UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-14161
KEYSPAN CORPORATION
(Exact name of Registrant as specified in its charter)
New York 11-3431358
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
175 East Old Country Road, Hicksville, New York 11801
One MetroTech Center, Brooklyn, New York 11201
(Address of principal executive offices) (Zip Code)
(516) 755-6650 (Hicksville)
(718) 403-1000 (Brooklyn)
(Registrant's telephone number, including area code)
MARKETSPAN CORPORATION
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Stock Outstanding at July 29, 1999
$.01 par value 139,292,752
KEYSPAN CORPORATION AND SUBSIDIARIES
INDEX
-----
Part I. FINANCIAL INFORMATION Page No.
--------
Item I. Financial Statements
Condensed Consolidated Balance Sheet -
June 30, 1999 and December 31, 1998 3
Condensed Consolidated Statement of Income -
Three and Six Months Ended June 30,
1999 and 1998 5
Condensed Consolidated Statement of Cash Flows -
Three and Six Months Ended June 30,
1999 and 1998 6
Notes to Condensed Consolidated Financial
Statements 7
Item 2. Management's Discussion and Analysis Of Financial
Condition and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 36
Part II. OTHER INFORMATION
Item 1 - Legal Proceedings 37
Item 4. Submission of Matters to a Vote of
Security Holders 40
Item 6 - Exhibits and Reports on Form 8-K 41
Signature 43
2
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS)
JUNE 30,1999 December 31, 1998
------------------ -------------------
(UNAUDITED) (Audited)
ASSETS
CURRENT ASSETS
Cash and temporary cash investments $ 307,295 $ 942,776
Customer accounts receivable 201,017 320,836
Other accounts receivable 203,568 230,479
Allowance for uncollectible accounts (24,142) (20,026)
Special deposits 108,377 145,684
Gas in storage, at average cost 95,178 145,277
Materials and supplies, at average cost 75,835 74,193
Other 122,848 72,818
------------------ -------------------
1,089,976 1,912,037
------------------ -------------------
EQUITY INVESTMENTS 308,578 289,193
------------------ -------------------
PROPERTY
Electric 1,322,162 1,109,199
Gas 3,330,828 3,257,726
Other 361,595 345,007
Accumulated depreciation (1,540,284) (1,480,038)
Gas exploration and production, at cost 1,052,428 994,104
Accumulated depletion (481,478) (447,733)
------------------ -------------------
4,045,251 3,778,265
------------------ -------------------
DEFERRED CHARGES
Regulatory assets 311,577 279,524
Goodwill 241,316 254,040
Other 388,480 382,043
------------------ -------------------
941,373 915,607
------------------ -------------------
TOTAL ASSETS $ 6,385,178 $ 6,895,102
================== ===================
See accompanying notes to the Condensed Consolidated Financial Statements.
3
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS)
JUNE 30,1999 December 31, 1998
------------------ -------------------
(UNAUDITED) (Audited)
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Current maturities of long-term debt $ 1,000 $ 398,000
Current redemption of preferred stock 363,000 -
Accounts payable and accrued expenses 421,875 519,288
Dividends payable 66,095 66,232
Taxes accrued 8,939 69,742
Customer deposits 30,075 29,774
Interest accrued 15,306 19,965
------------------ -------------------
906,290 1,103,001
------------------ -------------------
DEFERRED CREDITS AND OTHER LIABILITIES
Regulatory liabilities 26,235 27,854
Deferred federal income tax 163,948 71,549
Operating reserves 486,952 457,459
Other 80,239 75,740
------------------ -------------------
757,374 632,602
------------------ -------------------
CAPITALIZATION
Common stock, $.01 par value, authorized
450,000,000 shares; outstanding 140,120,152
and 144,628,654 shares stated at 2,973,388 2,973,388
Retained earnings 496,242 474,188
Accumulated foreign currency adjustment 4,783 (952)
Treasury stock purchased (546,448) (423,716)
------------------ -------------------
Total common equity 2,927,965 3,022,908
Preferred stock 84,485 447,973
Long-term debt 1,637,491 1,619,067
------------------ -------------------
TOTAL CAPITALIZATION 4,649,941 5,089,948
------------------ -------------------
MINORITY INTEREST IN SUBSIDIARY COMPANY 71,573 69,551
------------------ -------------------
TOTAL LIABILITIES AND CAPITALIZATION $ 6,385,178 $ 6,895,102
================== ===================
See accompanying notes to the Condensed Consolidated Financial Statements.
4
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
(IN THOUSANDS OF DOLLARS ,EXCEPT PER SHARE AMOUNTS)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1999 1998 1999 1998
------------ ---------- ------------ -----------
REVENUES
Gas Distribution $ 277,482 $ 152,904 $ 993,312 $ 424,798
Gas Exploration and Production 35,021 11,713 61,541 11,713
Electric Services 189,734 68,365 364,271 68,365
Electric Distribution - 330,011 - 885,693
Energy Related Services 37,125 6,386 78,557 6,386
------------ ---------- ------------ -----------
Total Revenues 539,362 569,379 1,497,681 1,396,955
OPERATING EXPENSES
Purchased gas 96,819 63,189 408,073 191,590
Fuel and purchased power - 91,762 - 257,786
Operations and maintenance 242,066 187,940 485,148 320,102
Depreciation, depletion and amortization 59,382 43,990 117,568 88,199
Electric regulatory amortizations - (40,005) - (79,875)
Operating taxes 77,145 97,768 181,038 214,880
------------ ---------- ------------ -----------
Total Operating Expenses 475,412 444,644 1,191,827 992,682
------------ ---------- ------------ -----------
OPERATING INCOME 63,950 124,735 305,854 404,273
------------ ---------- ------------ -----------
OTHER INCOME AND (DEDUCTIONS)
Income from equity investments 2,509 (207) 5,481 (207)
Interest income 7,746 12,895 18,789 16,609
Minority interest (1,887) (568) (2,191) (568)
Transaction related expenses,net - (6,450) - (6,450)
Other (2,820) 10,177 (551) 13,797
------------ ---------- ------------ -----------
Total Other Income 5,548 15,847 21,528 23,181
------------ ---------- ------------ -----------
INCOME BEFORE INTEREST CHARGES
AND INCOME TAXES 69,498 140,582 327,382 427,454
------------ ---------- ------------ -----------
INTEREST CHARGES 33,756 76,825 68,340 176,852
------------ ---------- ------------ -----------
INCOME TAXES
Current (39,505) 121,184 7,141 143,757
Deferred 52,258 (94,677) 85,691 (46,344)
------------ ---------- ------------ -----------
Total Income Taxes 12,753 26,507 92,832 97,413
------------ ---------- ------------ -----------
NET INCOME 22,989 37,250 166,210 153,189
Preferred stock dividend requirements 8,690 11,216 17,379 24,163
------------ ---------- ------------ -----------
EARNINGS FOR COMMON STOCK $ 14,299 $ 26,034 $ 148,831 $ 129,026
Foreign Currency Adjustment 2,425 (1,429) 5,735 (1,429)
============ ========== ============ ===========
COMPREHENSIVE INCOME $ 16,724 $ 24,605 $ 154,566 $ 127,597
============ ========== ============ ===========
AVERAGE COMMON
SHARES OUTSTANDING (000) 140,749 134,166 141,865 127,916
BASIC AND DILUTED EARNINGS
PER COMMON SHARE $ 0.10 $ 0.19 $ 1.05 $ 1.01
============ ========== ============ ===========
See accompanying notes to the Condensed Consolidated Financial Statements.
5
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(IN THOUSANDS OF DOLLARS)
THREE MONTHS Three Months SIX MONTHS Six Months
ENDED Ended ENDED Ended
JUNE 30, 1999 June 30, 1998 JUNE 30, 1999 June 30, 1998
--------------- -------------- ---------------- -------------
OPERATING ACTIVITIES
Net Income $ 22,989 $ 37,250 $ 166,210 $ 153,189
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Depreciation, depletion and amortization 59,382 43,990 117,568 88,199
Electric regulatory amortization - (40,005) - (79,875)
Deferred income tax 52,258 (94,677) 85,691 (46,344)
Income from equity investments (2,509) 207 (5,481) 207
Dividends from equity investments - - 4,296 -
CHANGES IN ASSETS AND LIABILITIES
Accounts receivable 217,523 90,418 146,397 82,095
Materials and supplies, fuel oil and gas in storage (54,475) (3,766) 48,252 66,858
Accounts payable and accrued expenses (75,596) (9,864) (161,065) (89,652)
Interest accrued (2,433) 67,486 (4,647) 56,306
Special deposits 12,449 65,947 37,307 37,588
Pensions and other post retirement benefits - (285,212) - (285,212)
Other (30,539) (113,481) (35,856) (96,360)
------------- -------------- ---------------- ---------------
Net Cash Provided by (Used in) Operating Activities 199,049 (241,707) 398,672 (113,001)
------------- -------------- ---------------- ---------------
INVESTING ACTIVITIES
Capital expenditures (310,031) (100,199) (396,362) (155,935)
Net cash from KeySpan Acquisition - 165,168 - 165,168
Net proceeds from LIPA Transaction - 2,314,588 - 2,314,588
Other (3,563) (8,390) 12,451 (17,679)
------------- -------------- ---------------- ---------------
Net Cash (Used in) Provided by Investing Activities (313,594) 2,371,167 (383,911) 2,306,142
------------- -------------- ---------------- ---------------
FINANCING ACTIVITIES
Proceeds from sale of common stock - 6,514 - 11,068
Treasury stock purchased (68,671) - (122,732) -
Issuance of preferred stock - 75,000 - 75,000
Issuance of long-term debt 8,000 - 15,000 -
Payment of long-term debt (397,000) (100,000) (397,000) (100,000)
Preferred stock dividends paid (8,690) (12,926) (17,379) (25,873)
Common stock dividends paid (63,323) (90,353) (127,683) (144,385)
Other 186 (16,965) (448) (17,297)
------------- -------------- ---------------- ---------------
Net Cash (Used in) Financing Activities (529,498) (138,730) (650,242) (201,487)
------------- -------------- ---------------- ---------------
Net (Decrease) or Increase in Cash and Cash Equivalents $ (644,043) $ 1,990,730 $ (635,481)$ 1,991,654
============= ============== ================ ===============
Cash and cash equivalents at beginning of period $ 951,338 $ 180,919 $ 942,776 $ 179,995
Net (Decrease) or Increase in cash and cash equivalents (644,043) 1,990,730 (635,481) 1,991,654
============= ============== ================ ===============
Cash and Cash Equivalents at End of Period $ 307,295 $ 2,171,649 $ 307,295 $ 2,171,649
============= ============== ================ ===============
See accompanying notes to the Condensed Consolidated Financial Statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION OF THE COMPANY
KeySpan Corporation, d/b/a KeySpan Energy (the "Company"), a New York
corporation, is the successor to Long Island Lighting Company
("LILCO"), as a result of the transaction with the Long Island Power
Authority ("LIPA")and following the acquisition of KeySpan Energy
Corporation ("KSE"). The Company is a "predominately intrastate" public
utility holding company exempt from most of the provisions of the
Public Utility Holding Company Act of 1935, as amended.
On May 28, 1998, the Company completed two business combinations as a
result of which it (i) became the successor operator of the non-nuclear
electric generating facilities, gas distribution operations and common
plant formerly owned by LILCO and entered into long-term service
agreements to operate the electric transmission and distribution
("T&D") system acquired by LIPA (the "LIPA Transaction"); and (ii)
acquired KSE, the parent company of The Brooklyn Union Gas Company
("Brooklyn Union")(the "KeySpan Acquisition").
With the exception of a small portion of Queens County, the Company's
subsidiaries are the only providers of gas distribution services in the
New York City counties of Kings, Richmond and Queens and the Long
Island counties of Nassau and Suffolk. Brooklyn Union provides gas
distribution services to customers in the New York City boroughs of
Brooklyn, Queens and Staten Island, and KeySpan Gas East Corporation
d/b/a Brooklyn Union of Long Island ("Brooklyn Union of Long Island"),
a Company subsidiary, provides gas distribution services to customers
in the Long Island counties of Nassau and Suffolk and the Rockaway
Peninsula of Queens County.
In addition, Company subsidiaries operate the electric T&D system owned
by LIPA, own and sell capacity and energy to LIPA from the Company's
generating facilities located on Long Island and manage fuel supplies
for LIPA to fuel the Company's Long Island generating facilities
through long-term service contracts that range from eight to fifteen
years. Moreover, on June 18, 1999, Company subsidiaries became the
owner, lessee and operator of the 2,168 megawatt Ravenswood electric
generation facility located in Long Island City, Queens. (See Note 10
"Contractual Obligations and Contingencies" for a description of the
Ravenswood Acquisition.)
7
Other Company subsidiaries are involved in gas and oil exploration and
production; wholesale and retail gas and electric marketing; appliance,
heating, ventilation and air conditioning services; and large
energy-system ownership, installation and management. Further, certain
subsidiaries have investments in natural gas pipelines and gas
distribution facilities; midstream natural gas processing and gathering
facilities and gas storage facilities, domestically and
internationally. (See Note 8 "Business Segments" for additional
information.)
2. BASIS OF PRESENTATION
The financial statements presented herein reflect the results of
operations of the consolidated Company for the three and six months
ended June 30, 1999. For financial reporting purposes, LILCO is deemed
the acquiring company pursuant to a purchase accounting transaction in
which KSE was acquired. Consequently, the financial statements
presented herein for the three and six months ended June 30, 1998
reflect the results of operations of the consolidated Company from May
29, 1998 through June 30, 1998. Periods prior to May 29, 1998, (i.e.,
January 1, 1998 through May 28, 1998)reflect results of operations of
LILCO only. Since the acquisition of KSE was accounted for as a
purchase, purchase accounting adjustments, including goodwill, have
been reflected in the financial statements included herein.
The weighted average number of common shares outstanding used in the
calculation of earnings per share for the three and six months ended
June 30, 1999 and 1998 reflect the issuance of common stock to
consummate the KeySpan Acquisition and the reduction associated with
repurchases of common stock.
In the opinion of the Company, the accompanying unaudited Condensed
Consolidated Financial Statements contain all adjustments necessary to
present fairly the financial position of the Company as of June 30,
1999, and the results of its operations and cash flows for the three
and six months ended June 30, 1999 and 1998. Certain reclassifications
were made to conform prior period financial statements with the current
period financial statement presentation. Other than as noted,
adjustments were of a normal, recurring nature.
As permitted by the rules and regulations of the Securities and
Exchange Commission ("SEC"), the Condensed Consolidated Financial
Statements do not include all of the accounting information normally
included with financial statements prepared in accordance with
generally accepted accounting principles. Accordingly, the Condensed
Consolidated Financial Statements should be read in conjunction with
the financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the Transition Period ended December 31,
1998.
3. REVENUES
The Gas Distribution segment of the Company is influenced by seasonal
weather conditions. Annual gas revenues are substantially realized
during the heating season (November 1 to April 30) as a result of the
large proportion of heating sales, primarily residential, compared with
total sales. Accordingly, results of operations for gas distribution
operations historically are most favorable in the three months ended
March 31, with results of operations being next most favorable in the
three months ended December 31. Results for the quarter ended June 30
are marginally profitable or unprofitable, and losses are generally
incurred in the quarter ended September 30.
The Company's gas distribution subsidiaries each operate under a
utility tariff that contains a weather normalization adjustment that
largely offsets shortfalls or excesses of firm net revenues (i.e.,
revenues less gas costs and revenue taxes) during a heating season due
to variations from normal weather.
Electric Services revenues are derived from billings to LIPA for the
management and operation of LIPA's T&D system, electric generation, and
fuel management. (For a description of the various services agreements
with LIPA see the Company's Form 10K for the Transition Period ended
December 31, 1998.) In addition, electric revenues, since June 18,
1999, also include revenues from the Ravenswood facility. Revenues from
electric generation are not affected by weather since billings are
based on fully allocated capacity.
Prior to the LIPA Transaction, electric revenues were comprised of
cycle billings rendered to residential, commercial and industrial
customers and the accrual of electric revenues for services rendered to
customers not billed at month-end. In addition, LILCO's rate structure
provided for a revenue reconciliation mechanism which
8
eliminated the impact on earnings of electric sales that were above or
below the levels reflected in rates.
4. GAS EXPLORATION AND PRODUCTION
The Houston Exploration Company ("THEC"), a 64% owned subsidiary of the
Company which is engaged in gas and oil exploration and production,
uses the full cost method of accounting for its investment in natural
gas and oil properties. Under the full cost method of accounting, all
costs of acquisition, exploration and development of natural gas and
oil reserves are capitalized into a "full cost pool". To the extent
that such capitalized costs (net of accumulated depreciation, depletion
and amortization) less deferred taxes, exceed the present value (using
a 10% discount rate) of estimated future net cash flows from proved
natural gas and oil reserves and the lower of cost or fair value of
unproved properties, such excess costs are charged to operations.
As of June 30, 1999, THEC estimates, using prices in effect as of such
date, that the ceiling limitation imposed under full cost accounting
rules exceeded actual capitalized costs.
5. GOODWILL
At June 30, 1999, the Company had recorded goodwill in the amount of
$241.3 million, representing the excess of acquisition cost over the
fair value of net assets acquired related to its purchases of certain
consolidated and unconsolidated subsidiaries, including $166.3 million,
net of accumulated amortization of $4.6 million relating to the KeySpan
Acquisition. Goodwill is being amortized over 15 to 40 years.
6. ENVIRONMENTAL MATTERS
The Company has recorded a liability of approximately $129 million
associated with investigation and remedial obligations with respect to
14 of the Company's former manufactured gas plant ("MGP")sites, three
of which are designated as "Class II Sites." Three MGP sites (one Class
II Site) are associated with Brooklyn Union's operations or its
predecessors; 11 MGP sites are associated with the operations of
Brooklyn Union of Long Island or its predecessors (two of which are
designated
9
as Class II Sites). With respect to the Brooklyn Union MGP sites, a
total of approximately $47.8 million has been accrued, representing the
best estimate of remedial costs for two sites that are subject to
Administrative Orders on Consent ("AOC's") with the New York State
Department of Environmental Conservation ("DEC") and the minimum range
of an estimate for the investigation and/or remediation of other sites.
Discussions with the DEC are ongoing with regards to investigation of
other sites. With respect to Brooklyn Union of Long Island MGP sites, a
total of approximately $81.2 million has been accrued as a minimum of
an estimated range of costs for the 11 sites that will be
investigated/remediated pursuant to AOC's with the DEC. Two AOC's were
executed on March 31, 1999 for Brooklyn Union of Long Island MGP sites.
One AOC addressed two MGP sites classified as Class II Sites on the
State registry of inactive hazardous waste sites. The other AOC
addressed four other MGP sites. Both AOC's generally require Brooklyn
Union of Long Island to investigate the condition of each site and
conduct remediation activities depending on the results of the
investigation. Brooklyn Union of Long Island also expects to enter into
an AOC with the DEC requiring the Company to conduct preliminary site
assessments for the five other former MGP sites that are no longer
owned by the Company.
Under prior rate orders, the Public Service Commission of the State of
New York ("NYPSC") has allowed recovery of costs related to certain
Brooklyn Union MGP sites. At June 30, 1999, the Company has a total
remaining regulatory asset of approximately $100 million. The Company
believes that current rate plans in effect for both Gas Distribution
subsidiaries provide for recovery of environmental costs attributable
to the Gas Distribution segment.
7. REGULATORY ASSETS AND LIABILITIES
The Company's regulated subsidiaries are subject to the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 71,
"Accounting for the Effects of Certain Types of Regulation". Regulatory
assets arise from the allocation of costs and revenues to accounting
periods for utility ratemaking purposes differently from bases
generally applied by nonregulated companies. Regulatory assets and
liabilities are recognized in accordance with SFAS-71.
10
The Company's regulatory assets of $311.6 million are primarily
comprised of regulatory tax assets, costs associated with the KeySpan
Acquisition, certain environmental remediation and investigation costs
and postretirement benefits other than pensions. In the opinion of
management, regulatory assets are fully recoverable in rates.
In the event that the provisions of SFAS-71 were no longer applicable,
the Company estimates that the related write-off of net regulatory
assets (regulatory assets less regulatory liabilities) could result in
a charge to net income of approximately $185.5 million, or
approximately $1.32 per share of common stock, which would be
classified as an extraordinary item.
8. BUSINESS SEGMENTS
The Company has six reportable segments: Gas Distribution, Electric
Services, Gas Exploration and Production, Energy Related Investments,
Energy Related Services and Other.
The Gas Distribution segment consists of Brooklyn Union and Brooklyn
Union of Long Island. The Electric Services segment consists of
subsidiaries that own and operate oil and gas fired generating plants
in Queens and Long Island, and through long-term contracts, manage the
electric T&D system, the fuel and electric purchases, and the
off-system electric sales for LIPA.
The Gas Exploration and Production segment is engaged in gas and oil
exploration and production, and the development and acquisition of
domestic natural gas and oil properties. This segment consists of our
64% equity interest in THEC, an independent natural gas and oil
exploration company, as well as KeySpan Exploration and Production LLC,
our wholly owned subsidiary engaged in a joint venture with THEC.
Subsidiaries in the Energy Related Investments segment include our 20%
equity interest in the Iroquois Gas Transmission System LP; a 50%
interest in the Premier Transco Pipeline and a 24.5% interest in
Phoenix Natural Gas, both in Northern Ireland; and investments in
certain midstream natural gas assets in Western Canada owned jointly
with Gulf Canada Resources Limited, through the Gulf Midstream Services
Partnership ("GMS"). These subsidiaries are accounted for under the
equity method since the Company's ownership
11
interests are 50% or less. Accordingly, equity income from these
investments is reflected in Other Income and (Deductions) in the
Condensed Consolidated Income Statement.
The Company's Energy Related Services segment primarily includes
KeySpan Energy Management Inc. ("KEM"), KeySpan Energy Services Inc.
("KES"), KeySpan Energy Solutions, LLC ("KESol") and KeySpan Fritze,
LLC ("Fritze"). KEM owns, designs and/or operates energy systems for
commercial and industrial customers and provides energy-related
services to clients located primarily within the New York City
metropolitan area. KES markets gas and electricity, and arranges
transportation and related services, largely to retail customers,
including those served by the Company's two gas distribution
subsidiaries. KESol and Fritze provide various appliance, heating,
ventilation and air conditioning services to customers primarily within
the Company's service territory. KESol was established in April 1998
and Fritze was acquired in November 1998.
The Other segment primarily represents unallocated administrative
expenses of the Company, preferred stock dividends, and earnings from
the investment of cash proceeds from the LIPA Transaction.
The accounting policies of the segments are the same as those used for
the preparation of the Condensed Consolidated Financial Statements. The
Company's segments are strategic business units that are managed
separately because of their different operating and regulatory
environments. As of June 30, 1999, the total assets of each reportable
segment have not changed materially from those levels reported at
December 31, 1998 except for the Gas Exploration and Production segment
whose assets increased by $14.5 million due to our formation of and
investment in KeySpan Exploration and Production LLC and the Electric
Services segment whose assets increased by $230.0 million due to the
acquisition of the 2,168 megawatt Ravenswood electric generation
facility located in Long Island City, Queens, a portion of which has
been leased to a Company subsidiary under a master lease financing
arrangement. (See Note 10 "Contractual Obligations and Contingencies"
for more details.) The segment information presented below reflects
amounts reported in the Condensed Consolidated Financial Statements,
excluding special charges, for the three and six months ended June 30,
1999 and 1998.
12
THREE MONTHS ENDED JUNE 30, 1999 (In Thousands of Dollars)
===================================================================================================================================
Gas Exploration Energy Related Energy Related
Gas Distribution Electric Servies and Production Investments Services Other Total
===================================================================================================================================
Revenue $ 277,482 $ 189,734 $ 35,021 $ $ 37,125 $ $ 539,362
- -----------------------------------------------------------------------------------------------------------------------------------
Cost of Gas 96,819 - - - - - 96,819
Operations and
Maintenance 88,148 108,120 6,326 1,580 37,327 565 242,066
Depreciation
Depletion &
Amortization 24,351 10,337 17,972 286 703 5,733 59,382
Operating Taxes 45,836 28,447 113 1 - 2,748 77,145
Intercompany
Billings 867 10,398 - - - (11,265) -
- -----------------------------------------------------------------------------------------------------------------------------------
Total Expense $ 256,021 $ 157,302 $ 24,411 $ 1,867 $ 38,030 $ (2,219) $ 475,412
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Income $ 21,461 $ 32,432 $ 10,610 $ (1,867) $ (905) $ 2,219 $ 63,950
===================================================================================================================================
Earnings for
Common Stock $ 1,220 $ 15,037 $ 3,326 $ 2,448 $ (254) $ (7,478) $ 14,299
===================================================================================================================================
Basic and Diluted
EPS $ 0.01 $ 0.11 $ 0.02 $ 0.02 $ 0.00 $ (0.06) $ 0.10
===================================================================================================================================
THREE MONTHS ENDED JUNE 30, 1999 (In Thousands of Dollars)
===================================================================================================================================
Gas Exploration Energy Related Energy Related
Gas Distribution Electric Servies and Production Investments Services Other Total
===================================================================================================================================
Revenue $ 152,904 $ 398,376 $ 11,713 $ 28 $ 6,358 $ - $ 569,379
- -----------------------------------------------------------------------------------------------------------------------------------
Cost of Gas 63,189 91,762 - - - - 154,951
Operations and
Maintenance 61,329 114,378 2,138 600 6,701 2,794 187,940
Depreciation
Depletion &
Amortization 8,817 26,220 6,781 - 162 2,010 43,990
Electric
Regulatory
Amortization - (40,005) - - - - (40,005)
Operating Taxes 25,672 70,805 45 - 168 1,078 97,768
Intercompany
Billings 3,494 1,172 - - - (4,666) -
- -----------------------------------------------------------------------------------------------------------------------------------
Total Expense $ 162,501 $ 264,332 $ 8,964 $ 600 $ 7,031 $ 1,216 $ 444,644
====================================================================================================================================
Operating Income $ (9,597) $ 134,044 $ 2,749 $ (572) $ (673) $ (1,216) $ 124,735
====================================================================================================================================
Earnings for
Common Stock $ (16,381) $ 51,155 $ 1,028 $ 48 $ (317) $ (3,049) $ 32,484(a)
====================================================================================================================================
Basic and Diluted
EPS $ (0.12) $ 0.38 $ 0.01 $ 0.00 $ 0.00 $ (0.03) $ 0.24(a)
====================================================================================================================================
(a) Excludes $6.5 million or $0.05 per diluted share of non-recurring
charges associated with the LIPA Transaction.
13
SIX MONTHS ENDED JUNE 30, 1999 (In Thousands of Dollars)
===================================================================================================================================
Gas Exploration Energy Related Energy Related
Gas Distribution Electric Services and Production Investments Services Other Total
===================================================================================================================================
Revenue $ 993,312 $ 364,271 $ 61,541 $ - $ 78,557 $ - $1,497,681
- ------------------------------------------------------------------------------------------------------------------------------------
Cost of Gas 408,073 - - - - - 408,073
Operations and
Maintenance 187,228 200,288 12,285 2,669 80,555 2,123 485,148
Depreciation
Depletion &
Amortization 48,605 20,265 35,029 618 1,472 11,579 117,568
Operating Taxes 118,289 57,440 146 8 3 5,152 181,038
Intercompany
Billings 3,917 21,041 - - - (24,958) -
- ------------------------------------------------------------------------------------------------------------------------------------
Total Expense $ 766,112 $ 299,034 $ 47,460 $ 3,295 $ 82,030 $ (6,104) $1,191,827
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Income $ 227,200 $ 65,237 $ 14,081 $ (3,295) $ (3,473) $ 6,104 $ 305,854
====================================================================================================================================
Earnings for
Common Stock $ 121,909 $ 31,621 $ 3,804 $ 2,750 $ (1,693) $ (9,560) $ 148,831
====================================================================================================================================
Basic and Diluted
EPS $ 0.86 $ 0.22 $ 0.03 $ 0.02 $ (0.01) $ (0.07) $ 1.05
====================================================================================================================================
SIX MONTHS ENDED JUNE 30, 1999 (In Thousands of Dollars)
===================================================================================================================================
Gas Exploration Energy Related Energy Related
Gas Distribution Electric Services and Production Investments Services Other Total
===================================================================================================================================
Revenue $ 424,798 $ 954,058 $ 11,713 $ 28 $ 6,358 $ $ 1,396,955
- ------------------------------------------------------------------------------------------------------------------------------------
Cost of Gas 191,590 257,786 - - - - 449,376
Operations and
Maintenance 93,408 214,461 2,138 600 6,701 2,794 320,102
Depreciation
Depletion &
Amortization 19,522 59,724 6,781 - 162 2,010 88,199
Electric
Regulatory
Amortization - (79,875) - - - - (79,875)
Operating Taxes 50,381 163,208 45 - 168 1,078 214,880
Intercompany
Billings 3,494 1,172 - - - (4,666) -
- ------------------------------------------------------------------------------------------------------------------------------------
Total Expense $ 358,395 $ 616,476 $ 8,964 $ 600 $ 7,031 $ 1,216 $ 992,682
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Income $ 66,403 $ 337,582 $ 2,749 $ (572) $ (673) $(1,216) $ 404,273
====================================================================================================================================
Earnings for
Common Stock $ 23,162 $ 114,604 $ 1,028 $ 48 $ (317) $(3,049) $ 135,476(a)
====================================================================================================================================
Basic and Diluted
EPS $ 0.1 $ 0.90 $ 0.01 $ 0.00 $ 0.00 $ (0.03) $ 1.06(a)
====================================================================================================================================
(a) Excludes $6.5 million or $0.05 per diluted share of non-recurring charges
associated with the LIPA Transaction.
14
9. EXTINGUISHMENT OF LONG-TERM DEBT
On June 15, 1999 the Company, in accordance with the LIPA Agreement,
extinguished its obligations to LIPA under a promissory note relating to the
7.30% Debentures due July 15, 1999. The Company's obligation for these
debentures of $411.5 million consisted of the principal amount of $397.0
million and $14.5 million of interest accrued and unpaid.
10. CONTRACTUAL OBLIGATIONS AND CONTINGENCIES
On June 18, 1999 the Company completed its acquisition of the 2,168 megawatt
Ravenswood electric generating facility located in Long Island City, Queens,
New York from Consolidated Edison Company of New York, Inc. ("Con Ed"), for
approximately $597
million.
As a means of financing this acquisition, the Company entered into a lease
agreement with a special purpose, unaffiliated financing entity that acquired
a portion of the facility directly from Con Ed and leased it to a subsidiary
of the Company under a ten year lease. The Company has guaranteed all payment
and performance obligations of its subsidiary under the lease. Another
subsidiary of the Company provides all operating, maintenance and construction
services for the facility. The lease program was established in order for the
Company to finance approximately $425 million of the acquisition cost of the
facility. The lease qualifies as an operating lease for financial reporting
purposes while preserving the Company's ownership of the facility for federal
and state income tax purposes. The balance of the funds needed to acquire the
facility were provided from cash on hand. The Company has recorded an asset of
approximately $230 million, representing its ownership interest in the assets
acquired.
The Company has assumed all of Con Ed's historical contingent environmental
obligations relating to facility operations other than liabilities arising
from pre-closing disposal of waste at off-site locations and any monetary
fines arising from Con Ed's pre-closing conduct. These environmental exposures
are generally divided between (1) future capital expenditures, in the nature
of property and leasehold improvements, necessary to address compliance
obligations and (2) expenditures to investigate and, as necessary, remediate
certain on-site contamination which may or may not result in leasehold
improvements. Given the recent nature of the acquisition, our
15
actual knowledge of facility conditions is in the developmental stage and
implementation plans and estimates are, therefore, preliminary.
Presently, there are four AOC's issued to Con Ed by the DEC. The Company has
contractually agreed to assume Con Ed's remaining obligations at the
Ravenswood facility under these AOC's. Generally, the Company's derivative
obligations are expected to include investigation and remediation of certain
petroleum releases, inspection and any necessary corrective action for certain
aboveground storage tanks and underground piping, potential upgrades to
existing cooling water intake structures, and implementation of an air
emissions opacity reduction program. The Company is currently negotiating a
consolidated AOC with the DEC that will clarify the scope and timing of these
activities.
The Company has identified certain capital expenditures for environmental
compliance purposes at Ravenswood that are reasonably likely to occur. To
address an anticipated shortfall of NOx emissions allowances beginning in May
2003, the Company may incur immaterial capital costs for additional air
pollution control equipment. Alternatively, the Company may elect to purchase
additional allowances. The Company probably will be required to upgrade the
Ravenswood cooling intake structures to meet the best available technology
requirements of the Federal Clean Water Act. The extent and cost of any
upgrades are uncertain and will depend upon the results of analysis of certain
studies.
Pursuant to its derivative AOC obligations, the Company will complete the
investigation and remediation of certain petroleum and other hazardous
material releases at Ravenswood, as necessary. The Company will also address
similar releases not covered by the AOC's. The Ravenswood facility is located
on a former MGP site. The Company has no current obligation to investigate or
remediate the property for contamination resulting from historical MGP
operations, although there may be a need to perform certain site remediation
as part of an overall improvement of property related to the installation of
new generation capacity. Based on information currently available for
environmental contingencies related to the Ravenswood acquisition, the Company
has accrued $5 million as the minimum liability to be incurred.
16
The Company intends to seek regulatory approvals to upgrade the Ravenswood
facility through the installation of a gas-fired combined cycle generation
unit with a capacity of approximately 250 megawatts of electricity that would
increase electric generation capacity at the plant by 12%. The new capacity
could be operational by 2002 depending upon the timeliness and responsiveness
of regulatory approvals.
11. NEW FINANCIAL ACCOUNTING STANDARDS
In June 1999, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of SFAS No. 133." SFAS No. 137 defers the
effective date of SFAS No. 133 from fiscal years beginning after July 15, 1999
to fiscal years beginning after July 15, 2000. The Company will therefore,
adopt SFAS No. 133 in the first quarter of fiscal year 2001. SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that an entity recognize all derivatives
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. The Company does not expect any
material earnings effect from adoption of this statement.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of operations for the three and six months ended June 30, 1999 reflect
the operations of the consolidated Company, which includes all KSE-acquired
companies, Brooklyn Union of Long Island and subsidiaries providing electric
services. As required under purchase accounting rules for the KeySpan
Acquisition, results of operations for the three months ended June 30, 1998
reflect the results of LILCO only for the period April 1, 1998 through May 28,
1998 and results of the consolidated Company from May 29, 1998 through June 30,
1998. Results of operations for the six months ended June 30, 1998 reflect the
results of LILCO only for the period January 1, 1998 through May 28, 1998 and
results of the consolidated Company from May 29, 1998 through June 30, 1998.
(Capitalized terms used in the discussions to follow but not otherwise defined,
have the same meaning as when used in the Footnotes to the Condensed
Consolidated Financial Statements included under Item 1.)
EARNINGS SUMMARY
Consolidated earnings for the quarter ended June 30, 1999 were $14.3 million, or
$0.10 per diluted share, compared to earnings of $26.0 million, or $0.19 per
diluted share, in the corresponding quarter last year. During the quarter ended
June 30, 1998, the Company incurred special charges associated with the LIPA
Transaction of $6.5 million or $0.05 per diluted share. Consolidated earnings,
excluding special charges, for the quarter ended June 30, 1998 were $32.5
million or $0.24 per diluted share. (See Note 8. to the Condensed Consolidated
Financial Statements "Business Segments" for a summary of earnings for each
business segment.)
Consolidated earnings for the six months ended June 30, 1999 were $148.8
million, or $1.05 per diluted share, compared to earnings of $129.0 million, or
$1.01 per diluted share, in the corresponding period last year. Consolidated
earnings, excluding special charges, for the six months ended June 30, 1998 were
$135.5 million or $1.06 per diluted share. (See Note 8. to the Condensed
Consolidated Financial Statements "Business Segments" for a summary of earnings
for each business segment.)
Due to the change in the structure of the Company's business as a result of the
LIPA Transaction and the requirements of purchase accounting rules applicable to
the KeySpan Acquisition, results of operations for the periods ended June 30,
1999 are not comparable to the results of operations for the periods ended June
30, 1998. Therefore, for comparative purposes, we will combine the results of
18
operations, excluding special charges associated with the LIPA Transaction, of
KSE and LILCO for the entire three and six month periods ended June 30, 1998.
These combined results are intended to reflect the results of the Company as if
the KeySpan Acquisition occurred on the first day of the reporting period, i.e.,
January 1, 1998. This "proforma, combined company basis" format will be used to
explain variations in operating results between periods in the discussions to
follow.
On a proforma, combined company basis, earnings for the three and six months
ended June 30, 1998 were $36.0 million and $219.3 million, respectively. The
following table sets forth consolidated net income for the quarter and six
months ended June 30, 1999 and the proforma, combined company basis consolidated
net income for the three and six months ended June 30, 1998:
- -------------------------------------------------------------------------------------------------------------
Results of Operations Three Months Ended Three Months Ended Six Months Ended Six Months Ended
(In Thousands of Dollars) June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
- -------------------------------------------------------------------------------------------------------------
Gas Distribution $ 1,220 ($11,539) $121,909 $108,722
Gas Exploration and Production 3,326 3,472 3,804 7,805
Electric Services 15,037 51,155 31,621 114,604
Energy Related Investments 2,448 (1,198) 2,750 (1,864)
Energy Related Services (254) (2,071) (1,693) (5,728)
Other (7,478) (3,851) (9,560) (4,233)
- -------------------------------------------------------------------------------------------------------------
Earnings for Common Stock $14,299 $35,968 $148,831 $219,306
=============================================================================================================
Gas Distribution earnings for the quarter and six months ended June 30, 1999 as
compared to the same periods in 1998, on a proforma, combined company basis
reflect the benefits of significantly lower operating expenses offset, in part,
by lower net revenues (revenues less gas costs and revenue taxes) due to rate
reductions associated with the KeySpan Acquisition. As previously indicated, Gas
Distribution earnings for the quarter ended June 30 generally are marginally
profitable or unprofitable due to the seasonal nature of gas heating sales.
Earnings from the Gas Exploration and Production segment for the quarter ended
June 30, 1999 remained relatively constant as compared to the corresponding
period in 1998, on a proforma, combined company basis. The benefits from
slightly higher production volumes and decreased operating expenses were offset
by slightly lower average realized gas prices and increased interest expense of
$2.2 million due to higher levels of debt outstanding. Earnings for the six
months ended June 1999 as compared to the same period in 1998, primarily reflect
significantly lower average
19
realized gas prices (experienced during the quarter ended March 1999) as
compared to the same period in 1998 and higher interest expense of $5 million.
The change in the Company's asset base and electric operations resulting from
the LIPA Transaction contributed to the comparative reduction in Electric
Services earnings, which now reflect primarily service-fee revenues under
various service contracts with LIPA. The Company's operating margins under the
agreements with LIPA are lower than those experienced prior to the LIPA
Transaction. Earnings for the quarter and six months ended June 30, 1999 also
include earnings of $2.9 million from our acquisition of the Ravenswood
facility. The purchase of Ravenswood was completed on June 18, 1999. (See Note
10 to the Condensed Consolidated Financial Statements "Contractual Obligations
and Contingencies.")
Comparative earnings from the Energy Related Investments segment for the quarter
and six months ended June 30, 1999 as compared to the corresponding periods last
year, on a proforma, combined company basis, primarily reflect earnings from our
investment in Gulf Midstream Services Partnership ("GMS"), formed in December
1998, and more favorably results from our investments in Northern Ireland. In
addition, for the quarter and six months ended June 30, 1998 results of
operations from this segment reflect after-tax costs of $1.6 million and $3.2
million, respectively, to settle certain contracts associated with the sale, in
1997, of our domestic cogeneration investments and related fuel management
operations.
Operating results from the Energy Related Services segment for the quarter and
six months ended June 30, 1999 as compared to the corresponding periods last
year, on a proforma, combined company basis reflect the benefits derived from
the continued integration of companies acquired during the past two years and
more favorable results from gas and electric marketing services. These benefits
were offset by losses incurred by subsidiaries providing appliance and repair
services, due to the start-up nature of their operations in highly competitive
markets.
Earnings from the Other segment for the quarter and six months ended June 30,
1999 reflect charges, including preferred stock dividends, incurred by the
corporate and administrative areas of the Company that have not been allocated
to the various business segments, offset, in part, by interest income earned on
investments of the proceeds from the LIPA Transaction.
20
REVENUES
GAS DISTRIBUTION
Utility firm gas and transportation sales volumes for the quarter and six months
ended June 30, 1999, were 29,650 MDTH and 116,189 MDTH, respectively. Total gas
sales and transportation, which includes sales and transportation to
interruptible and off-system customers, were 38,648 MDTH and 142,027 MDTH for
the quarter and six months ended June 30, 1999, respectively.
On a proforma, combined company basis, firm gas and transportation sales volumes
for the quarter and six months ended June 30, 1998, were 30,120 MDTH and 106,213
MDTH, respectively. On a proforma, combined company basis total gas sales and
transportation for the quarter and six months ended June 30, 1998 were 40,105
MDTH and 139,223 MDTH, respectively.
Weather, as measured by annual degree days, was 9.2% warmer than normal for the
six months ended June 30, 1999 as compared to 18.3% warmer than normal for the
corresponding period last year. Firm gas sales normalized for weather were 2.5%
higher in the six months ended June 30, 1999 as compared to the six months ended
June 30, 1998, reflecting ongoing gas sales growth.
Gas Distribution revenues for the quarter and six months ended June 30, 1999
were $277.5 million and $993.3 million, respectively, compared to $152.9 million
and $424.8 million for the comparable periods in 1998. The increase in revenues
for the quarter and six months was principally the result of the inclusion of
Brooklyn Union revenues for the entire quarter and six months ended June 30,
1999. Reported revenues for the quarter and six months ended June 30, 1998
include Brooklyn Union revenues for the period May 29, 1998 through June 30,
1998 only. On a proforma, combined company basis, total Gas Distribution
revenues for the quarter and six months ended June 30, 1998 were $303.7 million
and $1,063.7 million, respectively. Set forth below are net gas revenues on a
proforma, combined company basis:
(In Thousands of Dollars)
- -------------------------------------------------------------------------------------------------------------------
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------
Gas Distribution
Revenues $ 277,482 $ 303,714 $ 993,312 $ 1,063,681
Cost of Gas 96,819 115,439 408,073 447,155
Revenue Taxes 18,425 20,436 62,621 67,042
- ------------------------------------------------------------------------------------------------------------------
Net Revenues $ 162,238 $ 167,839 $ 522,618 $ 549,484
==================================================================================================================
21
The decrease in comparative net gas revenues of $5.6 million and $26.9 million
for the three and six months respectively, was due primarily to rate reductions
associated with the KeySpan Acquisition. Brooklyn Union reduced rates to its
core customers by $23.9 million on an annual basis effective May 29, 1998 and
Brooklyn Union of Long Island reduced its rates to core customers by $12.2
million annually effective February 5, 1998 and by an additional $6.3 million
annually effective May 29, 1998. Reduced net revenues resulting from the
reductions amounted to $4.8 million for the quarter ended June 30, 1999 and
$19.2 million for the six months ended June 30, 1999. Further, revenues derived
from Brooklyn Union's appliance and repair services are included in Gas
Distribution revenues for the period January 1, 1998 through March 31, 1998. In
April 1998, Brooklyn Union "spun-off" its appliance and repair services to KESol
and, as a result, Gas Distribution revenues for 1999 do not include revenues
from such services. As required by the NYPSC, on July 1, 1999, Brooklyn Union of
Long Island discontinued providing non-safety related appliance repair services.
These services are now offered by KESol to customers within Brooklyn Union of
Long Island's service territory. Net revenues as a percentage of Gas
Distribution sales were approximately 53% and 52% for the six months ended June
30, 1999 and 1998, respectively.
GAS EXPLORATION AND PRODUCTION
Gas Exploration and Production revenues for the quarter and six months ended
June 30, 1999 were $35.0 million and $61.5 million respectively, as compared to
$11.7 million for the quarter and six months ended June 30, 1998. For the
periods ended June 30, 1998, Gas Exploration and Production revenues are
reflected for the period May 29, 1998 through June 30, 1998 only.
On a proforma combined company basis, revenues from this segment were $35.1
million and $68.0 million for the quarter and six months ended June 30, 1998,
respectively. Revenues for the quarter ended June 30, 1999 as compared to the
same period last year reflect the benefits derived from a 6% increase in
production volumes, offset by a 6% decrease in average realized gas prices.
Revenues for the six months ended June 1999 as compared to the same period in
1998 primarily reflect significantly lower average realized gas prices in the
quarter ended March 1999. The effective price realized (average wellhead price
received for production including hedging gains and losses) generally has been
increasing recently and was $2.03 per MCF for the quarter ended June 30, 1999
compared to $2.17 per MCF for the corresponding quarter of 1998. The average
wellhead price was also $2.03 per MCF in the current quarter compared to $2.13
per MCF for the quarter ended June 30, 1998. The effective wellhead prices for
the six months ended June 30, 1999
22
and 1998 were $1.82 per MCF and $2.15 per MCF, respectively. Gas production for
the three and six months ended June 30, 1999 was 17.2 BCFe and 33.7 BCFe,
respectively as compared to 16.2 BCFe and 31.6 BCFe for the three and six months
ended June 30, 1998, respectively. At December 31, 1998, THEC had total natural
gas reserves of approximately 480 BCFe, primarily in the Gulf of Mexico and
Texas.
ELECTRIC SERVICES
Electric Services revenues of $189.7 million and $364.3 million for the quarter
and six months ended June 30, 1999 represent revenues under various LIPA Service
Agreements and approximately two weeks of revenues from our Ravenswood
investment. Revenues of $398.4 million for the quarter ended June 30, 1998
reflect Electric Distribution revenues of LILCO only for the period April 1,
1998 through May 28, 1998 and Electric Services revenues for the period May 29,
1998 through June 30, 1998 under various LIPA Service Agreements. Revenues of
$954.1 million for the six months ended June 30, 1998 reflect Electric
Distribution revenues of LILCO only for the period January 1, 1998 through May
28, 1998 and Electric Services revenues under various LIPA Service Agreements
for the period May 29, 1998 through June 30, 1998.
The decrease in electric revenues for the three and six months ended June 30,
1999 when compared to the same period in 1998, was the result of the LIPA
Transaction. Prior to the LIPA Transaction, LILCO provided fully integrated
electric services to its customers. Included within the rates charged to
customers was a return on the capital investment in the generation and T&D
assets, as well as recovery of the electric business costs to operate the
system. Upon completion of the LIPA Transaction, the nature of the Company's
electric business changed from that of owner of an electric generation and T&D
system, with a significant capital investment, to a new role as owner of the
non-nuclear generation facilities and as manager of the T&D system now owned by
LIPA. In its new role, the Company's capital investment is significantly reduced
and accordingly, its revenues under the LIPA contracts reflect that reduction.
Revenues resulting from the LIPA Service Agreements included the following:
Revenues realized under the Management Services Agreement("MSA") were $105.6
million for the quarter and $204.9 million for the six months ended June 30,
1999. These revenues are derived from the performance, by KeySpan Electric
Services, LLC, of the day-to-day operation and maintenance of LIPA's T&D system,
management of construction additions to the T&D system, and management of LIPA's
23
interest in the Nine Mile Point Nuclear Power Station, Unit 2
("NMP2").
Revenues realized by KeySpan Generation, LLC under the Power Supply Agreement
("PSA") were $74.0 million for the quarter and $147.0 million for the six months
ended June 30, 1999 and are derived from the sale of capacity and energy to LIPA
from the Company's generating facilities at rates approved by the Federal Energy
Regulatory Commission ("FERC").
Revenues realized by KeySpan Energy Trading Services, LLC under the Energy
Management Agreement ("EMA") were $1.4 million for the quarter and $3.7 million
for the six months ended June 30, 1999 and result from the management of fuel
supplies for LIPA to fuel the Company's generating facilities, the management of
energy purchases on a least-cost basis to meet LIPA's needs and the management
of off-system electric sales.
Revenues realized from the Ravenswood facility from June 18, 1999 through June
30, 1999 were $8.7 million. (See Note 10 "Contractual Obligations and
Contingencies" to the Condensed Consolidated Financial Statements for more
details on the Ravenswood acquisition.)
ENERGY RELATED SERVICES
Revenues from the Energy Related Services segment were $37.1 million and $78.6
million for the quarter and six months ended June 30, 1999 respectively, as
compared to $6.4 million for the comparable periods in 1998. For the periods
ended June 30, 1998, Energy Related Services revenues are reflected for the
period May 29, 1998 through June 30, 1998 only.
Revenues on a proforma, combined company basis from this segment were $17.3
million for the quarter ended June 30, 1998 and $32.1 million for the six months
ended June 30, 1998, respectively. The increase in comparative revenues for the
periods ended June 30, 1999 was due primarily to the inclusion of revenues from
Fritze of $10.4 million and $20.9 million for the quarter and six months ended
June 30, 1999, respectively. Moreover, revenues from KEM and KES increased for
both the quarter and six months ended June 30, 1999 as compared to the
comparable periods last year due to the benefits derived from companies acquired
during the past two years and the growth in the number of customers purchasing
energy from KES.
24
OPERATING EXPENSES
Total operating expenses were $475.4 million for the quarter ended June 30, 1999
as compared to $444.6 million for the quarter ended June 30, 1998. For the six
months ended June 30, 1999 total operating expenses were $1,191.8 million as
compared to $992.7 million for the six months ended June 30, 1998. Comparative
total operating expenses reflect the change in the structure of the Company's
business and the timing of the LIPA Transaction and KeySpan Acquisition.
Operating expenses, excluding the cost of gas and revenue taxes (i.e., net
operating expenses), were $360.2 million and $721.1 for the three and six months
ended June 30, 1999, respectively. On a proforma, combined company basis, net
operating expenses, excluding special charges, were $480.3 million and $1,053.8
million for the quarter and six months ended June 30, 1998. The discussion that
follows presents a comparison of net operating expenses, excluding special
charges, on a proforma, combined company basis, by major segment for the quarter
and six months ended June 30, 1999 compared to the corresponding periods last
year.
GAS DISTRIBUTION
Net operating expenses were $140.8 million, or 51% of Gas Distribution revenues,
for the quarter ended June 30, 1999 as compared to $164.4 million, or 54% of Gas
Distribution revenues, for the quarter ended June 30, 1998 on a proforma,
combined company basis. For the six months ended June 30, 1999 net operating
expenses were $295.4 million as compared to $337.8 million for the six months
ended June 30, 1998 on a proforma, combined company basis. The decrease of $23.6
million and $42.4 million for the quarter and six months ended June 30, 1999 as
compared to the corresponding periods last year was due to a significant
reduction in operations and maintenance expense reflecting, primarily, the
benefits derived from cost reduction measures and operating efficiencies
employed during the past few years. Such measures included, but were not limited
to, the early retirement program completed in 1998, and similar measures
employed in prior years by Brooklyn Union. Further, Brooklyn Union's "spin-off"
of non-safety related appliance repair services to KESol in 1998 contributed to
the reduction in operating and maintenance expense for the six months ended June
30, 1999. Brooklyn Union of Long Island discontinued providing non-safety
related appliance repair services on July 1, 1999.
The Company is committed to realizing the forecasted $1 billion of net operating
synergy savings (over a ten-year period) currently being reflected in utility
tariff rates and contracts with LIPA;
25
however, no assurances can be given as to what level of savings
will be realized.
GAS EXPLORATION AND PRODUCTION
Gas Exploration and Production operating expenses for the quarter ended June 30,
1999 were $24.4 million, or 70% of Gas Exploration and Production revenues, as
compared to $26.8 million, or 76% of Gas Exploration and Production revenues,
for the corresponding period last year on a proforma, combined company basis.
Operating expenses were $47.5 million for the six months ended June 30, 1999 as
compared to $52.7 million for the six months ended June 30, 1998 on a proforma,
combined company basis. The comparative decrease in expenses for the quarter and
six months was primarily due to a decrease in depletion expense. In December
1998, THEC recorded a pre-tax impairment charge of $130 million to reduce the
value of its proved gas reserves in accordance with the asset ceiling test
limitations of the SEC applicable to gas exploration and development operations
accounted for under the full cost method. As a result, THEC's depletion rate for
the quarter and six months ended June 30, 1999 was $1.05 per MCFe of production
and $1.04 per MCFe of production, respectively, as compared to $1.25 per MCFe of
production for both the quarter and six months ended June 30, 1998.
ELECTRIC SERVICES
Operating expenses for the quarter and six months ended June 30, 1999 were
$157.3 million and $299.0 million, respectively as compared to $264.3 million
and $616.5 million for the quarter and six months ended June 30, 1998,
respectively. The decrease in operating expenses was due primarily to the
elimination of electric fuel expense. As a result of the LIPA Transaction, and
in accordance with the terms of the EMA, LIPA is responsible for paying directly
the cost of fuel and purchased power. Further, for the quarter and six months
ended June 30, 1999 depreciation expense decreased by $15.9 million and $39.5
million, respectively, and operating taxes decreased by $42.4 million and $105.8
million, respectively, as compared to the corresponding periods last year. Due
to the LIPA Transaction, significant property related assets were sold to LIPA
and, as a result, related depreciation and property taxes are no longer incurred
by the Company. Offsetting these decreases was the effect on operating expenses
associated with electric regulatory amortizations, primarily the Rate Moderation
Component ("RMC"), which reduced operating expenses by $40.0 million in the
quarter ended June 30, 1998 and by $79.9 million in the six months ended June
30, 1998.
ENERGY RELATED SERVICES
Operating expenses for the quarter ended June 30, 1999 were $38.0 million, as
compared to $20.7 million for the quarter ended June 30, 1998 on a proforma,
combined company basis. Operating expenses
26
were $82.0 million for the six months ended June 30, 1999 as compared to $41.2
million for the six months ended June 30, 1998 on a proforma, combined company
basis. The comparative increase in operating expenses for both periods was due
to the formation and commencement of operations of KESol, the acquisition of
Fritze in November 1998 and the integration of operations of other acquired
companies during the past few years and increased purchased gas costs of KES.
OTHER INCOME AND DEDUCTIONS
Other income for the quarter and six months ended June 30, 1999 includes
primarily earnings from the investment of the proceeds from the LIPA Transaction
and equity earnings from subsidiaries comprising the Energy Related Investments
segment, offset by a charge of $6 million to accrue carrying charges on certain
rate settlement items previously recorded. For the three and six months ended
June 30, 1998, other income includes benefits of approximately $10 million
primarily related to certain electric regulatory incentives that have been
discontinued due to the LIPA Transaction.
OTHER EXPENSES
Interest expense for the three and six months ended June 30, 1999 reflects the
significantly reduced level of outstanding debt resulting from the LIPA
Transaction. This benefit was offset, in part, by the interest expense from the
KSE-acquired companies. Upon consummation of the LIPA Transaction, LIPA assumed
substantially all of the outstanding debt of LILCO. The Company, in return,
issued promissory notes to LIPA for its continuing obligation to pay principal
and interest on certain series of debt that were assumed by LIPA. Since the LIPA
Transaction occurred on May 28, 1998, interest expense for the three and six
months ended June 30, 1998 reflects only one month of the reduced level of
outstanding debt. However, interest expense for the three and six months ended
June 30, 1999 reflects the reduction in outstanding debt for the entire periods.
Outstanding debt at June 30, 1999 was $1.6 billion as compared to $4.5 billion
(LILCO only) prior to the LIPA Transaction.
Income tax expense for the quarter and six months ended June 30, 1999 reflects
the level of pre-tax income in both periods and an adjustment to deferred tax
expense and current tax expense for the utilization of a previously deferred net
operating loss carryforward ("NOL") recorded in 1998. In 1998, the Company
recorded, as a deferred tax asset, a benefit of $52.2 million for a NOL that it
will apply in its 1999 federal income tax return. In the quarter ended June 30,
1999, the Company reversed the deferred
27
tax asset and recorded the NOL benefit in its current tax provision in
anticipation of applying this NOL to this year's federal income tax payment.
LIQUIDITY, CAPITAL REQUIREMENTS AND DIVIDENDS
LIQUIDITY
The increase in cash flow from operations for the three and six months ended
June 30, 1999 as compared to the corresponding periods last year, reflects
continued strong results from core utility operations and the benefits from the
integration of KSE-acquired companies. Further, cash flow from operations in
1999 reflects the benefit of the $52.2 million NOL on quarterly federal income
tax payments for 1999, as previously discussed. Moreover, in May 1998, $250
million was funded into other postretirement Voluntary Employee Beneficiary
Trusts and as a result, cash flow from operations for the three and six months
ended June 30, 1998 was adversely affected.
At June 30, 1999, the Company had cash and temporary cash investments of $307.3
million and had available unsecured bank lines of credit of $300 million. In
addition, THEC has an unsecured available line of credit with a commercial bank
that provides for a current commitment of $200 million. This line can be
increased to $250 million, subject to certain conditions. During the quarter
ended June 30, 1999, THEC incurred borrowings of $8.0 million under this
facility, at which time $148 million was outstanding. Subsequent to June 30,
1999, THEC had borrowed an additional $4 million, bringing borrowings under this
facility to $152 million.
CAPITAL REQUIREMENTS
On June 15, 1999 the Company extinguished its promissory note to LIPA relating
to the 7.30% Debentures due July 15, 1999. The Company's obligation for these
debentures of $411.5 million consisted of the principal amount of $397.0 million
and $14.5 million of interest accrued and unpaid. (See Note 9. to the Condensed
Consolidated Financial Statements "Extinguishment of Long-Term Debt.")
The Company acquired the Ravenswood facility on June 18, 1999. As a means of
financing the acquisition, the Company entered into a lease agreement with a
special purpose, unaffiliated financing entity that acquired a portion of the
facility directly from Con Ed and leased it to a subsidiary of the Company. The
lease program was established in order for the Company to finance up to $425
million of the $597 million acquisition cost of the facility. The balance of the
funds needed to acquire the facility were provided from cash on hand. (See Note
10. to the Condensed Consolidated
28
Financial Statements "Contractual Obligations and Contingencies" for more
details on the lease agreement.)
In 1998, the Company's Board of Directors authorized the repurchase of a portion
of the Company's outstanding common stock. The initial authorization permitted
the repurchase of up to 10 percent of the Company's then outstanding stock, or
approximately 15 million common shares. A second authorization permits the
Company to use up to an additional $500 million of cash for the purchase of
common shares. As of July 29, 1999, the Company had repurchased 19.6 million of
its common shares for $568.9 million. In addition, the Company has commenced an
"odd-lot" program whereby holders of less than 100 shares of the Company's
common stock may sell their shares to the Company or "round-up" their holdings
to 100 shares. The Company intends to continue repurchasing its common stock on
the open market.
As a result of the LIPA Transaction, the Company had a significant amount of
cash which it has used to, among other things, repurchase shares of its common
stock on the open market, expand its operations through increased investments in
energy related activities, such as gas processing plants and gas exploration,
and acquire the Ravenswood facility. Management expects to access the financial
markets during the fourth quarter of fiscal 1999 and during fiscal 2000 in order
to issue approximately $500 million of debt securities. It is anticipated that a
combination of tax-exempt debt obligations through the New York State Energy
Research Development Authority ("NYSERDA"), and publicly traded unsecured debt
obligations will be issued. Moreover, the debt may be issued through one or more
wholly owned subsidiaries. It is anticipated that these securities will be
issued to replace debt obligations that have matured, as previously discussed,
and/or provide working capital. In addition, the Company intends to enter into
certain interest rate swap transactions to hedge a portion of its outstanding
fixed rate debt. The specific timing of these transactions will be determined in
light of market conditions and other factors.
In addition, THEC may sell, in one or more offerings, shares of common and
preferred stock, and/or unsecured debt securities. The aggregate initial
offering price of the securities that will be issued are not expected to exceed
$250 million. The specific timing of these offerings, as well as the prices and
terms of the securities to be issued, will be determined in light of market
conditions and other factors. THEC indicated that the net proceeds received from
the sale of any securities will be used for the repayment of debt and general
corporate purposes. The Company intends to, at a minimum, maintain its current
64% ownership
29
interest of THEC and therefore, will purchase additional shares as necessary to
maintain this level of ownership interest.
The Company is currently evaluating its entire capital structure to determine
the appropriate levels of debt and equity. Further, the Company is evaluating
certain credit facilities and may issue commercial paper during the fourth
quarter. The Company anticipates that this evaluation process will be completed
toward the latter part of 1999. At this point in time, except as indicated, the
Company cannot determine the outcome of this evaluation process.
Through a subsidiary, the Company owns a 300-mile fiber optic network on Long
Island and in New York City and is currently in the process of evaluating its
options with respect to the use of this network. Specifically, the options under
consideration include entering into a partnership with or acquiring a
telecommunications company; using excess capacity on the fiber-optic network to
provide services to other carriers, including telecommunications companies,
Internet providers, cable television, as well as providing high-capacity
transmission to commercial customers; or expanding the fiber-optic business
network by bundling energy and telecommunications products and services for
commercial customers.
The Company also continues to explore opportunities for expansion of its
operations through one or more of the following types of transactions: mergers
with or acquisitions of other utilities or entities; investments in new gas
pipelines (and related assets) and gas exploration; or the purchase and/or
construction of additional electric power plants. However, no assurance can be
given that any additional transactions will occur or that such transactions, if
completed, will be integrated with the Company's operations or prove to be
profitable.
DIVIDENDS
On June 21, 1999, the Board of Directors declared a quarterly cash dividend of
$0.445 per share on its outstanding common stock payable on August 1, 1999 to
shareholders of record on July 14, 1999. The Company is currently paying a
dividend at an annual rate of $1.78 per common share. The Company's dividend
policy 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.
GAS DISTRIBUTION - RATE MATTERS
By orders dated February 5, 1998 and April 14, 1998 the NYPSC approved a
Stipulation and Agreement ("Stipulation") among Brooklyn Union, LILCO, the Staff
of the NYPSC and six other parties that in
30
effect approved the KeySpan Acquisition and established gas rates for both
Brooklyn Union and Brooklyn Union of Long Island that are currently in effect.
(For more information on these agreements refer to the Company's Annual Report
on Form 10-K for the Transition Period ended December 31, 1998.)
ENVIRONMENTAL MATTERS
The Company is subject to various federal, state and local laws and regulatory
programs related to the environment. Ongoing environmental compliance
activities, which have not been material, are charged to operation and
maintenance activities. The Company estimates that the remaining minimum cost of
its MGP-related environmental cleanup activities, including costs associated
with Ravenswood, will be approximately $134 million and has recorded a related
liability for such amount. Further, as of June 30, 1999, the Company has
expended a total of $13.2 million. (See Note 6. "Environmental Matters" and Note
10. "Contractual Obligations and Contingencies" to the Condensed Consolidated
Financial Statements.)
YEAR 2000 ISSUES
The Company's computer applications are generally based on two digits and have
required additional programming to recognize the start of the new millennium.
Embedded hardware systems have also been updated in order to properly operate
into the year 2000. The remediation and testing of critical systems necessary
for the reliable and safe delivery of electricity and gas have been completed.
System Readiness
A corporate-wide project has been in progress since 1997 to review Company
software, hardware, embedded systems and associated compliance plans. The
project includes both information technology ("IT") and non-IT systems. Non-IT
systems are basically vendor supplied embedded systems that are critical to the
daily operations of the Company. These systems are generally in the following
areas: electric production, distribution, and transmission; gas distribution;
and communications. The readiness of suppliers and vendor systems has also been
under review. The project is under the direction of the Year 2000 Program
Office, chaired by the Vice President, Technology Operations and Corporate Y2K
Officer.
The critical areas of operations have been addressed through a mission critical
process review methodology. Each of the Company's mission critical processes has
been reviewed to: identify and inventory sub-components; assess for year 2000
compliance;
31
establish repair plans as necessary; and test in a year 2000 environment.
Mission critical functions consist of both service critical functions and
business critical functions. Service critical functions relate to our ability to
procure gas from suppliers and deliver the gas to our customers in a safe and
reliable manner; and to generate electricity and maintain the electric
transmission and distribution system for LIPA. As of July 1, 1999, inventory,
assessment, repair, testing and the development of contingency plans for these
systems have been completed. Business critical systems, which includes metering,
billing and certain financial and accounting systems, are 96% complete in
remediation and 90% complete in testing. Testing of the last of these systems
will be complete by November 1, 1999. Reports have been filed with the NYPSC
documenting, in detail, this status.
Vendors and business partners needed to support the mission critical processes
are also being reviewed for their year 2000 readiness. At this time, none of
these vendors have indicated to the Company that they will be materially
adversely affected by the year 2000 problem. However, many vendors and business
partners have not responded to repeated requests for their year 2000 readiness
status. Included in the Company's overall contingency plans, are contingency
plans that address vendor and business partners year 2000 risks.
Risk Scenarios and Contingency Plans
The Company has analyzed each of the mission critical processes to identify
possible year 2000 risks. Each mission critical process will be certified by the
responsible corporate officer as being year 2000 ready. The most reasonably
likely worst case scenarios have been identified. Operating procedures have been
reviewed to ensure that risks are minimized when entering the year 2000 and
other high risk dates. Contingency plans have been completed to address possible
failure points in each mission critical process. These plans will continue to be
reviewed and revised as necessary. Revisions may be required based on the status
of critical vendors and business partners. Testing of these contingency plans
will continue to be performed internally, as well as with neighboring utilities
and business partners.
While the Company must plan for the following possible worst case scenarios,
management believes that these events are improbable:
LOSS OF GAS PIPELINE DELIVERY
The Company's gas utility subsidiaries receive gas delivery from multiple
national and international pipelines and therefore the effects of a loss in any
one pipeline can be mitigated through the
32
use of other pipelines. Complete loss of all the supply lines is not considered
a reasonable scenario. Nevertheless, the impact of the loss of any one pipeline
is dependent on temperature and vaporization rate. Should gas supply be
decreased due to the loss of a pipeline, each of the Company's gas utility
subsidiaries also has a local liquefied natural gas facility under its direct
control that stores sufficient gas to offset the temporary loss of any one
pipeline. The partial loss of gas supply will not affect the Company's ability
to supply electricity since most of the plants have the ability to operate on
oil.
LOSS OF ELECTRIC GENERATION OR ELECTRIC TRANSMISSION AND
DISTRIBUTION
Electric utilities are physically connected on a regional basis to manage
electric load. This interconnection is often referred to as the regional grid.
Presently the Company is working, on behalf of LIPA, with other regional
utilities to develop a coordinated operating plan. Should there be an
instability in the grid, the Company has the ability to remove LIPA's facilities
and operate independently.
Certain electric system components such as individual generating units, T&D
control facilities, and the electric energy management system have the potential
to be affected by the year 2000 problem. The Company has inventoried both its
and LIPA's electric system components and developed a plan to certify mission
critical processes as year 2000 ready. As manager of the T&D facilities, the
Company is responsible for ensuring that these facilities operate properly and
that related systems are year 2000 ready. Under the terms of the various LIPA
contracts, LIPA will reimburse the Company for certain year 2000 costs incurred
by the Company for these facilities. Contingency plans have been developed,
where appropriate, for loss of critical system elements.
LOSS OF TELECOMMUNICATIONS
The Company has a substantial dependency on many telecommunication systems and
services for both internal and external communication providers. External
communications with the public and the ability of customers to contact the
Company in cases of emergency response is essential. The Company is coordinating
its emergency response efforts with the offices of emergency management of the
various local governments within its service territory. Internally, there are a
number of critical processes in both the gas and electric operating areas that
rely on external communication providers. Contingency plans address methods for
manually monitoring these functions and/or utilizing alternative communication
methods.
33
In addition to the above, the Company has also planned for the following
scenarios: short term reduction in system power generating capability;
limitation to fuel oil operations; reduction in quality of power output; loss of
automated meter reading; loss of ability to read customer meters, prepare bills
and collect and process customer payments; and loss of the purchasing/materials
management system.
The Company believes that, with modifications to existing software and
conversions to new hardware and software, the year 2000 issue will not pose
significant operational problems for its computer systems. However, if such
modifications and conversions do not perform as expected and contingency plans
fail, the year 2000 issue could have a material adverse impact on the operations
of the Company, the extent of which cannot currently be determined.
Cost of Remediation
The Company expects to spend a total of approximately $30.8 million to address
the year 2000 issue. As of June 30, 1999, $21.5 million had been expended on the
project. The largest percentage expended is attributable to the assessment,
repair and testing of corporate IT supported computer software and in-house
written applications. In 1999, the IT year 2000 costs are expected to be 8.3% of
the IT budget. The year 2000 issue has not directly resulted in delaying any
other IT projects. Presently, the Company expects that cash flow from operations
and cash on-hand will be sufficient to fund any remaining year 2000 project
expenditures.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q concerning expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements which are other than statements of
historical facts, are "forward-looking statements" within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended. Without limiting the
foregoing, all statements relating to the Company's anticipated capital
expenditures, future cash flows and borrowings, pursuit of potential future
acquisition opportunities and sources of funding are forward-looking statements.
Such forward-looking statements reflect numerous assumptions and involve a
number of risks and uncertainties and actual results may differ materially from
those discussed in such statements. Among the factors that could cause actual
results to differ materially are: available sources and cost of fuel; federal
and state regulatory initiatives that increase competition, threaten cost and
investment recovery, and impact rate structures; the ability of the Company to
successfully reduce its
34
cost structure; the successful integration of the Company's subsidiaries; the
degree to which the Company develops unregulated business ventures; the ability
of the Company to identify and make complementary acquisitions, as well as the
successful integration of such acquisitions; inflationary trends and interest
rates; the ability of the Company and its significant vendors to modify their
computer software, hardware and databases to accommodate the year 2000; and
other risks detailed from time to time in other reports and other documents
filed by the Company and its predecessors with the Securities and Exchange
Commission. For any of these statements, the Company claims the protection of
the safe harbor for forward-looking information contained in the Private
Securities Litigation Reform Act of 1995, as amended.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company and its subsidiaries are subject to various risk exposures and
uncertainties associated with their operations. The primary risk exposures are
related to firm gas contracts, financial instruments, various regulatory
initiatives of the NYPSC and FERC, the increasingly competitive energy
environment, and foreign currency fluctuations. The Company's exposure to the
aforementioned market risks has remained substantially unchanged from December
31, 1998. However, due to the increased level of investment in Canadian
affiliates in December 1998 and its continued investment in Northern Ireland,
the Company's exposure to foreign currency fluctuations has increased. At June
30, 1999, the Company has approximately $230 million invested in these
affiliates.
Also, during the period from January 1, 1999 to June 30, 1999, Brooklyn Union
utilized derivative instruments, primarily swaps, to "lock-in" approximately 40%
of its profit margins related to sales to its large-volume customers. The
utility tariff applicable to certain large-volume customers permits gas to be
sold at prices established monthly within a specified range expressed as a
percentage of prevailing alternate fuel oil prices. Whenever hedge positions are
in effect, the Company's subsidiaries 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. The Company believes that the credit risk related to the swap
instruments is no greater than that associated with the primary commodity
contracts which they hedge, and that reduction of the exposure to price risk
lowers the Company's overall business risk.
35
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Subsequent to the closing of the LIPA Transaction and KeySpan Acquisition,
former shareholders of LILCO commenced 13 class action lawsuits in the New York
State Supreme Court, Nassau County, against the Company and each of the former
officers and directors of LILCO . These actions were consolidated in August
1998. The consolidated action alleges that, in connection with certain payments
LILCO had determined were payable in connection with the LIPA Transaction and
KeySpan Acquisition to LILCO's chairman, and to former officers of LILCO (the
"Payments"): (i) the named defendants breached their fiduciary duty owed to
LILCO and KSE former and/or current Company shareholders as a result of the
Payments; (ii) the named defendants intended to defraud such shareholders by
means of manipulative, deceptive and wrongful conduct, including materially
inaccurate and incomplete news reports and filings with the SEC; and (iii) the
named defendants recklessly and/or negligently failed to disclose material facts
associated with the Payments.
In addition, three shareholder derivative actions have been commenced pursuant
to which such shareholders seek the return of the Payments or damages resulting
from among other things, an alleged breach of fiduciary duty on the part of the
former LILCO officers and directors. One action was brought on behalf of LILCO
in federal court. The Company moved to dismiss this action in September 1998,
and on June 25, 1999, the federal court issued an order dismissing this action.
The other two actions were brought on behalf of the Company in New York State
Supreme Court, Nassau County. In one of these state court actions, the Company's
directors and the recipients of the Payments are also named as defendants.
Finally, two class action securities suits were filed in federal court alleging
that certain officers and directors of LILCO violated the federal securities
laws by failing to properly disclose that the LIPA Transaction and KeySpan
Acquisitions would trigger the Payments. These actions were consolidated in
October 1998.
On April 28, 1999, the Company signed a Stipulation and Agreement of Settlement
to settle the above-referenced actions, except for the federal court derivative
action, in exchange for (i) $7.9 million to be distributed (less plaintiffs'
attorneys fees) to certain former LILCO and KSE shareholders and certain
MarketSpan shareholders and (ii) the Company's agreement to implement certain
36
corporate governance and executive compensation procedures. In this respect, the
Company has agreed to, among other things, certain requirements with respect to
the composition of its Audit and Compensation and Nominating Committees and has
agreed to be bound by a number of enumerated principles in connection with the
establishment and payment of executive compensation and severance benefits.
These requirements, which are also required to be detailed in the Company's
proxy statements for annual meetings of shareholders, may not be altered or
rescinded prior to January 1, 2002. Further, the entire $7.9 million settlement
commitment will be funded from insurance. The parties have submitted the
settlement to the Nassau County Supreme Court for its review and approval. On
June 30, 1999, following a hearing to consider the fairness of the settlement,
the court gave final approval of the settlement. The parties have submitted to
the court a judgment of settlement and on July 1, 1999 the court approved that
judgment. On August 3, 1999 an intervener plaintiff filed a notice of appeal of
that order and final judgment. Pending the outcome of the appeal, the parties
intend to make an application to the federal court for an order and final
judgment, dismissing the remaining federal court actions based, among other
things, on the binding effect of the state court judgment.
In addition to the above-mentioned actions, a class action lawsuit has also been
filed in the New York State Supreme Court, Suffolk County, by the County of
Suffolk, on behalf of itself and other Suffolk County ratepayers, against
LILCO's former officers and/or directors. The County of Suffolk alleges that the
Payments were improper, and seeks to recover the Payments for the benefit of
Suffolk County ratepayers. The Company moved to consolidate this action with the
above-mentioned consolidated action in October 1998. On May 4, 1999, the parties
submitted a stipulation of discontinuation to the court.
In October 1998, the County of Suffolk and the Towns of Huntington and Babylon
commenced an action against LIPA, the Company, the NYPSC and others in the
United States District Court for the Eastern District of New York (the
"Huntington Lawsuit"). The Huntington Lawsuit alleges, among other things, that
LILCO ratepayers (i) have a property right to receive or share in the alleged
capital gain that resulted from the transaction with LIPA (which gain is alleged
to be at least $1 billion); and (ii) that LILCO was required to refund to
ratepayers the amount of a Shoreham-related deferred tax reserve (alleged to be
at least $800 million) carried on the books of LILCO at the consummation of the
LIPA Transaction. In December 1998, and again in June 1999, the plaintiffs
amended their complaint. The amended complaint contains allegations relating to
the Payments and adds the
37
recipients of the Payments as defendants. In June 1999, the Company was served
with the second amended complaint. The Company intends to file a motion to
dismiss the second amended complaint.
Finally, certain other proceedings have been commenced relating to the Payments
and disclosures made by LILCO with respect thereto. These proceedings include
investigations by the New York State Attorney General, the NYPSC and LIPA, joint
hearings conducted by two committees of the New York State Assembly, and an
informal, non-public inquiry by the SEC. In December 1998, the Company settled
with LIPA and the NYPSC. The agreement includes a payment of $5.2 million by the
Company to LIPA that will be used by LIPA to supply postage-paid bill return
envelopes to customers for the next three years. The Company also agreed to
fully reimburse and indemnify LIPA for costs incurred by LIPA, amounting to
approximately $765,000, for attorneys and other consultants involved in the
investigation. Such amounts are not covered by insurance. In March 1999, the
Company settled with the New York Attorney General. The Company agreed to
implement and adhere to the corporate governance and executive compensation
procedures in accordance with the settlement of the shareholder actions and pay
the New York Attorney General $1.5 million. One half of the $1.5 million will be
covered by insurance. To date, no action has been taken by the SEC.
At this time the Company is unable to determine the outcome of the ongoing
proceedings, or any of the remaining lawsuits described above.
38
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Shareholders was held on May 20, 1999 (Annual
Meeting). The persons named below were elected as Directors by holders of the
Company's Common Stock, casting votes in favor or withholding votes as
indicated:
VOTES VOTES
DIRECTOR IN FAVOR WITHHELD
LILYAN H. AFFINITO 106,283,893 14,873,860
GEORGE BUGLIARELLO 106,386,066 14,771,687
ROBERT B. CATELL 106,496,729 14,661,024
HOWARD R. CURD 106,473,146 14,684,607
RICHARD N. DANIEL 106,567,865 14,589,888
DONALD H. ELLIOTT 106,519,662 14,638,091
ALAN H. FISHMAN 106,590,334 14,567,419
JAMES R. JONES 106,468,778 14,688,975
STEPHEN W. MCKESSY 106,534,614 14,623,139
EDWARD D. MILLER 106,579,640 14,578,113
BASIL A. PATERSON 106,353,423 14,804,330
JAMES Q. RIORDAN 106,458,082 14,699,671
FREDERIC V. SALERNO 106,509,267 14,648,486
VINCENT TESE 106,478,822 14,678,931
The voting results of the other items that were approved by shareholders at the
Annual Meeting are as follows:
1. Ratification of the appointment of Arthur Andersen LLP as independent
auditors for the period January 1, 1999 to December 31, 1999.
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
COMMON SHARES 119,885,950 601,527 670,276 NOT APPLICABLE
39
2. Approval of an amendment of the Company's Certificate of Incorporation to
change the Company's name to KeySpan Corporation.
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
COMMON SHARES 119,681,554 824,064 652,135 NOT APPLICABLE
3. Approval of the Company's Employee Discount Stock Purchase Plan.
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
COMMON SHARES 94,063,633 4,485,779 1,485,805 21,122,536
4. Approval of the Company's Long-Term Performance Incentive Compensation
Plan.
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
COMMON SHARES 75,968,065 22,006,732 2,060,420 21,122,536
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
*3.1 Certificate of Incorporation of the Company effective
April 16, 1998, Amendment to
Certificate of Incorporation of the Company effective May
26, 1998, Amendment to
Certificate of Incorporation of the Company effective May
26, 1998, Amendment to
Certificate of Incorporation of the Company effective
April 7, 1999, and Amendment to
Certificate of Incorporation of the Company effective May 20, 1999.
*10.1 Guaranty, dated as of June 9, 1999, from the Company in favor of
LIC Funding, Limited Partnership.
40
*10.2 Lease Agreement, dated as of June 9, 1999, between LIC
Funding, Limited Partnership and KeySpan-Ravenswood, Inc.
(Section 12(b)(i), (ii) and (iii) and Section 12(c)(i),
(ii) and (iii), have been omitted from the material and
filed separately with the Securities and Exchange
Commission pursuant to a request for confidential
treatment. These sections appear on pages 60 and 61 of
the complete document).
*10.3 Long-Term Performance Incentive Compensation Plan
effective May 20, 1999.
*27 Financial Data Schedule
(b) Reports on Form 8-K
In its Report on Form 8-K dated May 20, 1999, the Company reported that it
changed its corporate name from MarketSpan Corporation to KeySpan Corporation.
In its Report on Form 8-K dated June 22, 1999, the Company reported that on June
18, 1999 it acquired the 2,168 megawatt Ravenswood electric generation facility
from the Consolidated Edison Company of New York, Inc.
- -------------------------
*Filed Herewith
41
KEYSPAN CORPORATION AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf of the undersigned
there unto duly authorized.
KEYSPAN CORPORATION
(Registrant)
Date August 13, 1999 s/ Ronald S. Jendras
------------------------------
Ronald S. Jendras
Vice President, Controller
and Chief Accounting Officer