UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2006
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 (I.R.S. Employer Identification No.)
incorporation or organization)
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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $.01 par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
(Title of class)
Indicate by check mark if the registrant is a well known seasoned issuer, as
defined in Rule 405 of the Securities Act. X Yes ___No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. ___Yes X No
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. X Yes ___ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. X Yes ___ No
Indicate by check mark whether the registrant is a large accelerated filer, or a
non-accelerated filler.
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
The aggregate market value of the voting and non-voting common equity held by
non-affiliates (174,772,562 shares) of the registrant was $7,223,349,984 based
on the closing price of the New York Stock Exchange on February 20, 2007, of
$41.33 per share.
As of February 20, 2007, there were 175,588,130 shares of common stock, $.01 par
value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
KEYSPAN CORPORATION
INDEX TO FORM 10-K Page
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PART I
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ITEM 1. BUSINESS..................................................................................................1
ITEM 1A. RISK FACTORS.............................................................................................25
ITEM 1B. UNRESOLVED STAFF COMMENTS................................................................................33
ITEM 2. PROPERTIES...............................................................................................33
ITEM 3. LEGAL PROCEEDINGS........................................................................................33
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................................33
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES........................................................34
ITEM 6. SELECTED FINANCIAL DATA..................................................................................37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION.....................................................................................38
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...............................................92
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..............................................................95
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS................................................................101
INTRODUCTION TO THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS............................................101
Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES...........................................................103
Note 2. BUSINESS SEGMENTS....................................................................................125
Note 3. INCOME TAX...........................................................................................130
Note 4. POSTRETIREMENT BENEFITS..............................................................................132
Note 5. CAPITAL STOCK........................................................................................140
Note 6. LONG-TERM DEBT AND COMMERCIAL PAPER..................................................................140
Note 7. CONTRACTUAL OBLIGATIONS, FINANCIAL GUARANTEES
AND CONTINGENCIES....................................................................................144
Note 8. HEDGING, DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUES............................................156
Note 9. GAS PRODUCTION AND DEVELOPMENT PROPERTY - DEPLETION..................................................161
Note 10. ENERGY SERVICES- DISCONTINUED OPERATIONS............................................................162
Note 11. 2006 LIPA SETTLEMENT................................................................................164
Note 12. KEYSPAN GAS EAST CORPORATION SUMMARY FINANCIAL DATA.................................................166
Note 13. SUMMARY OF QUARTERLY INFORMATION (UNAUDITED)........................................................172
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE...............................................................................175
ITEM 9A. CONTROLS AND PROCEDURES................................................................................175
PART III
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE .................................................179
ITEM 11. EXECUTIVE COMPENSATION..................................................................................187
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS..............................................................224
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE............................................................................................225
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES..................................................................227
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.................................................................229
ii
PART I
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ITEM 1. BUSINESS
CORPORATE OVERVIEW
KeySpan Corporation ("KeySpan") is a member of the Standard and Poor's 500
Index. KeySpan is a New York corporation and a holding company under the Public
Utility Holding Company Act of 2005 ("PUHCA 2005"). KeySpan was formed in May
1998, as a result of the business combination of KeySpan Energy Corporation, the
parent of The Brooklyn Union Gas Company, and certain businesses of the Long
Island Lighting Company ("LILCO"). On November 8, 2000, KeySpan acquired Eastern
Enterprises ("Eastern"), now known as KeySpan New England, LLC ("KNE"), a
Massachusetts limited liability company, which primarily owns Boston Gas Company
("Boston Gas"), Colonial Gas Company ("Colonial Gas") and Essex Gas Company
("Essex Gas"), gas utilities operating in Massachusetts, as well as EnergyNorth
Natural Gas, Inc. ("EnergyNorth"), a gas utility operating principally in
central New Hampshire. 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.
KeySpan also owns, leases and operates electric generating plants in Nassau and
Suffolk Counties on Long Island and in Queens County in New York City and is the
largest electric generation operator in New York State. Under contractual
arrangements, KeySpan provides 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 production and development;
underground gas storage; liquefied natural gas ("LNG") storage; retail electric
marketing; large energy-system ownership, installation and management; service
and maintenance of energy systems; and engineering and consulting services.
KeySpan also invests and participates in the development of natural gas
pipelines, electric generation and other energy-related projects. As used
herein, "KeySpan," "we," "us" and "our" refers to KeySpan Corporation, its six
principal gas distribution subsidiaries and its other regulated and unregulated
subsidiaries, individually and in the aggregate.
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 (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 receipt of requisite regulatory approvals from certain
United States federal and state public utility, antitrust and other regulatory
authorities, all of which have been filed and many of which have been obtained.
Specifically, we filed our application for approval of the Merger pursuant to
1
the Federal Power Act in May 2006 and in October the requisite approval was
obtained from the Federal Energy Regulatory Commission ("FERC"). 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 ("NYPSC"). KeySpan has
also sought approval of the merger from the New Hampshire Public Utility
Commission. In October 2006, the State of New Jersey Board of Public Utilities
approved a change of control of KeySpan Communication Corp., which provides
telecommunications services in New Jersey. In addition, the Merger was approved
by our shareholders at our Annual Meeting on August 17, 2006. Shareholders of
National Grid plc approved the Merger at a meeting held on July 31, 2006.
In addition to seeking approval of the Merger, the application filed with the
NYPSC also contained proposed ten-year rate plans for KeySpan Energy Delivery of
New York ("KEDNY") and KeySpan Energy Delivery of Long Island ("KEDLI"), as well
as proposals concerning corporate structure and affiliate rules, the rate
treatment for synergy savings and for low income and energy efficiency programs,
among others. Specifically, the rate plan proposals provide 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 clauses would be increased to
recover, on a prospective basis, estimated 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 2.5% ($62.4 million) and 2.3% ($39.4 million),
respectively in years 3, 5, 7 and 9 of the rate plans. The proposed rate plans
contemplate 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. On October 3, 2006 National Grid plc filed testimony
and exhibits with the NYPSC that further explains the exhibits and attachments
that were previously submitted as part of the July 20, 2006 petition.
Separately from the merger application, on October 3, 2006, KEDNY and KEDLI
filed with the NYPSC individual applications for proposed annual increases in
revenues, which applications assumed that KEDNY and KEDLI remained as
stand-alone companies. The proposed revenue increases are for approximately 9.1%
and 10.9% for KEDNY and KEDLI, respectively. KEDNY's last base rate increase
took effect October 1, 1993 and since then base rates have been reduced twice -
once in 1996 and again in 1998. KEDLI's last base rate increase took effect
2
December 1, 1995. Since that time, KEDLI's base rates were reduced twice in
1998. The principal factors creating the need for rate relief are increases in
operating and maintenance expenses, increases in rate base, increased property
taxes and depreciation expense, and the need to commence recovery of previously
deferred costs such as pension and post retirement benefits, environmental
expenditures and property taxes.
The total projected increase in revenues is comprised of two components; (i) an
increase in base rates of $180.7 million for KEDNY and $145 million for KEDLI;
and (ii) projected increases of $32.8 million and $13.6 million for KEDNY and
KEDLI, respectively, for gas-related expenses that will be recovered through the
Gas Adjustment Clause ("GAC") and/or the Transportation Adjustment Clause
("TAC"). The proposed rate of return on equity is 11.0% for both KEDNY and
KEDLI.
The NYPSC may suspend the implementation of the proposed tariff changes for up
to eleven months, which would mean, absent other intervening events, an
effective date of September 3, 2007 for new rates. Although KEDNY and KEDLI
proposed the new rates described above in these tariff filings, it will not be
necessary to implement the rate increases proposed therein if the NYPSC approves
the Merger between National Grid plc and KeySpan and approves the related
ten-year rate plan previously noted, or some variation thereof.
On February 20, 2007, NYPSC Staff filed its direct testimony in the merger
proceeding. NYSPSC Staff opposed the current terms of the Merger on policy
grounds, but suggested that it could support the Merger under certain
circumstances. KeySpan and National Grid intend to file testimony responding to
the positions taken by Staff. In addition, on January 29, 2007, Staff filed its
direct testimony in the rate case proceedings and our rebuttal testimony was
filed on February 21, 2007. In connection with each of these proceedings,
hearings before an administrative law judge (ALJ) are scheduled to begin in late
March. Unless a settlement among the parties is otherwise reached, the ALJ will
issue its recommended decision to the NYPSC following such hearings. Ultimately,
the NYPSC may accept, reject, or modify all or any part of the ALJ's recommended
decision.
KeySpan and National Grid will continue to pursue all required approvals and
continue to anticipate that the Merger will be consummated in mid-2007. However,
we are unable to predict the outcome of these regulatory proceedings and no
assurance can be given that the Merger will occur or the timing of its
completion. Accordingly, any statements contained herein concerning
expectations, beliefs, plans, objectives, goals, strategies, future events or
performance and underlying assumptions are "forward-looking statements" and do
not take into account the occurrence or impact of any potential strategic
transaction on the future operations, financial condition and cash flows of
KeySpan.
KeySpan is a holding company under the Public Utility Holding Company Act of
2005, as amended ("PUHCA 2005"). 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 the Public Utility Holding Company Act of 1935, as
amended ("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 jurisdiction of
the Federal Energy Regulatory Commission ("FERC") pursuant to PUHCA 2005. See
"Regulation and Rate Matters" for additional information on the Energy Act and
PUHCA 2005.
3
Under our holding company structure, we have no independent operations and
conduct substantially all of our operations through our subsidiaries. Our
subsidiaries operate in the following four business segments: Gas Distribution,
Electric Services, Energy Services and Energy Investments.
The Gas Distribution segment consists of our six regulated gas distribution
subsidiaries, which operate in New York, Massachusetts and New Hampshire and
serve approximately 2.6 million customers.
The Electric Services segment consists of subsidiaries that manage the electric
transmission and distribution system ("T&D System") owned by LIPA; provide
generating capacity and, to the extent required, energy conversion services for
LIPA from our approximately 4,200 megawatts ("MW") of generating facilities
located on Long Island; and manage fuel supplies for LIPA to fuel our Long
Island generating facilities. The Electric Services segment also includes
subsidiaries that own, lease and operate the 2,200 MW Ravenswood electric
generation facility (the "Ravenswood Facility"), located in Queens County in New
York City, and the 250 MW combined cycle generating unit (the "Ravenswood
Expansion") which began full commercial operation in May 2004 (collectively, the
Ravenswood Facility and the Ravenswood Expansion are referred to herein as the
"Ravenswood Generating Station" and have a total electric capacity of 2,450 MW).
Moreover, subsidiaries in this segment also provide retail marketing of
electricity to commercial customers.
The Energy Services segment provides energy-related services to customers
primarily located within the Northeastern United States, with concentrations in
the New York City and Boston metropolitan areas.
The Energy Investments segment includes our gas production and development
activities, domestic pipelines, gas storage facilities and LNG facilities and
operations.
KeySpan's principal executive offices are located at One MetroTech Center,
Brooklyn, New York 11201 and 175 East Old Country Road, Hicksville, New York
11801, and its telephone numbers are (718) 403-1000 (Brooklyn) and (516)
755-6650 (Hicksville).
KeySpan makes available free of charge on or through its website,
http://www.keyspanenergy.com (Investor Relations section), its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports as soon as reasonably practicable after such
material is electronically filed with or furnished to the SEC. You may also read
and copy any of these documents at the SEC's public reference room at 100 F
Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for
further information on the public reference room. Our SEC filings are also
available to the public on the SEC's web site at www.sec.gov.
4
GAS DISTRIBUTION OVERVIEW
Our gas distribution activities are conducted by our six regulated gas
distribution subsidiaries, which operate in three states in the Northeast: New
York, Massachusetts and New Hampshire. We are the fifth largest gas distribution
company in the United States and the largest in the Northeast, with
approximately 2.6 million customers served within an aggregate service area
covering 4,273 square miles. In New York, The Brooklyn Union Gas Company, doing
business as KeySpan Energy Delivery New York ("KEDNY"), provides gas
distribution services to customers in the New York City Boroughs of Brooklyn,
Queens and Staten Island; and KeySpan Gas East Corporation, doing business as
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. In Massachusetts, Boston Gas provides gas
distribution services in eastern and central Massachusetts; Colonial Gas
provides gas distribution services on Cape Cod and in eastern Massachusetts; and
Essex Gas provides gas distribution services in eastern Massachusetts. In New
Hampshire, EnergyNorth provides gas distribution services to customers
principally located in central New Hampshire. Our New England gas companies all
do business as KeySpan Energy Delivery New England ("KEDNE").
In New York, there are two separate, but contiguous service territories served
by KEDNY and KEDLI, comprising approximately 1,417 square miles and 1.68 million
customers. In Massachusetts, Boston Gas, Colonial Gas and Essex Gas serve three
service territories consisting of 1,934 square miles and approximately 792,000
customers. In New Hampshire, EnergyNorth has a service territory that is
contiguous to Colonial Gas' and ranges from within 30 to 85 miles of the greater
Boston area. EnergyNorth provides service to approximately 80,000 customers over
a service area of approximately 922 square miles. Collectively, KeySpan owns and
operates gas distribution, transmission and storage systems that consist of
approximately 23,336 miles of gas mains and distribution pipelines.
Natural gas is offered for sale to residential and small commercial customers on
a "firm" basis, and to most large commercial and industrial customers on either
a "firm" or "interruptible" basis. "Firm" service is offered to customers under
tariffed schedules or contracts that anticipate no interruptions, whereas
"interruptible" service is offered to customers under tariffed schedules or
contracts that anticipate and permit interruption on short notice, generally in
peak-load seasons or for system reliability reasons. We maintain a diverse
portfolio of firm gas supply, storage and pipeline transportation capacity
contracts to adequately serve the requirements of our gas sales customers, to
maintain system reliability and system operations, and to meet our obligation to
serve our customers. We also engage in the use of derivative financial
instruments from time to time to reduce the cash flow volatility associated with
the purchase price for a portion of future natural gas purchases.
KeySpan actively promotes a competitive retail gas market by offering tariff
firm transportation services to firm gas customers who elect to purchase their
gas supplies from natural gas marketers rather than from the utility. In New
York, KeySpan further facilitates competition by releasing its pipeline
transportation capacity and offering bundled gas supply to natural gas marketers
that would otherwise not be able to obtain their own capacity. In Massachusetts
and New Hampshire, there are mandatory capacity assignment programs in place
whereby capacity is released to natural gas marketers on behalf of customers
they serve. However, net gas revenues are not significantly affected by
5
customers opting to purchase their gas supply from other sources since delivery
rates charged to transportation customers generally are the same as delivery
rates charged to sales service customers.
KeySpan also participates in interstate markets by releasing pipeline capacity
and by selling bundled gas services to customers located outside of our service
territory ("off-system" customers).
KeySpan purchases natural gas for firm gas customers under both long and
short-term supply contracts, as well as on the spot market, and utilizes its
firm pipeline transportation contracts to transport the gas from the point of
purchase to the market. KeySpan also contracts for firm capacity in natural gas
underground storage facilities to store gas during the summer for later
withdrawal during the winter heating season when gas customer demand is higher.
KeySpan also contracts for firm winter peaking supplies to meet firm gas
customer demand on the coldest days of the year.
KeySpan sells gas to firm gas customers at its cost for such gas, plus a charge
designed to recover the costs of distribution (including a return of and a
return on capital invested in our distribution facilities). We share with our
firm gas customers net revenues (operating revenues less the cost of gas and
associated revenue taxes) from off-system sales and capacity release
transactions. Further, net revenues from tariff gas balancing services and
certain interruptible on-system sales are refunded, for most of our
subsidiaries, to firm customers subject to certain sharing provisions.
Our gas operations can be significantly affected by seasonal weather conditions.
Annual revenues are substantially realized during the heating season as a result
of higher sales of gas due to cold weather. Accordingly, operating results
historically are most favorable in the first and fourth calendar quarters. KEDNY
and KEDLI each operate under a utility tariff that contains a weather
normalization adjustment that largely offsets variations in firm net revenues
due to fluctuations in normal weather. However, the tariffs for our four KEDNE
gas distribution companies do not contain such a weather normalization
adjustment and, therefore, fluctuations in seasonal weather conditions between
years may have a significant effect on results of operations and cash flows for
these four subsidiaries. We utilize weather derivatives for KEDNE to mitigate
variations in firm net revenues due to warmer-than-normal weather during the
heating season.
New York Gas Distribution Systems - KEDNY and KEDLY Supply and Storage
KEDNY and KEDLI have firm long-term contracts for the purchase of transportation
and underground storage services. Gas supplies are purchased under long and
short-term firm contracts, as well as on the spot market. Gas supplies are
transported by interstate pipelines from domestic and Canadian supply basins.
Peaking supplies are available to meet system requirements on the coldest days
of the winter season.
Peak-Day Capability. The design criteria for the New York gas system assumes an
average temperature of 0(0)F for peak-day demand. Under such criteria, we
estimate that the requirements to supply our firm gas customers would amount to
approximately 2,129 MDTH (one MDTH equals 1,000 DTH or 1 billion British Thermal
Units) of gas for a peak-day during the 2006/07 winter season and that the gas
available to us on such a peak-day amounts to approximately 2,235 MDTH.
6
The highest daily throughput most recently experienced occurred on February 5,
2007 in which the demand of the firm New York customers was 1,874 MDTH, and the
average temperature was 14(degree)F. KEDNY and KEDLI have sufficient gas supply
available to meet the requirements of their firm gas customers for the 2006/07
winter season.
Our New York firm gas peak-day capability is summarized in the following table:
Source MDTH per day % of Total
- ------------------------------------------ ---------------- ------------
Pipeline 865 39%
Underground Storage 800 36%
Peaking Supplies 570 25%
--- ---
Total 2,235 100%
======= =======
Pipelines. Our New York based gas distribution utilities purchase natural gas
for sale under contracts with suppliers of natural gas located in domestic and
Canadian supply basins and arrange for its transportation to our facilities
under firm long-term contracts with interstate pipeline companies. For the
2006/07 gas year, approximately 73% of our New York natural gas supply was
available from domestic sources and 27% from Canadian sources. We have available
under firm contract 865 MDTH per day of year-round and seasonal pipeline
transportation capacity. Our major providers of interstate pipeline capacity and
related services include: Transcontinental Gas Pipe Line Corporation
("Transco"), Texas Eastern Transmission Corporation ("Tetco"), Iroquois Gas
Transmission System, L.P. ("Iroquois"), Tennessee Gas Pipeline Company
("Tennessee"), Dominion Transmission Incorporated ("Dominion"), Texas Gas
Transmission Company, TransCanada Corporation and Union Gas.
Underground Storage. In order to meet winter demand in our New York service
territories, we also have long-term contracts with Transco, Tetco, Tennessee,
Dominion, Equitrans, Inc., National Fuel Gas Supply Corporation ("National
Fuel") and Honeoye Storage Corporation ("Honeoye") for underground storage
capacity of 60,766 MDTH and 800 MDTH per day of maximum deliverability.
Peaking Supplies. In addition to the pipeline and underground storage supply, we
supplement our winter supply portfolio with peaking supplies that are available
on the coldest days of the year to economically meet the increased requirements
of our heating customers. Our peaking supplies include: (i) two LNG plants; (ii)
peaking supply contracts with dual-fuel power producers located in our franchise
areas; and (iii) third-party peaking supply contracts with suppliers located
outside our franchise area. For the 2006/07 winter season, we have the
capability to provide maximum peaking supplies of 570 MDTH on extremely cold
days. The LNG plants provide us with peak-day capacity of 395 MDTH and winter
season availability of 2,053 MDTH. The peaking supply contracts with the dual
fuel power producers provide us with peak-day capacity of 175 MDTH and winter
season availability of 4,846 MDTH.
7
Gas Supply Management. We currently perform our New York-based gas supply
management services internally.
Gas Costs. The current gas rate structure of each of these companies includes a
gas adjustment clause pursuant to which variations between actual gas costs
incurred and gas costs billed are deferred and subsequently refunded to or
collected from firm customers.
Combined Gas Supply Portfolios. KEDNY and KEDLI combined the planning,
management and utilization of their respective gas supply portfolios to enable
each company to serve its customers more reliably and cost effectively.
Specifically, these companies plan the acquisition of incremental pipeline
capacity, underground storage, gas supply and peaking supply contracts to meet
projected growth in firm customer demand on a combined portfolio basis. This
approach enables these companies to realize synergies that would otherwise not
be attainable if they were to plan independently for the development of their
respective portfolios. These two companies, by virtue of their geographic
proximity, complementary customer demand profiles and similar gas contracts are
able to add incremental capacity more effectively to meet expected customer
demand growth by planning the portfolios on a combined basis.
Deregulation. Regulatory actions, economic factors and changes in customers and
their preferences continue to reshape our gas operations. A number of customers
currently purchase their gas supplies from natural gas marketers and then
contract with us for local transportation, balancing and other unbundled
services. In addition, our New York gas distribution companies release firm
capacity on our interstate pipeline transportation contracts to natural gas
marketers to ensure the marketers' gas supply is delivered on a firm basis and
in a reliable manner. As of January 1, 2007, approximately 98,968 gas customers
on the New York gas distribution system are purchasing their gas from marketers.
However, net gas revenues are not significantly affected by customers opting to
purchase their gas supply from other sources since delivery rates charged to
transportation customers generally are the same as delivery rates charged to
sales service customers.
New England Gas Distribution Systems - KEDNE Supply and Storage
KEDNE has firm long-term contracts for the purchase of transportation and
underground storage services. Gas supplies are purchased under long and
short-term firm contracts, as well as on the spot market. Gas supplies are
transported by interstate pipelines from domestic and Canadian supply basins.
Peaking supplies are available to meet system requirements on the coldest days
of the winter season.
Peak-Day Capability. The design criteria for the New England gas systems assumes
an average temperature of -6(0)F in Massachusetts and -8(0)F in New Hampshire
for peak-day demand. Under such criteria, we estimate that the requirements to
supply our firm gas customers would amount to approximately 1,389 MDTH of gas
for a peak-day during the 2006/07 winter season and that the gas available to us
on such a peak-day amounts to approximately 1,420 MDTH.
8
The highest daily throughput most recently experienced occurred on January 26,
2007 in which the demand of the firm New England customers (which includes both
firm sales and firm transportation) was 1,210 MDTH, and the average temperature
was 9(0)F. KEDNE has sufficient gas supply available to meet the requirements of
their firm gas customers for the 2006/07 winter season.
Our New England firm gas peak-day capability is summarized in the following
table:
Source MDTH per day % of Total
- --------------------------------------- ---------------- --------------
Pipeline 500 35%
Underground Storage 248 18%
Peaking Supplies 672 47%
--------- --
Total 1,420 100%
========= =======
Pipelines. Our New England based gas distribution utilities purchase natural gas
for sale under contracts with suppliers of natural gas located in domestic and
Canadian supply basins and arrange for transportation to our facilities under
firm long-term contracts with interstate pipeline companies. We have available
under firm contract 500 MDTH per day of year-round and seasonal pipeline
transportation capacity. Our major providers of interstate pipeline capacity and
related services include: Algonquin Gas Transmission Company, Iroquois,
Maritimes and Northeast Pipelines, Portland Natural Gas Transmission System,
Tennessee and TETCO.
Underground Storage. In order to meet winter demand in our New England service
territories, we also have long-term contracts with Tetco, Tennessee, Dominion,
National Fuel and Honeoye for underground storage capacity of 23,280 MDTH and
248 MDTH per day of maximum deliverability.
Peaking Supplies. In addition to the pipeline and underground storage supply, we
supplement our winter supply portfolio with peaking supplies that are available
on the coldest days of the year to economically meet the increased requirements
of our heating customers. Our peaking supplies include (i) local production
plants that store LNG and liquid propane until vaporized, which are located
strategically across the service territory and (ii) contracts for LNG storage
and delivery with our LNG subsidiary, KeySpan LNG LP, located in Providence,
Rhode Island and with Distrigas of Massachusetts located in Everett,
Massachusetts. For the 2006/07 winter season, we have the capability to provide
maximum peaking supplies of 672 MDTH on extremely cold days.
Gas Supply Management. KeySpan has a management contract with Merrill Lynch
Trading, under which KeySpan and Merrill Lynch Trading share the
responsibilities for managing KeySpan's upstream gas contracted 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
9
from the optimization of these assets. The Massachusetts Department of
Telecommunications and Energy ("MADTE") approved this contract in March 2006
effective April 1, 2006. KeySpan provides these services internally for its New
Hampshire gas distribution subsidiaries.
Gas Costs. The current gas rate structure of each of the KEDNE companies
includes a gas adjustment clause pursuant to which variations between actual gas
costs incurred and gas costs billed are deferred and subsequently refunded to or
collected from firm customers.
For additional information and for financial information concerning the gas
distribution segment, see the discussion in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - "Gas Distribution"
and Note 2 to the Consolidated Financial Statements, "Business Segments".
ELECTRIC SERVICES OVERVIEW
We are the largest electric generator in New York State. Our subsidiaries own
and operate 5 large generating plants and 13 smaller facilities which are
comprised of 57 generating units in Nassau and Suffolk Counties on Long Island
and the Rockaway Peninsula in Queens. In addition, we own, lease and operate the
Ravenswood Generating Station located in Queens County, which is the largest
generating facility in New York City. The Ravenswood Generating Station is
comprised of 3 large steam-generating units, a 250 MW combined cycle generating
unit and 17 gas turbine generators. We also operate and maintain a 55 MW gas
turbine unit in Greenport, Long Island under an agreement with a third party.
As more fully described below, we: (i) provide to LIPA all operation,
maintenance and construction services and significant administrative services
relating to the Long Island electric 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 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 through 2013; (ii) a new Option and Purchase and Sale Agreement (the
"2006 Option Agreement"), to replace the Generation Purchase Rights Agreement
(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."
These will become effective following approval by the New York State
10
Comptroller's Office and the New York State Attorney General. (For a further
discussion on these LIPA agreements see the discussion under the caption
"Electric Services - LIPA Agreements" and Note 11 to the Consolidated Financial
Statements "2006 LIPA Settlement"). The Electric Services segment also provides
retail marketing of electricity to commercial customers.
Portions of our Electric Services business can be affected by seasonal weather
conditions and market conditions. The majority of the capacity revenue
associated with the Ravenswood Generating Station is realized during the six
months between May and October of each year. Energy and ancillary service sales
from our Ravenswood Generating Station are directly correlated to the demand for
electricity and competition from other resources. Typically, the demand and
price for electricity increases during the extreme temperature conditions of
summer. However, depending on the availability of alternative competitive
supply, extreme temperature conditions may not result in increased revenue. As a
result, fluctuations in weather and competitive supply between years may have a
significant effect on results of operations in this portion of our Electric
Services business.
Generating Facility Operations
In June 1999, we acquired the 2,200 MW Ravenswood Facility located in New York
City from Consolidated Edison Company of New York, Inc. ("Consolidated Edison")
for approximately $597 million. In order to reduce our initial cash requirements
to finance this acquisition, we entered into an arrangement with an unaffiliated
variable interest entity through which we lease a portion of the Ravenswood
Facility. Under the arrangement, the variable interest entity acquired a portion
of the facility directly from Consolidated Edison and leased it to our wholly
owned subsidiary, KeySpan-Ravenswood, LLC ("KSR"). For more information
concerning this lease arrangement, see Note 7 to the Consolidated Financial
Statements, "Contractual Obligations, Financial Guarantees and Contingencies."
In 2004, we completed construction of the Ravenswood Expansion, a 250 MW
combined cycle generating unit at the Ravenswood Facility, thereby increasing
the total electric capacity of the Ravenswood Facility to 2,450 MW. In mid-May
2004, the Ravenswood Expansion began full commercial operations. To finance the
Ravenswood Expansion, we entered into a leveraged lease financing arrangement
pursuant to which the Ravenswood Expansion was acquired by an unaffiliated
lessor from KSR and simultaneously leased back to it. 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." See Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation - "Electric Services Revenue Mechanisms" for a further discussion of
these matters.
The Ravenswood Generating Station sells capacity, energy and ancillary services
into the New York Independent System Operator ("NYISO") electricity market at
market-based rates, subject to mitigation. The Ravenswood Generating Station
Facility has the ability to provide approximately 25% of New York City's
capacity requirements and is a strategic asset that is available to serve
residents and businesses in New York City.
11
The Ravenswood Generating Station and our New York City Operations
The NYISO's New York City local reliability rules require that 80% of the
electric capacity needs of New York City be provided by "in-City" generators.
Our Ravenswood Generating Station is an "in-City" generator. As the electric
infrastructure in New York City and the surrounding areas continues to change
and evolve and the demand for electric power increases, the "in-City" generator
requirement could be further modified. Construction of new transmission and
generation facilities may cause significant changes to the market for sales of
capacity, energy and ancillary services from our Ravenswood Generating Station.
KeySpan continues to believe that New York City represents a strong capacity
market and has entered into an International Swap Dealers Association ("ISDA")
Master Agreement for a fixed for float unforced capacity financial swap (the
"Swap Agreement") with Morgan Stanley Capital Group Inc. ("Morgan Stanley")
dated as of January 18, 2006. The Swap 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.
Settlement occurs on a monthly basis based on the In-City Unforced Capacity
price determined by the relevant New York Independent System Operator 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 pays 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 pays Morgan Stanley an amount equal to the product of (a) the
Notional Quantity and (b) the absolute value of such price difference.
The New York State competitive wholesale market for capacity, energy and
ancillary services administered by the NYISO is still evolving and FERC has
adopted several price mitigation measures which are subject to rehearing and
possible judicial review. See Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation - "Regulatory Issues and
Competitive Environment" for a further discussion of these matters.
Forty-six of our seventy-eight generating units are dual fuel units. In recent
years, we have reconfigured several of our facilities to enable them to burn
either natural gas or oil, thus enabling us to switch periodically between fuel
alternatives based upon cost and seasonal environmental requirements. Through
other innovative technological approaches, we instituted a program to reduce
nitrogen oxides for improved environmental performance while recovering 80 MW of
energy output.
12
The following table indicates the 2006 summer capacity of all of our steam
generation facilities and gas turbine ("GT") units as reported to the NYISO:
- --------------------------------------------------------------------------------------------------------------------
Location of Units Description Fuel Units MW
- --------------------------------------------------------------------------------------------------------------------
Long Island City Steam Turbine Dual* 3 1,651
Long Island City Combined Cycle Dual* 1 231
Northport, L.I. Steam Turbine Dual* 4 1,552
Port Jefferson, L.I. Steam Turbine Dual* 2 383
Glenwood, L.I. Steam Turbine Gas 2 239
Island Park, L.I. Steam Turbine Dual* 2 385
Far Rockaway, L.I. Steam Turbine Dual* 1 111
Long Island City GT Units Dual* 17 423
Glenwood and Port
Jefferson Energy
Center, L.I. GT Units Dual 4 159
Throughout L.I. GT Units Dual* 12 305
Throughout L.I. GT Units Oil 30 1067
-- ----
TOTAL 78 6506
====================================================================================================================
*Dual - Oil (#2 oil or #6 residual oil) or kerosene, and natural gas.
For additional information and for financial information concerning the Electric
Services segment, see the discussion in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - "Electric Services"
and Note 2 to the Consolidated Financial Statements, "Business Segments".
Agreements with LIPA
LIPA is a corporate municipal instrumentality and a political subdivision of the
State of New York. On May 28, 1998, certain of 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 system ("T&D
System") pursuant to the 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 the Power Supply
Agreement (the "1998 PSA") and other 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 the 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.
13
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. The
2006 LIPA Agreements become effective following approval by the New York State
Comptroller's Office and the New York State Attorney General.
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 results from the recent settlement with the
IRS regarding the audit of LILCO's tax returns for the years ended December 31,
1996 through March 31, 1999. On October 30, 2006, the IRS submitted the
settlement provisions of the recently concluded IRS audit to the Joint Committee
on Taxation for approval. Key provisions of the settlement included the
resolution of the tax basis of assets transferred to KeySpan at the time of the
KeySpan/LILCO merger, the tax deductibility of certain merger related costs and
the tax deductibility of certain environmental expenditures. The settlement
enabled KeySpan to utilize 100% of the available tax credits. (See Note 3 to the
Consolidated Financial Statements "Income Taxes" for additional information of
the settlement.) In recognition of these items, as well as for the modification
and extension of the 1998 MSA and the amendments to the GPRA, upon effectiveness
of the 2006 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 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 $90 million due from LIPA.
Generation Purchase Rights Agreement and 2006 Option Agreement. Under the
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 had the option during the period January 1, 2006
to December 31, 2006 to purchase only KeySpan's Far Rockaway and/or E.F. Barrett
14
Generating Stations (and certain related assets) at a price equal to the net
book value of each facility. In December 2006, KeySpan and LIPA entered into an
amendment to the 2006 Option Agreement whereby the parties agreed to extend the
expiration of the option period to the later of (i) December 31, 2007 or (ii)
180 days following the effective date of the 2006 Option Agreement. The 2006
Option Agreement replaces the GPRA, the expiration of which has been stayed
pending effectiveness of the 2006 LIPA Agreements. In the event such agreements
do not become effective by reason of failure to secure any of the requisite
governmental approvals, the GPRA will be reinstated for a period of 90 days from
the date such approval is denied. If LIPA were to exercise the option and
purchase one or both of the generation facilities then: (i) LIPA and KeySpan
will enter into an operation and maintenance agreement, pursuant to which
KeySpan will continue to operate these facilities through May 28, 2013 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.
Management Services Agreements. Pursuant to the 1998 MSA, KeySpan manages the
day-to-day operations, maintenance and capital improvements of the T&D System.
When originally executed, the 1998 MSA had a term expiring on May 28, 2006. In
2002, in connection with an extension of the GPRA term, the 1998 MSA was
extended for 31 months through 2008. As a result of the recent negotiations and
settlement between KeySpan and LIPA discussed above, the parties entered into
the 2006 MSA.
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, conservation
expenditures and storm costs.
15
The 2006 MSA provides for a number of performance metrics measuring various
aspects of KeySpan's performance in the operations and customer service areas.
Poor performance in any metric may subject KeySpan to financial and other
non-cost penalties (such financial penalties not to exceed $7 million in the
aggregate for all performance metrics in any contract year). Subject to certain
limitations, superior performance in certain metrics can be used to offset
underperformance in other metrics. Consistent failure to meet threshold
performance levels for two metrics, System Average Interruption Duration Index
(two out of three consecutive years) and Customer Satisfaction Index (three
consecutive years), will constitute an event of default under the 2006 MSA.
In the event LIPA sells the T&D System to a private entity during the term of
the 2006 MSA, LIPA shall have the right to terminate the 2006 MSA, provided that
LIPA will be required to pay KeySpan's reasonable transition costs and a
termination fee of (a) $28 million if the termination date occurs on or before
December 31, 2009, and (b) $20 million if the termination date occurs after
December 31, 2009.
Upon approval, the 2006 LIPA Agreements will be effective retroactive to January
1, 2006. KeySpan's reported operating income and net income for 2006, under the
2006 MSA, are substantially the same as they would have been if the terms and
provisions of the 1998 MSA had continued to be applied. At this point in time,
KeySpan is unable to estimate what the impact would be to its results of
operations, financial position and cash flows if the 2006 LIPA Agreements do not
become fully effective.
Power Supply Agreements. 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. Since October 1, 2004,
pursuant to a FERC approved settlement, the rates reflect a cost of equity of
9.5% with no revenue increase. The FERC also approved updated operating and
maintenance expense levels and KeySpan's recovery of certain other costs as
agreed to by the parties. Rates charged to LIPA include a fixed and variable
component. The variable component is billed to LIPA on a monthly per megawatt
hour basis and is dependent on the number of megawatt hours dispatched. LIPA has
no obligation to purchase energy conversion services from KeySpan and is able to
purchase energy or energy conversion services on a least-cost basis from all
available sources consistent with existing interconnection limitations of the
T&D System. The 1998 PSA provides incentives and penalties that can total $4
million annually for the maintenance of the output capability and the efficiency
of the generating facilities. In 2006, we earned $4.0 million in incentives
under this agreement.
The 1998 PSA has a term of fifteen years through May 2013, with LIPA having the
option to renew the 1998 PSA for an additional fifteen year term. If the 2006
LIPA Agreements receive the requisite governmental approvals and become
effective and if LIPA exercises its rights under the 2006 Option Agreement to
purchase the two generating plants, then 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 the 1998 PSA will be amended to reflect that the purchased
16
generating facilities would no longer be covered by the 1998 PSA. 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.
Energy Management Agreement. The 1998 EMA provides for KeySpan to procure and
manage fuel supplies on behalf of LIPA to fuel the generating facilities under
contract to it and perform off-system capacity and energy purchases on a
least-cost basis to meet LIPA's needs. In exchange for these services we earn an
annual fee of $1.5 million. In addition, we arrange for off-system sales on
behalf of LIPA of excess output from the generating facilities and other power
supplies either owned or under contract to LIPA. LIPA is entitled to two-thirds
of the profit from any off-system energy sales. In addition, the 1998 EMA
provides incentives and penalties that can total $5 million annually for
performance related to fuel purchases and off-system power purchases. In 2006,
we earned EMA incentives in an aggregate of $5.0 million.
The original term for the fuel supply service is fifteen years, expiring May 28,
2013, and the original term for the power supply management services described
was eight years, which expired on May 28, 2006. In March 2005, LIPA issued a
Request for Proposal ("RFP") for system power supply management services
beginning May 29, 2006 and fuel management services for certain of its peaking
generating units beginning January 1, 2006. KeySpan submitted a bid in response
to this RFP in April 2005. LIPA has not yet selected a service provider.
In 2005, the EMA was amended to extend the term for power supply management
services through December 31, 2006 and thereafter on a month-to-month basis,
unless terminated by LIPA on sixty days notice, but in no event later than
December 31, 2007.
In the event LIPA exercises its rights under the 2006 Option Agreement, KeySpan
and LIPA will enter into an amendment to the 1998 EMA reflecting that the
facilities that LIPA acquires pursuant to the Option Agreement are no longer
covered under the 1998 EMA and as noted above, an operation and maintenance
agreement, whereby KeySpan will continue to operate the newly acquired
facilities for a fixed management fee plus reimbursement for certain costs. It
is anticipated that the fees received pursuant to the operation and maintenance
agreement will offset the reduction in any fees earned by KeySpan pursuant to
the 1998 EMA.
Under the 1998 LIPA Agreements and the 2006 LIPA Agreements, we are required to
obtain a letter of credit in the aggregate amount of $60 million supporting our
obligations to provide the various services if our long-term debt is not rated
in the "A" range by a nationally recognized rating agency.
Power Purchase Agreements. KeySpan-Glenwood Energy Center, LLC and KeySpan-Port
Jefferson Energy Center LLC each have 25 year power purchase agreements with
LIPA expiring in 2027 (the "2002 LIPA PPAs"). Under the terms of the 2002 LIPA
PPAs, these subsidiaries sell capacity, energy conversion services and ancillary
services to LIPA. Each plant is designed to produce 79.9 MW. Pursuant to the
2002 LIPA PPAs, LIPA pays a monthly capacity fee, which guarantees full recovery
of each plant's construction costs, as well as an appropriate rate of return on
investment.
17
Other Rights. Pursuant to other agreements between LIPA and KeySpan, certain
future rights have been granted to LIPA. Subject to certain conditions, these
rights include the right for 99 years (from May 1998) to lease or purchase, at
fair market value, parcels of land and to acquire unlimited access to, as well
as appropriate easements at, the Long Island generating facilities for the
purpose of constructing new electric generating facilities to be owned by LIPA
or its designee. Subject to this right granted to LIPA, KeySpan has the right to
sell or lease property on or adjoining the Long Island generating facilities to
third parties.
We own common plant assets (such as administrative office buildings and computer
systems) formerly owned by LILCO and recover an allocable share of the carrying
costs of such plant assets through the MSA. KeySpan has agreed to provide LIPA,
for a period of 99 years (from May 1998), the right to enter into leases at fair
market value for common plant assets or sub-contract for common services which
it may assign to a subsequent manager of the transmission and distribution
system. We have also agreed: (i) for a period of 99 years (from May 1998) not to
compete with LIPA as a provider of transmission or distribution service on Long
Island; (ii) that LIPA will share in synergy (i.e., efficiency) savings over a
10-year period attributed to the May 28, 1998 transaction which resulted in the
formation of KeySpan (estimated to be approximately $1 billion), which savings
are incorporated into the cost structure under the 1998 LIPA Agreements; and
(iii) generally not to commence any tax certiorari case (during the pendency of
the 1998 PSA) challenging certain property tax assessments relating to the
former LILCO Long Island generating facilities.
Guarantees and Indemnities. We have entered into agreements with LIPA to provide
for the guarantee of certain obligations, indemnification against certain
liabilities and allocation of responsibility and liability for certain
pre-existing obligations and liabilities. In general, liabilities associated
with the LILCO assets transferred to KeySpan, have been assumed by KeySpan; and
liabilities associated with the assets acquired by LIPA, are borne by LIPA,
subject to certain specified exceptions. We have assumed all liabilities arising
from all manufactured gas plant ("MGP") operations of LILCO and its
predecessors, and LIPA has assumed certain liabilities relating to the former
LILCO Long Island generating facilities and all liabilities traceable to the
business and operations conducted by LIPA after completion of the 1998
KeySpan/LILCO transaction. An agreement also provides for an allocation of
liabilities which relates to the assets that were common to the operations of
LILCO and/or shared services or liabilities which are not traceable directly to
either the business or operations conducted by LIPA or KeySpan. In addition,
costs incurred by KeySpan for liabilities for asbestos exposure arising from the
activities of the generating facilities previously owned by LILCO are
recoverable from LIPA through the PSA.
ENERGY SERVICES OVERVIEW
The Energy Services segment includes companies that provide energy-related
services to customers located primarily within the Northeastern United States,
with concentrations in the New York City and Boston metropolitan areas.
Subsidiaries in this segment provide residential and small commercial customers
18
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. Our subsidiaries
in this segment have over 200,000 service contracts in place to provide home
energy services, completed over 240,000 service calls during 2006 and completed
more than 16,000 installations during 2006.
For additional information and financial information concerning the Energy
Services segment, see the discussion in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - "Energy Services",
Item 8. "Financial Statements and Supplementary Data", Note 2 to the
Consolidated Financial Statements, "Business Segments", and Note 10, "Energy
Services - Discontinued Operations".
ENERGY INVESTMENTS OVERVIEW
We are also engaged in Energy Investments which includes gas production and
development activities, domestic pipelines, gas storage facilities and LNG
facilities and operations.
Gas Production and Development
KeySpan is engaged in the production and development of domestic natural gas and
oil through wholly-owned subsidiaries Seneca-Upshur Petroleum, Inc., d/b/a
KeySpan Production & Development Company ("Seneca-Upshur") and KeySpan
Exploration and Production, LLC ("KeySpan Exploration and Production").
Seneca-Upshur's assets consist of 38 billion cubic feet of low risk, mature,
onshore gas producing properties. Specifically, Seneca-Upshur, headquartered in
Buckhannon, West Virginia, owns and operates onshore gas producing properties,
and operates approximately 1,300 wells in north central West Virginia. To manage
the inherent volatility in commodity prices, Seneca-Upshur entered into a
three-year hedge for a majority of its production. KeySpan Exploration is
involved in a joint venture with Merit Energy Corporation, an independent oil
and gas producer, which acquired its interest in the joint-venture from The
Houston Exploration Company ("Houston Exploration"). See Item 7. Management's
Discussion and Analysis of Financial Conditions and Results of Operations -
"Energy Investments" for a further discussion of these matters.
19
Domestic Pipelines and Gas Storage Facilities
We own a 20.4% interest in Iroquois Gas Transmission System LP, a partnership of
affiliates of six U.S. and Canadian energy companies, which is the owner of a
411-mile interstate natural gas pipeline extending from the U.S.-Canadian border
at Waddington, NY through western Connecticut to its terminus in Commack, NY,
and from Huntington to the Bronx. Its wholly owned subsidiary, the Iroquois
Pipeline Operating Company, headquartered in Shelton, Connecticut, is the agent
for and operator of the pipeline. The Iroquois pipeline can transport up to
1,124,500 DTH per day of Canadian gas supply from the New York-Canadian border
to markets in the Northeastern United States. KeySpan is also a shipper on
Iroquois and currently transports up to 304,950 DTH of gas per day.
We also have a 50% interest in Islander East Pipeline Company, LLC ("Islander
East"), which 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. In addition, we own a 26.25% interest in the
Millennium Pipeline project which 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.
We are also the owner and operator of a 600,000 barrel LNG storage and receiving
facility located in Providence, Rhode Island, known as KeySpan LNG. Our
subsidiary, Boston Gas is the facility's largest customer and contracts for more
than half of the LNG facility's storage. KeySpan LNG is regulated by FERC.
We also have equity investments in two gas storage facilities in the State of
New York: Honeoye Storage Corporation and Steuben Gas Storage Company. We own a
52% interest in Honeoye, an underground gas storage facility which provides up
to 4.3 billion cubic feet of storage service to New York and New England.
Additionally, we own 34% of a partnership that has a 50% interest in the Steuben
facility that provides up to 6.2 billion cubic feet of storage service to New
Jersey and Massachusetts.
For additional information concerning these energy related investments in
pipelines and gas storage facilities, see the discussion on "Energy Investments"
in Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations contained herein.
ENVIRONMENTAL MATTERS OVERVIEW
KeySpan's ordinary business operations subject it to regulation in accordance
with various federal, state and local laws, rules and regulations dealing with
the environment, including air, water, and hazardous substances. These
requirements govern both our normal, ongoing operations and the remediation of
impacted properties historically used in utility operations. Potential liability
associated with our historical operations may be imposed without regard to
fault, even if the activities were lawful at the time they occurred.
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Except as set forth below, or in Note 7 to the Consolidated Financial Statements
"Contractual Obligations and Contingencies - Environmental Matters," no material
proceedings relating to environmental matters have been commenced or, to our
knowledge, are contemplated by any federal, state or local agency against
KeySpan, and we are not a defendant in any material litigation with respect to
any matter relating to the protection of the environment. We believe that our
operations are in substantial compliance with environmental laws and that
requirements imposed by existing environmental laws are not likely to have a
material adverse impact upon us. We are also pursuing claims against insurance
carriers and potentially responsible parties which seek the recovery of certain
environmental costs associated with the investigation and remediation of
contaminated properties. We believe that investigation and remediation costs
prudently incurred at facilities associated with utility operations, not
recoverable through insurance or some other means, will be recoverable from our
customers in accordance with the terms of our rate recovery agreements for each
regulated subsidiary.
Air. The Federal Clean Air Act ("CAA") provides for the regulation of a variety
of air emissions from new and existing electric generating plants. Final, five
year renewable permits in accordance with the requirements of Title V of the
1990 amendments to the CAA have been issued for all of our electric generating
facilities except that renewal applications were submitted in a timely manner in
2006 for the Ravenswood Expansion and Far Rockaway generating station. Renewal
permits are expected to be issued in 2007. The existing permits and timely
renewal applications allow our electric generating plants to continue to operate
without any additional significant expenditures, except as described below.
Our generating facilities are located within a CAA ozone non-attainment and PM
2.5 (fine particulate matter) non-attainment area, and are subject to
increasingly stringent NOx emission limitations to be implemented under
forthcoming requirements of the United States Environmental Protection Agency
("EPA") pursuant to the Clean Air Interstate Rule ("CAIR") and potentially under
the Ozone Transport Commission's "CAIR PLUS" program. These efforts are designed
to improve both ozone and particulate matter air quality. Our previous
investments in low NOX boiler combustion modifications, the use of natural gas
firing systems at our steam electric generating stations, and the compliance
flexibility available under these cap and trade programs, have enabled KeySpan
to achieve our prior emission reductions in a cost-effective manner. KeySpan is
currently developing its compliance strategy to address the anticipated
requirements of CAIR and CAIR PLUS by 2009. At the present time, it is
anticipated that NOx control equipment may be required at one or more of
KeySpan's Long Island facilities at a cost of between $20 to $30 million.
However, such amounts are recoverable from LIPA.
In 2003, New York State promulgated regulations which establish separate NOX and
SO2 emission reduction requirements on electric generating facilities in New
York State, which commenced in late 2004 for NOX emissions and in 2005 for SO2
emissions. KeySpan's facilities have been able to comply with the NOX
requirements without material additional capital expenditures because of
previously installed emissions control equipment and gas combustion capability.
SO2 compliance was achieved through a reduction in the sulfur content of the
fuel oil used in our Northport and Port Jefferson facilities. Further reduction
in SO2 emissions expected to be required in 2008 will be achieved either through
reliance on natural gas or lower sulfur oil fuel.
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In 2004, the EPA issued regulations that require reductions, on a national
basis, of mercury emissions from electric generating facilities. The mercury
regulations have no impact on KeySpan facilities since their application is
limited to coal-fired plants. EPA determined that nickel emissions from oil
fired plants do not pose health risks that require regulation. This
determination has been challenged and litigation is pending. Until a final
outcome is obtained, the nature and extent of the financial impact on KeySpan
from nickel regulation, if any, cannot be determined.
KeySpan recognizes the growing concern about greenhouse gas emissions and their
contribution to global climate change. Our investments in additional natural gas
firing capability have resulted in approximately a 15% reduction in carbon
dioxide emissions since 1990, while the electric generation industry as a whole
increased carbon dioxide emissions by more than 25%. The addition of the
efficient, combined cycle unit which began operation at the Ravenswood
Generating Station in 2004 has further reduced average KeySpan CO2 emission
rates.
In 2003, the Governor of New York initiated a Regional Greenhouse Gas Initiative
("RGGI") that seeks to establish a coordinated multi-state plan to reduce
greenhouse gas emissions (primarily carbon dioxide ("CO2") from electric
generating emission sources in the Northeast. In December of 2005, seven
northeast states, including New York, issued a memorandum of understanding
("MOU") capping CO2 emissions from electric generating facilities beginning in
2009 and, beginning in 2015, gradually requiring a 10 percent reduction in
regional emissions by 2018. Each of the states will be promulgating individual
state rules to implement the MOU. Several congressional initiatives under
consideration may also require greenhouse gas reductions from electric
generating facilities nationwide. At the present time it is not possible to
predict the nature of the requirements which ultimately will be imposed on
KeySpan, nor what, if any, financial impact such requirements would have on
KeySpan electric generation facilities. However, KeySpan believes that the
ability of its major generating facilities to burn low CO2 emitting natural gas
positions them for future compliance requirements better than plants which burn
exclusively coal or oil. Additionally, KeySpan believes that the relatively low
greenhouse gas emissions associated with the commercial and residential use of
natural gas may present business opportunities for further growth of its gas
business.
Water. The Federal Clean Water Act provides for effluent limitations, to be
implemented by a permit system, to regulate the discharge of pollutants into
United States waters. We possess permits for our generating units which
authorize discharges from cooling water circulating systems and chemical
treatment systems. These permits are renewed from time to time, as required by
regulation. Additional capital expenditures associated with the renewal of the
surface water discharge permits for our power plants will likely be required by
the New York State Department of Environmental Conservation ("NYSDEC"). We
continue to conduct studies as directed by the NYSDEC to determine the impacts
of our discharges on aquatic resources and are engaged in discussions with the
NYSDEC regarding the nature of capital upgrades or other mitigation measures
necessary to reduce any impacts. It is difficult to predict with any certainty
the costs of such capital investments, but these upgrades are expected to cost
up to $60 million. However, such amounts are recoverable from LIPA. The
Ravenswood Generating Station may also require upgrades at a cost of up to $15
million. The actual expenditures will depend upon the outcome of the ongoing
studies and the subsequent determination by the NYSDEC of how to apply the
standards set forth in recently promulgated federal regulations under Section
316 of the Clean Water Act designed to mitigate such impacts.
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Land. The Federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980 and certain similar state laws (collectively "Superfund")
impose liability, regardless of fault, upon generators of hazardous substances
even before Superfund was enacted for costs associated with investigating and
remediating contaminated property. In the course of our business operations, we
generate materials which, after disposal, may become subject to Superfund. From
time to time, we have received notices under Superfund concerning possible
claims with respect to sites where hazardous substances generated by KeySpan or
its predecessors and other potentially responsible parties were allegedly
disposed. Normally, the costs associated with such claims are allocated among
the potentially responsible parties on a pro rata basis. Superfund does,
however, provide for joint and several liability against a single potentially
responsible party. In the unlikely event that Superfund claims were pursued
against us on that basis, the costs may be material to our financial condition,
results of operations or cash flows.
KeySpan has identified certain MGP sites which were historically owned or
operated by its subsidiaries (or such companies' predecessors). Operations at
these sites between the mid-1800s to mid-1900s may have resulted in the release
of hazardous substances. For a discussion on our MGP sites and further
information concerning environmental matters, see Note 7 to the Consolidated
Financial Statements, "Contractual Obligations and Contingencies - Environmental
Matters."
COMPETITION, REGULATION AND RATE MATTERS
Competition. Over the last several years, the natural gas and electric
industries have undergone significant change as market forces moved towards
replacing or supplementing rate regulation through the introduction of
competition. A significant number of natural gas and electric utilities reacted
to the changing structure of the energy industry by entering into business
combinations, with the goal of reducing common costs, gaining size to better
withstand competitive pressures and business cycles, and attaining synergies
from the combination of operations. We engaged in two such combinations, the
KeySpan/LILCO transaction in 1998 and our November 2000 acquisition of Eastern
and EnergyNorth and are anticipating the consummation of the Merger with
National Grid plc.
The Ravenswood Generating Station, the merchant plant in our Electric Services
segment, is subject to competitive and other risks that could adversely impact
the market price for the plant's output. Such risks include, but are not limited
to, the construction of new generation or transmission capacity serving the New
York City market.
Regulation. Public utility holding companies, like KeySpan, are now regulated by
the FERC pursuant to PUHCA 2005 and to some extent by state utility commissions
through the regulation of certain affiliate transactions. Our utility
subsidiaries are subject to extensive federal and state regulation by FERC and
state utility commissions. In general, state public utility commissions, such as
the New York Public Service Commission ("NYPSC"), the MADTE and the New
Hampshire Public Utilities Commission ("NHPUC") regulate the provision of retail
23
services, including the distribution and sale of natural gas and electricity to
consumers. Each of the federal and state regulators also regulates certain
transactions among our affiliates. FERC also regulates interstate natural gas
transportation and electric transmission, and has jurisdiction over certain
wholesale natural gas sales and wholesale electric sales.
In addition, our non-utility subsidiaries are subject to a wide variety of
federal, state and local laws, rules and regulations with respect to their
business activities, including but not limited to those affecting public sector
projects, environmental and labor laws and regulations, and state licensing
requirements.
State Utility Commissions. As noted above, our regulated gas distribution
utility subsidiaries are subject to regulation by the NYPSC, MADTE and NHPUC.
The NYPSC regulates KEDNY and KEDLI. Although KeySpan is not regulated by the
NYPSC, it is impacted by conditions that were included in the NYPSC order
authorizing the 1998 KeySpan/LILCO transaction. Those conditions address, among
other things, the manner in which KeySpan, its service company subsidiaries and
its unregulated subsidiaries may interact with KEDNY and KEDLI. The NYPSC also
regulates the safety, reliability and certain financial transactions of our Long
Island generating facilities and our Ravenswood Generating Station under a
lightened regulatory standard. Our KEDNE subsidiaries and to some extent our
service companies are also subject to regulation by the MADTE and NHPUC.
Securities and Exchange Commission. As a result of the acquisition of Eastern
and EnergyNorth, we became a holding company under PUHCA 1935. The Energy Act
repealed PUHCA 1935 and replaced it with PUHCA 2005 effective February 8, 2006.
Whereas our corporate and financial activities and those of our subsidiaries had
been subject to regulation by the SEC, FERC now has jurisdiction over certain of
our holding company activities. However, the SEC continues to have jurisdiction
over the registration and issuance of our securities under the federal
securities laws.
Under our holding company structure, we have no independent operations or source
of income of our own and conduct substantially all of our operations through our
subsidiaries and, as a result, we depend on the earnings and cash flow of, and
dividends or distributions from, our subsidiaries to provide the funds necessary
to meet our debt and contractual obligations and to pay dividends to our
shareholders. Furthermore, a substantial portion of our consolidated assets,
earnings and cash flow is derived from the operations of our regulated utility
subsidiaries, whose legal authority to pay dividends or make other distributions
to us is subject to regulation by state regulatory authorities.
In addition, KeySpan operates three mutual service companies: KeySpan Corporate
Services LLC ("KCS"), KeySpan Utility Services LLC ("KUS") and KeySpan
Engineering & Survey, Inc. ("KENG"). These companies operate to provide various
services to KeySpan subsidiaries, including regulated utility companies and
LIPA, at cost fairly and equitably allocated among them. The regulation of our
three service companies has also been transferred to FERC under PUHCA 2005.
24
Federal Energy Regulatory Commission. FERC 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. In addition to its new authority pursuant to PUHCA 2005, FERC also
regulates the sale of electricity at wholesale and the transmission of
electricity in interstate commerce as well as certain corporate and financial
activities of companies that are engaged in such activities. The Long Island
generating facilities and the Ravenswood Generating Station are subject to FERC
regulation based on their wholesale energy transactions.
Our Ravenswood Generating Station's rates are based on a market-based rate
application approved by FERC. The rates that our Ravenswood Generating Station
may charge are subject to FERC mandated mitigation measures due to market power
issues. The mitigation measures are administered by the NYISO. FERC retains the
ability in future proceedings, either on its own motion or upon a complaint
filed with FERC, to modify the Ravenswood Generating Station's rates, as well as
the mitigation measures, if FERC concludes that it is in the public interest to
do so.
KeySpan currently offers and sells the energy, capacity and ancillary services
from the Ravenswood Generating Station through the energy market operated by the
NYISO. For information concerning the NYISO, see Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operation - "Regulatory
Issues and Competitive Environment."
FERC also has jurisdiction to regulate certain natural gas sales for resale in
interstate commerce, the transportation of natural gas in interstate commerce
and, unless an exemption applies, companies engaged in such activities. The
natural gas distribution activities of KEDNY, KEDLI, KEDNE and certain related
intrastate gas transportation functions are not subject to FERC jurisdiction.
However, to the extent that KEDNY, KEDLI or KEDNE purchases or sells gas for
resale in interstate commerce, such transactions are subject to FERC
jurisdiction and have been authorized by FERC. Our interests in Iroquois,
Honeoye, Steuben and KeySpan LNG are also fully regulated by FERC as natural gas
companies.
EMPLOYEE MATTERS
As of December 31, 2006, KeySpan and its wholly-owned subsidiaries had
approximately 9,594 employees. Of that total, approximately 6,168 employees are
covered under collective bargaining agreements. KeySpan has not experienced any
work stoppage during the past five years and considers its relationship with
employees, including those covered by collective bargaining agreements, to be
good.
ITEM 1A. RISK FACTORS
Certain statements contained in this Annual Report on Form 10-K 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
25
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Without limiting the foregoing, all statements under the captions "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Item 7A. Quantitative and Qualitative Disclosures About Market
Risk" relating to our future outlook, anticipated capital expenditures, future
cash flows and borrowings, pursuit of potential 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. The risks, uncertainties and factors that could cause actual
results to differ materially include but are not limited to the following:
We are a Holding Company, and Our Subsidiaries are Subject to State Regulation
Which Limits Their Ability to Pay Dividends and Make Distributions to Us
We are a holding company with no business operations or sources of income
of our own. We conduct all of our operations through our subsidiaries and
depend on the earnings and cash flow of, and dividends or distributions
from, our subsidiaries to provide the funds necessary to meet our debt and
contractual obligations and to pay dividends on our common stock.
In addition, a substantial portion of our consolidated assets, earnings and
cash flow is derived from the operation of our regulated utility
subsidiaries, whose legal authority to pay dividends or make other
distributions to us is subject to regulation by the utility regulatory
commissions of New York, Massachusetts and New Hampshire. Pursuant to NYPSC
orders, the ability of KEDNY and KEDLI to pay dividends to us is
conditioned upon their maintenance of a utility capital structure with debt
not exceeding 55% and 58%, respectively, of total utility capitalization.
In addition, the level of dividends paid by both utilities may not be
increased from current levels if a 40 basis point penalty is incurred under
a customer service performance program. At the end of KEDNY's and KEDLI's
rate years (September 30, 2006 and November 30, 2006, respectively), their
ratios of debt to total utility capitalization were in compliance with the
ratios set forth above and we have incurred no penalties under the
outstanding customer service performance program.
Our Gas Distribution and Electric Services Businesses May Be Adversely Affected
by Changes in Federal and State Regulation
The regulatory environment applicable to our gas distribution and our
electric services businesses has undergone substantial changes in recent
years, on both the federal and state levels. These changes have
significantly affected the nature of the gas and electric utility and power
industries and the manner in which their participants conduct their
businesses. Moreover, existing statutes and regulations may be revised or
reinterpreted, new laws and regulations may be adopted or become applicable
to us or our facilities and future changes in laws and regulations may
affect our gas distribution and our electric services businesses in ways
that we cannot predict.
In addition, our operations are subject to extensive government regulation
and require numerous permits, approvals and certificates from various
federal, state and local governmental agencies. A significant portion of
our revenues in our Gas Distribution and Electric Services segments are
26
directly dependent on rates established by federal or state regulatory
authorities, and any change in these rates and regulatory structure could
significantly impact our financial results. Increases in utility costs
other than gas, not otherwise offset by increases in revenues or reductions
in other expenses, could have an adverse effect on earnings due to the time
lag associated with obtaining regulatory approval to recover such increased
costs and expenses in rates. Various rulemaking proposals and market design
revisions related to the wholesale power market are being reviewed at the
federal level. These proposals, as well as legislative and other attention
to the electric power industry could have a material adverse effect on our
strategies and results of operations for our electric services business and
our financial condition. In particular, we sell capacity, energy and
ancillary services from our Ravenswood Generating Station facility into the
New York Independent System Operator, or NYISO, energy market at
market-based rates, subject to mitigation measures approved by the FERC.
The pricing for capacity, energy sales and ancillary services in to the
NYISO market is still evolving and some of the FERC's price mitigation
measures are subject to rehearing and possible judicial review, as well as
revision in response to market participant complaints or NYISO requests.
Our Risk Mitigation Techniques Such as Hedging and Purchase of Insurance May Not
Adequately Provide Protection
To mitigate our financial exposure related to commodity price fluctuations,
KeySpan routinely enters into contracts to hedge a portion of our purchase
and sale commitments, weather fluctuations, electricity sales, natural gas
supply and other commodities. However, we do not always cover the entire
exposure of our assets or our positions to market price volatility and the
coverage will vary over time. To the extent we have unhedged positions or
our hedging strategies do not work as planned, fluctuating commodity prices
could cause our sales and net income to be volatile.
In addition, our business is subject to many hazards from which our
insurance may not adequately provide coverage. An unexpected outage at our
Ravenswood Generating Station, especially in the significant summer period,
could materially impact our financial results. Damage to pipelines,
equipment, properties and people caused by natural disasters, accidents,
terrorism or other damage by third parties could exceed our insurance
coverage. Although we do have insurance to protect against many of these
contingent liabilities, this insurance is capped at certain levels, has
self-insured retentions and does not provide coverage for all liabilities.
SEC Rules for Exploration and Production Companies May Require Us to Recognize a
Non-Cash Impairment Charge at the End of Our Reporting Periods
Our investments in natural gas and oil consist of our ownership of KeySpan
Exploration and Production and Seneca-Upshur. We use the full cost method
for KeySpan Exploration and Production and Seneca-Upshur. Under the full
cost method, all costs of acquisition, exploration and development of
natural gas and oil reserves are capitalized into a full cost pool as
incurred, and properties in the pool are depleted and charged to operations
using the unit-of-production method based on production and proved reserve
quantities. To the extent that these capitalized costs, net of accumulated
depletion, less deferred taxes exceed the present value (using a 10%
discount rate) of estimated future net cash flows from proved natural gas
27
and oil reserves and the lower of cost or fair value of unproved
properties, those excess costs are charged to operations. If a write-down
is required, it would result in a charge to earnings but would not have an
impact on cash flows. Once incurred, an impairment of gas properties is not
reversible at a later date, even if gas prices increase.
Our Operating Results May Fluctuate on a Seasonal and Quarterly Basis
Our gas distribution business is a seasonal business and is subject to
weather conditions. We receive most of our gas distribution revenues in the
first and fourth quarters, when demand for natural gas increases due to
colder weather conditions. As a result, we are subject to seasonal
variations in working capital because we purchase natural gas supplies for
storage in the second and third quarters and must finance these purchases.
Accordingly, our results of operations fluctuate substantially on a
seasonal basis. In addition, our New England-based gas distribution
subsidiaries do not have weather normalization tariffs, as we do in New
York. In addition, portions of our Electric Service business are seasonal
and subject to weather and market conditions. The majority of the capacity
revenue associated with the Ravenswood Generating Station facility is
realized during the six months between May and October of each year. Energy
and ancillary service sales from our Ravenswood Generating Station facility
are directly correlated to the demand for electricity and competition from
other resources. Typically, the demand and price for electricity increases
during extreme temperature conditions. However, depending on the
availability of alternative competitive supply, extreme temperature
conditions may not result in increased revenue. As a result, fluctuations
in weather and competitive supply between years may have a significant
effect on our results of operations for these subsidiaries; both gas and
electric.
A Substantial Portion Of Our Revenues Are Derived From Our Agreements With LIPA
And No Assurances Can Be Made That These Arrangements Will Not Be Discontinued
At Some Point In The Future Or That The New Agreements Will Become Effective
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. On February 1, 2006, KeySpan and LIPA
entered into amended and restated agreements whereby KeySpan will continue
to operate and maintain the electric T&D System owned by LIPA on Long
Island. The parties also entered into the 2006 Option Agreement, where LIPA
had the right to acquire two of our facilities, our Far Rockaway and/or
E.F. Barrett Generating Stations during the period January 1, 2006 to
December 31, 2006. On December 13, 2006, KeySpan and LIPA entered into an
amendment to the 2006 Option Agreement whereby the parties agreed to extend
the expiration of the option period to the later of (i) December 31, 2007
or (ii) 180 days following the effective date of the Option Agreement.
Additionally, the new agreements resolve many outstanding issues between
the parties regarding the current LIPA Agreements and provide new pricing
and extensions of the Agreements. There is a risk that these agreements
will not receive the necessary governmental approvals, which are pending,
and the effectiveness of each of the 2006 LIPA Agreements and the amendment
to the 2006 Option Agreement is conditioned upon all of the 2006 LIPA
Agreements becoming effective. If the 2006 LIPA Agreements do not become
effective, there is uncertainty as to whether LIPA will exercise their
option under the GPRA and the status of the resolution of the various
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disputes between KeySpan and LIPA. At this point in time, KeySpan is unable
to estimate what the impact would be to its results of operations,
financial position and cash flows if the 2006 LIPA Agreements do not become
fully effective.
A Decline or an Otherwise Negative Change in the Ratings or Outlook on Our
Securities Could Have a Materially Adverse Impact on Our Ability to Secure
Additional Financing on Favorable Terms
The credit rating agencies that rate our debt securities regularly review
our financial condition and results of operations. We can provide no
assurances that the ratings or outlook on our debt securities will not be
reduced or otherwise negatively changed. A negative change in the ratings
or outlook on our debt securities could have a materially adverse impact on
our ability to secure additional financing on favorable terms.
Our Costs of Compliance with Environmental Laws are Significant, and the Cost of
Compliance with Future Environmental Laws Could Adversely Affect Us
Our operations are subject to extensive federal, state and local
environmental laws and regulations relating to air quality, water quality,
waste management, natural resources and the health and safety of our
employees. These environmental laws and regulations expose us to costs and
liabilities relating to our operations and our current and formerly owned
properties. Compliance with these legal requirements requires us to commit
significant capital toward environmental monitoring, installation of
pollution control equipment and permits at our facilities. Costs of
compliance with environmental regulations, and in particular emission
regulations, could have a material impact on our Electric Services segment
and our results of operations and financial position, especially if
emission limits are tightened, more extensive permitting requirements are
imposed, additional substances become regulated or the number and type of
electric generating plants we operate increase.
In addition, we are responsible for the clean-up of contamination at
certain MGP sites and at other sites and are aware of additional MGP sites
where we may have responsibility for clean-up costs. While our gas utility
subsidiaries' rate plans generally allow for the full recovery of the costs
of investigation and remediation of most of our MGP sites, these rate
recovery mechanisms may change in the future. To the extent rate recovery
mechanisms change in the future, or if additional environmental matters
arise in the future at our currently or historically owned facilities, at
sites we may acquire in the future or at third-party waste disposal sites,
costs associated with investigating and remediating these sites could have
a material adverse effect on our results of operations, cash flows and
financial condition.
Our Businesses are Subject to Competition and General Economic Conditions
Impacting Demand for Services
The Ravenswood Facility and Ravenswood Expansion are subject to competition
that could adversely impact the market price for the capacity, energy and
ancillary services they sell. In addition, if new generation and/or
transmission facilities are constructed, and/or the availability of our
Ravenswood Generating Station deteriorates, then the quantities of capacity
and energy sales could be adversely affected. We cannot predict, however,
29
when or if new power plants or transmission facilities will be built or the
nature of the future New York City capacity and energy requirements.
Competition facing our unregulated Energy Services businesses, including
but not limited to competition from other heating, ventilation and air
conditioning, and engineering companies, as well as other utilities and
utility holding companies that are permitted to engage in such activities,
could adversely impact our financial results and the value of those
businesses, resulting in decreased earnings as well as write-downs of the
carrying value of those businesses.
Our Gas Distribution segment faces competition with distributors of
alternative fuels and forms of energy, including fuel oil and propane. Our
ability to continue to add new gas distribution customers may significantly
impact financial results. The gas distribution industry has experienced a
decrease in consumption per customer over time, partially due to increased
efficiency of customers' appliances, economic factors and price elasticity.
In addition, our Gas Distribution segment's future growth is dependent upon
the ability to add new customers to our system in a cost-effective manner.
While our Long Island and New England utilities have significant growth
potential, we cannot be sure new customers will continue to offset the
decrease in consumption of our existing customer base. There are a number
of factors outside of our control that impact customer conversions from an
alternative fuel to gas, including general economic factors impacting
customers' willingness to invest in new gas equipment.
Risk Associated with our Financial Swap Agreement for In-City Unforced Capacity
KeySpan believes that the New York City market represents a strong capacity
market due to, among other things, its local reliability rules, increasing
demand and the time required for new resources to be constructed. KeySpan
anticipates that demand will increase and that the high cost to construct
capacity in New York City will result in favorable In-City Unforced
Capacity prices. Therefore, KeySpan entered into an ISDA Master Agreement
for a fixed for floating unforced capacity financial swap for a notional
quantity of 1,800,000kW at the Fixed Price is $7.57/kW-month. If the demand
is less than KeySpan's estimates, additional resources enter the market, or
costs are less than forecast, In-City Unforced Capacity prices could be on
average less than the Fixed Price resulting in a loss to KeySpan, which
under certain circumstances could be material.
Labor Disruptions at Our Facilities Could Adversely Affect Our Results of
Operations and Cash Flow
Approximately 6,168 employees, or 64% of our employees, are represented by
unions through various collective bargaining agreements that expire between
2007 and 2011. The bargaining agreements expiring in 2007 affect
approximately 5% of the unionized workforce; 230 employees who work for
KeySpan Home Energy Services in New York and another 70 employees at KEDNE
in Cape Cod, Massachusetts. KeySpan is currently engaging in discussions
with these unions for new collective bargaining agreements. It is possible
that our employees may seek an increase in wages and benefits at the
expiration of these agreements, and that we may be unable to negotiate new
agreements without labor disruption.
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Counterparties to Our Transactions May Fail to Perform their Obligations, Which
Could Harm Our Results of Operations
Our operations are exposed to the risk that counterparties to our
transactions that owe us money or supplies will not perform their
obligations. Should the counterparties to arrangements with us fail to
perform, we might be forced to enter into alternative hedging arrangements
or honor our underlying commitment at then-current market prices that may
exceed our contractual prices. In such event, we might incur additional
losses to the extent of amounts, if any, already paid to counterparties.
This risk is most significant where we have concentrations of receivables
from natural gas and electric utilities and their affiliates, as well as
industrial customers and marketers throughout the Northeastern United
States.
We Are Exposed to Risks That Are Beyond Our Control
The cost of repairing damage to our operating subsidiaries' facilities and
the potential disruption of their operations or supplier operations due to
storms, natural disasters, wars, terrorist acts and other catastrophic
events could be substantial. The occurrence or risk of occurrence of future
terrorist attacks or related acts of war may lead to increased political,
economic and financial market instability and volatility in prices for
natural gas which could materially adversely affect us in ways we cannot
predict at this time. A lower level of economic activity for these or other
reasons could result in a decline in energy consumption, which could
adversely affect our net revenues.
The Long-Term Financial Condition of Our Gas Distribution Business Depends on
the Continued Availability of Natural Gas Reserves
The development of additional natural gas reserves requires significant
capital expenditures by others for exploring, drilling and installing
production, gathering, storage, transportation and other facilities that
permit natural gas to be produced and delivered to our distribution
systems. Low prices for natural gas, regulatory restrictions, or the lack
of available capital for these projects could adversely affect the
development of additional natural gas reserves. Additional natural gas
reserves may not be developed in sufficient amounts to fill the capacities
of our distribution systems, thus limiting our prospects for long-term
growth.
Gathering, Processing and Transporting Activities Involve Numerous Risks that
May Result in Accidents and Other Operating Risks and Costs
Our gas distribution facilities pose a variety of hazards and operating
risks, such as leaks, explosions and mechanical problems caused by natural
disasters, accidents, terrorism or other damage by third parties, which
could cause substantial financial losses. In addition to impairing our
operations, these risks could also result in loss of human life and
environmental pollution. In accordance with standard industry practice, we
maintain insurance against some, but not all, of these potential risks and
losses. The occurrence of any of these events not fully covered by
insurance could have a material adverse effect on our financial position
and results of operations.
31
Additional risks, uncertainties and factors that could cause actual results to
differ materially include, but are not limited to, the following:
- - the occurrence of any event, change or other circumstances that could give
rise to the termination of the Merger Agreement with National Grid plc or
the failure of the Merger to close for any reason;
- - volatility of fuel prices used to generate electricity;
- - fluctuations in weather and in gas and electric prices;
- - general economic conditions, especially in the Northeast United States;
- - our ability to successfully manage our cost structure and operate
efficiently;
- - our ability to successfully contract for natural gas supplies required to
meet the needs of our customers;
- - implementation of new accounting standards or changes in accounting
standards or Generally Accepted Accounting Principles 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 and state regulatory policies affecting our ability to retain and
operate such business ventures profitably;
- - a change in the fair market 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 LIPA and the NYISO, our two largest
customers;
32
- - changes in the unforced capacity financial swap pricing structure;
- - receipt of approval for, and the timing thereof, the 2006 LIPA Agreements;
and
- - other risks detailed from time to time in other reports and other documents
filed by KeySpan with the SEC
For any of these statements, KeySpan claims the protection of the safe harbor
for forward-looking information contained in the Private Securities Litigation
Reform Act of 1995, as amended. For additional discussion on these risks,
uncertainties and assumptions, see Item 1. "Description of the Business," Item
2. "Properties," Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Item 7A. "Quantitative and Qualitative
Disclosures About Market Risk" contained herein.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Information with respect to KeySpan's material properties used in the conduct of
its business is set forth in, or incorporated by reference in, Item 1 hereof.
Except where otherwise specified, all such properties are owned or, in the case
of certain rights-of-way, used in the conduct of its gas distribution business,
held pursuant to municipal consents, easements or long-term leases, and in the
case of gas and oil properties, held under long-term mineral leases. In addition
to the information set forth therein with respect to properties utilized by each
business segment, KeySpan leases the executive headquarters located in Brooklyn,
New York. In addition, we lease other office and building space, office
equipment, vehicles and power operated equipment. Our properties are adequate
and suitable to meet our current and expected business requirements. Moreover,
their productive capacity and utilization meet our needs for the foreseeable
future. KeySpan continually examines its real property and other property for
its contribution and relevance to our businesses and when such properties are no
longer productive or suitable, they are disposed of as promptly as possible. In
the case of leased office space, we anticipate no significant difficulty in
leasing alternative space at reasonable rates in the event of the expiration,
cancellation or termination of a lease.
ITEM 3. LEGAL PROCEEDINGS
See Note 7 to the Consolidated Financial Statements, "Contractual Obligations
and Contingencies - Legal Matters."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders during the last
quarter of the 12 months ended December 31, 2006.
33
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
KeySpan's common stock is listed and traded on the New York Stock Exchange under
the symbol "KSE." As of February 20, 2007, there were approximately 64,664
registered record holders of KeySpan's common stock. In the fourth quarter of
2006 KeySpan increased its dividend to an annual rate of $1.90 per common share
beginning with the quarterly dividend to be paid in February 2007. Our dividend
framework is reviewed annually by the Board of Directors. The amount and timing
of all dividend payments is subject to the discretion of the Board of Directors
and will depend upon business conditions, results of operations, financial
conditions and other factors. Based on currently foreseeable market conditions,
we intend to maintain the annual dividend approximately at the $1.90 level to be
paid on a quarterly basis at a rate of approximately $0.475. KeySpan's scheduled
dividend payment dates are February 1, May 1, August 1 and November 1, or the
next business day, if such date is not a business day.
The following table sets forth, for the quarters indicated, the high and low
sales prices and dividends declared per share for the periods indicated:
2006 High Low Dividends per Share
-----------------------------------------------------------------------------
First Quarter $41.52 $35.38 $0.465
Second Quarter $41.10 $39.68 $0.465
Third Quarter $41.42 $39.95 $0.465
Fourth Quarter $41.36 $40.40 $0.465
2005 High Low Dividends per Share
-----------------------------------------------------------------------------
First Quarter $40.90 $38.04 $0.455
Second Quarter $40.88 $36.83 $0.455
Third Quarter $41.03 $36.35 $0.455
Fourth Quarter $37.10 $32.66 $0.455
34
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth securities authorized for issuance under equity
compensation plans for the year ended December 31, 2006:
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
Number of securities
Number of securities remaining available for
to be issued upon Weighted-average future issuance under
exercise of outstanding exercise price of equity compensation plans
options, warrants and outstanding options, (excluding securities
Plan category rights warrants and rights reflected in column (a)
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
(a) (b) (c)
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
Equity compensation plans
approved by security holders
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
KeySpan Long Term
Incentive Compensation Plan
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
Stock Options 9,403,104 $33.82 -
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
Restricted Stock 175,414 N/A -
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
Performance Shares 512,176 (1) N/A -
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
Equity compensation plans not
approved by security holders N/A N/A N/A
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
Total (2) $33.82 3,036,898 (3)
- --------------------------------------- ------------------------------- ------------------------------ -----------------------------
(1) Performance shares shown at target, or 100% payout.
(2) Includes grants of options, restricted stock, and performance shares
pursuant to KeySpan's Long-Term Incentive Compensation Plan, as amended,
and options granted pursuant to the Brooklyn Union Long-Term Incentive
Compensation Plan, the Eastern Enterprises 1995 Stock Option Plan and the
Eastern Enterprises 1996 Non-Employee Trustee's Stock Option Plan.
(3) This total amount reflects the aggregate number of stock options,
restricted stock and performance shares available for issuance pursuant to
KeySpan's Long-Term Incentive Compensation Plan.
See Item 11. Executive Compensation for more information on the equity
compensation plans.
35
PERFORMANCE GRAPH
The following graph presents, for the period beginning December 31, 2001 through
December 31, 2006, a comparison of cumulative total shareholder returns for
KeySpan, the Standard & Poor's Utilities Index and the Standard & Poor's 500
Index.
[GRAPHIC OMITTED]
December 31, 2001 December 31, 2002 December 31, 2003
----------------- ----------------- -----------------
KeySpan $100.00 $106.89 $117.43
S&P Utility Index $100.00 $70.06 $88.27
S&P 500 Index $100.00 $77.05 $100.27
December 31, 2004 December 31, 2005 December 31, 2006
----------------- ----------------- -----------------
KeySpan $131.83 $125.09 $151.01
S&P Utility Index $109.57 $127.89 $154.70
S&P 500 Index $111.15 $116.59 $134.96
Assumes $100 invested on December 31, 2001 in shares of KeySpan Common Stock,
the S&P Utilities Index and the S&P 500 Index, and that all dividends were
reinvested.
36
ITEM 6. SELECTED FINANCIAL DATA
- ----------------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars, Year Ended December 31,
Except Per Share Amounts) 2006 2005 2004 2003 2002
- --------------------------------------------- --------------- ---------------- ---------------- ----------------- ----------------
Income Summary
Revenues
Gas Distribution $ 5,062.6 $ 5,390.1 $ 4,407.3 $ 4,161.3 $ 3,163.8
Electric Services 1,880.6 2,042.8 1,738.7 1,606.0 1,645.7
Energy Services 203.4 191.2 182.4 158.9 208.6
Energy Investments 35.0 37.9 322.1 609.3 447.1
--------------- ---------------- ---------------- ----------------- ----------------
Total revenues 7,181.6 7,662.0 6,650.5 6,535.5 5,465.2
--------------- ---------------- ---------------- ----------------- ----------------
Operating expenses
Purchased gas for resale 3,331.5 3,597.3 2,664.5 2,495.1 1,653.3
Fuel and purchased power 548.6 752.1 540.3 414.6 395.9
Operations and maintenance 1,680.0 1,617.9 1,567.0 1,622.6 1,631.3
Depreciation, depletion and
amortization 397.5 396.5 551.8 571.7 513.7
Operating taxes 411.2 407.1 404.2 418.2 380.5
Impairment Charges - - 41.0 - -
--------------- ---------------- ---------------- ----------------- ----------------
Total operating expenses 6,368.8 6,770.9 5,768.8 5,522.2 4,574.7
--------------- ---------------- ---------------- ----------------- ----------------
Gain on sale of property 1.6 1.6 7.0 15.1 4.7
Income from equity investments 13.1 15.1 46.5 19.2 14.1
--------------- ---------------- ---------------- ----------------- ----------------
Operating income 827.5 907.8 935.3 1,047.6 909.3
Other income and (deductions) (217.8) (269.9) 4.9 (340.3) (301.4)
Income taxes 175.5 239.3 325.5 281.3 229.6
--------------- ---------------- ---------------- ----------------- ----------------
Earnings from continuing operations 434.2 398.6 614.7 426.0 378.3
--------------- ---------------- ---------------- ----------------- ----------------
Discontinued Operations
Income (loss) from operations,
net of tax - (4.1) (79.0) (1.9) 15.7
Loss on disposal, net of tax - 2.3 (72.0) - (16.3)
--------------- ---------------- ---------------- ----------------- ----------------
Loss from discontinued operations - (1.8) (151.0) (1.9) (0.6)
Cumulative change in accounting
principles - (6.6) - (37.4) -
--------------- ---------------- ---------------- ----------------- ----------------
Net income 434.2 390.2 463.7 386.7 377.7
Preferred stock dividend requirements - 2.2 5.6 5.8 5.8
--------------- ---------------- ---------------- ----------------- ----------------
Earnings for common stock $ 434.2 $ 388.0 $ 458.1 $ 380.9 $ 371.9
=============== ================ ================ ================= ================
Financial Summary
Earnings per share ($) 2.48 2.28 2.86 2.41 2.63
Cash dividends declared per share ($) 1.86 1.82 1.78 1.78 1.78
Book value per share, year-end ($) 25.17 25.60 24.22 22.99 20.67
Market value per share, year-end ($) 41.18 35.69 39.45 36.80 35.24
Shareholders, year-end 65,398 68,421 72,549 75,067 78,281
Capital expenditures ($) 524.0 539.5 750.3 1,009.4 1,057.5
Total assets ($) 14,437.5 13,812.6 13,364.1 14,640.2 12,980.1
Common shareholders' equity ($) 4,518.8 4,464.1 3,894.7 3,670.7 2,944.6
Preferred stock redemption required ($) - - 75.0 75.0 75.0
Preferred stock no redemption
required ($) - - - 8.6 8.8
Long-term debt ($) 4,419.1 3,920.8 4,418.7 5,610.9 5,224.1
Total capitalization ($) 8,937.9 8,384.9 8,333.2 9,365.2 8,252.5
- --------------------------------------------- --------------- ---------------- ---------------- ----------------- ----------------
37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
KeySpan Corporation (referred to herein 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 production and development; 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 to the Consolidated Financial Statements
"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 (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. Assuming
receipt of all required approvals, it is currently anticipated that the Merger
will be consummated in mid-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. See the Introduction to the Notes to the
Consolidated Financial Statements for additional information regarding the
Merger.
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
38
companies, has been transferred to the jurisdiction of the FERC pursuant to
PUHCA 2005. See the discussion under the caption "Regulation and Rate Matters"
for additional information on the Energy Act and PUHCA 2005.
EXECUTIVE SUMMARY
Below is a table comparing the more significant items impacting earnings from
continuing operations and earnings available for common stock for the periods
indicated. Management believes that this representation is necessary for a clear
understanding of the major drivers impacting comparative results for the periods
indicated.
- ---------------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars, Except per Share Amounts)
Year Ended December 31, 2006 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings E.P.S. Earnings E.P.S. Earnings E.P.S.
Earnings from continuing operations, less
preferred stock dividends $ 434.2 $ 2.48 $ 396.4 $ 2.33 $ 609.1 $ 3.80
Discontinued operations - - (1.8) (0.01) (151.0) (0.94)
Cummulative change in accounting principle - - (6.6) (0.04) - -
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings for Common Stock $ 434.2 $ 2.48 $ 388.0 $ 2.28 $ 458.1 $ 2.86
- ---------------------------------------------------------------------------------------------------------------------------------
Components of Continuing Operations:
- ---------------------------------------------------------------------------------------------------------------------------------
Core operations $ 395.9 $ 2.27 $ 403.2 $ 2.37 $ 359.4 $ 2.25
Incremental merger costs (16.7) (0.10) - - - -
Income tax settlements 55.0 0.31 - - - -
Asset sales - - - - 257.5 1.60
Non core operations - - - - 83.9 0.52
Impairment charges - - - - (62.4) (0.39)
Debt redemption costs - - (6.8) (0.04) (29.3) (0.18)
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations, less
preferred stock dividends $ 434.2 $ 2.48 $ 396.4 $ 2.33 $ 609.1 $ 3.80
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings from Continuing Operations 2006 vs 2005
KeySpan's earnings from continuing operations, less preferred stock dividends,
for the year ended December 31, 2006 were $434.2 million or $2.48 per share, an
increase of $37.8 million, or $0.15 per share compared to $396.4 million, or
$2.33 per share realized in 2005. KeySpan's financial results for the year ended
December 31, 2006, reflects the following items that had a significant impact on
comparative results: (i) incremental pre-tax Merger related costs of $27.1
million, primarily representing investment banking, legal, accounting and other
consulting fees; (ii) resolution of certain income tax issues; (iii) the impact
of cooler-than-normal summer weather and competition on KeySpan's merchant
electric generation operations; and (iv) the impact of warmer-than-normal winter
weather on KeySpan's gas distribution businesses.
39
In 2006, KeySpan resolved its dispute with the New York City Department of
Taxation and Finance with respect to income taxes relating to the operations of
its merchant electric generating facility. As a result of the favorable
settlement of this issue, KeySpan reversed a previously recorded New York City
income tax reserve of $11.9 million ($7.1 million after federal income taxes),
as well as an interest reserve of $5.9 million ($3.4 million after-tax)
established in connection with this dispute. In addition, pursuant to indemnity
obligations contained in the Long Island Lighting Company ("LILCO") / KeySpan
merger agreement of May 1998, KeySpan had been working with the Internal Revenue
Service ("IRS") to resolve certain disputes with regard to 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 (d/b/a KEDNY) tax returns for the years
ended September 30, 1997 through December 31, 1998. A settlement of the
outstanding issues was reached in 2006 and, following IRS procedure, the
settlement was submitted to the Joint Committee on Taxation on October 30, 2006
for final approval, which is expected in early 2007. Accordingly, KeySpan
reversed $44.5 million of previously established federal income tax reserves.
KeySpan's consolidated results of operations are dependent primarily on the
operating results of its Gas Distribution and Electric Services segments. As
indicated in the above table, KeySpan's earnings from its core operations
decreased $7.3 million or $0.10 per share reflecting, for the most part, lower
earnings from the Electric Services segment. The lower operating income in this
segment resulted from a decrease in net electric revenues associated with
KeySpan's merchant electric generation business, the Ravenswood Generating
Station, which was significantly impacted by the entry of competing electric
generating units into the New York City energy and capacity markets in 2006 and
by comparatively cooler weather during the 2006 summer. A substantial portion of
the yearly operating income from this business is realized during its peak
electric generating period July through September. As measured in cooling-degree
days, weather was 25% cooler during the July - September 2006 time period
compared to the same period in 2005, resulting in a comparative adverse impact
to realized electric revenues.
Operating income for 2006 from KeySpan's Gas Distribution segment remained
consistent with such earnings realized in 2005. KeySpan's gas distribution
activities are also impacted by seasonal weather fluctuations. However, certain
of KeySpan's gas distribution subsidiaries operate under utility tariffs that
contain a weather normalization adjustment that significantly offsets variations
in firm net revenues due to fluctuations in weather. Additionally, KeySpan
employs weather derivatives to mitigate the adverse impact from
warmer-than-normal weather. As measured in heating degree days, weather during
the primary heating season of 2006, January-March, was approximately 15% warmer
than the same period of 2005 throughout KeySpan's service territories.
Additionally, weather during the secondary heating season in 2006,
October-December, was approximately 20% warmer than the same period of 2005. The
benefits associated with the weather normalization adjustments and weather
derivatives, combined with significantly lower operating expenses more than
offset the adverse impact from the warm weather during the two heating seasons.
See the discussion under the caption "Review of Operating Segments" for
additional information on each operating segment.
40
In addition to the above, interest charges were lower year-over-year, due, for
the most part, to lower regulatory carrying charges. Also, income on certain
investments increased in 2006 compared to 2005.
Earnings per share in 2006 were adversely impacted by the higher level of common
shares outstanding. 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 for a full year in 2006 from this issuance, in
addition to KeySpan's employee stock purchase plans, was approximately $0.07 per
share.
Earnings Available for Common Stock 2006 vs 2005
Earnings available for common stock for 2005 also included losses from
discontinued operations associated with KeySpan's former mechanical contracting
subsidiaries; these companies were discontinued in the fourth quarter of 2004
and sold in early 2005. In the fourth quarter of 2004, KeySpan's investment in
its mechanical contracting subsidiaries was written-down to fair value. During
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 an
after-tax 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 year ended December 31, 2005.
Further, earnings available for common stock for 2005 included a $6.6 million,
or $0.04 per share, cumulative change in accounting principle charge as a result
of implementing the accounting requirements of Financial Accounting Standards
Board ("FASB") Interpretation No. 47 ("FIN 47") "Accounting for Conditional
Asset Retirement Obligations." This pronouncement required KeySpan to record a
liability for the estimated future cost associated with the legal obligation to
dispose of long-lived assets at the time of their retirement or disposal date.
Upon initial implementation, December 31, 2005, a cumulative change in
accounting principle charge was recorded on KeySpan's Consolidated Statement of
Income, representing the present value of KeySpan's future retirement
obligation. See Note 7 to the Consolidated Financial Statements "Contractual
Obligations, Financial Guarantees and Contingencies" for further information on
this charge.
Earnings from Continuing Operations 2005 vs 2004
KeySpan's earnings from continuing operations, less preferred stock dividends,
for the year ended December 31, 2005 were $396.4 million or $2.33 per share, a
decrease of $212.7 million, or $1.47 per share compared to $609.1 million, or
$3.80 per share realized in 2004. KeySpan's financial results for the year ended
December 31, 2005 and 2004 reflected the following items that had a significant
impact on comparative results: (i) earnings from core operations; (ii) asset
sales of non-core subsidiaries recorded in 2004 and their respective results for
2004; (iii) impairment charges recorded in 2004; and (iv) debt redemption
charges recorded in both 2005 and 2004.
41
As indicated in the preceding table, KeySpan's earnings from core operations
increased $43.8 million or $0.12 per share in 2005 compared to 2004, primarily
reflecting higher earnings from the Electric Services segment, improved results
from the Energy Services segment, and a decrease in interest charges. KeySpan's
electric services operations benefited from an increase in net electric revenues
principally as a result of higher electric prices that were due, in part, to the
warm weather during the 2005 summer and to the impact of two hurricanes
experienced in 2005. Lower operating losses were incurred at the Energy Services
segment as a result of lower operating expenses.
The decrease in interest expense resulted from the benefits attributable to
lower outstanding debt resulting from debt redemptions in 2004 and the first
quarter of 2005, as well as from the sale of Houston Exploration and KeySpan
Canada. These favorable results were somewhat offset by a decrease in operating
income from KeySpan's gas distribution operations as a result of higher
operating expenses, primarily due to an increase in the provision for
uncollectible accounts receivable as a result of increasing gas costs and the
adverse impact from collection experience in 2005.
The full benefit to earnings per share from the favorable operating results of
the Electric Services and Energy Services segments, as well as the decrease in
interest charges was offset by the higher level of common shares outstanding. As
noted earlier, on May 16, 2005, KeySpan issued 12.1 million shares of common
stock upon the scheduled conversion of the MEDs Equity Units. The dilutive
effect of this issuance on earnings per share for the year ended December 31,
2005, was approximately $0.12 per share.
The remaining items impacting comparative earnings from continuing operations -
asset sales, impairment charges and debt redemption charges - are discussed
below.
During 2004, KeySpan sold its remaining 55% equity interest in The Houston
Exploration Company ("Houston Exploration"), an independent natural gas and oil
exploration company based in Houston, Texas. We received cash proceeds of
approximately $758 million in two stock transactions that resulted in after-tax
gains of $222.7 million, or $1.39 per share. The first transaction occurred in
June 2004 and the second transaction was completed in November 2004. The
operations of Houston Exploration were fully consolidated in KeySpan's
Consolidated Financial Statements during the first five months of 2004, but were
then accounted for on the equity method of accounting after the first
transaction reduced our ownership interest below 50%.
Also in 2004, KeySpan sold its remaining 60.9% investment in KeySpan Energy
Canada Partnership ("KeySpan Canada"), a company that owned certain midstream
natural gas assets in Western Canada. We received cash proceeds of approximately
$255 million in two transactions that resulted in a total after-tax gain of
$34.8 million, or $0.21 per share. The first transaction took place in April
2004 and the second transaction was completed in December 2004. The operations
of KeySpan Canada were fully consolidated in KeySpan's Consolidated Financial
Statements during the first three months of 2004, but then were accounted for on
the equity method of accounting after the first transaction reduced our
ownership interest below 50%.
42
Combined, these asset sales provided KeySpan with approximately $1 billion in
cash proceeds and after-tax earnings of $257.5 million, or $1.60 per share.
Further, during 2004, KeySpan's share of the after-tax operating earnings of
Houston Exploration and KeySpan Canada was $83.9 million or $0.52 per share. See
Note 2 to the Consolidated Financial Statements "Business Segments" and the
discussions under the caption "Review of Operating Segments" for a more detailed
discussion of each of the above noted non-core transactions.
KeySpan recorded three significant impairment charges during 2004: (i) a
goodwill impairment charge recorded in the Energy Services segment; (ii) a
ceiling test write-down recorded in the Energy Investments segment; and (iii) a
carrying value impairment charge also recorded in the Energy Investments
segment. These impairment charges resulted in after-tax charges to continuing
operations of $62.4 million, or $0.39 per share.
Specifically, during 2004 the Energy Services segment recorded an after-tax
non-cash goodwill impairment charge of $12.6 million, or $0.08 per share in
continuing operations as a result of an evaluation of the carrying value of
goodwill recorded in this segment. That evaluation resulted in a total
impairment charge of $152.4 million after-tax, or $0.95 per share - $12.6
million of this charge was attributable to continuing operations, while the
remaining $139.9 million, or $0.87 per share, was reflected in discontinued
operations. (See Note 10 to the Consolidated Financial Statements "Energy
Services - Discontinued Operations" for additional details on this charge.)
KeySpan's remaining wholly owned gas production and development subsidiaries
recorded a non-cash impairment charge of $48.2 million ($31.1 million after-tax,
or $0.19 per share) in 2004 to recognize the reduced valuation of proved
reserves. (See Note 9 to the Consolidated Financial Statements "Gas Production
and Development Property - Depletion," for additional details on this charge.)
In addition to the asset sales noted previously, in the fourth quarter of 2004,
KeySpan anticipated selling its previous 50% ownership interest in Premier
Transmission Limited ("Premier"), a gas pipeline from southwest Scotland to
Northern Ireland. In the fourth quarter of 2004, KeySpan recorded a non-cash
impairment charge of $26.5 million - $18.8 million after-tax or $0.12 per share,
reflecting the difference between the anticipated cash proceeds from the sale of
Premier compared to its carrying value. This investment was accounted for under
the equity method of accounting in the Energy Investments segment. The sale of
Premier was completed in the first quarter of 2005 and resulted in cash proceeds
of approximately $48.1 million and a pre-tax gain of $4.1 million reflecting the
difference from earlier estimates. (See Note 2 to the Consolidated Financial
Statements "Business Segments" and the discussions under the caption "Review of
Operating Segments" for a more detailed discussion of the sale.)
The remaining significant item impacting comparative results, as noted above,
was debt redemption costs incurred in both 2005 and 2004. In 2005, KeySpan
redeemed $500 million of 6.15% Notes due in 2006. KeySpan incurred $20.9 million
in call premiums, which were expensed and recorded in other income and
43
deductions on the Consolidated Statement of Income, and wrote-off $1.3 million
of previously deferred financing costs. Further, KeySpan accelerated the
amortization of approximately $11.2 million of previously unamortized benefits
associated with an interest rate swap on these Notes. The accelerated
amortization was recorded as a reduction to interest expense. The net after-tax
expense of this debt redemption was $6.8 million or $0.04 per share. In 2004,
KeySpan redeemed approximately $758 million of various series of outstanding
long-term debt. KeySpan incurred $54.5 million in call premiums associated with
these redemptions, of which $45.9 was expensed and recorded in other income and
deductions on the Consolidated Statement of Income. The remaining amount of the
call premiums have been deferred for future rate recovery. Further, KeySpan
wrote-off $8.2 million of previously deferred financing costs which have been
reflected in interest expense on the Consolidated Statement of Income. The total
after-tax expense of the 2004 debt redemption was $29.3 million or $0.18 per
share.
The net impact of the above mentioned items resulted in a decrease to earnings
from continuing operations of $6.8 million or $0.04 per share for the year ended
December 31, 2005, compared to a gain of $249.7 million, or $1.55 per share, in
2004.
Earnings Available for Common Stock 2005 vs 2004
As noted previously, earnings available for common stock in 2005 also included
losses from discontinued operations associated with KeySpan's former mechanical
contracting subsidiaries amounting to $1.8 million, or $0.01 per share. Further,
as noted, earnings available for common stock for 2005 included a $6.6 million,
or $0.04 per share, cumulative change in accounting principle charge as a result
of implementing the accounting requirements of FIN 47 "Accounting for
Conditional Asset Retirement Obligations."
Also as noted previously, in 2004 KeySpan conducted an evaluation of the
carrying value of its investments in the Energy Services segment. As a result of
this evaluation, KeySpan recorded a loss in discontinued operations of $151.0
million, or $0.94 per share. This loss reflects a $139.9 million after-tax
impairment charge to reflect a reduction to the carrying value of assets
associated with our mechanical contracting activities and operating losses of
$11.1 million. (See Note 10 to the Consolidated Financial Statements "Energy
Services - Discontinued Operations" for additional details on these items.)
44
CONSOLIDATED SUMMARY OF RESULTS
Operating income by segment, as well as consolidated earnings available for
common stock is set forth in the following table for the periods indicated.
- -------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts) 2006 2005 2004
- -------------------------------------------------------------------------------------------------------------------------
Gas Distribution $ 568.6 $ 565.7 $ 579.6
Electric Services 293.0 342.3 289.8
Energy Services
Operations 5.3 (2.7) (33.9)
Goodwill impairment charge - - (14.4)
Energy Investments
Operations of continuing companies 15.5 20.6 24.4
Operations of sold companies - - 155.0
Ceiling test write-down and impairment charge - - (74.7)
Eliminations and other (54.9) (18.1) 9.5
- -------------------------------------------------------------------------------------------------------------------------
Operating Income 827.5 907.8 935.3
- -------------------------------------------------------------------------------------------------------------------------
Other Income and (Deductions)
Interest charges (256.1) (269.3) (331.3)
Gain on sale of subsidiary stock - 4.1 388.3
Cost of debt redemption - (20.9) (45.9)
Minority interest (0.8) (0.4) (36.8)
Other income and (deductions) 39.1 16.6 30.6
- -------------------------------------------------------------------------------------------------------------------------
(217.8) (269.9) 4.9
- -------------------------------------------------------------------------------------------------------------------------
Income taxes (175.5) (239.3) (325.5)
- -------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations 434.2 398.6 614.7
Loss from discontinued operations - (1.8) (151.0)
Cumulative change in accounting principles - (6.6) -
- -------------------------------------------------------------------------------------------------------------------------
Net Income 434.2 390.2 463.7
Preferred stock dividend requirements - 2.2 5.6
- -------------------------------------------------------------------------------------------------------------------------
Earnings for Common Stock $ 434.2 $ 388.0 $ 458.1
- -------------------------------------------------------------------------------------------------------------------------
Basic Earnings per Share:
Continuing operations, less preferred stock dividends $ 2.48 $ 2.33 $ 3.80
Discontinued operations - (0.01) (0.94)
Cumulative change in accounting principles - (0.04) -
- -------------------------------------------------------------------------------------------------------------------------
$ 2.48 $ 2.28 $ 2.86
- -------------------------------------------------------------------------------------------------------------------------
Operating Income 2006 vs 2005
As indicated in the above table, operating income decreased $80.3 million, or
9%, for the twelve months ended December 31, 2006 compared to the same period of
2005. As noted earlier, during 2006, KeySpan incurred pre-tax incremental Merger
costs of $27.1 million related to its proposed merger with National Grid plc,
representing investment banking, legal, accounting and other consulting fees.
For reporting purposes, the majority of these costs reside at the holding
45
company level (elimination and other) and have not been allocated to the
operating segments. The remaining variation is due, for the most part, to a
decrease of $49.3 million in the operating income of the Electric Services
segment. As noted earlier, the Ravenswood Generating Station was adversely
impacted by additional competing electric generating units and the comparatively
cooler 2006 summer weather, resulting in a decrease of $110.3 million in net
electric margins. However, net electric margins from KeySpan's service
agreements with LIPA and its electric marketing operations increased in 2006
compared to 2005, offsetting some of the lost margin from the Ravenswood
Generating Station. Further, this segment also recognized a $46.5 million gain
on a fixed for floating unforced capacity financial swap which is reflected in
the operating results of this segment.
KeySpan's gas distribution business realized a slight increase, $2.9 million, in
operating income year-over-year. Operating expenses decreased $54.7 million in
2006 compared to 2005, while net gas revenues decreased $51.8 million over the
same time period. The decrease in net gas revenues reflects the significantly
warmer weather experienced during the first and fourth quarter winter heating
seasons, whereas the decrease in operating expenses was mainly driven by a lower
provision for uncollectible accounts receivable resulting from the decrease in
firm sales quantities, and from the beneficial impact of a recent regulatory
order and improved accounts receivable collection activities. The favorable
comparative results from the Energy Services segment were due to higher
operating margins on engineering, energy supply and service contracts and lower
general and administrative expenses. The decrease in operating income from the
Energy Investments segment reflects, in part, lower earnings from KeySpan's
investment in the Iroquois Gas Transmission System pipeline, as well as lower
earnings from the transportation of liquefied natural gas. (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 twelve months ended December 31, 2006, other income
and (deductions) reflects a net expense of $217.8 million compared to a net
expense of $269.9 million for the same period of 2005. The favorable variation
of $52.1 million is due, in part, to debt redemption costs incurred in 2005. As
discussed previously, in 2005, KeySpan redeemed $500 million 6.15% Series Notes
due in 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.
Interest expense for the twelve months ended December 31, 2006 decreased $13.2
million compared to the same period in 2005, reflecting, in part, the reversal
of a previously recorded $5.9 million reserve established in connection with an
income tax dispute with the New York City Department of Taxation and Finance. In
2006, KeySpan resolved its dispute with the New York City Department of Taxation
and Finance with respect to income taxes relating to the operations of the
Ravenswood Generating Station. As a result of the favorable settlement of this
issue, KeySpan reversed the previously recorded interest reserve. Further,
comparative interest expense reflects lower carrying charges on regulatory
46
deferrals in 2006, offset by the benefits recorded in 2005 associated with the
amortization of the interest rate swap. The favorable variation in other income
and (deductions) for the twelve months ended December 31, 2006, compared to the
same period in 2005, also reflects higher income on certain investments.
Other income and (deductions) for the twelve months ended December 31, 2005,
includes 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.
Income tax expense decreased $63.8 million in 2006, compared to 2005, primarily
reflecting the settlements with the New York City Department of Taxation and
Finance and the IRS, as previously noted, amounting to $51.6 million; the
remaining decrease reflects lower pre-tax income.
As a result of the items discussed above, earnings available for common stock
were $434.2 million, or $2.48 per share for the year ended December 31, 2006,
compared to $388.0 million, or $2.28 per share realized in 2005. As noted
earlier, earnings available for common stock for the year ended December 31,
2005, included losses of $1.8 million, or $0.01 per share, from discontinued
operations, as well as a $6.6 million, or $0.04 per share cumulative change in
accounting principles charge.
Operating Income 2005 vs 2004
Operating income decreased $27.5 million, or 3%, for the twelve months ended
December 31, 2005 compared to the same period of 2004. The comparative operating
results reflect the following two items that had a significant impact on
results: (i) operating results of non-core subsidiaries recorded in 2004 and
which were sold in 2005; offset by (ii) impairment charges recorded in 2004. As
noted earlier, during 2004 KeySpan held equity ownership interests in Houston
Exploration and KeySpan Canada. For the twelve months ended December 31, 2004,
KeySpan's share of the combined operating income of Houston Exploration and
KeySpan Canada was $155.0 million. KeySpan sold its remaining ownership interest
in these non-core operations in the fourth quarter of 2004. Offsetting this
income to some extent were pre-tax non-cash impairment charges of $89.1 million
recorded in 2004. As noted earlier, KeySpan recorded the following three
impairment charges during 2004: (i) a goodwill impairment charge recorded in the
Energy Services segment attributable to continuing operations of $14.4 million;
(ii) a ceiling test write-down of $48.2 million to recognize the reduced
valuation of proved reserves associated with KeySpan's wholly-owned gas
production and development subsidiaries; and (iii) a non-cash impairment charge
of $26.5 million also recorded in the Energy Investments segment reflecting the
difference between the anticipated cash proceeds from the sale of Premier
compared to its carrying value.
47
The combined impact of the non-core operating income recorded in 2004 offset by
the impairment charges contributed $65.9 million to operating income for the
twelve months ended December 31, 2004. KeySpan's core businesses, therefore,
posted an increase in operating income of $38.4 million for the twelve months
ended December 31, 2005, compared to the same period of 2004, primarily
reflecting an increase of $52.5 million in the Electric Services segment,
partially offset by a $13.9 million decrease in the Gas Distribution segment.
The favorable results from KeySpan's electric services operations reflect an
increase in net electric revenues as a result of higher electric prices that
were due, in part, to the warm weather during the summer of 2005 and the impact
of two hurricanes that occurred in the summer of 2005. Gas distribution results,
however, were adversely impacted by higher operating expenses, primarily due to
an increase in the provision for uncollectible accounts receivable as a result
of higher gas costs and by higher property taxes. For the most part, the
beneficial impact on comparative operating income from lower net operating
losses incurred at the Energy Services segment, was offset by an increase in
expenses residing at the holding company level. Further, in 2004 KeySpan reached
a settlement with certain of its insurance carriers regarding cost recovery for
expenses incurred at a non-utility environmental site and recorded an $11.6
million gain from the settlement as a reduction to expense.
Other income and (deductions) reflects interest charges, costs associated with
debt redemptions, income from subsidiary stock transactions, minority interest
charges and other miscellaneous items. For the twelve months ended December 31,
2005, other income and (deductions) reflects a net expense of $269.9 million
compared to income of $4.9 million for the twelve months ended December 31,
2004. This unfavorable variation of $274.8 million is due to higher gains from
asset sales recorded in 2004 compared to 2005 of $384.2 million, offset by a
decrease in interest charges of $62.0 million, lower debt redemption costs of
$25.0 million and the absence of minority interest expenses of $36.4 million.
The following is a discussion of these items.
As noted earlier, in the first quarter of 2005, KeySpan finalized its sale of
Premier. The final sale of Premier resulted in a pre-tax gain of $4.1 million
reflecting the difference from earlier estimates and what was recorded in the
first quarter of 2005. For the twelve months ended December 31, 2004, KeySpan
realized pre-tax income of $388.3 million from subsidiary stock transactions
associated with Houston Exploration and KeySpan Canada, as discussed earlier.
Interest expense decreased $62.0 million, or 19%, for the twelve months ended
December 31, 2005, compared to the same period of 2004, reflecting the benefits
attributable to debt redemptions, as well as the sale of Houston Exploration and
KeySpan Canada. In addition, as noted earlier, in 2005 KeySpan redeemed $500
million 6.15% Series Notes due 2006. KeySpan incurred $20.9 million in call
premiums, wrote-off $1.3 million of previously deferred financing costs and
accelerated the amortization of approximately $11.2 million of previously
unamortized benefits associated with an interest rate swap on these bonds. The
accelerated amortization of the interest rate swap and the write-off of
previously deferred financing costs reduced interest expense in 2005 by $9.9
million.
In 2004, KeySpan redeemed approximately $758 million of various series of
outstanding debt and incurred $45.9 million in call premiums and wrote-off $8.2
million of previously deferred financing costs. The net impact of the 2005 and
2004 debt redemptions lowered comparative interest expense by $18.1 million.
48
For the year ended December 31, 2004 other income and (deductions) also includes
the effects of minority interest of $36.8 million related to our previous
majority ownership interests in Houston Exploration and KeySpan Canada. Finally,
other income and (deductions) for the year ended December 31, 2004 reflects a
$12.6 million gain recorded on the settlement of a derivative financial
instrument entered into in connection with the sale/leaseback transaction
associated with the Ravenswood Expansion, a 250 MW combined cycle generating
facility located at the Ravenswood Generating Station site, as well as a $5.5
million foreign currency gain.
Income taxes decreased $86.2 million for the year ended December 31, 2005
compared to 2004 due, for the most part, to lower pre-tax earnings. In addition,
tax expense for 2004 reflects: (i) a $6.0 million benefit resulting from a
revised appraisal associated with property that was disposed of in 2003; (ii) a
tax benefit of $12 million related to the repatriation of earnings from
KeySpan's foreign investments; and (iii) the beneficial tax treatment afforded
to the stock transaction with Houston Exploration.
As noted earlier, earnings available for common stock for the year ended
December 31, 2005, also included losses of $1.8 million, or $0.01 per share,
from discontinued operations, as well as a $6.6 million, or $0.04 per share
cumulative change in accounting principles charge. Earnings available for common
stock for the year ended December 31, 2004, included losses of $151.0 million,
or $0.94 per share, from discontinued operations.
As a result of the items discussed above, earnings available for common stock
were $388.0 million, or $2.28 per share for the year ended December 31, 2005,
compared to $458.1 million, or $2.86 per share realized in 2004.
REVIEW OF OPERATING SEGMENTS
KeySpan's segment results are reported 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
The Brooklyn Union Gas Company, doing business as 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. KeySpan Gas
East Corporation, doing business as 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
natural gas distribution companies - Boston Gas Company, Essex Gas Company,
Colonial 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.
49
The table below highlights certain significant financial data and operating
statistics for the Gas Distribution segment for the periods indicated.
- -------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- -------------------------------------------------------------------------------------------------------------------------------
Revenues $ 5,062.6 $ 5,390.1 $ 4,407.3
Cost of gas 3,336.6 3,607.0 2,664.7
Revenue taxes 60.4 65.8 73.3
- -------------------------------------------------------------------------------------------------------------------------------
Net Gas Revenues 1,665.6 1,717.3 1,669.3
- -------------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 681.4 727.0 672.5
Depreciation and amortization 266.7 276.9 276.5
Operating taxes 148.9 147.8 140.7
- -------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 1,097.0 1,151.7 1,089.7
- -------------------------------------------------------------------------------------------------------------------------------
Gain on the sale of property - 0.1 -
Operating Income $ 568.6 $ 565.7 $ 579.6
- -------------------------------------------------------------------------------------------------------------------------------
Firm gas sales and transportation (MDTH) 283,693 323,347 324,549
Transportation - Electric Generation (MDTH) 67,273 25,076 27,656
Other sales (MDTH) 190,244 187,805 155,992
Warmer (Colder) than Normal - New York & Long Island 16.0% (1.0%) (1.0%)
Warmer (Colder) than Normal - New England 7.6% (8.6%) (6.8%)
- -------------------------------------------------------------------------------------------------------------------------------
A MDTH is 10,000 therms 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.
Operating Income 2006 vs 2005
Executive Summary
Operating income increased $2.9 million for the twelve months ended December 31,
2006, compared to the same period last year reflecting a decrease in operating
expenses of $54.7 million, substantially offset by a decrease in net gas
revenues (revenues less the cost of gas and associated revenue taxes) of $51.7
million. The lower operating expenses were primarily due to a decrease in the
provision for uncollectible accounts receivable of $60.9 million. The
exceptionally warm weather during the first and fourth quarters of 2006 -
KeySpan's primary heating seasons - was the primary driver behind the decrease
in net gas revenues.
Net Revenues
Net gas revenues from our gas distribution operations decreased $51.7 million,
or 3%, for the twelve months ended December 31, 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 2006
winter heating seasons - January through April and October through December. As
measured in heating degree days, weather in 2006 in our New York and New England
service territories was approximately 16% and 7.6% warmer than normal,
respectively, and was approximately 16% warmer than last year across KeySpan's
service territories.
50
Net revenues from firm gas customers (residential, commercial and industrial
customers) decreased $70.2 million in 2006 compared to 2005. 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 seasons, the use of more efficient gas heating equipment and higher gas
costs. KeySpan estimates that the warm weather during the two heating seasons
resulted in an adverse impact to net gas revenues of approximately $32 million,
net of the benefits from the weather normalization adjustment and weather
derivatives discussed below. Further, KeySpan earned $6.5 million less in
regulatory incentives for the twelve months ended December 31, 2006, compared to
the same period last year.
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 $57 million during the twelve months ended
December 31, 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 and 2006/2007 winter heating season.
Since weather was warmer than normal in November and December of 2006, these
derivative instruments resulted in a $9.1 million benefit to net gas revenues in
2006. (See Note 8 to the Consolidated Financial Statements "Hedging, Derivative
Financial Instruments and Fair Values" 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 $18.5 million during the twelve months ended December
31, 2006, compared to the same period last year primarily reflecting higher
pricing.
Firm Sales, Transportation and Other Sales Quantities
Firm gas sales and transportation quantities for the twelve months ended
December 31, 2006, decreased 12% compared to the same period in 2006 due
primarily to the warmer weather this year compared to last year. On a weather
normalized basis, firm gas sales and transportation quantities decreased 2.4% in
2006 compared to 2005 due to lower usage per customer. Customer additions and
oil-to-gas conversions, however, offset the full impact of the warmer weather
and lower usage per customer. Net revenues are not affected by customers opting
to purchase their gas supply from other sources, since delivery rates charged to
transportation customers generally are the same as delivery rates charged to
full sales service customers. Transportation quantities related to electric
generation reflect the transportation of gas to our electric generating
facilities located on Long Island. Net revenues from these services are not
material.
51
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 share the responsibilities
for managing KeySpan's upstream gas contracted 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
("MADTE") approved this contract in March 2006 effective April 1, 2006. KeySpan
provides these services internally for its New York and New Hampshire gas
distribution subsidiaries.
Purchased Gas for Resale
The decrease in gas costs for the twelve months ended December 31, 2006 compared
to the same period of 2005 of $270.4 million, or 7%, is reflective of a decrease
of 14% in the quantity of gas purchased due to the warm weather during the two
winter heating seasons. However, the price per dekatherm of gas used by firm gas
sales customers increased 4%, in 2006 compared to 2005. 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 for the twelve months ended December 31, 2006, compared to
the same period of 2005, decreased $54.7 million, or 5%. Operations and
maintenance expense decreased $45.6 million, or 6%, in 2006 compared to 2005
primarily as a result of a decrease of $60.9 million in the provision for
uncollectible accounts receivable. In December 2005, The Boston Gas Company
("Boston Gas") received a MADTE order, effective January 1, 2006, permitting
Boston Gas 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. Additionally, in 2006 we recovered the 2005 gas cost component
of bad debts as well. These benefits were the primary driver behind the
reduction in the provision for uncollectible accounts receivable, combined with
a decrease in firm gas sales quantities in 2006 compared to 2005 and improved
collection efforts. (See the discussion under the caption "Regulation and Rate
Matters - Gas Matters" for additional details of the MADTE order.) Offsetting
the favorable impact of the MADTE order, to some extent, was higher employee
benefit related expenses, including postretirement costs, and generally higher
administrative and general costs.
The decrease in depreciation and amortization charges of $10.2 million, or 4%,
for the twelve months ended December 31, 2006 compared to the same period of
2005, reflects a decrease in depreciation charges of $8.4 million and lower
regulatory amortization charges of $1.8 million. The decrease in depreciation
charges reflects an adjustment to the depreciation allowance to correct for an
error in useful lives associated with certain gas distribution assets.
52
Operating Income 2005 vs 2004
Executive Summary
Operating income decreased $13.9 million, or 2%, for the twelve months ended
December 31, 2005, compared to the same period of 2004 due to higher operating
expenses. Operating expenses increased $62.0 million reflecting primarily an
increase in the provision for uncollectible accounts receivable and higher
property taxes totaling $45.8 million. Partially offsetting the higher operating
expenses was an increase of $48.0 million in net gas revenues resulting from
customer additions and oil-to-gas conversions in our firm gas sales market, as
well as from higher net gas revenues in our large-volume heating markets.
Net Revenues
Net gas revenues from our gas distribution operations increased $48.0 million,
or 3%, for the twelve months ended December 31, 2005, compared to the same
period of 2004. Net gas revenues benefited from customer additions and
oil-to-gas conversions in our firm gas sales market as well as from higher net
gas revenues in our large-volume heating and interruptible (non-firm) markets.
As measured in heating degree days, weather in 2005 in our New York and New
England service territories was approximately 1.0% and 8.6% colder than normal,
respectively. Compared to 2004, weather in 2005 was 1.2% colder in KeySpan's New
England service territory, while weather was consistent between years in the New
York service territory.
Net revenues from firm gas customers increased $24.3 million for the twelve
months ended December 31, 2005, compared to same period of 2004. Customer
additions and oil-to-gas conversions, net of attrition and conservation, added
$25.1 million to net gas revenues. Further, we realized a benefit of $3.8
million as a result of the Boston Gas Performance Based Rate Plan (the "Plan")
that was approved by the MADTE in 2003. The Plan provides for firm gas sales
rates to be adjusted each year based on an inflation factor offset by a
productivity factor. (See the caption under "Regulation and Rate Matters" for
further information regarding the rate filing.)
Offsetting, to some extent, the beneficial impact of the customer additions and
oil-to-gas conversions was the adverse impact to comparative net gas revenues
from the additional billing day in 2004 due to the leap year. In 2004, KeySpan
realized $5.7 million in additional net gas revenues from the additional billing
day. Further, KeySpan earned $8.7 million less in regulatory incentives for the
twelve months ended December 31, 2005, compared to the same period of 2004.
Also included in net revenues is the recovery of certain regulatory items and
certain taxes that added $6.6 million to net revenues. However, the recovery of
these items through revenues does not impact net income since a similar amount
was expensed as amortization charges and income taxes, as appropriate, on the
Consolidated Statement of Income. Firm gas distribution rates for KEDNY, KEDLI
and KEDNE in 2005, other than for the recovery of gas costs and resulting from
the Plan, remained substantially unchanged from rates charged in 2004.
53
KEDNY and KEDLI each operate under a utility tariff that contains a weather
normalization adjustment that significantly offsets variations in firm net
revenues due to fluctuations in normal weather. However, the gas distribution
operations of our New England based subsidiaries do not have a weather
normalization adjustment. To mitigate the effect of fluctuations in normal
weather patterns on KEDNE's results of operations and cash flows, weather
derivatives were in place for the 2004/2005 and 2005/2006 winter heating
seasons. These financial derivatives afforded KeySpan some protection against
warmer than normal weather. As a result of the weather fluctuations and
financial weather derivatives, weather had a $3.2 million favorable impact on
comparative net gas revenues.
In our large-volume heating and interruptible (non-firm) markets, which include
large apartment houses, government buildings and schools, gas service is
provided under rates that are designed to compete with prices of alternative
fuel, including No. 2 and No. 6 grade heating oil. These "dual-fuel" customers
can consume either natural gas or fuel oil for heating purposes. Net revenues in
these markets increased $23.7 million during the twelve months ended December
31, 2005, compared to the same period of 2004, primarily reflecting higher
pricing. Further, since weather during January 2004 was significantly colder
than normal, KeySpan interrupted service to a segment of its dual-fuel customers
for a number of days during that month, as permitted under its tariff, to ensure
reliable service to firm customers. The majority of interruptible profits earned
by KEDLI and KEDNE are returned to firm customers as an offset to gas costs.
Firm Sales, Transportation and Other Sales Quantities
Both actual firm gas sales and transportation quantities, as well as weather
normalized sales quantities for the twelve months ended December 31, 2005,
remained consistent with those quantities realized in 2004. Net revenues are not
affected by customers opting to purchase their gas supply from other sources,
since delivery rates charged to transportation customers generally are the same
as delivery rates charged to full sales service customers. Transportation
quantities related to electric generation reflect the transportation of gas to
our electric generating facilities located on Long Island. Net revenues from
transportation services are not material.
Other sales quantities include on-system interruptible quantities, off-system
sales quantities (sales made to customers outside of our service territories)
and related transportation. The increase in these sales quantities for the
twelve months ended December 31, 2005, compared to the same period of 2004
reflects higher off-system sales. The majority of these profits earned are
returned to firm customers as an offset to gas costs. From April 1, 2002 through
March 31, 2005, we had an agreement with Coral Resources, L.P. ("Coral"), a
subsidiary of Shell Oil Company, under which Coral assisted in the origination,
structuring, valuation and execution of energy-related transactions on behalf of
KEDNY and KEDLI. Upon expiration of this agreement, these services have been
provided by KeySpan employees. KeySpan also provides these services internally
for its New Hampshire gas distribution subsidiaries. In 2004 and 2005, we also
had a portfolio management contract with Merrill Lynch Trading, under which
Merrill Lynch Trading was responsible for managing KeySpan's upstream gas
contracted assets associated with its Massachusetts gas distribution
subsidiaries, as well as providing city-gate delivered supply. As noted above,
beginning in April 2006, KeySpan and Merrill Lynch Trading have a new three-year
agreement under which KeySpan and Merrill Lynch share the responsibilities for
managing KeySpan's upstream gas contracted assets associated with its
Massachusetts gas distribution subsidiaries.
54
Purchased Gas for Resale
The increase in gas costs for the twelve months ended December 31, 2005,
compared to the same period of 2004, of $942.3 million, or 35%, reflects an
increase of 23% in the price per dekatherm of gas purchased for firm gas sales
customers, as well as an increase in the quantity of gas purchased for
large-volume heating and interruptible (non-firm) customers. The current gas
rate structure of each of our gas distribution utilities includes a gas
adjustment clause, pursuant to which variations between actual gas costs
incurred for resale to firm sales customers and gas costs billed to firm sales
customers are deferred and refunded to or collected from customers in a
subsequent period.
Operating Expenses
For the twelve months ended December 31, 2005, operating expenses increased
$62.0 million, or 6% compared to the same period in 2004. Operations and
maintenance expense increased $54.5 million, or 8%, in 2005 compared to 2004
primarily due to an increase of $38.7 million in the provision for uncollectible
accounts as a result of increasing gas costs and the adverse impact from
collection experience. Further, the gas distribution operations realized an
increase in insurance and regulatory fees, as well as postretirement expenses in
2005 compared to 2004. In 2004, KeySpan recognized a benefit of approximately $3
million, net of amounts subject to regulatory deferral treatment, associated
with the implementation of the Medicare Prescription Drug Improvement and
Modernization Act of 2003 ( the "Medicare Act") and implementation of Financial
Accounting Standards Board Staff Position ("FSP") 106-2. In addition, in 2004,
Boston Gas reached an agreement with an insurance carrier for recovery of
previously incurred environmental expenditures. Insurance and third-party
recoveries, after deducting legal fees, are shared between Boston Gas and its
firm gas customers as provided under a previously issued MADTE rate order. As a
result of this insurance settlement, Boston Gas recorded a $5 million benefit to
operations and maintenance expense.
Comparative operating taxes increased $7.1 million due to the expiration of a
five-year property tax assessment agreement with New York City, as well as to a
$2.5 million property tax refund received in 2004. Higher depreciation charges
of $4.5 million reflecting the continued expansion of the gas distribution
system were offset by lower regulatory amortization charges of $4.1 million.
Gas Supply and Pricing
KeySpan has adequate gas supply available to meet its gas load demand in its
service territories for the 2006/2007 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, the volatility of natural gas prices
can have an adverse impact on customers' gas bills and recovery of customer
55
accounts receivable. High gas prices have led to 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 has helped to mitigate any increase in bad
debt expense.
With KeySpan's continuing strategy of having its storage facilities 100% full at
the start of the heating season and through the use of financial derivatives,
KeySpan has effectively hedged the price of approximately two-thirds of the gas
supply needed to serve its gas heating customers during the 2006/2007 winter
heating season. 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, the
expansion of which we supported through the Energy Policy Act of 2005.
Management believes that these measures help mitigate the impact of volatile 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 volatility in 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 of our market segments to serve new housing
and commercial 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 and the pursuit of
opportunities to grow multi-family, industrial and commercial markets.
In order to serve the anticipated market requirements in our New York service
territories, KeySpan and Spectra Energy Corporation (formerly a part of Duke
Energy Corporation) formed Islander East Pipeline Company, LLC ("Islander East")
in 2000. Once in service, the pipeline is expected to have the capacity 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 26.25% 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 175,000 DTH of natural
gas per day of transportation capacity from the Millennium Pipeline system,
increasing to 200,000 DTH in the second 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.
56
ELECTRIC SERVICES
The Electric Services segment primarily consists of subsidiaries that own, lease
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 through 2013; (ii) a new Option and Purchase and Sale Agreement (the
"2006 Option Agreement"), to replace the Generation Purchase Rights Agreement
(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."
These agreements will become effective following approval by the New York State
Comptroller's Office and the New York State Attorney General. (For a further
discussion on these LIPA agreements see the discussion under the caption
"Electric Services - LIPA Agreements" and Note 11 to the Consolidated Financial
Statements "2006 LIPA Settlement"). The Electric Services segment also provides
retail marketing of electricity to commercial customers.
57
Selected financial data for the Electric Services segment is set forth in the
table below for the periods indicated.
- -----------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- -----------------------------------------------------------------------------------------------
Revenues $ 1,834.2 $ 2,047.3 $ 1,738.7
Purchased fuel 548.4 751.4 539.6
- -----------------------------------------------------------------------------------------------
Net Revenues from Operations 1,285.8 1,295.9 1,199.1
Derivative Financial Instrument 46.5 - -
- -----------------------------------------------------------------------------------------------
Net Electric Revenues 1,332.3 1,295.9 1,199.1
- -----------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 750.8 684.5 653.3
Depreciation 102.1 91.7 88.3
Operating taxes 186.9 178.6 169.7
- -----------------------------------------------------------------------------------------------
Total Operating Expenses 1,039.8 954.8 911.3
- -----------------------------------------------------------------------------------------------
Gain on the sale of property 0.5 1.2 2.0
Operating Income $ 293.0 $ 342.3 $ 289.8
- -----------------------------------------------------------------------------------------------
Electric sales (MWH)* 4,480,996 6,364,279 6,232,190
Capacity(MW)* 2,450 2,450 2,450
Cooling degree days 1,130 1,472 1,045
- -----------------------------------------------------------------------------------------------
*Reflects the operations of the Ravenswood Generating Station only.
Operating Income 2006 vs 2005
Executive Summary
Operating income decreased $49.3 million, or 14%, for the twelve months ended
December 31, 2006, compared to the same period last year, due primarily to a
decrease in net revenues from the Ravenswood Generating Station of $110.3
million as a result of lower energy margins and lower capacity revenues,
partially offset by higher revenues associated with KeySpan's service agreements
with LIPA and its electric marketing activities of $10.6 million. KeySpan also
recognized a gain of $46.5 million on a fixed for floating unforced capacity
financial swap.
Net Revenues
Total electric net revenues realized in 2006 were $36.4 million higher than such
revenues realized in 2005.
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. ("Swap Agreement"). This agreement has a three year
term that began on May 1, 2006. For the twelve months ended December 31, 2006
KeySpan recognized a gain of $46.5 million from this derivative financial
instrument. (See Note 8 to the Consolidated Financial Statements, "Hedging,
Derivative Financial Instruments and Fair Values," for further information on
this swap agreement.)
Net revenues for the twelve months ended December 31, 2006 from the service
agreements with LIPA, including the power purchase agreements associated with
two electric peaking facilities, increased $96.6 million compared to the same
period of 2005. The increase is due, for the most part, to recovery of
operations and maintenance charges billed to LIPA of approximately $76 million
58
and the recovery of depreciation charges and property taxes of approximately $14
million. These recoveries had no impact on operating income since actual
expenses increased by a like amount. Therefore, only approximately $7 million of
the increase in net revenues resulted in a benefit to operating income. This
increase in net revenues from the LIPA service agreements was driven by higher
off-system electric energy sales and emission credit sales, as well as the
recovery of certain past service costs, offset by lower performance incentives.
In 2006, KeySpan earned $9.0 million associated with non-cost performance
incentives provided for under these agreements, compared to $16.4 million earned
in 2005, due to the discontinuation of certain performance incentives contained
in the MSA.
Net revenues associated with KeySpan's electric marketing activities increased
$3.6 million during the twelve months ended December 31, 2006, compared to the
same period of 2005.
Net revenues from the Ravenswood Generating Station decreased $110.3 million, or
25% for the twelve months ended December 31, 2006, compared to the same period
of 2005 reflecting lower capacity revenues of $80.5 million and a decrease in
energy margins of $29.8 million. The decrease in capacity revenues was primarily
due to the planned installation of 1,000 megawatts of additional electric
capacity in New York City in 2006.
The decrease in energy margins in 2006 reflects, in part, a 50% 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 megawatt
hours ("MWh") sold into the NYISO energy market decreased 30% due to increased
competition and cooler weather in the summer of 2006 compared to the summer of
2005 - the peak cooling season. As measured in cooling-degree days, weather was
25% cooler during the summer of 2006 compared to the summer of 2005, and 2%
warmer than normal. Combined, these two items reduced energy margins by $124.9
million or 63%. It should be noted, that in 2005 KeySpan benefited from the
pricing differential between number 6-grade fuel oil and natural gas used in the
Ravenswood Generating Station. Due to the dual-fuel capability of the Ravenswood
Generating Station, KeySpan was able to take advantage of the ability to switch
to cheaper fuel as the gap between number 6 grade fuel oil and gas prices spread
during the later part of the 2005 summer. The two hurricanes which occurred in
the summer of 2005 in the Gulf Coast of the United States contributed to the gap
between number 6-grade fuel oil and natural gas prices.
Partially offsetting these adverse impacts to comparative energy margins were
the benefits recognized from derivative financial instruments. We employ
derivative financial instruments to economically hedge the cash flow variability
for a portion of forecasted purchases of natural gas and fuel oil consumed at
the Ravenswood Generating Station, as well as for a portion of forecasted
electric energy sales. These derivative instruments, the impacts of which are
reflected in net electric margins, resulted in a comparative gain of $95.1
million year-over-year. Hedging gains realized in 2006 were $79.1 million
compared to hedging losses of $16.0 million realized in 2005.
The Ravenswood Generating Station is a dual-fuel electric facility that can burn
either number 6-grade fuel oil or natural gas to generate electricity. To take
full advantage of the dual-fuel capability of the Ravenswood Generating Station,
KeySpan uses the cheaper of the two fuels in the generation of electricity and,
59
as a result, KeySpan may not be able to apply hedge accounting treatment for all
of its aforementioned risk management strategies in the future and therefore may
experience some degree of fluctuations in its recorded net electric revenues due
to changes in the market value of outstanding derivative instruments and the
related underlying commodity. (See Note 8 to the Consolidated Financial
Statements "Hedging, Derivative Financial Instruments and Fair Values" as well
as Item 7A. Quantitative and Qualitative Disclosures about Market Risk for
further information on KeySpan's hedging strategies.)
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 "Regulatory Issues and the Competitive
Environment" for further details on these matters.
Operating Expenses
For the twelve months ended December 31, 2006, operating expenses increased
$85.0 million compared to the same period of 2005. Operations and maintenance
expenses increased $66.3 million during the twelve months ended December 31,
2006, compared to the same period of 2005 reflecting a $76 million increase in
costs recovered from LIPA. As noted previously, this increase had no impact on
operating income since revenues increased by a similar amount. Therefore, the
operations and maintenance expenses that impacted operating income actually
decreased approximately $10 million due to a decrease in overhaul costs and
non-outage maintenance work on the Ravenswood Generating Station and our Long
Island based electric generating units.
Depreciation expense and operating taxes increased $18.7 million in 2006
compared to 2005. Of this amount, approximately $14 million is associated with
KeySpan's Long Island based electric generating units and are fully recoverable
from LIPA, as noted above. The remaining increase in these line items is
associated with the Ravenswood Generating Station and did impact comparative
operating income.
Operating Income 2005 vs 2004
Executive Summary
For the twelve months ended December 31, 2005, operating income increased $52.5
million, or 18%, compared to the same period of 2004, primarily due to an
increase in net revenues from the Ravenswood Generating Station of $78.7 million
mainly as a result of improved pricing. The increase in net revenues was
partially offset by an increase in operating expenses associated with the
Ravenswood Generating Station of $11.8 million, as well as lower net revenues
associated with KeySpan's retail electric marketing activities of $7.6 million.
Net Revenues
Total electric net revenues realized during the twelve months ended December 31,
2005, were $96.8 million, or 8% higher than such revenues realized during the
corresponding period of 2004.
60
For the year ended December 31, 2005, net revenues from the Ravenswood
Generating Station increased $78.7 million, or 22%, compared to the same period
in 2004 reflecting higher energy margins of $66.0 million, as well as increased
capacity revenues of $12.7 million. The increase in capacity revenues reflected
the operation of the Ravenswood Expansion which went into full commercial
operation in May 2004, as well as load growth in New York City.
The increase in energy margins for 2005 reflects an increase of 54% in
"spark-spreads" (the selling price of electricity less the cost of fuel,
exclusive of hedging gains or losses), as well as from an increase of 2% in the
level of MWh sold into the NYISO energy market. These favorable energy results
were primarily driven by the pricing differential between number 6-grade fuel
oil and natural gas used in the Ravenswood Generating Station in 2005. As noted
previously, due to the dual-fuel nature of the Ravenswood Generating Station,
KeySpan was able to take advantage of the ability to switch to cheaper fuel as
the gap between number 6 grade fuel oil and gas prices spread during the later
part of the 2005 summer. Further, in 2005 KeySpan received $9.2 million from the
NYISO to settle billing issues regarding the sale of energy provided by the
Ravenswood Generating Station to the NYISO in May 2000. Weather for 2005, as
measured in cooling degree days, was 40% warmer than 2004 and 28% warmer than
normal.
As mentioned 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 as well as a
portion of forecasted electric energy sales. These derivative instruments
resulted in hedging losses, which are reflected in net electric margins, of
$16.0 million in 2005, compared to hedging gains of $23.0 million in 2004.
Net revenues for the twelve months ended December 31, 2005, from the service
agreements with LIPA, including the power purchase agreements associated with
two electric peaking facilities, increased $25.7 million compared to the
corresponding period of 2004. The increase was due, in part, to recovery of
operating expenses billed to LIPA of approximately $14 million and the recovery
of depreciation charges and property taxes of approximately $8 million. These
recoveries had no impact on operating income since actual expenses increased by
a like amount. The remaining increase primarily reflects an increase in emission
credits earned and variable revenues, which are a function of electric
generation output. In 2005 and 2004, we earned a total of $16.4 million
associated with non-cost performance incentives provided for under these
agreements.
Net revenues associated with KeySpan's retail electric marketing activities
decreased $7.6 million in 2005 compared to 2004, due to a significant
curtailment in these activities. In 2005, KeySpan terminated all indexed price
contracts and elected to maintain only its fixed priced contracts. As a result,
the retail electric marketing business had approximately 40 MW under contract
during 2005.
Operating Expenses
For the twelve months ended December 31, 2005, operating expenses increased
$43.5 million, or 5%, compared to the same period of 2004. Operations and
maintenance expense in 2005 increased $31.2 million, or 5% over 2004 reflecting
an increase of $7.5 million in operating lease costs associated with our
61
financing arrangement for the Ravenswood Expansion, as well as an increase in
overhaul work and plant retirement costs associated with the Ravenswood
Generating Station amounting to approximately $8 million. The remaining increase
reflected operating costs billed to LIPA of approximately $14 million.
Depreciation expense and operating taxes increased $12.3 million in 2005
compared to 2004. Of this amount, approximately $8 million was associated with
KeySpan's Long Island based electric generating units and were fully recoverable
from LIPA, as noted above. The remaining increase in these line items was
associated with the Ravenswood Generating Station.
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. Additionally,
in August 2006, the NYISO included the Melville project in its Reliability
Report as one of the market solutions to help address the long-term reliability
of New York State's electric grid. At December 31, 2006, total capitalized costs
associated with the siting, permitting and procurement of equipment for the
Melville facility were $63.6 million.
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.
62
The table below highlights selected financial information associated with the
Energy Services segment.
- -----------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- -----------------------------------------------------------------------------------------------
Revenues $ 213.0 $ 202.0 $ 193.9
Less: Operating expenses 207.7 204.7 227.8
Goodwill impairment - - 14.4
- -----------------------------------------------------------------------------------------------
Operating Income (Loss) $ 5.3 $ (2.7) $ (48.3)
- -----------------------------------------------------------------------------------------------
Operating Income 2006 vs 2005
The Energy Services segment posted an operating profit of $5.3 million for the
twelve months ended December 31, 2006, compared to an operating loss of $2.7
million incurred during the twelve months ended December 31, 2005. The improved
performance reflects higher operating margins on engineering contracts, as well
as favorable billings under a long-term energy service and energy supply
contract. KeySpan's fiber optic operations realized a benefit to operating
income from an increase in bandwidth sales and the successful completion of
certain projects. Finally, general and administrative expenses were lower in
2006 compared to 2005 as a result of the implementation of cost containment
measures.
Operating Income 2005 vs 2004
In January and February of 2005, KeySpan sold its mechanical contracting
subsidiaries in this segment and exited such businesses. In the fourth quarter
of 2004, KeySpan's investment in its discontinued mechanical contracting
subsidiaries was written-down to an estimated fair value. (See Note 2 to the
Consolidated Financial Statements "Business Segments" for additional details on
the sale of the mechanical companies.)
The Energy Services segment incurred an operating loss of $2.7 million in 2005,
compared to a loss of $48.3 million in 2004. In 2004, KeySpan recorded a
non-cash goodwill impairment charge in continuing operations of $14.4 million as
a result of an evaluation of the carrying value of goodwill recorded in this
segment. That evaluation resulted in a total pre-tax impairment charge of $208.6
million ($152.4 million, or $0.95 per share after-tax) - $14.4 million of this
charge was attributable to continuing operations, while the remaining $194.2
million ($139.9 million after-tax, or $0.87 per share), was reflected in
discontinued operations. (See Note 10 to the Consolidated Financial Statements
"Energy Services - Discontinued Operations" for additional details on this
charge.)
For 2005, the improved performance over 2004, excluding the goodwill impairment
charge, primarily reflected a reduction in operating expenses. In 2004, charges
associated with the write-off of accounts receivable and contract revenues on
certain projects that were determined to be uncollectible, were incurred as well
as the write-down of inventory balances. Further, this segment experienced an
increase in gross profit margins and generally lower administrative costs in
2005.
63
ENERGY INVESTMENTS
The Energy Investments segment consists of our gas production and development
investments, as well as certain other domestic energy-related investments.
KeySpan's gas production and development 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 production and development activities primarily in West Virginia.
KeySpan Exploration is involved in a joint venture with Merit Energy
Corporation, an independent oil and gas producer, which acquired its interest in
the joint-venture from Houston Exploration.
This segment is also engaged in pipeline development activities. KeySpan and
Spectra Energy Corporation (formerly a part of 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 26.25 % interest in the Millennium Pipeline Company LLC, the
developer of the Millennium pipeline project which is expected to have the
capacity to transport up to 525,000 DTH of natural gas a day from Corning, New
York 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.
Selected financial data and operating statistics for these energy-related
investments are set forth in the following table for the periods indicated.
- -----------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- -----------------------------------------------------------------------------------------------------
Revenues $ 40.3 $ 43.0 $ 58.9
Less: Operation and maintenance expense 26.3 26.5 33.5
Ceiling test write-down - - 48.2
Impairment charge - - 26.5
Other operating expenses 11.9 11.1 15.3
Add: Equity earnings 13.1 15.1 25.8
Sale of assets 0.3 0.1 5.0
- -----------------------------------------------------------------------------------------------------
Operating Income (Loss) $ 15.5 $ 20.6 $ (33.8)
- -----------------------------------------------------------------------------------------------------
Operating income above reflects 100% of KeySpan Canada's results from January 1,
2004 through April 1, 2004.
64
Operating Income 2006 vs 2005
For the twelve months ended December 31, 2006, operating income decreased $5.1
million compared to the same period in 2005 due, in part, to lower earnings from
KeySpan's investment in the Iroquois Gas Transmission System. 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. Further, a KeySpan subsidiary engaged in the transportation of
liquefied natural gas realized lower earnings due to the warm weather during the
two winter seasons in calendar year 2006. Finally, comparative equity earnings
were adversely impacted by the sale of Premier Transmission Limited in March
2005.
Operating Income 2005 vs 2004
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 pursuant
to a Share Sale and Purchase Agreement with BG Energy Holdings Limited and
Premier Transmission Financing Public Limited Company ("PTFPL"), under which all
of the outstanding shares of Premier were to be purchased by PTFPL. On March 18,
2005, the sale was completed and generated cash proceeds of $48.1 million. In
the fourth quarter of 2004, KeySpan recorded a pre-tax non-cash impairment
charge of $26.5 million reflecting the difference between the anticipated cash
proceeds from the sale of Premier compared to its carrying value. 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.
During the first quarter of 2004, KeySpan had an approximate 61% investment in
certain midstream natural gas assets in Western Canada through KeySpan Canada.
These assets included 14 processing plants and associated gathering systems that
produced approximately 1.5 BCFe of natural gas daily and provided associated
natural gas liquids fractionation. These operations were fully consolidated in
KeySpan's Consolidated Financial Statements. On April 1, 2004, KeySpan and
KeySpan Facilities Income Fund (the "Fund"), an open-ended income trust which
previously owned a 39% interest in KeySpan Canada, consummated a transaction
that reduced KeySpan's ownership interest in KeySpan Canada to 25%. The
transaction resulted in a gain of $22.8 million ($10.1 million after-tax, or
$0.06 per share). Effective April 1, 2004, KeySpan Canada's earnings and our
ownership interest in KeySpan Canada were accounted for on the equity method of
accounting.
In July 2004, the Fund issued an additional 10.7 million units, the proceeds of
which were used to fund the acquisition of the midstream assets of Chevron
Canada Midstream Inc. This transaction had the effect of further diluting
KeySpan's ownership of KeySpan Canada to 17.4%.
In December 2004, KeySpan sold its remaining 17.4% interest in KeySpan Canada to
the Fund and received net proceeds of approximately $119 million and recorded a
pre-tax gain of $35.8 million, which is reflected in other income and
(deductions) on the Consolidated Statement of Income. The after-tax gain was
approximately $24.7 million, or $0.15 per share. (See Note 2 to the Consolidated
Financial Statements "Business Segments" for additional details regarding this
transaction.)
65
For the twelve months ended December 31, 2005, operating income for this segment
increased $54.4 million compared to the same period of 2004, reflecting non-cash
impairment charges recorded in 2004 of $74.7 million. In 2004, KeySpan's wholly
owned gas production and development subsidiaries that remained with KeySpan
after the transaction with Houston Exploration, discussed below, recorded a
non-cash impairment charge of $48.2 million to recognize the reduced valuation
of proved reserves. (See Note 1 to the Consolidated Financial Statements
"Summary of Significant Accounting Policies" Item F "Gas Production and
Development Property - Depletion" for further information on this charge.)
Further, as mentioned, in 2004 KeySpan recorded a pre-tax non-cash impairment
charge of $26.5 million reflecting the difference between the anticipated cash
proceeds from the sale of Premier compared to its carrying value.
Operating income for the twelve months ended December 31, 2004, also includes
$16.5 million in earnings from KeySpan Canada. The remaining activities
reflected a decrease in operating income of $3.8 million primarily due to the
sale of real property in 2004.
Houston Exploration
Selected financial data and operating statistics for Houston Exploration for
2004 are set forth in the following table.
- --------------------------------------------------------------------
Year Ended
(In Millions of Dollars) December 31, 2004
- --------------------------------------------------------------------
Revenues $ 268.1
Depletion and amortization expense 104.6
Other operating expenses 45.7
Add: Equity Earnings 20.7
- --------------------------------------------------------------------
Operating Income $ 138.5
- --------------------------------------------------------------------
During the first five months of 2004, our gas production and development
investments included a 55% equity interest in Houston Exploration, the
operations of which were consolidated in KeySpan's Consolidated Financial
Statements. On June 2, 2004, KeySpan exchanged 10.8 million shares of common
stock of Houston Exploration for 100% of the stock of Seneca-Upshur, previously
a wholly owned subsidiary of Houston Exploration. This transaction reduced our
interest in Houston Exploration from 55% to 23.5%. Effective June 2, 2004,
Houston Exploration's earnings and our ownership interest in Houston Exploration
were accounted for on the equity method of accounting. KeySpan follows an
accounting policy of income statement recognition for parent company gains or
losses from common stock transactions initiated by its subsidiaries. As a
result, this transaction resulted in a gain to KeySpan of $150.1 million. The
deconsolidation of Houston Exploration required the recognition of certain
deferred taxes on our remaining investment, resulting in a net deferred tax
expense of $44.1 million. Therefore, the net gain on the share exchange less the
deferred tax provision was $106 million, or $0.66 per share.
66
In November 2004, KeySpan sold its remaining 23.5% interest in Houston
Exploration (6.6 million shares) and received cash proceeds of approximately
$369 million. KeySpan recorded a pre-tax gain of $179.6 million which was
reflected in other income and (deductions) on the Consolidated Statement of
Income. The after-tax gain was $116.8 million or $0.73 per share.
Other Matters
In order to serve the anticipated market requirements in our New York service
territories, KeySpan and Spectra Energy Corporation (formerly a part of Duke
Energy Corporation) formed Islander East Pipeline Company, LLC ("Islander East")
in 2000. Islander East is owned 50% by KeySpan and 50% by Spectra Energy
Corporation, 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 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 which 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 by the State of
Connecticut and a decision from that court is pending. Following an appeal filed
by Islander East, the Second Circuit Court of Appeals ruled on October 5, 2006
that, among other things, the Connecticut Department of Environmental Protection
("CTDEP") acted arbitrarily and capriciously in denying the Clean Water Act
permit. The Court remanded the matter to CTDEP to either provide sufficient
evidence to support the denial or otherwise take any action necessary in
furtherance of the development of the project. In December 2006, the CTDEP
issued an order again denying the Clean Water Act permit. Islander East filed a
motion for review with the Second Circuit Court of Appeals, which is pending.
KeySpan anticipates that this pipeline will be in service in late 2008. As of
December 31, 2006, KeySpan's total capitalized costs associated with the siting
and permitting of the Islander East pipeline were approximately $30.3 million.
As noted, KeySpan also owns a 26.25% 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.
("Columbia Transmission"), a unit of NiSource Incorporated and DTE Energy
Company. The Millennium Pipeline project is anticipated to have the capacity 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, subject to certain conditions. On August 1,
2005, the project filed an application to amend the FERC certificate requesting,
among other things, authority to phase in over time the construction of the
proposed pipeline system, 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 Transmission.
In December 2006 the FERC issued an order granting the amended certificate.
Additionally, Consolidated Edison, KEDLI and Columbia Transmission have each
entered into amended precedent agreements to purchase capacity on the pipeline.
67
KEDLI has agreed to purchase 175,000 DTH per day from the Millennium Pipeline
system, increasing to 200,000 DTH in the second 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. Millennium is in the process of
securing all remaining environmental permits, financing and the finalization of
certain agreements prior to actual construction. Subject to the receipt of
remaining permits and financing, Millennium expects that the first phase of the
project will be in service by November 2008. As of December 31, 2006, KeySpan's
investment in the Millennium Pipeline project was $18.2 million
In 2005, KeySpan LNG entered into a precedent agreement with BG LNG Services, a
subsidiary of British Gas, to provide liquefied natural gas terminalling
service. KeySpan LNG proposed to upgrade the liquefied natural gas facility to
accept marine deliveries and to triple vaporization (or regasification) capacity
to provide these services. 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 new construction and safety standards.
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. The
Court is expected 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 April 2005, the
Rhode Island 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 Court stayed the litigation
pending resolution of the FERC appeal process discussed above. As of December
31, 2006, our investment in this project was $18.4 million, a portion of which
may be subject to reimbursement from BG LNG pursuant to the terms of the
precedent 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
68
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,
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 plc, 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 twelve months
ended December 31, 2006, associated with these settlement agreements.
The operating income variation between 2005 and 2004 was due primarily to costs
residing at KeySpan's holding company level such as corporate advertising and
strategic review costs. Further, in 2004 KeySpan reached a settlement with its
insurance carriers regarding cost recovery for expenses incurred at a
non-utility environmental site and recorded an $11.6 million gain from the
settlement as a reduction to operating expenses.
LIQUIDITY
Cash flow from operations increased $655.3 million for the twelve months ended
December 31, 2006 compared to the same period last year primarily due to
favorable working capital requirements of approximately $520 million and lower
income tax payments. The favorable working capital requirements were primarily
driven by receipt of customer payments associated with the 2005 fourth quarter
winter heating season gas sales and lower payments for inventory requirements.
Outstanding accounts receivable balances associated with KeySpan's gas
distribution activities at December 31, 2005 were unusually high due to strong
gas sales in 2005 and high natural gas prices. The collection of these balances
in 2006, and improved collection experience, resulted in a significant cash flow
benefit to KeySpan. Further, due to the impact of the warm weather experienced
during the two winter heating seasons in 2006, KeySpan purchased less natural
gas in 2006 than it did 2005 to refill its inventory supplies. Also, the average
unit price associated with gas purchased for inventory purposes was lower in
2006 compared to 2005. Both of these events had a favorable impact to KeySpan's
cash flows in 2006.
Additionally, KeySpan's income tax payments were $23 million lower during the
twelve months ended December 31, 2006, compared to the same period last year. In
2005, the IRS published new regulations related to the capitalization of costs
of self-constructed property for income tax purposes that were detrimental to
KeySpan. As a result, in 2006 KeySpan adopted a new tax methodology related to
the capitalization of costs of self-constructed property that resulted in lower
income tax payments in 2006 compared to 2005.
Cash flow from operations decreased $346.8 million, or 46%, for the twelve
months ended December 31, 2005 compared to 2004, reflecting, in part, the
absence of Houston Exploration and KeySpan Canada which combined contributed
approximately $230 million to consolidated operating cash flow in 2004. It
should be noted that in prior years, Houston Exploration funded its gas
69
exploration and development activities, in part, from available cash flow from
operations. In addition, due to the significant increase in natural gas prices
in 2005, KeySpan's gas distribution utilities paid approximately $215 million
more in 2005 compared to 2004 for the purchase of natural gas that was put in
inventory. As noted previously, 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 sale to firm customers and gas
costs billed to firm customers are deferred and refunded to or collected from
customers in a subsequent period. Further, in 2005 the IRS published new
regulations related to the capitalization of costs of self-constructed property
for income tax purposes. As a result of these regulations, KeySpan incurred
approximately $77 million in higher income tax payments for the twelve months
ended December 31, 2005 compared to the same period in 2004. These adverse
impacts to cash flow from operations were partially offset by lower interest
payments and higher core earnings.
At December 31, 2006, we had cash and temporary cash investments of $210.9
million. During 2006, we repaid $572.6 million of commercial paper and, at
December 31, 2006, $85.0 million of commercial paper was outstanding at a
weighted-average annualized interest rate of 5.43%. We had the ability to borrow
up to an additional $1.4 billion at December 31, 2006, under the terms of our
credit facility.
KeySpan has two credit facilities which total $1.5 billion - $920 million
available through 2010, and $580 million available 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 KeySpan to borrow using several different types of
loans; specifically, Eurodollar loans, ABR loans, or competitively bid loans.
Eurodollar loans are based on the Eurodollar rate plus a margin that is tied to
our applicable credit ratings. ABR loans are based on the higher of the Prime
Rate, the base CD rate plus 1%, or the Federal Funds Effective Rate plus 0.5%.
Competitive bid loans are based on bid results requested by KeySpan from the
lenders. We do not anticipate borrowing against these facilities; however, if
the credit rating on our commercial paper program were to be downgraded, it may
be necessary to do so.
The facilities contain certain affirmative and negative operating covenants,
including restrictions on KeySpan's ability to mortgage, pledge, encumber or
otherwise subject its utility property to any lien, as well as certain financial
covenants that require us to, among other things, maintain a consolidated
indebtedness to consolidated capitalization ratio of no more than 65% as 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
December 31, 2006, KeySpan's consolidated indebtedness was 49.9% of its
consolidated capitalization and KeySpan was in compliance with all covenants.
70
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 the discussion under the caption "Electric Services - LIPA Agreements" for
information regarding the proposed 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.
CAPITAL EXPENDITURES AND FINANCING
Construction Expenditures
The table below sets forth our construction expenditures by operating segment
for the periods indicated:
- --------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005
- --------------------------------------------------------------------------
Gas Distribution $ 400.5 $ 410.3
Electric Services 78.9 88.8
Energy Investments 18.7 22.6
Energy Services and other 25.9 17.8
- --------------------------------------------------------------------------
$ 524.0 $ 539.5
- --------------------------------------------------------------------------
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.
Construction expenditures for 2007 are estimated to be approximately $570
million, including estimated expenditures for the Islander East and Millennium
pipelines. KeySpan and its partners are currently evaluating various options for
the financing of these projects. The amount of future construction expenditures
is reviewed on an ongoing basis and can be affected by timing, scope and changes
in investment opportunities.
71
Financing
In November 2006, KeySpan issued $400 million Senior Unsecured Notes at KEDNY
and $100 million Senior Unsecured Notes at KEDLI pursuant to a private placement
that was exempt from registration under the Securities Act of 1933. The Notes
bear interest at a rate of 5.60% annually and mature in 2016. The net proceeds
from the issuance of the Notes were used by KEDNY and KEDLI to refinance
existing intercompany indebtedness and for general working capital purposes.
KeySpan utilized a $125 million treasury lock, at 4.77%, to hedge the 5-year US
Treasury component of the underlying notes and a $125 million treasury lock, at
4.82%, to hedge the 10-year US Treasury component of the underlying notes. These
derivative instruments settled on October 25, 2006 at which time KeySpan paid
$0.2 million to the counterparty to the contracts. The loss on the settlement of
these contracts has been deferred for future collection from firm gas sales
customers consistent with regulatory requirements.
KeySpan does not anticipate issuing permanent financing in 2007.
The following table represents the ratings of our long-term debt at December 31,
2006. During the fourth quarter of 2004 Standard & Poor's reaffirmed its ratings
on KeySpan's and its subsidiaries' long-term debt and removed its negative
outlook. Further in the second quarter of 2005, Fitch Ratings revised its
ratings on KeySpan's and its subsidiaries' long-term debt to positive outlook.
Moody's Investor Services, however, continues to maintain its negative outlook
ratings on KeySpan's and its subsidiaries' long-term debt.
- -------------------------------------------------------------------------------
Moody's Investor Standard
Services & Poor's FitchRatings
- -------------------------------------------------------------------------------
KeySpan Corporation A3 A A-
KEDNY N/A A+ A+
KEDLI A2 A+ A
Boston Gas A2 A N/A
Colonial Gas A2 A+ N/A
KeySpan Generation A3 A N/A
- -------------------------------------------------------------------------------
OFF-BALANCE SHEET ARRANGEMENTS
Guarantees
KeySpan had a number of financial guarantees with its subsidiaries at December
31, 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
72
Balance Sheet; the sale/leaseback obligation is not recorded on the Consolidated
Balance Sheet. Further, KeySpan has guaranteed: (i) up to $65.2 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 $64.6
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 7 to the
Consolidated Financial Statements, "Contractual Obligations, Financial
Guarantees and Contingencies" for additional information regarding KeySpan's
guarantees, as well as Note 10 "Energy Services - Discontinued Operations" for
additional information on the discontinued mechanical contracting companies.)
Contractual Obligations
KeySpan has certain contractual obligations related to its outstanding long-term
debt, outstanding credit facility borrowings, outstanding commercial paper
borrowings, various leases, and demand charges associated with certain commodity
purchases. KeySpan's outstanding short-term and long-term debt issuances are
explained in more detail in Note 6 to the Consolidated Financial Statements
"Long-Term Debt and Commercial Paper." KeySpan's leases, as well as its demand
charges are more fully detailed in Note 7 to the Consolidated Financial
Statements "Contractual Obligations, Financial Guarantees and Contingencies."
The table below reflects maturity schedules for KeySpan's contractual
obligations at December 31, 2006. Included in the table is the long-term debt
that has been consolidated as part of the variable interest entity associated
with the Ravenswood Master Lease.
- ---------------------------------------------------------------------------------------------------
(In Millions of Dollars)
Contractual Obligations Total 1 - 3 Years 4 - 5 Years After 5 Years
- ---------------------------------------------------------------------------------------------------
Long-term Debt $ 4,422.9 $ 717.3 $ 1,130.0 $ 2,575.6
Capital Leases 9.8 3.4 2.6 3.8
Operating Leases 549.8 215.1 133.1 201.6
Master Lease Payments 71.2 71.2 - -
Sale/Leaseback Arrangement 549.1 92.0 78.7 378.4
Interest Payments 2,940.7 731.8 350.7 1,858.2
Demand Charges 449.0 449.0 - -
- ---------------------------------------------------------------------------------------------------
Total Contractual
Cash Obligations $ 8,992.5 $ 2,279.8 $ 1,695.1 $ 5,017.6
- ---------------------------------------------------------------------------------------------------
Commercial Paper $ 85.0 Revolving
- ---------------------------------------------------------------------------------------------------
73
For information regarding projected postretirement contributions, see Note 4 to
the Consolidated Financial Statements "Postretirement Benefits." For information
regarding asset retirement obligations, see Note 7 to the Consolidated Financial
Statements "Contractual Obligations, Financial Guarantees and Contingencies."
DISCUSSION 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. The critical
accounting policies requiring such subjectivity are discussed below.
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 Standard ("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.
As prescribed in SFAS 142, KeySpan is required to compare the fair value of a
reporting unit to its carrying amount, including goodwill. This evaluation is
required to be performed at least annually, unless facts and circumstances
indicate that the evaluation should be performed at an interim period during the
year. At December 31, 2006, KeySpan had $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.
As noted previously, during 2004, KeySpan conducted an evaluation of the
carrying value of goodwill recorded in its Energy Services segment. As a result
of this evaluation, KeySpan recorded a non-cash goodwill impairment charge of
$108.3 million ($80.3 million after tax, or $0.50 per share) in 2004. This
charge was recorded as follows: (i) $14.4 million as an operating expense on the
Consolidated Statement of Income reflecting the write-down of goodwill on the
Energy Services segment's continuing operations; and (ii) $93.9 million as
discontinued operations reflecting the impairment on the mechanical contracting
companies. (See Note 10 to the Consolidated Financial Statements "Energy
Services-Discontinued Operations" for further details.)
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Also as noted previously, at the end of 2004, KeySpan anticipated selling its
then 50% interest in Premier. This investment was accounted for under the equity
method of accounting in the Energy Investments segment. In the fourth quarter of
2004 KeySpan recorded a pre-tax non-cash impairment charge of $26.5 million -
$18.8 million after-tax or $0.12 per share. The impairment charge reflected the
difference between the anticipated cash proceeds from the sale of Premier
compared to its carrying value at that time and was recorded as a reduction to
goodwill.
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 and
EnergyNorth Natural Gas Inc.) are subject to the provisions of SFAS 71,
"Accounting for the Effects of Certain Types of Regulation." This statement
recognizes the actions of regulators, through the ratemaking process, to create
future economic benefits and obligations affecting rate-regulated companies.
In separate orders issued by the MADTE relating to the acquisition by Eastern
Enterprises of Colonial Gas Company and Essex Gas Company, the base rates
charged by these companies have been frozen at their current levels for a
ten-year period ending 2009 and 2008 respectively. Due to the length of these
base rate freezes, Colonial Gas Company and Essex Gas Company had previously
discontinued the application of SFAS 71.
SFAS 71 allows for the deferral of expenses and income on the Consolidated
Balance Sheet as regulatory assets and liabilities when it is probable that
those expenses and income will be allowed in the rate setting process in a
period different from the period in which they would have been reflected in the
consolidated statements of income of an unregulated company. These deferred
regulatory assets and liabilities are then recognized in the Consolidated
Statement of Income in the period in which the amounts are reflected in rates.
In the event that regulation significantly changes the opportunity for us to
recover costs in the future, all or a portion of our regulated operations may no
longer meet the criteria for the application of SFAS 71. In that event, a
write-down of our existing regulatory assets and liabilities could result. If we
were unable to continue to apply the provisions of SFAS 71 for any of our rate
regulated subsidiaries, we would apply the provisions of SFAS 101 "Regulated
Enterprises - Accounting for the Discontinuation of Application of FASB
Statement No. 71." We estimate that the write-off of our net regulatory assets
at December 31, 2006, before consideration of removal cost recovered, could
result in a charge to net income of approximately $630.4 million or $3.60 per
share, which would be classified as an extraordinary item. In management's
opinion, our regulated subsidiaries that currently are subject to the provisions
of SFAS 71 will continue to be subject to SFAS 71 for the foreseeable future.
As is further discussed under the caption "Regulation and Rate Matters," in
October 2003 the MADTE rendered its decision on the Boston Gas base rate case
and Performance Based Rate Plan proposal submitted to the MADTE in April 2003.
The rate plans previously in effect for KEDNY and KEDLI have expired and the
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rates established in those plans remain in effect. EnergyNorth Natural Gas
Inc.'s base rates continue as set by the NHPUC in 1993. 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 plc Merger,
KeySpan has filed proposed rate plans for KEDNY and KEDLI with the NYPSC. In
addition, individual applications for a proposed annual increase in revenues for
KEDNY and KEDLI were filed. 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
As discussed in Note 4 to the Consolidated Financial Statements, "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 expected results are amortized
to expense over ten years.
Certain gas distribution subsidiaries are subject to SFAS 71, and, as a result,
changes in postretirement expenses are deferred for future recovery from or
refund to gas sales customers. (However, KEDNY, although subject to SFAS 71,
does not have a recovery mechanism in place for changes in postretirement
costs.) Further, changes in postretirement expenses associated with subsidiaries
that service the LIPA Agreements are also deferred for future recovery from or
refund to LIPA.
For 2006, the assumed long-term rate of return on our postretirement plans'
assets was 8.5% (pre-tax), net of expenses. This is an appropriate long-term
expected rate of return on assets based on KeySpan's investment strategy, asset
allocation and the historical performance of equity and fixed income investments
over long periods of time. The actual 10 year compound annual rate of return for
the KeySpan Plans is greater than 8.5%.
KeySpan's master trust investment allocation policy target is 70% equity and 30%
fixed income. At December 31, 2006, the actual investment allocation was in line
with the target. In an effort to maximize plan performance, actual asset
allocation will fluctuate from year to year depending on the then current
economic environment.
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Based on the results of an asset and liability study projecting asset returns
and expected benefit payments over a 10-year period, KeySpan has developed a
multiyear funding strategy for its postretirement plans. KeySpan believes that
it is reasonable to assume assets can achieve or outperform the assumed
long-term rate of return with the target allocation as a result of historical
performance of equity investments over long-term periods.
A 25 basis point increase or decrease in the assumed long-term rate of return on
plan assets would have impacted 2006 expense by approximately $6 million, before
deferrals.
The year-end December 31, 2006 assumed discount rate used to determine
postretirement obligations was 6.00%. Our discount rate assumption is based upon
the Citigroup above-median pension discount curve. A 25 basis point increase or
decrease in the assumed year-end discount rate would have had no impact on 2006
expense. A year-end discount rate of 5.75% would have required an additional
$144 million increase to the pension and other postretirement reserve balance
and a debit to accumulated other comprehensive income before taxes and
deferrals.
At January 1, 2006, the assumed discount rate used to determine postretirement
obligations was 5.75%. A 25 basis point increase or decrease in the assumed
discount rate at the beginning of the year would have impacted 2006 expense by
approximately $16 million, before deferrals.
Our health care cost trend assumptions are developed based on historical cost
data, the near-term outlook and an assessment of likely long-term trends. The
salary growth assumptions reflect our long-term outlook.
Historically, we have funded our qualified pension plans in excess of the amount
required to satisfy minimum ERISA funding requirements. At December 31, 2006, we
had a funding credit balance in excess of the ERISA minimum funding requirements
and as a result KeySpan was not required to make any contributions to its
qualified pension plans in 2006. Although the KeySpan qualified pension and
other postretirement plans were not required to make a contribution in 2006, the
pension plans are under-funded on a projected benefit obligation basis. During
2006, KeySpan contributed $131 million to its postretirement plans.
The Pension Protection Act of 2006 was passed in August 2006 and provided a
comprehensive overhaul of pension funding rules. KeySpan will implement several
pension plan changes effective January 2008 based on the new requirements.
During 2006, KeySpan performed a stochastic projection analyses of its pension
plan's assets and liabilities and concluded, at the 50% percentile, that its
current funding policy is sufficient for existing ERISA rules and will meet the
requirements of the Pension Protection Act of 2006 for approximately the next
ten years.
For 2007, KeySpan expects to contribute approximately $131 million to its funded
and under funded post-retirement plans. Future funding requirements are heavily
dependent on actual return on plan assets and prevailing interest rates.
Valuation of Derivative Instruments
We employ derivative instruments to hedge a portion of our exposure to commodity
price risk and interest rate risk, to partially hedge the cash flow variability
associated with our electric energy sales from the Ravenswood Generation
Station, as well as to economically hedge certain other commodity exposures.
For those derivative instruments designated as cash flow hedges, changes in the
market value are recorded in accumulated other comprehensive income, (in line
with effectiveness measurements) and are not recorded through earnings until the
derivative positions are settled. With respect to those derivative instruments
that are not designated as hedging instruments, such derivatives are accounted
for on the Consolidated Balance Sheet at fair value, with all changes in fair
value reported in earnings.
When available, quoted market prices are used to record a contract's fair value.
However, market values for certain derivative contracts may not be readily
available or determinable. A number of our commodity related derivative
instruments are exchange traded and, accordingly, fair value measurements are
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based on available quotes. Additionally, we use market quoted forward prices for
commodities that are not exchange traded, such as No. 6 grade fuel oil and
electric power swaps. The fair value of our electric capacity hedge is based on
published NYISO capacity bidding prices. Further, if no active market exists for
a commodity, fair values may be based on pricing models.
SFAS 133 establishes criteria that must be satisfied in order for forward
contracts for the physical delivery of commodities to qualify for the normal
purchases and sales exception. Those contracts that qualify for the normal
purchase and sale exception, and where the exception has been elected, are not
recognized in the financial statements until settlement. The distinguishing
characteristics between contracts that qualify for the normal purchases and
sales exception and those that do not are, at times, subjective and require
judgment.
All fair value measurements, whether calculated using available quotes or other
valuation techniques, are subjective and subject to fluctuations in commodity
prices, interest rates and overall economic market conditions and, as a result,
our fair value measurements may not be precise and can fluctuate significantly
from period to period.
DIVIDENDS
KeySpan's annual dividend rate for 2007 is $1.90 per common share. Our dividend
framework is reviewed annually by the Board of Directors. The amount and timing
of all dividend payments is subject to the discretion of the Board of Directors
and will depend upon business conditions, results of operations, financial
conditions and other factors. Based on currently foreseeable market conditions,
we intend to maintain the annual dividend at the $1.90 level.
Pursuant to NYPSC orders, the ability of KEDNY and KEDLI to pay dividends to
KeySpan is conditioned upon maintenance of a utility capital structure with debt
not exceeding 55% and 58%, respectively, of total utility capitalization. In
addition, the level of dividends paid by both utilities may not be increased
from current levels if a 40 basis point penalty is incurred under the customer
service performance program. At the end of KEDNY's and KEDLI's most recent rate
years (September 30, 2006 and November 30, 2006, respectively), each company was
in compliance with the utility capital structure required by the NYPSC.
Additionally, we have met the requisite customer service performance standards.
REGULATION AND RATE MATTERS
Gas Distribution
On September 30, 2002, KEDNY's rate agreement with the NYPSC expired. Under the
terms of the agreement, the then current gas distribution rates and all other
provisions, including the earnings sharing provision (at a 13.25% return on
equity), remain in effect until changed by the NYPSC. Under the agreement, KEDNY
is subject to an earnings sharing provision pursuant to which it is required to
credit firm customers with 60% of any utility earnings up to 100 basis points
above a 13.25% return on equity (other than any earnings associated with
discrete incentives) and 50% of any utility earnings in excess of 100 basis
points above such threshold level. KEDNY did not earn above a 13.25% return on
equity in its rate year ended September 30, 2006.
On November 30, 2000, KEDLI's rate agreement with the NYPSC expired. Under the
terms of the agreement, the then current gas distribution rates and all other
provisions, including the earnings sharing provision, remain in effect until
changed by the NYPSC. Under the agreement, KEDLI is subject to an earnings
sharing provision pursuant to which it is required to credit to firm customers
60% of any utility earnings for any rate year ended November 30, up to 100 basis
points above a return on equity of 11.10% and 50% of any utility earnings in
excess of a return on equity of 12.10%. KEDLI did not earn above an 11.10%
return on equity in its rate year ended November 30, 2006.
KeySpan has recently filed proposed rate plans for KEDNY and KEDLI with the
NYPSC as part of its application for approval of the KeySpan / National Grid plc
Merger, as well as individual applications for a proposed annual increase in
revenues for KEDNY and KEDLI. See the "Introduction to the Notes to the
Consolidated Financial Statements" for additional details on the filings.
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Boston Gas, Colonial Gas and Essex Gas operations are subject to Massachusetts'
statutes applicable to gas utilities. Rates for gas sales and transportation
service, distribution safety practices, issuance of securities and affiliate
transactions are regulated by the MADTE.
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, 2006, the MADTE approved a base rate
increase of $8.6 million under the Plan. In addition, an increase of $2.7
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 the Boston Gas 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 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 Natural Gas Inc.'s 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 was 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. Both of these
favorable recovery mechanisms were reflected in our December 31, 2005 Allowance
for Doubtful Accounts reserve requirement and related expense. On October 31,
2006, the MADTE granted Boston Gas recovery of $12 million of the 2005 gas cost
component of bad debt write-offs from Boston Gas ratepayers beginning November
1, 2006. This amount is being recovered through the cost-of-gas adjustment
clause.
Electric Rate 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%. The FERC approved updated operating and maintenance expense
levels and recovery of certain other costs as agreed to by the parties.
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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. (See Electric Services -
"LIPA Agreements" for a discussion of the 2006 settlement between KeySpan and
LIPA regarding the current contractual 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 of the United Sates of America.
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.
Electric Services - LIPA Agreements
LIPA is a corporate municipal instrumentality and a political subdivision of the
State of New York. On May 28, 1998, certain of 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 system ("T&D
System") pursuant to the 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 the Power Supply
Agreement (the "1998 PSA") and other 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
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facilities, as well as all aspects of the capacity and energy owned by or under
contract to LIPA pursuant to the 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. The
2006 LIPA Agreements will become effective following approval by the New York
State Comptroller's Office and the New York State Attorney General.
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 results from the recent settlement with the
IRS regarding the audit of LILCO's tax returns for the years ended December 31,
1996 through March 31, 1999. On October 30, 2006, the IRS submitted the
settlement provisions of the recently concluded IRS audit to the Joint Committee
on Taxation for approval. Key provisions of the settlement included the
resolution of the tax basis of assets transferred to KeySpan at the time of the
KeySpan/LILCO merger, the tax deductibility of certain merger related costs and
the tax deductibility of certain environmental expenditures. The settlement
enabled KeySpan to utilize 100% of the available tax credits. (See Note 3 to the
Consolidated Financial Statements "Income Taxes" for additional information of
the settlement.) In recognition of these items, as well as for the modification
and extension of the 1998 MSA and the amendments to the GPRA, upon effectiveness
of the 2006 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 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 $90 million due from LIPA.
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Generation Purchase Rights Agreement and 2006 Option Agreement. Under the
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 had 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. In December 2006, KeySpan and LIPA entered into an
amendment to the 2006 Option Agreement whereby the parties agreed to extend the
expiration of the option period to the later of (i) December 31, 2007 or (ii)
180 days following the effective date of the 2006 Option Agreement. The 2006
Option Agreement replaces the GPRA, the expiration of which has been stayed
pending effectiveness of the 2006 LIPA Agreements. In the event such agreements
do not become effective by reason of failure to secure any of the requisite
governmental approvals, the GPRA will be reinstated for a period of 90 days from
the date such approval is denied. If LIPA were to exercise the option and
purchase one or both of the generation facilities then: (i) LIPA and KeySpan
will enter into an operation and maintenance agreement, pursuant to which
KeySpan will continue to operate these facilities through May 28, 2013 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.
Management Services Agreements. Pursuant to the 1998 MSA, KeySpan manages the
day-to-day operations, maintenance and capital improvements of the T&D System.
When originally executed, the 1998 MSA had a term expiring on May 28, 2006. In
2002, in connection with an extension of the GPRA term, the 1998 MSA was
extended for 31 months through 2008. As a result of the recent negotiations and
settlement between KeySpan and LIPA discussed above, the parties entered into
the 2006 MSA.
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.
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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, conservation
expenditures and storm costs.
The 2006 MSA provides for a number of performance metrics measuring various
aspects of KeySpan's performance in the operations and customer service areas.
Poor performance in any metric may subject KeySpan to financial and other
non-cost penalties (such financial penalties not to exceed $7 million in the
aggregate for all performance metrics in any contract year). Subject to certain
limitations, superior performance in certain metrics can be used to offset
underperformance in other metrics. Consistent failure to meet threshold
performance levels for two metrics, System Average Interruption Duration Index
(two out of three consecutive years) and Customer Satisfaction Index (three
consecutive years), will constitute an event of default under the 2006 MSA.
In the event LIPA sells the T&D System to a private entity during the term of
the 2006 MSA, LIPA shall have the right to terminate the 2006 MSA, provided that
LIPA will be required to pay KeySpan's reasonable transition costs and a
termination fee of (a) $28 million if the termination date occurs on or before
December 31, 2009, and (b) $20 million if the termination date occurs after
December 31, 2009.
Upon approval, the 2006 LIPA Agreements will be effective retroactive to January
1, 2006. KeySpan's reported operating income and net income for 2006, under the
2006 MSA, are substantially the same as they would have been if the terms and
provisions of the 1998 MSA had continued to be applied. At this point in time,
KeySpan is unable to estimate what the impact would be to its results of
operations, financial position and cash flows if the 2006 LIPA Agreements do not
become fully effective.
Power Supply Agreements. 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. Since October 1, 2004,
pursuant to a FERC approved settlement, the rates reflect a cost of equity of
9.5%. The FERC also approved updated operating and maintenance expense levels
and KeySpan's recovery of certain other costs as agreed to by the parties. Rates
charged to LIPA include a fixed and variable component. The variable component
is billed to LIPA on a monthly per megawatt hour basis and is dependent on the
number of megawatt hours dispatched. LIPA has no obligation to purchase energy
conversion services from KeySpan and is able to purchase energy or energy
conversion services on a least-cost basis from all available sources consistent
with existing interconnection limitations of the T&D System. The 1998 PSA
provides incentives and penalties that can total $4 million annually for the
maintenance of the output capability and the efficiency of the generating
facilities. In 2006, we earned $4.0 million in incentives under this agreement.
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The 1998 PSA has a term of fifteen years through May 2013, with LIPA having the
option to renew the 1998 PSA for an additional fifteen year term. If the 2006
LIPA Agreements receive the requisite governmental approvals and become
effective and if LIPA exercises its rights under the 2006 Option Agreement to
purchase the two generating plants, then 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 the 1998 PSA will be amended to reflect that the purchased
generating facilities would no longer be covered by the 1998 PSA. 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.
Energy Management Agreement. The 1998 EMA provides for KeySpan to procure and
manage fuel supplies on behalf of LIPA to fuel the generating facilities under
contract to it and perform off-system capacity and energy purchases on a
least-cost basis to meet LIPA's needs. In exchange for these services we earn an
annual fee of $1.5 million. In addition, we arrange for off-system sales on
behalf of LIPA of excess output from the generating facilities and other power
supplies either owned or under contract to LIPA. LIPA is entitled to two-thirds
of the profit from any off-system energy sales. In addition, the 1998 EMA
provides incentives and penalties that can total $5 million annually for
performance related to fuel purchases and off-system power purchases. In 2006,
we earned EMA incentives in an aggregate of $5.0 million.
The original term for the fuel supply service is fifteen years, expiring May 28,
2013, and the original term for the power supply management services described
was eight years, which expired on May 28, 2006. In March 2005, LIPA issued a
Request for Proposal ("RFP") for system power supply management services
beginning May 29, 2006 and fuel management services for certain of its peaking
generating units beginning January 1, 2006. KeySpan submitted a bid in response
to this RFP in April 2005. LIPA has not yet selected a service provider.
In 2005, the EMA was amended to extend the term for power supply management
services through December 31, 2006 and thereafter on a month-to-month basis,
unless terminated by LIPA on sixty days notice, but in no event later than
December 31, 2007.
In the event LIPA exercises its rights under the 2006 Option Agreement, KeySpan
and LIPA will enter into an amendment to the 1998 EMA reflecting that the
facilities that LIPA acquires pursuant to the Option Agreement are no longer
covered under the 1998 EMA and as noted above, an operation and maintenance
agreement, whereby KeySpan will continue to operate the newly acquired
facilities for a fixed management fee plus reimbursement for certain costs. It
is anticipated that the fees received pursuant to the operation and maintenance
agreement will offset the reduction in any fees earned by KeySpan pursuant to
the 1998 EMA.
Under the 1998 LIPA Agreements and the 2006 LIPA Agreements, we are required to
obtain a letter of credit in the aggregate amount of $60 million supporting our
obligations to provide the various services if our long-term debt is not rated
in the "A" range by a nationally recognized rating agency.
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Power Purchase Agreements. KeySpan-Glenwood Energy Center, LLC and KeySpan-Port
Jefferson Energy Center LLC each have 25 year power purchase agreements with
LIPA expiring in 2027 (the "2002 LIPA PPAs"). Under the terms of the 2002 LIPA
PPAs, these subsidiaries sell capacity, energy conversion services and ancillary
services to LIPA. Each plant is designed to produce 79.9 MW. Pursuant to the
2002 LIPA PPAs, LIPA pays a monthly capacity fee, which guarantees full recovery
of each plant's construction costs, as well as an appropriate rate of return on
investment.
Ravenswood Generating Station
We currently sell capacity, energy and ancillary services associated with the
Ravenswood Generating Station through a bidding process into the NYISO energy
and capacity markets. Energy is sold on both a day-ahead and a real-time basis.
We also have the ability to enter into bilateral transactions to sell all or a
portion of the energy produced by the Ravenswood Generating Station to load
serving entities, i.e. entities that sell to end-users or to brokers and
marketers.
Other Contingencies
In 2005, 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 were
discussed above. Following the announcement of the proposed acquisition of
KeySpan by National Grid plc, LIPA, National Grid plc 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, such discussions may
have on the 2006 LIPA Agreements and the receipt and timing of governmental
approvals relating thereto.
Pursuant to indemnity obligations contained in the LILCO / KeySpan Merger
Agreement, KeySpan had been in discussions with the IRS with regard to 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. All outstanding issues were
resolved in 2006. The IRS submitted the case to the Joint Committee on Taxation
on October 30, 2006 for final approval. Additionally, the IRS recently commenced
the examination of KeySpan's tax returns for the years ended 2002 and 2003. At
this time, we cannot predict the result of these audits. (See Note 3 to the
Consolidated Financial Statements "Income Taxes" for additional information.)
85
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 $361.1 million and we have recorded a related liability
for such amount. We have also recorded an additional $11.4 million liability,
representing the estimated environmental cleanup costs related to a former coal
tar processing facility. As of December 31, 2006, we have expended a total of
$225.3 million on environmental investigation and remediation activities. (See
Note 7 to the Consolidated Financial Statements, "Contractual Obligations,
Guarantees and Contingencies" for a further explanation of these matters.)
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.
86
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 THE COMPETITIVE ENVIRONMENT
We are subject to various other risk exposures and uncertainties associated with
our gas and electric operations. Set forth below is a description of these
exposures.
The Gas Industry
New York and Long Island
- ------------------------
For the last several years, the NYPSC has been monitoring the progress of
competition in the energy market. Based upon its findings of the current market
and its stated desire to move toward fully competitive markets, the NYPSC, in
August 2004, issued companion policy statements regarding its vision for the
future of competitive markets and guidelines for separately stating the cost of
competitive services currently performed by New York utilities. In the first of
these policy statements the NYPSC provided its vision for the future of
competitive markets and required, among other items, that utilities' future rate
filings must include plans for facilitating customer migration to competitive
markets and fully embedded cost of service studies that develop unbundled rates
for the utilities' delivery service and all potentially competitive services.
The NYPSC's second policy statement of August 2004 addressed the means by which
New York utilities should state separately, or "unbundle," the costs of
competitive and potentially competitive services currently performed by
utilities from the cost of providing local distribution service. The objective
of unbundling is to facilitate competition by providing customers with
information as to savings available from purchasing competitive services from
third-party providers, and to credit the customer's utility bill for the cost of
unbundled services when they migrate to competitive suppliers. In its unbundling
policy statement, the NYPSC directed utilities to file with their next base rate
proceedings updated cost studies for unbundled competitive services that, once
approved by the NYPSC, would replace existing backout credits for these services
established in prior proceedings. The NYPSC also asked utilities to file with
87
the unbundled cost studies a lost revenue recovery mechanism that would permit
the utility to recover revenue associated with the difference between the cost
the utility is able to avoid when a customer migrates to a competitive service
provider and the unbundled rate for that service credited to the customer's
bill.
In their individual rate cases filed on October 3, 2006, KEDNY and KEDLI filed
proposed new unbundled rates. The proposed unbundled supply rates were $0.58/dth
and $0.22/dth for KEDNY and KEDLI, respectively, which would replace their
current supply function backout credits of $0.21/dth and $0.19/dth. The proposed
unbundled billing and payment processing rates are $0.76 per account, per month
and $0.65 per account, per month for KEDNY and KEDLI, respectively, which would
replace their current billing backout credits, both of which are set at $0.78
per account, per month. Pursuant to a May 2001 Order of the NYSPSC, customers
that purchase commodity service from third-party providers and receive a
consolidated bill from the utility receive a credit on their utility bills for
the unbundled billing rate. The utility then invoices the third-party commodity
provider for the billing service at the same unbundled billing rate credited to
the customer's utility bill, which eliminates the risk of lost revenue. In
contrast, there is a risk of lost revenue with respect to the unbundled supply
rates if KEDNY and KEDLI are not able to avoid costs, such as credit and
collections and promotional advertising expense, at the same pace as these costs
are credited to customers who migrate to competitive gas suppliers. KEDNY and
KEDLI proposed to recover any such revenue loss through their respective
balancing accounts. KEDNY and KEDLI made the same proposals for new unbundled
rates and lost revenue recovery mechanisms in the rate plans filed with the
joint petition with National Grid plc on July 20, 2006.
New England
- -----------
In February 1999, the MADTE issued its order on unbundling of natural gas
service. For a five year transition period, the MADTE determined that
contractual commitments with local distribution companies ("LDCs") to upstream
capacity would be assigned on a mandatory, pro-rata basis to marketers selling
gas supply to the LDCs' customers. The approved mandatory assignment method
eliminates the possibility that the costs of upstream capacity purchased by the
LDCs to serve firm customers will be absorbed by the LDC or other customers
through the transition period. The MADTE also found that, through the transition
period, LDCs would retain primary responsibility for upstream capacity planning
and procurement to assure that adequate capacity is available to support
customer requirements and growth. Since November 1, 2000, all Massachusetts gas
customers have the option to purchase their gas supplies from third party
sources other than the LDCs.
In January 2004, the MADTE began a proceeding to re-examine whether the upstream
capacity market has been sufficiently competitive to allow voluntary capacity
assignment. On June 6, 2005, the MADTE issued an order in its continuing
investigation into gas unbundling and found that mandatory capacity assignment
should be continued.
Beginning on November 1, 2001, the NHPUC has required gas utilities to offer
transportation only services to all commercial and residential customers. The
New Hampshire unbundling program provides for mandatory capacity assignment
similar to the Massachusetts rules.
88
In September 2006, Boston Gas filed its third annual Performance Based Rate
("PBR") compliance in accordance with the PBR rate plan approved by the MADTE.
In October, 2006, the DTE issued an order that (1) allowed the Boston Gas
proposed inflation-based increase of 2.72% or $8.6 million, (2) allowed
exogenous cost recovery of $12 million in bad debt expense through the cost of
gas adjustment clause and (3) disallowed an exogenous cost recovery request
related to new gate box maintenance requirements pursuant to Massachusetts law.
In November, 2006, Boston Gas filed a motion for reconsideration of the
exogenous cost decisions along with a motion to extend the time for filing an
appeal to the Massachusetts Supreme Judicial Court. The MADTE has not ruled on
the Boston Gas motion.
Electric Industry
10-Minute Spinning and Non-Spinning Reserves
- --------------------------------------------
Due to the volatility in the market clearing price of 10-minute spinning and
non-spinning reserves during the first quarter of 2000, the NYISO requested that
FERC approve a bid cap on such reserves, as well as requiring a refunding of so
called alleged "excess payments" received by sellers, including the Ravenswood
Facility. On May 31, 2000, FERC issued an order that granted approval of a $2.52
per MWh bid cap for 10-minute non-spinning reserves, plus payments for the
opportunity cost of not making energy sales. The NYISO's other requests, such as
a bid cap for spinning reserves, retroactive refunds, recalculation of reserve
prices, etc., were rejected.
The NYISO, The Consolidated Edison Company of New York ("Con Edison"), Niagara
Mohawk Power Corporation and Rochester Gas and Electric each individually
appealed FERC's order in federal court. The appeals were consolidated into one
case and on November 7, 2003, the United States Court of Appeals for the
District of Columbia (the "Court") issued its decision in the case of
Consolidated Edison Company of New York, Inc., v. Federal Energy Regulatory
Commission (the "Decision"). Essentially, the Court found errors in FERC's order
and remanded some issues back to FERC for further explanation and action.
On June 25, 2004, the NYISO submitted a motion to FERC seeking refunds as a
result of the Decision. KeySpan and others submitted statements of opposition
opposing the refunds. On March 4, 2005, FERC issued an order upholding its
original decision not to order refunds. FERC also provided the further
explanation requested by the Court as to why refunds were not being ordered. The
NYISO and various New York Transmission Owners requested rehearing of FERC's
latest order and on November 17, 2005, FERC denied those requests. The NYISO and
various New York Transmission Owners appealed FERC's November 17, 2005 order to
the United States Court of Appeals for the District of Columbia.
On September 25, 2006, the Court issued a briefing schedule, which was revised
on November 1, 2006. The NYISO and various New York Transmission Owners filed
their brief on December 11, 2006. FERC filed its response on February 9, 2007,
and KeySpan will file its brief on February 26, 2007.
89
The Ravenswood Generating Station and our 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%.
Our Ravenswood Generating Station is an "in-City" generator. As the electric
infrastructure in New York City and the surrounding areas continues to change
and evolve and the demand for electric power increases, the "in-City" generator
requirement could be further modified. Construction of new transmission and
generation facilities may cause significant changes to the market for sales of
capacity, energy and ancillary services from our Ravenswood Generating Station.
Approximately, 1000 MW of additional capacity came on line in 2006. We can not
be certain as to the nature of future New York City energy, capacity or
ancillary services market requirements or design.
NYISO In-City Capacity Mitigation
- ---------------------------------
The NYPSC, Con Edison and other load serving entities ("LSEs") complained to the
NYISO that in-City capacity market clearing prices during the summer of 2006 did
not decline as they had expected with the introduction of additional supply in
the New York City market. The NYISO issued a letter to FERC indicating that no
tariff violations occurred and that prices were as it expected. Nevertheless,
the NYISO stated that if changes to the market are warranted, the NYISO would
consider making revisions as necessary.
Accordingly, the NYPSC and Con Edison developed additional mitigation measures
that would apply to certain in-City generation owned by KeySpan. These
mitigation measures essentially would reduce the capacity offer cap on bids by
the Ravenswood Generating Station and certain other generation owners of
capacity into the NYISO Spot Demand Curve Auction Market. The current offer cap
is $105/kW-year and is proposed to be reduced to $82/kW-year plus 3%.
90
The reduced offer cap would be implemented using a conduct and impact test on
the offers of capacity from the Ravenswood Generating Station and other owners
of Consolidated Edison divested generation units. Under the proposal, if an
offer to sell capacity is 3% or more above $82/kW-year, then the offer is
subject to possible mitigation. To determine if mitigation will be applied, a
second test, an impact test, is utilized. If the unmitigated offer raises the
total market cost of capacity by 3% or more as compared to the total cost of
capacity derived using those generators' $82/kW-year reference bid, then the
offer will be mitigated to $82/kW-year.
The NYISO's Management Committee and NYISO's Board of Directors approved the
above proposal, notwithstanding KeySpan's analysis and objections. The NYISO
filed the mitigation measures with the FERC for approval. KeySpan intervened and
protested the filing, which is pending at FERC. At this time, we are unable to
predict the outcome of this proceeding and what effect it will have on our
financial condition, results of operations, and cash flows. However, adoption
and implementation of the proposal in its current form could materially
adversely affect the revenue realized by KeySpan from the sale of capacity from
the Ravenswood Generating Station, as well as the potential revenue that could
be realized in connection with the fixed for floating financial Swap Agreement.
NYISO May 2006 In-City Capacity Market Error
- --------------------------------------------
On December 1, 2006, the NYISO filed a complaint against SCS/Astoria Energy LLC
("Astoria"), an in-City electric generating unit, alleging that it did not
follow the NYISO tariff rules related to the certification and sale of capacity
in relation to its auctions for the sale of capacity to the NYISO market. As a
result, a certain amount of capacity that was sold in the May 2006 auctions was
determined by the NYISO to be ineligible. In its complaint, the NYISO proposes
to impose a deficiency charge against Astoria for the improperly-certified
capacity. The NYISO could then award additional capacity payments to another
in-City supplier (including the Ravenswood Generating Station) because that
supplier would have sold additional capacity if not for for the Astoria
discrepancy. A decision by the FERC is pending.
Summer 2002 Capacity Under procurement Complaint
- ------------------------------------------------
On January 12, 2007, the Court of Appeals for the District of Columbia Circuit
("Court") issued its decision related to a KeySpan complaint against the NYISO
related to capacity procurement activities during the summer of 2002. KeySpan
had complained to FERC that the NYISO violated its tariff and as a result
received $23.3 million less than it would have if the NYISO had followed the
tariff. The Court vacated rulings by the FERC that denied KeySpan's complaint.
The Court determined that the NYISO did in fact violate its tariff but remanded
two issues back to the FERC for further consideration. The two issues relate to
whether FERC should grant KeySpan's requested relief for the tariff violation.
At this time, we are unable to predict the outcome of this proceeding and what
effect it will have on KeySpan's results of operations, financial position and
cash flows.
91
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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
production and development 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 when
economically appropriate to do so. Seneca-Upshur utilizes OTC natural gas swaps
to hedge cash flow variability associated with forecasted sales of natural gas.
Commodity Derivative Instruments that are not Accounted for as Hedges: The
Ravenswood Generating Station uses derivative financial instruments to
financially 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 financially hedges the cash
flow variability associated with a portion of electric energy sales using OTC
electricity swaps. KeySpan has also, 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.
The following tables set forth selected financial data associated with these
derivative financial instruments that were outstanding at December 31, 2006.
- ----------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Current Fair Value
Type of Contract Maturity (mmcf) Price($) Price($) ($Millions)
- ----------------------------------------------------------------------------------------------------------------------
Gas
Swaps/Futures - Long Natural Gas 2007 8,565 7.68 - 11.94 5.84 - 7.93 (17.3)
2008 670 9.08 - 9.82 7.45 - 8.90 (0.5)
OTC Swaps - Short Natural Gas 2007 1,770 5.86 - 5.97 5.84 - 8.56 (2.3)
2008 1,614 6.77 - 6.85 7.45 - 8.90 (2.5)
2009 1,314 7.60 - 10.90 7.21 - 8.89 0.9
Optimization Contract 2007 - - - 1.4
- ----------------------------------------------------------------------------------------------------------------------
13,933 (20.3)
- ----------------------------------------------------------------------------------------------------------------------
92
- ----------------------------------------------------------------------------------------------------------------------
Year of Volumes Fixed Current Fair Value
Type of Contract Maturity (Barrels) Price($) Price($) ($Millions)
- ----------------------------------------------------------------------------------------------------------------------
Oil
Swaps - Long Fuel Oil 2007 726,708 50.35 - 69.08 45.74 - 57.11 (6.9)
2008 59,123 60.00 - 67.60 57.11 (0.5)
- ----------------------------------------------------------------------------------------------------------------------
785,831 (7.4)
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Year of Fixed Current Fair Value
Type of Contract Maturity MWh Price($) Price($) ($Millions)
- ----------------------------------------------------------------------------------------------------------------------
Electricity
Swaps - Energy 2007 1,154,018 66.25 - 150.50 57.00 - 118.32 22.4
2008 35,536 70.10 69.08 (0.3)
- ---------------------------------------------------------------------------------------------------------------------
1,189,554 22.1
- ---------------------------------------------------------------------------------------------------------------------
The following tables detail the changes in and sources of fair value for the
above derivatives:
- -------------------------------------------------------------------------------
(In Millions of Dollars) 2006
Change in Fair Value of Derivative Hedging Instruments ($Millions)
- -------------------------------------------------------------------------------
Fair value of contracts at January 1, 2006 $ (18.1)
Net (gains) on contracts realized (73.6)
Increase in fair value of all open contracts 86.1
- -------------------------------------------------------------------------------
Fair value of contracts outstanding at December 31, $ (5.6)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
(In Millions of Dollars)
- -------------------------------------------------------------------------------------------------
Fair Value of Contracts
- -------------------------------------------------------------------------------------------------
Maturity Total
Sources of Fair Value In 12 Months Thereafter Fair Value
- -------------------------------------------------------------------------------------------------
Prices actively quoted $ (15.0) $ (2.1) $ (17.1)
Local published indicies 12.3 (0.8) $ 11.5
- -------------------------------------------------------------------------------------------------
$ (2.7) $ (2.9) $ (5.6)
- -------------------------------------------------------------------------------------------------
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 December 31, 2006 a 10% increase/decrease in natural gas prices
would decrease/increase the value of derivative instruments maturing in one year
by $2.4 million.
Commodity Derivative Instruments - Regulated Utilities: We use derivative
financial instruments to reduce the cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations. The accounting for these derivative instruments is
subject to SFAS 71 "Accounting for the Effects of Certain Types of Regulation."
Therefore, changes in the fair value of these derivatives have been recorded as
a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
Gains or losses on the settlement of these contracts are initially deferred and
then refunded to or collected from our firm gas sales customers consistent with
regulatory requirements.
93
The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at December 31, 2006.
- ----------------------------------------------------------------------------------------------------------------------------
Year of Volumes Ceiling Fixed Current Fair Value
Type of Contract Maturity (mmcf) ($) Price($) Price($) ($Millions)
- ----------------------------------------------------------------------------------------------------------------------------
Gas
Options 2007 3,900 7.00 - 8.00 - 6.30 - 6.60 2.7
Swaps 2007 62,792 - 6.81 - 12.28 6.30 - 8.90 (169.2)
2008 28,475 - 7.16 - 11.64 7.25 - 8.90 (25.6)
- ----------------------------------------------------------------------------------------------------------------------------
95,167 (192.1)
- ----------------------------------------------------------------------------------------------------------------------------
See Note 8 to the Consolidated Financial Statements "Hedging, Derivative
Financial Instruments and Fair Values" for a further description of all our
derivative instruments.
94
ITEM 8. Financial Statements and Supplementary Data
CONSOLIDATED BALANCE SHEET
- ------------------------------------------------------------------------------------------------------------------
December 31,
(In Millions of Dollars) 2006 2005
- ------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash investments $ 210.9 $ 124.5
Restricted cash 7.9 13.2
Accounts receivable 943.7 1,035.6
Unbilled revenue 531.2 685.6
Allowance for uncollectible accounts (56.9) (62.8)
Gas in storage, at average cost 646.0 766.9
Material and supplies, at average cost 137.1 140.5
Derivative contracts 54.1 142.8
Prepayments 236.2 95.8
Other 76.8 78.0
----------------------------------------
2,787.0 3,020.1
----------------------------------------
Equity Investments and Other 269.7 242.4
----------------------------------------
Property
Gas 7,639.4 7,275.9
Electric 2,575.4 2,492.3
Other 441.5 416.3
Accumulated depreciation (3,151.2) (2,922.6)
Gas production and development, at cost 186.9 184.2
Accumulated depletion (113.7) (109.2)
----------------------------------------
7,578.3 7,336.9
----------------------------------------
Deferred Charges
Regulatory assets:
Miscellaneous assets 937.5 688.3
Derivative contracts 196.3 30.9
Goodwill and other intangible assets, net of amortization 1,666.3 1,666.3
Derivative contracts 127.3 75.2
Other 875.1 752.5
----------------------------------------
3,802.5 3,213.2
----------------------------------------
Total Assets $ 14,437.5 $ 13,812.6
========================================
- ------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
95
CONSOLIDATED BALANCE SHEET
- -----------------------------------------------------------------------------------------------------------------
December 31,
(In Millions of Dollars) 2006 2005
- -----------------------------------------------------------------------------------------------------------------
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable and other liabilities $ 1,026.0 $ 1,087.0
Commercial paper 85.0 657.6
Current maturities of long-term debt & capital leases 1.2 13.0
Taxes accrued 200.8 176.3
Dividends payable 83.3 81.1
Customer deposits 33.5 39.1
Interest accrued 58.5 53.8
Other current liability, derivative contracts 219.7 47.3
----------------------------------------
1,708.0 2,155.2
----------------------------------------
Deferred Credits and Other Liabilities
Regulatory liabilities:
Miscellaneous liabilities 43.4 69.9
Removal costs recovered 556.2 516.4
Derivative accounts 120.6 175.4
Asset retirement obligations 47.3 47.4
Deferred income tax 1,176.4 1,157.9
Postretirement benefits and other reserves 1,667.3 1,118.4
Derivative contracts 43.1 44.3
Other 121.6 127.5
----------------------------------------
3,775.9 3,257.2
----------------------------------------
Commitments and Contingencies (See Note 7) - -
Capitalization
Common stock 3,994.0 3,975.9
Retained earnings 973.7 866.9
Accumulated other comprehensive loss (175.3) (74.8)
Treasury stock (273.6) (303.9)
----------------------------------------
Total common shareholders' equity 4,518.8 4,464.1
Long-term debt and capital leases 4,419.1 3,920.8
----------------------------------------
Total Capitalization 8,937.9 8,384.9
----------------------------------------
Minority Interest in Consolidated Companies 15.7 15.3
----------------------------------------
Total Liabilities and Capitalization $ 14,437.5 $ 13,812.6
========================================
- -----------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
96
CONSOLIDATED STATEMENT OF INCOME
- ------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts) 2006 2005 2004
- ------------------------------------------------------------------------------------------------------------------------
Revenues
Gas Distribution $ 5,062.6 $ 5,390.1 $ 4,407.3
Electric Services 1,880.6 2,042.7 1,738.7
Energy Services 203.4 191.2 182.4
Houston Exploration - - 268.1
Energy Investments 35.0 38.0 54.0
---------------------------------------------------
Total Revenues 7,181.6 7,662.0 6,650.5
---------------------------------------------------
Operating Expenses
Purchased gas for resale 3,331.5 3,597.3 2,664.5
Fuel and purchased power 548.6 752.1 540.3
Operations and maintenance 1,680.0 1,617.9 1,567.0
Depreciation, depletion and amortization 397.5 396.5 551.8
Operating taxes 411.2 407.1 404.2
Impairment charges - - 41.0
---------------------------------------------------
Total Operating Expenses 6,368.8 6,770.9 5,768.8
---------------------------------------------------
Gain on sale of property 1.6 1.6 7.0
Income from equity investments 13.1 15.1 46.5
---------------------------------------------------
Operating Income 827.5 907.8 935.3
---------------------------------------------------
Other Income and (Deductions)
Interest charges (256.1) (269.3) (331.3)
Sale of subsidiary stock - 4.1 388.3
Cost of debt redemption - (20.9) (45.9)
Minority interest (0.8) (0.4) (36.8)
Other 39.1 16.6 30.6
---------------------------------------------------
Total Other Income and (Deductions) (217.8) (269.9) 4.9
---------------------------------------------------
Income Taxes
Current 57.9 206.6 201.9
Deferred 117.6 32.7 123.6
---------------------------------------------------
Total Income Taxes 175.5 239.3 325.5
---------------------------------------------------
Earnings from Continuing Operations 434.2 398.6 614.7
---------------------------------------------------
Discontinued Operations
Income (loss) from operations, net of tax - (4.1) (79.0)
Gain (loss) on disposal, net of tax - 2.3 (72.0)
---------------------------------------------------
Loss from Discontinued Operations - (1.8) (151.0)
---------------------------------------------------
Cumulative Change in Accounting Principles, net of tax - (6.6) -
---------------------------------------------------
Net Income 434.2 390.2 463.7
Preferred stock dividend requirements - 2.2 5.6
---------------------------------------------------
Earnings for Common Stock $ 434.2 $ 388.0 $ 458.1
===================================================
Basic Earnings Per Share
Continuing Operations, less preferred stock dividends $ 2.48 $ 2.33 $ 3.80
Discontinued Operations - (0.01) (0.94)
Cumulative Change in Accounting Principles - (0.04) -
---------------------------------------------------
Basic Earnings Per Share $ 2.48 $ 2.28 $ 2.86
===================================================
Diluted Earnings Per Share
Continuing Operations, less preferred stock dividends $ 2.46 $ 2.32 $ 3.78
Discontinued Operations - (0.01) (0.94)
Cumulative Change in Accounting Principles - (0.04) -
---------------------------------------------------
Diluted Earnings Per Share $ 2.46 $ 2.27 $ 2.84
===================================================
Average Common Shares Outstanding (000) 175,040 169,940 160,294
Average Common Shares Outstanding - Diluted (000) 176,151 170,801 161,277
- ------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
97
CONSOLIDATED STATEMENT OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 434.2 $ 390.2 $ 463.7
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Depreciation, depletion and amortization 397.5 396.5 551.8
Deferred income tax 117.6 32.7 123.6
Income from equity investments (13.1) (15.1) (46.5)
Dividends from equity investments 8.9 9.3 14.2
Amortization of financing fees / interest rate swaps 8.2 (1.4) (14.9)
Gain on sale of investments and property (1.6) (5.6) (395.3)
Hedging (gain)/losses 2.9 (3.2) 2.5
Amortization of property taxes 146.3 126.2 101.9
Impairment charges - - 41.0
Loss from discontinued operations - 1.8 151.0
Cumulative change in accounting principle - 6.6 -
Minority interest 0.8 0.4 36.8
Changes in assets and liabilities
Accounts receivable 317.9 (305.7) (234.2)
Materials and supplies, fuel oil and gas in storage (5.7) (268.4) (39.0)
Accounts payable and accrued expenses (163.4) 196.3 159.5
Prepaid property taxes (150.5) (136.2) (112.1)
Reserve payments (51.2) (35.7) (37.3)
Insurance settlements 16.6 21.1 -
Other (6.8) (6.5) (16.6)
--------------------------------------------------
Net Cash Provided by Continuing Operating Activities 1,058.6 403.3 750.1
--------------------------------------------------
Investing Activities
Construction expenditures (524.0) (539.5) (750.3)
Cost of removal (32.6) (27.8) (36.3)
Net proceeds from sale of property and investments 1.6 47.0 1,021.3
Derivative margin call (33.9) (8.9) -
--------------------------------------------------
Net Cash (Used in) Provided by Continuing Investing Activities (588.9) (529.2) 234.7
--------------------------------------------------
Financing Activities
Treasury stock issued 30.1 41.2 33.4
Common stock issuance - 460.0 -
Issuance of long-term debt 500.0 - 49.3
Payment of long-term debt (13.0) (515.0) (920.1)
Issuance / (payment) of commercial paper (572.6) (254.6) 430.4
Redemption of preferred stock - (75.0) (8.5)
Net proceeds from sale/leasback transaction - - 382.0
Common and preferred stock dividends paid (325.3) (308.4) (291.1)
Gain on interest rate swap - - 12.7
Other (2.5) (5.4) 36.1
--------------------------------------------------
Net Cash Used in Continuing Financing Activities (383.3) (657.2) (275.8)
--------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ 86.4 $ (783.1) $ 709.0
Cash Flow from Discontinued Operations - Operating Activities - (3.8) 8.1
Cash Flow from Discontinued Operations - Investing Activities - (10.6) 1.3
Cash Flow from Discontinued Operations - Financing Activities - - 0.2
Cash and Cash Equivalents at Beginning of Period 124.5 922.0 203.4
--------------------------------------------------
Cash and Cash Equivalents at End of Period $ 210.9 $ 124.5 $ 922.0
==================================================
Interest Paid $ 256.9 $ 262.7 $ 336.5
Income Tax Paid $ 175.7 $ 198.8 $ 122.0
- ------------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
98
CONSOLIDATED STATEMENT OF RETAINED EARNINGS
- --------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- --------------------------------------------------------------------------------------------------
Balance at Beginning of Period $ 866.9 $ 792.2 $ 621.4
Net Income for Period 434.2 390.2 463.7
- --------------------------------------------------------------------------------------------------
1,301.1 1,182.4 1,085.1
Deductions:
Cash dividends declared on common stock 327.4 313.3 287.3
Cash dividends declared on preferred stock - 2.2 5.6
- --------------------------------------------------------------------------------------------------
Balance at End of Period $ 973.7 $ 866.9 $ 792.2
- --------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
- ----------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- ----------------------------------------------------------------------------------------------------------------------
Net Income $ 434.2 $ 390.2 $ 463.7
- ----------------------------------------------------------------------------------------------------------------------
Other comprehensive income, net of tax
Reclassification of (gains) losses included in net income (47.8) 23.8 (0.3)
Unrealized (losses) gains on derivative financial instruments 55.4 (35.1) 15.4
Deconsolidation of certain subsidiaries - - 9.3
Foreign currency translation adjustments - (5.0) (21.5)
Unrealized gains (losses) on marketable securities 2.0 (0.5) 7.1
Premium on derivative instrument - - 3.4
Accrued unfunded pension obligation 37.9 (3.7) (7.8)
- ----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 47.5 (20.5) 5.6
- ----------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 481.7 $ 369.7 $ 469.3
- ----------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Reclassification of (gains) losses included in net income (25.8) 12.8 (0.2)
Unrealized (losses) gains on derivative financial instruments 31.5 (20.7) 8.2
Deconsolidation of certain subsidiaries - - 5.0
Foreign currency translation adjustments - (2.7) (11.6)
Unrealized gains (losses) on marketable securities 1.1 (0.2) 3.8
Premium on derivative instrument - - 1.9
Accrued unfunded pension obligation 20.4 (2.1) (4.2)
- ----------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense $ 27.2 $ (12.9) $ 2.9
- ----------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
99
CONSOLIDATED STATEMENT OF CAPITALIZATION
- --------------------------------------------------------------------------------------------------------------------------
December 31, December 31,
(In Millions of Dollars) 2006 2005 2006 2005
- --------------------------------------------------------------------------------------------------------------------------
Common Shareholders' Equity Shares Issued
Common stock, $0.01 par value 184,864,124 184,864,124 $ 1.8 $ 1.8
Premium on capital stock 3,992.2 3,974.1
Retained earnings 973.7 866.9
Accumulated other comprehensive loss (175.3) (74.8)
Treasury stock (9,451,408) (10,495,743) (273.6) (303.9)
- --------------------------------------------------------------------------------------------------------------------------
Total Common Shareholders' Equity 175,412,716 174,368,381 4,518.8 4,464.1
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
Long - Term Debt Interest Rate Maturity
- --------------------------------------------------------------------------------------------------------------------------
Medium and Long Term Notes 4.65% - 9.75% 2008-2035 2,925.4 2,437.2
Gas Facilities Revenue Bonds Variable 2020 - 2026 230.0 230.0
4.70% - 6.95% 2020 - 2026 410.5 410.5
- --------------------------------------------------------------------------------------------------------------------------
Total Gas Facilities Revenue Bonds 640.5 640.5
- --------------------------------------------------------------------------------------------------------------------------
Promissory Notes to LIPA
Pollution Control Revenue Bonds 5.15% 2016 - 2025 108.0 108.0
Electric Facilities Revenue Bonds 5.30% 2023 - 2025 47.4 47.4
- ---------------------------------------------------------------------------------------------------------------------------
Total Promissory Notes to LIPA 155.4 155.4
- ---------------------------------------------------------------------------------------------------------------------------
Industrial Development Bonds 5.25% 2027 128.3 128.3
First Mortgage Bonds 6.34% - 8.80% 2008 - 2028 95.0 95.0
Authority Financing Notes Variable 2027 - 2028 66.0 66.0
Ravenswood Master Lease & Capital Leases 2007 - 2014 422.1 423.0
- ---------------------------------------------------------------------------------------------------------------------------
Subtotal 4,432.7 3,945.4
Unamortized interest rate hedge and debt discount (29.2) (30.4)
Derivative impact on debt 16.8 18.8
Less: current maturities 1.2 13.0
- ---------------------------------------------------------------------------------------------------------------------------
Total Long-Term Debt 4,419.1 3,920.8
- ---------------------------------------------------------------------------------------------------------------------------
Total Capitalization $ 8,937.9 $ 8,384.9
- ---------------------------------------------------------------------------------------------------------------------------
See accompanying Notes to the Consolidated Financial Statements.
100
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
INTRODUCTION TO THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
KeySpan Corporation (referred to herein 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 production and development; 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 to the Consolidated Financial Statements
"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 (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 receipt of requisite regulatory approvals from certain
United States federal and state public utility, antitrust and other regulatory
authorities, all of which have been filed and many of which have been obtained.
Specifically, we filed our application for approval of the Merger pursuant to
the Federal Power Act in May 2006 and in October the requisite approval was
obtained from the Federal Energy Regulatory Commission ("FERC"). 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 ("NYPSC"). KeySpan has
also sought approval of the Merger from the New Hampshire Public Utility
Commission. In October 2006, the State of New Jersey Board of Public Utilities
approved a change of control of KeySpan Communication Corp., which provides
telecommunications services in New Jersey. In addition, the Merger was approved
by our shareholders at our Annual Meeting on August 17, 2006. Shareholders of
National Grid plc approved the Merger at a meeting held on July 31, 2006.
101
In addition to seeking approval of the Merger, the application filed with the
NYPSC also contained proposed ten-year rate plans for KeySpan Energy Delivery of
New York ("KEDNY") and KeySpan Energy Delivery of Long Island ("KEDLI"), as well
as proposals concerning corporate structure and affiliate rules, the rate
treatment for synergy savings and for low income and energy efficiency programs,
among others. Specifically, the rate plan proposals provide 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 clauses would be increased to
recover, on a prospective basis, estimated 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 2.5% ($62.4 million) and 2.3% ($39.4 million),
respectively in years 3, 5, 7 and 9 of the rate plans. The proposed rate plans
contemplate 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. On October 3, 2006 National Grid plc filed testimony
and exhibits with the NYPSC that further explains the exhibits and attachments
that were previously submitted as part of the July 20, 2006 petition.
Separately from the merger application, on October 3, 2006, KEDNY and KEDLI
filed with the NYPSC individual applications for proposed annual increases in
revenues, which applications assumed that KEDNY and KEDLI remained as
stand-alone companies. The proposed revenue increases are for approximately 9.1%
and 10.9% for KEDNY and KEDLI, respectively. KEDNY's last base rate increase
took effect October 1, 1993 and since then base rates have been reduced twice -
once in 1996 and again in 1998. KEDLI's last base rate increase took effect
December 1, 1995. Since that time, KEDLI's base rates were reduced twice in
1998. The principal factors creating the need for rate relief are increases in
operating and maintenance expenses, increases in rate base, increased property
taxes and depreciation expense, and the need to commence recovery of previously
deferred costs such as pension and post retirement benefits, environmental
expenditures and property taxes.
The total projected increase in revenues is comprised of two components; (i) an
increase in base rates of $180.7 million for KEDNY and $145 million for KEDLI;
and (ii) projected increases of $32.8 million and $13.6 million for KEDNY and
KEDLI, respectively, for gas-related expenses that will be recovered through the
Gas Adjustment Clause ("GAC") and/or the Transportation Adjustment Clause
("TAC"). The proposed rate of return on equity is 11.0% for both KEDNY and
KEDLI.
The NYPSC may suspend the implementation of the proposed tariff changes for up
to eleven months, which would mean, absent other intervening events, an
effective date of September 3, 2007 for new rates. Although KEDNY and KEDLI
proposed the new rates described above in these tariff filings, it will not be
necessary to implement the rate increases proposed therein if the NYPSC approves
the Merger between National Grid plc and KeySpan and approves the related
ten-year rate plan previously noted, or some variation thereof.
102
On February 20, 2007, NYPSC Staff filed its direct testimony in the merger
proceeding. NYSPSC Staff opposed the current terms of the Merger on policy
grounds, but suggested that it could support the Merger under certain
circumstances. KeySpan and National Grid intend to file testimony responding to
the positions taken by Staff. In addition, on January 29, 2007, Staff filed its
direct testimony in the rate case proceedings and our rebuttal testimony was
filed on February 21, 2007. In connection with each of these proceedings,
hearings before an administrative law judge (ALJ) are scheduled to begin in late
March. Unless a settlement among the parties is otherwise reached, the ALJ will
issue its recommended decision to the NYPSC following such hearings. Ultimately,
the NYPSC may accept, reject, or modify all or any part of the ALJ's recommended
decision.
KeySpan and National Grid will continue to pursue all required approvals and
continue to anticipate that the Merger will be consummated in mid-2007. However,
we are unable to predict the outcome of these regulatory proceedings and no
assurance can be given that the Merger will occur or the timing of its
completion.
Note 1. Summary of Significant Accounting Policies
A. Organization of the Company
KeySpan Corporation, a New York corporation, was formed in May 1998, as a result
of the business combination of KeySpan Energy Corporation, the parent of The
Brooklyn Union Gas Company, and certain businesses of the Long Island Lighting
Company ("LILCO"). On November 8, 2000, KeySpan acquired Eastern Enterprises
("Eastern"), a Massachusetts business trust, and the parent of several gas
utilities operating in Massachusetts. Also on November 8, 2000, Eastern acquired
EnergyNorth, Inc. ("ENI"), the parent of a gas utility operating in central New
Hampshire.
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 FERC pursuant to PUHCA 2005.
Pursuant to PUHCA 2005, the SEC no longer has jurisdiction over our holding
company activities, other than those 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 Public Service Commission of the State of New York ("NYPSC"), the
Massachusetts Department of Telecommunications and Energy ("MADTE") and the New
Hampshire Public Utility Commission ("NHPUC") in addition to FERC.
103
Under our holding company structure, we have no independent operations or source
of income of our own and conduct all of our operations through our subsidiaries
and, as a result, we depend on the earnings and cash flow of, and dividends or
distributions from, our subsidiaries to provide the funds necessary to meet our
debt and contractual obligations. Furthermore, a substantial portion of our
consolidated assets, earnings and cash flow is derived from the operations of
our regulated utility subsidiaries, whose legal authority to pay dividends or
make other distributions to us is subject to regulation by state regulatory
authorities.
Pursuant to NYPSC orders, the ability of KEDNY and KEDLI to pay dividends to
KeySpan is conditioned upon maintenance of a utility capital structure with debt
not exceeding 55% and 58%, respectively, of total utility capitalization. In
addition, the level of dividends paid by both utilities may not be increased
from current levels if a 40 basis point penalty is incurred under the customer
service performance program.
KeySpan's businesses are engaged in gas distribution, electric services and
generation and other energy related activities. KeySpan's gas distribution
operations are conducted by our six regulated gas utility subsidiaries: The
Brooklyn Union Gas Company d/b/a KeySpan Energy Delivery New York ("KEDNY") and
KeySpan Gas East Corporation d/b/a KeySpan Energy Delivery Long Island ("KEDLI")
distribute gas to customers in the Boroughs of Brooklyn, Staten Island, a
portion of the Borough of Queens in New York City, and the counties of Nassau
and Suffolk on Long Island and the Rockaway Peninsula in Queens, respectively;
Boston Gas Company, Colonial Gas Company and Essex Gas Company, each doing
business as KeySpan Energy Delivery New England ("KEDNE"), distribute gas to
customers in southern, eastern and central Massachusetts; and EnergyNorth
Natural Gas, Inc., d/b/a KeySpan Energy Delivery New England distributes gas to
customers in central New Hampshire. Together, these companies distribute gas to
approximately 2.6 million customers throughout the Northeast.
We own, lease and operate electric generating plants on Long Island and in New
York City. Under contractual arrangements, we provide electric 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"). On February 1, 2006, KeySpan and LIPA entered into agreements to
extend, amend and restate these contractual arrangements. See Note 11 "2006 LIPA
Settlement" for a discussion of the settlement.
Our other subsidiaries are involved in gas production and development; gas
storage; liquefied natural gas storage; retail electric marketing; appliance
service; fiber optic services; and engineering and consulting services. We also
invest in, 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.)
104
B. Basis of Presentation
The Consolidated Financial Statements presented herein reflect the accounts of
KeySpan and its subsidiaries. Most of our subsidiaries are fully consolidated in
the financial information presented, except for certain subsidiary investments
in the Energy Investments segment which are accounted for on the equity method
as we do not have a controlling voting interest or otherwise have control over
the management of such companies. All intercompany transactions have been
eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles ("GAAP") requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
C. Accounting for the Effects of Rate Regulation
The accounting records for our six regulated gas utilities are maintained in
accordance with the Uniform System of Accounts prescribed by the NYPSC, the
NHPUC, and the MADTE. Our electric generation subsidiaries are not subject to
state rate regulation, but they are subject to FERC regulation. Our financial
statements reflect the ratemaking policies and actions of these regulators in
conformity with GAAP for rate-regulated enterprises.
Four of our six regulated gas utilities (KEDNY, KEDLI, Boston Gas Company and
EnergyNorth Natural Gas, Inc.) and our Long Island based electric generation
subsidiaries are subject to the provisions of Statement of Financial Accounting
Standards ("SFAS") 71, "Accounting for the Effects of Certain Types of
Regulation." This statement recognizes the ability of regulators, through the
ratemaking process, to create future economic benefits and obligations affecting
rate-regulated companies. Accordingly, we record these future economic benefits
and obligations as regulatory assets and regulatory liabilities on the
Consolidated Balance Sheet, respectively.
In separate merger related orders issued by the MADTE, the base rates charged by
Colonial Gas Company and Essex Gas Company have been frozen at their current
levels for ten-year periods ending 2009 and 2008, respectively. Due to the
length of these base rate freezes, the Colonial and Essex Gas companies had
previously discontinued the application of SFAS 71.
105
The following table presents our net regulatory assets at December 31, 2006 and
December 31, 2005.
- -----------------------------------------------------------------------------------------------
December 31,
(In Millions of Dollars) 2006 2005
- -----------------------------------------------------------------------------------------------
Regulatory Assets:
Regulatory tax asset $ 30.2 $ 33.4
Property and other taxes 95.0 53.8
Environmental costs 416.7 454.7
Postretirement benefits 364.6 109.3
Costs associated with the KeySpan/LILCO transaction 15.6 27.3
Derivative financial instruments 196.3 30.9
Other 15.4 9.8
- -----------------------------------------------------------------------------------------------
Total Regulatory Assets 1,133.8 719.2
- -----------------------------------------------------------------------------------------------
Regulatory Liabilities:
Derivative financial instruments (120.6) (175.4)
Miscellaneous (43.4) (69.9)
- -----------------------------------------------------------------------------------------------
Total Regulatory Liabilities (164.0) (245.3)
- -----------------------------------------------------------------------------------------------
Net Regulatory Assets 969.8 473.9
Removal Costs Recovered (556.2) (516.4)
- -----------------------------------------------------------------------------------------------
$ 413.6 $ (42.5)
- -----------------------------------------------------------------------------------------------
The regulatory assets above are not included in utility rate base. However, we
record carrying charges on the property tax and costs associated with the
KeySpan/LILCO transaction cost deferrals. We also record carrying charges on our
regulatory liabilities except for the current market value of our derivative
financial instruments. The remaining regulatory assets represent, primarily,
costs for which expenditures have not yet been made, and therefore, carrying
charges are not recorded. We anticipate recovering these costs in our gas rates
concurrently with future cash expenditures. If recovery is not concurrent with
the cash expenditures, we will record the appropriate level of carrying charges.
Deferred gas costs of $46.3 million and $11.3 million at December 31, 2006 and
December 31, 2005, respectively are reflected in accounts receivable on the
Consolidated Balance Sheet. Deferred gas costs are subject to current recovery
from customers.
D. Revenues
Gas Distribution. Utility gas customers are billed monthly or bi-monthly on a
cycle basis. Revenues include unbilled amounts related to the estimated gas
usage that occurred from the most recent meter reading to the end of each month.
106
The cost of gas used is recovered when billed to firm customers through the
operation of gas adjustment clauses ("GAC") included in utility tariffs. The GAC
provision requires periodic reconciliation of recoverable gas costs and GAC
revenues. Any difference is deferred pending recovery from or refund to firm
customers. Further, net revenues from tariff gas balancing services, off-system
sales and certain on-system interruptible sales are refunded, for the most part,
to firm customers subject to certain sharing provisions.
The New York and Long Island gas utility tariffs contain weather normalization
adjustments that largely offset shortfalls or excesses of firm net revenues
(revenues less gas costs and revenue taxes) during a heating season due to
variations from normal weather. Revenues are adjusted each month the clause is
in effect and are generally included in rates in the following month. The New
England gas utility rate structures contain no weather normalization feature,
therefore their net revenues are subject to weather related demand fluctuations.
As a result, fluctuations from normal weather may have a significant positive or
negative effect on the results of these operations. To mitigate the effect of
fluctuations from normal weather on our financial position and cash flows, we
may enter into weather related derivative instruments from time to time. (See
Note 8 "Hedging, Derivative Financial Instruments and Fair Values" for
additional information on these derivatives.)
In December 2005, The Boston Gas Company ("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 was
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. On October 31, 2006, the MADTE granted Boston Gas recovery of
$12 million of the 2005 gas cost component of bad debt write-offs from Boston
Gas ratepayers beginning November 1, 2006. This amount will also be recovered
through the cost-of-gas adjustment clause.
Electric Services. Electric revenues are primarily derived from: (i) billings to
LIPA for management of LIPA's transmission and distribution system ("T&D
System"), electric generation, and procurement of fuel, and (ii): subsidiaries
that own, lease and operate the 2,200 megawatt ("MW") Ravenswood electric
generation facility ("Ravenswood Facility") and the 250 MW combined cycle
generating facility located at the Ravenswood facility site ("Ravenswood
Expansion"). Collectively, the Ravenswood Facility and Ravenswood Expansion are
referred to as the Ravenswood Generating Station.
LIPA Agreements. In 1998, 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 T&D System pursuant to the 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 the 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 the Energy Management Agreement (the "1998 EMA"). The 1998 MSA, 1998 PSA and
1998 EMA all are collectively referred to as the 1998 LIPA Agreements and are
discussed in greater detail below.
107
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 effectively 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 upon
all of the 2006 LIPA Agreements receiving the required governmental approvals;
otherwise none of the 2006 LIPA Agreements will become effective. These
agreements will become effective following approval by the New York State
Comptroller's Office and the New York State Attorney General. Following the
announcement of the proposed acquisition of KeySpan by National Grid plc, LIPA,
National Grid plc 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. See Note 11, "2006 LIPA Settlement" for additional details on
these agreements.
In place of the previous compensation structure under the 1998 MSA (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 electric transmission and distribution system owned by LIPA 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.
In addition, KeySpan sells to LIPA under the 1998 PSA all of the capacity and,
to the extent requested, energy conversion services from its 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. Rates charged to
LIPA include a fixed and variable component. The variable component is billed to
LIPA on a monthly per megawatt hour basis and is dependent on the number of
megawatt hours dispatched. The 1998 PSA provides incentives and penalties that
can total $4 million annually for the maintenance of the output capability and
the efficiency of the generating facilities.
108
KeySpan also procures and manages fuel supplies on behalf of LIPA, under the
1998 EMA, to fuel the generating facilities under contract to it and perform
off-system capacity and energy purchases on a least-cost basis to meet LIPA's
needs. In exchange for these services KeySpan earns an annual fee of $1.5
million. In addition, we arrange for off-system sales on behalf of LIPA of
excess output from the generating facilities and other power supplies either
owned or under contract to LIPA. LIPA is entitled to two-thirds of the profit
from any off-system energy sales. In addition, the 1998 EMA provides incentives
and penalties that can total $5 million annually for performance related to fuel
purchases and off-system power purchases. The 1998 EMA is expected to be in
effect through 2013 for the procurement of fuel supplies. In 2005, the EMA was
amended to extend the term for off-system power purchases through December 31,
2006 and thereafter on a month-to-month basis unless terminated by LIPA on sixty
days notice, but in no event later than December 31, 2007.
KeySpan Glenwood Energy Center, LLC and KeySpan Port Jefferson Energy Center,
LLC have entered into 25 year Power Purchase Agreements with LIPA (the "PPAs").
Under the terms of the PPAs, these subsidiaries sell capacity, energy conversion
services and ancillary services to LIPA. Each plant is designed to produce 79.9
MW. Under the PPAs, LIPA pays a monthly capacity fee, which guarantees full
recovery of each plant's construction costs, as well as an appropriate rate of
return on investment. The PPAs also obligate LIPA to pay for each plant's costs
of operation and maintenance. These costs are billed on a monthly estimated
basis and are subject to true-up for actual costs incurred.
The Electric Services segment also conducts retail marketing of electricity to
commercial customers. Energy sales made by our electric marketing subsidiary are
recorded upon delivery of the related commodity.
Ravenswood Generating Station. In addition, electric revenues are derived from
our investment in the 2,200 MW Ravenswood electric generation facility
("Ravenswood Facility"), (which KeySpan acquired in June 1999). KeySpan has an
arrangement with a variable interest entity through which we lease a portion of
the Ravenswood Facility. Further, in May 2004 KeySpan completed construction of
a 250 MW combined cycle generating facility located at the Ravenswood facility
site ("Ravenswood Expansion"). To finance the Ravenswood Expansion, KeySpan
entered into a leveraged lease financing arrangement. (See Note 7 "Contractual
Obligations, Financial Guarantees and Contingencies" for a description of the
financing arrangements associated with the Ravenswood Generating Station.) The
Ravenswood Generating Station earns revenues through the sale, at wholesale, of
energy, capacity, and ancillary services to the New York Independent System
Operator ("NYISO"). Energy and ancillary services are sold through a bidding
process into the NYISO energy markets on a day ahead or real time basis.
Energy Services. Revenues earned by our Energy Services segment for service and
maintenance contracts associated with small commercial and residential
appliances are recognized as earned or over the life of the service contract, as
appropriate. Revenues earned for engineering services are derived from services
109
rendered under fixed price and cost-plus contracts and generally are recognized
on the percentage-of-completion method. Fiber optic service revenue is
recognized upon delivery of service access. We have unearned revenue recorded in
deferred credits and other liabilities - other on the Consolidated Balance Sheet
totaling $30.3 million and $29.3 million as of December 31, 2006, and December
31, 2005, respectively. These balances represent primarily unearned revenues for
service contracts and are generally amortized to income over a one year period.
KeySpan completed its sale of its mechanical contracting companies in the first
quarter of 2005, and therefore, no longer has revenues from mechanical
contracting operations. (See Note 10 "Energy Services - Discontinued Operations"
for additional details on the mechanical contracting companies.)
Gas Production and Development. Natural gas and oil revenues earned by our gas
production and development activities are recognized using the entitlements
method of accounting. Under this method of accounting, income is recorded based
on the net revenue interest in production or nominated deliveries. Production
gas volume imbalances are incurred in the ordinary course of business. Net
deliveries in excess of entitled amounts are recorded as liabilities, while net
under deliveries are recorded as assets. Imbalances are reduced either by
subsequent recoupment of over and under deliveries or by cash settlement, as
required by applicable contracts. Production imbalances are marked-to-market at
the end of each month using the market price at the end of each period. During
2004 KeySpan disposed of its interest in The Houston Exploration Company
("Houston Exploration"), an independent natural gas and oil exploration company.
KeySpan continues to maintain, on a significantly smaller scale, gas production
and development activities. (See Note 2 "Business Segments" for a discussion on
the disposition of Houston Exploration and KeySpan's remaining gas production
and development activities.)
E. Utility and Other Property - Depreciation and Maintenance
Property, principally utility gas property is stated at original cost of
construction, which includes allocations of overheads, including taxes, and an
allowance for funds used during construction. The rates at which KeySpan
subsidiaries capitalized interest for the year ended December 31, 2006 ranged
from 1.88% to 7.02%. Capitalized interest for 2006, 2005 and 2004 was $2.5
million, $1.4 million and $7.4 million, respectively.
Depreciation is provided on a straight-line basis in amounts equivalent to
composite rates on average depreciable property. In 2006, an adjustment to the
depreciation allowance was recorded to correct for an error in useful lives
associated with certain gas distribution assets. The cost of property retired is
charged to accumulated depreciation.
KeySpan recovers cost of removal through rates charged to customers as a portion
of depreciation expense. At December 31, 2006 and 2005, KeySpan had costs
recovered in excess of costs incurred totaling $556.2 million and $516.4
million, respectively. These amounts are reflected as a regulatory liability.
110
The cost of repair and minor replacement and renewal of property is charged to
maintenance expense. The composite rates on average depreciable property were as
follows:
- -----------------------------------------------------------------
Year Ended December 31,
2006 2005 2004
- -----------------------------------------------------------------
Electric 3.86% 3.75% 3.87%
Gas 3.14% 3.72% 3.55%
- -----------------------------------------------------------------
- -----------------------------------------------------------------
We also had $441.5 million of other property at December 31, 2006, consisting of
assets held primarily by our corporate service subsidiary of $307.6 million and
$104.2 million in Energy Services assets. The corporate service assets consist
largely of land, buildings, office equipment and furniture, vehicles, computer
and telecommunications equipment and systems. These assets have depreciable
lives ranging from three to 40 years. We allocate the carrying cost of these
assets to our operating subsidiaries through our filed allocation methodology.
Energy Services assets consist largely of computer equipment and fiber optic
cable and related electronics and have service lives ranging from seven to 40
years.
KeySpan's repair and maintenance costs, including planned major maintenance in
the Electric Services segment for turbine and generator overhauls, are expensed
as incurred unless they represent replacement of property to be capitalized.
Planned major maintenance cycles primarily range from seven to eight years.
Smaller periodic overhauls are performed approximately every 18 months.
KeySpan capitalizes costs incurred in connection with its projects to develop
and build energy facilities after a project has been determined to be probable
of completion.
F. Gas Production and Development Property - Depletion
KeySpan maintains gas production and development activities through its two
wholly-owned subsidiaries - KeySpan Exploration and Production, LLC ("KeySpan
Exploration") and Seneca-Upshur Petroleum, Inc. ("Seneca-Upshur"). At December
31, 2006, these subsidiaries had net production and development property in the
amount of $73.2 million. These assets are accounted for under the full cost
method of accounting. Under the full cost method, costs of acquisition and
development of natural gas and oil reserves plus asset retirement obligations
are capitalized into a "full cost pool" as incurred. Unproved properties and
related costs are excluded from the depletion and amortization base until a
determination is made as to the existence of proved reserves. Properties are
depleted and charged to operations using the unit of production method using
proved reserve quantities.
To the extent that such capitalized costs (net of accumulated depletion) less
deferred taxes exceed the present value (using a 10% discount rate) of estimated
future net cash flows from proved natural gas and oil reserves and the lower of
cost or fair value of unproved properties, less deferred taxes, such excess
costs are charged to operations, but would not have an impact on cash flows.
Once incurred, such impairment of gas properties is not reversible at a later
date even if gas prices increase.
111
The ceiling test is calculated using natural gas and oil prices in effect as of
the balance sheet date, held flat over the life of the reserves. We use
derivative financial instruments that qualify for hedge accounting under SFAS
133 "Accounting for Derivative Instruments and Hedging Activities," to hedge the
volatility of natural gas prices. In accordance with current SEC guidelines, we
have included estimated future cash flows from our hedging program in ceiling
test calculations.
As of December 31, 2006, we estimated that our capitalized costs did not exceed
the ceiling test limitation. We used an average wellhead price of $6.15 per MCF,
adjusted for derivative instruments.
As a result of the disposition of Houston Exploration in 2004, during 2004
KeySpan calculated the ceiling test on KeySpan Exploration and Production's and
Seneca-Uphsur's assets independently of Houston Exploration's assets. Based on a
report furnished by an independent reservoir engineer during the second quarter
of 2004, it was determined that the remaining proved undeveloped oil reserves
held in the joint venture required a substantial investment in order to develop.
Therefore, KeySpan and Houston Exploration elected not to develop these oil
reserves. As a result, in the second quarter of 2004, we recorded a $48.2
million non-cash impairment charge to write down our wholly-owned gas production
and development subsidiaries' assets. This charge was recorded in depreciation,
depletion and amortization on the Consolidated Statement of Income.
Natural gas prices continue to be volatile and the risk that a write down to the
full cost pool increases when, among other things, natural gas prices are low or
there are significant downward revisions in our estimated proved reserves.
In 2004, Houston Exploration capitalized interest related to unevaluated natural
gas and oil properties, as well as some properties under development which were
not being amortized. For the year ended December 31, 2004, capitalized interest
was $3.4 million.
G. Goodwill and Other Intangible Assets
The balance of goodwill and other intangible assets was $1.7 billion at December
31, 2006 and December 31, 2005, representing primarily the excess of acquisition
cost over the fair value of net assets acquired. Goodwill and other intangible
assets reflect the Eastern and EnergyNorth acquisitions, the KeySpan/LILCO
transaction, as well as acquisitions of non-utility energy-related service
companies and also relates to certain ownership interests of 50% or less in
energy-related investments, which are accounted for under the equity method.
112
The table below summarizes the goodwill and other intangible assets balance for
each segment at December 31, 2006 and 2005:
- ------------------------------------------------------------------------
(In Millions of Dollars) At December 31,
2006 2005
- ------------------------------------------------------------------------
Operating Segment
Gas Distribution $1,436.9 $1,436.9
Energy Services 65.2 65.2
Energy Investments and other 164.2 164.2
- ------------------------------------------------------------------------
$1,666.3 $1,666.3
- ------------------------------------------------------------------------
As prescribed in SFAS 142 "Goodwill and Other Intangible Assets," KeySpan is
required to compare the fair value of a reporting unit to its carrying amount,
including goodwill. This evaluation is required to be performed at least
annually, unless facts and circumstances indicated that the evaluation should be
performed at an interim period during the year. At December 31, 2006, KeySpan
had $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.
During 2004, KeySpan conducted an evaluation of the carrying value of goodwill
recorded in its Energy Services segment. As a result of this evaluation, KeySpan
recorded a non-cash goodwill impairment charge of $108.3 million ($80.3 million
after tax, or $0.50 per share) in 2004. This charge was recorded as follows: (i)
$14.4 million as an operating expense on the Consolidated Statement of Income
reflecting the write-down of goodwill on Energy Services segment's continuing
operations; and (ii) $93.9 million as discontinued operations reflecting the
impairment on the mechanical contracting companies. (See Note 10 "Energy
Services-Discontinued Operations" for further details.)
In 2004, KeySpan entered into an agreement to sell its then 50% interest in
Premier Transmission Limited ("Premier"). This investment was accounted for
under the equity method of accounting in the Energy Investments segment. In the
fourth quarter of 2004 KeySpan recorded a partial pre-tax non-cash impairment
charge of $26.5 million - $18.8 million after-tax or $0.12 per share. The
impairment charge reflected the difference between the anticipated cash proceeds
from the sale of Premier compared to its carrying value at that time and was
recorded as a reduction to goodwill.
H. Hedging and Derivative Financial Instruments
From time to time, we employ derivative instruments to hedge a portion of our
exposure to commodity price risk, interest rate risk and weather fluctuations as
well as to hedge cash flow variability associated with a portion of our peak
electric energy sales. Whenever hedge positions are in effect, we are exposed to
credit risk in the event of nonperformance by counter-parties to derivative
contracts, as well as nonperformance by the counter-parties of the transactions
against which they are hedged. We believe that the credit risk related to the
futures, options and swap instruments is no greater than that associated with
the primary commodity contracts which they hedge.
113
Financially-Settled Commodity Derivative Instruments. We employ derivative
financial instruments, such as futures, options and swaps, for the purpose of
hedging the cash flow variability associated with forecasted purchases and sales
of various energy-related commodities. All such derivative instruments are
accounted for pursuant to the requirements of SFAS 133 "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 149,
"Amendment of Statement 133 Derivative Instruments and Hedging Activities"
(collectively, "SFAS 133"). With respect to those commodity derivative
instruments that are designated and accounted for as cash flow hedges, the
effective portion of periodic changes in the fair market value of cash flow
hedges is recorded as other comprehensive income on the Consolidated Balance
Sheet, while the ineffective portion of such changes in fair value is recognized
in earnings. Unrealized gains and losses (on such cash flow hedges) that are
recorded as other comprehensive income are subsequently reclassified into
earnings concurrent when hedged transactions impact earnings. With respect to
those commodity derivative instruments that are not designated as hedging
instruments, such derivatives are accounted for on the Consolidated Balance
Sheet at fair value, with all changes in fair value reported in earnings.
Firm Gas Sales Derivatives Instruments - Regulated Utilities. We use derivative
financial instruments to reduce cash flow variability associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations. Our strategy is to minimize fluctuations in firm
gas sales prices to our regulated firm gas sales customers in our New York and
New England service territories. The accounting for these derivative instruments
is subject to SFAS 71. Therefore, the fair value of these derivatives is
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.
Physically-Settled Commodity Derivative Instruments. Certain of our contracts
for the physical purchase of natural gas were assessed as no longer being exempt
from the requirements of SFAS 133 as normal purchases. As such, these contracts
are recorded on the Consolidated Balance Sheet at fair market value. However,
since such contracts were executed for the purchases of natural gas that is sold
to regulated firm gas sales customers, and pursuant to the requirements of SFAS
71, changes in the fair market value of these contracts are recorded as a
regulatory asset or regulatory liability on the Consolidated Balance Sheet.
Weather Derivatives. The utility tariffs associated with our New England gas
distribution 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. To mitigate the effect of
fluctuations from normal weather on our financial position and cash flows, we
may enter into derivative instruments from time to time. Based on the terms of
the contracts, we account for these instruments pursuant to the requirements of
Emerging Issues Task Force ("EITF") 99-2 "Accounting for Weather Derivatives."
In this regard, we account for weather derivatives using the "intrinsic value
method" as set forth in such guidance.
114
Interest Rate Derivative Instruments. We continually assess the cost
relationship between fixed and variable rate debt. Consistent with our objective
to minimize our cost of capital, we periodically enter into hedging transactions
that effectively convert the terms of underlying debt obligations from fixed to
variable or variable to fixed. Payments made or received on these derivative
contracts are recognized as an adjustment to interest expense as incurred.
Hedging transactions that effectively convert the terms of underlying debt
obligations from fixed to variable are designated and accounted for as
fair-value hedges pursuant to the requirements of SFAS 133. Hedging transactions
that effectively convert the terms of underlying debt obligations from variable
to fixed are considered cash flow hedges.
I. Equity Investments and Other
Certain subsidiaries own as their principal assets, investments (including
goodwill), representing ownership interests of 50% or less in energy-related
businesses that are accounted for under the equity method. None of these current
investments are publicly traded. Additionally, KeySpan has corporate assets
recorded on the Consolidated Balance Sheet representing funds designated for
Supplemental Executive Retirement Plans. These funds are invested in corporate
owned life insurance policies. KeySpan records changes in the value of these
assets in accordance with FAS Technical Bulletin 85-4 "Accounting for the
Purchase of Life Insurance." As such, increases and decreases in the value of
these assets are recorded through earnings in the Consolidated Statement of
Income concurrent with the change in the value of the underlying assets.
J. Income and Excise Tax
Upon implementation of SFAS 109, "Accounting for Income Taxes," certain of our
regulated subsidiaries recorded a regulatory asset and a net deferred tax
liability for the cumulative effect of providing deferred income taxes on
certain differences between the financial statement carrying amounts of assets
and liabilities, and their respective tax bases. This regulatory asset continues
to be amortized over the lives of the individual assets and liabilities to which
it relates. Additionally, investment tax credits which were available prior to
the Tax Reform Act of 1986, were deferred and generally amortized as a reduction
of income tax over the estimated lives of the related property.
We report our collections and payments of excise taxes on a gross basis. Gas
distribution revenues include the collection of excise taxes, while operating
taxes include the related expense. For the years ended December 31, 2006, 2005
and 2004, excise taxes collected and paid were $60.4 million, $65.8 million and
$73.3 million, respectively.
K. Subsidiary Common Stock Issuances to Third Parties
We follow an accounting policy of income statement recognition for parent
company gains or losses from issuances of common stock by subsidiaries to
unaffiliated third parties.
115
L. Foreign Currency Translation
We followed the principles of SFAS 52, "Foreign Currency Translation," for
recording our investments in foreign affiliates. Under this statement, all
elements of the financial statements are translated by using a current exchange
rate. Translation adjustments result from changes in exchange rates from one
reporting period to another. At December 31, 2006 and 2005, SFAS 52 was not
applicable to KeySpan since we completed the sale of our remaining foreign
investment in the first quarter of 2005.
M. Earnings Per Share
Basic earnings per share ("EPS") is calculated by dividing earnings for common
stock by the weighted average number of shares of common stock outstanding
during the period. No dilution for any potentially anti-dilutive securities is
included. Diluted EPS assumes the conversion of all potentially dilutive
securities and is calculated by dividing earnings 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 SFAS 128, "Earnings Per Share" our basic and diluted
EPS are as follows:
- ---------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts) 2006 2005 2004
- ---------------------------------------------------------------------------------------------------------------
Earnings for common stock $ 434.2 $ 388.0 $ 458.1
- ---------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (000) 175,040 169,940 160,294
Add dilutive securities:
Options 991 861 983
Performance shares 120 - -
- ---------------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution 176,151 170,801 161,277
- ---------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 2.48 $ 2.28 $ 2.86
- ---------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 2.46 $ 2.27 $ 2.84
- ---------------------------------------------------------------------------------------------------------------
N. 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 the Incentive 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 December
31, 2006, after adjusting for forfeitures, there are approximately 3.0 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.
116
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 twelve
months ended December 31, 2005 and 2004 would have decreased to the pro-forma
amounts indicated below:
- -----------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004
- -----------------------------------------------------------------------------------------------------------------
Earnings available for common stock:
As reported $ 388.0 $ 458.1
Add: recorded stock-based compensation expense, net of tax 7.0 9.1
Deduct: total stock-based compensation expense, net of tax (8.9) (12.4)
- -----------------------------------------------------------------------------------------------------------------
Pro-forma earnings $ 386.1 $ 454.8
- -----------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 2.28 $ 2.86
Basic - pro-forma $ 2.27 $ 2.84
Diluted - as reported $ 2.27 $ 2.84
Diluted - pro-forma $ 2.26 $ 2.82
- -----------------------------------------------------------------------------------------------------------------
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 twelve
months ended December 31, 2006, KeySpan recorded an expense of $1.4 million for
stock option awards previously accounted for under APB 25 and which have now
fully vested.
117
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.
- -------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- -------------------------------------------------------------------------------------------------------------------------
Performance shares $ 8.2 $ (1.0) $ 4.9
Restricted stock 4.1 0.9 0.7
Stock options 6.1 5.5 3.7
EDSPP discount 4.8 5.4 4.7
- -------------------------------------------------------------------------------------------------------------------------
Total stock-based compensation included in operations and
maintenance expense 23.2 10.8 14.0
Income tax benefit (8.1) (3.8) (4.9)
- -------------------------------------------------------------------------------------------------------------------------
Total stock based compensation expense, net of tax $ 15.1 $ 7.0 $ 9.1
- -------------------------------------------------------------------------------------------------------------------------
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 twelve months ended December 31, 2006, 2005 and 2004 cash received
from stock options exercised was $31.1 million, $43.0 million and $32.2 million,
respectively. The tax benefit realized for tax deductions from stock options
exercised during the twelve months ended December 31, 2006, 2005 and 2004 was
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.
118
During 2005, it became apparent to management that the 2003 performance share
award would not be achieved and the 2004 performance share award would not be
achieved at the level of expense being recorded. Since these awards meet the
definition of a performance condition not achieved under SFAS 123, KeySpan
reversed the previously recognized expense for the 2003 award and one half of
previously recognized expense for the 2004 award amounting to $3.8 million ($2.5
million after tax).
The 2006 performance share award reflects the new performance condition criteria
under SFAS 123R. In 2006, 315,900 performance shares were granted. 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
December 31, 2006 associated with all of the performance share awards was $11.5
million.
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 the
2002 and 2005 awards was amortized to compensation expense over the vesting
period. 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 expense has
been fully amortized and the 2006 award was expensed in 2006. Upon a change of
control, all restricted stock awards will vest immediately.
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 358,731 shares remaining to be issued.
119
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 options
granted in 2006. The following table presents the weighted average fair value,
exercise price and assumptions used for the 2005 and 2004 stock option grants:
- -------------------------------------------------------------------------
Year Ended December 31,
2005 2004
- -------------------------------------------------------------------------
Fair value of grants issued $ 6.15 $ 5.47
Dividend yield 4.64% 4.74%
Expected volatility 22.63% 23.48%
Risk free rate 4.10% 3.22%
Expected lives 6.4 years 6.5 years
Exercise price $ 39.25 $ 37.54
- -------------------------------------------------------------------------
A summary of the status of our fixed stock option plans and changes is presented
below for the periods indicated:
- -----------------------------------------------------------------------------------------------------------------------------------
2006 2005 2004
- ----------------- ------------------------------------- ----------------------------------- ------------------------------------
Weighted Aggregate Weighted Aggregate Weighted Aggregate
Average Intrinsic Average Intrinsic Average Intrinsic
Exercise Value Exercise Value Exercise Value
Fixed Options Shares Price (In Millions) Shares Price (In Millions) Shares Price (In Millions)
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of
period 10,443,055 $ 33.74 10,540,946 $ 32.61 10,320,743 $ 31.39
Granted during
the year - $ - 1,451,650 $ 39.25 1,602,850 $ 37.54
Exercised (955,500) $ 32.54 (1,400,190) $ 30.65 (1,150,464) $ 28.05
Forfeited (84,451) $ 38.54 (149,351) $ 36.32 (232,183) $ 35.18
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at
end of period 9,403,104 $ 33.82 $ 66.4 10,443,055 $ 33.74 $ 34.8 10,540,946 $ 32.61 $ 73.2
- -----------------------------------------------------------------------------------------------------------------------------------
Exercisable at
end of period 6,885,572 $ 32.73 $ 56.1 5,673,084 $ 31.55 $ 29.1 5,523,259 $ 30.39 $ 50.6
- -----------------------------------------------------------------------------------------------------------------------------------
The total intrinsic value of the options exercised during the 12 months ended
December 31, 2006, 2005 and 2004 was approximately $6.8 million, $11.4 million
and $11.3 million, respectively.
120
- ----------------------------------------------------------------------------------------------------------------------------------
Remaining Options Weighted Range of Options Weighted Range of
Contractual Outstanding at Average Exercise Exercisable at Average Exercise
Life December 31, 2006 Exercise Price Price December 31, 2006 Exercise Price Price
- ----------------------------------------------------------------------------------------------------------------------------------
1 year - - - - - -
2 years 185,000 32.63 32.63 185,000 32.63 32.63
3 years 681,958 28.00 24.73 - 29.38 681,958 28.00 24.73 - 29.38
4 years 382,181 26.97 21.99 - 27.06 382,181 26.97 21.99 - 27.06
5 years 960,947 22.69 22.50 - 32.76 960,947 22.69 22.50 - 32.76
6 years 1,511,064 39.50 39.50 1,511,064 39.50 39.50
7 years 1,750,205 32.66 32.66 1,422,105 32.66 32.66
8 years 1,165,112 32.40 32.40 766,552 32.40 32.40
9 years 1,414,766 37.54 37.54 655,231 37.54 37.54
10 years 1,351,871 39.25 39.25 320,534 39.25 39.25
- ----------------------------------------------------------------------------------------------------------------------------------
9,403,104 6,885,572
- ----------------------------------------------------------------------------------------------------------------------------------
As of December 31, 2006, there are approximately 2.5 million options which have
not yet vested. The unearned compensation cost related to these stock option
awards is $3.2 million which is expected to be recognized over a weighted
average period of 2 years.
O. Recent Accounting Pronouncements
In February 2007, Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") 159 "The Fair Value Option for
Financial Assets and Financial Liabilities." This statement permits entities to
choose to measure many financial instruments and certain other items at fair
value that are not currently required to be measured at fair value. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions. This statement requires a business entity to report
unrealized gains and losses on items for which the fair value option has been
elected in earnings at each subsequent reporting date. An entity may decide
whether to elect the fair value option for each eligible item on its election
date, subject to certain requirements described in the statement. This statement
shall be effective as of the beginning of each reporting entity's first fiscal
year that begins after November 15, 2007. KeySpan is currently reviewing the
requirements of this statement and, at this point in time, we can not determine
the impact, if any, that this statement may have on results of operations,
financial position or cash flows.
On September 29, 2006, the FASB issued SFAS 158 Employers' Accounting for
Defined Benefit Pensions and Other Postretirement Benefit Plans, an amendment of
FASB Statements No. 87, 88, 106 and 132(R)." SFAS 158 requires employers to
fully recognize all postretirement plans funded status on the balance sheet as a
net liability or asset and requires an offsetting adjustment to accumulated
other comprehensive income in shareholders' equity. Certain of KeySpan's
subsidiaries are subject to deferral accounting requirements pursuant to rate
agreements with the NYPSC, MADTE and NHPUC. Further, KeySpan has certain
contractual rights to reimbursement for postretirement liabilities in its
agreements with LIPA. As such, a portion of the offsetting position to the
increase in the total postretirement liabilities has been reflected as a
regulatory asset and contractual asset. SFAS 158 does not change how
postretirement benefits are accounted for and reported in the income statement;
companies will continue to apply existing accounting guidance. KeySpan adopted
the provisions of SFAS 158 in December 2006. See Note 4 "Post Retirement
Benefits" for further information on SFAS 158.
121
On September 15, 2006, the FASB issued SFAS 157 "Fair Value Measurements." This
statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles and expands disclosures about fair
value. SFAS 157 expands the disclosures about the use of fair value to measure
assets and liabilities in interim and annual periods subsequent to initial
recognition. The disclosures focus on the inputs used to measure fair value, the
recurring fair value measurements using significant unobservable inputs and the
effect of the measurement on earnings (or changes in net assets) for the period.
The guidance in SFAS 157 also applies for derivatives and other financial
instruments measured at fair value under Statement 133 "Accounting for
Derivative Instruments and Hedging Activities" at initial recognition and in all
subsequent periods. This Statement is effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. KeySpan is
currently reviewing the requirements of SFAS 157, and at this point in time
cannot determine what impact, if any, SFAS 157 will have on its results of
operations or financial position. This Statement will have no impact on cash
flow.
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 prescribes a
recognition threshold and a measurement attribute for the financial statement
recognition and measurement of tax positions taken or expected to be taken in a
tax return. For those benefits to be recognized, a tax position must be
more-likely-than-not to be sustained upon examination by taxing authorities. The
amount recognized is measured as the largest amount of benefit that is greater
than 50 percent likely of being realized upon ultimate settlement. The
Interpretation requires application for fiscal years beginning after December
15, 2006, for first quarter 2007 reporting. KeySpan is currently reviewing the
requirements of this Interpretation and, at this point in time, we can not
determine the impact, if any, that this Interpretation may have on results of
operations and financial position.
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
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
122
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.
P. Impact of Cumulative Effect of Change in Accounting Principles
KeySpan implemented FASB Interpretation No. 47 ("FIN 47"), effective December
31, 2005. FIN 47 required KeySpan to record a liability and corresponding asset
representing the present value of conditional asset retirement obligations
associated with the retirement of tangible, long-lived assets on the date the
obligations were incurred. At December 31, 2005, we recorded a $45.6 million
liability and corresponding asset representing the present value of conditional
asset retirement obligations associated with the retirement of tangible,
long-lived assets on the date the obligations were incurred. For the $45.6
million initial asset recorded, approximately $4.3 million represents asset
retirement costs that have been deferred on the Consolidated Balance Sheet and
will be depreciated over the remaining life of the underlying associated assets
lives. The remaining $41.3 million represented cumulative accretion and
depreciation expense associated with the liability and asset from the dates the
various obligations would have been recorded had this Interpretation been in
effect at the time the obligations were incurred.
Of the $41.3 million recorded, $11.3 million ($6.6 million, after-tax), was
recorded as a cumulative change in accounting principle on the Consolidated
Statement of Income. The remaining $30.0 million was attributable to the Gas
Distribution segment and was recorded as a reduction to removal cost recovered.
For asset retirement costs incurred in the Gas Distribution segment, KeySpan is
recovering these costs from utility customers and has been expensing a like
amount through its depreciation expense. A portion of this depreciation expense
represents removal costs not yet incurred. The $30.0 million recorded to removal
cost recovered is for purposes of reclassifying a portion of this reserve to the
asset retirement obligation. (See Note 7, "Contractual Obligations, Financial
Guarantees and Contingencies - Asset Retirement Obligations" for further
details.)
123
Under Accounting Principle Board Opinion No. 20 ("APB 20"), the pro-forma impact
of the retroactive application resulting from the adoption of a change in
accounting principle is to be disclosed as follows:
- ----------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts) 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------
Earnings for common stock $ 388.0 $ 458.1
Add back: Cumulative effect of a change in accounting principle 6.6 -
- ----------------------------------------------------------------------------------------------------------------------------
Earnings for common stock before cumulative effect of a change in
accounting principle 394.6 458.1
Less: FIN 47 Accretion expense, net of taxes (0.5) (0.4)
Add: FIN 47 Depreciation expense, net of taxes (0.2) (0.2)
- ----------------------------------------------------------------------------------------------------------------------------
Pro-forma earnings $ 393.9 $ 457.5
- ----------------------------------------------------------------------------------------------------------------------------
Earnings per share before cumulative change in accounting principle:
Basic - as reported $ 2.32 $ 2.86
Basic - pro-forma $ 2.32 $ 2.85
Diluted - as reported $ 2.31 $ 2.84
Diluted - pro-forma $ 2.31 $ 2.84
- ----------------------------------------------------------------------------------------------------------------------------
Earnings per share for common stock:
Basic - as reported $ 2.28 $ 2.86
Basic - pro-forma $ 2.32 $ 2.85
Diluted - as reported $ 2.27 $ 2.84
Diluted - pro-forma $ 2.31 $ 2.84
- ----------------------------------------------------------------------------------------------------------------------------
In addition to the above disclosure, FIN 47 requires disclosure of the pro-forma
impact of the liability for the asset retirement obligation for the beginning of
the earliest year presented and at the end of all years presented as if this
Interpretation had been applied during all periods effected. The disclosure is
as follows:
- ------------------------------------------------------------------------------------------
(In Millions of Dollars) December 31,
2006 2005
- ------------------------------------------------------------------------------------------
Asset retirement obligation - January 1 $ 47.4 $ 44.9
Accretion 2.6 2.5
Cost Incurred (2.7) -
- ------------------------------------------------------------------------------------------
Asset retirement obligation - December 31 $ 47.3 $ 47.4
- ------------------------------------------------------------------------------------------
124
Q. Accumulated Other Comprehensive Income
As required by SFAS 130, "Reporting Comprehensive Income," the components of
accumulated other comprehensive income are as follows:
- -------------------------------------------------------------------------------------------
December 31,
(In Millions of Dollars) 2006 2005
- -------------------------------------------------------------------------------------------
Unrealized gains (losses) on marketable securities $ 1.1 $ (0.9)
Accrued unfunded pension obligation (25.6) (63.5)
SFAS 158 transition (148.0) -
Unrealized losses on derivative financial instruments (2.8) (10.4)
- -------------------------------------------------------------------------------------------
Accumulated other comprehensive loss $ (175.3) $ (74.8)
- -------------------------------------------------------------------------------------------
R. Pension and Other Postretirement Plan Assets
Consistent with past practice and as required by SFAS 158, KeySpan values its
pension and other postretirement assets using the year-end market value of those
assets. Benefit obligations are also measured at year-end.
Note 2. Business Segments
We have four reportable segments: Gas Distribution, Electric Services, Energy
Services and Energy Investments.
The Gas Distribution segment consists of our six gas distribution subsidiaries.
KEDNY provides gas distribution services to customers in the New York City
Boroughs of Brooklyn, Queens and Staten 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, collectively referred to as 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 six years and
power purchase agreements having remaining terms that range from six to 20
years. On February 1, 2006, KeySpan and LIPA agreed to extend, amend and restate
these contractual arrangements. (See Note 11, "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 NYISO energy markets. To finance the purchase and/or construction of the
Ravenswood Generating Station, KeySpan entered into leasing arrangement for each
facility. The Electric Services segment also conducts retail marketing of
electricity to commercial customers. (See Note 7 "Contractual Obligations,
Financial Guarantees and Contingencies" for further details on the leasing
arrangements.)
125
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. In the fourth quarter of 2004, KeySpan's
investment in its mechanical contracting subsidiaries was written-down to an
estimated fair value. During 2004, KeySpan recorded a non-cash goodwill
impairment charge of $108.3 million ($80.3 million after tax, or $0.50 per
share) associated with its mechanical contracting operations and certain
remaining operations. In addition, an impairment charge of $100.3 million ($72.1
million after-tax or $0.45 per share) was also recorded to reduce the carrying
value of the remaining assets of the mechanical contracting companies. (See Note
10 "Energy Services - Discontinued Operations" for additional details regarding
these charges.) During the first six months of 2005, operating losses were
incurred through the dates of sale of these companies of $4.1 million after-tax,
including but not limited to costs incurred for employee related benefits.
Partially offsetting these losses was a gain of $2.3 million associated with the
related divestitures, reflecting the difference between the fair value estimates
and the financial impact of the actual sale transactions. The net income impact
of the operating losses and the disposal gain was a loss of $1.8 million, or
$0.01 per share for the twelve months ended December 31, 2005.
The Energy Investments segment consists of our gas production and development
investments, as well as certain other domestic energy-related investments.
KeySpan's gas production and development 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 production and development activities primarily in West Virginia.
KeySpan Exploration is involved in a joint venture with Merit Energy
Corporation, an independent oil and gas producer that purchased its interest in
the Joint Venture from Houston Exploration.
This segment is also engaged in pipeline development activities. KeySpan and
Spectra Energy Corporation (formerly part of 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 26.25% interest in the Millennium Pipeline
Company LLC, the developer of the Millennium pipeline project, which is expected
to have the capacity to transport up to 525,000 DTH of natural gas a day from
Corning, New York to Ramapo, New York, where it will connect to an existing
pipeline. Additionally, subsidiaries in this segment hold a 20% equity interest
126
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.
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. On February 25, 2005, KeySpan entered into a Share Sale and
Purchase Agreement with BG Energy Holdings Limited and Premier Transmission
Financing Public Limited Company ("PTFPL"), pursuant to which all of the
outstanding shares of Premier were to be purchased by PTFPL. On March 18, 2005,
the sale was completed and generated cash proceeds of approximately $48.1
million. In the fourth quarter of 2004, KeySpan recorded a pre-tax non-cash
impairment charge of $26.5 million reflecting the difference between the
anticipated cash proceeds from the sale of Premier compared to its carrying
value. 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.
During the first five months of 2004, our gas exploration and production
investments also included a 55% equity interest in The Houston Exploration
Company ("Houston Exploration"), an independent natural gas and oil exploration
company located in Houston, Texas, the operations of which were fully
consolidated in KeySpan's Consolidated Financial Statements. On June 2, 2004,
KeySpan exchanged 10.8 million shares of common stock of Houston Exploration for
100% of the stock of Seneca-Upshur, previously a wholly owned subsidiary of
Houston Exploration. This transaction reduced our interest in Houston
Exploration from 55% to 23.5%. Effective June 1, 2004, Houston Exploration's
earnings and our ownership interest in Houston Exploration were accounted for on
the equity method of accounting. This transaction resulted in a gain to KeySpan
of $150.1 million and was reflected in other income and (deductions) on the
Consolidated Statement of Income. The deconsolidation of Houston Exploration
required the recognition of certain deferred taxes on our remaining investment
resulting in a net deferred tax expense of $44.1 million. Therefore, the net
gain on the share exchange less the deferred tax provision was $106 million, or
$0.66 per share.
In November 2004, KeySpan sold its remaining 23.5% interest in Houston
Exploration (6.6 million shares) and received cash proceeds of approximately
$369 million. KeySpan recorded a pre-tax gain of $179.6 million which is
reflected in other income and (deductions) on the Consolidated Statement of
Income. The after-tax gain was $116.8 million or $0.73 per share.
Houston Exploration's revenues, which are reflected in KeySpan's Consolidated
Statement of Income in 2004 were $268.1 million. Houston Exploration's operating
income, including KeySpan's share of equity earnings, was $138.5 million in
2004.
127
During the first quarter of 2004, we also had an approximate 61% investment in
certain midstream natural gas assets in Western Canada through KeySpan Energy
Canada Partnership ("KeySpan Canada"). These assets included 14 processing
plants and associated gathering systems that produced approximately 1.5 BCFe of
natural gas daily and provided associated natural gas liquids fractionation.
These operations were fully consolidated in KeySpan's Consolidated Financial
Statements. On April 1, 2004, KeySpan and KeySpan Facilities Income Fund (the
"Fund"), which previously owned a 39.09% interest in KeySpan Canada, consummated
a transaction whereby the Fund sold 15.617 million units of the Fund and
acquired an additional 35.91% interest in KeySpan Canada from KeySpan. As a
result of this transaction, KeySpan's ownership of KeySpan Canada decreased to
25%. KeySpan recorded a gain of $22.8 million ($10.1 million after-tax, or $0.06
per share) at the time of this transaction. This gain was reflected in other
income and (deductions) on the Consolidated Statement of Income. Effective April
1, 2004 KeySpan Canada's earnings and our ownership interest in KeySpan Canada
were accounted for on the equity method of accounting.
In July 2004, the Fund issued an additional 10.7 million units, the proceeds of
which were used to fund the acquisition of the midstream assets of Chevron
Canada Midstream Inc. This transaction had the effect of further diluting
KeySpan's ownership of KeySpan Canada to 17.4%. KeySpan continued to account for
its investment in KeySpan Canada on the equity basis of accounting since it
still exercised significant influence over this entity.
In December 2004, KeySpan sold its remaining 17.4% interest in KeySpan Canada to
the Fund and received net proceeds of approximately $119 million and recorded a
pre-tax gain of approximately $35.8 million, which is reflected in other income
and (deductions) on the Consolidated Statement of Income. The after-tax gain was
approximately $24.7 million, or $0.15 per share.
KeySpan Canada's revenues, which are reflected in KeySpan's Consolidated
Statement of Income in 2004 were $25.2 million. KeySpan Canada's operating
income, including KeySpan's share of equity earnings, was $16.5 million in 2004.
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. For fiscal year 2004, the operating
data of Houston Exploration has been separately displayed. The reportable
segment information is as follows:
128
- ---------------------------------------------------------------------------------------------------------------------------------
Gas Electric Energy Energy
(In Millions of Dollars) Distribution Services Services Investments Eliminations Consolidated
- ---------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2006
Unaffiliated revenue 5,062.6 1,880.6 203.4 35.0 - 7,181.6
Intersegment revenue - - 9.6 5.3 (14.9) -
Depreciation, depletion and amortization 266.7 102.2 8.3 7.3 13.0 397.5
Gain on sales of property - 0.5 - 0.3 0.8 1.6
Income from equity investments - - - 13.1 - 13.1
Operating income 568.6 293.0 5.3 15.5 (54.9) 827.5
Interest income 1.5 0.6 0.1 0.4 10.6 13.2
Interest charges 179.6 65.0 20.9 1.5 (10.9) 256.1
Total assets 10,536.6 2,471.8 192.3 351.3 885.5 14,437.5
Equity method investments - - - 124.2 - 124.2
Construction expenditures 400.5 78.9 8.0 18.7 17.9 524.0
- ---------------------------------------------------------------------------------------------------------------------------------
Eliminating items include intercompany interest income and expense and the
elimination of certain intercompany accounts as well as activities of our
corporate and administrative subsidiaries.
Electric Services revenues from LIPA and the NYISO of $1.8 billion for the year
ended December 31, 2006 represents approximately 26% of our consolidated
revenues during that period.
- -----------------------------------------------------------------------------------------------------------------------------------
Gas Electric Energy Energy
(In Millions of Dollars) Distribution Services Services Investments Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2005
Unaffiliated revenue 5,390.1 2,042.7 191.2 38.0 - 7,662.0
Intersegment revenue - 4.6 10.8 5.0 (20.4) -
Depreciation, depletion and amortization 277.0 91.7 7.6 6.8 13.4 396.5
Gain on sales of property 0.1 1.2 - 0.1 0.2 1.6
Income from equity investments - - - 15.1 - 15.1
Operating income 565.7 342.3 (2.7) 20.6 (18.1) 907.8
Interest income 0.9 0.8 0.2 2.8 7.6 12.3
Interest charges 178.2 71.7 18.4 1.8 (0.8) 269.3
Total assets 10,052.5 2,348.0 199.0 341.9 871.2 13,812.6
Equity method investments - - - 106.7 - 106.7
Construction expenditures 410.3 88.8 8.4 22.6 9.4 539.5
- -----------------------------------------------------------------------------------------------------------------------------------
Eliminating items include intercompany interest income and expense, the
elimination of certain intercompany accounts, as well as activities of our
corporate and administrative subsidiaries.
Electric Services revenues from LIPA and the NYISO of $2.0 billion for the year
ended December 31, 2005 represents approximately 26% of our consolidated
revenues during that period.
129
- ------------------------------------------------------------------------------------------------------------------------------------
Gas Electric Energy Houston Other Energy
(In Millions of Dollars) Distribution Service Services Exploration Investments Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004
Unaffiliated revenue 4,407.3 1,738.7 182.4 268.1 54.0 - 6,650.5
Intersegment revenue - - 11.5 - 4.9 (16.4) -
Depreciation, depletion and
amortization 276.5 88.2 7.5 104.6 59.7 15.3 551.8
Gain on sales of property - 2.0 - - 5.0 - 7.0
Income from equity investments - - - 20.7 25.8 - 46.5
Operating income 579.6 289.8 (48.3) 138.5 (33.8) 9.5 935.3
Interest income 2.2 9.9 - 3.5 3.0 (9.2) 9.4
Interest charges 176.8 72.9 19.4 3.5 3.9 54.8 331.3
Total assets 8,908.8 2,144.3 246.6 - 701.3 1,363.1 13,364.1
Equity method investments - - - - 107.1 - 107.1
Construction expenditures 414.5 150.3 13.7 146.5 13.7 11.6 750.3
- ------------------------------------------------------------------------------------------------------------------------------------
Eliminating items include intercompany interest income and expense and the
elimination of certain intercompany accounts as well as activities of our
corporate and administrative subsidiaries.
Electric Services revenues from LIPA and the NYISO of $1.7 billion for the year
ended December 31, 2004 represents approximately 25% of our consolidated
revenues during that period.
Note 3. Income Tax
KeySpan files a consolidated federal income tax return. A tax sharing agreement
between the KeySpan's holding company and its subsidiaries provides for the
allocation of a realized tax liability or asset based upon separate return
contributions of each subsidiary to the consolidated taxable income or loss in
the consolidated income tax return. The subsidiaries record income tax payable
or receivable from KeySpan resulting from the inclusion of their taxable income
or loss in the consolidated return.
Income tax expense is reflected as follows in the Consolidated Statement of
Income:
- ----------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- ----------------------------------------------------------------------------
Current Income Tax
Federal 41.3 175.7 205.1
State and Local 16.6 30.9 (3.2)
------------------------------------------------
Total Current Income Tax $ 57.9 $ 206.6 $ 201.9
------------------------------------------------
Deferred Income Tax
Federal 93.8 17.1 118.3
State and Local 23.8 15.6 5.3
------------------------------------------------
Total Deferred Income Tax $ 117.6 $ 32.7 $ 123.6
- ----------------------------------------------------------------------------
Total income tax $ 175.5 $ 239.3 $ 325.5
- ----------------------------------------------------------------------------
130
At December 31, the significant components of KeySpan's deferred tax assets and
liabilities calculated under the provisions of SFAS No.109 "Accounting for
Income Taxes" were as follows:
- --------------------------------------------------------------------------------
December 31,
(In Millions of Dollars) 2006 2005
- --------------------------------------------------------------------------------
Reserves not currently deductible $ 46.1 $ 28.4
State income tax (49.7) (20.6)
Property related differences (1,179.3) (1,080.8)
Regulatory tax asset (29.3) (24.5)
Employess benefits and compensation 24.6 (30.3)
Property taxes (82.7) (84.1)
Other items - net 93.9 54.0
- --------------------------------------------------------------------------------
Net deferred tax liability $ (1,176.4) $ (1,157.9)
- --------------------------------------------------------------------------------
The federal income tax amounts included in the Consolidated Statement of Income
differ from the amounts which result from applying the statutory federal income
tax rate to income before income tax.
The table below sets forth the reasons for such differences:
- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- ---------------------------------------------------------------------------------------------------------------------
Computed at the statutory rate $ 213.2 $ 223.3 $ 329.1
Adjustments related to:
State income tax, net of Federal benefit 29.4 29.0 24.8
Tax credits (1.3) (1.4) (2.2)
Removal costs (2.1) (2.9) (0.6)
Accrual to return adjustments (3.8) 6.7 (10.7)
Sale of subsidiary stock - - (22.5)
Minority interest in Houston Exploration - - 12.9
Contribution of land - (3.8) -
Dividends paid to employee benefit plan (3.7) (3.9) (3.6)
Impact of IRS audit settlement (44.5) - -
Impact of NYC audit settlement (7.1) - -
Other items - net (4.6) (7.7) (1.7)
- ---------------------------------------------------------------------------------------------------------------------
Total income tax $ 175.5 $ 239.3 $ 325.5
- ---------------------------------------------------------------------------------------------------------------------
Effective income tax rate (1) 29% 38% 35%
- ---------------------------------------------------------------------------------------------------------------------
(1) Reflects both federal as well as state income taxes.
KeySpan's consolidated effective income tax rate, including city and state
income taxes, was 28.8% for the twelve months ended December 31, 2006 compared
to 37.5% for the corresponding period in 2005. In 2006, KeySpan resolved its
dispute with the New York City Department of Taxation and Finance with respect
to income taxes relating to the operations of its merchant electric generating
facility. As a result of the favorable settlement of this issue, KeySpan
reversed a previously recorded tax reserve of $11.9 million ($7.1 million after
federal income taxes). In addition, pursuant to indemnity obligations contained
in the Long Island Lighting Company ("LILCO") / KeySpan merger agreement of May
1998, KeySpan had been working with the Internal Revenue Service ("IRS") to
resolve certain disputes with regard to LILCO's tax returns for the tax years
131
ended December 31, 1996 through March 31, 1999 and KeySpan's and The Brooklyn
Union Gas Company's (d/b/a KEDNY) tax returns for the years ended September 30,
1997 through December 31, 1998. A settlement of the outstanding issues was
reached in 2006 and, following IRS procedure, the settlement was submitted to
the Joint Committee on Taxation on October 30, 2006 for final approval, which is
expected in early 2007. Accordingly, KeySpan reversed $44.5 million of
previously established tax reserves. Further, a $3.4 million benefit was
recorded in 2006 reflecting an accrual for prior investment tax credits that
KeySpan is entitled to. KeySpan has recently filed amended tax returns to
reflect its entitlement to investment tax credits for the period 2000 through
2004. The decrease in the effective tax rate for the twelve months ended
December 31, 2006 compared to the same period in 2005, was primarily due to the
aforementioned items.
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.
The American Jobs Creation Act of 2004, signed into law on October 22, 2004
provides for a special one-time tax deduction, or dividend received deduction
("DRD") of 85% of qualifying foreign earnings that were repatriated in 2004 or
2005. We currently estimate that KeySpan has repatriated dividends of
approximately $9.5 million of earnings under this provision and received, as a
result, a tax benefit of $2.8 million.
As of December 31, 2006 KeySpan has $412 million of state net operating losses
which will expire between 2011 and 2022.
Note 4. Postretirement Benefits
Pension Plans. The following information represents the consolidated results 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 MADTE, respectively for pension costs and
other postretirement benefit costs. Further, KeySpan's electric subsidiaries are
subject to certain "true-up" provisions in accordance with the LIPA service
agreements.
The calculation of net periodic pension cost is as follows:
- ------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- ------------------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 62.7 $ 56.5 $ 52.9
Interest cost on projected benefit obligation 155.1 148.5 144.2
Expected return on plan assets (186.0) (173.1) (158.2)
Net amortization and deferral 88.7 74.1 63.3
Special termination benefits - 2.2 -
- ------------------------------------------------------------------------------------------------
Total pension cost $ 120.5 $ 108.2 $ 102.2
- ------------------------------------------------------------------------------------------------
132
The following table sets forth the pension plans' funded status at December 31,
2006 and December 31, 2005.
- ----------------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005
- ----------------------------------------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation at beginning of period $ (2,715.0) $ (2,520.1)
Service cost (62.7) (56.6)
Interest cost (155.0) (148.5)
Amendments (11.5) (0.1)
Actuarial loss 28.3 (117.9)
Benefits paid 133.8 130.4
Special termination benefits - (2.2)
- ----------------------------------------------------------------------------------------------------------------
Benefit obligation at end of period $ (2,782.1) $ (2,715.0)
- ----------------------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of period 2,213.5 2,028.9
Actual return on plan assets 299.6 166.7
Employer contribution 94.9 148.3
Benefits paid (133.8) (130.4)
- ----------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of period 2,474.2 2,213.5
- ----------------------------------------------------------------------------------------------------------------
Funded status (307.9) (501.5)
- ----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
Amounts recognized in the statement of financial position consist of:
Noncurrent assets $ -
Current liabilities (6.3)
Noncurrent liabilities (301.6)
- -----------------------------------------------------------------------------------------------
Total $ (307.9)
- -----------------------------------------------------------------------------------------------
Amounts recognized in accumulated other comprehensive income consist of:
Net gain/(loss) $ (451.8)
Prior service cost (49.4)
- -----------------------------------------------------------------------------------------------
Total $ (501.2)*
- -----------------------------------------------------------------------------------------------
Estimated amounts of accumulated other comprehensive income to be
recognized in the next fiscal year through net periodic pension cost:
Net gain/(loss) $ (53.3)
Prior service cost (10.3)
- -----------------------------------------------------------------------------------------------
Total $ (63.6)*
- -----------------------------------------------------------------------------------------------
*The above amounts are before adjustments for regulatory and contractual
deferrals and deferred taxes
133
The table below details the end-of-year assumptions used for both the net
periodic cost calculations and liability amounts.
- -----------------------------------------------------------------------------------------------
Year End December 31,
2006 2005 2004 2003
- -----------------------------------------------------------------------------------------------
Assumptions:
Obligation discount 6.00% 5.75% 6.00% 6.25%
Asset return, net of expenses 8.50% 8.50% 8.50% 8.50%
Average annual increase in compensation 4.00% 4.00% 4.00% 4.00%
- -----------------------------------------------------------------------------------------------
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid in the years indicated:
- -------------------------------------------------
(In Millions of Dollars) Pension Benefits
- -------------------------------------------------
2007 $ 138.3
2008 $ 141.8
2009 $ 145.5
2010 $ 150.4
2011 $ 156.0
Years 2012- 2016 $ 906.4
- -------------------------------------------------
Under Funded Pension Obligation. SFAS 158 "Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans" requires full balance sheet
recognition of the net overfunded or underfunded status of each pension and
other postretirement plan. The funded status of pension plans is to be measured
as the difference between the fair value of plan assets minus the projected
benefit obligation. At December 31, 2006, KeySpan's projected benefit obligation
was in excess of pension assets by $307.9 million. Amounts that are not
recognized in net periodic benefit costs will be recorded through accumulated
other comprehensive income. At December 31, 2006, the amount recognized in
accumulated other comprehensive income was $134.7 million, net of tax and
regulatory and contractual deferrals.
134
The following table reconciles the 2005 Consolidated Balance Sheet with the
impact of SFAS 158:
- ------------------------------------------------------------------------------
(In Millions of Dollars) Pension
- ------------------------------------------------------------------------------
Liability AOCI
- ------------------------------------------------------------------------------
Prepaid Asset December 31, 2005 $ 218.9 $ -
Additional minimum liability (257.4) (63.5)
- ------------------------------------------------------------------------------
Balance at December 31, 2005 (38.5) (63.5)
2006 activity (25.6) -
Reduction to additional minimum liability 137.0 137.0
Incremental SFAS 158 liability (380.8) (380.8)
Intangible asset reversal - (41.1)
Incremental deferrals and deferred taxes - 213.7
- ------------------------------------------------------------------------------
Balance at December 31, 2006 $ (307.9) $ (134.7)
- ------------------------------------------------------------------------------
At December 31, 2006 the projected benefit obligation, accumulated benefit
obligation and value of assets for plans with accumulated benefit obligations in
excess of plan assets were $1.4 billion, $1.3 billion and $1.2 billion,
respectively.
At December 31, 2005 the accumulated benefit obligation was in excess of pension
assets. As prescribed by SFAS 87 "Employers' Accounting for Pensions," KeySpan
had a $257.4 million minimum liability at December 31, 2005, for this unfunded
pension obligation. As permitted under accounting guidelines then applicable,
these accruals were offset by a corresponding debit to a long-term asset up to
the amount of accumulated unrecognized prior service costs. Any remaining amount
was to be recorded in accumulated other comprehensive income on the Consolidated
Balance Sheet.
Therefore, at December 31, 2005, we had a long-term asset in deferred charges
other of $41.1 million, representing the amount of unrecognized prior service
cost and a debit to accumulated other comprehensive income of $97.8 million, or
$63.6 million after-tax. The remaining amount of $118.3 million was recorded as
a contractual receivable from LIPA of $103.8 million and a regulatory asset of
$14.5 million, representing the amounts that could be recovered from LIPA and
the Boston Gas ratepayer in accordance with our service and rate agreements.
At December 31, 2005 the projected benefit obligation, accumulated benefit
obligation and value of assets for plans with accumulated benefit obligations in
excess of plan assets were $1.4 billion, $1.3 billion and $997 million,
respectively.
Other Postretirement Benefits. The following information represents the
consolidated results for our non-contributory 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.
135
Net periodic other postretirement benefit cost included the following
components:
- --------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005 2004
- --------------------------------------------------------------------------------------
Service cost, benefits earned during the period $ 24.9 $ 24.4 $ 19.7
Interest cost on accumulated
postretirement benefit obligation 74.9 75.7 70.2
Expected return on plan assets (36.6) (36.1) (33.9)
Net amortization and deferral 57.3 59.9 41.0
Special termination benefit - 1.7 -
- --------------------------------------------------------------------------------------
Other postretirement cost $ 120.5 $ 125.6 $ 97.0
- --------------------------------------------------------------------------------------
136
The following table sets forth the plans' funded status at December 31, 2006 and
December 31, 2005.
- -----------------------------------------------------------------------------------------------------------
Year Ended December 31,
(In Millions of Dollars) 2006 2005
- -----------------------------------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation at beginning of period $ (1,414.3) $ (1,336.7)
Actual Medicare Part D subsidy received (0.9) -
Expected less actual Medicare Part D subsidy received in 2006 (2.7) -
Service cost (24.9) (24.4)
Interest cost (74.9) (75.7)
Plan participants' contributions (3.5) (3.4)
Amendments - 3.2
Actuarial gain (loss) 132.4 (38.3)
Benefits paid 65.8 62.7
Special termination benefit - (1.7)
- -----------------------------------------------------------------------------------------------------------
Benefit obligation at end of period (1,323.0) (1,414.3)
- -----------------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of period 469.6 464.0
Actual return on plan assets 56.8 29.1
Employer contribution 36.3 35.8
Plan participants' contributions 3.5 3.4
Benefits paid (65.8) (62.7)
- -----------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of period 500.4 469.6
- -----------------------------------------------------------------------------------------------------------
Funded status (822.6) (944.7)
- -----------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
Amounts recognized in the statement of financial position consist of:
Noncurrent assets $ 13.6
Current liabilities (6.6)
Noncurrent liabilities (829.6)
- --------------------------------------------------------------------------------------------
Total $ (822.6)
- --------------------------------------------------------------------------------------------
Amounts recognized in accumulated other comprehensive income consist of:
Net gain / (loss) $ (337.9)
Prior service cost 85.1
- --------------------------------------------------------------------------------------------
Total $ (252.8)*
- --------------------------------------------------------------------------------------------
Estimated amounts of accumulated other comprehensive income to be recognized in
the next fiscal year through net periodic pension cost:
Net gain / (losss) $ (61.4)
Prior service cost 12.3
- --------------------------------------------------------------------------------------------
Total $ (49.1)*
- --------------------------------------------------------------------------------------------
*The above amounts are before adjustments for regulatory and contractual
deferrals and deferred taxes
137
The table below details the end-of-year assumptions used for both the net
periodic cost calculations and liability amounts.
- ---------------------------------------------------------------------------------------------------
Year End December 31,
2006 2005 2004 2003
- ---------------------------------------------------------------------------------------------------
Assumptions:
Obligation discount 6.00% 5.75% 6.00% 6.25%
Asset return, net of tax 8.25% 8.25% 8.25% 8.00%
Average annual increase in compensation 4.00% 4.00% 4.00% 4.00%
- ---------------------------------------------------------------------------------------------------
The measurement of plan liabilities assumes a health care cost trend rate of
9.0% grading down to 4.75% in the year 2012. A 1% increase in the health care
cost trend rate would have the effect of increasing the accumulated
postretirement benefit obligation as of December 31, 2006 by $157.3 million and
the net periodic health care expense by $14.5 million. A 1% decrease in the
health care cost trend rate would have the effect of decreasing the accumulated
postretirement benefit obligation as of December 31, 2006 by $137.4 million and
the net periodic health care expense by $12.3 million.
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid in the years indicated:
- -------------------------------------------------------------------------------
Gross Benefit Subsidiary Receipts
(In Millions of Dollars) Payments Expected**
- -------------------------------------------------------------------------------
2007 $ 68.0 $ 3.9
2008 $ 72.4 $ 4.3
2009 $ 77.1 $ 4.6
2010 $ 81.6 $ 4.9
2011 $ 85.6 $ 5.2
Years 2012- 2016 $ 472.4 $ 29.7
- --------------------------------------------------------------------------------
** Rebates are based on calendar year in which prescription drug costs are
incurred. Actual receipt of rebates may occur in the following year.
Under Funded Other Postretirement Obligation. As noted previously, SFAS 158
requires full balance sheet recognition of the net overfunded or underfunded
status of each pension and other postretirement plan. The funded status of other
postretirement plans is to be measured as the difference between the fair value
of plan assets minus the accumulated benefit obligation. At December 31, 2006,
KeySpan's accumulated benefit obligation was in excess of other postretiment
assets by $822.6 million. Amounts that are not recognized in net periodic
benefit costs will be recorded through accumulated other comprehensive income.
At December 31, 2006, the amount recognized in accumulated other comprehensive
income was $39.0 million, net of tax and regulatory and contractual deferrals.
138
The following table reconciles the 2005 Consolidated Balance Sheet with the
impact of FAS 158:
- -------------------------------------------------------------------------------
(In Millions of Dollars) OPEB
- -------------------------------------------------------------------------------
Liability AOCI
- ------------------------------------------------------------------------------
Accrual at December 31, 2005 $ (484.7) $ -
- -------------------------------------------------------------------------------
2006 activity (85.1) -
Incremental SFAS 158 liability (252.8) (252.8)
Incremental deferrals and deferred taxes - 213.8
- -------------------------------------------------------------------------------
Balance at December 31, 2006 $ (822.6) $ (39.0)
- -------------------------------------------------------------------------------
At December 31, 2006, KeySpan had a contractual receivable from LIPA of $583.7
million representing pension and other postretirement benefits associated with
the electric business unit employees recorded in deferred charges other on the
Consolidated Balance Sheet. LIPA has been reimbursing us for costs related to
the postretirement benefits of the electric business unit employees in
accordance with the LIPA Agreements.
Pension/Other Post Retirement Benefit Plan Assets. KeySpan's weighted average
asset allocations at December 31, 2006 and 2005, by asset category, for both the
pension and other postretirement benefit plans are as follows:
- -----------------------------------------------------------------------------
Pension OPEB
Asset Category 2006 2005 2006 2005
- -----------------------------------------------------------------------------
Equity securities 67% 65% 69% 70%
Debt securities 26% 27% 24% 23%
Cash and equivalents 1% 3% 2% 2%
Venture capital 6% 5% 5% 5%
- -----------------------------------------------------------------------------
Total 100% 100% 100% 100%
- -----------------------------------------------------------------------------
The long-term rate of return on assets (pre-tax) is assumed to be 8.5%, net of
expenses which management believes is an appropriate long-term expected rate of
return on assets based on our investment strategy, asset allocation mix and the
historical performance of equity and fixed income investments over long periods
of time. The actual ten- year compound rate of return, net of expenses, for our
Plans is greater than 8.5%.
Our master trust investment allocation policy target for the assets of the
pension and other postretirement benefit plans is 70% equity and 30% fixed
income.
KeySpan has developed a multi-year funding strategy for its plans. We believe
that it is reasonable to assume assets can achieve or outperform the assumed
long-term rate of return with the target allocation as a result of historical
performance of equity investments over long-term periods.
Cash Contributions. In 2007, KeySpan is expected to contribute approximately $95
million to its pension plan and approximately $36 million to its other
postretirement benefit plan.
Defined Contribution Plan. KeySpan also offers both its union and management
employees a defined contribution plan. Both the KeySpan Energy 401(k) Plan for
Management Employees and the KeySpan Energy 401(k) Plan for Union Employees are
available to all eligible employees. These Plans are defined contribution plans
subject to Title I of the Employee Retirement Income Security Act of 1974
("ERISA"). Eligible employees contributing to the Plan may receive certain
139
employer contributions including matching contributions and a 10% discount on
the purchase of KeySpan common stock in the Plan. The matching contributions
were in KeySpan's common stock until January 2006. The matching contributions
are now determined at election of KeySpan employees. For the years ended
December 31, 2006, 2005 and 2004, we recorded an expense of $14.7 million, $15.2
million, and $14.7 million, respectively.
Required disclosures on the Impact of the Adoption of SFAS No.158 on the Balance
Sheet. SFAS 158 requires that in the transition year KeySpan must first
calculate the minimum pension liability as of the end of the year the statute is
implemented and disclose the change that would have been reflected in OCI for
that year. The difference between the recorded amounts in OCI and the amounts
reflected in the implementation of SFAS 158 constitute the transition adjustment
amount. The following table reflects the effect of the transition.
- -------------------------------------------------------------------------------------------------------------
(In Millions of Dollars)
- -------------------------------------------------------------------------------------------------------------
December 31, 2006 SFAS 158 December 31,
Before SFAS 158 Transition 2006
- -------------------------------------------------------------------------------------------------------------
Miscellaneous regulatory assets $ 710.9 $ 226.6 $ 937.5
Other deferred charges $ 695.2 $ 179.9 $ 875.1
Deferred income taxes $ 1,309.0 $ (132.6) $ 1,176.4
Postretirement benefits and other reserves $ 1,033.0 $ 634.3 $ 1,667.3
Accumulated other comprehensive Income $ (27.3) $ (148.0) $ (175.3)
Total common equity $ 4,666.8 $ (148.0) $ 4,518.8
- -------------------------------------------------------------------------------------------------------------
Note 5. Capital Stock
Common Stock. Currently KeySpan has 450,000,000 shares of authorized common
stock. At December 31, 2006, KeySpan had 9.5 million shares, or $273.6 million
of treasury stock outstanding. During 2006, KeySpan issued approximately 1.0
million shares out of treasury for the dividend reinvestment feature of our
Investor Program, the Employee Discount Stock Purchase Plan, the 401(k) Plan and
the Long-Term Incentive Compensation Plan.
On May 16, 2005, KeySpan issued 12.1 million shares of common stock, in
association with the MEDS Equity Units conversion, at an issuance price of
$37.93 per share pursuant to the terms of the forward purchase contract. KeySpan
received proceeds of approximately $460 million from the equity conversion. The
number of shares issued was dependent on the average closing price of our common
stock over the 20 day trading period ending on the third trading day prior to
May 16, 2005. (See Note 6 "Long-Term Debt and Commercial Paper" for further
details on the MEDS Equity Units.)
Preferred Stock. We have the authority to issue 100,000,000 shares of preferred
stock with the following classifications: 16,000,000 shares of preferred stock,
par value $25 per share; 1,000,000 shares of preferred stock, par value $100 per
share; and 83,000,000 shares of preferred stock, par value $.01 per share. There
was no outstanding preferred stock at December 31, 2006 and 2005.
Note 6. Long-Term Debt And Commercial Paper
Notes Payable. During 2006, KeySpan issued at KEDNY and KEDLI, respectively,
$400 million and $100 million of Senior Unsecured Notes at 5.60% due November
29, 2016. Additionally, KEDLI has $125 million of Medium-Term Notes at 6.90% due
January 15, 2008, and $400 million of 7.875% Medium-Term Notes due February 1,
2010, outstanding at December 31, 2006 each of which is guaranteed by KeySpan.
140
KeySpan also has $1.9 billion of medium and long term notes outstanding at
December 31, 2005 of which $950 million of these notes were associated with the
acquisition of Eastern and ENI. These notes were issued in two series as
follows: $700 million of 7.625% Notes due 2010 and $250 million of 8.00% Notes
due 2030. In addition, KeySpan has $467.2 million of notes outstanding pursuant
to the MEDS Equity Units conversion in 2005. The MEDS Equity Units consisted of
a three-year forward purchase contract for our common stock and a six-year note.
The purchase contract required us, three years from the date of issuance of the
MEDS Equity Units, May 16, 2005, to issue and the investors to purchase, a
number of shares of our common stock based on a formula tied to the market price
of our common stock at that time. The 8.75% coupon was composed of interest
payments on the six-year note of 4.9% and premium payments on the three-year
equity forward contract of 3.85%.
In 2005, KeySpan was required to remarket the note component of the Equity Units
and reset the interest rate to the then current market rate of interest;
however, the reset interest rate could not be set below 4.9%. In March 2005,
KeySpan remarketed the note component of $394.9 million of the Equity Units at
the reset interest rate of 4.9% through their maturity date of May 2008. The
balance of the notes ($65.1 million) were held by the original MEDS equity
holders in accordance with their terms and not remarketed. KeySpan then
exchanged $300 million of the remarketed notes for $307.2 million of new 30 year
notes bearing an interest rate of 5.8%. Therefore, KeySpan now has $160 million
of 4.9% notes outstanding with a maturity date of May 2008 and $307.2 million of
5.8% notes outstanding with a maturity date of April 2035 that are classified as
medium and long term notes.
On May 16, 2005 KeySpan issued 12.1 million shares of common stock, at an
issuance price of $37.93 per share, pursuant to the terms of the financial
purchase contract described above. KeySpan received proceeds of approximately
$460 million from the equity conversion. The number of shares issued was
dependent on the average closing price of our common stock over the 20 day
trading period ending on the third trading day prior to May 16, 2005.
The remaining debt of $483.2 million had interest rates ranging from 4.65% to
9.75%.
Gas Facilities Revenue Bonds. KEDNY can issue tax-exempt bonds through the New
York State Energy Research and Development Authority ("NYSERDA"). Whenever bonds
are issued for new gas facilities projects, proceeds are deposited in trust and
subsequently withdrawn to finance qualified expenditures. There are no sinking
fund requirements on any of our Gas Facilities Revenue Bonds ("GFRBs"). At
December 31, 2006, $640.5 million of GFRBs were outstanding. The interest rate
on the variable rate series due through July 1, 2026 is reset weekly and ranged
from 2.55% to 3.65% during the year ended December 31, 2006, at which time the
rate was 3.65%.
Promissory Notes to LIPA. In connection with the KeySpan/LILCO transaction,
KeySpan and certain of its subsidiaries issued promissory notes to LIPA to
support certain debt obligations assumed by LIPA. At December 31, 2006, $155.4
million of these promissory notes remained outstanding. Under these promissory
notes, KeySpan is required to obtain letters of credit to secure its payment
obligations if its long-term debt is not rated at least in the "A" range by at
least two nationally recognized statistical rating agencies. At December 31,
2006, KeySpan was in compliance with this requirement.
141
Industrial Development Revenue Bonds. At December 31, 2006, KeySpan had
outstanding $128.3 million of tax-exempt bonds with a 5.25% coupon maturing in
June 2027. Fifty-three million dollars of these Industrial Development Revenue
Bonds were issued in its behalf through the Nassau County Industrial Development
Authority for the construction of the Glenwood Energy Center, an
electric-generation peaking plant, and the balance of $75 million was issued in
its behalf by the Suffolk County Industrial Development Authority for the Port
Jefferson Energy Center an electric-generation peaking plant. KeySpan has
guaranteed all payment obligations of these subsidiaries with regard to these
bonds.
First Mortgage Bonds. Colonial Gas Company had outstanding $95.0 million of
first mortgage bonds at December 31, 2006. These bonds are secured by gas
utility property. The first mortgage bond indentures include, among other
provisions, limitations on: (i) the issuance of long-term debt; (ii) engaging in
additional lease obligations; and (iii) the payment of dividends from retained
earnings. At December 31, 2006, these bonds remain outstanding and have interest
rates ranging from 6.34% to 8.80% and maturities that range from 2008-2028.
Authority Financing Notes. Certain of our electric generation subsidiaries can
issue tax-exempt bonds through the NYSERDA. At December 31, 2006, $41.1 million
of Authority Financing Notes 1999 Series A Pollution Control Revenue Bonds due
October 1, 2028 were outstanding. The interest rate on these notes is reset
based on an auction procedure. The interest rate during 2006 ranged from 2.70%
to 3.65%, through December 31, 2006, at which time the rate was 3.65%.
We also have outstanding $24.9 million variable rate 1997 Series A Electric
Facilities Revenue Bonds due December 1, 2027. The interest rate on these bonds
is reset weekly and ranged from 2.98% to 4.00% for the year ended December 31,
2006, at which time the rate was 3.95%.
Ravenswood Master Lease. We have an arrangement with an unaffiliated variable
interest financing entity through which we lease a portion of the Ravenswood
Facility. We acquired the Ravenswood Facility, in part, through the variable
interest entity, from the Consolidated Edison Company of New York ("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 the variable interest entity that acquired a portion of the
facility, or three steam generating units, directly from Consolidated Edison and
leased it to a KeySpan subsidiary. The variable interest 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
under the Master Lease. Monthly lease payments are substantially equal to the
monthly interest expense on the debt securities.
142
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 as
defined in Financial Accounting Standards Board Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51." 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
$307.7 million. Under the terms of our credit facilities, the Master Lease is
considered debt in the ratio of debt-to-total capitalization. (See Note 7
"Contractual Obligations, Financial Guarantees and Contingencies" for additional
information regarding the leasing arrangement associated with the Master Lease
Agreement.)
Commercial Paper and Revolving Credit Agreements. KeySpan has two credit
facilities, which total $1.5 billion - $920 million for five years through 2010,
and $580 million through 2009 - which will 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.
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
December 31, 2006, KeySpan's consolidated indebtedness was 49.9% 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 December 31, 2006, we had cash and temporary cash investments of $210.9
million. During 2006, we repaid $572.6 million of commercial paper and, at
December 31, 2006, $85.0 million of commercial paper was outstanding at a
weighted average annualized interest rate of 5.43%. At December 31, 2006,
KeySpan had the ability to issue up to an additional $1.4 billion, under its
commercial paper program.
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Capital Leases. Our subsidiaries lease certain facilities and equipment under
long-term leases, which expire on various dates through 2014. The weighted
average interest rate on these obligations was 6.0%.
Debt Maturity. The following table reflects the maturity schedule for our debt
repayment requirements, including capitalized leases and related maturities, at
December 31, 2006:
- -------------------------------------------------------------------------------
Long-Term Capital
(In Millions of Dollars) Debt Leases Total
- -------------------------------------------------------------------------------
Repayments:
2007 $ - $ 1.2 $ 1.2
2008 305.0 1.1 306.1
2009 412.3 1.2 413.5
2010 1,110.0 1.3 1,111.3
2011 20.0 1.3 21.3
Thereafter 2,575.6 3.7 2,579.3
- -------------------------------------------------------------------------------
$ 4,422.9 $ 9.8 $ 4,432.7
- -------------------------------------------------------------------------------
Note 7. Contractual Obligations, Financial Guarantees and Contingencies
Lease Obligations. Lease costs included in operating expense were $76.2 million
in 2006 including the lease of KeySpan's Brooklyn headquarters of $10.7 million.
KeySpan has a leveraged lease financing arrangement associated with the
Ravenswood Expansion. The yearly operating lease expense is approximately $17
million per year. (See the caption below "Sale/Leaseback Transaction" for
further details of this lease.) Lease costs also include leases for other
buildings, office equipment, vehicles and power operated equipment. Lease costs
for the year ended December 31, 2005 and 2004 were $76.5 million and $67.7
million, respectively. As previously mentioned, the Master Lease is consolidated
and, as a result, lease payments are reflected as interest expense on the
Consolidated Statement of Income. The future minimum cash lease payments under
various leases, excluding the Master Lease, but including the Ravenswood
Expansion lease, all of which are operating leases, are $103.8 million per year
over the next five years and $580.1 million, in the aggregate, for all years
thereafter. (See discussion below for further information regarding the Master
Lease and the Ravenswood Expansion sale/leaseback transaction.)
Variable Interest Entity. As mentioned, KeySpan has an arrangement with a
variable interest entity through which it leases 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
the Master Lease with a variable interest, unaffiliated financing entity that
acquired a portion of the facility, or three steam generating units, directly
144
from Consolidated Edison and leased it to our subsidiary, KeySpan Ravenswood,
LLC. 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 KeySpan Ravenswood, LLC, under the
Master Lease. Monthly lease payments substantially equal the monthly interest
expense on such debt securities. Interest expense for the year ended December
31, 2006 was $30.0 million.
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
$307.7 million. If 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 generated cash proceeds of $385 million, before transaction costs,
which approximates the fair market value of the facility, as determined by a
third-party appraiser. 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." The lease has an initial term of 36 years and the yearly operating
lease expense is approximately $17 million per year. Lease payments will
fluctuate from year to year, but are substantially paid over the first 16 years.
The future minimum cash lease payments under this lease is approximately $171
million over the next five years and $378 million, in the aggregate, for all
years thereafter. The sale/leaseback transaction resulted in a pre-tax gain of
approximately $6 million which has been deferred and is being amortized over the
life of the lease.
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Asset Retirement Obligations. On December 31, 2005, KeySpan implemented FIN 47
"Accounting for Conditional Asset Retirement Obligations." FIN 47 was issued to
clarify that the term conditional asset obligation used in SFAS 143 "Accounting
for Asset Retirement Obligations" refers to a legal obligation to perform an
asset retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of the
entity. Previously, KeySpan adopted SFAS 143 on January 1, 2003. SFAS 143
required us to record a liability and corresponding asset representing the
present value of legal obligations associated with the retirement of tangible,
long-lived assets that existed at the inception of the obligation.
The following table presents our asset retirement obligation at December 31,
2006 and December 31, 2005:
- -------------------------------------------------------------------------------------------
(In Millions of Dollars)
-----------------------------------------------------------------------------------------
December 31, 2006 2005
-----------------------------------------------------------------------------------------
Asset Retirement Obligations
Asbestos removal (i) $ 3.5 $ 3.5
Tanks removal and cleaning (ii) 7.3 6.9
Main -cutting, purging and capping (iii) 29.7 30.6
Wells - plug and capping (iv) 0.2 0.2
KeySpan LNG tank demolition (v) 2.3 2.1
Waste water treatment pond removal (vi) 1.5 1.4
Fiber network removal (vii) 0.9 0.8
Exploration wells-plug and capping (viii) 1.9 1.9
-----------------------------------------------------------------------------------------
Total Asset Retirement Obligations $ 47.3 $ 47.4
-----------------------------------------------------------------------------------------
(i) Asbestos-containing materials exist in roof flashing, floor tiles, pipe
insulation and mechanical room insulation within our common facilities as
well as in our older generation plants. KeySpan has a legal obligation to
remove asbestos upon either a major renovation or demolition.
(ii) KeySpan has numerous storage tanks that contain among other things waste
oil, #2 and #6 grade fuel oil, diesel fuel, multi chemicals, lube oil,
kerosene, ammonia, and other waste contaminants. All of these tanks are
subject to cleaning and removal requirements prior to demolition and
retirement if so specified by law or regulation.
(iii) KeySpan has a legal requirement 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. Gas mains are generally abandoned in place when
retired, unless the main and other equipment needs to be removed due to
sewer or water system rerouting or other roadblock work. When such a main
and equipment are removed certain PCB test procedures must be employed.
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(iv) KeySpan owns approximately 52% of an underground gas storage facility in
western New York State. The facility includes 39 gas injection and
extraction wells. There is a regulatory obligation to close and seal the
wells.
(v) KeySpan owns a 600,000 gallon Liquefied Natural Gas ("LNG") tank and
ancillary facilities located in Providence, RI under a 30 year contract
with New England Gas Company entered into on November 1, 1999. At the end
of the contract, the contract can be; (i) Extended; or (ii) New England Gas
Company can require KeySpan to dismantle and remove the LNG tank and
ancillary facilities or; (iii) KeySpan can elect to dismantle and remove
the LNG tank and ancillary facilities. Since we may or may not be required
to dismantle and remove the LNG tank and ancillary facilities, the
obligation to perform was discounted to a 50% probability as premitted
under FIN 47.
(vi) KeySpan has several wastewater treatment ponds associated with certain of
its power stations. There are closure requirements for wastewater treatment
pond systems based on regulations promulgated by the State of New York
which were effective May 11, 2003.
(vii) KeySpan Communications has portions of its fiber optic network
(underground and above ground) that are required to be removed upon
termination of various agreements.
(viii) KeySpan has a regulatory obligation to close and seal the wells primarily
associated with its gas production and development activities.
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 December 31, 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
(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) 65.2 2006 - 2010
Commodity Guarantees and Other (vi) 64.6 2006 - 2009
Letters of Credit (vii) 80.3 2007 - 2010
- ----------------------------------------------------------------------------------------------
$ 1,691.9
- ----------------------------------------------------------------------------------------------
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 are included in long-term debt on the Consolidated Balance
Sheet.
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(ii) KeySpan has fully and unconditionally guaranteed the payment obligations of
its subsidiaries with regard to $128 million of Industrial Development
Revenue Bonds issued through the Nassau County and Suffolk County
Industrial Development Authorities for the construction of two
electric-generation peaking plants on Long Island. The face value of these
notes are included in long-term debt on the Consolidated Balance Sheet.
(iii) KeySpan has guaranteed all payment and performance obligations of KeySpan
Ravenswood, LLC, the lessee under the Master Lease. The term extends
through 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 250 MW 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 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 December 31, 2006, the total cost to complete such
remaining bonded projects is estimated to be approximately $28.5 million.
(vi) KeySpan has guaranteed commodity-related payments for subsidiaries within
the Electric Services segment. 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 December 31, 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
148
and vendors under those contracts. Certain of our vendors also require
letters of credit to ensure reimbursement for amounts they are disbursing
on behalf of our subsidiaries, such as to beneficiaries under our
self-funded insurance programs. Such letters of credit are generally issued
by a bank or similar financial institution. The letters of credit commit
the issuer to pay specified amounts to the holder of the letter of credit
if the holder demonstrates that we have failed to perform specified
actions. If this were to occur, KeySpan would be required to reimburse the
issuer of the letter of credit.
To date, KeySpan has not had a claim made against it for any of the above
guarantees and we have no reason to believe that our subsidiaries or former
subsidiaries will default on their current obligations. However, we cannot
predict when or if any defaults may take place or the impact any such defaults
may have on our consolidated results of operations, financial condition or cash
flows.
Fixed Charges Under Firm Contracts. Our utility subsidiaries and the Ravenswood
Generating Station have entered into various contracts for gas delivery, storage
and supply services. Certain of these contracts require payment of annual demand
charges in the aggregate amount of approximately $449 million. We are liable for
these payments regardless of the level of service we require from third parties.
Such charges associated with gas distribution operations are currently recovered
from utility customers through the gas adjustment clause.
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, 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 KeySpan and its directors. The complaint, which was filed
in the New York State Supreme Court for the County of Kings (the "Court"),
related to the execution of the Merger Agreement with National Grid plc and
alleged that the merger consideration which KeySpan's stockholders would receive
in connection with the proposed merger transaction was inadequate and unfair
because the transaction value of $42.00 for each share of KeySpan's common stock
outstanding did not provide its 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 could be
granted. On May 26, 2006, the plaintiff served an amended complaint adding
National Grid plc as a defendant. The amended complaint alleged that National
Grid plc aided and abetted the alleged breach of fiduciary duties and added
claims of inadequate disclosure with respect to KeySpan's preliminary proxy
materials. In June 2006, the parties agreed in principle to settle the case, the
terms of which provide for, among other things, the inclusion of additional
disclosures in our 2006 Annual Meeting Proxy Statement concerning the background
and principle events leading to execution of the Merger Agreement, as well as
149
the payment of plaintiff's counsel fees of up to $350,000 following closing of
the transaction. In October 2006, definitive settlement documents were executed
by the parties and submitted to the Court. The settlement remains subject to a
number of conditions, including Court approval following notice to shareholders.
Several lawsuits have been filed which allege damages resulting from
contamination associated with the historic operations of former manufactured gas
plants located in Bay Shore and Staten Island, New York. KeySpan has been
conducting site investigations and remediations at these locations pursuant to
Orders on Consent with the DEC. With respect to Bay Shore, on July 12, 2006, a
purported class action and a separate complaint were filed. Motions to dismiss
these matters have been filed and are pending. On November 27, 2006 and December
28, 2006, two other lawsuits were filed by property owners in the Bay Shore
area. In addition, on October 31, 2006, a lawsuit was filed alleging damages in
Staten Island, New York. KeySpan intends to contest each of these proceedings
vigorously. On February 8, 2007, we received a Notice of Intent to File Suit
from the Office of the Attorney General for the State of New York ("AG") against
KeySpan and four other companies in connection with the cleanup of historical
contamination found in certain lands located in Greenpoint, Brooklyn and in an
adjoining waterway. KeySpan has previously agreed to remediate portions of the
properties referenced in this notice and will work cooperatively with the DEC
and AG to address environmental conditions associated with the remainder of the
properties. At this time, we are unable to predict what effect, if any, the
outcome of these proceedings will have on our financial condition, results of
operation and cash flows.
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 11 "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 11 "2006 LIPA Settlement." Following the announcement of the
proposed acquisition of KeySpan by National Grid plc, LIPA, National Grid plc
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, such discussions may have on the 2006 LIPA Agreements and the receipt and
timing of governmental approvals relating thereto.
150
ENVIRONMENTAL MATTERS
Air. Our generating facilities are located within a Clean Air Act ("CAA") ozone
non-attainment and PM 2.5 (fine particulate matter) non-attainment area, and are
subject to increasingly stringent NOx emission limitations to be implemented
under forthcoming requirements of the United States Environmental Protection
Agency ("EPA") pursuant to the Clean Air Interstate Rule ("CAIR") and
potentially under the Ozone Transport Commission's "CAIR PLUS" program. These
efforts are designed to improve both ozone and particulate matter air quality.
Our previous investments in low NOx boiler combustion modifications, the use of
natural gas firing systems at our steam electric generating stations, and the
compliance flexibility available under these cap and trade programs, have
enabled KeySpan to achieve our prior emission reductions in a cost-effective
manner. KeySpan is currently developing its compliance strategy to address the
anticipated requirements of CAIR and CAIR PLUS by 2009. Since detailed
requirements under CAIR have not yet been fully articulated, it is not possible
to definitively estimate capital expenditures that may be required to meet these
regulatory mandates. At the present time, it is anticipated that NOx control
equipment may be required at one or more of KeySpan's Long Island facilities at
a cost between $20 to $30 million. However, such amounts are recoverable from
LIPA.
Water. Additional capital expenditures associated with the renewal of the
surface water discharge permits for our power plants will likely be required by
the Department of Environmental Conservation ("DEC"). We are currently
conducting studies as directed by the DEC to determine the impacts of our
discharges on aquatic resources and are engaged in discussions with the DEC
regarding the nature of capital upgrades or other mitigation measures necessary
to reduce any impacts. These upgrades are expected to cost up to $60 million for
the Long Island units, however, such amounts are recoverable from LIPA. The
Ravenswood Generating Station may also require upgrades at a cost of up to $15
million. The actual expenditures will depend upon the outcome of the ongoing
studies and the subsequent determination by the DEC of how to apply the
standards set forth in recently promulgated federal regulations under Section
316 of the Clean Water Act designed to mitigate such impacts.
Land, Manufactured Gas Plants and Related Facilities.
New York Sites. Within the State of New York we have identified 43 historical
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 KeySpan, have been identified to the 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 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 these sites for their share of remedial cost. As a result
of the December 2004 Cooper Industries v. Aviall Services, Inc. decision by the
United States Supreme Court and the emerging case law in New York, KeySpan has
evaluated the potential for third party recovery at each of the remaining sites.
KeySpan intends to enter into an ACO for fifteen of these sites and continues to
evaluate how to proceed with respect to participation in the DEC's remediation
programs for the other sites.
151
KeySpan has 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 $80.1 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. 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 $62.5 million.
We presently estimate the remaining cost of our KEDNY and KEDLI MGP-related
environmental remediation activities will be $325.4 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, KEDNY and KEDLI rate plans generally provide
for the recovery from customers of investigation and remediation costs of
certain sites. At December 31, 2006, we have reflected a regulatory asset of
$373.2 million for KEDNY/KEDLI MGP sites. KeySpan has recently filed proposed
rate plans for KEDNY and KEDLI with the NYPSC as part of its application for
approval of the KeySpan / National Grid plc merger, as well as individual
applications for a proposed annual increase in revenues for KEDNY and KEDLI.
Among other things, these filings seek recovery of deferred expenses associated
with remediation of MGP sites, as well as recovery of ongoing remediation
expenses.
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 $1.4 million, which amount has been
accrued by us. Expenditures incurred to date total $3.6 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.
152
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 these Massachusetts KEDNE
MGP-related environmental cleanup activities will be $8.8 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 Eastern
Enterprises, with respect to these MGP-related activities total $34.7 million.
In 2004, Boston Gas Company reached settlements with certain insurance carriers
for recovery of a portion of previously incurred environmental expenditures.
Under a previously issued MADTE rate order, insurance and third-party
recoveries, after deducting legal fees, are shared between Boston Gas and its
firm gas customers. As a result of these settlements, in 2004 Boston Gas Company
recorded a $5.0 million benefit to operations and maintenance expense.
We may have or share responsibility under applicable environmental laws for the
remediation of 10 MGP sites and related facilities associated with the
historical operations of EnergyNorth. At four of these sites we have entered
into cost sharing agreements with other parties who share responsibility for
remediation of these sites. EnergyNorth also has entered into an agreement with
the EPA for the contamination from the Nashua site that was allegedly commingled
with asbestos at the so-called Nashua River Asbestos Site, adjacent to the
Nashua MGP site.
We presently estimate the remaining cost of EnergyNorth MGP-related
environmental cleanup activities will be $25.5 million, which amount has been
accrued by us as a reasonable estimate of probable cost for known sites, however
remediation costs for each site may be materially higher than noted, depending
upon changing technologies and regulatory standards, selected end use for each
site, and actual environmental conditions encountered. Expenditures incurred
since November 8, 2000, with respect to these MGP-related activities total $23.0
million.
By rate orders, the MADTE and the NHPUC provide for the recovery of site
investigation and remediation costs and, accordingly, at December 31, 2006, we
have reflected a regulatory asset of $43.4 million for the KEDNE MGP sites. As
previously mentioned, Colonial Gas Company and Essex Gas Company are not subject
to the provisions of SFAS 71 and therefore have recorded no regulatory asset.
However, rate orders currently in effect for these subsidiaries provide for the
recovery of investigation and remediation costs.
153
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, entered into an ACO with the Massachusetts
Department of Environmental Protection for the investigation and development of
a remedial response plan for a portion of that site. KeySpan, Honeywell and
Beazer East 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 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.
In 2004, KeySpan reached a settlement with insurance carriers regarding cost
recovery for expenses at one of the above noted sites and recorded an $11.6
million reduction to operating expenses. We presently estimate the remaining
cost of our environmental cleanup activities for the three non-utility sites
will be approximately $11.4 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 $21.4 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 Reimbursement of MGP Response Costs. We have instituted lawsuits in
New York, Massachusetts and New Hampshire against numerous insurance carriers
for reimbursement of costs incurred for the investigation and remediation of
these MGP sites.
In January 1998 and July 2001, KEDLI and KEDNY, respectively, filed complaints
for the recovery of its remediation costs in the New York State Supreme Court
against the various insurance companies that issued general comprehensive
liability policies to KEDLI and KEDNY. The outcome of these proceedings cannot
yet be determined.
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In March 1999, Boston Gas Company and a subsidiary of National Grid filed a
complaint for the recovery of remediation costs in the Massachusetts Superior
Court against various insurance companies that issued comprehensive general
liability policies to National Grid and its predecessors with respect to, among
other things, the 11 sites for which Boston Gas Company has agreed to make a
limited contribution. In October 2002, Boston Gas Company filed a complaint in
the United States District Court - Massachusetts District against one of the
insurance companies that issued comprehensive general liability policies to
Boston Gas Company for its remaining sites. In November 2005, the trial
commenced on the declaratory judgment action of Boston Gas against Century
Indemnity for insurance coverage for the costs incurred in the investigation and
remediation at the former Boston Gas Everett MGP site and in December 2005, the
jury returned a verdict in favor of KeySpan. KeySpan anticipates that Century
Indemnity will appeal this verdict. The outcome of these proceedings cannot yet
be determined.
EnergyNorth has filed a number of lawsuits in both the New Hampshire Superior
Court and the United States District Court for the District of New Hampshire for
recovery of its remediation costs against the various insurance companies that
issued comprehensive general liability and excess liability insurance policies
to EnergyNorth and its predecessors. In October 2004, EnergyNorth's case against
the London Market Insurers for the costs incurred investigating and remediating
the former MGP site in Laconia went to trial and the jury returned a verdict in
favor of EnergyNorth, finding that EnergyNorth was entitled to recover against
London Market Insurers. In February 2005, the trial of EnergyNorth's coverage
action for the Dover MGP site began against the only remaining defendant,
Century Indemnity (all other carriers settled prior to trial) and at the
conclusion of the trial the federal judge directed a verdict in EnergyNorth's
favor on all issues. Century Indemnity filed an appeal with the First Circuit
Court of Appeals and in a decision dated June 28, 2006, the First Circuit court
of Appeals denied Century Indemnity appeal in its entirety. In a jury trial in
the Nashua MGP action commenced against the London Market Insurers and Century
Indemnity in November 2005, the jury returned a verdict in favor of KeySpan
finding that London and Century Indemnity were obligated to indemnify
EnergyNorth for response costs incurred at the site. Century Indemnity has
sought reconsideration of this verdict. The outcome of this proceeding cannot
yet be determined.
In 1993, KeySpan New England LLC filed a declaratory judgment action against the
Hanover and Travelers insurance companies in the Superior Court for Middlesex
County for the Everett Facility. The declaratory judgment action sought to have
the court compel the insurers to defend KeySpan New England, LLC in connection
with the Massachusetts Department of Environmental Protection's Notice of
Responsibility ("NOR"). In 2004, the Court granted KeySpan New England LLC's
unopposed motion for leave to file a Second Amended Complaint in this action to
seek a declaratory ruling that the insurers have a duty to indemnify KeySpan New
England LLC for the costs associated with the Everett NOR and certain other
related private actions. The Second Amended Complaint also adds certain excess
insurance carriers as defendants in the action. The outcome of this proceeding
cannot yet be determined.
KeySpan has entered into confidential settlement agreements with certain of the
defendant insurance carriers for recovery of costs associated with the
investigation and remediation of the sites included in the above proceedings.
Pursuant to these settlements, KeySpan recorded a benefit of $5.5 million in its
Consolidated Statement of Income for the twelve months ended December 31, 2006,
reflecting the benefit accruing to KeySpan's shareholders. Recovery of
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environmental costs from insurance carriers associated with utility MGP sites
are refunded to KeySpan's ratepayers, subject to certain sharing provisions.
During the past year, KeySpan has received approximately $22 million from
insurance carriers in settlements for recovery of environmental costs associated
with remediation of MGP sites.
Note 8. Hedging, Derivative Financial Instruments and Fair Values
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 production and development activities and its electric
generating facilities at the Ravenswood Generating Station. As discussed in
greater detail below, certain derivative financial instruments employed by
KeySpan are accounted for as cash-flow hedges 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. However, KeySpan also employs derivative financial
instruments that do not qualify for hedge accounting treatment. Additionally,
certain derivative financial instruments employed by our Gas Distribution
operations are subject to SFAS 71 "Accounting for the Effects of Certain Types
of Regulation."
Commodity Derivative Instruments - Hedge Accounting: 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 December 31, 2006, Seneca-Upshur has hedge positions in place for
approximately 70% of its estimated 2006 through 2009 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 2009. The fair value of these
derivative instruments at December 31, 2006 was a liability of $3.9 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 $2.3 million.
Ineffectiveness associated with these outstanding derivative financial
instruments was immaterial for the twelve months ended December 31, 2006.
Certain derivative instruments employed by our gas distribution operations are
not subject to SFAS 71 and thus are not subject to deferral accounting
treatment. KeySpan uses OTC natural gas swaps to hedge the cash-flow variability
of gas purchases associated with certain large-volume gas sales customers. These
gas swaps are accounted for as cash-flow hedges. KeySpan uses market quoted
forward prices to value these swap positions. The maximum length of time over
which we have hedged such cash flow variability is through October 2007. The
fair value of these derivative instruments at December 31, 2006 was a liability
of $2.0 million, all of which 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 in 2006.
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The above noted derivative financial instruments are cash flow hedges that are
accounted for as hedges under 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 record 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 on settled transactions
are reflected as a component of either revenue or gas cost 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.
Commodity Derivative Instruments that are not Accounted for as Hedges: The
Ravenswood Generating Station financially hedges the cash flow variability
associated with a portion of electric energy sales and fuel purchases. Our
strategy is to financially hedge up to 50% of the on-peak capacity of the
Ravenswood Generating Station. The maximum length of time over which derivative
financial instruments are in-place is through August 2007. To accomplish our
stated risk management strategy, KeySpan employs financially-settled
electric-power swap contracts with offsetting financially-settled oil swap
contracts, physical natural gas forward contracts and OTC natural gas swaps. We
use market quoted forward prices to value the electric-power swap contracts. The
fair value of the electric power derivative instruments at December 31, 2006 was
$21.9 million. We use market quoted forward prices to value the oil swap
contracts and natural gas contracts. The fair value of these derivative
instruments at December 31, 2006, was a liability of $23.7 million.
During most of 2006 and in prior years, the derivative transactions associated
with the Ravenswood Generating Station qualified for hedge accounting treatment.
As a result, there is a net $1.2 million balance currently in accumulated other
comprehensive income which is expected to be reclassified into earnings within
the next twelve months. In 2006, KeySpan reclassified a $1.4 million loss from
accumulated other comprehensive income to earnings, based on management's
assessment that certain future oil purchases were not probable of occurrence.
Ineffectiveness associated with these outstanding derivative financial
instruments was immaterial in 2006.
On January 18, 2006, KeySpan entered into an International SWAP Dealers
Association Master Agreement for a fixed for float unforced capacity financial
swap (the " Swap Agreement") with Morgan Stanley Capital Group Inc. ("Morgan
Stanley"). The Swap Agreement has a three year term that began on May 1, 2006.
The notional quantity was 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
157
derivative instrument does not qualify for hedge accounting treatment under SFAS
133. The recognized fair value associated with this instrument is immaterial to
the consolidated financial statements at December 31, 2006. As noted, this is a
financial derivative instrument and is unrelated to any physical production of
electricity.
The NYPSC, Con Edison and other load serving entities ("LSEs") have proposed
price mitigation measures that would apply to the Ravenswood Generating Station.
These price mitigation measures, if approved as proposed, would essentially
reduce the capacity bid price that the Ravenswood Generating Station could bid
into the NYISO energy market. The NYISO's Management Committee and NYISO's Board
of Directors approved the price mitigation measures proposed by the NYPSC, Con
Edison and the other LSE's, notwithstanding KeySpan's analysis and objections.
The NYISO filed the mitigation measures with the FERC for approval; such
approval is pending. At this time, we are unable to predict the outcome of this
proceeding and what effect it will have on the potential revenue that could be
realized in connection with the fixed for floating financial Swap Agreement.
Commodity 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 is 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 December 31, 2006 the fair
value of these derivative instruments was a liability of $192.1 million.
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 December 31, 2006,
these derivatives had a net fair value of $101.2 million.
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. The
accounting for this contract is subject to SFAS 71 since the contract was
executed by KeySpan's regulated gas distribution utilities. At December 31,
2006, KeySpan's proportionate share of the fair value associated with these
derivative instruments amounted to $10.4 million, $9.5 million of which has been
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deferred for future sharing among the alliance members and Massachusetts
ratepayers. 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.
Interest Rate Derivative Instruments: In the fourth quarter of 2006, KeySpan
issued $400 million Senior Unsecured Notes at KEDNY and $100 million Senior
Unsecured Notes at KEDLI. KeySpan utilized a $125 million treasury lock, at
4.77%, to hedge the 5-year US Treasury component of the underlying notes and a
$125 million treasury lock, at 4.82%, to hedge the 10-year US Treasury component
of the underlying notes. These derivative instruments settled in the fourth
quarter of 2006 at which time KeySpan paid $0.2 million to the counterparty to
the contracts. The loss on the settlement of these contracts has been deferred
for future collection from firm gas sales customers consistent with regulatory
requirements.
The table below summarizes the fair value of all of the above outstanding
derivative instruments at December 31, 2006 and 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) December 31, 2006 December 31, 2005
- --------------------------------------------------------------------------------
Gas Contracts:
Other current assets $ 30.7 $ 132.1
Other deferred charges 127.1 75.2
Regulatory asset 196.3 30.9
Other current liability (211.7) (39.8)
Other deferred liabilities (42.1) (44.3)
Regulatory liability (120.6) (175.4)
Oil Contracts:
Other current assets 0.3 0.5
Other current liability (7.2) (6.8)
Other deferred liabilities (0.5) -
Electric Contracts:
Other current assets 23.2 10.2
Other deferred charges 0.3 -
Other current liability (0.8) (0.7)
Other deferred liabilities (0.6) -
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$ (5.6) $ (18.1)
- --------------------------------------------------------------------------------
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 2006, 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 2006/2007 winter heating season - November 2006 through March 2007.
These put options will pay KeySpan up to $37,500 per heating degree day when the
actual temperature is below 4,159 heating degree days, or approximately 5%
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warmer than normal, based on the most recent 20-year average for normal weather.
The maximum amount KeySpan will receive on these purchased put options is $15
million. The net premium cost for these options is $1.7 million and will be
amortized over the heating season. Since weather was warmer than normal during
the fourth quarter of 2006, KeySpan recorded a $9.1 million benefit to earnings
associated with the weather derivative. 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.
In 2005, we entered into heating-degree day put options, which expired during
the first quarter of 2006, 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.
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 December 31, 2006, KeySpan has received
$7.9 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
December 31, 2006, KeySpan has $33.9 million of outstanding margin calls to its
counterparties for open derivative instruments associated with its strategy to
minimize fluctuations in gas sales prices to its regulated firm gas sales
customers.
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Long-term Debt: The following tables depict the fair values and carrying values
of KeySpan's long-term debt at December 31, 2006 and 2005.
Fair Values of Long-Term Debt
- ------------------------------------------------------------------------------
December 31,
(In Millions of Dollars) 2006 2005
- ------------------------------------------------------------------------------
First Mortgage Bonds $ 111.4 $ 114.1
Notes 3,078.5 2,692.1
Gas Facilities Revenue Bonds 647.3 651.3
Authority Financing Notes 66.0 66.0
Promissory Notes 156.7 156.6
Master Lease 412.0 430.5
Tax Exempt Bonds 131.0 130.8
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$ 4,602.9 $ 4,241.4
- ------------------------------------------------------------------------------
Carrying Values of Long-Term Debt
- ------------------------------------------------------------------------------
December 31,
- ------------------------------------------------------------------------------
(In Millions of Dollars) 2006 2005
- ------------------------------------------------------------------------------
First Mortgage Bonds $ 95.0 $ 95.0
Notes 2,925.4 2,437.2
Gas Facilities Revenue Bonds 640.5 640.5
Authority Financing Notes 66.0 66.0
Promissory Notes 155.4 155.4
Master Lease 412.3 412.3
Tax Exempt Bonds 128.3 128.3
- ------------------------------------------------------------------------------
$ 4,422.9 $ 3,934.7
- ------------------------------------------------------------------------------
All other financial instruments included in the Consolidated Balance Sheet such
as cash, commercial paper, accounts receivable and accounts payable, are stated
at amounts that approximate fair value.
Note 9. Gas Production and Development Property - Depletion
As described in Note 2 "Business Segments," during much of 2004 KeySpan's
investment in gas production and development activities consisted of its
ownership interest in Houston Exploration, as well as KeySpan's wholly-owned
subsidiary KeySpan Exploration and Production. Further, KeySpan's investment in
these activities also includes its wholly-owned subsidiary Seneca-Upshur. These
assets are accounted for under the full cost method of accounting. Under the
full cost method, costs of acquisition, exploration and development of natural
gas and oil reserves plus asset retirement obligations are capitalized into a
"full cost pool" as incurred. Unproved properties and related costs are excluded
from the depletion and amortization base until a determination as to the
existence of proved reserves. Properties are depleted and charged to operations
using the unit of production method.
To the extent that such capitalized costs (net of accumulated depletion) less
deferred taxes exceed the present value (using a 10% discount rate) of estimated
future net cash flows from proved natural gas and oil reserves and the lower of
cost or fair value of unproved properties, less deferred taxes, such excess
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costs are charged to operations, but would not have an impact on cash flows.
Once incurred, such impairment of gas properties is not reversible at a later
date even if prices increase. The ceiling test is calculated using natural gas
and oil prices in effect as of the balance sheet date, adjusted for outstanding
derivative instruments, held flat over the life of the reserves.
As a result of the sale of Houston Exploration discussed in Note 2 "Business
Segments", KeySpan accounted for its investment in Houston Exploration on the
equity method from June 2004 through November 19, 2004. Therefore, we were
required to calculate a ceiling test on KeySpan Exploration and Production's and
Seneca-Uphsur's assets independently of Houston Exploration's assets in the
second quarter of 2004. Based on a report furnished by an independent reservoir
engineer at that time, it was determined that the remaining proved undeveloped
oil reserves held in the joint venture required a substantial investment in
order to develop. Therefore, KeySpan and Houston Exploration elected not to
develop these oil reserves. As a result, in the second quarter of 2004, KeySpan
recorded a $48.2 million non-cash impairment charge to write down its
wholly-owned gas exploration and production subsidiaries' assets. This charge
was recorded in depreciation, depletion and amortization on the Consolidated
Statement of Income.
Note 10. Energy Services - Discontinued Operations
In 2004, the Energy Services segment experienced significantly lower operating
profits and cash flows than originally projected. At a meeting held on November
2, 2004, KeySpan's Board of Directors authorized management to begin the process
of disposing of a significant portion of its ownership interests in certain
companies within the Energy Services segment - specifically those companies
engaged in mechanical contracting activities. In January and February of 2005,
KeySpan sold its mechanical contracting investments. The operating results and
cash flows of these businesses, are reflected as discontinued operations on the
Consolidated Statement of Income and Consolidated Statement of Cash Flows.
In regard to the January 2005 transactions, KeySpan received proceeds of
approximately $16 million, including approximately $5 million to be paid within
a three year period. In addition, KeySpan retained its previously incurred
indemnity support obligations related to certain surety, performance and payment
bonds issued for the benefit of KeySpan's former subsidiaries prior to closing.
In June 2005, the balance to be paid over the three year period was fully
collected on a present value basis and a significant portion of the performance
bonds were replaced without any remaining indemnification obligation on the part
of KeySpan. The buyers have completed the projects for which such indemnity
obligations were incurred.
In connection with the February 2005 transaction, KeySpan paid or contributed
approximately $26 million to its former subsidiary prior to closing the sale
transaction in exchange for, among other things, the disposition of outstanding
shares in the former subsidiary and the settlement of intercompany advances and
replacement of a performance and payment bond issued for the benefit of its
former subsidiary with respect to a pending project, which bond had been
supported by a $150 million indemnity obligation of KeySpan. In addition,
KeySpan received from its former subsidiary an indemnity bond issued by a third
party insurance company, the purpose of which is to reimburse KeySpan in an
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amount up to $80 million in the event it is required to perform under all other
indemnity obligations previously incurred by KeySpan to support the remaining
bonded projects of its former subsidiary as of the closing. As of December 31,
2006, the total cost to complete such remaining bonded projects is estimated to
be approximately $21.9 million. The aforementioned guarantees are reflected in
Note 7 "Contractual Obligations, Financial Guarantees and Contingencies".
KeySpan's former subsidiary has also agreed to complete the projects for which
such indemnity obligations were incurred and to indemnify and hold KeySpan
harmless with respect to its liabilities in connection with such bonds.
In anticipation of these sales and in connection with the preparation of the
third quarter and fourth quarter 2004 financial statements, KeySpan conducted an
evaluation of the carrying value of these investments, including recorded
goodwill. Further, we evaluated the carrying value of goodwill for the entire
Energy Services segment. As noted, KeySpan records goodwill on purchased
transactions, representing the excess of acquisition cost over the fair value of
net assets acquired.
As a result of these evaluations, KeySpan recorded a non-cash goodwill
impairment charge of $108.3 million ($80.3 million after tax, or $0.50 per
share) in 2004. This charge was recorded as follows: (i) $14.4 million as an
operating expense on the Consolidated Statement of Income reflecting the
write-down of goodwill on Energy Services segment's continuing operations; and
(ii) $93.9 million ($67.8 million after-tax) as discontinued operations
reflecting the impairment on the mechanical contracting companies.
In addition, an impairment charge of $100.3 million ($72.1 million after-tax or
$0.45 per share) was also recorded in 2004 to reduce the carrying value of the
remaining assets of the mechanical contracting companies. This charge is
reflected in discontinued operations on the Consolidated Statement of Income to
reflect the estimated loss on disposal.
KeySpan employed a combination of two methodologies in determining the estimated
fair value for its investment in the Energy Services segment, a market valuation
approach and an income valuation approach. Under the market valuation approach,
KeySpan utilized a range of near-term potential realizable values for the
mechanical contracting businesses. Under the income valuation approach, the fair
value was obtained by discounting the sum of (i) the expected future cash flows
and (ii) the terminal value. KeySpan utilized certain significant assumptions in
this valuation, specifically the weighted-average cost of capital, short and
long-term growth rates and expected future cash flows. Approximately $65 million
of goodwill remains in this segment.
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The information below highlights the major income and expense captions of the
discontinued mechanical contracting companies.
- -------------------------------------------------------------------------------
For the Year Ended
December 31,
(In Millions of Dollars) 2005 2004
- -------------------------------------------------------------------------------
Revenues $ 33.8 $ 338.7
Less:
Operating expenses 40.2 364.9
Goodwill impairment - 108.3
- -------------------------------------------------------------------------------
(6.4) (134.5)
Income taxes (benefit) (2.3) (55.5)
- -------------------------------------------------------------------------------
Operating loss (4.1) (79.0)
Gain (Loss) on disposal, net of tax 2.3 (72.0)
- -------------------------------------------------------------------------------
Net Loss $ (1.8) $ (151.0)
- -------------------------------------------------------------------------------
Note 11. 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 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 system ("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 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 upon all of the 2006 LIPA
Agreements receiving the required governmental approvals; otherwise none of the
2006 LIPA Agreements will become effective. These agreements will become
effective following approval by the New York State Comptroller's Office and the
164
New York State Attorney General. Following the announcement of the proposed
acquisition of KeySpan by National Grid plc, LIPA, National Grid plc 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 results from the recent settlement with the
IRS regarding the audit of LILCO's tax returns for the years ended December 31,
1996 through March 31, 1999. On October 30, 2006, the IRS submitted the
settlement provisions of the recently concluded IRS audit to the Joint Committee
on Taxation for approval. Key provisions of the settlement included the
resolution of the tax basis of assets transferred to KeySpan at the time of the
KeySpan/LILCO merger, the tax deductibility of certain merger related costs and
the tax deductibility of certain environmental expenditures. The settlement
enabled KeySpan to utilize 100% of the available tax credits. (See Note 3 to the
Consolidated Financial Statements "Income Taxes" for additional information of
the settlement.) In recognition of these items, as well as for the modification
and extension of the 1998 MSA and the amendments to 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 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 $90 million due from LIPA.
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 had 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. In December 2006, KeySpan and LIPA entered into an amendment to
the 2006 Option Agreement whereby the parties agreed to extend the expiration of
the option period to the later of (i) December 31, 2007 or (ii) 180 days
following the effective date of the 2006 Option Agreement. The 2006 Option
Agreement replaces the GPRA, the expiration of which has been stayed pending
effectiveness of the 2006 LIPA Agreements. In the event such agreements do not
become effective by reason of failure to secure any of the requisite
governmental approvals, the GPRA will be reinstated for a period of 90 days from
the date such approval is denied. If LIPA were to exercise the option and
165
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, through May 28, 2013, 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.
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.
Upon approval, the 2006 LIPA Agreements will be effective retroactive to January
1, 2006. KeySpan's reported operating income and net income for 2006 under the
2006 MSA are substantially the same as they would have been if the terms and
provisions of the 1998 MSA had continued to be applied. At this point in time,
KeySpan is unable to estimate what the impact would be to its results of
operations, financial position and cash flows if the 2006 LIPA Agreements do not
become fully effective.
Note 12. KeySpan Gas East Corporation Summary Financial Data
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 LILCO. KEDLI provides gas distribution services to
customers in the Long Island counties of Nassau and Suffolk and the Rockaway
peninsula of Queens county. KEDLI established a program for the issuance, from
time to time, of up to $600 million aggregate principal amount of Medium-Term
166
Notes, which will be 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. Additionally, in 2006, KEDLI
issued $100 million of Senior Unsecured Notes at 5.60% due November 29, 2016.
This debt is not guaranteed by the parent, KeySpan Corporation.
- --------------------------------------------------------------------------------------------------------------------------
Statement of Income
- --------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2006
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------------
Revenues $ 0.7 $ 1,319.4 $ 5,862.2 $ (0.7) $ 7,181.6
--------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 864.4 2,467.1 - 3,331.5
Fuel and purchased power - - 548.6 - 548.6
Operations and maintenance 62.4 138.9 1,478.7 - 1,680.0
Intercompany expense - 5.3 (4.6) (0.7) -
Depreciation and amortization - 77.5 320.0 - 397.5
Operating taxes - 65.1 346.1 - 411.2
--------------------------------------------------------------------------------------
Total Operating Expenses 62.4 1,151.2 5,155.9 (0.7) 6,368.8
--------------------------------------------------------------------------------------
Gain on sale of property - - 1.6 - 1.6
Income from equity investments - - 13.1 - 13.1
--------------------------------------------------------------------------------------
Operating Income (Loss) (61.7) 168.2 721.0 - 827.5
--------------------------------------------------------------------------------------
Interest charges (166.2) (54.4) (69.0) 33.5 (256.1)
Other income and (deductions) 575.2 2.3 (62.8) (476.4) 38.3
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
Total Other Income and (Deductions) 409.0 (52.1) (131.8) (442.9) (217.8)
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
Income Taxes (Benefit) (86.9) 42.2 220.2 - 175.5
--------------------------------------------------------------------------------------
Net Income $ 434.2 $ 73.9 $ 369.0 $ (442.9) $ 434.2
- ------------------------------------======================================================================================
167
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues $ 0.6 $ 1,432.9 $ 6,229.1 $ (0.6) $ 7,662.0
---------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 963.0 2,634.3 - 3,597.3
Fuel and purchased power - - 752.1 - 752.1
Operations and maintenance 22.0 133.5 1,462.4 - 1,617.9
Intercompany expense - 4.8 (4.2) (0.6) -
Depreciation and amortization - 76.9 319.6 - 396.5
Operating taxes 0.1 65.9 341.1 - 407.1
---------------------------------------------------------------------------------------
Total Operating Expenses 22.1 1,244.1 5,505.3 (0.6) 6,770.9
---------------------------------------------------------------------------------------
Gain on sale of property - - 1.6 - 1.6
Income from equity investments - - 15.1 - 15.1
---------------------------------------------------------------------------------------
Operating Income (Loss) (21.5) 188.8 740.5 - 907.8
---------------------------------------------------------------------------------------
Interest charges (144.5) (61.9) (83.9) 21.0 (269.3)
Other income and (deductions) 523.8 2.9 (81.3) (446.0) (0.6)
---------------------------------------------------------------------------------------
Total Other Income and (Deductions) 379.3 (59.0) (165.2) (425.0) (269.9)
---------------------------------------------------------------------------------------
Income Taxes (Benefit) (32.4) 48.2 223.5 - 239.3
---------------------------------------------------------------------------------------
Earnings from Continuing Operations 390.2 81.6 351.8 (425.0) 398.6
Discontinued Operations - - (1.8) - (1.8)
Cumulative Change in Accounting Principles - (0.2) (6.4) - (6.6)
---------------------------------------------------------------------------------------
Net Income $ 390.2 $ 81.4 $ 343.6 $ (425.0) $ 390.2
=======================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Income
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 0.6 $ 1,124.4 $ 5,526.1 $ (0.6) $ 6,650.5
--------------------------------------------------------------------------------------------
Operating Expenses
Purchased gas - 664.9 1,999.6 - 2,664.5
Fuel and purchased power - - 540.3 - 540.3
Operations and maintenance 5.3 137.8 1,423.9 - 1,567.0
Intercompany expense - 5.4 (5.4) - -
Depreciation and amortization - 79.9 471.9 - 551.8
Operating taxes - 65.7 338.4 - 404.1
Goodwill Impairment - - 41.0 - 41.0
--------------------------------------------------------------------------------------------
Total Operating Expenses 5.3 953.7 4,809.7 - 5,768.7
--------------------------------------------------------------------------------------------
Gain on sale of property - - 7.0 - 7.0
Income from equity investments - - 46.5 - 46.5
--------------------------------------------------------------------------------------------
Operating Income (Loss) (4.7) 170.7 769.9 (0.6) 935.3
--------------------------------------------------------------------------------------------
Interest charges (204.5) (61.5) (267.7) 202.4 (331.3)
Other income and (deductions) 635.4 0.8 423.9 (723.9) 336.2
--------------------------------------------------------------------------------------------
Total Other Income and (Deductions) 430.9 (60.7) 156.2 (521.5) 4.9
--------------------------------------------------------------------------------------------
Income Taxes (Benefit) (45.5) 35.8 335.2 - 325.5
--------------------------------------------------------------------------------------------
Earnings from Continuing Operations 471.7 74.2 590.9 (522.1) 614.7
Discontinued Operations - - (151.0) - (151.0)
--------------------------------------------------------------------------------------------
Net Income $ 471.7 $ 74.2 $ 439.9 $ (522.1) $ 463.7
============================================================================================
168
- --------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 2006
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and temporary cash
investments $ 140.5 $ 34.7 $ 35.7 $ - $ 210.9
Accounts receivable, net 0.5 175.6 710.7 - 886.8
Other current assets 1.5 314.0 1,373.8 - 1,689.3
------------------------------------------------------------------------------------------
142.5 524.3 2,120.2 - 2,787.0
------------------------------------------------------------------------------------------
Investments and Other 5,017.8 - 144.0 (4,892.1) 269.7
------------------------------------------------------------------------------------------
Property
Gas - 2,164.4 5,475.0 - 7,639.4
Other - 32.3 3,171.5 - 3,203.8
Accumulated depreciation and
depletion - (434.7) (2,830.2) - (3,264.9)
------------------------------------------------------------------------------------------
- 1,762.0 5,816.3 - 7,578.3
------------------------------------------------------------------------------------------
Intercompany Accounts Receivable 969.1 80.8 1,682.9 (2,732.8) -
Deferred Charges 1,942.3 502.0 1,358.2 - 3,802.5
------------------------------------------------------------------------------------------
Total Assets $ 8,071.7 $ 2,869.1 $ 11,121.6 $ (7,624.9) $ 14,437.5
==========================================================================================
LIABILITIES AND CAPITALIZATION
Current Liabilities
Accounts payable $ 57.2 $ 118.9 $ 850.0 $ - $ 1,026.1
Commercial paper 85.0 - - - 85.0
Other current liabilities 231.8 71.4 293.7 - 596.9
------------------------------------------------------------------------------------------
374.0 190.3 1,143.7 - 1,708.0
------------------------------------------------------------------------------------------
Intercompany Accounts Payable 2.6 319.4 897.0 (1,219.0) -
------------------------------------------------------------------------------------------
Deferred Credits and Other
Liabilities
Deferred income tax (24.3) 407.0 793.7 - 1,176.4
Other deferred credits and
liabilities 1,216.1 204.7 1,178.7 - 2,599.5
------------------------------------------------------------------------------------------
1,191.8 611.7 1,972.4 - 3,775.9
------------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity 4,641.5 996.8 3,772.6 (4,892.1) 4,518.8
Long-term debt 1,861.8 750.9 3,320.2 (1,513.8) 4,419.1
------------------------------------------------------------------------------------------
Total Capitalization 6,503.3 1,747.7 7,092.8 (6,405.9) 8,937.9
------------------------------------------------------------------------------------------
Minority Interest in Consolidated
Companies - - 15.7 - 15.7
------------------------------------------------------------------------------------------
Total Liabilities and Capitalization $ 8,071.7 $ 2,869.1 $ 11,121.6 $ (7,624.9) $ 14,437.5
==========================================================================================
- --------------------------------------------------------------------------------------------------------------------------------
169
- ----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
- ----------------------------------------------------------------------------------------------------------------------------------
December 31, 2005
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Eliminations Consolidated
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and 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 - - 7,275.9 7,275.9
Other - 2,111.3 981.5 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 Consolidated Companies 15.3 15.3
-----------------------------------------------------------------------------------
Total Liabilities and Capitalization $ 7,951.3 $ 2,594.4 $ 10,678.2 $ (7,411.3) $ 13,812.6
===================================================================================
- ----------------------------------------------------------------------------------------------------------------------------------
170
- --------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2006
------------------------------------------------------------
Other
(In Millions of Dollars) Guarantor KEDLI Subsidiaries Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash (Used in) Provided by Continuing Operating Activities $ (68.1) $ 112.6 $ 1,014.1 $ 1,058.6
------------------------------------------------------------
Investing Activities
Capital expenditures - (89.0) (435.0) (524.0)
Cost of removal - (7.7) (24.9) (32.6)
Proceeds from sale of property and investments - - 1.6 1.6
Derivative margin call - (15.2) (18.7) (33.9)
------------------------------------------------------------
Net Cash (Used in) Continuing Investing Activities - (111.9) (477.0) (588.9)
------------------------------------------------------------
Financing Activities
Treasury stock issued 30.1 - - 30.1
Issuance (payment) of debt, net (572.6) 100.0 387.0 (85.6)
Common and preferred stock dividends paid (325.3) - - (325.3)
Intercompany dividend payments 8.4 - (8.4) -
Other - - (2.5) (2.5)
Net intercompany accounts 988.4 (69.5) (918.9) -
------------------------------------------------------------
Net Cash Provided by (Used in) Continuing Financing Activities 129.0 30.5 (542.8) (383.3)
------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ 60.9 $ 31.2 $ (5.7) $ 86.4
Cash and Cash Equivalents at Beginning of Period 79.6 3.5 41.4 124.5
------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 140.5 $ 34.7 $ 35.7 $ 210.9
============================================================
- --------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2005
--------------------------------------------------------------
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash (Used in) Provided by Continuing Operating Activities $ (327.7) $ 168.5 $ 562.5 $ 403.3
--------------------------------------------------------------
Investing Activities
Capital expenditures - (113.3) (426.2) (539.5)
Cost of removal - (2.6) (25.2) (27.8)
Proceeds from sale of property and investments - (2.1) 49.1 47.0
Derivative margin call - - (8.9) (8.9)
--------------------------------------------------------------
Net Cash (Used in) Continuing Investing Activities - (118.0) (411.2) (529.2)
--------------------------------------------------------------
Financing Activities
Treasury stock issued 41.2 - - 41.2
Common stock issued associated with MEDS conversion 460.0 - - 460.0
Issuance (payment) of debt, net (754.6) - (15.0) (769.6)
Redemption of preferred stock (75.0) - - (75.0)
Common and preferred stock dividends paid (308.4) - - (308.4)
Dividend paid to parent 375.0 - (375.0) -
Other (1.6) - (3.8) (5.4)
Net intercompany accounts 90.0 (46.1) (43.9) -
--------------------------------------------------------------
Net Cash (Used in) Continuing Financing Activities (173.4) (46.1) (437.7) (657.2)
--------------------------------------------------------------
Net (Decrease) Increase in Cash and Cash Equivalents $ (501.1) $ 4.4 $ (286.4) $ (783.1)
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 $ 79.6 $ 3.5 $ 41.4 $ 124.5
==============================================================
- -----------------------------------------------------------------------------------------------------------------------------------
171
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004
------------------------------------------------------------------
(In Millions of Dollars) Guarantor KEDLI Other Subsidiaries Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net Cash (Used in) Provided by Continuing Operating Activities $ (88.7) $ 169.5 $ 669.3 $ 750.1
------------------------------------------------------------------
Investing Activities
Capital expenditures - (108.7) (641.6) (750.3)
Cost of removal - (7.1) (29.2) (36.3)
Proceeds from sale of property and investments - - 1,021.3 1,021.3
------------------------------------------------------------------
Net Cash (Used in) Provided by Continuing Investing Activities - (115.8) 350.5 234.7
------------------------------------------------------------------
Financing Activities
Treasury stock issued 33.4 - - 33.4
Issuance (payment) of debt, net (269.7) - (170.7) (440.4)
Redemption of preferred stock (8.5) - - (8.5)
Net proceeds from sale/leaseback transaction - - 382.0 382.0
Common and preferred stock dividends paid (291.1) - - (291.1)
Gain on interest rate swap 12.7 - - 12.7
Dividend paid to parent 447.6 (40.0) (407.6) -
Other 27.6 - 8.5 36.1
Net intercompany accounts 619.8 (16.2) (603.6) -
------------------------------------------------------------------
Net Cash Provided by (Used in) Continuing Financing Activities 571.8 (56.2) (791.4) (275.8)
------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents $ 483.1 $ (2.5) $ 228.4 $ 709.0
Net Cash Flow from Discontinued Operations - - 9.6 9.6
Cash and Cash Equivalents at Beginning of Period 97.6 1.6 104.2 203.4
------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 580.7 $ (0.9) $ 342.2 $ 922.0
==================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Note 13. Summary of Quarterly Information (Unaudited)
The following is a table of financial data for each quarter of KeySpan's year
ended December 31, 2006.
Quarter Ended
- ---------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars, Except Per Share Amounts) 3/31/2006 6/30/2006 9/30/2006 12/31/2006
- ---------------------------------------------------------------------------------------------------------------------------
Operating Revenue 2,661.1 1,377.7 1,218.5 1,924.3
Operating Income 389.1 107.5 135.8 195.1
Earnings for common stock 208.0 49.4 (a) 50.3 126.5 (b)
Basic earnings per common share 1.19 0.28 0.29 0.72
Diluted earnings per common share 1.18 0.28 0.29 0.71
Dividends declared 0.465 0.465 0.465 0.465
- ---------------------------------------------------------------------------------------------------------------------------
(a) and (b) Pursuant to indemnity obligations contained in the Long Island
Lighting Company ("LILCO") / KeySpan merger agreement of May 1998, KeySpan had
been working with the Internal Revenue Service ("IRS") to resolve certain
disputes with regard to 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
(d/b/a KEDNY) tax returns for the years ended September 30, 1997 through
December 31, 1998. During the second quarter of 2006, two issues were settled.
Accordingly, KeySpan reversed $9.5 million of previously established federal
income tax reserves. A settlement of the remaining outstanding issues was
reached in the fourth quarter and, following IRS procedure, the settlement was
submitted to the Joint Committee on Taxation on October 30, 2006 for final
approval, which is expected in early 2007. Accordingly, KeySpan reversed $35.0
million of previously established federal income tax reserves in the fourth
quarter of 2006.
172
The following is a table of financial data for each quarter of KeySpan's year
ended December 31, 2005.
Quarter Ended
- --------------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars, Except Per Share Amounts) 3/31/2005 6/30/2005 9/30/2005 12/31/2005
- --------------------------------------------------------------------------------------------------------------------------------
Operating Revenue 2,480.5 1,342.5 1,303.1 2,535.9
Operating Income 438.7 103.2 102.8 263.1
Earnings from continuing operations,
less preferred stock dividends 234.4 18.0 22.6 121.4
Cumulative change in accounting principles, net of tax - - - (6.6) (a)
Loss from discontinued operations - (1.8) - -
Earnings for common stock 234.4 16.2 22.6 114.8
Basic earnings per common share from continuing operations
less preferred stock dividends 1.45 0.11 0.13 0.70
Basic earnings per common share from discontinued operations - (0.01) - -
Basic earnings per common share from cumulative change in accounting
principles - - - (0.04) (a)
Basic earnings per common share 1.45 0.10 0.13 0.66
Diluted earnings per common share 1.44 0.09 0.13 0.65
Dividends declared 0.455 0.455 0.455 0.455
- --------------------------------------------------------------------------------------------------------------------------------
(a) Cumulative change in accounting principles for implementation of FASB
Interpretation No. 47 ("FIN 47") "Accounting for Conditional Asset
Retirement Obligations."
173
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of KeySpan Corporation:
We have audited the accompanying Consolidated Balance Sheets and the
Consolidated Statements of Capitalization of KeySpan Corporation and
subsidiaries (the "Company") as of December 31, 2006 and 2005, and the related
Consolidated Statements of Income, Retained Earnings, Comprehensive Income and
Cash Flows for each of the three years in the period ended December 31, 2006.
Our audits also included the financial statement schedule listed in the Index at
Item 15. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of KeySpan Corporation and
subsidiaries as of December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2006, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
As discussed in Notes 1 and 4 to the consolidated financial statements, on
December 31, 2006, the Company adopted Statement of Financial Accounting
Standards No. 158 "Employers' Accounting for Defined Benefit Pensions and Other
Postretirement Benefit Plans." As discussed in Notes 1 and 7, on December 31,
2005, the Company adopted Financial Accounting Standards Board Interpretation
No. 47, "Accounting for Conditional Asset Retirement Obligations."
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006, based on the
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated February 22, 2007 expressed an unqualified opinion on management's
assessment of the effectiveness of the Company's internal control over financial
reporting and an unqualified opinion on the effectiveness of the Company's
internal control over financial reporting.
/s/DELOITTE & TOUCHE LLP
New York, New York
February 22, 2007
174
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures (as defined under Exchange Act
Rule 13a-15(e)) that are designed to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to KeySpan's management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. Any control system, no
matter how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives. Our management, under the supervision
and with the participation of our Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of our disclosure controls and
procedures as of December 31, 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.
175
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined under Exchange Act Rule 13a-15(f)).
KeySpan's internal control over financial reporting is designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements, errors or fraud. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of or compliance with the policies or procedures may deteriorate.
Under the supervision and with participation of KeySpan's Chief Executive
Officer and Chief Financial Officer, our management assessed the effectiveness
of our internal control over financial reporting as of December 31, 2006. In
making this assessment, our management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in a
report entitled Internal Control-Integrated Framework. Our management concluded,
as of December 31, 2006, that KeySpan's internal control over financial
reporting is effective based on the COSO criteria.
Our independent registered public accounting firm, Deloitte & Touche LLP, has
issued their report on management's assessment of KeySpan's internal control
over financial reporting as of December 31, 2006, which is included herein.
176
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of KeySpan Corporation:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that KeySpan
Corporation and subsidiaries (the "Company") maintained effective internal
control over financial reporting as of December 31, 2006, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
177
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2006, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements and financial statement schedule as of and for the year ended
December 31, 2006 of the Company and our report dated February 22, 2007
expressed an unqualified opinion on those financial statements and financial
statement schedule and included an explanatory paragraph regarding the adoption
of Statement of Financial Accounting Standards No. 158 "Employers' Accounting
for Defined Benefit Pensions and Other Postretirement Benefit Plans," referred
to in Notes 1 and 4.
/s/DELOITTE & TOUCHE LLP
New York, New York
February 22, 2007
178
PART III
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS and CORPORATE GOVERNANCE
Directors of KeySpan
The following individuals were elected as directors of KeySpan at our last
annual meeting of shareholders held on August 17, 2006, to hold such position
for a one year term or until his or her successor is duly elected or chosen and
qualified:
Robert B. Catell - Age 70 - Director since May 1998 Chairman and Chief Executive
Officer of KeySpan Corporation since July 1998. Joined KeySpan's subsidiary, The
Brooklyn Union Gas Company, in 1958 and was elected Assistant Vice President in
1974, Vice President in 1977, Senior Vice President in 1981 and Executive Vice
President in 1984. Elected Brooklyn Union's Chief Operating Officer in 1986 and
President in 1990. Served as President and Chief Executive Officer from 1991 to
1996. He was then elected Chairman and Chief Executive Officer in 1996 and held
such position through the transformation of Brooklyn Union to KeySpan. He served
as President and Chief Operating Officer of KeySpan from May 1998 through July
1998 and was then elected as the Chairman in July 1998. Serves on the boards of
Alberta Northeast Gas, Ltd., Edison Electric Institute, New York State Energy
Research and Development Authority, the Business Council of New York State, Inc.
and the New York City Partnership, and as Chairman of the Long Island
Association. Mr. Catell also serves on the board of directors of The Houston
Exploration Company (NYSE:THX) and Keyera Energy Management Ltd. (TSX:KEY.UN).
Andrea S. Christensen - Age 67 - Director since January 2001
Special Counsel to the law firm of Kaye Scholer LLP since January 1, 2005.
Previously was a partner of Kaye Scholer LLP since 1976. Joined that firm in
1968 and previously was an associate with the law firm of Kelley, Drye & Warren.
Adjunct Professor at New York University School of Law from 1984 to 1994. Member
of the Association of the Bar of the City of New York, American Bar Association
and International Society for Labor Law and Social Security. Former Chairperson
of New York County Lawyers Association Committee on Labor Relations. Served as a
director of Brooklyn Union from 1980 to 2000, and the American Arbitration
Association from 1988 to 1999. Serves as a Member of the board of Inwood House
since 2000.
Robert J. Fani - Age 52 - Director since January 2005
President and Chief Operating Officer of KeySpan since October 2003. Joined
KeySpan's subsidiary, The Brooklyn Union in 1976 and has since held a variety of
management positions in distribution, engineering, planning, marketing, and
business development. Elected Vice President in 1992 and promoted to Senior Vice
President of Marketing and Sales in 1997 and was responsible for all marketing,
sales, rate and regulation activities. In September 1999, he became Senior Vice
President for Gas Operations and was promoted to Executive Vice President for
Strategic Services in February 2000 and then to President of the KeySpan Energy
Services and Supply Group in 2001 until assuming his current position as
179
President and Chief Operating Officer. Former Director of The Houston
Exploration Company (NYSE:THX) and serves as a director of the New York Building
Congress, the City College of New York, Stony Brook University and the Energy
Partnership of Long Island. He is also a member of the Society of Gas Lighters
and sits on the Board of the Gas Technology Institute.
Alan H. Fishman - Age 60 - Director since May 1998
President, Sovereign Bank, from June 2006 to December 2006. Former president,
Chief Executive Officer and a director of Independence Community Bank Corp.
(NASDAQ:ICBC), the parent savings and loan holding company of Independence
Community Bank. Joined Chemical Bank in 1969, named Chief Financial Officer in
1979 and elected Senior Vice President responsible for worldwide investment
banking activities in 1983. Joined Neuberger & Berman in 1988 and was
responsible for an investment partnership. Joined American International Group,
Inc. in 1989 as Senior Vice President of AIG. Joined the firm of Adler & Shaykin
in 1990 as a Managing Partner. Former Managing Partner and founder of Columbia
Financial Partners, L.P. in 1992. President and Chief Executive Officer of
ContiFinancial Corporation from July 1999 to March 2001. Chairman of the
Brooklyn Academy of Music and the Brooklyn Navy Yard and co-chairman of the
Downtown Brooklyn Partnership.
James R. Jones - Age 67 - Director since May 1998
Co-Chairman and Chief Executive Officer of Manatt Jones Global Strategies, LLP
since October 2001 and Chairman of GlobeRanger Corporation since September 1999.
Senior Counsel to the law firm of Manatt, Phelps & Phillips, LLP from March 1999
to present. Retired as President of Warnaco, Inc. - International Division in
1998. Director of Anheuser Busch (NYSE:BUD) since 1998 and Kansas City Southern
(NYSE:KSU) since 1997. White House Staff, Special Assistant and Appointments
Secretary from 1965 to 1969 and Congressman from Oklahoma from 1973 to 1987.
Partner in the law firm of Dickstein Shapiro Morin & Oshinsky LLP from 1987 to
1989. Chairman and Chief Executive Officer of the American Stock Exchange from
1989 to 1993. Served as United States Ambassador to Mexico from 1993 to 1997.
James L. Larocca - Age 63 - Director since January 2001
Distinguished Professor of Public Policy and former Dean of the College at Long
Island University's Southampton Graduate Campus since April 2000 and Adjunct
Professor of Public Policy at Hofstra University since January 1999. Chairman of
the Long Island Regional Planning Board. Practiced law with the firm of Cullen
and Dykman immediately prior to his appointment to Southampton College. Served
in the cabinets of two New York State governors as Commissioner of
Transportation, Commissioner of Energy, Director of Federal Affairs, Trustee of
the New York Power Authority and Chairman of the Energy Research and Development
Authority. Served as the President of the Long Island Association from 1985 to
1993. Served as a director of Brooklyn Union from 1992 to 1993 and from 1995 to
2000. Former director of European American Bank and ContiFinancial Corporation.
Current director and past Chairman of the Long Island Nature Conservancy.
Gloria C. Larson - Age 56 - Director since June 2003
Partner and Co-chair of the Government Practices Group at the law firm of Foley
Hoag LLP. Has held senior positions within the federal government and the
Commonwealth of Massachusetts government, including serving as the Massachusetts
Secretary of Economic Affairs, Deputy Director of Consumer Protection and
Attorney Advisor for the Federal Trade Commission. Current Chairperson of the
180
Massachusetts Convention Center Authority since 1998. Director of Unum Provident
Corp. (NYSE:UNM). Serves as a member of the Rose F. Kennedy Greenway Conservancy
board, as well as several Boston-based not-for-profit organizations, including
the Greater Boston Chamber of Commerce, the New England Council, the
Massachusetts Women's Forum and Blue Cross Blue Shield of Massachusetts. Serves
as co-Chair of the board of directors of MassINC.
Stephen W. McKessy - Age 69 - Director since May 1998
Elected as the Lead Director of KeySpan effective January 1, 2006. Retired
partner of PricewaterhouseCoopers. Served in various management and leadership
positions at PricewaterhouseCoopers from 1960 to 1997. Serves as a director of
The Houston Exploration Company (NYSE:THX), and the Boy Scouts of America.
Member of the board of advisors of St. John's University College of Business
Administration, past president and current member of the board of governors of
the Silver Spring Country Club, and member of the Property Owners Association at
SailFish Point, Florida.
Edward D. Miller - Age 65 - Director since May 1998
Served as a member of the supervisory board and senior advisor to the Chief
Executive Officer of AXA Group from June 2001 to April 2003. Served as President
and Chief Executive Officer of AXA Financial, Inc. from August 1997 through May
2001. Chairman and Chief Executive Officer of The Equitable Life Assurance
Society, the principal insurance subsidiary of AXA Financial, Inc., from August
1997 through May 2001. Served as Senior Vice Chairman of The Chase Manhattan
Bank from 1996 through 1997. Serves as a member of the board of directors of
American Express Company (NYSE:AXP) and Korn/Ferry International (NYSE:KFY).
Member of the board of governors of the United Way of Tri-State and Chairman of
the board of directors of Phoenix House. Trustee of the Inner-City Scholarship
Fund and the New York City Police Foundation. Chairman for New York City's
Partnership Security and Risk Management Task Force.
Vikki L. Pryor - Age 53 - Director since March 2004
President and Chief Executive Officer of SBLI USA Mutual Life Insurance Company,
Inc. and its family of companies since 1999. Served as Senior Vice President of
Oxford Health Plans from June 1998 to January 1999. Served in various Senior
Vice President and Vice President positions at Blue Cross Blue Shield of
Massachusetts from 1993 to 1997. Served as Director and in a variety of senior
level positions at Allstate Life Insurance Company from 1986 to 1992. Served in
various positions including acting assistant district counsel, senior attorney
and associate in the Office of Chief Counsel of the Internal Revenue Service,
Chicago office, from 1978 to 1986. Served on the boards of the Life Insurance
Council of New York (LICONY), New Jersey Chamber of Commerce, UST Corporation,
Pension Reserves Investment Management and River Source Funds, a mutual fund
company Serves on the Dean's Advisory Council of the University at Buffalo Law
School. Ms. Pryor is also a member of the board of the New York City Partnership
and the Forum 500 Board of Directors.
181
EXECUTIVE OFFICERS OF KEYSPAN
Certain information regarding executive officers of KeySpan and certain of its
subsidiaries is set forth below:
Robert B. Catell
Mr. Catell's biography appears under "Directors of KeySpan".
Robert J. Fani
Mr. Fani's biography appears under "Directors of KeySpan".
Wallace P. Parker Jr.
Mr. Parker, age 57, was elected President of the KeySpan Energy Delivery and
Customer Relations Group in January 2003. He also serves as Vice Chairman and
Chief Executive Officer of KeySpan Services, Inc. since January 2003. He had
previously served as President, KeySpan Energy Delivery, since June 2001, and
from February 2000 served as Executive Vice President of Gas Operations. He
joined KEDNY in 1971 and served in a wide variety of management positions. In
1987, he was named Assistant Vice President for marketing and advertising and
was elected Vice President in 1990. In 1994, Mr. Parker was promoted to Senior
Vice President of Human Resources for KEDNY and in August 1998 was promoted to
Senior Vice President of Human Resources of KeySpan.
Steven L. Zelkowitz
Mr. Zelkowitz, age 57, was elected President of KeySpan's Energy Assets and
Supply Group in October 2003. Prior to that, he served as Executive Vice
President and Chief Administrative Officer since January 2003. He joined KeySpan
as Senior Vice President and Deputy General Counsel in October 1998, and was
elected Senior Vice President and General Counsel in February 2000. In July
2001, Mr. Zelkowitz was promoted to Executive Vice President and General
Counsel, and in November 2002, he was named Executive Vice President,
Administration and Compliance, with responsibility for the offices of General
Counsel, Human Resources, Regulatory Affairs, Enterprise Risk Management and
administratively for Internal Auditing. Before joining KeySpan, Mr. Zelkowitz
practiced law with Cullen and Dykman LLP in Brooklyn, New York, specializing in
energy and utility law and had been a partner since 1984. He served on the
firm's Executive Committee and was head of its Corporate/Energy Department.
John J. Bishar, Jr.
Mr. Bishar, age 57, was elected Executive Vice President, General Counsel, Chief
Governance Officer and Secretary effective March 1, 2005. He became Senior Vice
President, General Counsel and Secretary in May 2003, with responsibility for
KeySpan's Legal Department and the Corporate Secretary's Office. Prior to that,
he joined KeySpan as Senior Vice President and General Counsel in November 2002.
Before joining KeySpan, Mr. Bishar practiced law with Cullen and Dykman LLP
since 1987. He was the Managing Partner from 1993 through 2002 and was a member
of the firm's Executive Committee. From 1980 to 1987, Mr. Bishar was Vice
President, General Counsel and Corporate Secretary of LITCO Bancorporation of
New York, Inc.
182
John A. Caroselli
Mr. Caroselli, age 51, was elected Executive Vice President and Chief Strategy
Officer in January 2003. Mr. Caroselli is responsible for Brand Management,
Strategic Marketing, Corporate Marketing, Sales and Account Management and
Customer Service, Strategic Planning, Strategic Performance and Information
Technology Strategy and Governance. Mr. Caroselli came to KeySpan in 2001 and at
that time served as Executive Vice President of Strategic Development. Before
joining KeySpan, Mr. Caroselli held the position of Executive Vice President of
Corporate Development at AXA Financial. Prior to that, he held senior officer
positions with Chase Manhattan, Chemical Bank and Manufacturers Hanover Trust.
He has extensive experience in strategic planning, brand management, marketing,
communications, human resources, and strategic execution.
Gerald Luterman
Mr. Luterman, age 63, was elected Executive Vice President and Chief Financial
Officer in February 2002. He previously served as Senior Vice President and
Chief Financial Officer since joining KeySpan in July 1999. He formerly served
as Chief Financial Officer of barnesandnoble.com and Senior Vice President and
Chief Financial Officer of Arrow Electronics, Inc. Prior to that, from 1985
through 1996, he held executive positions with American Express. Mr. Luterman
also serves on the Board of Directors for IKON Office Solutions Inc. (NYSE:IKN),
U.S. Shipping Partners L.P. (NYSE:USS) and Technology Solutions Company
(NASDAQ:TSCC).
David J. Manning
Mr. Manning, age 56, was elected Executive Vice President Corporate Affairs and
Chief Environmental Officer effective March 1, 2005. He became Senior Vice
President for Corporate Affairs in April 1999. Before joining KeySpan, Mr.
Manning had been President of the Canadian Association of Petroleum Producers
since 1995. From 1993 to 1995, he was Deputy Minister of Energy for the Province
of Alberta, Canada. From 1988 to 1993, he was Senior International Trade Counsel
for the Government of Alberta, based in New York City. Previously, he was in the
private practice of law in Canada as Queen's Counsel.
Anthony Nozzolillo
Mr. Nozzolillo, age 58, was elected Executive Vice President of Electric
Operations in February 2000. He previously served as Senior Vice President of
KeySpan's Electric Business Unit from December 1998 to January 2000. He joined
LILCO in 1972 and held various positions, including Manager of Financial
Planning and Manager of Systems Planning. Mr. Nozzolillo served as LILCO's
Treasurer from 1992 to 1994 and as Senior Vice President of Finance and Chief
Financial Officer from 1994 to 1998.
Nickolas Stavropoulos
Mr. Stavropoulos, age 47, was elected President, KeySpan Energy Delivery, in
June, 2004 and Executive Vice President in April 2002. He previously served as
President of KeySpan Energy New England since April 2002, and Senior Vice
President of sales and marketing in New England since 2000. Prior to joining
KeySpan, Mr. Stavropoulos was Senior Vice President of marketing and gas
resources for Boston Gas Company. Before joining Boston Gas, he was Executive
Vice President and Chief Financial Officer for Colonial Gas Company. In 1995,
Mr. Stavropoulos was elected Executive Vice President - Finance, Marketing and
CFO, and assumed responsibility for all of Colonial's financial, marketing,
information technology and customer service functions. Mr. Stavropoulos was a
director of Colonial Gas Company and currently serves on the Board of Directors
for Enterprise Bank and Trust Company (NASDAQ:EBTC) and Dynamics Research
Corporation (NASDAQ:DRCO).
183
Joseph F. Bodanza
Mr. Bodanza, age 59, was elected Senior Vice President Regulatory Affairs and
Asset Optimization effective March 1, 2005. He became Senior Vice President,
Regulatory Affairs and Chief Accounting Officer in April 2003. Prior to that, he
served as Senior Vice President of Finance Operations and Regulatory Affairs
since August 2001 and was Senior Vice President and Chief Financial Officer of
KEDNE. Mr. Bodanza previously served as Senior Vice President of Finance and
Management Information Systems and Treasurer of Eastern Enterprise's Gas
Distribution Operations. Mr. Bodanza joined Boston Gas Company in 1972, and held
a variety of positions in the financial and regulatory areas before becoming
Treasurer in 1984. He was elected Vice President and Treasurer in 1988.
Coleen A. Ceriello
Ms. Ceriello, age 48, was named Senior Vice President of Shared Services of
KeySpan Corporate Services, LLC, effective March 1, 2005. She had been KeySpan's
Vice President - Property, Security and Employee Related Services since January
2005. Prior to that time, she served as Vice President of Property and Security
since June 2004 and Vice President of Strategic Planning since August 1999. She
joined KEDNY in 1980 and over the years held a succession of positions in
Corporate Planning, Regulatory Relations, Information Technology and Strategic
Planning and Performance.
John F. Haran
Mr. Haran, age 56, was elected Senior Vice President of KeySpan Energy Delivery
and Chief Gas Engineer in March 2004. He had been Senior Vice President of gas
operations for KEDNY and KEDLI in April 2002. Mr. Haran joined KEDNY in 1972,
and has held management positions in operations, engineering and marketing and
sales. He was named Vice President of KEDNY gas operations in 1996 and in 2000
moved to the position of Vice President of KEDLI gas operations.
Michael J. Taunton
Mr. Taunton, age 51, was elected Senior Vice President, Treasurer and Chief Risk
Officer effective March 1, 2005. He became Senior Vice President and Treasurer
in March 2004, and had been KeySpan's Vice President and Treasurer since June
2000. Prior to that time, he served as Vice President of Investor Relations
since September 1998. He joined KEDNY in 1975 and held a succession of positions
in Accounting, Customer Service, Corporate Planning, Budgeting and Forecasting,
Marketing and Sales, and Business Process Improvement. During the KeySpan/LILCO
merger, Mr. Taunton co-managed the day-to-day transition process of the merger
and then served on the Transition Team during the acquisition of Eastern
Enterprises.
Elaine Weinstein
Ms. Weinstein, age 59, was named Senior Vice President for Human Resources and
Chief Diversity Officer in March 2004. She previously served as Senior Vice
President of KeySpan's Human Resources division since November 2000, and as Vice
President of Staffing and Organizational Development from September 1998, to her
election as Senior Vice President. Prior to that time, Ms. Weinstein was General
Manager of Employee Development since joining KEDNY in June of 1995. Prior to
1995, Ms. Weinstein was Vice President of Training and Organizational
Development at Merrill Lynch.
184
Lawrence S. Dryer
Mr. Dryer, age 47, was elected Vice President and General Auditor in June 2003.
He previously served in this position from September 1998 to August 2001. In
August 2001, he was named Senior Vice President and Chief Financial Officer of
KeySpan Services, Inc. Prior to such positions, Mr. Dryer had been with LILCO
from 1992 to 1998 as Director of Internal Audit. Prior to joining LILCO, Mr.
Dryer was an Audit Manager with Coopers & Lybrand.
Theresa A. Balog
Ms. Balog, age 44, was elected Vice President and Chief Accounting Officer
effective March 1, 2005. She became Vice President and Controller of KeySpan in
April 2003. She joined KeySpan in 2002 as Assistant Controller. Prior to joining
KeySpan, Ms. Balog was Chief Accounting Officer for NiSource Inc. and held a
variety of positions with the Columbia Energy Group.
Joseph E. Hajjar
Mr. Hajjar, age 54, was named Vice President and Controller effective March 1,
2005. He had been Senior Vice President and Chief Financial Officer of KeySpan
Services, Inc. since June 2003 and Senior Vice President and Chief Financial
Officer of KeySpan Business Solutions, LLC, since November 2001. Before joining
KeySpan from 1998 to 2001, Mr. Hajjar was Executive Vice President and Chief
Operating Officer of Opportunity America. He also was previously an officer of
the Bovis group and served for over 12 years with Price Waterhouse.
Michael A. Walker
Mr. Walker, age 50, was named Vice President and Deputy General Counsel of
KeySpan Corporation, effective March 1, 2005. He had been Senior Vice President
of KeySpan Services, Inc. since June 2004 and Senior Vice President and COO of
KeySpan Business Solutions, LLC, since June 2003. Prior to that time he was
Senior Vice President and General Counsel of KeySpan Services, Inc. from January
2001 to December 2003. Before joining KeySpan, Mr. Walker was a shareholder in
the Corporate Finance Section in the law firm of Buchanan Ingersoll. Prior to
joining Buchanan Ingersoll he worked for several law firms in the north east
representing both private and public sector clients on a wide variety of energy,
utility, regulatory, corporate and structured finance matters.
There are no family relationships among any of our executive officers or
directors.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires KeySpan's directors, executive
officers and persons who own more than ten percent (10%) of a registered class
of KeySpan's equity securities to file with the SEC initial reports of
beneficial ownership and reports of changes in beneficial ownership of common
stock and other equity securities of KeySpan. Executive officers, directors and
greater than ten percent (10%) shareholders are required by SEC regulation to
furnish KeySpan with copies of all Section 16(a) forms that they file.
To KeySpan's knowledge, based solely on review of information furnished to us,
reports filed through KeySpan and representations that no other reports were
required, all Section 16(a) filing requirements applicable to our directors,
executive officers and greater than ten percent (10%) beneficial owners were
complied with during the twelve-month period ended December 31, 2006.
185
Codes of Ethics
We adopted a code of ethics applicable to our directors, a code of ethics
applicable to our senior financial officers, and an ethical business conduct
statement applicable to all of our directors, officers and employees. Our codes
of ethics, ethical business conduct statement, corporate governance guidelines
and committee charters can each be found on the Investor Relations section of
our website, (http://www.keyspanenergy.com) or directly at the Corporation's
corporate governance website (http://governance.keyspanenergy.com), and provide
information on the framework and high standards set by us relating to our
corporate governance. Additionally, these documents are available in print to
any stockholder requesting a copy. The codes of ethics, ethical business conduct
statement, corporate governance guidelines and committee charters have all been
approved by the board of directors and are vital to securing the confidence of
our stockholders, customers, employees, governmental authorities and the
investment community.
Audit Committee
The Audit Committee provides oversight with respect to the quality and integrity
of our financial statements; compliance with legal and regulatory requirements;
the independent auditor's qualifications and independence; the performance of
our internal audit function and independent auditors, our business practices,
risk assessment and risk management, and the preparation of the Audit Committee
report required to be included in our annual proxy statement. The Audit
Committee is comprised of Mr. Fishman, Ms. Christensen, Mr. Larocca, Mr. McKessy
and Ms. Pryor. Pursuant to the rules of New York Stock Exchange ("NYSE") all
members of the Audit Committee of our board of directors are independent
directors. Our board of directors has determined that Mr. Fishman and Ms. Pryor
meet the qualifications of an "audit committee financial expert," as that term
is defined by the rules of the Securities and Exchange Commission ("SEC"). In
addition, our board of directors has determined that Mr. Fishman, Mr. McKessy
and Ms. Pryor have "accounting or related financial management expertise," in
accordance with the NYSE corporate governance standards rules, section 303A.07.
Each of the members of the Audit Committee is financially literate, in
accordance with the NYSE corporate governance standards rules, section 303A.07.
None of the Audit Committee members simultaneously serves on the audit
committees of more than three public companies. The Audit Committee is composed
of five independent directors and operates under a written charter adopted by
our board of directors, as amended and restated as of January 26, 2006; and can
be found on the Investor Relations section of our website at
http://www.keyspanenergy.com or directly at our corporate governance website
(http://governance.keyspanenergy.com).
186
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
Objectives of Executive Compensation Programs
Through the Compensation and Management Development Committee of the Board of
Directors (the "Committee"), which is responsible for the administration of our
executive compensation programs, a "pay for performance" executive compensation
philosophy was developed and adopted by the Board of Directors. Our executive
compensation philosophy for named executive officers and other executives is
intended to provide compensation at market competitive levels in order to
attract, motivate and retain talented executives and to align the interests of
these executives with those of our shareholders. The Committee, which has the
primary governance authority over our executive compensation programs, is
composed of five directors, each of whom are "independent" under all applicable
New York Stock Exchange and Securities and Exchange Commission rules and
regulations. The Committee operates pursuant to a written charter and is
authorized by the Board of Directors to retain outside consultants, advisors or
legal counsel to provide independent advice to the Committee. The overall
objective of the program is to provide a total compensation plan designed to
focus on our strategic business initiatives, financial performance objectives
and shareholder value.
We adhere to the following compensation principles in the design of our
compensation programs, which are intended to support our business objectives and
further our strategic vision:
o The executive compensation programs emphasize pay for performance and
encourage retention of those employees who enhance our overall performance.
o Compensation plan design maintains a reasonable balance among base salary,
annual incentive and long-term equity-based incentive compensation and
other benefits and should further the creation of long-term value for
shareholders.
o Incentive compensation is linked to the achievement of specific financial
and strategic objectives, which are established in advance and approved by
the Board of Directors, upon recommendation of the Committee.
o Annual and long-term incentive compensation for executives are competitive
with the levels of comparable executives within the energy industry, as
well as general industry, on a nationwide basis, with a focus on energy
companies for those positions unique to the energy industry.
o Total direct compensation, including base salary, annual and long-term
incentives, should be benchmarked to the 50th percentile of the nationwide
marketplace.
o If our performance results exceed that of our peer group, compensation
should be above the 50th percentile for such peer group; likewise, if
performance falls below that of our peer group, compensation should be
below the 50th percentile.
187
o In addition to external comparisons, compensation levels also reflect the
internal value of each executive compared to other executives within our
organization, as well as other factors such as succession planning and the
achievement of exceptional individual results.
Towers Perrin, a nationally recognized compensation consultant, was selected by
the Committee as their independent compensation consultant in 2005. Towers
Perrin attends Committee meetings in order to provide advice and counsel to the
Committee in regard to compensation plan design and recommendations made by
management. In addition, Towers Perrin provides advice regarding changes in
legislative and accounting considerations that may impact compensation plan
design.
To assist us in implementing our compensation programs, surveys are prepared by
Towers Perrin to provide an independent review of the compensation levels of
executives in peer energy companies and companies in general industry. The
primary survey source is the Towers Perrin Energy Industry database with data
from approximately 100 energy companies, as well as their general industry
database with data from approximately 800 companies nationwide. This survey data
is used as our peer group in assessing pay levels.
Both energy and general industry peer group data are used to benchmark base
salary and annual incentives, but, because of factors unique to the energy
industry, only energy industry data is used to benchmark the long-term incentive
component of our pay programs. Ultimately, Towers Perrin uses statistical
analysis to ensure comparability of our base salary, annual and long-term
incentive compensation levels and to correlate the market data to an
organization of our size and scope.
Our compensation plan design and philosophy is reviewed annually by the
Committee, with no material changes made during 2006. In 2006 the Committee met
five times. In addition to a review of the peer group data provided by Towers
Perrin, the Committee conducted a comprehensive assessment of our executive
compensation programs to ensure that our philosophy and programs are consistent
with best practices and provide a reasonable level of total compensation to our
named executive officers. In conducting this assessment, the Committee reviewed
and relied upon comprehensive reports or "tally sheets" for each executive,
which identified all elements of compensation provided to the executives in the
prior year or to which they are otherwise entitled. In addition, the Committee
held one executive session without management participation to enable discussion
of the key elements of the named executive officers' performance evaluation and
compensation recommendations.
Role of Executives in Establishing Compensation
Mr. Catell and Mr. Fani attend all Committee meetings. At such Committee
meetings, they each periodically review KeySpan's financial and operating
performance, major changes in organizational plans and the performance of key
officers. Certain other senior executives also attend Committee meetings and are
responsible for developing potential compensation programs, incentive
compensation, plan design and individual salary recommendations with input from
both Mr. Catell and Mr. Fani, utilizing the survey data and advice provided by
Towers Perrin. With respect to Mr. Catell and Mr. Fani, all discussions
regarding their compensation is conducted by the Committee in Executive Session
without their attendance.
188
Compensation Program
Our compensation program reflects our compensation philosophy and principles as
set forth above. To achieve our objectives, direct compensation includes three
basic components: base salary, annual incentive compensation and long-term
incentive compensation.
We place significant emphasis on variable pay (i.e. pay that is contingent upon
performance), with the greatest proportion of total compensation being variable
for Mr. Catell when compared to the other named executive officers. In terms of
the variable pay component, which includes annual and long-term incentives, more
emphasis is placed on the long-term component than the annual component. Mr.
Catell has the highest portion of pay linked to long-term compensation, placing
greater emphasis on long-term shareholder value. All variable pay programs are
linked directly to performance measures that drive financial results, strategic
performance measures and other goals and objectives that are intended to
increase shareholder value.
The following provides a summary of the mix of compensation for the named
executive officers for 2006:
2006 Mix of Total Direct Compensation Components
- -------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Long-Term
Name Base Pay Annual Incentive Incentive Total
- -------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Catell 22% 22% 56% 100%
- -------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Fani 30% 22% 48% 100%
- -------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Parker 34% 24% 42% 100%
- -------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Zelkowitz 34% 24% 42% 100%
- -------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Luterman 36% 24% 40% 100%
- -------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Executives are provided with benefits and perquisites that are intended to be
comparable to those provided to executives in our peer group. These other
programs include the following:
o ability to allocate a portion of any annual incentive payment into a
deferred stock unit plan
o ability to allocate a portion of base salary into a deferred compensation
plan
o retirement plans
o 401(k) plan with employer match (available to all employees)
189
o executive group replacement life insurance
o severance and change in control termination protection
o other reasonable and customary perquisites
In the design of our programs, the compensation amounts realized in prior years
are not taken into consideration when establishing compensation targets or
awards. We also have no policy that would automatically result in an adjustment
to payments if the relevant performance measures upon which they are based are
restated or otherwise adjusted in subsequent years in a manner that would reduce
or increase the size of a previous payment. However, in an instance such as
this, the Committee would have discretion to consider an adjustment, if
warranted.
Base Salary
- -----------
We provide a base salary program in order to compete for executive talent in the
marketplace. Base salaries for our executives are established based on the scope
of their responsibilities, taking into account competitive market compensation
levels for similar positions. Generally, we believe that executive base salaries
should be targeted near the median of the range of salaries for executives in
similar positions with similar responsibilities at comparable companies. Base
salaries are reviewed annually and adjusted from time to time to realign
salaries with market levels, taking into account individual responsibilities,
performance and experience. Other factors such as internal equity and succession
planning are also considered when setting base salary.
In determining the base salary level for the named executive officers, the
Committee considers individual contributions, internal equity, succession
planning and performance, as well as competitive market data. In terms of
performance results and contributions, the named executive officers are
evaluated on an increase in overall earnings per share, continued focus on the
core business and the achievement of our short and long-term strategic
initiatives and financial goals. For further discussion of the named executive
officers' base salary in 2006 and 2007, see the narrative following the Summary
Compensation Table and the Grants of Plan-Based Awards table.
Annual Incentive Compensation
- -----------------------------
Annual incentive compensation is intended to encourage management to achieve
critical short-term goals that we believe are integrally linked to long-term
value creation. The Board of Directors adopted the Corporate Annual Incentive
Compensation and Gainsharing Plan (the "Corporate Plan") in September 1998. The
Corporate Plan provides annual incentive awards to officers and all management
employees based on the achievement of corporate goals that the Committee
believes enhance shareholder value. For 2006, the performance measurement period
included the twelve-month period from January 1, 2006 to December 31, 2006. The
awards for this period were approved by the Committee and the Board of Directors
in February 2007 and will be paid in March 2007. The specific corporate goals
for the Corporate Plan are proposed by management and reviewed and approved by
the Committee and the Board of Directors.
190
In 2006, the performance objectives for each of the named executive officers
included financial and strategic objectives consisting of the following:
o earnings per share
o cash flow
o business unit operating income
o customer satisfaction
o control of operating expenses
o employee diversity, and
o individual strategic initiatives
The incentive award ranges are established annually by the Committee for
executives and management employees. Incentive award levels provide awards that
are competitive both within and outside the energy industry when target
performance results are achieved.
Under the Corporate Plan, award payouts can range from zero for below threshold
performance up to a maximum award potential of two times the target level
established for each named executive officer. Actual award payouts are
calculated using cumulative base earnings paid during the calendar year and are
determined based upon each named executive officer's performance measured
against the established financial, strategic and individual performance
objectives set by the Committee and the Board of Directors. Actual awards also
reflect modification based upon each named executive officer's individual
performance rating using a modifier percentage as approved by the Committee. The
modifier allows the Committee to use its discretion to increase or decrease an
award with a maximum modification of +/- 15%, based on the named executive
officers' performance relative to leadership, teamwork, strategic thinking,
urgency for results, enterprise-wide commitment, developing organizational
talent and integrity.
For each named executive officer, the specific performance objectives are
weighted dependent upon the executive's level of responsibility for delivering
results against these objectives. The weightings for the named executive
officers with respect to each objective ranged as follows:
Earnings Per Share: 35% to 50%
------------------
Corporate/Business Unit Operating Income: zero to 25%
----------------------------------------
Free Cash Flow: 10% to 20%
--------------
Control of Operation and Maintenance Costs: zero to 20%
------------------------------------------
Diversity: 10% for each named executive officer
---------
Customer Satisfaction: 10% for each named executive officer
---------------------
Other Strategic Initiatives: zero to 10%
---------------------------
191
The overall assessment of the achievement of each named executive's goals
determines the percent of the target award that will be paid to the executive as
an annual incentive award. In addition, the Committee may take into
consideration certain unanticipated or extraordinary items, such as changes in
accounting or tax rules, that may have impacted the difficulty or ease of
achieving the desired targets and has discretion to adjust award payouts.
The performance metrics used in the 2006 Corporate Plan are summarized in the
chart below. These objectives were selected as key performance indicators in
support of our annual objectives and long-term strategy. The setting of the
target level of performance generally reflects a reasonable level of improvement
in performance when compared to the actual results achieved in the prior year.
The threshold level of performance reflects the minimum acceptable level of
performance. The maximum level of performance reflects performance results that
would be considered exceptional when compared to the expected target level of
results. The corporate performance objectives and the threshold, target and
maximum levels are reviewed and approved by both the Committee and the Board of
Directors at the beginning of each year.
2006 Performance Goals
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Performance Objective Threshold Target Maximum Actual Actual Results
Performance as a % of
Results(1) Target
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Earnings Per Share (2) $2.40 $2.46 $2.60 $2.63 200%
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Corporate Operating Income (3) $876M $918M $1,100M $970.4M 181.1%
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Operating Income Gas Business $548M $567M $606M $598.8M 181.1%
Unit and Energy Services (4)
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Operating Income Electric $319M $341M $385M $371.6M 169.1%
Business Unit and Energy
Related Investments (5)
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Free Cash Flow (2) $0 $150M $450M $511M 200%
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Control of Operation and $22.3M $21.7M $20.4M $19.96M 200%
Maintenance Costs (6)
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Diversity (2) (7) 63% 70% 85% 52% 0%
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Customer Satisfaction (2) (8) 87% 89% 93% 89% 100%
- ---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
(1) Actual performance results reflect adjustment for certain unanticipated
expenses associated with the pending transaction with National Grid.
(2) Goal applicable to all named executive officers.
(3) Goal applicable to Mr. Fani. Payout result reflects business unit
weightings of gas, electric, energy development and energy services
business units.
(4) Goal applicable to Mr. Parker.
(5) Goal applicable to Mr. Zelkowitz.
(6) The performance measure for the Control of Operation and Maintenance Costs
for Mr. Luterman reflects the expense levels associated with his areas of
responsibility.
192
(7) The Diversity goal measures the percentage of diverse candidates selected
for positions as compared to the total candidate population for those
positions that are underrepresented by diverse incumbents.
(8) The Customer Satisfaction goal measures the percentage of customers who
have had contact with us and have provided a satisfactory rating or better
with respect to the level of service provided to them. A random sample of
customers is used for this survey process. The survey is conducted by an
outside agency.
The Corporate Plan includes both primary and secondary performance trigger
mechanisms. The primary trigger is earnings per share. In order for the named
executives and all other participants in the Corporate Plan to receive any
incentive award payment, at least the threshold performance level of earnings
per share must be achieved. If earnings per share results are between threshold
and target, the award payout for all goals is pro-rated downward consistent with
the level of performance. Once the target level of earnings per share
performance is achieved, all goals are paid based upon actual performance
results, with results in excess of target paid up to the maximum award level in
the plan. The secondary performance trigger for the business units is operating
income. The secondary performance trigger for all corporate staff and
administrative areas is operation and maintenance expense. If the secondary
trigger for any business unit or the corporate staff/administrative area is
below threshold, the award payout for this measure is forfeited and award
payouts for any other performance measures are reduced by 75% for that
particular business unit.
We believe that the existence of these trigger mechanisms clearly emphasizes the
importance of enhancing shareholder value and ensures that incentive awards are
not paid (or are paid at substantially reduced levels) if key objectives are not
achieved. For further discussion of the Corporate Plan and awards relative to
2006 performance, see the narrative to the Summary Compensation Table and the
Grants of Plan-Based Awards table.
Long-Term Incentive Compensation
- --------------------------------
The purpose of long-term compensation is to encourage actions that are directly
aligned with the interests of our shareholders. We directly link officer
compensation to shareholder return by awarding a portion of compensation in
equity. The Committee recommended, and the Board of Directors adopted, the
KeySpan Long-Term Performance Incentive Compensation Plan (the "Incentive Plan")
in March 1999. The Incentive Plan was approved by shareholders at the May 1999
Annual Meeting. Under the Incentive Plan, we have awarded executives with three
types of equity-based compensation: (1) stock options, (2) performance shares
and (3) restricted stock.
The Committee is responsible for approving all equity awards granted under the
Incentive Plan. The type and amount of long-term compensation (as a percentage
of base salary) awarded to each named executive officer is determined, in part,
by the compensation value of the long-term component at the 50th percentile in
the Towers Perrin energy industry peer group. The actual shares awarded reflect
modification based upon each named executive officer's individual performance
rating using a modifier percentage as approved by the Committee. The modifier
allows the Committee to increase or decrease an award using discretion, with a
maximum modification of +/- 20%.
All equity awards are granted on the same day the Committee approves the awards
(typically at a meeting in February), and are priced based upon the closing
price of our stock on that date. With respect to newly hired or promoted
executives, grants of equity awards may be approved and granted on their date of
hire or promotion.
193
Below is a brief discussion of each type of equity-based compensation awarded
pursuant to the Incentive Plan. For more detailed information regarding
long-term compensation and each form of equity, see the 2006 Outstanding Equity
Awards at Fiscal Year-End table and accompanying narrative.
Stock Options
- -------------
The stock option component of the Incentive Plan permits the participants to
purchase shares of KeySpan common stock at an exercise price per share
determined by the Committee that is no less than the closing price of the common
stock on the New York Stock Exchange on the date of the grant. We have been
expensing stock options since 2003. We did not grant stock options in 2006 or
2007. The decision not to grant stock options in 2006 and 2007 was based upon
the fact that the expense associated with such stock options would exceed the
compensation value of the award and offer little incentive to executives due to
the pending transaction with National Grid.
Stock option awards have never been re-priced or granted at less than market
value. For a discussion of options granted prior to 2006, see the 2006
Outstanding Equity Awards at Fiscal Year-End table and the following narrative.
Restricted Stock
- ----------------
The restricted stock component of the Incentive Plan provides for the award of
common stock that may not be traded or otherwise disposed of by the participant
until specific restrictions have lapsed. Due to the fact that restricted stock
does not vest until after a multi-year period has lapsed, the interests of
executives are aligned with the interests of shareholders and we believe the
award encourages the retention of key executives.
For further discussion of the restricted stock awards in 2006, see the narrative
following the Summary Compensation Table and Grants of Plan-Based Awards table.
For 2007, the named executive officers received their entire long-term incentive
award in restricted stock. On February 20, 2007, the Committee approved the
following grants of restricted stock: Mr. Catell 26,000; Mr. Luterman 5,110; Mr.
Fani 15,000; Mr. Parker 10,000; and Mr. Zelkowitz 10,000. Restricted stock was
considered the most appropriate form of equity in view of the fact that the
establishment of multi-year performance goals was not realistic considering the
pending acquisition of us by National Grid. Moreover, in order to account for
the expected timing of this pending transaction, named executive officers'
long-term grant levels were adjusted to provide approximately one-third of the
target share level.
Performance Shares
- ------------------
The performance share component of the Incentive Plan entitles the participants
to receive shares of common stock if certain performance goals are achieved.
Executives may earn from 0% to 150% of the target level of performance shares
granted based upon our total shareholder return relative to the Standard and
Poor's Utility Group. This type of equity compensation encourages officers to
increase shareholder return because of the contingent nature of the award, which
remains at risk unless the goals are achieved.
194
The performance goal for performance shares granted in 2003, 2004 and 2005 was
linked solely to total shareholder return ("TSR"). The performance goal measures
KeySpan's cumulative TSR for a three year performance period as compared to the
Standard and Poor's Utilities Group. For the performance shares granted to
officers in 2003 and 2004, the threshold performance level was not achieved and
as a result all performance shares granted in 2003 and 2004 were forfeited
without payment, reinforcing KeySpan's "pay for performance" compensation
philosophy.
For a complete discussion of 2005 and 2006 performance share grants, see the
narrative following the Summary Compensation Table and Grants of Plan-Based
Awards table, and the narrative following the 2006 Outstanding Equity Awards at
Fiscal Year-End table.
Other Compensation Programs
Executive Group Replacement Life Insurance
- ------------------------------------------
The named executive officers as well as all other executives and eligible
management employees are also provided with KeySpan paid individual life
insurance. The executives do not participate in the group term life insurance
plan that is provided to all other employees. The level of benefit provided to
the executives under this replacement coverage is equal to the level of benefit
that was formerly provided to all employees in the group plan. We determined
that the cost of this coverage as a group term policy would be more expensive to
us than the replacement coverage that is now provided.
The life insurance benefit for executives provides a benefit level of three
times base salary and annual bonus up to a maximum of $1,500,000. All named
executive officers are at the $1,500,000 limit. At retirement, if the executive
is under age 65, the benefit level decreases to a maximum of $500,000 and
thereafter, decreases again each year between ages 66 and age 70 to a maximum of
$250,000. For executives who terminate employment prior to retirement age, we
discontinue the payment of premiums. These are variable life insurance policies
that are individually owned by the executive and accumulate cash value so that
at age 65 or later, if premiums have not been paid for a 10 year period, there
is sufficient value within the policy to allow us to discontinue premium
payments and continue to provide the benefit level stated above in retirement.
The cash surrender values as of December 31, 2006, for the named executives are
as follows: Mr. Catell - $163,500; Mr. Luterman $99,700; Mr. Fani - $25,900; Mr.
Parker - $45,300; and Mr. Zelkowitz - $45,200. The premiums paid by us are
taxable to each named executive officer.
Perquisites
- -----------
We maintain a perquisite program for our named executive officers, all other
executives and key management employees. The perquisites provided to the
executives are designed to provide a level of benefit to help attract and retain
executives. Our named executive officers are reimbursed for an annual medical
exam up to a cost of $1,000 and are also eligible for health club membership
reimbursement up to annual limit of $ 900. The annual medical exam and health
club subsidy are viewed as part of our initiative to encourage a healthy
195
lifestyle. There is also a financial and estate planning perquisite that
provides reimbursement up to $2,000 annually to the named executive officers.
The reimbursements for health club and financial and estate planning are taxable
to each named executive officer.
Due to the nature of our business which requires emergency response to ensure
public safety, as well as our geographically dispersed facilities, cars and
drivers are available for Mr. Catell, Mr. Fani, Mr. Parker and Mr. Zelkowitz.
The incremental cost of personal use of the company car for commutation purposes
has been valued, and a portion of the cost of the annual lease, the driver and
maintenance of the vehicle is imputed as income to the executives.
Each named executive officer is also provided a leased vehicle for business and
personal use. The lease term is 48 months, with an upper dollar limit of $30,000
plus sales tax on the value of the lease paid by us for 2006. If the value of
the vehicle exceeds $30,000, the named executive is responsible for payment of
the full amount in excess of this limit including taxes. The named executives
are eligible for reimbursement of up to $1,700 annually for maintenance expense.
The executive is taxed each year for personal use of the leased vehicle.
All such perquisites are reflected in the All Other Compensation column of the
Summary Compensation Table and the accompanying footnotes.
Post-Retirement and Post-Employment Plans
- -----------------------------------------
We also provide the following post-retirement and post-employment plans to our
executives:
o Our qualified pension plan, supplemental retirement plan and individual
agreements are discussed in detail in the narrative following the Pension
Benefits table. We provide a qualified pension plan to all employees in
order to be competitive in the marketplace, to provide a tax effective
method for us to fund retirement benefits, and to help attract and retain
executives. In addition to the qualified plan, the named executive officers
also participate in the KeySpan supplemental pension plan. We maintain this
unfunded plan to provide named executive officers and other eligible
employees with a pension benefit that will make up for the lost pension
benefits that result from the Internal Revenue Code limits on the qualified
plan.
We have established a deferred compensation trust and have contributed
assets to purchase corporate owned life insurance to provide a source of
funds for these supplemental benefits.
Individual supplemental retirement agreements have been provided to Mr.
Catell, Mr. Zelkowitz and Mr. Luterman. The agreement for Mr. Catell was
negotiated when he accepted the role of Chairman and CEO following the
merger of the Brooklyn Union Gas Company and the Long Island Lighting
Company in 1998. Effective January 1, 2005, we entered into a new agreement
with Mr. Catell that supersedes the 1998 agreement and continues to provide
for supplemental pension benefits.
196
We also provided both Mr. Zelkowitz and Mr. Luterman individual
supplemental pension agreements due to their shorter length of service as
compared to other executives and to provide incentives to remain with us.
For a more detailed discussion, see the narrative following the 2006
Pension Benefits table below.
o Executives may elect to defer until retirement or termination of employment
from 10% to 50% of their annual incentive awards to the Officers' Deferred
Stock Unit Plan (the "ODSUP"). We provide this unfunded plan to encourage
officers to increase their stock ownership in KeySpan and further align the
interests of the executives with that of our shareholders. The ODSUP is
discussed in detail in the narrative following the Nonqualified Deferred
Compensation table.
o Executives may elect to defer until retirement or termination of employment
up to 10% of their base salary to the Deferred Compensation Plan. We
provide this unfunded plan to allow executives an opportunity to defer
income and associated income taxes on their compensation. In addition, when
recruiting senior executives, the opportunity to defer compensation is an
attractive feature in the recruitment process. The Deferred Compensation
Plan is discussed in the narrative following the Nonqualified Deferred
Compensation table.
o Change of control protection and severance benefits are provided in Mr.
Catell's, Mr. Luterman's and Mr. Zelkowitz's employment agreements as well
as to all officers in the KeySpan Senior Executive Change of Control
Severance Plan (the "Change of Control Plan"). Change of control severance
benefits are discussed in detail in the narrative following the
Nonqualified Deferred Compensation table. These individual agreement
benefits and the Change of Control Plan benefits are provided to ensure the
continued employment of the executive leadership team during a period of
time when there may be a great deal of uncertainty pending a change in
control.
Policy with Respect to Section 162(m) Deduction Limit
Under Section 162(m) of the Internal Revenue Code of 1986, as amended, we cannot
deduct compensation in excess of $1,000,000 paid in any year to the Chief
Executive Officer or any of the other named executive officers. Certain benefit
plans and compensation paid under plans that are performance based are not
subject to the $1,000,000 annual limit if certain requirements are satisfied.
Although our compensation policy is designed to relate compensation to
performance, certain payments do not meet such requirement because they allow
the Committee and the Board of Directors to exercise discretion in setting
compensation. The Committee is of the opinion that it is in our best interest
for the Committee and the Board of Directors to retain this discretion in order
to preserve flexibility in compensating such executive officers, especially in
light of an increasingly competitive marketplace.
KeySpan Executive Stock Ownership Policy
The KeySpan Executive Stock Ownership Policy was adopted by the Committee in
January 2005. The policy requires increased ownership of KeySpan common stock to
ensure that the interests of the executives are closely aligned with the
interest of shareholders. The policy establishes target levels of ownership of
KeySpan stock for officers which must be achieved within a five-year period.
Officers that do not meet the stock ownership requirements or are not on target
to meet such requirements within a five year period are subject to certain
remedial actions by the Corporation.
197
Our officers are expected to own shares of KeySpan common stock with a value
equal to a specific multiple of such officer's base salary, as follows:
Position Multiple of Base Salary
-------- -----------------------
Chief Executive Officer 5x
Chief Operating Officer 4x
Presidents 3x
Executive Vice Presidents 2x
Senior Vice Presidents 1.5x
Vice Presidents 1x
All named executive officers are currently in compliance with the ownership
policy. In the event an executive is not in compliance, any one or more of the
following measures will apply to the executive:
o May not liquidate any holdings in KeySpan stock.
o Can not reduce or discontinue any payroll deductions for the purchase of
KeySpan stock.
o 50% of the after-tax proceeds from the exercise of stock options, or the
sale of restricted stock or performance shares, are required to be retained
as KeySpan stock.
Conclusion
We strive to ensure that each element of compensation delivered to the named
executive officers is reasonable and appropriate as compared to the type and
levels of compensation and benefits provided to executives in the marketplace.
We also believe that such compensation should properly reflect the performance
and results achieved by each individual. We have also established performance
measures that ensure that each component of compensation is aligned with
shareholders. Along with the Committee, we continually monitor trends in
executive pay to ensure that recommendations and plan design reflect best
practice.
198
Summary Compensation Table
- ------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Name and Year Salary Bonus Stock Option Non- Change in Pension All Other Total ($)
Principal ($) ($) Awards Awards Equity Value and Compensation
Position ($) ($) Incentive Nonqualified ($)
(1) Plan Deferred
Compensation Compensation
($) Earnings
($)
- ------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Robert B. 2006 1,140,000 0 3,514,017 0 2,223,900 721,242 (2) 336,830 (3) 7,935,989
Catell,
Chairman &
Principal
Executive
Officer
- ------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Gerald 2006 486,250 0 274,115 0 590,218 129,804 (2) 87,893 (4) 1,568,280
Luterman,
Executive
Vice
President
&
Principal
Financial
Officer
- ------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Robert J. 2006 814,500 0 581,225 0 1,104,827 997,503 (5) 239,491 (6) 3,737,546
Fani,
President
& Chief
Operating
Officer
- ------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Wallace 2006 625,000 0 363,098 0 797,968 592,332 (5) 212,007 (7) 2,590,405
P. Parker
Jr.,
President,
KeySpan
Energy
Delivery
and
KeySpan
Services
- ------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Steven L. 2006 625,000 0 410,426 0 784,407 477,570 (5) 206,877 (8) 2,504,280
Zelkowitz,
President,
Energy
Assets
and
Supply
Group
199
(1) For a discussion of assumptions made in the valuation of restricted stock
and performance shares, see "Note 1. Summary of Significant Accounting
Policies" to our audited financial statements for the year ended December
31, 2006.
(2) Includes change in pension values (Mr. Catell: $709,752; Mr. Luterman:
$128,210) as well as the earnings on deferred compensation under the
Deferred Compensation Plan that is above market and calculated based upon
the difference between the Federal Reserve Prime Rate and 120% of the
Federal Long-Term Rate (Mr. Catell: $11,490; Mr. Luterman: $1,594).
(3) Includes the cost of life insurance of $12,848; the 20% match of $140,000
contributed by us on amounts payable under our Corporate Plan but deferred
to the Officers' Deferred Stock Unit Plan; $161,309 as the total expense
incurred to provide a car and driver used for business and security
purposes, with income imputed for personal commutation; and $22,673 in
certain other compensation and perquisites, including a leased vehicle,
club membership, physical exam and 401(k) employer match, each of which are
valued at less than $10,000.
(4) Includes the cost of life insurance of $29,603; the 20% match of $38,828
contributed by us on amounts payable under our Corporate Plan but deferred
to the Officers' Deferred Stock Unit Plan; and $19,462 in certain other
compensation and perquisites, including a leased vehicle, financial
planning, health club membership, physical exam and 401(k) employer match,
each of which are valued at less than $10,000.
(5) Reflects the change in pension value. These named executive officers do not
participate in the nonqualified deferred compensation plan.
(6) Includes the 20% match of $37,059 contributed by us on amounts payable
under our Corporate Plan but deferred to the Officers' Deferred Stock Unit
Plan; $166,306 as the total expense incurred to provide a car and driver
used for business and security purposes, with income imputed for personal
commutation; $11,809 for a leased vehicle and $24,318 in certain other
compensation and perquisites, including the cost of life insurance,
financial planning, health club membership, club membership and 401(k)
employer match, each of which are valued at less than $10,000.
(7) Includes the cost of life insurance of $13,082; the 20% match of $55,009
contributed by us on amounts payable under our Corporate Plan but deferred
to the Officers' Deferred Stock Unit Plan; $118,355 as the total expense
incurred to provide a car and driver used for business and security
purposes, with income imputed for personal commutation; and $25,561 in
certain other compensation and perquisites, including supplemental long
term disability, a leased vehicle, financial planning, health club
membership, physical exam, club membership and 401(k) employer match, each
of which are valued at less than $10,000.
(8) Includes the cost of life insurance of $13,849; the 20% match of $51,313
contributed by us on amounts payable under our Corporate Plan but deferred
to the Officers' Deferred Stock Unit Plan; $123,752 as the total expense
incurred to provide a car and driver used for business and security
purposes, with income imputed for personal commutation; $17,064 for a
leased vehicle, health club membership and 401(k) employer match valued at
less than $10,000.
200
2006 Grants of Plan-Based Awards
- ---------- ------- ---------------------------------------- ----------------------------------- -------- ------- -------- ----------
Name Grant Estimated Future Payouts Under Estimated Future Payouts All All Exercise Grant
Date Non-Equity Incentive Plan Under Equity Incentive Plan Other Other or Base Date
Awards Awards Stock Option Price Fair
Awards: Awards: of Value
Number Number Option of
of of Awards Stock
Shares Secur- ($/Sh) and
of Stock ities Option
or Units Under- Awards
(#) lying ($)
Options
(#)
- ---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Thres- Target Maxi- Thres Target Maxi
hold ($) mum -hold (#) -mum
($) ($) (#) (#)
- ---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Robert B. 2/23/06 570,000 1,140,000 2,280,000 0 0 0 85,520 0 N/A 3,514,017
Catell (1)
- ---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Gerald 2/23/06 158,031 316,063 632,125 9,180 18,360 27,540 0 0 N/A 633,236
Luterman (2)
- ---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Robert J. 2/23/06 305,438 610,875 1,221,750 19,465 38,930 58,395 0 0 N/A 1,342,696
Fani (2)
- ---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Wallace P 2/23/06 218,750 437,500 875,000 12,160 24,320 36,480 0 0 N/A 838,797
Parker Jr (2)
- ---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Steven L. 2/23/06 218,750 437,500 875,000 13,745 27,490 41,235 0 0 N/A 948,130
Zelkowitz (2)
- ---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
(1) Reflects the grant date fair value pursuant to the Statement of Financial
Accounting Standards No. 123 (revised 2004) - Share-based Payment ("FAS
123R") of the restricted stock granted in 2006.
(2) Reflects the grant date fair value at threshold level pursuant to FAS 123R
of performance shares granted in 2006.
201
Salary
- ------
On February 23, 2006, upon recommendation of the Compensation and Management
Development Committee, the Board of Directors approved base salary increases for
2006 for the named executive officers as follows:
Approved Base Salary Increases for 2006
- ------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Name Previous Base Salary Base Salary Increased To Effective Date of Increase
- ------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Catell $1,075,000 $1,140,000 January 1, 2006
- ------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Luterman $467,000 $488,000 February 1, 2006
- ------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Fani $734,000 $782,000, and then to January 1, 2006
$860,000 (1) August 1, 2006
- ------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Parker $587,000 $625,000 January 1, 2006
- ------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Zelkowitz $545,000 $625,000 (2) January 1, 2006
- ------------------------ ------------------------------------ ------------------------------------ ---------------------------------
(1) Mr. Fani received a second mid-year increase to reflect his planned
succession to the Chief Executive Officer position. Consistent with this
succession plan, upon recommendation of the Committee, on May 3, 2006, the
Board of Directors approved a base salary increase for Mr. Fani from
$782,000 to $860,000 effective August 1, 2006.
(2) The increase for Mr. Zelkowitz reflects both a merit increase and an
adjustment to address internal equity considerations at the President
level.
On February 21, 2007, upon recommendation of the Committee, the Board of
Directors approved base salary increases for the named executive officers as
follows:
Approved Base Salary Increases for 2007
- ----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Name Base Salary from Base Salary to Effective Date
- ----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Catell $1,140,000 $1,220,000 January 1, 2007
- ----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Luterman $488,000 $522,000 February 1, 2007
- ----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Fani $860,000 $919,000 January 1, 2007
- ----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Parker $625,000 $668,000 January 1, 2007
- ----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Zelkowitz $625,000 $668,000 January 1, 2007
- ----------------------- ------------------------------------ ------------------------------------ ----------------------------------
These increases were based on the individual executive's performance appraisal
rating and accomplishments for the 2005 and 2006 calendar years, respectively,
which took into account performance results achieved in 2005 and 2006, as well
as competencies such as leadership, teamwork, strategic thinking, urgency for
results, enterprise-wide commitment, developing organizational talent and
integrity.
The amounts shown in the Non-Equity Incentive Plan Compensation column of the
Summary Compensation Committee include any amounts deferred to the ODSUP. The
ODSUP is described more fully in the narrative following the Non-Qualified
Deferred Compensation table.
202
Stock Awards
- ------------
On February 23, 2006, the Committee approved a grant to Mr. Catell of 85,520
shares of restricted stock pursuant to the Incentive Plan. The restrictions on
the restricted stock will lapse after two years on February 23, 2008. The
Committee has the discretion to lapse restrictions after one year on February
23, 2007 based on the success of the senior executive transition. On February
20, 2007, the Committee elected not to accelerate the lapse on these restricted
shares. In the event of retirement or upon a change of control, the restrictions
on the shares granted shall fully lapse. Restricted shares constitute issued and
outstanding shares of common stock, and therefore, Mr. Catell has the right to
vote such restricted shares. Dividends paid on the restricted stock are
reinvested and are subject to all of the same restrictions as the restricted
stock granted to him.
Also on February 23, 2006, the Committee approved performance share grants to
the named executive officers (other than Mr. Catell). The estimated future
payout of performance shares at threshold, target and maximum is provided in the
2006 Grants of Plan-Based Awards table under the Equity Incentive Plan Awards
columns. Performance shares were granted at the target level 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 target level of shares granted and will be linked
to the following two performance measures, using a matrix approach that
encompasses both measures:
o the percentage improvement in Return on Invested Capital ("ROIC"), and
o KeySpan's cumulative three-year TSR relative to the cumulative three-year
TSR for the Standard and Poor's Utilities Group.
The payout matrix is as follows:
- ---------- -------- ------------ ---------------------------------------------------------------------------------------------------
Three - Year Cumulative TSR Relative to S&P Utility Group
---------------------------------------------------------------------------------------------------
Threshold Target Maximum
-------------------------- ------------------------- ------------------------ ---------------------
< 35th Percentile 35th Percentile 50th Percentile 90th Percentile
- ---------- --------
Three
year %
Improvement
in ROIC < 1% 0% 0% 0% 0%
- ---------- -------- -------------------------- ------------------------- ------------------------ ---------------------
Threshold 1% 25% 50% 75% 100%
- ---------- -------- -------------------------- ------------------------- ----------------------- ---------------------
Target 3% 50% 75% 100% 125%
- ---------- -------- -------------------------- ------------------------- ------------------------ ---------------------
Maximum 5% 75% 100% 125% 150%
- ---------- -------- ------------ -------------------------- ------------------------- ------------------------ ---------------------
203
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. In the
event of an officer's retirement, performance shares shall be distributed based
upon results achieved at the end of the performance period and pro-rated through
the date of retirement. Upon a change of control, performance shares shall be
distributed based upon the greater of the number of performance shares
originally awarded at target level or the number of shares earned based on
actual performance through the change of control date.
The dual performance measures were introduced in 2006 based upon an analysis of
accounting considerations under the Statement of Financial Accounting Standards
No. 123 (revised 2004) - Share-based Payment ("FAS 123R"). In this regard, the
use of TSR as well as ROIC as an internal performance measure, with ROIC as the
trigger, allows for more favorable accounting treatment in the event of
forfeitures. If the TSR goal is the sole measure, the FAS 123R accounting rules
will not allow for the reversal of expense in the event shares are forfeited.
Using ROIC as the trigger allows for the reversal of expense in the event shares
are forfeited.
The FAS 123R value expensed in 2006 for the restricted shares granted to Mr.
Catell and for the performance shares granted to the other named executive
officers is reported in the Stock Awards column of the Summary Compensation
Table.
The grant date fair value pursuant to FAS 123R with respect to the entire 2006
restricted share grant to Mr. Catell is reported in the last column of the
Grants of Plan Based Awards table. The amounts reported in this table for the
other named executive officers reflects the grant date fair value at threshold
for the 2006 performance share awards pursuant to FAS 123R.
There were no grants of stock options to the named executive officers during
2006. Outstanding options from previous grants are reflected in the Outstanding
Equity Awards at Fiscal Year-End table.
Non-Equity Incentive Plan Compensation
- --------------------------------------
The Non-Equity Incentive Plan Compensation column of the Summary Compensation
Table reflects amounts earned pursuant to the Corporate Plan. These amounts will
be paid in March of 2007 and are based upon performance results achieved during
the twelve-month period from January 1, 2006 to December 31, 2006. The awards
earned under the Corporate Plan are paid as cash (with the option to defer
between 10% and 50% of the award to the ODSUP, as discussed in the narrative
following the Nonqualified Deferred Compensation table) based upon annual
performance results. The amounts reported in the Non-Equity Incentive Plan
Compensation column include any amounts deferred pursuant to the ODSUP.
Incentive awards for 2006 performance were determined based upon our
performance, strategic business group performance and individual performance
results, and were calculated as a percentage of cumulative base salary paid
during 2006. The incentive award ranges for 2006 were zero for below threshold
performance, and at threshold, target and maximum as a percentage of cumulative
base salary paid as follows:
204
Threshold Target Maximum
--------- ------ -------
Mr. Catell 50.0% 100% 200%
Mr. Fani 37.5% 75% 150%
Mr. Parker 35.0% 70% 140%
Mr. Zelkowitz 35.0% 70% 140%
Mr. Luterman 32.5% 65% 130%
Threshold, target and maximum annual incentive awards for 2006 are shown in the
Grants of Plan-Based Awards table. The actual awards paid in 2007 based on 2006
performance were modified to reflect individual performance appraisal ratings by
the following percentages: Mr. Catell: 15%; Mr. Luterman: 10%; Mr. Fani: 10%;
Mr. Parker: 10%; and Mr. Zelkowitz: 10%.
Change in Pension Value and Nonqualified Deferred Compensation Earnings
- -----------------------------------------------------------------------
With respect to Mr. Catell and Mr. Luterman, the amounts shown in the Change in
Pension Value and Nonqualified Deferred Compensation Earnings column of the
Summary Compensation Table includes change in pension values (Catell: $709,751;
Luterman: $151,109) as well as earnings on deferred compensation under the
Deferred Compensation Plan that is above market and calculated based upon the
difference between the Federal Reserve Prime Rate and 120% of the Federal
Long-Term Rate (Catell: $11,490; Luterman: $1,594). The change in pension value
is calculated using the accrued pension benefit as of December 31, 2005, and
compared to the accrued pension benefit as of December 31, 2006. These accrued
amounts are then converted to a present value using the discount rate and
mortality assumptions as used at year-end in the valuation of our pension plan.
The change in value reflects the difference between these present value amounts.
The accrued benefit amounts reflect the annuity amounts that are payable at age
65 or earlier if the executive is eligible for an unreduced retirement benefit
at an earlier age. The Deferred Compensation Plan is more fully described in the
narrative following the Non-Qualified Deferred Compensation table.
205
2006 Outstanding Equity Awards at Fiscal Year-End
- --------- ----------------------------------------------------------------------- --------------------------------------------------
Option Awards Stock Awards
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Name Number of Number of Equity Option Option Number Market Equity Equity
Securities Securities Incentive Exercise Expiration of Value Incentive Incentive
Underlying Underlying Plan Awards: Price Date Shares of Plan Plan
Unexercised Unexercised Number of ($) or Shares Awards: Awards:
Options Options Securities Units of or Number Market or
(#) (#) Underlying Stock Units of Payout
Exercisable Unexercisable Unexercised That of Unearned Value of
Unearned Have Stock Shares, Unearned
Options Not That Units Shares
(#) Vested Have or Units or
(#) Not Other Other
Vested Rights Rights
($) That That
Have Not Have
Vested Not
(#) Vested
($) (1)
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Robert B. 90,040 135,060 N/A 37.54 3/9/14(a) 16,741 (2) 689,394 40,350 (4) 1,791,742
Catell 125,280 83,520 32.40 3/4/13(b)
297,600 74,400 32.66 2/29/12(c) 88,490 (3)
267,000 39.50 2/12/11(d) 3,644,018
525,000 22.50 1/19/10(e)
43,800 22.50 1/19/10(f)
186,667 27.0625 5/20/09(g)
111,000 29.375 12/15/08(h)
235,000 27.75 8/12/08(i)
23,334 27.75 8/12/08(j)
125,000 32.625 11/21/07(k)
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Gerald 10,960 43,840 N/A 39.25 2/23/15(l) 3,689 (5) 151,913 3,550 (7) 548,476
Luterman 16,600 24,900 37.54 3/9/14(a)
25,980 17,320 32.40 3/4/13(b) 5,431 (6) 9,180 (8)
65,600 16,400 32.66 2/29/12(c) 223,649
60,000 39.50 2/12/11(d)
25,000 22.50 1/19/10(e)
6,800 22.50 1/19/10(f)
66,667 27.75 7/29/09(m)
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Robert J. 25,160 100,640 N/A 39.25 2/23/15(l) 5,383 (9) 221,672 8,150 (10) 1,190,623
Fani 38,240 57,360 37.54 3/9/14(a)
41,700 27,800 32.40 3/4/13(b) 19,465 (11)
96,000 24,000 32.66 2/29/12(c)
60,000 39.50 2/12/11(d)
18,200 36.59 7/1/11(n)
83,334 22.50 1/19/10(e)
30,000 27.0625 5/20/09(g)
17,000 27.75 8/12/08(j)
206
2006 Outstanding Equity Awards at Fiscal Year-End
- --------- ----------------------------------------------------------------------- --------------------------------------------------
Option Awards Stock Awards
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Name Number of Number of Equity Option Option Number Market Equity Equity
Securities Securities Incentive Exercise Expiration of Value Incentive Incentive
Underlying Underlying Plan Awards: Price Date Shares of Plan Plan
Unexercised Unexercised Number of ($) or Shares Awards: Awards:
Options Options Securities Units of or Number Market or
(#) (#) Underlying Stock Units of Payout
Exercisable Unexercisable Unexercised That of Unearned Value of
Unearned Have Stock Shares, Unearned
Options Not That Units Shares
(#) Vested Have or Units or
(#) Not Other Other
Vested Rights Rights
($) That That
Have Not Have
Vested Not
(#) Vested
($) (1)
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Wallace 17,720 70,880 N/A 39.25 2/23/15(l) 5,383 (12) 221,672 5,700 (13) 770,821
P. Parker 29,880 44,820 37.54 3/9/14(a)
Jr. 41,700 27,800 32.40 3/4/13(b) 12,160 (14)
96,000 24,000 32.66 2/29/12(c)
60,000 39.50 2/12/11(d)
18,200 36.59 7/1/11(n)
68,334 22.50 1/19/10(e)
4,400 22.50 1/19/10(f)
15,000 27.0625 5/20/09(g)
59,000 27.75 8/12/08(i)
5,667 27.75 8/12/08(j)
17,000 32.625 11/21/07(k)
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Steven L. 17,720 70,880 N/A 39.25 2/23/15(l) 3,689 (15) 151,913 5,700 (16) 838,302
Zelkowitz 23,840 35,760 37.54 3/9/14(a)
25,980 17,320 32.40 3/4/13(b) 13,745 (17)
65,600 16,400 32.66 2/29/12(c)
60,000 39.50 2/12/11(d)
75,000 22.50 1/19/10(e)
- --------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Option Awards footnotes follow:
- -------------------------------
(a) The stock options were granted on March 10, 2004 and are subject to a three
year vesting schedule if the total stockholder return performance goal is
achieved, otherwise the stock options vest pro-rata over a five year vesting
schedule with a 10 year exercise period.
(b) The stock options were granted on March 5, 2003 and are subject to a three
year vesting schedule if the total stockholder return performance goal is
achieved, otherwise the stock options vest pro-rata over a five year vesting
schedule with a 10 year exercise period.
(c) The stock options were granted on March 1, 2002 and are subject to a three
year vesting schedule if the total stockholder return performance goal is
achieved, otherwise the stock options vest pro-rata over a five year vesting
schedule with a 10 year exercise period.
(d) The stock options were granted on February 13, 2001 and were fully vested as
of February 2006 with a 10 year exercise period.
(e) The stock options were granted on January 20, 2000 and were fully vested as
of January 2003 with a 10 year exercise period.
207
(f) The stock options were granted on January 20, 2000 and were fully vested as
of January 2001 with a 10 year exercise period.
(g) The stock options were granted on May 20, 1999 and were fully vested as of
May 2002 with a 10 year exercise period.
(h) The stock options were granted on December 16, 1998 and were fully vested as
of December 1999 with a 10 year exercise period.
(i) The stock options were granted on August 13, 1998 and were fully vested as
of August 1999 with a 10 year exercise period.
(j) The stock options were granted on August 13, 1998 and were fully vested as
of August 2001 with a 10 year exercise period.
(k) The stock options were granted November 21, 1997 and were fully vested as of
November 2000 with a 10 year exercise period.
(l) The stock options were granted on February 24, 2005 and are subject to a
three year vesting schedule if the total stockholder return performance goal is
achieved, otherwise the stock options vest pro-rata over a five year vesting
schedule with a 10 year exercise period.
(m) The stock options were granted on July 29, 1999 and were fully vested as of
July 2002 with a 10 year exercise period.
(n) The stock options were granted on July 2, 2001 and were fully vested as of
July 2006 with a 10 year exercise period.
Stock Awards footnotes follow:
- ------------------------------
(1) Reflects the fair value of all outstanding performance shares and
accumulated dividends at the threshold award level.
(2) Includes 13,295 restricted shares granted on March 1, 2002 with reinvested
dividends of 3,446 shares accrued through December 31, 2006. Such restricted
shares are restricted for six years and fully vest on March 1, 2008.
(3) Includes 85,520 restricted shares granted on February 23, 2006 with
reinvested dividends of 2,970 shares accrued through December 31, 2006. Such
restricted shares are restricted for two years and fully vest on February 23,
2008.
(4) Reflects performance shares at threshold level granted on February 24, 2005.
(5) Includes 2,930 restricted shares granted on March 1, 2002 with reinvested
dividends of 759 shares accrued through December 31, 2006. Such restricted
shares are restricted for six years and fully vest on March 1, 2008.
(6) Includes 5,000 restricted shares granted on February 24, 2005 with
reinvested dividends of 431 shares accrued through December 31, 2006. Such
restricted shares are restricted for two years and fully vest on February 24,
2007.
(7) Reflects performance shares at threshold level granted on February 24, 2005.
(8) Reflects performance shares at threshold level granted on February 23, 2006.
(9) Includes 4,275 restricted shares granted on March 1, 2002 with reinvested
dividends of 1,108 shares accrued through December 31, 2006. Such restricted
shares are restricted for six years and fully vest on March 1, 2008.
(10) Reflects performance shares at threshold level granted on February 24,
2005.
(11) Reflects performance shares at threshold level granted on February 23,
2006.
(12) Includes 4,275 restricted shares granted on March 1, 2002 with reinvested
dividends of 1,108 shares accrued through December 31, 2006. Such restricted
shares are restricted for six years and fully vest on March 1, 2008.
(13) Reflects performance shares at threshold level granted on February 24,
2005.
208
(14) Reflects performance shares at threshold level granted on February 23,
2006.
(15) Includes 2,930 restricted shares granted on March 1, 2002 with reinvested
dividends of 759 shares accrued through December 31, 2006. Such restricted
shares are restricted for six years and fully vest on March 1, 2008.
(16) Reflects performance shares at threshold level granted on February 24,
2005.
(17) Reflects performance shares at threshold level granted on February 23,
2006.
The Outstanding Equity Awards at Fiscal Year-End table reflects holdings of
equity-based interests that relate to compensation or are potential sources of
future compensation. The table represents equity-based interests that were
awarded in 2006 and all prior years, as well as equity-based interests that are
"at risk" of forfeiture or expiration prior to exercise.
The Option Awards section of the above table reflects all outstanding vested and
unvested options. In the event of termination or retirement, the named
executives may forfeit all or a portion of the unexercisable options depending
on whether or not they are retirement eligible. At retirement or termination of
employment due to death or disability, an adjustment to the vesting schedule is
made to the options that include a 5 year pro-rata vesting schedule to reflect a
36 month vesting schedule. As a result, the options shall become vested and the
shares may be exercised based upon a 36 month pro-rata vesting schedule with
such options vesting monthly based on the number of full months that have lapsed
between the grant date and the date of retirement. All outstanding KeySpan stock
options will immediately vest on consummation of a change of control and will
remain exercisable until the close of business on the expiration date.
The stock option award process included a performance goal feature in the stock
option vesting schedule for officers which directly links three-year TSR for
KeySpan common stock to the options granted since 2001. The TSR goal measures
the total return to shareholders of KeySpan common stock, including price
appreciation and dividends. KeySpan's performance will be measured against the
S&P Utility Group over a three-year performance period, with the goal for
KeySpan's TSR to be at or above the median of those comprising the group.
Options were granted with a five-year pro-rata vesting schedule. If KeySpan
achieves its TSR goal at the end of the three-year performance period, then
those options that are not yet vested will vest immediately. If the TSR goal is
not achieved in year three, the remaining unvested options will continue to vest
on the five-year schedule. Stock options granted in 2001 and 2002 are fully
vested. For stock options granted in 2003 and 2004, the required TSR performance
target that would accelerate vesting was not achieved and the stock options
granted in these years continue to vest over the five year period.
The Stock Awards section of the table reflects outstanding restricted stock and
performance shares. Restricted stock outstanding is reflected in the Number of
Shares or Units of Stock That Have Not Vested column and includes restricted
stock granted including reinvested dividends.
In 2002, restricted stock was granted to each named executive officer. The
restrictions on the restricted stock granted in 2002 will lapse on March 1,
2008. In the event of retirement, the restriction period shall be adjusted to
reflect the number of full months that have lapsed between the date of the award
and the date of retirement using a 48 month restriction period. In the event of
retirement after the 48 month period, all restrictions would lapse on such
shares and reinvested dividends. In the event of termination of employment due
to death or disability, all restrictions would lapse on such shares and
reinvested dividends.
In 2005, Mr. Luterman was granted 5,000 shares of restricted stock. The
restrictions on this grant of restricted stock will lapse on February 24, 2007.
For both Mr. Luterman's 2005 grant and Mr. Catell's 2006 grant of restricted
stock described above, in the event of termination of employment due to death,
disability or retirement, all restrictions would lapse on such shares and
reinvested dividends. For all restricted stock grants to date, in the event of
change of control, the restrictions on all such outstanding shares and
reinvested dividends will fully lapse on the date of the change of control.
209
Performance shares outstanding are reflected at threshold, or 50% of target
grant level, in the Equity Incentive Plan Awards columns of the 2006 Outstanding
Equity Awards at Fiscal Year-End table. The awards are reflected at the
threshold level due to the forfeiture of the 2004 performance shares.
Performance shares granted in 2005 have a three-year performance period (January
1, 2005 through December 31, 2007). The performance goal to be measured will
compare KeySpan's cumulative TSR for a three year period, as compared to the S&P
Utilities Group cumulative shareholder return for the same three-year
measurement period. The performance shares issued will vary based upon a sliding
scale from 50% to 150% of the number of performance shares awarded at the target
level based upon the level of achievement of the performance goal. If the
threshold level of the performance goal is not achieved, the right to
performance shares will be forfeited without payment. The 2005 performance
shares granted will be earned on a pro-rata basis based upon the degree of
achievement of the performance goal established by the Committee and the shares
will be issued and fully transferable, in accordance with the following
schedule:
KeySpan Cumulative Return Percent of Target
Compared to S&P Utility Group Performance Shares Earned
------------------------------ -------------------------
0 to 34th percentile 0 %
35th percentile 50%
50th percentile 100%
90th percentile or over 150%
For information related to the performance measures related to the 2006 grant of
performance shares, see the narrative following the Summary Compensation Table
and Grants of Plan Based Awards table.
For both the 2005 and 2006 performance share awards, in the event of termination
of employment due to retirement or disability, performance shares and
accumulated dividends shall be distributed to the named executive officers based
upon the degree of achievement of the performance goal at the end of the three
year performance period, with an adjustment to the total shares calculated on a
pro-rata basis, utilizing the number of full months from the beginning of the
performance period to the date of retirement or disability, divided by 36
months.
In the event of termination of employment due to death, the target award amount
will be calculated and distributed on a pro-rata basis utilizing the number of
full months from the beginning of the performance period to the date of death,
divided by 36 months regardless of performance results.
In the event of change of control, the performance shares including accumulated
dividends will be calculated and distributed at the change of control date based
upon the greater of the number of shares originally awarded at target level and
the number of shares earned based upon actual performance through the change of
control date.
The Merger Agreement provides that each outstanding share of our common stock
(other than shares of our common stock owned by us as treasury stock or by a
subsidiary of us, or by National Grid or a subsidiary of National Grid) will be
converted into the right to receive $42.00 per share in cash, without interest,
210
or the "merger consideration." With respect to all outstanding options, upon
consummation of the Merger all unvested options will immediately vest, and the
holders of all options shall receive an amount in cash equal to the excess of
the merger consideration over the exercise price per share applicable to all
such outstanding stock options. With respect to shares of restricted stock and
reinvested dividends, all restrictions on such stock will lapse upon
consummation of the Merger. With respect to performance shares issued pursuant
to our Incentive Plan, target performance levels will be assumed with respect to
performance shares granted in 2005 and 2006 and, at such target performance, the
target level of such shares and accumulated dividends will be paid. However, if
actual performance levels through the date of change of control result in a
greater number of shares than target, then such greater number of shares and
accumulated dividends will be paid upon consummation of the change of control.
2006 Option Exercises and Stock Vested
- --------------------- --------------------------------------------------- ----------------------------------------------------------
Option Awards Stock Awards
- --------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Name Number of Shares Value Realized on Exercise Number of Shares Acquired Value Realized on Vesting
Acquired on Exercise ($) on Vesting ($)
(#) (#)
- --------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Robert B. Catell 100,000 1,050,000 0 0
- --------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Gerald Luterman 0 0 0 0
- --------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Robert J. Fani 0 0 0 0
- --------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Wallace P. Parker Jr. 17,000 169,524 0 0
- --------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Steven L. Zelkowitz 0 0 0 0
- --------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Options expire after a 10 year term if not otherwise exercised. None of the
named executive officer options have expired prior to being exercised. As
reflected in the above table, in 2006, Mr. Catell and Mr. Parker exercised
options due to the approaching expiration date of those options.
211
2006 Pension Benefits
- ------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Name Plan Name Number of Years Credited Present Value of Payments During Last
Service Accumulated Benefit Fiscal Year
(#) ($) ($)
- ------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Robert B. Catell KeySpan Retirement Plan 48 & 6/12 2,299,169 0
KeySpan Supplemental
Pension Plan 48 & 6/12 10,807,207
Supplemental Executive
Retirement Plan Agreement
N/A 5,559,066
- ------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Gerald Luterman KeySpan Retirement Plan 7 & 2/12 241,490 0
KeySpan Supplemental
Pension Plan 7 & 2/12 554,906
Supplemental Retirement
Agreement
N/A 220,708
- ------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Robert J. Fani KeySpan Retirement Plan 30 & 6/12 1,647,015 0
KeySpan Supplemental
Pension Plan 30 & 6/12 4,623,290
- ------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Wallace P. Parker Jr. KeySpan Retirement Plan 35 & 6/12 1,792,745 0
KeySpan Supplemental
Pension Plan 35 & 6/12 4,039,073
- ------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Steven L. Zelkowitz KeySpan Retirement Plan 8 244,702 0
KeySpan Supplemental
Pension Plan 8 709,496
Supplemental Retirement
Agreement
8 954,198
- ------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
The table above provides the present value ("PV") of the accrued pension benefit
payable at age 65, or earlier if the named executive officer is eligible to
receive an unreduced benefit at an earlier age. The benefit amounts provided
reflect the PV of the accrued benefit as of December 31, 2006. The PV of the
accrued benefits is referred to as Accumulated Benefits in the table above.
212
All amounts above were calculated based upon the pension plan measurement date
used for our audited financial statements and financial reporting purposes under
generally accepted accounting principles. A 6% discount rate and the mortality
assumptions used at year-end in the plans were used in these calculations.
Under all of our pension plans and supplemental agreements, the earliest age a
named executive officer may retire without a reduction to their pension benefit
for age is age 60. However, if the named executive's age plus service is equal
to 80 or greater, the named executive officer may retire as early as age 52 with
no reduction for age. In this regard, the calculations provided in the 2006
Pension Benefits table assume early retirement with no reduction for age for Mr.
Fani (age 53) and Mr. Parker (age 57) as of December 31, 2006. Mr. Catell (age
69) and Mr. Luterman (age 62) are also eligible for unreduced benefits as of
December 31, 2006. Mr. Zelkowitz who is age 57 as of December 31, 2006 will not
be eligible for an unreduced benefit until age 60. His accrued benefit
calculation assumes his pension commences at age 60.
The KeySpan Retirement Plan is a qualified pension plan under ERISA and provides
retirement benefits to employees who are vested and meet the plan's retirement
eligibility age. The benefit formula for the named executives in the plan is
consistent with the formula provided to all other management employees
participating in the plan. The accrued benefit amount under this plan is
calculated using base salary and annual incentive awards in the calculation of
compensation under the plan. The accrued benefit is based upon the average of
the final five consecutive years of compensation multiplied by 1.5% and length
of service. This accrued amount, which is payable only as an annual annuity
under the plan, has been converted to the PV amount using the methodology
described above. The form of annuity used in this calculation reflects a
lifetime annuity with no beneficiary option. The normal form of annuity option
under the plan is a 50% joint and survivor option.
The named executive officers also participate in the KeySpan Supplemental
Pension Plan. This supplemental plan is maintained to provide retirement
benefits using the same broad based plan formula under the qualified KeySpan
Retirement Plan to provide for accrued benefits that are in excess of IRC Code
Sections 415 and 401(a)(17) and can not be paid pursuant to the KeySpan
Retirement Plan. The accrued amount under this supplemental plan is also only
payable as an annual annuity. The annual annuity has been been converted to PV
amount in the table. The PV amount in the table has been calculated using the
methodology described above. The form of annuity used in this calculation
reflects a lifetime annuity with no beneficiary option. The normal form of
annuity option under the plan is a 50% joint and survivor option.
Mr. Catell's supplemental pension benefit formula uses his base pay and annual
incentive compensation in determining the pension benefit amount provided
pursuant to his agreement. In this regard, Mr. Catell's cumulative base salary
and highest annual bonus (as defined below) paid over any consecutive 36 month
period is determined and then divided by three to determine an annual average
amount. This annual average amount is then multiplied by 65%. The resulting
amount is the gross annual pension benefit. The gross annual pension benefit is
then reduced by several other pension amounts (i) 50% of Mr. Catell's primary
social security amount; (ii) his KeySpan Retirement Plan benefit; and (iii) his
KeySpan Supplemental Plan Benefit to determine his Agreement's supplemental
213
retirement benefit. This benefit is identified as the Supplemental Executive
Retirement Plan Agreement benefit in the 2006 Pension Benefit Table. In the
event his annual incentive target is decreased, Mr. Catell's supplemental
pension benefit under the 2005 Agreement will be determined based upon the
highest annual target level approved by our Board of Directors during his
employment in the event his actual award in any year is less than his highest
annual target. The normal form of benefit provided under the agreement is a 100%
joint and survivor annuity with his spouse or the actuarial equivalent form of
benefit including a single lump sum. Pursuant to the provision of the
agreements, Mr. Catell has elected a lump sum option under both his 1998 and
2005 Agreements.
We have also entered into a Supplemental Retirement Agreement with Mr. Zelkowitz
dated as of January 1, 2002. The agreement provides one added year of credited
service for each year worked after completion of five years of service, up to a
maximum of ten years in the calculation of his pension benefits. The maximum
benefit would add 10 years of credited service providing an incremental benefit
of 15% of his final five-year average earnings under the KeySpan Retirement and
Supplemental plans. In addition, at retirement, Mr. Zelkowitz will receive
medical and dental coverage at the same level of employee contribution in effect
at retirement, with any amounts that may be subject to taxes grossed up for
federal and state taxes. If Mr. Zelkowitz is terminated in connection with a
change of control, based upon eight years of actual service through December 31,
2006, the agreement will provide additional credited service to the maximum of
ten years.
We have also entered into a Supplemental Retirement Agreement with Mr. Luterman
dated as of July 1, 2002. The agreement provides that Mr. Luterman will receive
an annual supplemental retirement amount determined by multiplying Mr.
Luterman's age 62 accrued benefit from the KeySpan Retirement Plan and the
KeySpan Supplemental Pension Plan by 35%. Mr. Luterman vested in this benefit in
June 2005. In addition, at retirement, Mr. Luterman will receive medical and
dental coverage at the same level of employee contribution in effect at
retirement, with any amounts that may be subject to taxes grossed up for federal
and state taxes.
Employment Agreements Including Change of Control - Post Termination
In September 1998, we entered into an employment agreement with Mr. Catell
relating to his service as Chairman and Chief Executive Officer, which was
amended on February 24, 2000 and June 26, 2002 (the "1998 Agreement"). The
agreement covered the period beginning July 31, 1998 and ending July 31, 2005.
Effective January 1, 2005, we entered into a new agreement (the "2005
Agreement"), which supersedes the 1998 Agreement. The 2005 Agreement provided
for Mr. Catell's continued employment until July 31, 2006. The 2005 Agreement
also provides that the term of the agreement would be extended in the event of a
change of control (as defined in the 2005 Agreement). Pursuant to the agreement,
and as a result of the pending acquisition of KeySpan by National Grid, the term
of the agreement has been extended until two years following the closing of the
transaction.
Mr. Catell's employment agreement also provides for severance benefits to be
paid to him in the event his employment is terminated by KeySpan without cause
or if Mr. Catell terminates his employment for good reason. The severance
benefits to be provided during the Severance Period (as defined below) include:
(a) payment to Mr. Catell in a single lump sum of (i) all accrued obligations
214
(the accrued obligations include any base salary, annual or long-term incentive
compensation actually earned but not yet paid through the date of termination,
accrued but unpaid vacation pay, and any compensation previously deferred,
inclusive of any accrued interest), and (ii) the aggregate amount of salary and
annual incentive compensation that he would have received had he remained
employed through the end of the employment period; (b) continued accrual of
Supplemental Executive Retirement Plan benefits (as provided in the agreement)
to the end of the term of the agreement; (c) continuation of all other employee
benefits; and (d) acceleration of vesting of all equity awards, as if he had
remained employed by KeySpan during the term of the agreement. If Mr. Catell
voluntarily terminates his employment, other than for good reason, we will pay
the accrued obligations to Mr. Catell and he shall be entitled to retire and
receive all the pension benefits as provided under the various pension plans, as
well as retiree medical and dental coverage provided under the group health
plan. In addition, he is eligible for the benefits under the Executive Group
Replacement Life Insurance Policy as described in the above Compensation
Discussion and Analysis. If Mr. Catell is terminated without cause or resigns
for good reason during the Protection Period, Mr. Catell will be provided with
severance at a multiple of two times base salary and highest annual bonus,
continued benefits and additional supplemental pension benefits accrual for the
two year period following his termination. The highest annual bonus under the
agreement is calculated based upon the higher of the average of the three most
recent years of bonus received prior to the change of control and the most
recently received annual bonus.
The protection period under his agreement begins on the date that we enter into
a definitive agreement that would constitute a change of control transaction (as
defined in the Change of Control Plan) and ends on the second anniversary of the
date following consummation of such change of control.
Mr. Catell may resign for any reason in the thirteenth month following a change
of control with all severance benefits. In the event that any payments or other
severance benefits Mr. Catell receives from us or otherwise are subject to a
parachute excise tax, then Mr. Catell will be entitled to a gross-up payment in
order to put him in the same after-tax position he would have been in without
the imposition of the excise tax.
In March 2006, we entered into a letter agreement with Mr. Luterman relating to
his service as Executive Vice President and Chief Financial Officer. The letter
agreement provides that in the event of his termination of employment as a
result of the change of control of KeySpan, he would be entitled to separation
benefits under the Change of Control Plan without regard to his age as of any
date of termination or mandatory retirement age. Under the qualified pension
plan, age 65 is the mandatory retirement age. The Change of Control Plan would
have otherwise capped his separation benefit at this age.
Senior Executive Change of Control Severance Plan
On October 29, 2003, after a competitive market analysis and a due diligence
review by an outside consultant, our Board of Directors authorized a five year
extension of the Change of Control Plan. The Change of Control Plan expires
October 30, 2008, unless extended for an additional period by our Board of
Directors; provided that, following a change of control, the Change of Control
Plan shall continue until after all the executives who become entitled to any
payments or benefits thereunder shall have received such payments in full.
215
With the exception of Mr. Catell, all other named executive officers participate
in the Change of Control Plan. The Change of Control Plan provides for the
payment of severance and other benefits upon certain qualifying terminations of
such executives within two (2) years of a "change of control" (as defined in the
Change of Control Plan). The protection period under the Change of Control Plan
commences upon the date that we enter into a definitive agreement contemplating
a change of control and will continue for a period of two years after the
effective date of the actual change of control. Upon the signing of the
definitive Merger Agreement with National Grid, the protection period went into
effect on February 25, 2006. The benefits payable under the Change of Control
Plan provide for:
(i) the payment of the executive's base salary and compensation previously
deferred by the executive, earned through the date of termination;
(ii) the payment of an amount equal to three times an executive's base
salary and highest annual bonus (as defined in footnote 1 following the table
below) for any President, any Executive Vice President and any Senior Vice
President and two times an executive's base salary and highest annual bonus for
Vice Presidents;
(iii) the payment of amounts under retirement plan formulas, including the
applicable two to three year period as added service and compensation under the
plans; and
(iv) the continuation of medical, dental and life insurance benefits for a
period of two to three years depending on the executive's position with us.
In addition to severance benefits provided under the Change of Control Plan, the
occurrence of a change of control will also result in the acceleration of
vesting of all equity based awards under the provisions of the Incentive Plan.
Estimated Change of Control/Severance Payments
The following table shows the amount of potential severance benefits including
potential gross-up amounts for excise taxes for the named executive officers
pursuant to the Change of Control Plan, or in the case of Mr. Catell, his 2005
Agreement, and in the case of Mr. Luterman, his 2006 agreement, assuming a
change of control took place in 2006 and the named executive officers were
terminated on December 31, 2006. The table also shows the estimated present
value of continuing coverage for the benefits provided under our group health,
dental, executive life insurance and all retirement plans. The amounts indicated
are applicable only in the event the named executive officers are not retained
upon a change of control or they resign for good reason under the terms of the
plan. Upon termination of employment, each named executive officer is eligible
for outplacement benefits not to exceed $30,000.
Mr. Catell has agreed to serve as Deputy Chairman of National Grid and Executive
Chairman of National Grid US8 for a two-year period following the change of
control date. Assuming he serves in such capacities for such period, he will not
be entitled to receive the severance benefits listed in the table below.
216
Likewise, in the event the other named executive officers continue their
employment beyond a two-year protection period, they also will not be entitled
to receive the payments listed in the table below. However, pursuant to the
Change of Control Plan, an excise tax and gross-up payment of $2,146,137 and
$1,195,864, regardless of their continued employment, will be made to Mr. Catell
and Mr. Fani, respectively, as a result of the acceleration of vesting upon
change of control associated with unvested options, restricted stock and
performance shares.
Estimated Estimated Present Estimated
Potential Cash Value of Value of Excise Tax
Severance Welfare Retirement and Gross-up
Executive Officers Payment (1) Benefits (2) Benefits (3) Payments (4)
Robert B. Catell (5) $ 6,480,000 $ 45,000 $ 2,600,768 $7,069,925
Gerald Luterman $ 3,017,125 $ 117,300 $ 605,298 $2,299,900
Robert J. Fani $ 5,544,700 $ 54,900 $ 3,783,892 $6,256,851
Wallace P. Parker Jr. $ 4,075,361 $ 69,300 $ 2,151,370 $4,053,558
Steven L. Zelkowitz $ 3,927,516 $ 72,900 $ 2,135,649 $3,977,279
(1) Cash severance benefit is a lump sum payment based on the annual base
salary prior to termination plus the highest annual bonus times the
severance multiple. Highest annual bonus is defined as the greater of the
bonus most recently paid prior to the change of control or the average of
the three prior years ("Highest Annual Bonus"). The lump sum also includes
an amount which represents the Highest Annual Bonus prorated from January 1
to the date of termination divided by 365. The severance multiple for Mr.
Catell pursuant to his employment agreement is two times while all other
named executive officers listed above have a multiple of three times.
(2) Includes the cost of continuation of employee coverage for medical, dental
and life insurance during the two year period for Mr. Catell and the three
year period for all other named executive officers.
(3) Represents the present value of the increase in the annual lifetime pension
annuity attributed to the added service and compensation associated with
the two year period for Mr. Catell and the three year period for all other
named executive officers.
(4) The executive officers are entitled to receive a gross-up payment to
eliminate the effect on any "golden parachute" excise taxes that may be
imposed on the executives under Sections 280G and 4999 of the Internal
Revenue Code. This is a tax imposed on the executive above and beyond
ordinary income taxes. The amount of such gross-up payment has been
calculated taking into consideration the value of the all cash severance
payments, the value of all benefits and the acceleration of equity awards
attributed to change of control. This payment amount is provided to pay the
excise taxes that may be imposed on the executive as well as any taxes on
this gross-up check. All other federal, state and local income taxes that
are attributed to the cash severance payments, benefits and equity awards
will be paid by the executive.
(5) Mr. Catell's severance benefits are provided pursuant to his employment
agreement dated January 1, 2005. Mr. Catell is not a participant in the
Change of Control Plan.
217
The following table provides a summary of the value of unvested stock options,
restricted stock and performance shares that vest upon a change of control.
Accelerated Vesting of Equity Awards Attributed to Change of Control
- --------------------------- ------------------------------- ----------------------------------- ------------------------------------
Unvested Restricted Stock Unvested Performance Shares
Unvested Stock Options ($) (2) ($) (3)
($) (1)
- --------------------------- ------------------------------- ----------------------------------- ------------------------------------
Robert B. Catell 1,858,813 4,333,412 5,074,658
- --------------------------- ------------------------------- ----------------------------------- ------------------------------------
Gerald Luterman 467,046 375,562 1,371,813
- --------------------------- ------------------------------- ----------------------------------- ------------------------------------
Robert J. Fani 851,591 221,672 3,014,580
- --------------------------- ------------------------------- ----------------------------------- ------------------------------------
Wallace P. Parker Jr. 748,510 221,672 2,036,389
- --------------------------- ------------------------------- ----------------------------------- ------------------------------------
Steven L. Zelkowitz 558,765 151,913 2,071,571
- --------------------------- ------------------------------- ----------------------------------- ------------------------------------
(1) The value of all unvested options reflects the difference between the
exercise price of each unvested option and the closing price of our stock
at the fiscal year end ($41.18 per share).
(2) The value of all unvested restricted shares reflects the closing price of
our stock at fiscal year end ($41.18 per share) including reinvested
dividends, with all restrictions assumed to be lapsed on December 31, 2006.
(3) The value of all unvested performance shares reflects shares granted in
2004, 2005 and 2006, and assumes that the shares and accumulated dividends
vested at the target grant level at the closing price of our stock at
fiscal year end ($41.18 per share). While the 2004 grant of performance
shares would have vested under an assumed change of control on December 31,
2006, in actuality these shares and accumulated dividends thereon have been
forfeited because the performance result required to vest this award as of
December 31, 2006 was not achieved. The amounts forfeited by each named
executive officer are as follows: Mr. Catell: $1,491,174; Mr. Luterman:
$274,860; Mr. Fani: $633,334; Mr. Parker: $494,749; and Mr. Zelkowitz:
$394,967.
218
2006 Nonqualified Deferred Compensation
- ------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Name Executive Registrant Aggregate Aggregate Aggregate
Contributions in Last Contributions in Earnings in Withdrawals/ Balance at
FY Last FY Last FY Distributions Last FYE
($) ($) ($) ($) ($)
(1) (2) (3) (4)
- ------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Robert B. 700,000 140,000 191,220 (5) 0 4,167,494
Catell
- ------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Gerald 194,141 38,828 33,759 (5) 0 772,696
Luterman
- ------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Robert J. 185,294 37,058 57,189 0 1,359,983
Fani
- ------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Wallace P. 275,045 55,009 56,410 0 1,369,767
Parker Jr.
- ------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Steven L. 256,565 51,312 48,834 0 1,191,472
Zelkowitz
- ------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
(1) Reflects amounts deferred by each named executive officer to the ODSUP from
the amount earned under the Corporate Plan for the purchase of our stock
units. The amounts deferred would have been paid to each of the named
executives in 2006 attributable to performance in 2005.
(2) Represents the 20% match on the amount deferred into the ODSUP.
(3) Includes dividends paid on shares held in the ODSUP. Dividends paid in the
ODSUP are equal to dividends paid to all KeySpan stockholders and
therefore, no amount is preferential or above the market rate. Since
dividends paid in the ODSUP are not above the market rate, earnings on the
ODSUP are not included in the Summary Compensation Table, but rather, are
included in this column in its entirety.
(4) Aggregate balance of deferred compensation represents amounts previously
deferred by the named executive officers and any earnings thereon. The
ODSUP shares have been valued at the full market value closing price of our
stock per share at fiscal year end ($41.18 per share).
(5) Also includes earnings on amounts deferred pursuant to the Deferred
Compensation Plan.
Officers' Deferred Stock Unit Plan
- ----------------------------------
Pursuant to the ODSUP and consistent with our desire to encourage increased
officer stock ownership to further align the interests of our executives and
stockholders, the named executive officers and certain other executives may
elect to defer between 10% and 50% of their annual cash award earned under the
Corporate Plan to deferred stock units held within the ODSUP. The deferred stock
units track the performance of our common stock but do not possess voting
rights. The deferred stock units receive dividends which accumulate during the
deferral period.
Executives also receive a 20% match from us on the amounts deferred in each
year, which amounts are reported in the All Other Compensation column of the
Summary Compensation Table. The match component and dividends on the deferral
will track the performance of our common stock and will generally be payable in
cash upon retirement. Amounts held within the ODSUP must be deferred until
retirement or resignation and are payable in common stock for the amounts
deferred by the executive, and either in stock or cash for the match component
and dividends. In the event of the executive's resignation prior to retirement,
the match and dividends are forfeited. Each of the named executive officers
elected to defer the following amounts of their annual cash awards payable in
2006 (attributable to 2005 performance) and 2007 (attributable to 2006
performance), respectively:
219
2006 2007
---- ----
Mr. Catell 50% 50%
Mr. Fani 25% 25%
Mr. Parker 50% 50%
Mr. Zelkowitz 50% 50%
Mr. Luterman 50% 40%
Upon a change in control, all deferred stock units, the match and accumulated
dividends will be converted to cash and distributed to the executives pursuant
to the plan provisions as permitted under Internal Revenue Code section 409A.
Deferred Compensation Plan
- --------------------------
Pursuant to the Deferred Compensation Plan, by December 31st of each year, each
eligible executive and management employee may elect to defer receipt of between
1% and 10% of the following year's base pay. Deferred compensation for each
participant shall be credited to an account on our books (the "Deferred
Account"). Interest on amounts in a Deferred Account shall be credited and
compounded monthly based on the average reference rate during such month (the
"Prime Rate").
In the event of an executive's separation from service, the amounts in the
executive's Deferred Account shall be distributed consistent with the
distribution election made by the executive and as permitted under Internal
Revenue Code section 409A.
Mr. Catell and Mr. Luterman maintain a balance in this plan while the other
named executive officers do not participate in this plan.
220
2006 Director Compensation
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
Name (1) Fees Earned Stock Awards Option Awards Non-Equity Incentive Change in Pension All Other Total
or Paid in ($) (2) ($) Plan Compensation Value and Compensation ($)
Cash ($) Nonqualified ($)
($) Deferred
Compensation Earnings
($)
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
A. S. 73,500 64,000 0 0 0 0 137,500
Christensen
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
A. H. 81,500 (3) 64,000 0 0 0 0 145,500
Fishman
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
J. R. 70,500 (4) 64,000 0 0 0 0 134,500
Jones
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
J. L. 75,500 (5) 64,000 0 0 0 0 139,500
Larocca
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
G. C. 63,500 (6) 64,000 0 0 0 0 127,500
Larson
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
S. W. 81,500 (7) 64,000 0 0 0 0 145,500
McKessy
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
E. D. 70,500 (8) 64,000 0 0 0 0 134,500
Miller
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
V. L. 69,500 (9) 64,000 0 0 0 0 133,500
Pryor
- ------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
(1) Messrs. Catell and Fani are not listed in the above table because neither
receives any additional compensation for serving on our board of directors
or its committees.
(2) Stock awards are received as common stock equivalents pursuant to the
Directors' Deferred Compensation Plan.
(3) Includes $48,900 elected by the director to be received as a stock
equivalent and deferred pursuant to the Directors' Deferred Compensation
Plan.
(4) Includes $35,250 elected by the director to be received as a stock
equivalent and deferred pursuant to the Directors' Deferred Compensation
Plan.
(5) Includes $18,875 elected by the director to be received as a stock
equivalent and deferred pursuant to the Directors' Deferred Compensation
Plan.
(6) Includes $63,500 elected by the director to be received as a stock
equivalent and deferred pursuant to the Directors' Deferred Compensation
Plan.
(7) Includes $40,750 elected by the director to be received as a stock
equivalent and deferred pursuant to the Directors' Deferred Compensation
Plan.
(8) Includes $70,500 elected by the director to be received as a stock
equivalent and deferred pursuant to the Directors' Deferred Compensation
Plan.
(9) Includes $69,500 elected by the director to be received as a stock
equivalent and deferred pursuant to the Directors' Deferred Compensation
Plan.
221
The directors' compensation as reflected in the table above includes the
following amounts:
Non-employee directors:
$43,500 annual retainer;
$2,000 committee meeting fee;
$5,000 committee chairman retainer;
$10,000 audit committee chairman retainer;
$10,000 Lead Director retainer; and
$64,000 in common stock equivalents granted under the Directors' Deferred
Compensation Plan.
The employee directors receive no additional compensation for serving on the
Board or its committees.
The board of directors has adopted Directors' Deferred Compensation Plans (pre
2005 and post 2005 plans) to directly align the non-employee directors'
financial interest with those of the shareholders. The Directors' Deferred
Compensation Plans provide all non-employee directors with the opportunity to
defer any portion of their cash compensation received as directors, in exchange
for common stock equivalents or into a deferred cash account. Common stock
equivalents are valued by utilizing the average of the high and low price per
share of our common stock on the first trading day of the quarter following the
quarter in which contributions are received. Dividends are paid on common stock
equivalents in additional common stock equivalents in the same proportion as
dividends paid on common stock. Compensation not deferred and exchanged for
common stock equivalents may be deferred into a cash account bearing interest at
the prime rate. Additionally, a director may elect to invest his or her
compensation by participating in the KeySpan Investor Program (a dividend
reinvestment plan). Upon retirement, death or termination of service as a
director, all amounts in a director's common stock equivalent account and/or
cash account shall, at the director's election, (i) be paid in a lump sum in
cash; (ii) be deferred for up to five years; and/or (iii) be paid in the number
of annual installments, up to ten, specified by the director. Our current
non-employee directors are not entitled to benefits under any of our retirement
plan.
With the exception of Ms. Christensen, each listed director elected to defer a
portion or all of his or her cash earnings for 2006 into stock equivalents under
the Directors' Deferred Compensation Plans. No director elected to defer any
compensation into the deferred cash account under the Directors' Deferred
Compensation Plans.
Compensation Committee Interlocks and Insider Participation
Neither Ms. Larson nor Messrs. Jones, Larocca, McKessy and Miller, the current
members of the Committee, is an officer or employee, or former officer or
employee, of us or any of our subsidiaries. No interlocking relationship exists
between the members of our Board of Directors or the Committee and the
compensation committee, or board committee performing equivalent functions, of
any other company, nor has any such interlocking relationship existed in the
past.
222
Compensation Committee Report
Under the rules of the New York Stock Exchange and the Sarbanes-Oxley Act of
2002, the Board of Directors must determine that each member of the Committee is
independent under all applicable standards. Additionally, no director may serve
unless he or she is a "Non-employee Director" for purposes of Rule 16b-3 under
the Securities Exchange Act of 1934, as amended, and satisfies the requirements
of an "outside director" for purposes of Section 162 (m) of the Internal Revenue
Code. The members of the Committee are James R. Jones, James L. Larocca, Gloria
C. Larson, Stephen W. McKessy and Edward D. Miller serving as chairperson. None
of such members is or has been an officer or employee of KeySpan or any of its
subsidiaries and they meet the required standards of independence. The Committee
operates under a written charter adopted by the Board of Directors which is
available on our internet site at http://www.keyspanenergy.com.
The Committee has reviewed and discussed the Company's Compensation Discussion
and Analysis with management at meetings held on December 24, 2006, January 24,
2007 and February 20, 2007. Based on the review and discussions, the Committee
recommended to the Board of Directors that the Compensation Discussion and
Analysis be included in our annual report on Form 10-K.
Compensation and Management Development Committee
James R. Jones Stephen W. McKessy
James L. Larocca Edward D. Miller, Chairperson
Gloria C. Larson
223
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
Security Ownership of Certain Beneficial Owners
As of February 20, 2007, there were no beneficial owners of more than 5% of our
common stock.
Security Ownership of Management
The following table sets forth information as of February 20, 2007, with respect
to the number of shares of common stock beneficially owned (including vested
stock options), common stock equivalents and/or deferred stock units and
performance shares credited to each director, each named executive officer and
all directors and executive officers as a group.
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
Name of Amount and Nature of Common Stock Equivalents or Performance Percent of
Beneficial Owner Beneficial Ownership of Deferred Stock Units(2) Shares(3) Outstanding Common
Common Stock (including Stock((4))
Vested Stock Options)(1)
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
Named R. B. Catell* 2,358,448 89,151 80,700 1.4%
Executive
Officers
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
G. Luterman 302,737 17,146 25,460 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
R. J. Fani* 449,103 33,409 55,230 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
W. P. Parker Jr. 470,269 33,649 35,720 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
S. L. Zelkowitz 297,249 29,269 38,890 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
Directors A. S. Christensen 8,871 19,345 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
A. H. Fishman 13,061 27,584 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
J. R. Jones 11,227 15,829 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
J. L. Larocca 14,573 17,037 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
G. C. Larson 556 10,505 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
S. W. McKessy 10,615 23,579 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
E. D. Miller 21,318 34,318 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
V. L. Pryor 0 8,088 0 **
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
All directors and 5,490,385(4)(5)(6) 479,917 420,070 3.6%
executives as a group,
including those named
above, a total of 28
persons.
- ----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
* Messrs. Catell and Fani are also directors
** Less than 1%.
(1) Beneficial ownership of common stock includes holdings in KeySpan's 401(k)
Plan, Employee Discount Stock Purchase Plan, Dividend Reinvestment Plan,
and/or in other stock accounts, as well as issued and outstanding vested
stock options. Such stock options give the holder the right to purchase
underlying shares of common stock at the respective exercise price per
share of the option. All such stock options were granted at an exercise
price equal to the closing price of our common stock on the respective date
of grant.
224
(2) Includes common stock equivalents or deferred stock units. The term "common
stock equivalents" refers to units of value which track the performance of
common stock. Such units do not possess voting rights and have been issued
pursuant to the Directors' Deferred Compensation Plans. The term "deferred
stock units" also refers to units of value which track the performance of
common stock. Such units do not possess voting rights and have been issued
pursuant to the Officers' Deferred Stock Unit Plans.
(3) Performance shares have been granted with a three-year performance period
with a threshold, target and maximum performance level. At threshold
performance, 50% of the award shall be earned; at target, 100% of the award
shall be earned; and at maximum, 150% of the award shall be earned. The
number of shares set forth above assumes the target level of performance
with a 100% payout.
(4) Calculated as the total of the three previous columns divided by
175,588,130 the number of shares outstanding on February 20, 2007.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, and
DIRECTOR INDEPENDENCE
Please see Item 11. Executive Compensation for a description of our employment
and change of control agreements and plans.
Directors and Officers Liability Insurance and Indemnity
We have director and officer, or "D&O" liability insurance for the purpose of
reimbursing us when we have indemnified our directors and officers. D&O
liability insurance also provides direct payment to our directors and officers
under certain circumstances when we have not previously provided
indemnification. We also have liability insurance which provides fiduciary
coverage for us, our directors, officers and employees for any alleged breach of
fiduciary duty under the Employee Retirement Income Security Act. Our D&O
liability insurance was purchased from Associated Electric & Gas Insurance
Services, Energy Insurance Mutual, Zurich American, Hartford, Starr Excess, St.
Paul Mercury Insurance Co. and Liberty Mutual for a one year period commencing
on May 28, 2006 at a cost of $3,483,325. Fiduciary liability insurance from the
American International Group, CHUBB, Zurich American and Energy Insurance Mutual
for a one year period commencing on August 26, 2006 at a cost of $733,207. We
plan to renew both programs upon expiration.
Director Independence
Pursuant to our Corporate Governance Guidelines, which can be found on the
Investor Relations section of our website at http://www.keyspanenergy.com or
directly on our corporate governance website
(http://governance.keyspanenergy.com), our board undertook a review of director
independence. As a result of this review, our board affirmatively determined
that all of the directors are independent under the standards set forth in the
Corporate Governance Guidelines, and the relevant NYSE and SEC rules and
regulations, with the exception of Robert B. Catell and Robert J. Fani. Mr.
Catell cannot be deemed independent under the Corporate Governance Guidelines or
applicable rules and regulations because he serves as Chief Executive Officer of
the Corporation. Mr. Fani cannot be deemed independent under the Corporate
Governance Guidelines or applicable rules and regulations because he serves as
Chief Operating Officer and President of the Corporation.
225
The basis for our board's determination that the independent directors are
indeed independent is set forth in our Corporate Governance Guidelines and is
set forth, in relevant part, below:
At all times, a majority of the directors shall be independent directors
under the rules of the NYSE and the Sarbanes-Oxley Act of 2002 and the
regulations promulgated thereunder. The following guidelines are
established to assist our board in determining the independence of a
director:
a. A director will not be considered independent if, within the preceding
three years: (i) the director was employed by KeySpan or one of its
subsidiaries; (ii) an immediate family member of the director was
employed by KeySpan as an officer; (iii) the director received more
than $100,000 in direct compensation from KeySpan or its subsidiaries,
other than for board service or pension or deferred compensation; (vi)
an immediate family member of the director received more than $100,000
in direct compensation from KeySpan or its subsidiaries, other than
for Board service or pension or deferred compensation; (v) the
director was employed by or affiliated with KeySpan's independent
auditor; (vi) an immediate family member of the director was employed
by KeySpan's independent auditor; (vii) the director was employed as
an executive officer of another company where any of KeySpan's
officers serve on that company's compensation committee; or (viii) an
immediate family member of the director was employed as an executive
officer of another company where any of KeySpan's officers serve on
that company's compensation committee;
b. A director will not be considered independent if: (i) the director or
an immediate family member of the director currently serves as an
executive officer of another company that does business with KeySpan
and the annual sales to, or purchases from, KeySpan in any of the
preceding three years, exceeds the greater of $1 million or two
percent of the annual consolidated gross revenues of the company; (ii)
the director is an executive officer of another company which is
indebted to KeySpan, or to which KeySpan is indebted, and the total
amount of either company's indebtedness to the other is greater than
one percent of the total consolidated assets of the company he or she
serves as an executive officer; and (iii) if a director serves as an
officer, director or trustee of a tax exempt organization, and
KeySpan's charitable contributions to the organization are greater
than $1 million or two percent of that organization's total
consolidated gross revenues. The Board will annually review all
commercial and charitable relationships of the directors.
For relationships not covered by the guidelines in subsection (b) above,
the determination of whether the relationship is material or not, and
therefore whether the director would be independent or not, shall be made
by the directors who satisfy the independence guidelines set forth in
subsections (a) and (b) above. For example, if a director is the chief
executive officer of a company that purchases products and services from
KeySpan that are not more than two percent of that company's annual
revenues, the independent directors could determine, after considering all
of the relevant circumstances, whether such a relationship was material or
immaterial, and whether the director would therefore be considered
independent.
226
KeySpan will not make any personal loans or extensions of credit to
directors or officers.
Our directors complete and submit an annual director questionnaire to identify
and assess relationships so that the entire Board can determine independence
under these standards. The directors also complete and submit an annual
statement that they are in compliance with our Corporate Policy Statement
Concerning Ethical Business Conduct and our Corporate Policy Statement
Concerning Affiliate Transactions. The directors also annually certify that they
have, and continue to agree to comply with, the KeySpan Corporation Board Of
Directors Code of Ethics which sets forth standards of diligence, loyalty, good
faith and the avoidance of conflicts of interests for the directors.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table provides information on the aggregate fees for services
performed by Deloitte & Touche LLP ("Deloitte & Touche"), the member firms of
Deloitte & Touche Tohmatsu, and their respective affiliates for the years ended
December 31, 2006 and December 31, 2005:
2006 2005
---- ----
Audit Fees (a) $ 4,164,594 $ 3,682,325
Audit-Related Fees (b) 96,200 88,000
Tax Fees (c) 318,419 385,522
All Other Fees (d) 132,010 50,121
------------ ---------------
Total $ 4,711,223 $ 4,205,968
(a) In 2006, audit fees include base fees for the annual and statutory
financial statement audits, audit of internal control over financial
reporting, and quarterly reviews of $3,509,100 and fees for
consultations on financial accounting standards as part of the audit
of $655,494. In 2005, audit fees include base fees for the annual and
statutory financial statement audits, audit of internal control over
financial reporting, and quarterly reviews of $3,212,089; $185,498 for
fees related to financings and fees for consultations on financial
accounting standards as part of the audit of $284,738.
(b) Audit-related fees include benefit plan audits.
(c) Fees for tax services billed in 2006 and 2005 consisted of tax
compliance, tax consultation services and software licensing. Fees for
tax compliance services totaled $192,928 and $313,738 in 2006 and
2005, respectively. Tax compliance services include services such as
assistance with federal, state and local income tax returns. Fees for
tax consultation services and software licensing totaled $125,491 and
$71,784 in 2006 and 2005, respectively.
(d) Other fees include training.
In accordance with the Audit Committee Charter and the rules and regulations of
the SEC, the Audit Committee reviews the scope of the audit and approves the
nature and cost of all services provided by Deloitte & Touche. The Audit
Committee has reviewed the nature and scope of the services provided by Deloitte
& Touche and considers such to have been compatible with the maintenance of
Deloitte & Touche's independence throughout its service to KeySpan.
227
The Audit Committee has also determined that the scope of services to be
provided by Deloitte & Touche in 2007 will generally be limited to audit and
audit related services and tax services. The Audit Committee will expressly
approve the provision of any services by Deloitte & Touche outside the scope of
the foregoing services. Although it is the intent of the Audit Committee to
pre-approve all non-audit services to be provided by Deloitte & Touche, any
inadvertent failure to do so will not be deemed a breach of the Audit Committee
charter if: (i) the aggregate amount of all such non-audit services provided to
the Corporation constitutes not more than five percent of the total amount of
revenues paid by the Corporation to its auditor during the fiscal year in which
the non-audit services are provided; (ii) such services were not recognized by
the Corporation at the time of the engagement to be non-audit services; and
(iii) such services are promptly brought to the attention of the Committee and
approved prior to the completion of the audit by the Committee or its Chairman
pursuant to delegated authority.
228
PART IV
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ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Required Documents
1. Financial Statements
The following consolidated financial statements of KeySpan and its subsidiaries
and Reports of the Independent Registered Public Accounting Firm are included in
Item 8 and are filed as part of this Report:
o Consolidated Statement of Income for the year ended December 31, 2006,
the year ended December 31, 2005, and the year ended December 31, 2004
o Consolidated Statement of Retained Earnings for the year ended
December 31, 2006, the year ended December 31, 2005, and the year
ended December 31, 2004
o Consolidated Balance Sheet at December 31, 2006 and December 31, 2005
o Consolidated Statement of Capitalization at December 31, 2006 and
December 31, 2005
o Consolidated Statement of Cash Flows for the year ended December 31,
2006, the year ended December 31, 2005, and the year ended December
31, 2004
o Consolidated Statement of Comprehensive Income for the Year ended
December 31, 2006, the year ended December 31, 2005 and the year ended
December 31, 2004
o Notes to Consolidated Financial Statements
o Report of the Independent Registered Public Accounting Firm
2. Financial Statement Schedules
Consolidated Schedule of Valuation and Qualifying Accounts for the year ended
December 31, 2006, the year ended December 31, 2005, and the year ended December
31, 2004.
229
Schedule of Valuation and Qualifying Accounts
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at Charged to Balance at
Beginning of costs and Net End of
Descriptions Period expenses Deductions Period
- ------------------------------------------------------------------------------------------------------------------------------------
Twelve Months Ended December 31, 2006
- -------------------------------------
Deducted from asset accounts:
Allowance for doubtful accounts $ 62,827 $ 76,919 $ 82,831 $ 56,915
Additions to liability accounts:
Reserve for injury and damages $ 9,300 $ - $ 211 $ 9,089
Reserve for environmental expenditures $ 423,666 $ - $ 51,229 $ 372,437
Twelve Months Ended December 31, 2005
- -------------------------------------
Deducted from asset accounts:
Allowance for doubtful accounts $ 67,796 $ 96,818 $ 101,787 $ 62,827
Additions to liability accounts:
Reserve for injury and damages $ 9,370 $ 500 $ 570 $ 9,300
Reserve for environmental expenditures $ 256,789 $ 210,596 $ 43,719 $ 423,666
Twelve Months Ended December 31, 2004
- -------------------------------------
Deducted from asset accounts:
Allowance for doubtful accounts $ 75,671 $ 74,089 $ 81,964 $ 67,796
Additions to liability accounts:
Reserve for injury and damages $ 9,370 $ - $ - $ 9,370
Reserve for environmental expenditures $ 294,691 $ - $ 37,902 $ 256,789
- ------------------------------------------------------------------------------------------------------------------------------------
* Reflects adjustment for discontinued operations.
All other schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
(b) Exhibits
Exhibits listed below which have been filed with the SEC pursuant to the
Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as
amended, and which were filed as noted below, are hereby incorporated by
reference and made a part of this report with the same effect as if filed
herewith.
2.1 Agreement and Plan of Merger, dated as of February 25, 2006, by and
among National Grid plc, National Grid US8 Inc. and KeySpan
Corporation (filed as Exhibit 2.1 to KeySpan's Form 8-K dated March 1,
2006)
3.1 Certificate of Incorporation of KeySpan effective April 16, 1998,
Amendment to Certificate of Incorporation of KeySpan effective May 26,
1998, Amendment to Certificate of Incorporation of KeySpan effective
June 1, 1998, Amendment to the Certificate of Incorporation of KeySpan
effective April 7, 1999 and Amendment to the Certificate of
Incorporation of KeySpan effective May 20, 1999 (filed as Exhibit 3.1
to KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)
230
3.2 By-Laws of KeySpan in effect as of June 25, 2003, as amended (filed as
Exhibit 3.1 to KeySpan's Form 10-Q for the quarterly period ended June
30, 2003)
4.1 Credit Agreement dated as of June 24, 2005 among KeySpan Corporation,
the several lenders, The Royal Bank of Scotland PLC and Citibank,
N.A., as Co-Syndication Agents, The Bank of New York and The Bank of
Nova Scotia, as Co-Documentation Agents, and JPMorgan Chase Bank,
N.A., as Administrative Agent (filed as Exhibit 4.1 to KeySpan's Form
8-K dated as of June 29, 2005)
4.2 Amended and Restated Credit Agreement dated as of June 24, 2005 among
KeySpan Corporation, the several lenders, The Royal Bank of Scotland
PLC and Citibank, N.A., as Co-Syndication Agents, The Bank of New York
and The Bank of Nova Scotia, as Co-Documentation Agents, and JPMorgan
Chase Bank, N.A., as Administrative Agent (filed as Exhibit 4.2 to
KeySpan's Form 8-K dated as of June 29, 2005)
4.3 Indenture, dated as of November 1, 2000, between KeySpan Corporation
and the Chase Manhattan Bank, as Trustee, with respect to the issuance
of Debt Securities (filed as Exhibit 4-a to Amendment No. 1 to Form
S-3 Registration Statement No. 333-43768 and filed as Exhibit 4-a to
KeySpan's Form 8-K on November 20, 2000)
4.4 Form of Note issued in connection with the issuance of the KeySpan
Corporation $700 million of 7.625% Notes due 2010 issued on November
20, 2000 (filed as Exhibit 4-c to KeySpan's Form 8-K on November 20,
2000)
4.5 Form of Note issued in connection with the issuance of the KeySpan
Corporation $250 million of 8.0% Notes due 2030 issued on November 20,
2000 (filed as Exhibit 4-d to KeySpan's Form 8-K on November 20, 2000)
4.6 Form of Note issued in connection with the issuance of the KeySpan
Corporation $150 million of 4.65% Notes issued on April 1, 2003 (filed
as Exhibit 4.1 to KeySpan's Form 8-K dated as of April 8, 2003)
4.7 Form of Note issued in connection with the issuance of the KeySpan
Corporation $150 million of 5.875% Notes issued on April 1, 2003
(filed as Exhibit 4.2 to KeySpan's Form 8-K dated as of April 8, 2003)
4.8 Form of Note issued in connection with the issuance of the KeySpan
Corporation $307.2 million of 5.803% Notes issued on March 29, 2005
(filed as Exhibit 4.1 to KeySpan's Form 8-K dated as of March 31,
2005)
231
4.9 Supplemental Remarketing Agreement dated as of March 21, 2005 among
KeySpan Corporation, J.P. Morgan Securities Inc. and JPMorgan Chase
Bank, N.A. in connection with the remarketing of the 4.9% Notes due
2008 (filed as Exhibit 99.1 to KeySpan's Form 8-K dated as of March
24, 2005)
4.10 Indenture, dated December 1, 1999, between KeySpan and KeySpan Gas
East Corporation, the Registrants, and the Chase Manhattan Bank, as
Trustee, with respect to the issuance of Medium-Term Notes, Series A,
(filed as Exhibit 4-a to Amendment No. 1 to KeySpan's and KeySpan Gas
East Corporation's Form S-3 Registration Statement No. 333-92003)
4.11 Form of Medium-Term Note issued in connection with the issuance of
KeySpan Gas East Corporation 7 7/8% Notes issued on February 1, 2000
(filed as Exhibit 4 to KeySpan's Form 8-K on February 1, 2000)
4.12 Form of Medium-Term Note issued in connection with the issuance of
KeySpan Gas East Corporation 6.9% Notes issued on January 19, 2001
(filed as Exhibit 4.3 to KeySpan's Form 10-K for the year ended
December 31, 2000)
4.13 Participation Agreement, dated as of July 1, 1991, between New York
State Energy Research and Development Authority ("NYSERDA") and The
Brooklyn Union Gas Company relating to the Gas Facilities Revenue
Bonds ("GFRBs") Series 1991A and 1991B (The Brooklyn Union Gas Company
Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form
10-K for the year ended September 30, 1991)
4.14 Indenture of Trust, dated as of July 1, 1991, between NYSERDA and
Manufacturers Hanover Trust Company, as Trustee, relating to the GFRBs
Series 1991A and 1991B (The Brooklyn Union Gas Company Project) (filed
as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the
year ended September 30, 1991)
4.15 Participation Agreement, dated as of July 1, 1992, between NYSERDA and
The Brooklyn Union Gas Company relating to the GFRBs Series 1993A and
1993B (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to
The Brooklyn Union Gas Company's Form 10-K for the year ended
September 30, 1992)
4.16 Indenture of Trust, dated as of July 1, 1992, between NYSERDA and
Chemical Bank, as Trustee, relating to the GFRBs Series 1993A and
1993B (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to
The Brooklyn Union Gas Company Form 10-K for the year ended September
30, 1992)
4.17 Participation Agreement dated as of July 1, 1991 between NYSERDA and
The Brooklyn Union Gas Company relating to the GFRBs Series D (The
Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The
Brooklyn Union Gas Company's Form 10-K for the year ended September
30, 1991)
232
4.18 First Supplemental Participation Agreement dated as of June 1, 1993
between NYSERDA and The Brooklyn Union Gas Company relating to GFRBs
Series D (The Brooklyn Union Gas Company Project) (filed as Exhibit 4
to The Brooklyn Union Gas Company's Form 10-K for the year ended
September 30, 1993)
4.19 Trust Indenture, dated as of July 1, 1991 between NYSERDA and
Manufacturers Hanover Trust Company relating to the GFRBs Series D
(filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for
the year ended September 30, 1991)
4.20 First Supplemental Trust Indenture, dated as of June 1, 1993 between
NYSERDA and Chemical Bank (as successor to Manufacturers Hanover Trust
Company) relating to the GFRBs Series D (filed as Exhibit 4 to The
Brooklyn Union Gas Company's Form 10-K for the year ended September
30, 1993)
4.21 Participation Agreement, dated January 1, 1996, between NYSERDA and
The Brooklyn Union Gas Company relating to GFRBs Series 1996 (The
Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The
Brooklyn Union Gas Company's Form 10-K for the year ended September
30, 1996)
4.22 Indenture of Trust, dated January 1, 1996, between NYSERDA and
Chemical Bank, as Trustee, relating to GFRBs Series 1996 (The Brooklyn
Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union
Gas Company's Form 10-K for the year ended September 30, 1996)
4.23 Participation Agreement, dated as of January 1, 1997, between NYSERDA
and The Brooklyn Union Gas Company relating to GFRBs 1997 Series A
(The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The
Brooklyn Union Gas Company's Form 10-K for the year ended September
30, 1997)
4.24 Indenture of Trust, dated January 1, 1997, between NYSERDA and Chase
Manhattan Bank, as Trustee, relating to GFRBs 1997 Series A (The
Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The
Brooklyn Union Gas Company's Form 10-K for the year ended September
30, 1997)
4.25 Supplemental Trust Indenture, dated as of January 1, 2000, by and
between NYSERDA and The Chase Manhattan Bank, as Trustee, relating to
the GFRBs 1997 Series A (The Brooklyn Union Gas Company Project)
(filed as Exhibit 4.11 to KeySpan's Form 10-K for the year ended
December 31, 1999)
4.26 Bond Purchase Agreement, dated as of October 26, 2005, among The
Brooklyn Union Gas Company and NYSERDA and Morgan Stanley & Co.
Incorporated, BNY Capital Markets, Inc., Sovereign Securities
Corporation, LLC and The Williams Capital Group, L.P., as Series A
Underwriters, for the issuance of $82 million aggregate principal
amount of 4.7% GFRBs, 2005, Series A. (The Brooklyn Union Gas Company
Project) (filed as Exhibit 10.1 to KeySpan's Form 8-K dated November
1, 2005)
233
4.27 Indenture of Trust, dated as of November 1, 2005, between NYSERDA and
Citibank, N.A., as Trustee, relating to the issuance of $82 million
GFRBs, 2005 Series A, 4.7% due February 2024 (The Brooklyn Union Gas
Company Project) (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the
quarterly period ended September 30, 2005)
4.28 Participation Agreement, dated as of November 1, 2005, between NYSERDA
and The Brooklyn Union Gas Company relating to the issuance of $82
million GFRBs, 2005 Series A, 4.7% due February 2024 (filed as Exhibit
10.2 to KeySpan's Form 10-Q for the quarterly period ended September
30, 2005)
4.29 Promissory Note, dated as of November 1, 2005, executed by the
Brooklyn Union Gas Company for issuance of $82 million GFRBs, 2005
Series A, 4.7% due February 2024 (filed as Exhibit 10.3 to KeySpan's
Form 10-Q for the quarterly period ended September 30, 2005)
4.30 Bond Purchase Agreement, dated as of October 26, 2005, among The
Brooklyn Union Gas Company and NYSERDA and Goldman Sachs & Co., BNY
Capital Markets, Inc., Sovereign Securities Corporation, LLC and The
Williams Capital Group, L.P., as Series A Underwriters, for the
issuance of $55 million aggregate principal amount of GFRBs, 2005,
Series B (filed as Exhibit 10.2 to KeySpan's Form 8-K dated November
1, 2005)
4.31 Indenture of Trust, dated as of November 1, 2005, between NYSERDA and
Citibank, N.A., as Trustee, relating to the issuance of $55 million
GFRBs, 2005 Series B due June 2025 (filed as Exhibit 10.4 to KeySpan's
Form 10-Q for the quarterly period ended September 30, 2005)
4.32 Participation Agreement, dated as of November 1, 2005, between NYSERDA
and The Brooklyn Union Gas Company relating to the issuance of $55
million GFRBs, 2005 Series B, due February 2025 (filed as Exhibit 10.5
to KeySpan's Form 10-Q for the quarterly period ended September 30,
2005)
4.33 Promissory Note, dated as of November 1, 2005, executed by the
Brooklyn Union Gas Company for the issuance of $55 million GFRBs, 2005
Series B, due June 2025 (filed as Exhibit 10.6 to KeySpan's Form 10-Q
for the quarterly period ended September 30, 2005)
4.34 Letter of Credit and Reimbursement Agreement, dated December 9, 2003,
by and between KeySpan Generation LLC and Royal Bank of Scotland Bank
PLC (filed as Exhibit 4.34 to KeySpan's Form 10-K for the year ended
December 31, 2003)
234
4.35 Participation Agreement dated as of December 1, 1997 by and between
NYSERDA and Long Island Lighting Company relating to the 1997 Electric
Facilities Revenue Bonds ("EFRBs"), Series A (KeySpan Generation LLC)
(filed as Exhibit 10(a) to KeySpan's Form 10-Q for the quarterly
period ended September 30, 1998)
4.36 Indenture of Trust, dated as of December 1, 1997, by and between
NYSERDA and The Chase Manhattan Bank, as Trustee, relating to the 1997
EFRBs, Series A (KeySpan Generation LLC) (filed as Exhibit 10(a) to
KeySpan's Form 10-Q for the quarterly period ended September 30, 1998)
4.37 Participation Agreement, dated as of October 1, 1999, by and between
NYSERDA and KeySpan Generation LLC relating to the 1999 Pollution
Control Refunding Revenue Bonds ("PCRB's"), Series A (filed as Exhibit
4.10 to KeySpan's Form 10-K for the year ended December 31, 1999)
4.38 Trust Indenture, dated as of October 1, 1999, by and between NYSERDA
and The Chase Manhattan Bank, as Trustee, relating to the 1999 PCRBs,
Series A (filed as Exhibit 4.10 to KeySpan's Form 10-K for the year
ended December 31, 1999)
4.39 Indenture, dated as of December 1, 1989, between Boston Gas Company
and The Bank of New York, as Trustee (filed as Exhibit 4.2 to Boston
Gas Company's Form S-3 (File No. 33-31869))
4.40 Second Amended and Restated First Mortgage Indenture for Colonial Gas
Company, dated as of June 1, 1992 (filed as Exhibit 4(b) to Colonial
Gas Company's Form 10-Q for the quarter ended June 30, 1992)
4.41 First Supplemental Indenture for Colonial Gas Company dated as of June
15, 1992 (filed as Exhibit 4(c) to Colonial Gas Company's Form 10-Q
for the quarter ended June 30, 1992)
4.42 Second Supplemental Indenture for Colonial Gas Company dated as of
September 27, 1995 (filed as Exhibit 4(c) to Colonial Gas Company's
Form 10-K for the fiscal year ended December 31, 1995)
4.43 Amendment to Second Supplemental Indenture for Colonial Gas Company
dated as of October 12, 1995 (filed as Exhibit 4(d) to Colonial Gas
Company's Form 10-K for the fiscal year ended December 31, 1995)
4.44 Third Supplemental Indenture for Colonial Gas Company dated as of
December 15, 1995 (filed as Exhibit 4(f) to Colonial Gas Company's
Form S-3 Registration Statement dated January 5, 1998)
235
4.45 Fourth Supplemental Indenture for Colonial Gas Company dated as of
March 1, 1998 (filed as Exhibit 4(l) to Colonial Gas Company's Form
10-Q for the quarter ended March 31, 1998)
4.46 Trust Agreement, dated as of June 22, 1990, between Colonial Gas
Company, as Trustor, and Shawmut Bank, N.A., as Trustee (filed as
Exhibit 10(d) to Colonial Gas Company's Form 10-Q for the quarterly
period ended June 30, 1990)
4.47 Lease Agreement, dated as of November 1, 2003, by and between the
Suffolk County Industrial Development Agency and KeySpan-Port
Jefferson Energy Center, LLC (filed as Exhibit 4.14-a to KeySpan's
Form 10-K for the year ended December 31, 2003)
4.48 Company Lease Agreement, dated as of November 1, 2003, by and between
KeySpan-Port Jefferson Energy Center, LLC and the Suffolk County
Industrial Development Agency (filed as Exhibit 4.14-b to KeySpan's
Form 10-K for the year ended December 31, 2003)
4.49 Guaranty, dated as of November 26, 2003, from KeySpan Corporation to
the Suffolk County Industrial Development Agency (filed as Exhibit
4.14-c to KeySpan's Form 10-K for the year ended December 31, 2003)
4.50 Lease Agreement, dated as of November 1, 2003, by and between the
Nassau County Industrial Development Agency and KeySpan-Glenwood
Energy Center, LLC (filed as Exhibit 4.15-a to KeySpan's Form 10-K for
the year ended December 31, 2003)
4.51 Company Lease Agreement, dated as of November 1, 2003, by and between
KeySpan-Glenwood Energy Center, LLC and the Nassau County Industrial
Development Agency (filed as Exhibit 4.15-b to KeySpan's Form 10-K for
the year ended December 31, 2003)
4.52 Guaranty, dated as of November 26, 2003, from KeySpan Corporation to
the Nassau County Industrial Development Agency (filed as Exhibit
4.14-c to KeySpan's Form 10-K for the year ended December 31, 2003)
4.53 Lease Agreement, dated June 9, 1999, between KeySpan-Ravenswood, LLC
and LIC Funding, Limited Partnership (filed as Exhibit 10.2 to
KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)
4.54 First Amendment to the Lease Agreement between KeySpan-Ravenswood, LLC
and LIC Funding, Limited Partnership, dated as of June 27, 2002 (filed
as Exhibit 10.25 to KeySpan's Form 10-K for the year ended December
31, 2002)
236
4.55 KeySpan Corporation Guaranty dated June 9, 1999, from KeySpan in favor
of LIC Funding, Limited Partnership (filed as Exhibit 10.1 to
KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)
4.56 KeySpan Corporation Guaranty dated May 25, 2004, relating to the 250
MW Ravenswood Expansion (filed as Exhibit 10.1 to KeySpan's Form 10-Q
for the quarterly period ended June 30, 2004)
4.57 Facility Lease Agreement, dated as of May 25, 2004, between SE
Ravenswood Trust, a Delaware statutory trust, and KeySpan-Ravenswood,
LLC relating to the 250 MW Ravenswood Expansion(filed as Exhibit 10.2
to KeySpan's Form 10-Q for the quarterly period ended June 30, 2004)
4.58 Site Lease and Easement Agreement, dated as of May 25, 2004, between
KeySpan-Ravenswood, LLC and SE Ravenswood Trust relating to the 250 MW
Ravenswood Expansion (filed as Exhibit 10.3 to KeySpan's Form 10-Q for
the quarterly period ended June 30, 2004)
4.59 Site Sublease, dated as of May 25, 2004, between SE Ravenswood Trust
and KeySpan-Ravenswood, LLC relating to the 250 MW Ravenswood
Expansion (filed as Exhibit 10.4 to KeySpan's Form 10-Q for the
quarterly period ended June 30, 2004)
4.60 Amendment, Assignment and Assumption Agreement, dated as of September
29, 1997, by and among The Brooklyn Union Gas Company, Long Island
Lighting Company and KeySpan Energy Corporation (filed as Exhibit 2.5
to Schedule 13D by Long Island Lighting Company on October 24, 1997)
10.1 Agreement and Plan of Merger, dated as of June 26, 1997, by and among
BL Holding Corp., Long Island Lighting Company, Long Island Power
Authority and LIPA Acquisition Corp. (filed as Annex D to the Joint
Registration Statement on Form S-4 of The Brooklyn Union Gas Company
and Long Island Lighting Company, Registration No. 333-30353 on June
30, 1997)
10.2 Management Services Agreement between Long Island Power Authority and
Long Island Lighting Company dated as of June 26, 1997 (filed as Annex
D to the Joint Registration Statement on Form S-4 of The Brooklyn
Union Gas Company and Long Island Lighting Company, Registration No.
333-30353 on June 30, 1997)
10.3 Amendment, dated as of March 29, 2002, to Management Services
Agreement between Long Island Lighting Company d/b/a LIPA and KeySpan
Electric Services LLC dated as of June 26, 1997 (filed as Exhibit
10.4-b to KeySpan's Form 10-K for the year ended December 31, 2002)
237
10.4 Amended and Restated Management Services Agreement dated as of January
1, 2006 between the Long Island Lighting Company ("LILCO") d/b/a LIPA
and KeySpan Electric Services LLC (filed as Exhibit 10.1 to KeySpan's
Form 8-K filed on February 7, 2006)
10.5 Power Supply Agreement between Long Island Lighting Company and Long
Island Power Authority dated as of June 26, 1997 (filed as Annex D to
the Joint Registration Statement on Form S-4 of The Brooklyn Union Gas
Company and Long Island Lighting Company, Registration No. 333-30353
on June 30, 1997)
10.6 Energy Management Agreement between Long Island Lighting Company and
Long Island Power Authority dated as of June 26, 1997 (filed as Annex
D to Registration Statement on Form S-4, No. 333-30353, on June 30,
1997)
10.7 Amendment, dated as of March 29, 2002, to Energy Management Agreement
between Long Island Lighting Company d/b/a LIPA and KeySpan Energy
Trading Services LLC dated as of June 26, 1997 (filed as Exhibit
10.6-b to KeySpan's Form 10-K for the year ended December 31, 2002)
10.8 Generation Purchase Rights Agreement between Long Island Lighting
Company and Long Island Power Authority dated as of June 26, 1997
(filed as Exhibit 10.17 to KeySpan's Form 10-K for the year ended
December 31, 2001)
10.9 Amendment, dated as of March 29, 2002, to Generation Purchase Rights
Agreement by and between KeySpan Corporation, as Seller, and Long
Island Lighting Company d/b/a LIPA, as Buyer, dated as of June 26,
1997 (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly
period ended March 31, 2002)
10.10 Generation Purchase Right Extension Agreement between KeySpan and the
Long Island Power Authority dated as of March 28, 2005 (filed as
Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period ended
March 31, 2005)
10.11 Option and Purchase and Sale Agreement dated as of January 1, 2006 by
and between LILCO d/b/a LIPA and KeySpan Electric Services LLC (filed
as Exhibit 10.2 to KeySpan's Form 8-K filed on February 7, 2006)
10.12 Letter Amendment to the Option and Purchase and Sale Agreement between
KeySpan Generation LLC and Long Island Lighting Company d/b/a LIPA,
dated as of December 11, 2006 (filed as Exhibit 10.1 to KeySpan's Form
8-K dated December 19, 2006)
10.13 Settlement Agreement and Release dated as of January 1, 2006 by and
among KeySpan, KeySpan Generation LLC, KeySpan Electric Services LLC,
KeySpan Energy Trading Services LLC and LIPA (filed as Exhibit 10.3 to
KeySpan's Form 8-K filed on February 7, 2006)
238
10.14 Agreement of Lease between Forest City Jay Street Associates and The
Brooklyn Union Gas Company dated September 15, 1988 (filed as an
Exhibit to The Brooklyn Union Gas Company's Form 10-K for the year
ended September 30, 1996)
10.15 Second Amendment, dated as of March 24, 2005, to the Lease Agreement
dated as of September 15, 1998 between The Brooklyn Union Gas Company
and Forest City Jay Street Associates, L.P. (filed as Exhibit 10 to
KeySpan's Form 8-K dated as of March 30, 2005)
10.16 ISDA Master Agreement, dated as of January 18, 2006, between KeySpan
Corporation and Morgan Stanley Capital Group Inc. (filed as Exhibit
10.1 to KeySpan's Form 8-K dated January 24, 2006)
10.17 Restated Exploration Agreement between The Houston Exploration Company
and KeySpan Exploration and Production, L.L.C. dated June 30, 2000
(filed as Exhibit 10.1 to The Houston Exploration Company's Form 10-Q
for the quarter ended September 30, 2000, File No. 001-11899)
10.18 Distribution Agreement, dated June 2, 2004, by and among The Houston
Exploration Company, Seneca-Upshur Petroleum, Inc., THEC Holdings
Corp. and KeySpan Corporation (filed as Exhibit 99.2 to The Houston
Exploration Company's Form 8-K dated as of June 3, 2004)
10.19 Asset Contribution Agreement, dated June 2, 2004, between The Houston
Exploration Company and Seneca-Upshur Petroleum, Inc. (filed as
Exhibit 99.3 to The Houston Exploration Company's Form 8-K dated as of
June 3, 2004)
10.20 Tax Matters Agreement, dated June 2, 2004, by and among The Houston
Exploration Company, Seneca-Upshur Petroleum, Inc., THEC Holdings
Corp. and KeySpan Corporation (filed as Exhibit 99.4 to The Houston
Exploration Company's Form 8-K dated as of June 3, 2004)
10.21 Share Sale and Purchase Agreement dated February 25, 2005 with BG
Energy Holdings Limited and Premier Transmission Financing Public
Limited Company (filed as Exhibit 10.37 to KeySpan's Form 10-K for the
year ended December 31, 2004)
10.22 Purchase Agreement, dated January 28, 2005, among Robert B. Snyder,
Frank J. Sullivan, Robert B. Snyder, Jr., Philip J. Andreoli, William
J. McKean, Binsky & Snyder, LLC, Binsky & Snyder Service, LLC and
KeySpan Business Solutions, LLC (filed as Exhibit 10.35 to KeySpan's
Form 10-K for the year ended December 31, 2004)
239
10.23 Purchase Agreement, dated February 11, 2005, among WDF Holding Corp.,
WDF, Inc. and KeySpan Business Solutions, LLC (filed as Exhibit 10.36
to KeySpan's Form 10-K for the year ended December 31, 2004)
10.24 Note Purchase Agreement, dated as of November 29, 2006, between KEDNY
and certain investors for the issuance of $400 million of Senior
Unsecured Notes, due November 29, 2016 (filed as Exhibit 10.1 to
KeySpan's Form 8-K dated December 5, 2006)
10.25 Note Purchase Agreement, dated as of November 29, 2006, between KEDLI
and certain investors for the issuance of $100 million of Senior
Unsecured Notes, due November 29, 2016 (filed as Exhibit 10.2 to
KeySpan's Form 8-K dated December 5, 2006)
10.26 KEDNY Form of 5.60% Senior Unsecured Note due November 29, 2016 (filed
as Exhibit 10.2 to KeySpan's Form 8-K dated December 5, 2006)
10.27 KEDLI Form of 5.60% Senior Unsecured Note due November 29, 2016 (filed
as Exhibit 10.2 to KeySpan's Form 8-K dated December 5, 2006)
10.28 ISDA Master Agreement between the Company and Morgan Stanley Capital
Group Inc. dated as of January 18, 2006 (filed as Exhibit 10.1 to
KeySpan's Form 8-K dated January 24, 2006)
Compensation Agreements
-----------------------
10.29* Cash Compensation for Non-Management Directors of KeySpan
10.30* Base Salaries of Named Executive Officers of KeySpan in effect as of
February 20, 2007
10.31 Copy of the Amendment to the Employment Agreement dated January 1,
2005 between KeySpan Corporation and Anthony Sartor (filed as Exhibit
10.1 to KeySpan's Form 8-K dated September 8, 2006)
10.32 Agreement and Waiver of Rights and Claims between KeySpan and Lenore
F. Puleo dated as of March 24, 2006 (filed as Exhibit 10.2 to
KeySpan's Form 8-K dated March 30, 2006)
10.33 Letter Agreement between KeySpan and Gerald Luterman dated March 24,
2006 (filed as Exhibit 10.1 to KeySpan's Form 8-K dated March 30,
2006)
10.34 Employment Agreement, dated February 24, 2005, between KeySpan and
Robert B. Catell (filed as Exhibit 10.10 to KeySpan's Form 10-K for
the year ended December 31, 2004)
10.35 Employment Agreement, dated January 1, 2005, between KeySpan and
Anthony Sartor (filed as Exhibit 10.01 to KeySpan's Form 8-K dated as
of January 4, 2005)
10.36 Supplemental Retirement Agreement, dated January 1, 2005, between
KeySpan and Anthony Sartor (filed as Exhibit 10.12 to Company's Form
8-K dated as of January 4, 2005)
240
10.37 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
and Steven L. Zelkowitz (filed as Exhibit 10.12 to KeySpan's Annual
Report on Form 10-K for the year ended December 31, 2002)
10.38 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
and Gerald Luterman (filed as Exhibit 10.11 to KeySpan's Annual Report
on Form 10-K for the year ended December 31, 2002)
10.39 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
and David J. Manning (filed as Exhibit 10.13 to KeySpan's Annual
Report on Form 10-K for the year ended December 31, 2002)
10.40 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
and Elaine Weinstein (filed as Exhibit 10.15 to KeySpan's Annual
Report on Form 10-K for the year ended December 31, 2002)
10.41 Directors' Deferred Compensation Plan effective April 2003 (filed as
Exhibit 10.16 to KeySpan's Annual Report on Form 10-K for the year
ended December 31, 2003)
10.42 Officers' Deferred Stock Unit Plan of KeySpan Corporation (filed as
Exhibit 10.17 to KeySpan's Annual Report on Form 10-K for the year
ended December 31, 2002)
10.43 Officers' Deferred Stock Unit Plan of KeySpan Services, Inc. (filed as
Exhibit 10.18 to KeySpan's Annual Report on Form 10-K for the year
ended December 31, 2002)
10.44 Corporate Annual Incentive Compensation and Gainsharing Plan (filed as
Exhibit 10.20 to KeySpan's Form 10-K for the year ended December 31,
2000)
10.45* Corporate Annual Incentive Compensation Plan Target Performance Award
Level for Fiscal Year 2007
10.46 Senior Executive Change of Control Severance Plan effective as of
October 29, 2003 (filed as Exhibit 10.20 to KeySpan's Form 10-K for
the year ended December 31, 2003)
10.47 KeySpan's Amended Senior Executive Change of Control Severance Plan
(filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period
ended March 31, 2006)
10.48 KeySpan's Amended Long-Term Performance Incentive Compensation Plan
(filed as Exhibit A to KeySpan's 2001 Proxy Statement filed on March
23, 2001)
10.49* KeySpan's Long-Term Performance Incentive Compensation Plan
Performance Target Award Level for Fiscal Year 2007
241
14 Code of Ethics (filed as Exhibit 14 to KeySpan's Annual Report on Form
10-K for the year ended December 31, 2003).
21* Subsidiaries of the Registrant
23.1* Consent of Deloitte & Touche LLP, Independent Registered Public
Accounting Firm
24.1* Power of Attorney executed by Andrea S. Christensen on February 21,
2007
24.2* Power of Attorney executed by Robert J. Fani on February 21, 2007
24.3* Power of Attorney executed by Alan H. Fishman on February 21, 2007
24.4* Power of Attorney executed by James R. Jones on February 21, 2007
24.5* Power of Attorney executed by James L. Larocca on February 21, 2007
24.6* Power of Attorney executed by Gloria C. Larson on February 21, 2007
24.7* Power of Attorney executed by Stephen W. McKessy on February 21, 2007
24.8* Power of Attorney executed by Edward D. Miller on February 21, 2007
24.9* Power of Attorney executed by Vikki L. Pryor on February 21, 2007
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
242
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
KEYSPAN CORPORATION
(Registrant)
Signature: Date:
By: /s/Gerald Luterman February 22, 2007
------------------
Gerald Luterman
Executive Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signatures: Date:
By: /s/Robert B. Catell February 22, 2007
-------------------
Robert B. Catell
Chairman of the Board of Directors
and Chief Executive Officer
By: /s/Gerald Luterman February 22, 2007
------------------
Gerald Luterman
Executive Vice President and
Chief Financial Officer
By: /s/Theresa A. Balog February 22, 2007
-------------------
Theresa A. Balog
Vice President and
Chief Accounting Officer
*
- -----------------------------------------
Andrea S. Christensen
Director
243
*
- -----------------------------------------
Robert J. Fani
President, Chief Operating Officer and Director
*
- -----------------------------------------
Alan H. Fishman
Director
*
- -----------------------------------------
James R. Jones
Director
*
- -----------------------------------------
James L. Larocca
Director
*
- -----------------------------------------
Gloria C. Larson
Director
*
- -----------------------------------------
Stephen W. McKessy
Lead Director
*
- -----------------------------------------
Edward D. Miller
Director
*
- -----------------------------------------
Vikki L. Pryor
Director
* Such signature has been affixed pursuant to a Power of Attorney filed as an
exhibit hereto and incorporated herein by reference thereto
244