks containing waste oil and other waste contaminants;
and (iii) legal requirements to remove asbestos upon major renovation or
demolition of structures and facilities. At June 30, 2006, these obligations
total $48.8 million. See KeySpan's Annual Report on Form 10-K for the year ended
December 31, 2005, Note 7 to the Consolidated Financial Statements "Contractual
Obligations, Financial Guarantees and Contingencies" for additional information
regarding these obligations.
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 ("VCA") have been executed with the DEC to address the investigation
and/or remediation activities associated with certain sites and one waterway. In
March 2005, KeySpan withdrew its previously filed applications under the DEC's
Brownfield Cleanup Program ("BCP") because of the uncertainty associated with
contribution suits which we may need to bring against other parties who impacted
20
these sites for their share of remedial cost. As a result of the United States
Supreme Court's December 2004 decision in Cooper Industries v. Aviall Services,
Inc. and the emerging case law in New York, KeySpan continues to evaluate how to
proceed with respect to participation in the BCP or alternative DEC remediation
programs.
We have identified 28 of these sites as being associated with the historical
operations of KEDNY. One site has been fully remediated. Subject to the issues
described in the preceding paragraph, the remaining 27 sites will be
investigated and, if necessary, remediated under the terms and conditions of
ACOs, VCAs, or Brownfield Cleanup Agreements ("BCA"). Expenditures incurred to
date by us with respect to KEDNY MGP-related activities total $70.0 million.
The remaining 15 sites have been identified as being associated with the
historical operations of KEDLI. One site has been fully investigated and
requires no further action. Subject to the issues described above, the remaining
sites will be investigated and, if necessary, remediated under the terms and
conditions of ACOs, VCAs, or BCAs. Expenditures incurred to date by us with
respect to KEDLI MGP-related activities total $56.4 million.
We presently estimate the remaining cost of our KEDNY and KEDLI MGP-related
environmental remediation activities will be $341.7 million, which amount has
been accrued by us as a reasonable estimate of probable cost for known sites.
However, remediation costs for each site may be materially higher than noted,
depending upon changing technologies and regulatory standards, selected end use
for each site, and actual environmental conditions encountered.
With respect to remediation costs, the KEDNY and KEDLI rate plans generally
provide for the recovery from customers of investigation and remediation costs
of certain sites. At June 30, 2006, we have reflected a regulatory asset of
$381.8 million for our KEDNY/KEDLI MGP sites. 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.
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 $1.6 million, which amount has been
accrued by us. Expenditures incurred to date total $3.4 million.
New England Sites: Within the Commonwealth of Massachusetts and the State of New
Hampshire, we are aware of 74 former MGP sites and related facilities within the
existing or former service territories of KEDNE.
21
Boston Gas Company, Colonial Gas Company and Essex Gas Company may have or share
responsibility under applicable environmental laws for the remediation of 64 of
these sites. A subsidiary of National Grid USA ("National Grid"), formerly New
England Electric System, has assumed responsibility for remediating 11 of these
sites, subject to a limited contribution from Boston Gas Company, and has
provided full indemnification to Boston Gas Company with respect to eight other
sites. In addition, Boston Gas Company, Colonial Gas Company, and Essex Gas
Company have assumed responsibility for remediating three sites each. At this
time, it is uncertain as to whether Boston Gas Company, Colonial Gas Company or
Essex Gas Company have or share responsibility for remediating any of the other
sites. No notice of responsibility has been issued to us for any of these sites
from any governmental environmental authority.
We presently estimate the remaining cost of the Massachusetts KEDNE MGP-related
environmental cleanup activities will be $11.0 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 these subsidiaries, with
respect to these MGP-related activities total $32.4 million.
We may have or share responsibility under applicable environmental laws for the
remediation of 10 MGP sites and related facilities associated with the
historical operations of EnergyNorth in New Hampshire. 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 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.
The Nashua River Asbestos Site now has been fully remediated.
We presently estimate the remaining cost of EnergyNorth MGP-related
environmental cleanup activities will be $28.0 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 this subsidiary, with
respect to these MGP-related activities total $20.4 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
June 30, 2006, we have reflected a regulatory asset of $61.7 million for the
KEDNE MGP sites.
22
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. In 1989,
KeySpan, Honeywell and Beazer East entered into a cost-sharing agreement under
which each company agreed to pay one-third of the costs of compliance with the
consent order, while preserving any claims it may have against the other
companies for, among other things, reallocation of proportionate liability. In
2002, Beazer East commenced an action in the U.S. District Court for the
Southern District of New York, which sought a judicial determination on the
allocation of liability for the Everett Facility. A confidential settlement
agreement has been executed on favorable terms to KeySpan and the Beazer lawsuit
has been discontinued.
We presently estimate the remaining cost of our environmental cleanup activities
for these three non-utility sites will be approximately $16.6 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
$16.3 million.
We believe that in the aggregate, the accrued liability for these MGP sites and
related facilities identified above are reasonable estimates of the probable
cost for the investigation and remediation of these sites and facilities. As
circumstances warrant, we periodically re-evaluate the accrued liabilities
associated with MGP sites and related facilities. We may be required to
investigate and, if necessary, remediate each site previously noted, or other
currently unknown former sites and related facility sites, the cost of which is
not presently determinable but may be material to our financial position,
results of operations or cash flows.
Insurance Settlements: KeySpan has entered into confidential settlement
agreements with certain of its insurance carriers for recovery of costs
associated with the investigation and remediation of its MGP sites and the
KeySpan New England LLC non-utility sites. Pursuant to these settlements,
KeySpan recorded a benefit of $5.5 million in its Consolidated Statement of
Income for the three and six months ended June 30, 2006 reflecting the benefit
accruing to KeySpan's shareholders. Recovery of environmental costs from
insurance carriers associated with utility MGP sites are refunded to KeySpan's
ratepayers, subject to certain sharing provisions.
See KeySpan's Annual Report on Form 10-K for the year ended December 31, 2005
Note 7, to those Consolidated Financial Statements "Contractual Obligations,
Financial Guarantees and Contingencies" for further information on environmental
matters.
23
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, 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.
On March 20, 2006, a purported class action lawsuit was filed alleging breach of
fiduciary duty against us and our directors. The complaint, which was filed in
the New York State Supreme Court for the County of Kings, relates to the
execution of the merger agreement with National Grid plc and alleges that the
merger consideration which our stockholders will receive in connection with the
proposed merger transaction is inadequate and unfair because the transaction
value of $42.00 for each share of our common stock does not provide our
stockholders with a meaningful premium over the market price of the common
stock. On April 19, 2006, we moved to dismiss the complaint for failure to state
a cause of action upon which relief can be granted. On May 26, 2006, the
plaintiff served an amended complaint adding National Grid as a defendant. The
amended complaint alleged that National Grid aided and abetted the alleged
breach of fiduciary duties and added claims of inadequate disclosure with
respect to KeySpan's preliminary proxy materials. On or about June 16, 2006, the
parties agreed in principle to settle the case. The agreement is subject to
negotiating and executing definitive settlement documentation, confirmatory
discovery of the fairness of the settlement, and court approval of the
settlement following notice to shareholders.
On July 12, 2006, a purported class action was filed alleging damages resulting
from contamination associated with the historic operations of the former
manufactured gas plant in Bay Shore, New York. We believe the lawsuit to be
without merit and we intend to contest it vigorously.
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. KeySpan and LIPA have entered
into agreements to extend, amend, and restate these contractual arrangements.
See Note 10 "2006 LIPA Settlement" for a further discussion of these agreements.
LIPA completed its strategic review initiative that it had undertaken in
connection with, among other reasons, its option under the Generation Purchase
Rights Agreement with KeySpan. As part of its review, LIPA engaged a team of
advisors and consultants, held public hearings and explored its strategic
options, including continuing its existing operations, municipalizing,
privatizing, selling some, but not all of its assets, becoming a regulator of
rates and services, or merging with one or more utilities. Upon completion of
its strategic review, LIPA determined that it would continue its existing
operations and entered into the renegotiated 2006 LIPA Agreements that are
discussed in Note 10 "2006 LIPA Settlement." Following the announcement of the
proposed acquisition of KeySpan by National Grid, LIPA, National Grid and
24
KeySpan have engaged in discussions concerning the impact of the transaction on
LIPA's operations. At this time, we are unable to determine what impact, if any,
such discussions may have on the 2006 LIPA Agreements and the receipt and timing
of governmental approvals relating thereto.
As reported in KeySpan's Annual Report on Form 10-K for the year ended December
31, 2005, KeySpan is currently in discussions with the Internal Revenue Service
("IRS") at the Appeals level with regard to the Long Island Lighting Company's
("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
years ended September 30, 1997 through December 31, 1998. The primary issue
relates to the valuation of the transferred assets in the KeySpan/LILCO
combination. However, two issues were resolved in the second quarter of 2006.
Additionally, the IRS has recently commenced the examination of KeySpan's tax
returns for the year ended 2002 and 2003. At this time, we cannot predict the
result of these audits.
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
June 30, 2006, 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 Millions of Dollars) Exposure Dates
- --------------------------------------------------------------------------------------
Guarantees for Subsidiaries
Medium-Term Notes - KEDLI (i) $ 525.0 2008-2010
Industrial Development Revenue Bonds (ii) 128.3 2027
Ravenswood - Master Lease (iii) 425.0 2009
Ravenswood - Sale/leaseback (iv) 403.5 2019
Surety Bonds (v) 72.1 2006 - 2008
Commodity Guarantees and Other (vi) 64.7 2006 - 2009
Letters of Credit (vii) 80.3 2006 - 2010
- --------------------------------------------------------------------------------------
$ 1,698.9
- --------------------------------------------------------------------------------------
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.
25
(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.
(v) KeySpan has agreed to indemnify the issuers of various surety and
performance bonds associated with certain construction projects being
performed by certain current or former subsidiaries. In the event that the
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 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 June 30, 2006, the total cost to complete such
remaining bonded projects is estimated to be approximately $28 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 June 30, 2006.
(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.
26
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.
7. STOCK BASED COMPENSATION
From time to time, KeySpan awards stock based compensation to officers,
directors, consultants and certain other management employees, primarily under
the Long Term Performance Incentive Compensation Plan (the "Incentive Plan").
The Incentive Plan provides for the award of incentive stock options,
non-qualified stock options, performance shares and restricted shares. The
purpose of the Incentive Plan is to optimize KeySpan's performance through
incentives that directly link the participant's goals to those of KeySpan's
shareholders and to attract and retain participants who make significant
contributions to the success of KeySpan.
Under this Plan, 19,250,000 shares were authorized for issuance of which the
total shares awarded to date include 16.9 million stock options, 222,143 shares
of restricted stock, and 891,555 performance shares. At June 30, 2006, after
adjusting for forfeitures, there are approximately 3.1 million shares still
eligible to be granted under the Incentive Plan. In addition, under previous
plans, there were an additional 1.7 million shares authorized for which
approximately 1.2 million stock options were awarded.
In 2005, KeySpan continued to apply APB Opinion 25 "Accounting for Stock Issued
to Employees," in accounting for grants awarded prior to January 1, 2003. No
compensation cost had been recognized for these stock option awards 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 "Accounting for
Stock-Based Compensation," our net income and earnings per share for the three
and six months ended June 30, 2005 would have decreased to the pro-forma amounts
indicated below:
27
- -----------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
(In Millions of Dollars, Except Per Share Amounts) June 30, 2005 June 30, 2005
- -----------------------------------------------------------------------------------------------------
Earnings available for common stock:
As reported $ 16.2 $ 250.6
Add: recorded stock-based compensation expense, net of tax 3.0 6.1
Deduct: total stock-based compensation expense, net of tax (3.5) (7.0)
- -----------------------------------------------------------------------------------------------------
Pro-forma earnings $ 15.7 $ 249.7
- -----------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 0.10 $ 1.51
Basic - pro-forma $ 0.09 $ 1.51
Diluted - as reported $ 0.09 $ 1.51
Diluted - pro-forma $ 0.09 $ 1.50
- -----------------------------------------------------------------------------------------------------
In 2003, KeySpan adopted the prospective method of transition of accounting for
stock based compensation 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 for grants awarded after January 1, 2003.
In January 2006, KeySpan adopted SFAS 123 (revised 2004) "Share-Based Payment
("SFAS 123R")." The implementation of this standard required KeySpan to expense
certain stock options that had previously been accounted for under the
requirements of APB Opinion 25 and related Interpretations, i.e. awards issued
prior to January 1, 2003. No compensation cost had 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. For the six
months ended June 30, 2006, KeySpan recorded an expense of $0.7 million for
stock option awards previously accounted for under APB 25 and which have not
fully vested.
The following table presents the actual expense for all of KeySpan's stock based
compensation awards recorded in the Consolidated Statement of Income for the
periods indicated.
- ----------------------------------------------------------------------------------------------------------
Six Months Ended
June 30 June 30
(In Millions of Dollars, Except Per Share Amounts) 2006 2005
- ----------------------------------------------------------------------------------------------------------
Performance shares $ 4.6 $ 3.4
Restricted stock 3.8 0.5
Stock options 3.1 2.8
EDSPP discount 2.7 2.5
- ----------------------------------------------------------------------------------------------------------
Total stock-based compensation included in operations and
maintenance expense 14.2 9.2
Income tax benefit (5.0) (3.2)
- ----------------------------------------------------------------------------------------------------------
Total stock based compensation expense, net of tax $ 9.2 $ 6.0
- ----------------------------------------------------------------------------------------------------------
28
Prior to the adoption of SFAS 123R, KeySpan presented all tax benefits for
deductions resulting from the exercise of stock options and disqualifying
dispositions as operating cash flows in its Consolidated Statement of Cash
Flows. SFAS 123R requires the benefits of tax deductions in excess of recognized
compensation expense to be reported as a financing cash flow, rather than as an
operating cash flow. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after adoption. Total cash flow
will remain unchanged from what would have been reported under prior accounting
rules.
During the six months ended June 30, 2006 and 2005, cash received from stock
options exercised was $18.1 million and $37.6 million, respectively. The actual
tax benefit realized for tax deductions from stock options exercised was $1.8
million and $4.6 million for the six months ended June 30, 2006 and 2005,
respectively. The benefits received from these tax deductions were less than the
recognized compensation expense and accordingly there were no excess tax
deductions reported in the financing section of the Consolidated Statement of
Cash Flows.
The following represents a discussion of the various awards granted under our
stock based compensation plans:
Performance shares
Performance shares were awarded under the Incentive Plan in 2004 and 2005 based
upon the attainment of overall corporate performance goals. These performance
shares are measured over a three year period by comparing KeySpan's cumulative
total shareholder return to the S&P Utilities Group. For actual performance
achieved at a threshold level, 50% of the award will be granted; for actual
performance achieved at a targeted level, 100% of the award will be granted; and
for actual performance achieved at the maximum level, 150% of the award will be
granted. The 2004 and 2005 awards are being expensed ratably over their
remaining performance periods.
The 2006 performance share award reflects the new performance condition criteria
under SFAS 123R. In 2006, 314,560 performance shares were granted to officers.
Performance shares were granted with a three-year performance period with a
threshold, target and maximum performance level. The number of performance
shares earned at the end of the performance period can range from 0% to 150% of
the shares granted and will be linked to two performance measures: the
percentage improvement in return on invested capital, or "ROIC," and KeySpan's
cumulative three-year total stockholder return, or "TSR," relative to the
cumulative three-year TSR for the Standard and Poor's Utilities Group, using a
matrix approach that encompasses both measures. The ROIC goal will act as the
primary trigger. If the ROIC goal performance is below the threshold level, all
shares shall be forfeited without payment. Upon a change of control, performance
shares shall be distributed based upon the greater of the number of performance
shares awarded at target level or the number of shares earned based on actual
performance through the change of control date. Performance share awards were
priced at fair value on the date of grant. The unearned compensation as of June
30, 2006 associated with all of the performance share awards was $16.1 million.
29
Restricted Stock Awards
KeySpan has made certain grants of restricted stock to officers and directors
under the Incentive Plan. Awards of restricted stock were made in 2002, 2005 and
2006. These awards may not be sold or otherwise transferred until certain
restrictions have lapsed. The unearned stock-based compensation related to these
awards is being amortized to compensation expense over the period in which the
awards vest. The share-based expense for these awards was determined based on
the fair value of the stock at the date of grant applied to the total number of
shares that were anticipated to fully vest. The 2002 and 2005 awards will be
fully expensed by the end of this year and the 2006 award was expensed in the
first quarter of 2006. Upon a change of control, all restricted stock awards
will vest immediately. The unearned compensation as of June 30, 2006 associated
with these awards was $0.3 million.
Employee Discount Stock Purchase Plan
KeySpan's Employee Discount Stock Purchase Plan ("EDSPP") allows KeySpan
employees to purchase shares of KeySpan stock at a 10% discount through payroll
deductions. KeySpan is currently expensing the discount. The number of shares of
common stock authorized for issuance under the EDSPP is 1,750,000 shares and
there are 488,919 shares remaining to be issued.
Stock Options
The stock option component of the Incentive Plan entitles the participants to
purchase shares of common stock at an exercise price per share which is no less
than the closing price of the common stock on the date of the grant. Stock
options generally vest over a three-to-five year period and have an exercise
period of ten years. Upon a change of control, all stock options granted and
outstanding will vest immediately.
The value of all stock option grants are estimated on the date of the grant
using the Black-Scholes option-pricing model. There were no stock grants issued
in 2006. The following table presents the weighted average fair value, exercise
price and assumptions used for the 2005 stock option grant:
- ---------------------------------------------------
2005
- ---------------------------------------------------
Fair value of grants issued $ 6.15
Dividend yield 4.64%
Expected volatility 22.63%
Risk free rate 4.10%
Expected lives 6.4 years
Exercise price $ 39.25
- ---------------------------------------------------
30
A summary of the status of our fixed stock option plans and changes is presented
below for the six months ended June 30, 2006:
- ------------------------------------------------------------------------------------------
Weighted Aggregate
Average Intrinsic Value
Fixed Options Shares Exercise Price (In Millions)
- ------------------------------------------------------------------------------------------
Outstanding at beginning of period 10,443,055 $ 33.74
Granted during the year - $ -
Exercised (561,224) $ 32.39
Forfeited (131,113) $ 36.75
- ------------------------------------------------------------------------------------------
Outstanding at end of period 9,750,718 $ 33.78 $ 64.5
- ------------------------------------------------------------------------------------------
Exercisable at end of period 7,200,707 $ 32.71 $ 55.3
- ------------------------------------------------------------------------------------------
The total intrinsic value of the options exercised during the six months ended
June 30, 2006 and 2005 was approximately $4.5 million and $10.2 million,
respectively.
- ------------------------------------------------------------------------------------------------------------------------------------
Remaining Options Weighted Range of Options Weighted Range of
Contractual Outstanding at Average Exercise Exercisable at Average Exercise
Life June 30, 2006 Exercise Price Price June 30, 2006 Exercise Price Price
- ------------------------------------------------------------------------------------------------------------------------------------
1 years 119,500 $ 30.50 $30.50 119,500 $ 30.50 $30.50
2 years 186,410 $ 32.52 $ 19.15 - 32.63 186,410 $ 32.52 $ 19.15 - 32.63
3 years 724,625 $ 27.99 $ 24.73 - 29.38 724,625 $ 27.99 $ 24.73 - 29.38
4 years 382,181 $ 26.97 $ 21.99 - 27.06 382,181 $ 26.97 $ 21.99 - 27.06
5 years 975,437 $ 22.69 $ 22.50 - 32.76 975,437 $ 22.69 $ 22.50 - 32.76
6 years 1,572,663 $ 39.50 $39.50 1,572,663 $ 39.50 $39.50
7 years 1,795,711 $ 32.66 $32.66 1,462,611 $ 32.66 $32.66
8 years 1,190,664 $ 32.40 $32.40 786,824 $ 32.40 $32.40
9 years 1,433,927 $ 37.54 $37.54 665,732 $ 37.54 $37.54
10 years 1,369,600 $ 39.25 $39.25 324,724 $ 39.25 $39.25
- ------------------------------------------------------------------------------------------------------------------------------------
9,750,718 7,200,707
- ------------------------------------------------------------------------------------------------------------------------------------
As of June 30, 2006, there are approximately 2.6 million options which have not
yet vested. The unearned compensation cost related to these stock option awards
is $6.3 million which is expected to be recognized over a weighted average
period of 2 years.
8. POSTRETIREMENT BENEFITS
Pension Plans: The following information represents the consolidated net
periodic pension cost for the six months ended June 30, 2006 and 2005, 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.
31
The calculation of net periodic pension cost is as follows:
- -------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Millions of Dollars) 2006 2005 2006 2005
- -------------------------------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period 16.0 13.3 $ 32.1 $ 28.3
Interest cost on projected benefit obligation 38.6 36.9 77.2 74.3
Expected return on plan assets (47.0) (43.7) (94.0) (86.6)
Net amortization and deferral 21.9 18.1 43.8 37.0
- -------------------------------------------------------------------------------------------------------------------------------
Total pension cost 29.5 24.6 $ 59.1 $ 53.0
- -------------------------------------------------------------------------------------------------------------------------------
Other Postretirement Benefits: The following information represents the
consolidated net periodic other postretirement benefit cost for the six months
ended June 30, 2006 and 2005 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:
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Millions of Dollars) 2006 2005 2006 2005
- ----------------------------------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period 7.0 5.9 $ 13.9 $ 12.2
Interest cost on accumulated
postretirement benefit obligation 20.1 17.9 40.3 37.8
Expected return on plan assets (9.2) (9.0) (18.3) (18.1)
Net amortization and deferral 16.7 13.5 33.3 30.0
- ----------------------------------------------------------------------------------------------------------------------------
Other postretirement cost 34.6 28.3 $ 69.2 $ 61.9
- ----------------------------------------------------------------------------------------------------------------------------
During the first six months of 2006, KeySpan contributed $16.5 million to its
pension plans and $9.0 million to its other postretirement benefit plans.
KeySpan anticipates contributing an additional $94.5 million to its pension and
other postretirement benefit plans during the remainder of 2006. 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. COMMERCIAL PAPER
At June 30, 2006, KeySpan had two credit facilities totaling $1.5 billion - $920
million for five years through 2010, and $580 million through 2009, which
continue to support KeySpan's commercial paper program for ongoing working
capital needs.
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
32
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
June 30, 2006, KeySpan's consolidated indebtedness was 47.3 % 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 June 30, 2006, we had cash and temporary cash investments of $40.1 million.
During the first six months of 2006, we repaid $467.6 million of commercial
paper and, at June 30, 2006, $190.0 million of commercial paper was outstanding
at a weighted average annualized interest rate of 5.42%. At June 30, 2006,
KeySpan had the ability to issue up to an additional $1.3 billion, under its
commercial paper program.
10. 2006 LIPA SETTLEMENT
LIPA is a corporate municipal instrumentality and a political subdivision of the
State of New York. On May 28, 1998, certain of the Long Island Lighting
Company's ("LILCO's") business units were merged with KeySpan and LILCO's common
stock and remaining assets were acquired by LIPA. At the time of this
transaction, KeySpan and LIPA entered into three major long-term service
agreements that (i) provide to LIPA all operation, maintenance and construction
services and significant administrative services relating to the Long Island
electric transmission and distribution ("T&D") system pursuant to a Management
Services Agreement (the "1998 MSA"); (ii) supply LIPA with electric generating
capacity, energy conversion and ancillary services from our Long Island
generating units pursuant to a Power Supply Agreement (the "1998 PSA") and other
33
long-term agreements through which we provide LIPA with approximately one half
of its customers' energy needs; and (iii) manage all aspects of the fuel supply
for our Long Island generating facilities, as well as all aspects of the
capacity and energy owned by or under contract to LIPA pursuant to an Energy
Management Agreement (the "1998 EMA"). We also purchase energy, capacity and
ancillary services in the open market on LIPA's behalf under the 1998 EMA. The
1998 MSA, 1998 PSA and 1998 EMA all became effective on May 28, 1998 and are
collectively referred to as the 1998 LIPA Agreements.
On February 1, 2006, KeySpan and LIPA entered into (i) an amended and restated
Management Services Agreement (the "2006 MSA"), pursuant to which KeySpan will
continue to operate and maintain the electric T&D System owned by LIPA on Long
Island; (ii) a new Option and Purchase and Sale Agreement (the "2006 Option
Agreement"), to replace the Generation Purchase Rights Agreement (as amended,
the "GPRA"), pursuant to which LIPA had the option, through December 15, 2005,
to acquire substantially all of the electric generating facilities owned by
KeySpan on Long Island; and (iii) a Settlement Agreement (the "2006 Settlement
Agreement") resolving outstanding issues between the parties regarding the 1998
LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement
Agreement are collectively referred to herein as the "2006 LIPA Agreements."
Each of the 2006 LIPA Agreements will become effective as of January 1, 2006,
upon all of the 2006 LIPA Agreements receiving the required governmental
approvals; otherwise none of the 2006 LIPA Agreements will become effective.
Following the announcement of the proposed acquisition of KeySpan by National
Grid, LIPA, National Grid and KeySpan have engaged in discussions concerning the
impact of the transaction on LIPA's operations. At this time, we are unable to
determine what impact, if any, the results of such discussions may have on the
2006 LIPA Agreements and the receipt and timing of governmental approvals
relating thereto.
2006 Settlement Agreement
Pursuant to the terms of the 2006 Settlement Agreement, KeySpan and LIPA agreed
to resolve issues that have existed between the parties relating to the various
1998 LIPA Agreements. In addition to the resolution of these matters, KeySpan's
entitlement to utilize LILCO's available tax credits and other tax attributes
will increase from approximately $50 million to approximately $200 million.
These credits and attributes may be used to satisfy KeySpan's previously
incurred indemnity obligation to LIPA for any federal income tax liability that
may result from the settlement of a pending Internal Revenue Service ("IRS")
audit for LILCO's tax year ended March 31, 1999. In recognition of these items,
as well as for the modification and extension of the 1998 MSA and the
elimination of the GPRA, upon effectiveness of the Settlement Agreement, KeySpan
will record a contractual asset in the amount of approximately $160 million, of
which approximately $110 million will be attributed to the right to utilize such
additional tax credits and attributes and approximately $50 million will be
amortized over the eight year term of the 2006 MSA. In order to compensate LIPA
for the foregoing, KeySpan will pay LIPA $69 million in cash and will settle
certain accounts receivable in the amount of approximately $91 million due from
LIPA.
34
Generation Purchase Rights Agreement and 2006 Option Agreement.
Under an amended GPRA, LIPA had the right to acquire certain of KeySpan's Long
Island-based generating assets formerly owned by LILCO, at fair market value at
the time of the exercise of such right. LIPA was initially required to make a
determination by May 2005, but KeySpan and LIPA agreed to extend the date by
which LIPA was to make this determination to December 15, 2005. As part of the
2006 settlement between KeySpan and LIPA, the parties entered into the 2006
Option Agreement whereby LIPA has the option during the period January 1, 2006
to December 31, 2006 to purchase only KeySpan's Far Rockaway and/or E.F. Barrett
Generating Stations (and certain related assets) at a price equal to the net
book value of each facility. The 2006 Option Agreement replaces the GPRA, the
expiration of which has been stayed pending effectiveness of the 2006 LIPA
Agreements. If LIPA were to exercise the option and purchase one or both of the
generation facilities (i) LIPA and KeySpan will enter into an operation and
maintenance agreement, pursuant to which KeySpan will continue to operate these
facilities for a fixed management fee plus reimbursement for certain costs; and
(ii) the 1998 PSA and 1998 EMA will be amended to reflect that the purchased
generating facilities would no longer be covered by those agreements. It is
anticipated that the fees received pursuant to the operation and maintenance
agreement will offset the reduction in the operation and maintenance expense
recovery component of the 1998 PSA and the reduction in fees under the 1998 EMA.
In the event such agreements do not become effective by reason of failure to
secure the requisite governmental approvals, the GPRA will be reinstated for a
period of 90 days.
Management Services Agreements
In place of the previous compensation structure (whereby KeySpan was reimbursed
for budgeted costs, and earned a management fee and certain performance and
cost-based incentives), KeySpan's compensation for managing the T&D System under
the 2006 MSA consists of two components: a minimum compensation component of
$224 million per year and a variable component based on electric sales. The $224
million component will remain unchanged for three years and then increase
annually by 1.7%, plus inflation. The variable component, which will comprise no
more than 20% of KeySpan's compensation, is based on electric sales on Long
Island exceeding a base amount of 16,558 gigawatt hours, increasing by 1.7% in
each year. Above that level, KeySpan will receive approximately 1.34 cents per
kilowatt hour for the first contract year, 1.29 cents per kilowatt hour in the
second contract year (plus an annual inflation adjustment), 1.24 cents per
kilowatt hour in the third contract year (plus an annual inflation adjustment),
with the per kilowatt hour rate thereafter adjusted annually by inflation.
Subject to certain limitations, KeySpan will be able to retain all operational
efficiencies realized during the term of the 2006 MSA.
LIPA will continue to reimburse KeySpan for certain expenditures incurred in
connection with the operation and maintenance of the T&D System, and other
payments made on behalf of LIPA, including: real property and other T&D System
taxes, return postage, capital construction expenditures and storm costs.
35
11. INCOME TAXES
KeySpan's consolidated effective income tax rate, including city and state
income taxes, was 33.8% for the six months ended June 30, 2006 compared to 37.2%
for the corresponding period in 2005. During the second quarter of 2006, KeySpan
resolved its dispute with the New York City Department of Taxation and Finance
with respect to income taxes relating the operations of its merchant electric
generating facility. In addition, KeySpan is currently in discussions with the
IRS at the Appeals level with regard to the Long Island Lighting Company's
("LILCO") 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
years ended September 30, 1997 through December 31, 1998. The primary issue,
relating to the valuation of certain assets transferred in the KeySpan/LILCO
business combination of May 1998, remains open. However, two issues were
resolved in the second quarter of 2006. As a result of settling the two issues
with the IRS, as well as the New York City tax issue, KeySpan realized a tax
benefit of $16.4 million during the three and six months ended June 30, 2006,
thereby lowering the effective income tax rate.
The IRS has also recently commenced the examination of KeySpan's tax returns for
the years ended December 31, 2002 and 2003. At this time, we cannot predict the
result of these audits.
12. KEYSPAN GAS EAST CORPORATION SUMMARY FINANCIAL INFORMATION
KEDLI is a wholly owned subsidiary of KeySpan. KEDLI was formed on May 7, 1998
and on May 28, 1998 acquired substantially all of the assets related to the gas
distribution business of the Long Island Lighting Company. KEDLI established a
program for the issuance, from time to time, of up to $600 million aggregate
principal amount of Medium-Term Notes, which are fully and unconditionally
guaranteed by the parent, KeySpan Corporation. On February 1, 2000, KEDLI issued
$400 million of 7.875% Medium-Term Notes due 2010. In January 2001, KEDLI issued
an additional $125 million of Medium-Term Notes at 6.9% due January 2008. The
following condensed financial statements are required to be disclosed by SEC
regulations and set forth those of KEDLI, KeySpan Corporation as guarantor of
the Medium-Term Notes and our other subsidiaries on a combined basis.
36
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2006
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Revenues $ 0.2 $ 245.9 $ 1,131.8 $ (0.2) $ 1,377.7
-----------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 153.8 386.0 - 539.8
Fuel and purchased power - - 115.7 - 115.7
Operations and maintenance 9.3 34.5 376.8 - 420.6
Intercompany expense - 1.4 (1.4) -
Depreciation and amortization - 18.7 82.5 - 101.2
Operating taxes - 15.3 80.5 - 95.8
-----------------------------------------------------------------------------------------
Total Operating Expenses 9.3 223.7 1,040.1 - 1,273.1
-----------------------------------------------------------------------------------------
Income from equity investments - - 2.9 - 2.9
-----------------------------------------------------------------------------------------
Operating Income (Loss) (9.1) 22.2 94.6 (0.2) 107.5
-----------------------------------------------------------------------------------------
Interest charges (39.9) (13.2) (14.3) 8.0 (59.4)
Other income and (deductions) 75.8 0.9 (13.4) (57.1) 6.2
-----------------------------------------------------------------------------------------
Total Other Income and (Deductions) 35.9 (12.3) (27.7) (49.1) (53.2)
Income Taxes (Benefit) (22.6) 5.5 22.0 - 4.9
-----------------------------------------------------------------------------------------
Net Income $ 49.4 $ 4.4 $ 44.9 $ (49.3) $ 49.4
=========================================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Revenues $ 0.1 $ 227.5 $ 1,115.0 $ (0.1) $ 1,342.5
-----------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 137.6 364.0 - 501.6
Fuel and purchased power - - 159.2 - 159.2
Operations and maintenance 1.1 31.3 359.4 - 391.8
Intercompany expense - 1.2 (1.2) - -
Depreciation and amortization - 18.4 79.1 - 97.5
Operating taxes - 15.3 78.7 - 94.0
-----------------------------------------------------------------------------------------
Total Operating Expenses 1.1 203.8 1,039.2 - 1,244.1
-----------------------------------------------------------------------------------------
Income from equity investments - - 4.7 - 4.7
Gain on Sale of Property - - 0.1 - 0.1
-----------------------------------------------------------------------------------------
Operating Income (Loss) (1.0) 23.7 80.6 (0.1) 103.2
-----------------------------------------------------------------------------------------
Interest charges (37.9) (17.7) (52.7) 35.6 (72.6)
Other income and (deductions) 52.7 2.9 7.9 (59.3) 4.1
-----------------------------------------------------------------------------------------
Total Other Income and (Deductions) 14.8 (14.8) (44.8) (23.7) (68.5)
-----------------------------------------------------------------------------------------
Income Taxes (Benefit) (3.2) 4.1 14.9 - 15.8
-----------------------------------------------------------------------------------------
-
Earnings from Continuing Operations 17.1 4.7 20.9 (23.8) 18.9
Discontinued Operations - - (1.8) (1.8)
-----------------------------------------------------------------------------------------
Net Income $ 17.1 $ 4.7 $ 19.1 $ (23.8) $ 17.1
=========================================================================================
- -----------------------------------------------------------------------------------------------------------------------------------
37
- --------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- --------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2006
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
Revenues $ 0.3 $ 789.6 $ 3,249.2 $ (0.3) $ 4,038.8
----------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 518.7 1,532.5 - 2,051.2
Fuel and purchased power - - 245.7 - 245.7
Operations and maintenance 17.3 70.9 738.5 - 826.7
Intercompany expense - 2.6 (2.6) - -
Depreciation and amortization - 43.8 167.6 - 211.4
Operating taxes - 33.0 181.1 - 214.0
----------------------------------------------------------------------------------------
Total Operating Expenses 17.3 669.0 2,862.8 - 3,549.0
----------------------------------------------------------------------------------------
Income from equity investments - - 6.3 - 6.3
Gain on sale of assets - 0.1 0.4 - 0.5
----------------------------------------------------------------------------------------
Operating Income (Loss) (17.0) 120.7 393.2 (0.3) 496.6
----------------------------------------------------------------------------------------
Interest charges (79.7) (27.4) (31.0) 12.4 (125.6)
Other income and (deductions) 325.2 1.0 (30.6) (278.0) 17.6
----------------------------------------------------------------------------------------
Total Other Income and (Deductions) 245.5 (26.4) (61.6) (265.6) (108.0)
Income Taxes (Benefit) (28.9) 35.4 124.7 - 131.2
----------------------------------------------------------------------------------------
Net Income $ 257.4 $ 59.0 $ 206.9 $ (265.9) $ 257.4
========================================================================================
- --------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Revenues $ 0.2 $ 731.1 $ 3,091.9 $ (0.2) $ 3,823.0
-----------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 451.6 1,358.9 - 1,810.5
Fuel and purchased power - - 292.3 - 292.3
Operations and maintenance 7.3 63.8 707.9 - 779.0
Intercompany expense - 2.5 (2.5) - -
Depreciation and amortization - 44.9 158.7 - 203.6
Operating taxes - 32.5 173.3 - 205.8
-----------------------------------------------------------------------------------------
Total Operating Expenses 7.3 595.3 2,688.6 - 3,291.2
-----------------------------------------------------------------------------------------
Income from equity investments - - 10.0 - 10.0
Gain on Sale of Property - - 0.1 - 0.1
-----------------------------------------------------------------------------------------
Operating Income (Loss) (7.1) 135.8 413.4 (0.2) 541.9
-----------------------------------------------------------------------------------------
Interest charges (67.6) (32.5) (103.6) 71.0 (132.7)
Other income and (deductions) 314.4 3.0 27.0 (348.0) (3.6)
-----------------------------------------------------------------------------------------
Total Other Income and (Deductions) 246.8 (29.5) (76.6) (277.0) (136.3)
-----------------------------------------------------------------------------------------
Income Taxes (Benefit) (13.1) 38.2 125.9 - 151.0
-----------------------------------------------------------------------------------------
-
Earnings from Continuing Operations 252.8 68.1 210.9 (277.2) 254.6
Discontinued Operations - - (1.8) (1.8)
-----------------------------------------------------------------------------------------
Net Income $ 252.8 $ 68.1 $ 209.1 $ (277.2) $ 252.8
=========================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
38
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
June 30, 2006
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 14.5 $ 3.1 $ 22.5 $ - $ 40.1
Accounts receivable, net 0.7 128.3 964.7 - 1,093.7
Other current assets 1.4 236.2 737.3 - 974.9
-------------------------------------------------------------------------------------------
16.6 367.6 1,724.5 - 2,108.7
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Equity Investments 4,831.6 - 137.5 (4,717.8) 251.3
-------------------------------------------------------------------------------------------
Property
Gas - 2,148.5 5,296.4 - 7,444.9
Other - 1.6 3,140.1 - 3,141.7
Accumulated depreciation and
depletion - (416.9) (2,738.4) - (3,155.3)
-------------------------------------------------------------------------------------------
- 1,733.2 5,698.1 - 7,431.3
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Intercompany Accounts Receivable 876.5 1,069.3 2,819.4 (4,765.2) -
-------------------------------------------------------------------------------------------
Deferred Charges 1,994.2 336.2 938.5 - 3,268.9
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
Total Assets $ 7,718.9 $ 3,506.3 $ 11,318.0 $ (9,483.0) $ 13,060.2
===========================================================================================
===========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 40.2 $ 85.2 $ 557.8 $ - $ 683.2
Commercial paper 190.0 - - - 190.0
Other current liabilities 201.4 48.7 166.8 - 416.9
-------------------------------------------------------------------------------------------
431.6 133.9 724.6 - 1,290.1
Intercompany Accounts Payable 49.1 1,237.4 1,964.9 (3,251.4) -
-------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax 25.6 343.4 809.5 - 1,178.5
Other deferred credits and liabilities 740.1 184.8 1,144.2 - 2,069.1
-------------------------------------------------------------------------------------------
765.7 528.2 1,953.7 - 3,247.6
-------------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 4,610.3 955.9 3,738.9 (4,717.8) 4,587.3
Long-term debt 1,862.2 650.9 2,920.5 (1,513.8) 3,919.8
-------------------------------------------------------------------------------------------
Total Capitalization 6,472.5 1,606.8 6,659.4 (6,231.6) 8,507.1
-------------------------------------------------------------------------------------------
Minority Interest in Subsidiary
Companies - - 15.4 - 15.4
-------------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 7,718.9 $ 3,506.3 $ 11,318.0 $ (9,483.0) $ 13,060.2
===========================================================================================
===========================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
39
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash & temporary cash investments $ 79.6 $ 3.5 $ 41.4 $ - $ 124.5
Accounts receivable, net 0.6 149.9 822.2 - 972.7
Other current assets 4.0 368.9 1,550.0 - 1,922.9
-------------------------------------------------------------------------------------------
84.2 522.3 2,413.6 - 3,020.1
-------------------------------------------------------------------------------------------
Investments and Other 4,571.0 0.7 128.2 (4,457.5) 242.4
-------------------------------------------------------------------------------------------
Property
Gas - 2,111.3 5,164.6 - 7,275.9
Other - - 3,092.8 - 3,092.8
Accumulated depreciation and
depletion - (400.6) (2,631.2) - (3,031.8)
-------------------------------------------------------------------------------------------
- 1,710.7 5,626.2 - 7,336.9
-------------------------------------------------------------------------------------------
Intercompany Accounts Receivable 2,813.6 44.6 95.6 (2,953.8) -
Deferred Charges 482.5 316.1 2,414.6 - 3,213.2
-------------------------------------------------------------------------------------------
Total Assets $ 7,951.3 $ 2,594.4 $ 10,678.2 $ (7,411.3) $ 13,812.6
===========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 36.4 $ 149.7 $ 900.9 $ - $ 1,087.0
Commercial paper 657.6 - - - 657.6
Other current liabilities 196.2 128.5 85.9 - 410.6
-------------------------------------------------------------------------------------------
890.2 278.2 986.8 - 2,155.2
-------------------------------------------------------------------------------------------
Intercompany Accounts Payable 51.8 338.3 1,049.8 (1,439.9) -
-------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax 27.2 330.6 800.1 - 1,157.9
Other deferred credits and liabilities 634.0 225.3 1,240.0 - 2,099.3
-------------------------------------------------------------------------------------------
661.2 555.9 2,040.1 - 3,257.2
-------------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 4,485.4 897.0 3,539.3 (4,457.6) 4,464.1
Long-term debt 1,862.7 525.0 3,046.9 (1,513.8) 3,920.8
-------------------------------------------------------------------------------------------
Total Capitalization 6,348.1 1,422.0 6,586.2 (5,971.4) 8,384.9
-------------------------------------------------------------------------------------------
Minority Interest in Subsidiary
Companies - - 15.3 - 15.3
-------------------------------------------------------------------------------------------
Total Liabilities & Capitalization $ 7,951.3 $ 2,594.4 $ 10,678.2 $ (7,411.3) $ 13,812.6
===========================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
40
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2006
------------------------------------------------------------------------
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash Provided by Operating Activities $ (56.0) $ 263.9 $ 581.6 $ 789.5
------------------------------------------------------------------------
Investing Activities
Capital expenditures - (41.2) (205.8) (247.0)
Cost of removal - (3.8) (11.9) (15.7)
------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities - (45.0) (217.7) (262.7)
------------------------------------------------------------------------
Financing Activities
Treasury stock issued 18.8 - - 18.8
Payment of debt, net (467.6) - - (467.6)
Common and preferred stock dividends paid (162.4) - - (162.4)
Net intercompany accounts 602.2 (219.3) (382.9) -
------------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (9.0) (219.3) (382.9) (611.2)
------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ (65.0) $ (0.4) $ (19.0) $ (84.4)
Cash and Cash Equivalents at Beginning of Period 79.5 3.5 41.5 124.5
------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 14.5 $ 3.1 $ 22.5 $ 40.1
========================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- --------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2005
---------------------------------------------------------------------
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash Provided by (Used in )Operating Activities $ (94.6) $ 144.2 $ 415.6 $ 465.1
---------------------------------------------------------------------
Investing Activities
Capital expenditures - (43.2) (187.8) (231.0)
Cost of removal (2.5) (7.8) (10.3)
Proceeds from sale of investment - - 48.1 48.1
---------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities - (45.7) (147.6) (193.2)
---------------------------------------------------------------------
Financing Activities
Treasury stock issued 36.2 - - 36.2
Payment of debt, net (1,128.2) - (14.7) (1,142.9)
Redemption of preferred stock (75.0) - - (75.0)
Common and preferred stock dividends paid (149.8) - - (149.8)
MEDs equity conversion 460.0 - - 460.0
Other (2.4) - 18.4 16.0
Intercompany dividend payments 266.5 (266.5) -
Net intercompany accounts 289.2 (94.0) (195.2) -
-
---------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities (303.4) (94.0) (458.0) (855.5)
---------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ (398.0) $ 4.4 $ (190.0) $ (583.6)
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 $ 182.7 $ 3.5 $ 137.8 $ 324.0
=====================================================================
- --------------------------------------------------------------------------------------------------------------------------------
41
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
On February 25, 2006, KeySpan entered into an Agreement and Plan of Merger (the
"Merger Agreement"), with National Grid plc, a public limited company
incorporated under the laws of England and Wales ("Parent") and National Grid
US8, Inc., a New York Corporation ("Merger Sub"), pursuant to which Merger Sub
will merge with and into KeySpan (the "Merger"), with KeySpan continuing as the
surviving company and thereby becoming an indirect wholly-owned subsidiary of
the Parent.
Consummation of the Merger is subject to various closing conditions and the
adoption of the Merger Agreement by the stockholders of KeySpan and the Parent.
Assuming receipt of all required approvals, it is currently anticipated that the
Merger will be consummated in 2007. However, no assurance can be given that the
Merger will occur, or, the timing of its completion. See the Introduction to the
Notes to the Consolidated Financial Statements for additional information
regarding the Merger.
Consolidated Review of Results
- ------------------------------
The following is a summary of transactions affecting comparative earnings for
the three and six months ended June 30, 2006, compared to the three and six
months ended June 30, 2005. 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.
42
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 June 30, Six Months Ended June 30,
2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------------------------------------
Gas Distribution $ 39.5 $ 30.4 $ 376.0 $ 422.3
Electric Services 62.4 65.7 127.3 116.7
Energy Services 2.0 (2.8) 1.6 (5.6)
Energy Investments 3.7 5.5 6.7 11.9
Eliminations and other (0.1) 4.4 (15.0) (3.4)
- ---------------------------------------------------------------------------------------------------------------------------
Operating Income 107.5 103.2 496.6 541.9
- ---------------------------------------------------------------------------------------------------------------------------
Other Income and (Deductions)
Interest charges (59.4) (72.6) (125.6) (132.7)
Gain on sale of investments - - - 4.1
Cost of debt redemption - - - (20.9)
Other income and (deductions) 6.2 4.1 17.6 13.2
- ---------------------------------------------------------------------------------------------------------------------------
Total Other Income and (Deductions) (53.2) (68.5) (108.0) (136.3)
- ---------------------------------------------------------------------------------------------------------------------------
Income taxes 4.9 15.8 131.2 151.0
- ---------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations 49.4 18.9 257.4 254.6
Discontinued operations - (1.8) - (1.8)
- ---------------------------------------------------------------------------------------------------------------------------
Net Income 49.4 17.1 257.4 252.8
Preferred stock dividend requirements - 0.9 - 2.2
- ---------------------------------------------------------------------------------------------------------------------------
Earnings for Common Stock $ 49.4 $ 16.2 $ 257.4 $ 250.6
- ---------------------------------------------------------------------------------------------------------------------------
Basic Earnings per Share
Continuing operations, less preferred
stock dividends $ 0.28 $ 0.11 $ 1.47 $ 1.52
Discontinued operations - (0.01) - (0.01)
- ---------------------------------------------------------------------------------------------------------------------------
$ 0.28 $ 0.10 $ 1.47 $ 1.51
- ---------------------------------------------------------------------------------------------------------------------------
Results of Operations Quarter Ended June 30, 2006 vs 2005
KeySpan's earnings for common stock for the three months ended June 30, 2006,
were $49.4 million, or $0.28 per share, compared to $16.2 million or $0.10 per
share realized during the corresponding quarter last year, an increase of $33.2
million, or $0.18 per share. The favorable comparative operating results
reflect: (i) an increase in operating income; (ii) lower interest expense; and
(iii) a decrease in income tax expense due to the settlement of certain
outstanding issues with the New York City Department of Taxation and Finance and
the Internal Revenue Service ("IRS").
As indicated in the above table, operating income increased $4.3 million, or 4%
for the quarter ended June 30, 2006, compared to the corresponding quarter last
year. The comparative operating income primarily reflects higher earnings from
the Gas Distribution segment of $9.1 million, partially offset by lower earnings
from KeySpan's electric operations of $3.3 million. The favorable operating
results from the Gas Distribution segment reflect a partial rebound in
comparative net gas revenues (revenues less the cost of gas and associated
revenue taxes). The Electric Services segment results were adversely impacted by
43
an increase in operating expenses and a decrease in net electric revenues
associated with the Ravenswood Generating Station, KeySpan's merchant electric
generating facility. During the quarter, this segment also recognized a gain on
a fixed for floating unforced capacity financial swap which is reflected in
operating results of this segment. (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 and other
miscellaneous items. For the second quarter of 2006, other income and
(deductions) reflects a net expense of $53.2 million compared to a net expense
of $68.5 million for the second quarter of 2005. The favorable variation of
$15.3 million is primarily due to lower interest expense. During the second
quarter of 2006, KeySpan resolved its dispute with the New York City Department
of Taxation and Finance with respect to income taxes relating the operations of
its merchant electric generating facility. As a result of the favorable
settlement of this issue, KeySpan reversed a previously recorded $6 million
interest reserve established in connection with this dispute. Further, interest
expense in 2006 reflects lower carrying charges on regulatory deferrals.
KeySpan is currently in discussions with the IRS at the Appeals level with
regard to the Long Island Lighting Company's ("LILCO") tax returns for the tax
years ending December 31, 1996 through March 31, 1999 and KeySpan's and The
Brooklyn Union Gas Company's tax returns for the years ended September 30, 1997
through December 31, 1998. The primary issue, relating to the valuation of
certain assets transferred in the KeySpan/LILCO business combination of May
1998, remains open. However, two issues were resolved in the second quarter of
2006. In addition, as noted above, KeySpan resolved its dispute with New York
City Department of Taxation and Finance with respect to income taxes relating to
its merchant electric generating facility. As a result of settling the two
issues with the IRS, as well as the New York City issue, KeySpan realized a tax
benefit of $16.4 million during the three months ended June 30, 2006.
The IRS has also recently commenced the examination of KeySpan's tax returns for
the years ended December 31, 2002 and 2003. At this time, we cannot predict the
result of these audits.
Results of Operations Six Months Ended June 30, 2006 vs 2005
KeySpan's earnings for common stock for the six months ended June 30, 2006, were
$257.4 million, compared to $250.6 million realized during the same period last
year, an increase of $6.8 million. The favorable comparative earnings reflect
the impact of: (i) debt redemption costs incurred in 2005, but not repeated in
2006; (ii) lower interest expense; (iii) a decrease in income tax expense due to
the settlement of certain outstanding issues with the New York City Department
of Taxation and Finance and the IRS; offset by (iv) a decrease in operating
income.
KeySpan's earnings per share for the six months ended June 30, 2006, were $1.47
per share, compared to $1.51 per share realized during the same period last
year, a decrease of $0.04 per share. Earnings per share for the six months ended
June 30, 2006 reflect a higher average level of outstanding common stock
44
compared to last year. In May 2005, KeySpan issued 12.1 million shares of common
stock upon the conversion of previously held MEDs Equity Units. The dilutive
effect on earnings per share in 2006 from this issuance, in addition to
KeySpan's employee stock purchase plans, was approximately $0.08 per share. (See
KeySpan's Annual Report of Form 10-K for the year ended December 31, 2005, Note
6. to the Consolidated Financial Statements "Long-term Debt and Commercial
Paper" for additional details on the MEDs Equity Units.)
Operating income decreased $45.3 million, or 8% for the six months ended June
30, 2006, compared to the corresponding period last year. Comparative operating
income primarily reflects lower earnings from the Gas Distribution segment of
$46.3 million, partially offset by higher earnings from KeySpan's electric
operations of $10.6 million. Operating income from the Gas Distribution segment
was adversely impacted by the warm weather experienced during the first quarter
of 2006 (KeySpan's primary heating season) which resulted in a decrease to
comparative net gas revenues. The decrease in net gas revenues resulting from
the warm first quarter weather, was not fully recovered by an increase in net
gas revenues realized during the second quarter of 2006, as noted previously.
The Electric Services segment results were favorably affected by a gain
recognized on a fixed for floating unforced capacity financial swap. The
operating income variation as reflected in "elimination and other" is due
primarily to costs residing at KeySpan's holding company level such as
incremental costs related to the anticipated KeySpan / National Grid merger
including legal and consulting fees, as well as corporate advertising expenses.
(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 and other
miscellaneous items. For the six months ended June 30, 2006, other income and
(deductions) reflects a net expense of $108.0 million compared to a net expense
of $136.3 million for the same period of 2005. The favorable variation of $28.3
million is primarily due to debt redemption costs incurred in 2005. In 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. In addition, we accelerated the amortization of approximately
$11.2 million of previously unamortized benefits associated with an interest
rate swap on the redeemed bonds. The write-off of the deferred financing costs
and the amortization of the benefits associated with an interest rate swap were
recorded to interest expense. The remaining variation is due to lower interest
expense of $7.1 million reflecting the reversal of a previously recorded $6
million reserve established in connection with the income tax dispute with the
New York City Department of Taxation and Finance, as noted previously, and lower
carrying charges on regulatory deferrals, offset by the benefits recorded in
2005 associated with the amortization of the interest rate swap.
In addition, other income and (deductions) for the six months ended June 30,
2005, reflects the sale of KeySpan's 50% interest in Premier Transmission
Limited ("Premier"), a gas pipeline from southwest Scotland to Northern Ireland.
The sale generated cash proceeds of approximately $48.1 million. In the fourth
quarter of 2004, KeySpan reduced its carrying value in Premier to an amount
approximating the anticipated cash proceeds from the sale. The final sale of
Premier, which took place in the first quarter of 2005, resulted in a pre-tax
gain of $4.1 million reflecting the difference from earlier estimates.
45
The decrease in income tax expense for the six months ended June 30, 2006,
compared to same period of 2005 of $19.8 million reflects the settlement of
certain outstanding issues with the New York City Department of Taxation and
Finance and the IRS that resulted in a combined benefit to income tax expense of
$16.4 million, as previously noted.
Additionally, it should be noted that KeySpan recorded a $1.8 million loss from
discontinued operations for the three and six months ended June 30, 2005. In the
fourth quarter of 2004, KeySpan's investment in its mechanical contracting
subsidiaries was written-down to fair value. During the first six months of
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 three and
six months ended June 30, 2005.
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.
In light of the pending merger between KeySpan and National Grid and the
widespread integration efforts being undertaken by both companies, KeySpan
believes that it is no longer relevant to comment on guidance.
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.
46
The table below highlights certain significant financial data and operating
statistics for the Gas Distribution segment for the periods indicated.
- --------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June30,
(In Millions of Dollars) 2006 2005 2006 2005
- --------------------------------------------------------------------------------------------------------------------------
Revenues $ 873.2 $ 821.1 $ 3,053.3 $ 2,846.5
Cost of gas 541.1 501.6 2,053.7 1,815.1
Revenue taxes 10.0 10.5 36.2 35.2
- --------------------------------------------------------------------------------------------------------------------------
Net Revenues 322.1 309.0 963.4 996.2
- --------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 176.5 175.2 366.9 356.9
Depreciation and amortization 69.2 67.1 145.1 143.9
Operating taxes 36.9 36.3 75.4 73.1
- --------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 282.6 278.6 587.4 573.9
- --------------------------------------------------------------------------------------------------------------------------
Operating Income $ 39.5 $ 30.4 $ 376.0 $ 422.3
- --------------------------------------------------------------------------------------------------------------------------
Firm gas sales and transportation (MDTH) 48,851 49,614 175,755 200,240
Transportation - Electric Generation (MDTH) 20,709 8,592 27,180 11,432
Other Sales (MDTH) 45,539 37,913 97,871 94,461
Warmer (Colder) than Normal - New York 18% (2%) 14% (3%)
Warmer (Colder) than Normal - New England (6%) (29%) 5% (12%)
- --------------------------------------------------------------------------------------------------------------------------
A MDTH is 10,000 therms (British Thermal Units) and reflects the
heating content of approximately one million cubic feet of gas. A
therm reflects the heating content of approximately 100 cubic feet of
gas.One billion cubic feet (BCF) of gas equals approximately 1,000
MDTH.
Executive Summary
Operating income increased $9.1 million for the second quarter of 2006 compared
to the same quarter of 2005, primarily due to an increase in net gas revenues
(revenues less the cost of gas and associated revenue taxes) of $13.1 million.
The beneficial impact of higher net gas revenues was partially offset by an
increase of $4.0 million in operating expenses due primarily to higher
postretirement expenses and depreciation charges.
For the six months ended June 30, 2006, operating income decreased $46.3 million
compared to the same period last year, primarily due to a decrease in net gas
revenues of $32.8 million, primarily resulting from the warm first quarter
weather. Further, operating expenses increased $13.5 million due to an increase
in postretirement expenses and in the provision for uncollectible accounts
receivable as a result of higher gas costs.
Net Revenues
Net gas revenues from our gas distribution operations decreased $32.8 million,
or 3%, in the first six months of 2006 compared to the same period last year.
Both the New York and New England based gas distribution operations were
adversely impacted by the significantly warmer than normal weather experienced
throughout the Northeastern United States during the first six months of 2006.
47
As measured in heating degree days, weather for the first six months of 2006 in
our New York and New England service territories was approximately 14% and 5%
warmer than normal, respectively, and was approximately 15% warmer than last
year across KeySpan's service territories.
Net revenues from firm gas customers (residential, commercial and industrial
customers) decreased $39.3 million in the first six months of 2006 compared to
the same period last year. The favorable impact to net gas revenues from load
growth additions was more than offset by declining usage per customer due to the
extremely warm weather during the winter heating season, the use of more
efficient gas heating equipment and higher gas costs. KeySpan estimates that the
warm winter weather resulted in an adverse impact to net gas revenues of
approximately $26 million, net of the benefits from the weather normalization
adjustment and weather derivatives discussed below.
KEDNY and KEDLI each operate under utility tariffs that contain a weather
normalization adjustment that significantly offsets variations in firm net
revenues due to fluctuations in weather. These weather normalization adjustments
resulted in a benefit to KeySpan of $25 million during the first six months of
2006, but this did not fully mitigate the impact of the loss in revenues due to
the extremely warm weather experienced, as previously noted. The New
England-based gas distribution subsidiaries do not have weather normalization
adjustments. 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 2005/2006 winter heating season. Weather, during the first quarter
of 2006 was significantly warmer than normal as noted earlier. However, during
the entire primary winter heating season -November 2005 through March 2006 -
weather was slightly colder than normal. Therefore, there was no earnings impact
associated with these weather derivatives for the first six months of 2006. (See
Note 4 to the Consolidated Financial Statements "Hedging and Derivative
Financial Instruments" for further information).
Firm gas distribution rates for KEDNY, KEDLI and KEDNE in 2006, other than for
the recovery of gas costs, have remained substantially unchanged from rates
charged in 2005.
In our large-volume heating and other interruptible (non-firm) markets, which
include large apartment houses, government buildings and schools, gas service is
provided under rates that are designed to compete with prices of alternative
fuel, including No. 2 and No. 6 grade heating oil. These "dual-fuel" customers
can consume either natural gas or fuel oil for heating purposes. Net revenues in
these markets increased $6.5 million during the first six months of 2006
compared to the same period last year reflecting higher pricing.
Firm Sales, Transportation and Other Quantities
Firm gas sales and transportation quantities for the six months ended June 30,
2006, decreased 12% compared to the same period in 2005 due primarily to the
warmer weather this year compared to last year. Customer additions and
oil-to-gas conversions offset the full impact of the warmer weather. Net
revenues are not affected by customers opting to purchase their gas supply from
other sources, since delivery rates charged to transportation customers
48
generally are the same as delivery rates charged to full sales service
customers. Transportation quantities related to electric generation reflect the
transportation of gas to our electric generating facilities located on Long
Island. Net revenues from these services are not material.
Other sales quantities include on-system interruptible quantities, off-system
sales quantities (sales made to customers outside of our service territories)
and related transportation. We have a management contract with Merrill Lynch
Trading, under which KeySpan and Merrill Lynch Trading will share the
responsibilities for managing KeySpan's upstream gas distribution assets
associated with its Massachusetts gas distribution subsidiaries, as well as
providing city-gate delivered supply. KeySpan, Merrill Lynch Trading and
KeySpan's Massachusetts gas sales customers will share in the profits generated
from the optimization of these assets. The Massachusetts Department of
Telecommunications and Energy approved this contract in March 2006 to be
effective April 1, 2006. KeySpan provides these services internally for its New
York and New Hampshire gas distribution subsidiaries.
Purchased Gas for Resale
The increase in gas costs for the six months ended June 30, 2006 compared to the
same period of 2005 of $238.6 million, or 13%, reflects an increase of 25% in
the price per dekatherm of gas purchased for firm gas sales customers, offset by
a 13% decrease in the quantity of gas purchased due to the warm winter heating
season weather. 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 second quarter of 2006 compared to the same
quarter last year increased $4.0 million, or 1%. Operations and maintenance
expense increased $1.3 million in 2006 compared to 2005 reflecting an increase
of $7.7 million in postretirement costs, offset by lower repair and maintenance
costs due, in part, to the beneficial impact from productivity initiatives
implemented this year and the timing of these costs relative to last year.
Higher depreciation charges of $2.1 million reflect the continued expansion of
the gas distribution system.
For the six months ended June 30, 2006, operating expenses increased $13.5
million, or 2% compared to the same period last year. Operations and maintenance
expense increased $10.0 million, or 3%, in 2006 compared to 2005 primarily due
to an increase of $11.1 million in employee benefit costs, including
postretirement expenses and an increase in the provision for uncollectible
accounts receivable of $2.5 million as a result of increasing gas costs,
partially offset by lower repair and maintenance costs due, in part, to the
beneficial impact from productivity initiatives implemented this year and the
timing of these costs relative to last year.
49
Comparative operating taxes increased $2.3 million due to the expiration of a
five-year property tax assessment agreement with New York City. Higher
depreciation charges of $3.7 million reflecting the continued expansion of the
gas distribution system were offset by lower regulatory amortization charges of
$2.5 million.
Gas Supply and Pricing
KeySpan had adequate gas supply available to meet its gas load demand in its
service territories for the 2005/2006 winter heating season as KeySpan's gas
storage was 100% full at the start of the 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
volatility of 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.
Further, the high gas prices have led to an increase in price elasticity
resulting in an increase in customer conservation measures and attrition. The
MADTE order, received in the fourth quarter of 2005, permitting Boston Gas
regulatory recovery of the gas cost component of net bad debt write-offs should
help to mitigate the increase in bad debt expense.
With our strategy of having KeySpan's storage facilities 100% full at the start
of the heating season and our use of financial derivatives, KeySpan effectively
hedged the price of approximately two-thirds of the gas supply that was needed
to serve its customers during the 2005/2006 winter. This strategy mitigates the
volatility of 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 supported the expansion of through the
Energy Policy Act of 2005. Management believes that these measures helped
mitigate the 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
60% 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 approximately 60% of
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 of natural gas to the Long Island and
New York City energy markets, enough natural gas to heat 600,000 homes. In
addition, KeySpan has a 26.3% 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. KEDLI has executed a Precedent Agreement for 150,000
DTH of natural gas per day of transportation capacity from the Millennium
Pipeline system, increasing to 200,000 DTH in the third year of the pipeline
being in service. These pipeline projects will 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" which comprises the Ravenswood
Facility and Ravenswood Expansion) and the counties of Nassau and Suffolk on
Long Island. In addition, through long-term contracts of varying lengths, we (i)
provide to the Long Island Power Authority ("LIPA") all operation, maintenance
and construction services and significant administrative services relating to
the Long Island electric transmission and distribution ("T&D") system pursuant
to a Management Services Agreement (the "1998 MSA"); (ii) supply LIPA with
electric generating capacity, energy conversion and ancillary services from our
Long Island generating units pursuant to a Power Supply Agreement (the "1998
PSA"); and (iii) manage all aspects of the fuel supply for our Long Island
generating facilities, as well as all aspects of the capacity and energy owned
by or under contract to LIPA pursuant to an Energy Management Agreement (the
"1998 EMA"). The 1998 MSA, 1998 PSA and 1998 EMA all became effective on May 28,
1998 and are collectively referred to herein as the "1998 LIPA Agreements."
On February 1, 2006, KeySpan and LIPA entered into (i) an amended and restated
Management Services Agreement (the "2006 MSA"), pursuant to which KeySpan will
continue to operate and maintain the electric T&D System owned by LIPA on Long
Island; (ii) a new Option and Purchase and Sale Agreement (the "2006 Option
Agreement"), to replace the Generation Purchase Rights Agreement as amended (the
"GPRA"), pursuant to which LIPA had the option, through December 15, 2005, to
acquire substantially all of the electric generating facilities owned by KeySpan
on Long Island; and (iii) a Settlement Agreement (the "2006 Settlement
Agreement") resolving outstanding issues between the parties regarding the 1998
LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement
Agreement are collectively referred to herein as the "2006 LIPA Agreements."
(For a further discussion on these LIPA agreements see Note 10 to the
Consolidated Financial Statements "2006 LIPA Settlement.") The Electric Services
segment also provides retail marketing of electricity to commercial customers.
51
Selected financial data for the Electric Services segment is set forth in the
table below for the periods indicated.
- ------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Millions of Dollars) 2006 2005 2006 2005
- ------------------------------------------------------------------------------------------------------------
Revenues from Operations $ 426.5 $ 468.5 $ 851.3 $ 873.7
Purchased fuel 115.5 159.0 245.5 292.0
- ------------------------------------------------------------------------------------------------------------
Net Revenues from Operations 311.0 309.5 605.8 581.7
Derivative Financial Instrument 17.7 - 17.7 -
- ------------------------------------------------------------------------------------------------------------
Net Electric Revenues 328.7 309.5 623.5 581.7
- ------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 195.2 176.6 350.5 330.2
Depreciation 25.1 23.1 52.2 46.0
Operating taxes 46.0 44.1 93.5 88.8
- ------------------------------------------------------------------------------------------------------------
Total Operating Expenses 266.3 243.8 496.2 465.0
- ------------------------------------------------------------------------------------------------------------
Operating Income $ 62.4 $ 65.7 $ 127.3 $ 116.7
- ------------------------------------------------------------------------------------------------------------
Electric sales (MWH)* 1,080,775 1,445,109 1,887,452 2,446,517
Capacity(MW)* 2,450 2,450 2,450 2,450
Cooling degree days 276 313 276 313
- ------------------------------------------------------------------------------------------------------------
*Reflects the operations of the Ravenswood Generating Station only.
Executive Summary
Operating income decreased $3.3 million, or 5%, for the three months ended June
30, 2006, compared to the same quarter last year, due primarily to a decrease in
net revenues from the Ravenswood Generating Station of $25.0 million as a result
of lower energy margins and capacity revenues. KeySpan also recognized a gain of
$17.7 million on a fixed for floating unforced capacity financial swap, as well
as an increase of $4.2 in net revenues associated with KeySpan's electric
marketing activities.
For the six months ended June 30, 2006, operating income increased $10.6
million, or 9%, compared to the same period last year, due primarily to the
$17.7 million gain recognized on the fixed for floating unforced capacity
financial swap.
Net Revenues
Total electric net revenues realized during the second quarter of 2006 were
$19.2 million, or 6% higher than such revenues realized during the corresponding
period last year.
KeySpan has entered into an International SWAP Dealers Association Master
Agreement for a fixed for floating unforced capacity financial swap with Morgan
Stanley Capital Group Inc. This agreement has a three year term that began on
May 1, 2006. For the three months ended June 30, 2006 KeySpan recognized a gain
of $17.7 million from this derivative financial instrument. (See Note 4 to the
Consolidated Financial Statements, "Hedging and Derivative Financial
Instruments", for further information on this swap agreement.)
52
Net revenues for the second quarter of 2006 from the service agreements with
LIPA, including the power purchase agreements associated with two electric
peaking facilities, increased $22.3 million compared to the second quarter of
2005. This increase reflects the recovery of operations and maintenance costs
billed to LIPA, which increased by a similar amount. As a result, the increase
in net revenues from the service agreements with LIPA had little or no impact on
operating income. (For a description of the LIPA Agreements and power purchase
agreements, see KeySpan's 2005 Annual Report on Form 10-K for the year ended
December 31, 2005 Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations under the caption "Electric Services -
Revenue Mechanisms.")
Net revenues associated with KeySpan's electric marketing activities increased
$4.2 million during the second quarter of 2006 compared to the same quarter of
2005.
Net revenues from the Ravenswood Generating Station, however, decreased $25.0
million, or 25% for the three months ended June 30, 2006, compared to the same
quarter last year reflecting lower capacity revenues of $20.5 million and a
decrease in energy margins of $4.5 million. The decrease in capacity revenues
was due to recently installed capacity additions in New York City.
The decrease in energy margins for the second quarter of 2006 reflects, in part,
a 38% decrease in realized "spark-spreads" (the selling price of electricity
less the cost of fuel, exclusive of hedging gains or losses). Further, the level
of MWh sold into the New York Independent System Operator ("NYISO") energy
market decreased 25% due to increased competition. Combined, these two items
reduced energy margins by $11.0 million. Partially offsetting these adverse
impacts to energy margins were the benefits recognized from derivative financial
instruments. 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. We have also 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 gains, which are reflected in net electric margins, of $7.1 million for
the second quarter of 2006 compared to hedging gains of $0.6 million for the
second quarter of 2005. (See Note 4 to the Consolidated Financial Statements
"Hedging and Derivative Financial Instruments" for further information on
KeySpan's hedging strategy.)
Total electric net revenues realized during the six months ended June 30, 2006
were $41.8 million, or 7% higher than such revenues realized during the
corresponding period last year. For the six months ended June 30, 2006, KeySpan
recognized a gain of $17.7 million from the fixed for floating unforced capacity
derivative financial instrument described previously.
Net revenues for the six months ended June 30, 2006 from the service agreements
with LIPA, including the power purchase agreements associated with two electric
peaking facilities, increased $19.6 million compared to the same period of 2005,
reflecting the recovery of approximately $28 million in operations and
maintenance costs billed to LIPA and therefore had no impact on operating
53
income. Partially offsetting this increase to net revenues, was a decrease in
service fee revenues and the timing of performance incentives, that, on a
combined basis, resulted in an adverse impact to comparative net revenues of
approximately $8 million. KeySpan anticipates achieving approximately the same
level of performance incentives in 2006 as was achieved in 2005.
Net revenues associated with KeySpan's electric marketing activities increased
$5.7 million during the six months ended June 30, 2006 compared to the same
period of 2005.
The Ravenswood Generating Station, however, recognized a decrease of $1.2
million in net revenues during the six months ended June 30, 2006, compared to
the same period last year, reflecting lower capacity revenues of $34.7 million,
partially offset by an increase in energy margins of $33.5 million. Recently
installed capacity additions in New York City were the primary driver behind the
decrease in capacity revenues.
The increase in energy margins for the six months ended June 30, 2006 reflects
the settlement of derivative financial instruments. As noted previously, 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 and to hedge the cash flow
variability associated with a portion of forecasted electric energy sales. These
derivative instruments resulted in hedging gains, which are reflected in net
electric margins, of $62.8 million during the six months ended June 30, 2006
compared to hedging gains of $3.6 million during the same period of 2005. The
benefits to energy margins from KeySpan's hedging strategy were partially offset
by a 56% decrease in realized "spark-spreads." Further, the level of MWh sold
into the NYISO energy market decreased 23%. Combined, these two items reduced
the benefits on net revenues recognized from the hedging gains by $25.7 million.
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.
Operating Expenses
Operating expenses increased $22.5 million, or 9%, during the second quarter of
2006 compared to the second quarter of 2005 primarily reflecting a $21.7 million
increase in recoverable costs from LIPA, as noted previously.
Operating expenses increased $31.2 million, or 7%, in the six months ended June
30, 2006 compared to the same period of 2005. Operations and maintenance expense
posted a $20.3 million increase compared to last year reflecting higher costs
associated with the service agreements with LIPA of $28 million, which, as
mentioned earlier, are fully recoverable from LIPA, partially offset by a
decrease in overhaul costs associated with the Ravenswood Generating Station and
KeySpan's Long Island based electric generating units of approximately $5
million and the timing of other operating costs associated with the service
agreements with LIPA.
54
The increase in depreciation expense and operating taxes (primarily property
taxes) are associated with KeySpan's Long Island based electric generating units
and are generally 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 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 power from a non-Long Island source 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. In addition, given the intense public pressure to reduce
emissions from existing generating facilities, development of the Melville
project is possible as a means to "virtually re-power" older, less efficient
generating units. Specifically, KeySpan believes that it would be able to reduce
emissions on Long Island in a cost effective manner by developing the Melville
project and retiring an older, less efficient generating facility. We have begun
discussions with LIPA regarding this proposal. At June 30, 2006, total
capitalized costs associated with the siting, permitting and procurement of
equipment for the Melville facility were $62.8 million.
On February 6, 2006, the NYISO's New York City local reliability rules that
required that 80% of the electric capacity needs of New York City be provided by
"in-City" generators was increased to 83%. However, in March 2006, the NYISO
Operating Committee reversed its decision and returned the local reliability
rules to 80%. See the discussion under the caption "Market and Credit Risk
Management Activities - Regulatory Issues and the Competitive Environment" for
further information regarding this matter.
Energy Services
The Energy Services segment includes companies that provide energy-related
services to customers located primarily within the Northeastern United States.
Subsidiaries in this segment provide residential and small commercial customers
with service and maintenance of energy systems and appliances, as well as
operation and maintenance, design, engineering, consulting and fiber optic
services to commercial, institutional and industrial customers.
55
The table below highlights selected financial information associated with the
Energy Services segment.
- ----------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Millions of Dollars) 2006 2005 2006 2005
- ----------------------------------------------------------------------------------------------------------
Revenues $ 52.6 $ 47.9 $ 103.4 $ 94.9
Operating expenses 50.6 50.7 101.8 100.5
- ----------------------------------------------------------------------------------------------------------
Operating (Loss) $ 2.0 $ (2.8) $ 1.6 $ (5.6)
- ----------------------------------------------------------------------------------------------------------
The Energy Services segment posted operating profits of $2.0 million and $1.6
million for the quarter and six months ended June 30, 2006, respectively,
compared to operating losses of $2.8 million and $5.6 million incurred for the
quarter and six months ended June 30, 2005, respectively. The improved
performance reflects higher gross profit and operating margins on engineering
and service contracts, completion and favorable pricing on certain contracts, an
increase in bandwidth sales and a reduction in general and administrative
expenses as a result of cost containment measures implemented 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 The Houston
Exploration Company, an independent natural gas and oil exploration company that
was a former KeySpan subsidiary.
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 26.3% interest in the Millennium
Pipeline Company LLC, the developer of 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 investments 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 ("LNG") storage and
receiving facility in Providence, Rhode Island, through its wholly owned
subsidiary KeySpan LNG, the operations of which are fully consolidated. KeySpan
has filed a petition for judicial review of a FERC decision that denied KeySpan
LNG's application for FERC authorization to expand the facility to accept marine
deliveries and triple vaporization capacity.
56
As noted previously, in the first quarter of 2005, KeySpan sold its 50% interest
in Premier, a gas pipeline from southwest Scotland to Northern Ireland. On March
18, 2005, the sale was completed and generated cash proceeds of $48.1 million.
In the fourth quarter of 2004, KeySpan reduced its carrying value in Premier to
an amount approximating the anticipated cash proceeds from the sale. The final
sale of Premier 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.
Selected financial data for these energy-related investments is set forth in the
following table for the periods indicated.
- ----------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
(In Millions of Dollars) 2006 2005 2006 2005
- ----------------------------------------------------------------------------------------------------------------------
Revenues $ 11.2 $ 8.7 $ 20.4 $ 18.8
Less: Operation and maintenance expense 7.4 5.2 14.0 11.7
Other operating expenses 3.0 2.8 6.2 5.3
Add: Equity earnings 2.9 4.7 6.3 10.0
Sale of assets - 0.1 0.2 0.1
- ----------------------------------------------------------------------------------------------------------------------
Operating Income $ 3.7 $ 5.5 $ 6.7 $ 11.9
- ----------------------------------------------------------------------------------------------------------------------
As indicated in the above table, operating income for the Energy Investments
segment decreased $1.8 million in the second quarter of 2006 compared to the
second quarter of 2005, primarily reflecting lower earnings associated with
KeySpan's investment in the Iroquois Gas Transmission System. Earnings from this
investment have been adversely impacted by a decrease in pipeline transportation
rates. Further, in 2005, the Iroquois Gas Transmission System realized a benefit
from a court settlement relating to a gas supply contract that was defaulted on
by a counterparty in an earlier period.
For the six months ended June 30, 2006, operating income decreased $5.2 million
compared to the same period in 2005 due, in part, to lower earnings from
KeySpan's investment in the Iroquois Gas Transmission System for the reasons
noted above. Further, a KeySpan subsidiary engaged in the transportation of
liquefied natural gas realized lower earnings due to the warm winter weather.
Finally, equity earnings were adversely impacted by the sale of Premier in March
2005.
Other Matters
In order to serve the anticipated market requirements in our New York service
territories, KeySpan and Duke Energy Corporation formed Islander East Pipeline
Company, LLC ("Islander East") in 2000. Islander East is owned 50% by KeySpan
and 50% by Duke Energy, and was created to pursue the authorization and
construction of an interstate pipeline from Connecticut, across Long Island
Sound, to a terminus near Shoreham, Long Island. Applications for all necessary
regulatory authorizations were filed in 2000 and 2001. Islander East has
received a final certificate from the FERC and all necessary permits from the
57
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 Secretary of Commerce
overrode Connecticut's denial and granted the CZMA authorization. The
determination of the Secretary of Commerce was appealed to the United States
District Court for the District of Columbia and a decision from that court is
pending. 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 a provision of the Energy Policy Act of 2005 (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 Circuit and has
moved to stay the Connecticut case pending the Second Circuit's decision. The
State of Connecticut has filed a motion to challenge the constitutionality of
the provisions of the Energy Act providing this appeal. The appeal was argued in
January 2006. Further, oral arguments on the constitutional and jurisdictional
issues were held in April 2006. Onshore and offshore geotechnical work on this
project was completed in the second quarter of 2006. Assuming a favorable
outcome in the United States Court of Appeals, KeySpan anticipates that this
pipeline will be in service in 2008. As of June 30, 2006, KeySpan's total
capitalized costs associated with the siting and permitting of the Islander East
pipeline were approximately $27.5 million.
As noted, KeySpan also owns a 26.3% ownership interest in the Millennium
Pipeline Company LLC, the developer of the Millennium Pipeline project. The
other partners in the Millennium Pipeline are Columbia Gas Transmission Corp., a
unit of NiSource Incorporated and DTE Energy. The Millennium Pipeline project is
anticipated to transport up to 525,000 DTH of natural gas a day from Corning to
Ramapo, New York, 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, in December
2005, Consolidated Edison Company of New York Inc. ("Con Edison"), KEDLI and
Columbia Gas Transmission each entered into amended precedent agreements to
purchase capacity on the pipeline. KEDLI has agreed to purchase 150,000 DTH per
day from the Millennium Pipeline system, increasing to 200,000 DTH in the third
year of the pipeline being in service. This will provide KEDLI with new,
competitively priced supplies of natural gas from Canada and other North
American supply basins. The conditions in the precedent agreements are subject
to, among other things, the receipt of necessary regulatory approvals and
financing. It is anticipated that the Millennium Pipeline will be in service in
2008. In addition, the FERC issued a favorable draft supplemental environmental
impact statement on June 9, 2006. As of June 30, 2006, KeySpan's investment in
the Millennium Pipeline project was $17.7 million.
In 2005, KeySpan LNG entered into a development agreement with BG, LNG Services,
a subsidiary of British Gas, to upgrade the KeySpan LNG's liquefied natural gas
facility to accept marine deliveries and to triple vaporization (or
regasification) capacity. In June 2005, the FERC denied KeySpan LNG's
application to expand the facility citing concerns that the proposed upgraded
facility would not meet current federal safety standards, which the facility is
58
not currently subject to. KeySpan sought a rehearing with FERC, and on January
20, 2006, the FERC denied such request, although the order provided that KeySpan
LNG could file an amendment to its original application addressing a revised
expansion project which would differ substantially from that originally proposed
by KeySpan. Any amended application would need to include a detailed analysis of
the new project scope, including upgrades to the existing facilities and
alternative plans for any service disruptions that may be necessary during
construction of a new expanded project. KeySpan has filed a petition for
judicial review of the FERC order with the United States Circuit Court for the
District of Columbia. Motions to intervene by the Cities of Providence, East
Providence, the Governor and Attorney General of Rhode Island, Weaver's Cove
Energy, LLC and Northeast Energy Associates were granted on June 12, 2006. On
June 20, 2006, the Court ordered the intervenors to show cause, by July 20,
2006, why they should not be limited to one joint brief and one reply brief on
each side, subject to certain word limits. The Court is expected to issue a
briefing schedule after the responses to the show cause order are filed and to
issue a decision affirming or vacating the FERC orders by the second quarter of
2007.
In addition to the proceeding at FERC, KeySpan LNG also 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. As of June 30, 2006, our
investment in this project was $17.2 million, a portion of which may be subject
to reimbursement from BG LNG pursuant to the terms of the development agreement.
Allocated Costs
We are subject to the jurisdiction of the FERC under PUHCA 2005. As part of the
regulatory provisions of PUHCA 2005, the FERC regulates various transactions
among affiliates within a holding company system. In accordance with regulations
under PUHCA 2005 and regulations and policies of the New York State Public
Service Commission, the Massachusetts Department of Telecommunications and
Energy and the New Hampshire Public Utility Commission, we established service
companies that provide: (i) traditional corporate and administrative services;
(ii) gas and electric transmission and distribution system planning, marketing,
59
and gas supply planning and procurement; and (iii) engineering and surveying
services to subsidiaries. The operating income variation as reflected in
"elimination and other" is due primarily to costs residing at KeySpan's holding
company level such as incremental costs associated with the anticipated merger
with National Grid including legal and consulting fees, as well as corporate
advertising expenses. Also, KeySpan entered into confidential settlement
agreements with certain of its insurance carriers for recovery of environmental
costs associated with investigation and remediation of gas plant sites and
non-utility sites. KeySpan recorded a $5.5 million benefit in its Consolidated
Statement of Income for the three and six months ended June 30, 2006 associated
with these settlement agreements.
Liquidity
Cash flow from operations increased $324.4 million, or 70%, for the six months
ended June 30, 2006 compared to the same period last year primarily reflecting
the timing of cash payment for the funding of KeySpan's pension and other
postretirement plans, the timing of income tax payments and favorable working
capital requirements. During the six months ended June 30, 2006, KeySpan
contributed $25.5 million to its pension and other postretirement plans compared
to $114.5 million contributed during the same period in 2005. At this point in
time, KeySpan anticipates that its total 2006 pension and other postretirement
contributions will be approximately the same as its 2005 contributions. Further,
KeySpan's income tax payments were $28.4 million lower during the six months
ended June 30, 2006 compared to the same period last year. The favorable working
capital requirements primarily reflect receipt of customer payments associated
with winter heating season gas sales.
At June 30, 2006, we had cash and temporary cash investments of $40.1 million.
During the six months of 2006, we repaid $467.6 million of commercial paper and,
at June 30, 2006, $190.0 million of commercial paper was outstanding at a
weighted-average annualized interest rate of 5.42%. We had the ability to borrow
up to an additional $1.3 billion at June 30, 2006, under the terms of our credit
facility.
KeySpan has two credit facilities which total $1.5 billion - $920 million for
five years through 2010, and $580 million through 2009 - which continue to
support KeySpan's commercial paper program for ongoing working capital needs.
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.
60
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 of 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
June 30, 2006, KeySpan's consolidated indebtedness was 47.3% 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. Upon effectiveness of PUHCA 2005, KeySpan's ability to issue
commercial paper was no longer limited by the SEC. Accordingly, subject to
compliance with the foregoing conditions, KeySpan is currently able to issue up
to $1.5 billion of commercial paper.
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.
(See Note 10. to the Consolidated Financial Statements "2006 LIPA Settlement"
for information regarding the recent settlement between KeySpan and LIPA
regarding the current contractual agreements.)
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.
61
Capital Expenditures and Financing
Construction Expenditures
The table below sets forth our construction expenditures by operating segment
for the periods indicated:
- ------------------------------------------------------------------------
Six Months Ended June 30,
(In Millions of Dollars) 2006 2005
- ------------------------------------------------------------------------
Gas Distribution $ 184.9 $ 154.3
Electric Services 42.9 56.0
Energy Investments 12.8 14.0
Energy Services and other 6.4 6.7
- ------------------------------------------------------------------------
$ 247.0 $ 231.0
- ------------------------------------------------------------------------
Construction expenditures related to the Gas Distribution segment are primarily
for the renewal, replacement and expansion of the distribution system.
Construction expenditures for the Electric Services segment reflect costs to
maintain our generating facilities. The increase in capital expenditures for the
six months ended June 30, 2006 compared to the same period last year of $16.0
million reflects an increase in the Gas Distribution segment due, in part, to
the timing of capital main and service work, as well as to upgrades to KeySpan's
New York LNG facility. In total, KeySpan anticipates incurring approximately the
same amount of construction expenditures in 2006 as it incurred in 2005.
Financing
KeySpan did not engage in any financing activities in the first six months of
2006, other than commercial paper repayments as noted earlier. At this point in
time, KeySpan has no specific plans for additional financing for the remainder
of 2006.
The following table represents the ratings of our long-term debt at June 30,
2006. In 2004 Standard & Poor's reaffirmed its ratings on KeySpan's and its
subsidiaries' long-term debt and removed its negative outlook. Further in 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.
- -------------------------------------------------------------------------------
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
- -------------------------------------------------------------------------------
62
Off-Balance Sheet Arrangements
Guarantees
KeySpan had a number of financial guarantees with its subsidiaries at June 30,
2006. 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 obligation is not recorded on the Consolidated
Balance Sheet. Further, KeySpan has guaranteed: (i) up to $72.1 million of
surety bonds associated with certain construction projects currently being
performed by former subsidiaries; (ii) certain supply contracts, margin accounts
and purchase orders for certain subsidiaries in an aggregate amount of $64.7
million; and (iii) $80.3 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, 2005. (For additional details regarding these
obligations see KeySpan's Annual Report on Form 10-K for the year ended December
31, 2005, Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations, as well as Note 6 "Long-Term Debt" and Note 7
"Contractual Obligations, Financial Guarantees and Contingencies" to those
Consolidated Financial Statements.)
63
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.
Below is a discussion of KeySpan's critical accounting policies and assumptions
at June 30, 2006. 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, 2005, Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations "Discussion of Critical Accounting Policies and
Assumptions."
Valuation of Goodwill
KeySpan records goodwill on purchase transactions, representing the excess of
acquisition cost over the fair value of net assets acquired. In testing for
goodwill impairment under Statement of Financial Accounting Standards ("SFAS")
142 "Goodwill and Other Intangible Assets," significant reliance is placed upon
a number of estimates regarding future performance that require broad
assumptions and significant judgment by management. A change in the fair value
of our investments could cause a significant change in the carrying value of
goodwill. The assumptions used to measure the fair value of our investments are
the same as those used by us to prepare annual operating segment and
consolidated earnings and cash flow forecasts. In addition, these assumptions
are used to set annual budgetary guidelines. At June 30, 2006, 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.
64
In separate orders issued by the MADTE relating to the Eastern Enterprise
acquisition in 2000, the base rates charged by Colonial Gas Company and Essex
Gas Company have been frozen at their current levels for a ten-year period
ending 2009. Due to the length of these base rate freezes, the Colonial and
Essex Gas Companies had previously discontinued the application of SFAS 71.
As is further discussed under the caption "Regulation and Rate Matters," the
rate plans previously in effect for KEDNY and KEDLI have expired. The continued
application of SFAS 71 to record the activities of these subsidiaries is
contingent upon the actions of regulators with regard to future rate plans. As
part of its application for approval of the KeySpan/National Grid merger,
KeySpan has filed a proposed rate plan for KEDNY and KEDLI with the NYPSC. The
ultimate resolution of any future rate plans could have a significant impact on
the application of SFAS 71 to these entities and, accordingly, on our financial
position, results of operations and cash flows. However, management believes
that currently available facts support the continued application of SFAS 71 and
that all regulatory assets and liabilities are recoverable or refundable through
the regulatory environment.
Pension and Other Postretirement Benefits
KeySpan participates in both non-contributory defined benefit pension plans, as
well as other post-retirement benefit ("OPEB") plans (collectively
"postretirement plans"). KeySpan's reported costs of providing pension and OPEB
benefits are dependent upon numerous factors resulting from actual plan
experience and assumptions of future experience. Pension and OPEB costs
(collectively "postretirement costs") are impacted by actual employee
demographics, the level of contributions made to the plans, earnings on plan
assets, and health care cost trends. Changes made to the provisions of these
plans may also impact current and future postretirement costs. Postretirement
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 June 30, 2006, 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 2006,
KeySpan expects to contribute a total of $120 million to its funded and unfunded
post-retirement plans. Future funding requirements are heavily dependent on
actual return on plan assets and prevailing interest rates. (In addition to Item
7 Management's Discussion and Analysis of Financial Condition and Results of
Operations in KeySpan's Annual Report on Form 10-K for the year ended December
31, 2005, see also Note 4 of those Consolidated Financial Statements,
"Postretirement Benefits.")
65
Regulation and Rate Matters
Gas Matters
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. KeySpan has recently filed a
proposed rate plan for KEDNY and KEDLI with the NYPSC as part of its application
for approval of the KeySpan / National Grid merger. See the "Introduction to the
Notes to the Consolidated Financial Statements" for additional details on the
filing.
Effective November 1, 2003, the MADTE approved a $25.9 million increase in base
revenues for Boston Gas with an allowed return on equity of 10.2% reflecting an
equal balance of debt and equity. On January 27, 2004, the MADTE issued its
order 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. In addition, an increase of $7.5
million in the local distribution adjustment clause was approved to recover
pension and other postretirement costs. The MADTE also approved a true-up
mechanism for pension and other postretirement benefit costs under which
variations between actual pension and other postretirement benefit costs and
amounts used to establish rates are deferred and collected from or refunded to
customers in subsequent periods. This true-up mechanism allows for carrying
charges on deferred assets and liabilities at Boston Gas's weighted-average cost
of capital.
In connection with the Eastern Enterprises acquisition of Colonial Gas in 1999,
the MADTE approved a merger and rate plan that resulted in a ten year freeze of
base rates to Colonial Gas's firm customers. The base rate freeze is subject
only to certain exogenous factors, such as changes in tax laws, accounting
changes, or regulatory, judicial, or legislative changes. Due to the length of
the base rate freeze, Colonial Gas discontinued its application of SFAS 71.
Essex Gas is also under a ten-year base rate freeze and has also discontinued
its application of SFAS 71. EnergyNorth base rates continue as set by the NHPUC
in 1993.
In December 2005, Boston Gas received a MADTE order permitting regulatory
recovery of the 2004 gas cost component of bad debt write-offs. This was
approved for full recovery as an exogenous cost effective November 1, 2005. In
addition, effective January 1, 2006, Boston Gas is permitted to fully recover
the gas cost component of bad debt write-offs through its cost-of-gas adjustment
clause rather than filing for recovery as an exogenous cost. Boston Gas also
plans to request full recovery, as an exogenous cost, the 2005 gas cost
component of bad debt write-offs from Boston Gas ratepayers beginning November
1, 2006.
66
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, 2005,
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 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 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.
As noted earlier, on February 1, 2006, KeySpan and LIPA entered into (i) an
amended and restated Management Services Agreement; (ii) a new Option and
Purchase and Sale Agreement, to replace the Generation Purchase Rights Agreement
as amended; and (iii) a Settlement Agreement resolving outstanding issues
between the parties regarding the 1998 LIPA Agreements. (For a further
discussion on the LIPA agreements see Note 10 to the Consolidated Financial
Statements "2006 LIPA Settlement," as well as KeySpan's Annual Report on Form
10-K for the year ended December 31, 2005, Item 7 Management's Discussion and
Analysis of Financial Condition and Results of Operations "Electric Services -
LIPA Agreements.")
The Energy Policy Act of 2005 and the Public Utility Holding Company Acts of
1935 and 2005
In August 2005, the Energy Policy Act of 2005 (the "Energy Act") was enacted by
Congress and signed into law by the President. The Energy Act is a broad based
energy bill that places an increased emphasis on the production of energy and
promotes the development of new technologies and alternative energy sources by
providing tax credits to companies that produce natural gas, oil, coal,
electricity and renewable energy. For KeySpan, one of the more significant
provisions of the Energy Act was the repeal of PUHCA 1935, effective February 8,
2006, and the transfer of certain holding company oversight from the SEC to FERC
pursuant to PUHCA 2005.
Pursuant to PUHCA 2005, the SEC no longer has jurisdiction over our holding
company activities, other than those traditionally associated with the
registration and issuance of our securities under the federal securities laws.
FERC now has jurisdiction over certain of our holding company activities,
including (i) regulating certain transactions among our affiliates within our
holding company system; (ii) governing the issuance, acquisition and disposition
of securities and assets by certain of our public utility subsidiaries; and
(iii) approving certain utility mergers and acquisitions.
Moreover, our affiliate transactions also remain subject to certain regulations
of the NYPSC, MADTE and NHPUC, in addition to FERC.
67
Environmental Matters
KeySpan is subject to various federal, state and local laws and regulatory
programs related to the environment. Through various rate orders issued by the
NYPSC, MADTE and NHPUC, costs related to MGP environmental cleanup activities
are recovered in rates charged to gas distribution customers and, as a result,
adjustments to these reserve balances do not impact earnings. However,
environmental cleanup activities related to the three non-utility sites are not
subject to rate recovery.
We estimate that the remaining cost of our MGP related environmental cleanup
activities, including costs associated with the Ravenswood Generating Station,
will be approximately $382.3 million and we have recorded a related liability
for such amount. We have also recorded an additional $16.6 million liability,
representing the estimated environmental cleanup costs related to a former coal
tar processing facility. As of June 30, 2006, we have expended a total of $198.9
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.
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We have regional concentration of credit risk due to receivables from
residential, commercial and industrial customers in New York, New Hampshire and
Massachusetts, although this credit risk is spread over a diversified base of
residential, commercial and industrial customers. Customers' payment records are
monitored and action is taken, when appropriate and in accordance with various
regulatory requirements.
We also have credit risk from LIPA, our largest customer, and from other energy
and financial services companies. Counterparty credit risk may impact overall
exposure to credit risk in that our counterparties may be similarly impacted by
changes in economic, regulatory or other considerations. We actively monitor the
credit profile of our wholesale counterparties in derivative and other
contractual arrangements, and manage our level of exposure accordingly. In
instances where counterparties' credit quality has declined, or credit exposure
exceeds certain levels, we may limit our credit exposure by restricting new
transactions with the counterparty, requiring additional collateral or credit
support and negotiating the early termination of certain agreements.
Regulatory Issues and Competitive Environment: We are subject to various other
risk exposures and uncertainties associated with our gas and electric
operations. The most significant contingency involves the evolution of the gas
distribution and electric industries towards more competitive and deregulated
environments. The risks associated with KeySpan's gas distribution activities
have not changed substantially since December 31, 2005. For additional
information regarding these risks see KeySpan's Annual Report on Form 10-K for
the year ended December 31, 2005, 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.
The Ravenswood Generating Station and KeySpan's New York City Operations
On February 9, 2006, the NYISO Operating Committee increased the "in-City"
locational capacity requirements (LCR) from 80% to 83% beginning in May 2006
through the period ending April 2007, based in part on the statewide reserve
margin of 118% set by the New York State Reliability Council. However, in early
March 2006, the NYISO discovered data inconsistencies in the input files used in
the Multi Area Reliability Simulation (MARS) computer program that is used to
determine the statewide installed reserve margin (Statewide IRM) and the
corresponding minimum LCRs for New York City and Long Island. Revisions to the
data, and rerunning the MARS computer program resulted in a shift in the
relationship between the Statewide IRM and the minimum LCRs. On March 20, 2006,
the New York State Reliability Council voted to retain the Statewide IRM of 118%
and reported the corresponding revised minimum LCRs to the NYISO. On March 28,
2006, the NYISO Operating Committee approved revised minimum LCRs of 80% and 99%
for New York City and Long Island, respectively. For New York City, this action
effectively returned the locational requirement to the minimum level used for
the last six years (80%) and negated the increase to 83%.
KeySpan appealed this decision to the NYISO Board of Directors claiming the
revised study was hastily prepared and that there were historic factors that
justified using 83% as the New York City LCR. The NYISO Board of Directors
denied KeySpan's appeal on April 3, 2006 and the "in-City" locational capacity
requirement beginning May 1, 2006 through the period ending April 30, 2007 is
currently 80%.
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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
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 market quoted forward prices to value OTC swap contracts.
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. 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 remaining
period July 2006 through October 2006 and further complement our hedging
strategy noted above regarding sales to certain large-volume customers. In
addition, OTC fuel swaps do not qualify for hedge accounting treatment. The
Ravenswood Generating Station has also employed a limited number of financial
derivatives that do not qualify for hedge accounting treatment under SFAS 133
associated with the purchase of fuel oil. Additionally, KeySpan entered into an
International SWAP Dealers Association Master Agreement for a fixed for floating
unforced capacity financial swap with Morgan Stanley Capital Group Inc., as well
as a gas distribution asset optimization contract that employs derivative
financial instruments.
70
The following tables set forth selected financial data associated with these
derivative financial instruments noted above that were outstanding at June 30,
2006.
- ------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Current Fair Value
Type of Contract Maturity mmcf Price $ Price $ (In $ Millions)
- ------------------------------------------------------------------------------------------------------------------
Gas
Swaps/Futures - Long Natural Gas 2006 23,328 1.71 - 11.26 1.94 - 10.24 (11.1)
2007 7,347 1.74 - 11.94 1.94 - 11.76 (0.4)
2008 353 9.82 7.70 - 10.87 (0.2)
OTC Swaps - Short Natural Gas 2006 931 6.17 - 6.29 7.52 - 10.50 (1.1)
2007 1,702 5.86 - 5.97 9.27 - 11.16 (6.2)
2008 1,552 6.77 - 6.85 8.59 - 11.19 (3.9)
- ------------------------------------------------------------------------------------------------------------------
35,213 (22.9)
- ------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Current Fair Value
Type of Contract Maturity Barrels Price $ Price $ (In $ Millions)
- --------------------------------------------------------------------------------------------------------------------
Oil
Swaps - Long Fuel Oil 2006 115,778 57.00 - 66.80 53.49 - 58.10 (2.9)
2007 132,879 59.20 - 62.14 62.51 (0.5)
2008 33,862 67.60 64.23 (0.1)
Swaps - Short Heating Oil 2006 294,696 73.50 - 79.38 78.12 - 82.74 (3.0)
- --------------------------------------------------------------------------------------------------------------------
577,215 (6.5)
- --------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Year of Fixed Margin/ Current Fair Value
Type of Contract Maturity MWh Price $ Price $ (In $ Millions)
- ------------------------------------------------------------------------------------------------------------
Electricity
Swaps - Energy 2006 972 73.50 - 156.25 69.96 - 118.90 15.0
2007 142 101.50 - 150.50 88.72 - 150.50 1.6
- ------------------------------------------------------------------------------------------------------------
1,114 16.6
- ------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------
2006
Change in Fair Value of Derivative Instruments (In $ Millions)
- ----------------------------------------------------------------------------
Fair value of contracts at January 1, (18.1)
Net (gains) on contracts realized 59.8
Increase in fair value of all open contracts (54.5)
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
Fair value of contracts outstanding at June 30, (12.8)
- ----------------------------------------------------------------------------
71
- --------------------------------------------------------------------------------
(In Millions of Dollars)
- --------------------------------------------------------------------------------
Fair Value of Contracts
- --------------------------------------------------------------------------------
Mature Within Total
Sources of Fair Value 12 Months Thereafter Fair Value
- --------------------------------------------------------------------------------
Prices actively quoted $ (18.4) $ (6.8) $ (25.2)
Local published indicies 12.4 - 12.4
- --------------------------------------------------------------------------------
$ (6.0) $ (6.8) $ (12.8)
- --------------------------------------------------------------------------------
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 June 30, 2006 a 10% increase/decrease in natural gas prices would
decrease/increase the value of derivative instruments maturing in one year by
$3.1 million. Further, a 10% increase/decrease in electricity and fuel prices
would decrease/increase the value of derivative instruments maturing in one year
by $1.7 million.
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative
financial instruments to reduce the cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations. The accounting for these derivative instruments is
subject to SFAS 71 "Accounting for the Effects of Certain Types of Regulation."
Therefore, changes in the fair value of these derivatives have been recorded as
a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
Gains or losses on the settlement of these contracts are initially deferred and
then refunded to or collected from our firm gas sales customers consistent with
regulatory requirements.
The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at June 30, 2006.
- ------------------------------------------------------------------------------------------------------------------------------------
Year of Volumes Floor Ceiling Fixed Current Fair Value
Type of Contract Maturity mmcf ($) ($) Price ($) Price ($) (In $ Millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Options 2006 1,038 5.50 10.00 7.21 - 10.07 1.3
Swaps 2006 29,854 - - 7.35 - 11.63 7.21 - 10.07 (36.3)
2007 51,344 - - 6.81 - 11.99 8.90 - 10.72 (17.9)
2008 4,810 - - 7.68 - 11.64 7.95 - 10.87 (1.6)
- ------------------------------------------------------------------------------------------------------------------------------------
87,046 (54.5)
- ------------------------------------------------------------------------------------------------------------------------------------
See Note 4 to the Consolidated Financial Statements "Hedging and Derivative
Financial Instruments" for a further description of all our derivative
instruments.
Item 4. Controls and Procedures
We maintain disclosure controls and procedures (as defined under Exchange Act
Rule 13a-15(e) and 15d-15(e)) that are designed to ensure that information
required to be disclosed by us in the reports we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms,
and that such information is accumulated and communicated to KeySpan's
management, including our Chief Executive Officer and Chief Financial Officer,
72
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 June 30, 2006. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that the design and operation of our disclosure controls and procedures were
effective at the reasonable assurance level in alerting them timely to material
information required to be included in KeySpan's periodic SEC reports.
Furthermore, there has been no change in KeySpan's internal control over
financial reporting that occurred during KeySpan's last fiscal quarter, which
has materially affected, or is reasonably likely to materially affect, KeySpan's
internal control over financial reporting.
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings
See Note 6 to the Consolidated Financial Statements "Financial Guarantees and
Contingencies".
Item 1A. Risk Factors
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:
- - the occurrence of any event, change or other circumstances that could give
rise to the termination of the merger agreement with National Grid or the
failure of the merger to close for any reason;
- - 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;
73
- - our ability to manage our cost structure successfully 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;
- 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;
- - changes in the UCAP pricing structure;
- - timing of approval of the 2006 LIPA Agreements and;
- - other risks detailed from time to time in other reports and other documents
filed by KeySpan with the SEC.
74
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" and "Item 3. Quantitative and
Qualitative Disclosures About Market Risk."
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
31.1* Certification of the Chairman and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2* Certification of the Executive Vice President and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1* Certification of the Chairman and Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2* Certification of the Executive Vice President and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- ----------------------
*Filed Herewith
75
SIGNATURES
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)
By: /s/Gerald Luterman
-------------------------
Name: Gerald Luterman
Title: Executive Vice President and
Chief Financial Officer
Date: August 3, 2006 /s/ Gerald Luterman
----------------------
Gerald Luterman
Executive Vice President and
Chief Financial Officer
Date: August 3, 2006 /s/ Theresa A. Balog
--------------------
Theresa A. Balog
Vice President and
Chief Accounting Officer
76