FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENT RESPONSIBILITY
The Consolidated Financial Statements of the Company and its subsidiaries were
prepared by management in conformity with generally accepted accounting
principles.
The Company's system of internal controls is designed to provide reasonable
assurance that assets are safeguarded and that transactions are executed in
accordance with management's authorizations and recorded to permit preparation
of financial statements that present fairly the financial position and operating
results of the Company. The Company's internal auditors evaluate and test the
system of internal controls. The Company's Vice President and General Auditor
reports directly to the Audit Committee of the Board of Directors, which is
composed entirely of outside directors. The Audit Committee meets periodically
with management, the Vice President and General Auditor and Arthur Andersen LLP
to review and discuss internal accounting controls, audit results, accounting
principles and practices and financial reporting matters.
CONSOLIDATED BALANCE SHEET
(In Thousands of Dollars)
====================================================================================================================
DECEMBER 31, 1998 March 31, 1998
====================================================================================================================
ASSETS
PROPERTY
Electric $ 1,109,199 $ 4,102,166
Gas 3,257,726 1,246,432
Common 345,007 343,341
Accumulated depreciation (1,480,038) (1,877,858)
Gas exploration and production, at cost 994,104 -
Accumulated depletion (447,733) -
- --------------------------------------------------------------------------------------------------------------------
3,778,265 3,814,081
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
EQUITY INVESTMENTS AND OTHER 341,346 50,816
- --------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS
Cash and temporary cash investments 942,776 180,919
Customer accounts receivable 142,307 321,372
Accrued revenues 178,529 124,464
Other accounts receivable 230,479 43,744
Allowance for uncollectible accounts (20,026) (23,483)
Special deposits 145,684 95,790
Gas in storage, at average cost 145,277 14,634
Fuel oil, at average cost - 32,142
Materials and supplies, at average cost 74,193 54,883
Other 72,818 13,807
- --------------------------------------------------------------------------------------------------------------------
1,912,037 858,272
- --------------------------------------------------------------------------------------------------------------------
DEFERRED CHARGES
Regulatory assets
Electric related - 6,768,148
Other 279,524 163,765
Goodwill 201,887 -
Other 382,043 245,643
- --------------------------------------------------------------------------------------------------------------------
863,454 7,177,556
- --------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 6,895,102 $ 11,900,725
====================================================================================================================
The Notes to Consolidated Financial Statements are an integral part of these
statements.
8
CONSOLIDATED BALANCE SHEET
(In Thousands of Dollars)
====================================================================================================================
DECEMBER 31, 1998 March 31, 1998
====================================================================================================================
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common stock $ 2,973,388 $ 1,707,559
Retained earnings 474,188 956,092
Accumulated foreign currency adjustment (952) -
Treasury stock purchased (423,716) (1,204)
- --------------------------------------------------------------------------------------------------------------------
Total common shareholders' equity 3,022,908 2,662,447
Preferred stock 447,973 562,600
Long-term debt 1,619,067 4,381,949
- --------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION 5,089,948 7,606,996
- --------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES
Current maturities of long-term debt 398,000 101,000
Current redemption requirements of preferred stock - 139,374
Accounts payable and accrued expenses 519,288 318,701
Dividends payable 66,232 58,748
Taxes accrued 69,742 34,753
Customer deposits 29,774 28,627
Interest accrued 19,965 146,607
- --------------------------------------------------------------------------------------------------------------------
1,103,001 827,810
- --------------------------------------------------------------------------------------------------------------------
DEFERRED CREDITS AND OTHER LIABILITIES
Regulatory liabilities
Electric related - 358,363
Other 53,137 31,068
Deferred federal income tax 71,549 2,539,364
Postretirement benefits, claims & other reserves 457,459 467,655
Other 50,457 69,469
- --------------------------------------------------------------------------------------------------------------------
632,602 3,465,919
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
MINORITY INTEREST IN SUBSIDIARY COMPANY 69,551 -
- --------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION AND LIABILITIES $ 6,895,102 $ 11,900,725
====================================================================================================================
The Notes to Consolidated Financial Statements are an integral part of these
statements.
9
CONSOLIDATED STATEMENT OF INCOME
(In Thousands of Dollars, Except Per Share Amounts)
- ------------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS Twelve Months Three Months
ENDED Ended Ended Year Ended
DECEMBER 31, 1998 March 31, 1998 March 31, 1997 December 31, 1996
- ------------------------------------------------------------------------------------------------------------------------------------
REVENUES
Gas distribution $ 849,543 $ 645,659 $ 293,391 $ 684,260
Gas exploration and production 70,812 - - -
Electric services 408,305 - - -
Electric distribution 330,011 2,478,435 557,791 2,466,435
Other 63,181 - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total Revenues 1,721,852 3,124,094 851,182 3,150,695
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Purchased gas 318,703 299,469 136,727 322,641
Fuel and purchased power 91,762 658,338 165,140 640,610
Operations 734,957 400,045 95,673 381,076
Maintenance 113,714 111,120 29,340 118,135
Depreciation, depletion and amortization 294,864 169,770 39,820 171,681
Electric regulatory amortizations (40,005) 13,359 19,966 97,698
Operating taxes 257,124 466,326 117,513 472,076
Federal income taxes (credit) (62,506) 237,371 57,002 210,197
- ------------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 1,708,613 2,355,798 661,181 2,414,114
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME 13,239 768,296 190,001 736,581
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME AND (DEDUCTIONS)
Transaction related expenses (107,912) - - -
(net of $99,701 income tax )
Interest and other-net 37,314 (1,583) 3,574 27,512
Minority interest 29,141 - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total Other Income and (Deductions) (41,457) (1,583) 3,574 27,512
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INTEREST CHARGES (28,218) 766,713 193,575 764,093
- ------------------------------------------------------------------------------------------------------------------------------------
Interest charges 138,715 404,473 105,878 447,629
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (166,933) 362,240 87,697 316,464
Preferred stock dividend requirements 28,604 51,813 12,969 52,216
- ------------------------------------------------------------------------------------------------------------------------------------
EARNINGS (LOSS) FOR COMMON STOCK $ (195,537) $ 310,427 $ 74,728 $ 264,248
- ------------------------------------------------------------------------------------------------------------------------------------
Foreign currency adjustment (952) - - -
====================================================================================================================================
COMPREHENSIVE INCOME (LOSS) $ (196,489) $ 310,427 $ 74,728 $ 264,248
====================================================================================================================================
Average common shares outstanding (000) 145,767 121,415 120,995 120,360
BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE $ (1.34) $ 2.56 $ 0.62 $ 2.20
====================================================================================================================================
10
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands of Dollars)
- ------------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS Twelve Months Three Months
ENDED Ended Ended Year Ended
DECEMBER 31, 1998 March 31, 1998 March 31, 1997 December 31, 1996
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income (Loss) $ (166,933) $ 362,240 $ 87,697 $ 316,464
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Depreciation, depletion and amortization 294,864 169,770 39,820 171,681
Regulatory amortization and other (40,005) (10,273) 14,047 72,439
Deferred federal income tax (85,936) 146,859 32,835 167,060
Income from equity investments (5,842) - - -
Dividends from equity investments 4,219 - - -
CHANGES IN ASSETS AND LIABILITIES (NET OF ACQUISITION)
Accounts receivable and accrued revenues (81,024) 8,334 (26,817) 92,334
Pensions and other postretirement benefits (283,774) - - -
Materials and supplies, fuel oil and gas in storage (63,195) 14,391 67,242 (34,531)
Accounts payable and accrued expenses 132,028 (54,835) (69,958) (13,826)
Interest accrued (151,268) (2,624) 16,632 (2,289)
Special deposits (41,040) (58,159) 635 25,146
Other 27,618 98,381 (2,566) 97,835
- ------------------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities (460,288) 674,084 159,567 892,313
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Capital expenditures (676,563) (297,230) (62,479) (291,618)
Net cash from KeySpan Acquisition 165,168 - - -
Net proceeds from LIPA Transaction 2,314,588 - - -
Miscellaneous investment 13,466 (31,987) 160 (4,806)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities 1,816,659 (329,217) (62,319) (296,424)
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from sale of common stock 10,170 43,218 4,640 18,837
Treasury stock purchased (423,716) - - -
Issuance of preferred stock 84,973 - - -
Issuance of long-term debt 112,535 - - -
Redemption of long-term debt (103,000) (2,050) (250,000) (419,800)
Preferred stock dividends paid (28,604) (51,833) (12,969) (52,264)
Common stock dividends paid (210,177) (215,790) (53,749) (213,753)
Other (36,695) (2,032) (624) (369)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Cash (Used in) Financing Activities (594,514) (228,487) (312,702) (667,349)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 761,857 116,380 (215,454) (71,460)
====================================================================================================================================
Cash and cash equivalents at beginning of period $ 180,919 $ 64,539 $ 279,993 $ 351,453
Net increase (decrease) in cash and cash equivalents 761,857 116,380 (215,454) (71,460)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 942,776 $ 180,919 $ 64,539 $ 279,993
====================================================================================================================================
Interest paid $125,914 $364,864 $112,981 $404,663
Federal income tax paid $94,680 $108,980 - $45,050
The Notes to Consolidated Financial Statements are an integral part of these
statements.
11
CONSOLIDATED STATEMENT OF RETAINED EARNINGS
(In Thousands of Dollars)
==============================================================================================================================
DECEMBER 31, 1998 March 31, 1998 March 31, 1997 December 31, 1996
==============================================================================================================================
Balance at beginning of period $ 956,092 $ 861,751 $ 840,867 $ 790,919
Net income (loss) for period (166,933) 362,240 87,697 316,464
- ------------------------------------------------------------------------------------------------------------------------------
789,159 1,223,991 928,564 1,107,383
- ------------------------------------------------------------------------------------------------------------------------------
Deductions
Cash dividends declared on common stock 214,012 216,086 53,844 214,255
Cash dividends declared on preferred stock 28,604 51,813 12,969 52,240
Other, primarily write-off of 72,355 - - 21
capital stock expense
- ------------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 474,188 $ 956,092 $ 861,751 $ 840,867
- ------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
12
CONSOLIDATED STATEMENT OF CAPITALIZATION
==================================================================================================================================
Shares Issued (In Thousands of Dollars)
- ----------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1998 March 31, 1998 DECEMBER 31, 1998 March 31, 1998
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON SHAREHOLDERS' EQUITY
Common stock, $0.01 par value 144,628,654 $ 1,446 $ -
$5.00 par value 121,727,040 - 608,635
Premium on capital stock 2,971,942 1,098,924
Retained earnings 474,188 956,092
Accumulated foreign currency adjustment (952) -
Treasury stock, at cost 14,209,000 46,281 (423,716) (1,204)
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON SHAREHOLDERS' EQUITY 3,022,908 2,662,447
- ----------------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK - REDEMPTION REQUIRED
Par value $100 per share
7.40% Series L - 150,500 - 15,050
7.66% Series CC - 570,000 - 57,000
Less - Series called for redemption - - - 15,050
- ----------------------------------------------------------------------------------------------------------------------------------
- 57,000
- ----------------------------------------------------------------------------------------------------------------------------------
Par value $25 per share
7.95% Series AA 14,520,000 14,520,000 363,000 363,000
$1.67 Series GG - 880,000 - 22,000
$1.95 Series NN - 1,554,000 - 38,850
7.05% Series QQ - 3,464,000 - 86,600
6.875% Series UU - 2,240,000 - 56,000
Less - Series called for redemption - - - 38,850
Less - Mandatory redemption of preferred stock - - - 22,000
- ----------------------------------------------------------------------------------------------------------------------------------
363,000 505,600
- ----------------------------------------------------------------------------------------------------------------------------------
Total Preferred Stock - Redemption Required 363,000 562,600
- ----------------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK - NO REDEMPTION REQUIRED
Par value $100 per share
7.07% Series B - private placement 553,000 - 55,300 -
7.17% Series C - private placement 197,000 - 19,700 -
6.00% Series A - private placement 99,727 - 9,973 -
5.00% Series B - 100,000 - 10,000
4.25% Series D - 70,000 - 7,000
4.35% Series E - 200,000 - 20,000
4.35% Series F - 50,000 - 5,000
5 1/8% Series H - 200,000 - 20,000
5 3/4% Series I - Convertible - 14,743 - 1,474
Less - Series called for redemption - - - 63,474
- ----------------------------------------------------------------------------------------------------------------------------------
Total Preferred Stock - No Redemption Required 84,973 -
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK $ 447,973 $ 562,600
- ----------------------------------------------------------------------------------------------------------------------------------
The Notes to Consolidated Financial Statements are an integral part of these
statements.
13
CONSOLIDATED STATEMENT OF CAPITALIZATION (CONTINUED)
==================================================================================================================================
(In Thousands of Dollars)
Long-Term Debt Interest Rate Series DECEMBER 31, 1998 March 31, 1998
- ----------------------------------------------------------------------------------------------------------------------------------
GENERAL AND REFUNDING BONDS
April 15, 1998 through July 1, 2024 9 5/8% - 7 5/8% various $ - $ 1,286,000
- ----------------------------------------------------------------------------------------------------------------------------------
Total General and Refunding Bonds - 1,286,000
- ----------------------------------------------------------------------------------------------------------------------------------
DEBENTURES
July 15, 1999 through March 15, 2023 9.00% - 6.25% various - 2,270,000
- ----------------------------------------------------------------------------------------------------------------------------------
Total Debentures - 2,270,000
- ----------------------------------------------------------------------------------------------------------------------------------
AUTHORITY FINANCING NOTES
INDUSTRIAL DEVELOPMENT REVENUE BONDS
December 1, 2006 7.50% 1976 A,B - 2,000
POLLUTION CONTROL REVENUE BONDS
December 1, 2006 through March 1, 2016 8.25% - 3.58% various - 213,675
ELECTRIC FACILITIES REVENUE BONDS
September 1, 2019 through August 1, 2025 7.15% - 3.70% various - 724,880
December 1, 2027 variable 1997 A 24,880 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total Authority Financing Notes 24,880 940,555
- ----------------------------------------------------------------------------------------------------------------------------------
PROMISSORY NOTES TO LIPA
DEBENTURES
July 15, 1999 7.30% 397,000 -
March 15, 2023 8.20% 270,000 -
POLLUTION CONTROL REVENUE BONDS
December 1, 2006 7.50% 1976 A 26,375 -
December 1, 2009 7.80% 1979 B 19,100 -
March 1, 2016 variable 1985 A 58,022 -
March 1, 2016 variable 1985 B 50,000 -
ELECTRIC FACILITIES REVENUE BONDS
September 1, 2019 7.15% 1989 B 35,030 -
June 1, 2020 7.15% 1990 A 73,900 -
December 1, 2020 7.15% 1991 A 26,560 -
February 1, 2022 7.15% 1992 B 13,455 -
August 1, 2022 6.90% 1992 D 28,060 -
November 1, 2023 variable 1993 B 29,600 -
October 1, 2024 variable 1994 A 2,600 -
August 1, 2025 variable 1995 A 15,200 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total Promissory Notes to LIPA 1,044,902 -
- ----------------------------------------------------------------------------------------------------------------------------------
GAS FACILITIES REVENUE BONDS
April 1, 2020 6.368% 1993 A,B 75,000 -
January 1, 2021 5.50% 1996 153,500 -
February 1, 2024 6.75% 1989 A 45,000 -
February 1, 2024 6.75% 1989 B 45,000 -
June 1, 2025 5.60% 1993 C 55,000 -
July 1, 2026 6.95% 1991 A, B 100,000 -
July 1, 2026 5.635% 1993 D-1, D-2 50,000 -
December 1, 2020 variable 1997 125,000 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total Gas Facilities Revenue Bonds 648,500 -
- ----------------------------------------------------------------------------------------------------------------------------------
Unamortized Discount on Debt (1,750) (13,606)
- ----------------------------------------------------------------------------------------------------------------------------------
Total 1,716,532 4,482,949
Less Current Maturities 398,000 101,000
Other Subsidiary Debt 300,535 -
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT 1,619,067 4,381,949
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION $ 5,089,948 $ 7,606,996
==================================================================================================================================
The Notes to Consolidated Financial Statements are an integral part of these
statements.
14
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. REORGANIZATION
MarketSpan Corporation d/b/a KeySpan Energy (the "Company") is the successor to
Long Island Lighting Company ("LILCO"), as a result of a transaction with the
Long Island Power Authority ("LIPA") (the "LIPA Transaction") and following the
acquisition (the "KeySpan 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. As a result of the transaction with LIPA, LILCO became a
wholly-owned subsidiary of LIPA, a public authority and a political subdivision
of New York State. KSE, a wholly-owned subsidiary of the Company and also an
exempt utility holding company under the Public Utility Holding Company Act of
1935, as amended, is no longer a registrant under the Securities Act of 1933, as
amended, and the Securities Exchange Act of 1934, 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 system acquired by LIPA; and (ii)
acquired KSE, the parent company of The Brooklyn Union Gas Company ("Brooklyn
Union"). (See Note 2, "Sale of LILCO Assets, Acquisition of KeySpan Energy
Corporation and Transfer of Assets and Liabilities to the Company.")
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 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.
On September 10, 1998, the Company's Board of Directors authorized filings to
permit the Company to conduct its business under the name KeySpan Energy. The
Company will propose a formal name change for shareholder approval at its 1999
Annual Meeting of Shareholders. On October 20, 1998 the Company's symbol for its
common stock and preferred stock Series AA listed on the New York and Pacific
Stock Exchanges was changed to "KSE."
B. BASIS OF PRESENTATION
The Consolidated Financial Statements presented herein reflect the accounts of
the Company and its subsidiaries. Subsidiaries comprising the Gas Exploration
and Production reportable segment
15
and the Energy Related Services reportable segment are fully consolidated in the
financial information presented. All other subsidiary investments are accounted
for on the equity method as the Company does not have a controlling voting
interest or otherwise have control over the management of investee companies.
All significant intercompany transactions have been eliminated.
Certain reclassifications were made to conform prior period financial statements
with the current period financial statement presentation.
For financial reporting purposes, LILCO is deemed the acquiring company pursuant
to a purchase accounting transaction, in which KSE was acquired. Consequently,
financial results of the Company prior to May 29, 1998 reflect those of LILCO
only. Since the acquisition of KSE was accounted for as a purchase, related
accounting adjustments, including goodwill, have been reflected in the financial
statements herein. Further, the financial statements presented reflect the
results of operations of LILCO from April 1, 1998 through May 28, 1998 and of
the fully consolidated entity from May 29, 1998 through December 31, 1998. In
September 1998, the Company changed its fiscal year end to December 31. Further,
in April 1997, LILCO changed its year end from December 31 to March 31. As a
result, the financial statements presented herein include the nine month
transition period April 1, 1998 through December 31, 1998 (the "Transition
Period"), the twelve months ended March 31 1998, the three months ended March
31, 1997 and the twelve months ended December 31, 1996.
The weighted average number of common shares outstanding used in the calculation
of earnings per share for the nine months ended December 31, 1998 reflected the
issuance of common stock to consummate the KeySpan Acquisition and the reduction
associated with repurchases of common stock subsequent to August 17, 1998. (See
Note 5, "Capital Stock.") Further, as of December 31, 1998, the Company had
outstanding 921,066 unexercised common stock options held by key Company
employees. These options have not been considered in measuring diluted earnings
per share, since inclusion of these options in the calculation would have
resulted in an antidilutive effect for the Transition Period.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
16
C. ACCOUNTING FOR THE EFFECTS OF RATE REGULATION
The Company's accounting records for its two regulated gas utilities and its
generation subsidiary are maintained in accordance with the Uniform System of
Accounts prescribed by the Public Service Commission of the State of New York
("NYPSC") and the Federal Energy Regulatory Commission ("FERC"), respectively.
The Company's financial statements reflect the ratemaking policies and actions
of these regulators in conformity with generally accepted accounting principles
for rate- regulated enterprises.
The Company's two regulated gas utilities and its electric generation subsidiary
are subject to the provisions of Statement of Financial Accounting Standards
("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation."
This statement recognizes the ability of regulators, through the ratemaking
process, to create future economic benefits and obligations affecting
rate-regulated companies. Accordingly, the Company records these future economic
benefits and obligations as regulatory assets and regulatory liabilities,
respectively.
The Company's regulatory assets of $279.5 million at December 31, 1998 are
primarily comprised of regulatory tax assets, certain environmental remediation
and investigation costs, postretirement benefits other than pensions and costs
associated with the KeySpan Acquisition.
Rate regulation is undergoing significant change as regulators and customers
seek lower prices for utility service and greater competition among energy
service providers. In the event that regulation significantly changes the
opportunity for the Company to recover its costs in the future, all or a portion
of the Company's regulated operations may no longer meet the criteria for the
application of SFAS No. 71. In that event, a write-down of all or a portion of
the Company's existing regulatory assets and liabilities could result. If the
Company had been unable to continue to apply the provisions of SFAS No. 71 at
December 31, 1998, the Company would have applied the provisions of SFAS No. 101
"Regulated Enterprises - Accounting for the Discontinuation of Application of
FASB Statement No. 71." The Company estimates that the write-off of its net
regulatory asset (regulatory assets less regulatory liabilities) could result in
a charge to net income of $147.2 million or $1.01 per share of common stock,
which would be classified as an extraordinary item. In management's opinion, the
Company's regulated subsidiaries will be subject to SFAS No. 71 for the
foreseeable future.
As part of the LIPA Transaction, the Company has entered into various service
agreements with LIPA that prescribe the conduct of the Company's electric
operations. These agreements allow the Company to recover its costs, subject to
negotiation, incurred to service the agreements and potentially allow the
Company to earn a certain level of profit. The Company's electric operations,
other than the generation function which is FERC regulated, are no longer
subject to NYPSC rate regulation and as a result the Company no longer applies
SFAS No. 71 to its electric operations. As a result of the LIPA Transaction, all
regulatory assets and liabilities outstanding as of May 28, 1998 associated with
the Company's electric operations have been either sold or written-off and
therefore, are no longer recorded in the accounts of the Company. In addition,
certain issues relating to prior
17
electric operations, such as nuclear plant decommissioning and nuclear plant
insurance are no longer applicable to the Company since these assets were sold
to LIPA. The net regulatory assets that were sold to LIPA as part of the LIPA
Transaction amounted to $6.3 billion. See Note 13, "Disaggregated Condensed
Balance Sheet (Unaudited)" for additional information.
D. REVENUES
Utility gas customers are billed monthly and bi-monthly on a cycle basis.
Revenues include unbilled amounts related to the estimated gas usage that
occurred from the most recent meter reading to the end of each month.
The cost of gas is recovered as incurred when billed to firm customers through
the operation of the gas adjustment clause ("GAC") included in utility tariffs.
The GAC provision requires an annual reconciliation of recoverable gas costs and
GAC revenues. Any difference is deferred pending recovery from or refund to firm
customers during a subsequent twelve-month period. Further, net revenues from
tariff gas balancing services, off-system sales and certain on-system
interruptible sales are refunded to firm customers subject to certain sharing
provisions.
The gas utility tariffs contain a weather normalization adjustment that largely
offsets shortfalls or excesses of firm net revenues (revenues less gas costs)
during a heating season due to variations from normal weather.
Electric revenues since the LIPA Transaction are primarily derived from billings
to LIPA for management of LIPA's transmission and distribution ("T&D") system,
electric generation, and procurement of fuel. The agreements with LIPA include
provisions for the Company, to earn in the aggregate, approximately $11.5
million per year (plus up to an additional $5 million per year if certain cost
savings are achieved) in annual management service fees from LIPA for the
management of the LIPA T&D system and the management of all aspects of fuel and
power supply. Costs in excess of budgeted levels are assumed by the Company up
to $15 million, while cost reductions in excess of $5 million from budgeted
levels are shared with LIPA. These agreements also contain certain non-cost
incentive and penalty provisions which could impact earnings. Billings
associated with generation capacity are based on pre-determined levels of supply
to be dispatched to LIPA on a yearly basis. Rates charged to LIPA include fixed
and variable components. The variable component is billed to LIPA on a monthly
basis and is dependent on the amount of megawatt hours dispatched. In addition,
billings related to transmission, distribution and delivery services are based,
in part, on negotiated budgeted levels.
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 eliminated the impact on earnings of electric
sales that were above or below the levels reflected in rates. Moreover, LILCO's
electric tariff included a fuel cost adjustment ("FCA") clause which provided
for the disposition of the difference between actual
18
fuel costs and the fuel costs allowed in base tariff rates (base fuel costs).
LILCO deferred these differences to future periods for recovery from or refund
to customers, except for base electric fuel costs in excess of actual electric
fuel costs, which were credited to the Rate Moderation Component as incurred.
E. UTILITY PROPERTY - DEPRECIATION AND MAINTENANCE
Utility gas property is stated at original cost of construction, which includes
allocations of overheads and taxes and an allowance for funds used during
construction. Mass properties associated with gas operations, such as meters,
are accounted for on an average unit cost basis by year of installation. Prior
to the LIPA Transaction, electric T&D mass properties, such as poles and wire,
were accounted for on an average unit cost basis by year of installation. As
part of the LIPA Transaction, all T&D assets were sold to LIPA, and as a result,
all costs associated with the maintenance of the T&D system subsequent to May
28, 1998 are expensed and charged to LIPA.
Depreciation is provided on a straight-line basis in amounts equivalent to
composite rates on average depreciable property. The cost of property retired,
plus the cost of removal less salvage, is charged to accumulated depreciation.
The cost of repair and minor replacement and renewal of property is charged to
maintenance expense. The composite rates on average depreciable property were as
follows:
Period Electric Gas
------ -------- ---
9 Months Ended 12/31/98 2.40% 1.75%
12 Months Ended 3/31/98 3.07% 2.04%
3 Months Ended 3/31/97 .78% .51%
12 Months Ended 12/31/96 3.00% 2.00%
F. GAS EXPLORATION AND PRODUCTION PROPERTY- DEPLETION AND DEPRECIATION
The full cost method of accounting is used for investments in natural gas and
oil properties. Under this method, all costs of acquisition, exploration and
development of natural gas and oil reserves are capitalized into a "full cost
pool" as incurred, and properties in the pool are depleted and charged to
operations using the unit-of-production method based on the ratio of current
production to total proved natural gas and oil reserves. To the extent that such
capitalized costs (net of accumulated depreciation, depletion and amortization)
less deferred taxes exceed the present value (using a 10% discount rate) of
estimated future net cash flows from proved natural gas and oil reserves and the
lower of cost or fair value of unproved properties, such excess costs are
charged to operations. If a write-down is required, it would result in a charge
to earnings but would not have an impact on cash flows from operating
activities. Once incurred, such impairment of gas properties is not reversible
at a later date even if gas prices increase. At December 31, 1998, The Houston
Exploration Company ("THEC"), the Company's 64% owned gas and oil exploration
and production subsidiary, recorded a $130 million write-down to its investment
in its proved gas reserves, which
19
is reflected in the accompanying financial statements. As permitted under
generally accepted accounting principles, THEC utilized February 1999 prices to
measure the write-down. If THEC had utilized December 1998 prices to measure the
write-down, the write-down would have been $66.6 million less.
Provisions for depreciation of all other non-utility property are computed on a
straight line basis over useful lives of three to ten years.
G. DERIVATIVE FINANCIAL INSTRUMENTS
The Company's utility, marketing and gas and oil exploration and production
subsidiaries employ, from time to time, derivative financial instruments to
hedge exposure in cash flows due to fluctuations in the price of natural gas.
Utility hedging activities also involve use of derivatives related to fuel oil,
which in certain markets strongly influence the selling price for natural gas.
The Company's hedging strategies meet the criteria for hedge accounting
treatment under SFAS No. 80, "Accounting for Futures Contracts." Accordingly,
gains and losses on these instruments are recognized concurrently with the
recognition of the related physical transactions.
The subsidiaries regularly assess the relationship between natural gas commodity
prices in "cash" and futures markets. The correlation between prices in these
markets has been within a range generally deemed to be acceptable. If the
correlation were not to remain in an acceptable range, the subsidiaries would
account for financial instrument positions as trading activities.
H. EQUITY INVESTMENTS
Certain subsidiaries own as their principal assets investments, including
goodwill, representing ownership interests of 50% or less in energy-related
businesses that are accounted for under the equity method. Goodwill, at December
31, 1998, was $52.2 million for certain investments in Canada and Northern
Ireland. The amortization period for the goodwill is over 15 and 40 years.
I. FEDERAL INCOME TAX
In accordance with SFAS No. 109, "Accounting for Income Taxes" and NYPSC policy,
certain of the Company's regulated subsidiaries recorded a regulatory asset for
the net cumulative effect of having to provide deferred federal income taxes on
all differences between tax and book bases of assets and liabilities at the
current tax rate which have not yet been included in rates to customers.
Investment tax credits, which were available prior to the Tax Reform Act of
1986, were deferred in operating expense and are amortized as a reduction of
federal income tax in other income over the estimated lives of the related
property.
20
J. SUBSIDIARY COMMON STOCK ISSUANCES TO THIRD PARTIES
The Company follows an accounting policy of income statement recognition for
parent company gains or losses from issuances of common stock by subsidiaries.
K. Foreign Currency Translation
The Company follows the principles of SFAS No. 52, "Foreign Currency
Translation," for recording its investments in foreign affiliates. Under this
statement, all elements of financial statements are translated by using a
current exchange rate. Translation adjustments result from changes in exchange
rates from one reporting period to another. At December 31, 1998, the foreign
currency translation adjustment was included in a separate component of
shareholders' equity.
L. GOODWILL
At December 31, 1998, the Company has recorded goodwill in the amount of $201.9
million, representing the excess of acquisition cost over the fair value of net
assets acquired related to its purchases of certain consolidated subsidiaries.
Goodwill is amortized over 20 to 40 years. The Company recorded goodwill of
approximately $177.4 million net of accumulated amortization of $2.5 million
relating to the KeySpan Acquisition and approximately $24.5 million related to
the acquisition of a heating, ventilating, and air-conditioning company and the
acquisition of an engineering firm.
M. RECENT ACCOUNTING PRONOUNCEMENTS
COMPREHENSIVE INCOME
The Company has adopted SFAS No. 130 "Comprehensive Income." Comprehensive
income is the change in the equity of a company, not including those changes
that result from shareholder transactions. All components of comprehensive
income are required to be reported in a new financial statement that is
displayed with equal prominence as existing financial statements.
SEGMENT DISCLOSURES
At December 31, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for additional disclosure about operating segments for interim and
annual financial statements. More specifically, it requires financial
information to be disclosed for segments whose operating results are reviewed by
the chief operating decision-maker for decisions on resource allocation. It also
requires related disclosures about products and services, geographic areas and
major customers. The Company's segments are based on how management internally
analyzes the business and allocates resources. (See Note 10, "Business Segments"
for additional information.)
21
PENSION AND OTHER POSTRETIREMENT BENEFIT DISCLOSURES
At December 31, 1998, the Company adopted SFAS No 132, "Employers' Disclosure
about Pensions and Other Postretirement Benefits." This statement revises
employers' disclosure about pensions and other postretirement benefit plans. It
does not change the measurement or recognition of those plans. The statement
standardizes the disclosure requirements for pensions and other postretirement
benefits, requires additional information on changes in the benefit obligations
and fair values of plan assets that will facilitate financial analysis, and
eliminates certain disclosures that are no longer considered useful.
DERIVATIVE INSTRUMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
Statement 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 will adopt
SFAS No. 133 in the first quarter of fiscal year 2000. The Company does not
expect any material earnings effect from adoption of this statement as it
presently utilizes derivatives for hedging activities.
NOTE 2. SALE OF LILCO ASSETS, ACQUISITION OF KEYSPAN ENERGY CORPORATION AND
TRANSFER OF ASSETS AND LIABILITIES TO THE COMPANY
On May 28, 1998, pursuant to the Agreement and Plan of Merger, dated as of June
26, 1997 as amended, by and among the Company, LILCO, LIPA, and LIPA Acquisition
Corp. (the "Merger Agreement"), LIPA acquired all of the outstanding common
stock of LILCO for $2.4975 billion in cash and thereafter directly or indirectly
assumed certain liabilities including approximately $3.4 billion in debt. In
addition, LIPA reimbursed LILCO $339.1 million related to certain series of
preferred stock which were redeemed by LILCO prior to May 28, 1998. Immediately
prior to such acquisition, all of LILCO's assets employed in the conduct of its
gas distribution business and its non-nuclear electric generation business, and
all common assets used by LILCO in the operation and management of its electric
T&D business and its gas distribution business and/or its non-nuclear electric
generation business (the "Transferred Assets") were sold to the Company and
transferred to wholly-owned subsidiaries of the Company at the Company's
direction.
The consideration for the Transferred Assets consisted of (i) 3,440,625 shares
of the common stock of the Company (ii) 553,000 shares of the Series B preferred
stock of the Company, (iii) 197,000 shares of the Series C preferred stock of
the Company, and (iv) the assumption by the Company of certain liabilities of
LILCO. In connection with the transfer and prior to the effectiveness of the
LIPA Transaction, LILCO sold Series B and C preferred stock for $75 million in a
private placement.
22
Moreover, all of LILCO's outstanding long-term debt as of May 28, 1998, except
for its 1997 Series A Electric Facilities Revenue Bonds due December 1, 2027
which were assigned to the Company, was assumed by LIPA. In accordance with the
LIPA Transaction, the Company issued promissory notes to LIPA amounting to
$1.048 billion which represented an amount equivalent to the sum of (i) the
principal amount of 7.3% Series Debentures due July 15, 1999 and 8.2% Series
Debentures due March 15, 2023 outstanding as of May 28, 1998, and (ii) an
allocation of certain of the Authority Financing Notes. The promissory notes
contain identical terms to the debt referred to in items (i) and (ii) above.
(See Note 7, "Long-Term Debt" for additional information.)
On May 28, 1998, immediately subsequent to the LIPA Transaction, KSE was merged
with and into a subsidiary of the Company, pursuant to an Agreement and Plan of
Exchange and Merger, dated as of December 29, 1996, between LILCO and Brooklyn
Union. This agreement was amended and/or restated as of February 7, 1997, June
26, 1997, and September 29, 1997, to reflect certain technical changes and the
assignment by Brooklyn Union of all of its rights and obligations under the
agreement to KSE. On September 29, 1997, KSE became the parent company of
Brooklyn Union when Brooklyn Union reorganized into a holding company structure.
As a result of these transactions, holders of KSE common stock received one
share of the Company's common stock, par value $.01 per share, for each share of
KSE they owned and holders of LILCO common stock received 0.880 of a share of
the Company's common stock for each share of LILCO they owned. Upon the closing
of these transactions, former holders of KSE and LILCO owned 32% and 68%,
respectively, of the Company's common stock.
The purchase price of $1.223 billion for the acquisition of KSE has been
allocated to assets acquired and liabilities assumed based upon their estimated
fair values. The fair value of the utility assets acquired is represented by its
book value which approximates the value recognized by the NYPSC in establishing
rates for regulated utility services. The estimated fair value of KSE's
non-utility assets approximated their carrying values. At May 28, 1998, the
Company recorded goodwill in the amount of $179.9 million, representing
primarily the excess of the acquisition cost over the fair value of the net
assets acquired; the goodwill is being amortized over 40 years.
The following is the comparative unaudited proforma combined condensed financial
information for the nine months ended December 31, 1998 and the twelve months
ended March 31, 1998. The proforma disclosures are intended to reflect the
results of operations as if the KeySpan Acquisition was consummated on the first
day of each of the reporting periods below. The effects of the LIPA Transaction
have been reflected for the period May 29, 1998 through December 31, 1998. These
disclosures may not be indicative of future results.
23
Nine Months Twelve Months
Proforma Results Ended Ended
(in thousands of dollars except per share amounts): December 31, 1998 March 31, 1998
- -------------------------------------------------- ------------------- -----------------
Revenues $ 1,907,129 $ 4,554,093
Operating Income $ 4,416 $ 914,272
Net Income (Loss) $ (212,424) $ 436,794
Basic and Diluted Earnings (Loss) per Share $ (1.38) $ 2.78
The decrease in revenues for the Transition Period as compared to the twelve
months ended March 31, 1998 is due primarily to the LIPA Transaction consummated
on May 28, 1998. Electric revenues for the Transition Period are derived from
service agreements with LIPA for the period May 29, 1998 through December 31,
1998. For the period April 1, 1998 through May 28, 1998, and for the twelve
months ended March 31, 1998, revenues reflected fully integrated electric
service to customers. Included within rates charged to customers, prior to the
LIPA Transaction, was the return on the capital investment in the generation and
T&D assets required to operate the system 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 has changed from that of an owner
of an electric generation and T&D system, with 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 after May 28, 1998 reflect the impact
of the LIPA agreements which contribute marginally to earnings.
Gas distribution revenues for the Transition Period do not include revenues from
heating season operations (January through March) when the Company realizes the
major portion of its gas revenues. Gas distribution revenues during the
Transition Period were also impacted by rate reductions which were reflected at
the time of the KeySpan Acquisition. Brooklyn Union reduced rates to its core
customers by $23.9 million annually 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.
Net income for the Transition Period also reflected substantial non-recurring
charges associated with the LIPA Transaction of $107.9 million after-tax,
special charges related to the KeySpan Acquisition of $83.5 million after-tax
and a $13 million after-tax donation made by the Company to establish the
KeySpan Foundation. See Note 11, "Costs Related to the LIPA Transaction and
Special Charges" for additional details.
24
NOTE 3. FEDERAL INCOME TAX
Income tax expense (benefit) is reflected as follows in the Consolidated
Statement of Income:
(IN THOUSANDS OF DOLLARS)
- ------------------------------------------------------------------------------------------------------
Nine Months Twelve Months Three Months Year
Ended Ended Ended Ended
December 31, 1998 March 31, 1998 March 31, 1997 December 31, 1996
- ------------------------------------------------------------------------------------------------------
Operating Expenses
Current $ 20,144 $ 86,388 $ 23,378 $ 42,197
Deferred (82,650) 150,983 33,624 168,000
(62,506) 237,371 57,002 210,197
Other Income
Current 5,998 (594) - -
Deferred (3,286) (4,124) (789) (940)
2,712 (4,718) (789) (940)
Transaction Related (99,701) - - -
Total Federal Income Tax $(159,495) $232,653 $ 56,213 $209,257
The components of deferred tax assets and liabilities reflected in the
Consolidated Balance Sheet are as follows:
(IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
December 31, 1998 March 31, 1998
- --------------------------------------------------------------------------------
Deferred Tax Assets
Property related differences $ 151,430 $ 10,559
Benefits of tax loss carryforwards 52,157 65,176
Reserves not currently deductible 44,263 39,667
Other items - net 52,629 261,729
Total Deferred Tax Assets $ 300,479 $ 377,131
- --------------------------------------------------------------------------------
Deferred Tax Liabilities
1989 Settlement $ - $2,169,909
Property related differences 179,583 650,562
Regulatory tax asset 69,277 -
Other items - net 123,168 96,024
Total Deferred Tax Liabilities $ 372,028 $2,916,495
- --------------------------------------------------------------------------------
Net Deferred Tax Liabilities $ 71,549 $2,539,364
- --------------------------------------------------------------------------------
25
The following is a reconciliation between reported income tax and tax computed
at the statutory rate of 35%:
(IN THOUSANDS OF DOLLARS)
- ---------------------------------------------------------------------------------------------------------
Nine Months Twelve Months Three Months Year
Ended Ended Ended Ended
December 31, March 31, March 31, December 31,
1998 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
Computed at the statutory rate $(114,249) $208,213 $50,369 $184,002
Adjustments related to:
Net benefit from LIPA Transaction (1) (31,503) - - -
Tax credits (1,809) (2,464) (940) (4,383)
Excess of book over tax depreciation 2,859 17,912 4,356 18,339
Minority interest in THEC (10,220) - - -
Other items - net (4,573) 8,992 2,428 11,299
- ---------------------------------------------------------------------------------------------------------
Total Federal income tax $(159,495) $232,653 $56,213 $209,257
=========================================================================================================
Effective income tax rate (49%) 39% 39% 40%
- ---------------------------------------------------------------------------------------------------------
(1) Includes tax benefits relating to (a) the deferred federal income taxes
necessary to account for the difference between the carryover basis of the
Transferred Assets for financial reporting purposes and the new increased
tax basis and (b) certain credits for financial reporting purposes,
including tax benefits recognized on the funding of postretirement
benefits, partially offset by income taxes associated with the sale of the
Transferred Assets to the Company by LIPA which taxes are to be paid by the
Company.
The Company currently has federal income tax loss carryforwards of approximately
$149.1 million that expire in twenty years or in 2017, representing losses
incurred by the Company for the nine months ended December 31, 1998.
In 1990 and 1992, LILCO received an Internal Revenue Service Agents' Report
disallowing certain deductions and credits claimed by LILCO on its federal
income tax returns for the years 1981 through 1989. A settlement resolving all
audit issues was reached between LILCO and the Internal Revenue Service in May
1998. The settlement required the payment of taxes and interest of $9 million
and $35 million, respectively, which the Company made in May 1998. Adequate
reserves to cover such taxes and interest were previously provided.
27
NOTE 4. POSTRETIREMENT BENEFITS
PENSION PLANS: The following information represents consolidated results for the
Company and its subsidiaries (Brooklyn Union, Brooklyn Union of Long Island and
the former LILCO), whose noncontributory defined benefit pension plans cover
substantially all employees. Benefits are based on years of service and
compensation. Funding for pensions is in accordance with requirements of federal
law and regulations. Prior to the KeySpan Acquisition, pension benefits had been
managed separately by the Company's regulated subsidiaries, which were the only
subsidiaries with defined benefit plans. The Company is in the process of
examining the feasibility of integrating these plans into a more unified form
within the holding company structure.
The amounts presented are consolidated for periods subsequent to May 28, 1998.
Prior to that date the amounts pertain solely to the plan of LILCO. Brooklyn
Union of Long Island is subject to certain deferral accounting requirements
mandated by the NYPSC for pension costs and other postretirement benefit costs.
Amounts included herein also include accruals pertaining to supplemental plans
of the Company for obligations arising subsequent to May 28, 1998.
The calculation of net periodic pension cost follows:
(In Thousands of Dollars)
- ---------------------------------------------------------------------------------------------------------------------
Nine Months Ended Twelve Months Ended Three Months Ended Year Ended
December 31,1996 March 31, 1998 March 31, 1997 December 31, 1996
- ---------------------------------------------------------------------------------------------------------------------
Service cost, benefits earned
during the period $ 24,608 $ 21,114 $ 4,645 $ 17,384
Interest cost on projected
benefit obligation 66,341 56,379 12,494 47,927
Return on plan assets (51,745) (196,300) (3,500) (81,165)
Special termination charge (1) 61,558 - - -
Net amortization and deferral (33,942) 147,713 (9,640) 33,541
Total pension cost $ 66,820 $ 28,906 $ 3,999 $ 17,687
- ---------------------------------------------------------------------------------------------------------------------
(1) Early retirement plan completed in December 1998.
28
The following table sets forth the pension plans' funded status at December 31,
1998 and March 31, 1998. Plan assets principally are common stock and fixed
income securities:
(IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
December 31,1998 March 31, 1998
- --------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation at beginning of period $ (825,159) $ (807,703)
Benefit obligation of KSE (674,100) -
Service cost (24,608) (21,114)
Interest cost (66,341) (56,379)
Actuarial (loss) gain (61,929) 16,737
Special termination benefits (1) (61,558) -
Total benefits paid 63,575 43,300
- --------------------------------------------------------------------------------
Benefit obligation at end of period (1,650,120) (825,159)
- --------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of
period 919,100 744,400
Fair value of KSE plan assets 754,127 -
Actual return on plan assets 51,745 196,300
Employer contribution 13,500 18,000
Benefits paid from trust (62,868) (39,600)
- --------------------------------------------------------------------------------
Fair value of plan assets at end of period 1,675,604 919,100
- --------------------------------------------------------------------------------
Funded status 25,484 93,941
Unrecognized net (gain) from past experience
different from that assumed and from changes
in assumptions (158,103) (163,034)
Unrecognized prior service cost 54,234 -
Unrecognized transition obligation 4,138 62,652
- --------------------------------------------------------------------------------
Net accrued pension cost reflected
on consolidated balance sheet $ (74,247) $ (6,441)
================================================================================
(1) Early retirement plan completed in December 1998.
- -------------------------------------------------------------------------------------------------------------------
Nine Months Twelve Months Three Months
Ended Ended Ended Year Ended
December 31,1998 March 31, 1998 March 31, 1997 December 31, 1996
- -------------------------------------------------------------------------------------------------------------------
Obligation discount 6.50% 7.00% 7.00% 7.25%
Asset return 8.50% 8.50% 7.50% 7.50%
Average annual increase in compensation 5.00% 4.50% 5.00% 5.00%
29
INFORMATION ON THE LILCO SUPPLEMENTAL PLAN
The Supplemental Plan in effect prior to May 28, 1998 provided supplemental
death and retirement benefits for officers and other key executives without
contribution from such employees. The Supplemental Plan was a non-qualified plan
under the Internal Revenue Code of 1986, as amended (the "Code"). The provision
for plan benefits totaled $0.7 million for the three months ended March 31, 1997
and $2.7 million for the year ended December 31, 1996. For the twelve months
ended March 31, 1998, a charge of $31 million was recorded relating to certain
benefits earned by former officers of LILCO relating to the termination of their
annuity benefits earned through the supplemental retirement plan and other
executive retirement benefits. This charge, which was borne by LILCO, and not
recovered from ratepayers, resulted from provisions in the employment contracts
of LILCO officers.
OTHER POSTRETIREMENT BENEFITS - RETIREE HEALTH CARE AND LIFE INSURANCE: The
following information represents consolidated results for the Company and its
subsidiaries (Brooklyn Union, Brooklyn Union of Long Island and the former
LILCO) who sponsor noncontributory defined benefit plans under which is provided
certain health care and life insurance benefits for retired employees. The
Company has been funding a portion of future benefits over employees' active
service lives through Voluntary Employee Beneficiary Association ("VEBA")
trusts. Contributions to VEBA trusts are tax deductible, subject to limitations
contained in the Code. Prior to the KeySpan Acquisition other postretirement
benefits had been managed separately by the Company's regulated subsidiaries,
which were the only subsidiaries with defined benefit plans. The Company is in
the process of examining the feasibility of integrating these plans into a more
unified form within the holding company structure.
The amounts presented herein are consolidated for periods subsequent May 28,
1998. Prior to that date the amounts pertain solely to the plan of LILCO.
Net periodic other postretirement benefit cost included the following
components:
(IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------------------------------
Nine Months Twelve Months Three Months
Ended Ended Ended Year Ended
December 31, 1998 March 31, 1998 March 31, 1997 December 31, 1996
- --------------------------------------------------------------------------------------------------------
Service cost, benefits earned
during the period $ 9,569 $ 12,204 $ 2,821 $ 10,690
Interest cost on accumulated post-
retirement benefit obligation 26,414 27,328 6,642 25,030
Return on plan assets (13,857) (6,164) (628) (3,046)
Special termination charge (1) 3,073 - - -
Net amortization and deferral (14,665) (10,468) (3,409) (12,175)
- --------------------------------------------------------------------------------------------------------
Other postretirement benefit cost $ 10,534 $ 22,900 $ 5,426 $ 20,499
- --------------------------------------------------------------------------------------------------------
(1) Early retirement plan completed in December 1998.
30
The following table sets forth the plan's funded status at December 31, 1998 and
March 31, 1998. Plan assets principally are common stock and fixed income
securities:
(IN THOUSANDS OF DOLLARS)
- ----------------------------------------------------------------------------------------
December 31, 1998 March 31, 1998
- ----------------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation at beginning of period $ (358,941) $ (415,672)
Benefit obligation of KSE (226,645) -
Service cost (9,569) (12,204)
Interest cost (26,414) (27,328)
Plan participants' contributions (900) -
Actuarial (loss) gain (121,228) 83,793
Special termination benefits (1) (3,073) -
Total benefits paid 18,515 12,470
- ----------------------------------------------------------------------------------------
Benefit obligation at end of period (728,255) (358,941)
- ----------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of period 108,165 80,533
Fair value of KSE plan assets 113,917 -
Actual return on plan assets 13,857 6,164
Employer contribution 250,000 21,592
Plan participants' contributions - -
Benefits paid from trust (7,161) (124)
- ----------------------------------------------------------------------------------------
Fair value of plan assets at end of period 478,778 108,165
- ----------------------------------------------------------------------------------------
Funded status (249,477) (250,776)
Unrecognized net loss (gain) from past experience
different from that assumed and from changes in
assumptions 145,834 (102,346)
Unrecognized prior service cost 166 175
- ----------------------------------------------------------------------------------------
Accrued benefit cost reflected on
consolidated balance sheet $ (103,477) $ (352,947)
- ----------------------------------------------------------------------------------------
(1) Early retirement plan completed in December 1998.
- --------------------------------------------------------------------------------------------------
Nine Months Twelve Months Three Months
Ended Ended Ended Year Ended
December 31, 1998 March 31, 1998 March 31, 1997 December 31, 1996
- --------------------------------------------------------------------------------------------------
Assumptions:
Obligation discount 6.50% 7.00% 7.00% 7.25%
Asset return 8.50% 8.50% 7.50% 7.50%
Average annual increase in 5.00% 4.50% 5.00% 5.00%
compensation
31
The measurement of plan liabilities also assumes a health care cost trend rate
of 6% annually. A 1% increase in the health care cost trend rate would have the
effect of increasing the accumulated postretirement benefit obligation as of
December 31, 1998 by $103.8 million and the net periodic health care expense by
$7.9 million. A 1% decrease in the health care cost trend rate would have the
effect of decreasing the accumulated postretirement benefit obligation as of
December 31, 1998 by $82.3 million and the net periodic health care expense by
$6.2 million.
In 1993, LILCO adopted the provisions of SFAS No. 106, "Employer's Accounting
for Post- Employment Benefits Other Than Pensions," and recorded an accumulated
postretirement benefit obligation and a corresponding regulatory asset of $376.0
million. LIPA will reimburse the Company for costs related to postretirement
benefits of the electric business unit employees; therefore, the Company has
reclassified the regulatory asset for postretirement benefits to a receivable
from LIPA.
In 1994, LILCO established VEBA trusts for union and non-union employees for the
funding of costs collected in rates for postretirement benefits. The trusts were
funded with contributions of $21.0 million for the twelve months ended March 31,
1998, $5.0 million for the three months ended March 31, 1997 and $18.0 million
for the year ended December 31, 1996. In May 1998, an additional $250.0 million
was funded into the trusts.
NOTE 5. CAPITAL STOCK
COMMON STOCK: Currently the Company has 450,000,000 shares of authorized common
stock. In the nine month period ended December 31, 1998 the Company issued
396,570 shares for $10.2 million under the Dividend Reinvestment and Stock
Purchase Plan, the Discount Stock Purchase Plan for Employees, and the Employee
Savings Plan. In October 1998, the Company announced that the Board of Directors
authorized using up to $500 million for the purchase of common shares in
addition to the Board's previous authorization to purchase up to 15 million
common shares. As of December 31, 1998, the Company had repurchased 14.2 million
common shares for $423.7 million.
PREFERRED STOCK: The Company has the authority to issue 100,000,000 shares of
preferred stock with the following classifications: 16,000,000 shares of
preferred stock, par value $25 per share, 1,000,000 shares of preferred stock,
par value $100 per share and 83,000,000 shares of preferred stock, par value
$.01 per share.
At December 31, 1998, 14,520,000 redeemable shares of 7.95% Preferred Stock
Series AA par value $25 was outstanding totaling $363.0 million, which has a
mandatory redemption requirement on June 1, 2000. The Company also had 553,000
shares outstanding of private placement 7.07% Preferred Stock Series B par value
$100 and 197,000 shares outstanding of private placement 7.17% Preferred Stock
Series C par value $100 totaling $75.0 million. In addition, during the year the
Company issued, in a private placement, 99,727 nonredeemable shares totaling
approximately $10.0
32
million of 6% Preferred Stock Series A par value $100 to employees as incentive
compensation. Preferred Stock Series A, B and C were privately issued and are
not publicly traded.
On April 17, 1998, LILCO exercised its option to redeem the callable preferred
stock and called for redemption on May 19, 1998 all of the outstanding shares of
preferred stock Series B, Series D, Series E, Series F, Series H, Series
I-Convertible, Series L and Series NN. These preferred stock series were
redeemed for $117.5 million, including accrued and unpaid dividends, plus $4.5
million of call premiums. In addition, pursuant to the LIPA Transaction each
share of non-redeemable preferred stock Series CC, Series GG, Series QQ and
Series UU was canceled and converted to cash in the amount of the present value
plus accrued and unpaid dividends. The non-redeemable preferred stock was
converted for $223.2 million, including accrued and unpaid dividends, plus $18
million of call premiums. On May 28, 1998, LIPA reimbursed the Company $339.1
million for the preferred stock series that were redeemed.
Dividends on preferred stock are paid in preference to dividends on common stock
or any other stock ranking junior to preferred stock.
NOTE 6. NONQUALIFIED STOCK OPTIONS
At December 31, 1998, the Company had stock-based compensation plans that are
described below. Moreover, under a separate plan, THEC has issued 2,124,438
stock options to key THEC employees. The Company and THEC apply APB Opinion 25,
"Accounting for Stock Issued to Employees," and related Interpretations in
accounting for their plans. Accordingly, no compensation cost has been
recognized for these fixed stock option plans in the Consolidated Financial
Statements since the exercise prices and market values were equal on the grant
dates. Had compensation cost for these plans been determined based on the fair
value at the grant dates for awards under the plans consistent with SFAS 123,
"Accounting for Stock-Based Compensation," the Company's net loss and loss per
share would have been increased to the proforma amounts indicated below:
- --------------------------------------------------------------------------------
Nine Months Ended
December 31, 1998
- --------------------------------------------------------------------------------
Income (loss) available for common stock (000): As reported $(195,537)
Proforma $(198,996)
Primary earnings (loss) per share: As reported $(1.34)
Proforma $(1.37)
- --------------------------------------------------------------------------------
Prior to the KeySpan Acquisition, KSE had reserved for issuance 1,500,000 shares
of nonqualified stock options and had issued 426,000, 363,500 and 202,800
nonqualified stock options in November 1997, 1996 and 1995, respectively. These
options have remained outstanding and, under the terms
33
of the Merger Agreement, all options vested upon consummation of the KeySpan
Acquisition. Holders are now permitted to exercise vested options for Company
common stock.
The fair values of grants issued in November 1997, 1996 and 1995 were $4.62,
$4.27 and $2.78, respectively. All grants were estimated on the date of grant
using the Black-Scholes option-pricing model. The following weighted-average
assumptions were used for grants issued in November 1997, 1996 and 1995:
dividend yield of 5.00%, 4.66% and 5.57%; expected volatility of 16.24%, 16.56%
and 16.879%; risk free interest rate of 6.00%, 6.00% and 6.28%; and expected
lives of 6 years, respectively. The exercise prices are $32.63, $30.50 and
$27.00, respectively.
A summary of the status of the Company's fixed stock option plans as of December
31, 1998 and changes during the period is presented below:
Nine Months Ended December 31, 1998
- --------------------------------------------------------------------------------
Weighted Avg.
Fixed Options Shares Exercise Price
- --------------------------------------------------------------------------------
Outstanding at beginning of period 992,300 $30.70
Exercised (13,631) $28.67
Forfeited (57,603) $29.45
Outstanding and exercisable at end of period 921,066 $30.80
- --------------------------------------------------------------------------------
Options Outstanding and Exercisable
- --------------------------------------------------------------------------------
Number Weighted Avg.
Outstanding Remaining Weighted Avg.
Exercise Price at 12/31/98 Contractual Life Exercise Price
- --------------------------------------------------------------------------------
$27.00 168,066 7 years $27.00
$30.50 344,000 8 years $30.50
$32.63 409,000 9 years $32.63
- --------------------------------------------------------------------------------
921,066
- --------------------------------------------------------------------------------
At the 1999 Annual Meeting of Shareholders, the Company will seek shareholder
approval of its Long-Term Performance and Compensation Plan ("Plan"). This Plan,
if approved, will allow the Company to issue to key employees stock options and
incentive stock options, as well as restricted stock awards and performance
stock awards. The total shares to be issued under this Plan will not exceed
10,500,000 shares.
34
NOTE 7. LONG-TERM DEBT
Gas Facilities Revenue Bonds: Brooklyn Union can issue tax-exempt bonds through
the New York State Energy Research and Development Authority. Whenever bonds are
issued for new gas facilities projects, proceeds are deposited in trust and
subsequently withdrawn to finance qualified expenditures. There are no sinking
fund requirements on any of the Company's Gas Facilities Revenue Bonds. At
December 31, 1998, Brooklyn Union had $648.5 million of Gas Facilities Revenue
Bonds outstanding. The interest rate on the Variable Rate Series due December 1,
2020 is reset weekly and ranged from 2.48% to 4.23% through December 31, 1998,
at which time the average rate was 3.90%.
In December 1998, the Company purchased a portfolio of securities representing
direct purchase obligations of the United States Government. These securities
were placed in trust, irrevocably dedicated to the repayment of certain Gas
Facilities Revenue Bonds, thereby effecting an in-substance defeasance of
approximately $8.9 million including interest. The in-substance defeasance
represented $4 million of outstanding bonds of each of the 6.75% Series 1989A
due February 1, 2024 and 6.75% Series 1989B due February 1, 2024. The Company
has not been relieved of its obligation and remains the primary obligor for this
debt. Based on the accounting requirements of SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and the Extinguishment of
Liabilities," the liability is not considered extinguished and is recognized on
the accompanying Consolidated Balance Sheet.
AUTHORITY FINANCING NOTES: The Company's electric generation subsidiary can also
issue tax-exempt bonds through the New York State Energy Research and
Development Authority. At December 31, 1998, $24.9 million of Authority
Financing Notes were outstanding. The interest rate on these notes is variable
and ranged from 2.65% to 4.75% through December 31, 1998 at which time the
average rate was 4.10%.
PROMISSORY NOTES: At March 31, 1998, total long-term debt outstanding was $4.497
billion. In accordance with the LIPA Agreement, LIPA has assumed substantially
all of the outstanding long-term debt of LILCO except for the 1997 Series A
Electric Facilities Revenue Bonds due December 1, 2027 which were assigned to
the Company. In accordance with the LIPA Agreement, the Company issued
promissory notes to LIPA for $1.048 billion which represented an amount
equivalent to the sum of: (i) the principal amount of 7.3% Series Debentures due
July 15, 1999 and 8.2% Series Debentures due March 15, 2023 outstanding at May
28, 1998, and (ii) an allocation of certain of the Authority Financing Notes.
The promissory notes contain identical terms as the debt referred to in items
(i) and (ii) above.
On November 3, 1998, the Company extinguished a portion of its obligation of the
promissory notes to LIPA relating to certain series of bonds that were called by
LIPA on December 1, 1998. The Company's obligation for these bonds of $2.1
million consisted of the principal amount and the interest accrued and unpaid.
In addition, on December 1, 1998, the Company extinguished a portion
35
of its obligation of the promissory notes on a certain series of bonds due to a
mandatory sinking fund redemption payment of $1 million. The carrying value of
the promissory notes at December 31, 1998 was $1.045 billion.
The promissory notes issued to LIPA included an allocation for certain of the
Authority Financing Notes. Authority Financing Notes Series 1993B due November
1, 2023, Series 1994A due October 1, 2024 and Series 1995A due August 1, 2025
have variable interest rate features in which the interest rate is reset on a
weekly basis. The interest rates for these notes ranged from 2.30% to 4.35%
during the nine months ended December 31, 1998 at which time the average rate
was 4.10%. Authority Financing Notes Series 1985A due March 1, 2016 and Series
1985B due March 1, 2016 have variable interest rate features in which the
interest rate is reset on an annual basis. The interest rate for these notes at
December 31, 1998 was 3.58%. On March 1, 1999, LIPA converted the variable rate
features of these notes to fixed interest rates. Series 1993B, Series 1994A and
Series 1995A were converted to a fixed rate of 5.30% and Series 1985A and Series
1985B were converted to a fixed rate of 5.15%.
GENERAL & REFUNDING ("G&R") MORTGAGE BONDS: Upon consummation of the LIPA
Transaction, all of the series of G&R Bonds have been assumed and redeemed by
LIPA resulting in the termination of the G&R Mortgage.
OTHER LONG-TERM DEBT: THEC has an available line of credit of $150 million which
supports borrowings under a revolving loan agreement. Up to $5 million of this
line is available for the issuance of letters of credit to support performance
guarantees. This credit facility matures on July 1, 2000. At December 31, 1998,
borrowings of $133 million were outstanding under this line of credit and $0.4
million was committed under outstanding letter of credit obligations. Borrowings
under this facility bear interest, at THEC's option, at rates indexed at a
premium to the Federal Funds rate or LIBOR rate, or based on the prime rate. The
weighted average interest rate on this debt was 6.44% at December 31, 1998.
Covenants related to this line of credit require the maintenance of certain
financial ratios and involve other restrictions regarding cash dividends, the
purchase or redemption of stock and the pledging of assets. Moreover, at
December 31, 1998, THEC had $100 million of 8.625% Senior Subordinated Notes due
2008 outstanding. These notes were issued in a private placement in March 1998
and are subordinate to borrowings under THEC's line of credit.
A subsidiary of the Energy Related Investment segment had borrowings of $67.5
million outstanding at December 31, 1998, at an interest rate of 5.25%. Gulf
Midstream Services Partnership ("GMS") was then provided with a loan of $64.8
million that bears interest on commercial terms.
DEBT MATURITY SCHEDULE: The total long-term debt maturing in each of the next
five years ending December 31 is as follows: 1999, $398 million; 2000, $1.0
million; 2001, $1.0 million; 2002, $3.5 million; and 2003, $3.5 million.
36
NOTE 8. CONTRACTUAL OBLIGATIONS, FINANCIAL INSTRUMENTS AND CONTINGENCIES:
FIXED OBLIGATIONS: Lease costs included in operation expense were $28.9 million
in 1998. The future minimum lease payments under various leases, all of which
are operating leases, are $22.1 million per year over the next five years and
$119.2 million, in the aggregate, for all years thereafter.
FIXED CHARGES UNDER FIRM CONTRACTS: The Company's utility subsidiaries have
entered into various contracts for gas delivery, storage and supply services.
The contracts have remaining terms that cover from one to fourteen years.
Certain of these contracts require payment of monthly charges in the aggregate
amount of $5.1 million per month in all events regardless of the level of
service available. Such charges are recovered from utility customers as gas
costs.
FAIR VALUE OF FINANCIAL INSTRUMENTS: The fair value of the Company's preferred
stock at December 31, 1998 was $471.6 million and the carrying value was $448.0
million.
The Company's long-term debt consists primarily of publicly traded Gas
Facilities Revenue Bonds, Authority Financing Notes and Debentures, the fair
value of which is estimated on quoted market prices for the same or similar
issues. The Authority Financing Notes and Debentures are included in the
promissory notes to LIPA. (See Note 2, "Sale of LILCO Assets, Acquisition of
KeySpan Energy Corporation and Transfer of Assets and Liabilities to the
Company" and Note 7, "Long-Term Debt" for additional information.)
The carrying amounts and fair values of the Company's long-term debt at December
31, 1998 and March 31, 1998 were as follows:
FAIR VALUE (IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
DECEMBER 31, 1998 March 31, 1998
- --------------------------------------------------------------------------------
Gas facilities revenue bonds 687,863 -
General and refunding bonds - 1,288,470
Debentures - 2,407,178
Authority financing notes 24,880 987,646
Promissory notes 1,097,226 -
- --------------------------------------------------------------------------------
Total 1,809,969 4,683,294
================================================================================
CARRYING AMOUNT (IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
DECEMBER 31, 1998 March 31, 1998
- --------------------------------------------------------------------------------
Gas facilities revenue bonds 648,500 -
General and refunding bonds - 1,286,000
Debentures - 2,270,000
Authority financing notes 24,880 940,555
Promissory notes 1,044,902 -
- --------------------------------------------------------------------------------
Total 1,718,282 4,496,555
================================================================================
37
At December 31, 1998, THEC's $100 million 8.625% Senior Subordinated Notes due
2008 had a fair market value of $98 million. All other THEC debt and other
subsidiary debt is carried at an amount approximating fair value because
interest rates are based on current market rates. All other financial
instruments included in the Consolidated Balance Sheet are stated at amounts
that approximate fair values.
DERIVATIVE FINANCIAL INSTRUMENTS: The Company's utility, marketing and gas
exploration and production subsidiaries employ derivative financial instruments,
such as natural gas and oil futures, options and swaps, for the purpose of
hedging exposure to commodity price risk.
Utility tariffs applicable to certain large-volume customers permit gas to be
sold at prices established monthly within a specified range expressed as a
percentage of prevailing alternate fuel oil prices. The Company uses standard
New York Mercantile Exchange ("NYMEX") futures contracts to fix profit margins
on specified portions of the sales to this market in line with pricing
objectives. Implementation of the strategy involves establishment of long (buy)
positions in gas futures contracts with offsetting short (sell) positions in oil
futures contracts of equivalent energy value. The long gas futures position
follows, generally within a range of 80% to 120%, the cost of gas to serve this
market while the short oil futures position correspondingly replicates, within
the same range, the selling price of gas.
KeySpan Energy Services ("KES"), the Company's gas and electric marketing
subsidiary, sells gas at fixed annual rates and utilizes standard NYMEX futures
contracts and swaps to fix profit margins. In the swap instruments, which are
employed to hedge exposure to basis risk, KES pays the other parties the amount
by which the floating variable price (settlement price) is below the fixed price
and receives the amount by which the settlement price exceeds the fixed price.
THEC utilizes derivative commodity instruments to hedge future sales prices on a
portion of its natural gas production to achieve a more predictable cash flow,
as well as to reduce its exposure to adverse price fluctuations of natural gas.
Hedging instruments used include swaps, collars and options. With respect to any
particular swap transaction, the counter party is required to make a payment to
THEC in the event that the settlement price for any settlement period is less
than the swap price for such transaction, and THEC is required to make payment
to the counter party in the event that the settlement price for any settlement
period is greater than the swap price for such transaction. For any particular
collar transaction, the counter party is required to make a payment to THEC if
the settlement price for any settlement period is below the floor price for such
transaction, and THEC is required to make payment to the counter party if the
settlement price for any settlement period is above the ceiling price for such
transaction. For any particular floor transaction, the counter party is required
to make a payment to THEC if the settlement price for any settlement period is
below the floor price for such transaction. THEC is not required to make any
payment in connection with a floor transaction. For option contracts, THEC has
the option, but not the obligation, to buy contracts up to the day before the
last trading day for that NYMEX contract.
38
The following table summarizes the notional amounts and related fair values of
the derivative financial instrument positions outstanding at December 31, 1998.
Fair values are based on quotes for the same or similar instruments.
- ----------------------------------------------------------------------------------------------
Gas: Type of Fiscal Year of Fixed Price Per Volume Notional
Contracts Maturity Mcf (Mcf) Amount Fair Value
- --------------- ----------- ------------- ----------- ----------- ------------
(In Thousands of Dollars)
Futures 1999/2000 $1.90-$2.55 12,270,000 $28,295 $24,190
Collars 1999
Ceiling $2.90 280,000 $812 -
Floor $2.40 280,000 $672 $126
Swaps 1999 $2.50 755,000 $1,887 $534
- ----------------------------------------------------------------------------------------------
Oil: Type of Fiscal Year of Fixed Price Per Volume Notional
Contracts Maturity Gallon (Gallons) Amount Fair Value
- --------------- ----------- ------------- ----------- ----------- ------------
(In Thousands of Dollars)
Futures 1999 $0.56-$0.58 4,284,000 $476 $1,474
- ----------------------------------------------------------------------------------------------
As of December 31, 1998, no futures contract extended beyond May 2000. Margin
deposits with brokers at December 31, 1998 of $10.7 million were recorded in
Other in the Current Assets section of the Consolidated Balance Sheet. Deferred
losses on closed positions were $4.0 million at December 31, 1998. Such
deferrals are generally recorded in net income within one month.
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 futures,
options and swap contracts is no greater than that associated with the primary
contracts which they hedge, as these contracts are with major investment grade
financial institutions, and that elimination of the price risk lowers overall
business risk.
In addition to the derivative instruments discussed above, at December 31, 1998,
THEC had one interest rate swap agreement to exchange the differential between a
fixed rate of 6.025% and a market LIBOR rate using an aggregate notional
principal of $30.0 million over various 90-day periods from November 1998
through November 1999.
LEGAL MATTERS: From time to time, the Company is subject to various legal
proceedings arising out of the ordinary course of its business. Except as
described below, the Company does not consider any of such proceedings to be
material to its business or likely to result in a material adverse effect on its
results of operations or financial condition.
39
Subsequent to 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 each of the former officers and directors of LILCO and
the Company. 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 ("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 Securities and Exchange Commission ("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.
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
Acquisition would trigger the Payments. These actions were consolidated in
October 1998.
On March 17, 1999, the Company signed a Memorandum of Understanding to settle
the above-referenced actions, except the federal court derivative action, in
exchange for (i) $7.9 million to be distributed (less plaintiffs' attorneys
fees) to former LILCO and KSE shareholders and (ii) the Company's agreement to
implement certain corporate governance and executive compensation procedures.
The entire $7.9 million settlement commitment will be funded from insurance. The
parties intend to submit the settlement to the Nassau County Supreme Court for
its review and approval. If that Court approves the settlement, the parties will
then make an application to the federal court for an order and final judgment,
dismissing the three federal court actions, including the federal court
derivative action, 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 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.
40
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, the plaintiffs amended their complaint. The
amended complaint contains allegations relating to the Payments and adds the
recipients of the Payments as defendants. In January 1999, the Company was
served with the 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 included 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. The Company is
cooperating fully with the investigations of the New York State Attorney General
and the SEC. To date, no action has been taken either by the New York State
Attorney General or 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.
THE CLASS SETTLEMENT: The Class Settlement, which became effective in June 1989,
resolved a civil lawsuit against LILCO brought under the federal Racketeer
Influenced and Corrupt Organizations Act. The lawsuit, which the Class
Settlement resolved, had alleged that LILCO made inadequate disclosures before
the NYPSC concerning the construction and completion of nuclear generating
facilities. The Class Settlement provided electric customers with rate
reductions of $390.0 million that were being reflected as adjustments to their
monthly electric bills over a ten-year period which began on June 1, 1990. Upon
its effectiveness, a liability was recorded for the Class Settlement on a
present value basis at $170.0 million. The Class Settlement obligation of
approximately $75.0 million at December 31, 1998 reflects the present value of
the remaining reductions to be refunded to customers. The reduction in the
present value of this liability has been included in the accompanying
Consolidated Income Statement. As a result of the LIPA Transaction, LIPA will
reimburse the remaining balance to its electric customers as an adjustment to
their monthly electric bills. The Company will then, in turn, reimburse LIPA on
a monthly basis for such reductions on the customer's monthly bill. The Company
remains ultimately obligated for the refund of the Class Settlement.
41
ENVIRONMENTAL MATTERS: The Company has recorded a $130.3 million liability
associated with investigation and remedial obligations with respect to nine of
the Company's former manufactured gas plants ("MGP"). Three of these MGP sites
are associated with Brooklyn Union's operations or its predecessors; six MGP
sites are associated with the operations of Brooklyn Union of Long Island or its
predecessors. With respect to the former Brooklyn Union MGP sites, a total of
$48.3 million has been accrued representing the best estimate of remedial costs
for one site and the minimum range of an estimate for the investigation and/or
remediation of the other sites. With respect to Brooklyn Union of Long Island
MGP sites, a total of $82 million has been reserved as a minimum of an estimated
range of costs for the six sites which will be investigated/remediated pursuant
to upcoming Administrative Orders on Consent ("ACO's") with the New York State
Department of Environmental Conservation ("DEC"). As the Company continues its
investigations and makes remedial decisions pursuant to its ACO obligations, the
environmental conditions at each site will be clarified and the Company's total
remedial obligations are likely to be higher.
Under prior rate orders, the NYPSC has allowed recovery of investigation costs
related to certain Brooklyn Union MGP sites. Therefore, at December 31, 1998,
the Company had reflected a total remaining regulatory asset of approximately
$100.5 million. The Company believes that current rate plans in effect provide
for recovery of environmental costs.
NOTE 9. KSE AND SUBSIDIARIES
The following is the condensed consolidated statement of income for KSE and its
subsidiaries for the eight months ended May 28, 1998. As a result of purchase
accounting, such amounts have been excluded from the financial statements of the
Company and are disclosed here for informational purposes. The financial
statements for KSE's most recent fiscal year end were as of September 30, 1997.
KSE AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE PERIOD OCTOBER 1, 1997 - MAY 28, 1998
(In Thousands of Dollars)
Eight Months Ended
May 28, 1998
-----------------------------------------------------
Operating revenues $ 1,173,052
Operating expenses 1,029,981
Operating income 143,071
Other income 7,385
Interest charges 30,495
-----------------------------------------------------
Income available for common stock $ 119,961
-----------------------------------------------------
Earnings per share $ 2.35
-----------------------------------------------------
42
Consolidated earnings for the eight months ended May 28, 1998 were $120.0
million, or $2.35 per share. Core utility operations contributed $136.7 million
or $2.68 per share. THEC contributed $12.5 million or $0.24 per share to
earnings, while Energy Related Investments had a loss of $6.2 million or $0.12
per share and Energy Related Services showed a loss of $6.5 million or $0.13 per
share, reflecting the effect of various costs related to market development.
Utility results reflected the favorable effect of gas heating sales during the
prime heating months of November through April when total annual gas revenues
are substantially realized. Losses are incurred for the period May through
September and have not been reflected in these results. In addition, $16.5
million or $0.32 per share of primarily merger related expenses were recorded by
KSE's administrative and service area and were not allocated to KSE's
subsidiaries. Cash provided by operating activities for the eight months ended
May 28, 1998 was $253.6 million and cash provided by financing activities was
$5.5 million. For the eight months ended May 28, 1998 cash used in investing
activities was $130.9 million and at May 28, 1998 KSE had cash and temporary
cash investments of $165.2 million.
NOTE 10. BUSINESS SEGMENTS
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Company
Information," requires the reporting of certain financial information by
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 reportable segment
consists of the two gas distribution companies serving customers in the New York
City boroughs of Brooklyn, Staten Island and Queens and the Long Island counties
of Nassau and Suffolk. The Electric Services reportable segment consists of
subsidiaries that own and operate oil and gas fired generating plants, and
through long term contracts, manage the electric T&D system, the fuel and
electric purchases, and the off-system sales for LIPA. The Gas Exploration and
Production reportable segment, consisting of THEC, is engaged in gas and oil
exploration and production, and the development and acquisition of domestic
natural gas and oil properties. Subsidiaries included in the Energy Related
Investments segment have investments in natural gas pipelines, midstream natural
gas processing and gathering facilities and gas storage facilities. The Energy
Related Services segment consists of subsidiaries that primarily provide gas and
electric marketing and related energy systems installation, appliance service
contracts and management services to customers primarily in the New York City
metropolitan area. The Other reportable segment represents unallocated
administrative expenses of the Company.
43
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company's reportable segments
are strategic business units that are managed separately because of their
different operating and regulatory environments. The reportable segment
information is as follows:
Energy Energy
Gas Electric Gas Exploration Related Related Reconciling
Distribution Services and Production Investments Services Other Eliminations Consolidated
---------------------------------------------------------------------------------------------------------------
9 MONTHS ENDED (IN THOUSANDS OF DOLLARS)
DECEMBER 31, 1998
Revenues 851,656 753,636 70,812 117 62,435 171,414 (188,218) 1,721,852
Depreciation and
amortization 57,351 45,900 177,114 216 1,117 13,166 - 294,864
Interest income - - - - - 49,200 - 49,200
Interest expense 60,678 69,953 3,870 - - 58,682 (54,468) 138,715
Income (loss) before
special charges 8,582 57,119 2,218 (4,186) (3,708) 2,959 - 62,984*
Loss from equity method
subsidiaries - - - (5,842) - - - (5,842)
Total assets 3,919,311 1,456,094 569,454 428,746 116,940 12,151,745 (11,747,188) 6,895,102
Investment in equity
method subsidiaries - - - 341,346 - - - 341,346
Capital expenditures 128,405 54,090 182,729 231,791 28,421 51,127 - 676,563
*Excludes special charges of $258.5 million after-tax. See Note 11 -
Costs Related to the LIPA Transaction ges. and Special Charges.
Electric Services revenues from LIPA, its only customer, of $408.3
million for the nine months ended December 31, 1998 represents
approximately 24% of the Company's consolidated revenue during that
period.
Reconciling items include intercompany revenues and intercompany
interest expense and the elimination of intercompany ownership
interests within the affiliated entities.
44
Energy Energy
Gas Electric Gas Exploration Related Related Reconciling
Distribution Services and Production Investments Services Other Eliminations Consolidated
---------------------------------------------------------------------------------------------------------------
12 MONTHS ENDED (IN THOUSANDS OF DOLLARS)
MARCH 31, 1998
Revenues 645,659 2,478,435 - - - - - 3,124,094
Depreciation and
amortization 38,584 131,186 - - - - - 169,770
Interest expense 52,409 352,064 - - - - - 404,473
Net income 33,815 276,612 - - - - - 310,427
Total assets 1,444,745 10,455,980 - - - - - 11,900,725
Capital expenditures 78,897 218,333 - - - - - 297,230
Energy Energy
Gas Electric Gas Exploration Related Related Reconciling
Distribution Services and Production Investments Services Other Eliminations Consolidated
---------------------------------------------------------------------------------------------------------------
3 MONTHS ENDED (IN THOUSANDS OF DOLLARS)
MARCH 31, 1997
Revenues 293,391 557,791 - - - - - 851,182
Depreciation and
Amortization 7,827 31,993 - - - - - 39,820
Interest Expense 13,708 92,170 - - - - - 105,878
Net Income 46,925 27,803 - - - - - 74,728
Total Assets 1,267,600 10,582,400 - - - - - 11,850,000
Capital Expenditures 15,804 46,675 - - - - - 62,479
Energy Energy
Gas Electric Gas Exploration Related Related Reconciling
Distribution Services and Production Investments Services Other Eliminations Consolidated
---------------------------------------------------------------------------------------------------------------
12 MONTHS ENDED (IN THOUSANDS OF DOLLARS)
DECEMBER 31, 1996
Revenues 684,260 2,466,435 - - - - - 3,150,695
Depreciation and
amortization 43,147 128,534 - - - - - 171,681
Interest expense 54,811 392,818 - - - - - 447,629
Net income 38,471 225,777 - - - - - 264,248
Total assets 1,460,600 10,749,400 - - - - - 12,210,000
Capital expenditures 76,938 214,680 - - - - - 291,618
45
NOTE 11. COSTS RELATED TO THE LIPA TRANSACTION AND SPECIAL CHARGES
Special charges for the nine months ended December 31, 1998 were $258.5 million
after-tax. These charges reflected, in part, non-recurring charges associated
with the LIPA Transaction of $107.9 million after-tax. Costs relating to the
LIPA Transaction principally reflected taxes associated with the sale of assets
(the "Transferred Assets") to the Company by LIPA; the write-off of certain
regulatory assets that were no longer recoverable under various LIPA agreements;
and other transaction costs incurred to consummate the LIPA Transaction. These
charges were offset, in part, by tax benefits relating to the deferred federal
income taxes necessary to account for the difference between the carryover basis
of the Transferred Assets for financial reporting purposes and the new increased
tax basis of the assets, and tax benefits recognized on the funding of
post-employment benefits for employees of the successor company.
Further, the Company incurred charges related to the KeySpan Acquisition of
$83.5 million after-tax. These charges reflected a $42.0 million after-tax
charge for an early retirement program initiated by the Company in December 1998
in which approximately 600 employees participated, and a $41.5 million after-tax
charge for the write-off of a customer billing system that was in development.
Also, in December 1998, the Company made a $20.0 million donation ($13.0 million
after-tax) to establish the KeySpan Foundation, a not-for-profit philanthropic
foundation that will make donations to local charitable community organizations.
Special charges also reflected an after-tax impairment charge of $54.1 million,
which represented the Company's share of the impairment charge, recorded by the
Company's gas and oil exploration and production subsidiary to reduce the value
of its proved gas reserves in accordance with the asset ceiling test limitations
of the Securities and Exchange Commission applicable to gas exploration and
development operations accounted for under the full cost method.
NOTE 12. SUPPLEMENTAL DISCLOSURE OF KSE AND SUBSIDIARIES (UNAUDITED)
For the twelve months ended December 31, 1998 net income of the consolidated
entities comprising KSE was $12.5 million compared to $126.3 million for the
1997 corresponding period. Net income in 1998 was affected by rate reductions to
gas utility customers; significantly warmer than normal weather during the
period; certain special charges associated with the KeySpan Acquisition of $23.5
million after-tax, including charges associated with the early retirement
program; and an impairment charge of $54.1 million after-tax to reduce the value
of proved gas reserves. Energy Related Investment earnings for the twelve months
ended December 31, 1997 reflected the sale of certain subsidiary properties for
$15.2 million after-tax. Consolidated net income together with the effect of
special charges, is set forth in the following table:
KSE AND SUBSIDIARIES
Twelve Months Twelve Months
Results of Operations Ended Ended
(In Thousands of Dollars) December 31, 1998 December 31, 1997
- ------------------------------ ---------------- -----------------
Gas Distribution $99,406 $93,205
Gas Exploration and Production 8,995 15,774
Energy Related Investments (6,098) 21,669
Energy Related Services (9,119) (3,896)
Other (3,136) (487)
Income before special charges 90,048 126,265
Special charges (77,591) -
- ------------------------------ ---------------- -----------------
Consolidated net income $12,457 $126,265
============================== ================ =================
Earnings from Gas Distribution operations for the twelve months ended December
31, 1998 were impacted by synergy savings-related rate reductions of $23.9
million effective May 29, 1998. Brooklyn Union core customers have received the
benefits of these reductions before actual savings
46
could be achieved. Moreover, in 1998 results were affected by significantly
warmer than normal weather. Weather was 18% warmer than normal in 1998 as
compared to normal weather experienced in 1997. The effects of weather on Gas
Distribution revenues is largely mitigated by the weather normalization
adjustment included in Brooklyn Union's tariff; nevertheless, significant
fluctuations in normal weather will affect revenues collected from heating
customers. The effects of the rate reduction and the significantly warmer winter
heating season reduced net revenues, revenues less gas costs, by $24.2 million
for the twelve months ended December 31, 1998 as compared to the corresponding
period last year.
The aforementioned variations in net revenues were totally offset by cost
reduction measures and re-engineering processes employed by KSE during the past
few years. Further, operation and maintenance expense was lower in 1998 due to
the exceptionally warm weather experienced. Earnings from gas utility operations
provided an equity return, including discrete incentives, of 13.6% for the rate
year ending September 30, 1998 as compared to 13.5% for the rate year ending
September 30, 1997.
Earnings from Gas Exploration and Production activities in 1998 and 1997
reflected the continued expansion of operations, primarily in Texas and the Gulf
of Mexico, by THEC. Earnings in 1998, however, were significantly affected by
low gas production prices. Included in special charges above, is an after-tax
charge of $54.1 million representing the Company's share of an impairment charge
recorded by THEC to reduce the value of its investment in proved gas reserves in
accordance with the asset ceiling test limitations of the Securities and
Exchange Commission.
Revenues from gas production activities increased in 1998 as compared to 1997 by
approximately 9% due primarily to the continued development of additional
natural gas properties acquired by THEC during the past three years. The
benefits derived from increased production levels, however, were partially
offset, by decreases in average realized prices. In 1998, production was 62.8
billion cubic feet (BCFe), or 11.5 BCFe above the level of production last year.
In 1998, wellhead prices averaged $1.96 per MCF compared with $2.45 per MCF in
1997. The effective price realized (average wellhead price received for
production including recognized hedging gains and losses) was $2.02 per MCF in
1998 compared with $2.25 per MCF in 1997. Further, operating expenses,
including, depreciation, depletion and amortization expense, increased by
approximately 30% for the year ended December 31, 1998 as compared with the year
ended December 31, 1997 due primarily to increased production activity.
Earnings from the Energy Related Investments segment consists of results from
the Company's 20% interest in the Iroquois Gas Transmission System LP ,
investments in The Premier Transco Pipeline and Phoenix Natural Gas in Northern
Ireland and investments in midstream natural gas assets in Western Canada owned
jointly with Gulf Canada Resources Limited. Results from these investments, for
the year ended December 31, 1998, reflected the start-up nature of their
operations, while results relating to the investment in the Iroquois Gas
Transmission System for 1998 and 1997 were consistent with management's
expectations and reflected after-tax earnings of $6.5 million. The Company
completed its acquisition of midstream natural gas assets in Western Canada in
47
December 1998, and therefore, earnings from this investment will begin to be
realized in fiscal year 1999. Results also reflected costs to settle certain
contracts associated with the sale of the Company's domestic cogeneration
investments and fuel management operations, which took place in 1997. Earnings
in 1997 primarily reflected the sale of certain Canadian properties and the sale
of domestic cogeneration investments and fuel management operations.
Subsidiaries comprising the Energy Related Services segment incurred losses for
the past two years reflecting the start-up nature of their operations. Included
in this business segment are operations which market gas and electricity and
arrange transportation and related services, largely to retail customers,
including those served by the Company's gas distribution subsidiaries. In
addition, these subsidiaries provide a variety of technical and maintenance
services to customers that operate commercial and industrial facilities and
provide appliance repair service to residential customers, all located within
the New York City metropolitan area. During the past two years, the Company has
acquired an engineering firm, and major heating, ventilation and air
conditioning contractors and has integrated these operations into its strategies
for future growth.
Results from the Other segment reflected certain costs associated with corporate
and administrative functions that were not allocated to various business
segments.
48
NOTE 13. DISAGGREGATED CONDENSED BALANCE SHEET (UNAUDITED)
Set forth below is LILCO's condensed balanced sheet at May 28, 1998, which has
been disaggregated to reflect the effects of the LIPA Transaction. The assets,
capitalization and liabilities attributable to KeySpan subsidiaries represent
LILCO's transfer of its gas and generation business to KeySpan subsidiaries. The
assets, capitalization and liabilities attributable to LIPA represent those
items that have been acquired or assumed by LIPA through its acquisition of
LILCO's common stock. All such amounts exclude the proceeds from the sale of
common stock to LIPA. For a further discussion of the LIPA Transaction, see Note
2, "Sale of LILCO Assets, Acquisition of KeySpan Energy Corporation and Transfer
of Assets and Liabilities to the Company."
(In Millions of Dollars)
- ------------------------------------------------------------------------------------
Allocation of Assets/Liabilities
--------------------------------
KeySpan
LILCO Subsidiaries LIPA
- ------------------------------------------------------------------------------------
ASSETS
Total net utility plant $ 3,853.6 $ 1,798.0 $ 2,055.6
- ------------------------------------------------------------------------------------
Regulatory assets
Shoreham related 4,692.4 - 4,692.4
Regulatory tax asset 1,660.9 - 1,660.9
Other 681.4 445.9 235.5
- ------------------------------------------------------------------------------------
Total regulatory assets 7,034.7 445.9 6,588.8
Nonutility property and other investments 52.1 33.1 19.0
Current assets 1,083.1 397.0 686.1
Deferred charges 87.2 33.2 54.0
- ------------------------------------------------------------------------------------
Total assets $ 12,110.7 $ 2,707. $ 9,403.5
====================================================================================
CAPITALIZATION AND LIABILITIES
Capitalization
Long-term debt, including current
maturities $ 4,383.1 $ 24.4 $ 4,358.7
Promissory notes - 1,047.9 (1,047.9)
Preferred stock, including current 659.6 438.0 221.6
maturities
Common shareholders' equity $ 2,682.6 181.8 2,500.8
- ------------------------------------------------------------------------------------
Total capitalization 7,725.3 1,692.1 6,033.2
Regulatory liabilities 380.7 68.4 312.3
Current liabilities 1,103.8 752.3 351.5
Deferred credits 2,708.7 1.5 2,707.2
Operating reserves 192.2 192.9 ( 0.7)
- ------------------------------------------------------------------------------------
Total capitalization and liabilities $ 12,110.7 $ 2,707.2 $ 9,403.5
====================================================================================
49
Note 14. Supplemental Gas and Oil Disclosures (Unaudited)
This information includes amounts attributable to a 36% minority interest in
THEC at December 31, 1998 and a 34% minority interest in 1997 and 1996. Gas and
oil operations, and reserves, were predominantly located in the United States in
all years.
CAPITALIZED COSTS RELATING TO GAS AND OIL PRODUCING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------
At December 31, 1998 1997
- -----------------------------------------------------------------------------------------------------------
(In Thousands of Dollars)
Unproved properties not being amortized $145,317 $104,075
Properties being amortized - productive and nonproductive 828,168 566,868
- -----------------------------------------------------------------------------------------------------------
Total capitalized costs 973,485 670,943
Accumulated depletion (438,974) (229,776)
- -----------------------------------------------------------------------------------------------------------
Net capitalized costs $534,511 $441,167
- -----------------------------------------------------------------------------------------------------------
The following is a break-out of the costs (in thousands of dollars) which are
excluded from the amortization calculation as of December 31, 1998, by year of
acquisition: 1998 - $68,931 1997 - $34,259 and prior years $42,127 . The Company
cannot accurately predict when these costs will be included in the amortization
base, but it is expected that these costs will be evaluated within the next five
years.
COSTS INCURRED IN PROPERTY ACQUISITION, EXPLORATION AND DEVELOPMENT ACTIVITIES
- ---------------------------------------------------------------------------------------------------
Year Ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------------------------------------
(In Thousands of Dollars)
Acquisition of properties-
Unproved properties $33,803 $16,613 $23,317
Proved properties 162,083 24,007 94,774
Exploration 55,611 44,119 27,398
Development 51,046 59,244 31,243
- ---------------------------------------------------------------------------------------------------
Total costs incurred $302,543 $143,983 $176,732
- ---------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS FROM GAS AND OIL PRODUCING ACTIVITIES
- -----------------------------------------------------------------------------------------------------------
Year Ended December 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
(In Thousands of Dollars)
Revenues from gas and oil
producing activities-
Sales to unaffiliated parties $127,124 $116,349 $64,864
- ----------------------------------------------------------------------------------------------------------
Revenues 127,124 116,349 64,864
- ----------------------------------------------------------------------------------------------------------
Production and lifting costs 21,166 18,379 12,201
Depletion 209,838 59,081 33,732
- ----------------------------------------------------------------------------------------------------------
Total expenses 231,004 77,460 45,933
- ----------------------------------------------------------------------------------------------------------
Income before taxes (103,880) 38,889 18,931
Income taxes (37,410) 12,397 5,192
- ----------------------------------------------------------------------------------------------------------
Results of gas and oil producing
activities (excluding corporate
overhead and interest costs) ($66,470) $26,492 $13,739
- ----------------------------------------------------------------------------------------------------------
50
NOTE 14. SUPPLEMENTAL GAS AND OIL DISCLOSURES (CONTINUED)
The gas and oil reserves information is based on estimates of proved reserves
attributable to THEC's interest as of December 31 for each of the years
presented. These estimates principally were prepared by independent petroleum
consultants. Proved reserves are estimated quantities of natural gas and crude
oil which geological and engineering data demonstrate with reasonable certainty
to be recoverable in future years from known reservoirs under existing economic
and operating conditions.
The standardized measure of discounted future net cash flows was prepared by
applying year-end prices of gas and oil to the proved reserves, except for those
reserves devoted to future production that is hedged. Such reserves are priced
at their respective hedged amounts. The standardized measure does not purport,
nor should it be interpreted, to present the fair value of THEC's gas and oil
reserves. An estimate of fair value would also take into account, among other
things, the recovery of reserves not presently classified as proved, anticipated
future changes in prices and costs and a discount factor more representative of
the time value of money and the risks inherent in reserve estimates.
Reserve Quantity Information
Natural Gas (MMcf)
At December 31, 1998 1997 1996
- --------------- ---- ---- ----
Proved reserves-
Beginning of year 330,601 320,474 195,946
Revisions of previous estimates (4,656) (18,743) (8,665)
Extensions and discoveries 67,272 75,651 21,445
Production (61,479) (50,310) (31,215)
Purchases of reserves in place 139,994 3,778 143,688
Sales of reserves in place (1,285) (249) (725)
Proved reserves-
End of year 470,447 330,601 320,474
Proved developed reserves-
Beginning of year 256,632 236,544 162,784
End of year 369,931 256,632 236,544
Crude Oil, Condensate and Natural Gas Liquids (MBbls)
At December 31, 1998 1997 1996
- --------------- ---- ---- ----
Proved reserves-
beginning of year 1,077 1,131 889
Revisions of previous estimates (105) (62) (157)
Extensions and discoveries 249 184 198
Production (225) (171) (118)
Purchases of reserves in place 665 1 361
Sales of reserves in place (11) (6) (42)
Proved reserves-
end of year 1,650 1,077 1,131
Proved developed reserves-
Beginning of year 914 1,013 774
End of year 1,498 914 1,013
51
Note 14. Supplemental Gas and Oil Disclosures (continued)
Standardized Measure of Discounted Future Net Cash Flows Relating to
Proved Gas and Oil Reserves
At December 31, 1998 1997
- --------------- ---- ----
(In Thousands of Dollars)
Future cash flows $878,448 $781,336
Future costs-
Production (153,567) (135,437)
Development (103,915) (84,658)
Future net inflows
before income tax 620,966 561,241
Future income taxes (89,032) (124,510)
Future net cash flows 531,934 436,731
10% discount factor (135,874) (121,351)
Standardized measure of
discounted future net
cash flows $396,060 $315,380
Changes in Standardized Measure of Discounted Future Net Cash Flows from
Proved Reserve Quantities
Year Ended December 31, 1998 1997 1996
- ----------------------- ---- ---- ----
(In Thousands of Dollars)
Standardized measure -
beginning of year $315,380 $452,582 $171,459
Sales and transfers, net of
production costs (105,958) (97,968) (52,663)
Net change in sales and
transfer prices, net of
production costs (104,137) (223,169) 145,385
Extensions and discoveries and
improved recovery, net of
related costs 72,333 114,893 46,616
Changes in estimated future
development costs (6,656) (20,499) (14,068)
Development costs incurred
during the period that reduced
future development costs 15,891 16,154 19,594
Revisions of quantity estimates (4,982) (23,156) (19,132)
Accretion of discount 37,706 57,700 20,652
Net change in income taxes 44,812 62,733 (89,353)
Net purchases of reserves in place 155,259 1,855 250,990
Changes in production rates
(timing) and other (23,588) (25,745) (26,898)
Standardized measure -
end of year $396,060 $315,380 $452,582
52
Note 14. Supplemental Gas and Oil Disclosures (continued)
AVERAGE SALES PRICES AND PRODUCTION COSTS PER UNIT
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
Natural gas ($/MCF) 1.96 2.45 2.35
Oil, condensate and natural gas liquid ($/Bbl) 12.18 18.33 21.53
Production cost per equivalent MCF ($) 0.26 0.28 0.34
- ------------------------------------------------------------------------------------------------------------------------------
ACREAGE
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 Gross Net
- ------------------------------------------------------------------------------------------------------------------------------
Producing 297,360 197,902
Undeveloped 317,049 282,822
- ------------------------------------------------------------------------------------------------------------------------------
NUMBER OF PRODUCING WELLS
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 Gross Net
- ------------------------------------------------------------------------------------------------------------------------------
Gas wells 1,239 803
Oil wells 8 3
- ------------------------------------------------------------------------------------------------------------------------------
DRILLING ACTIVITY (Net)
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
Producing Dry Total Producing Dry Total Producing Dry Total
- ------------------------------------------------------------------------------------------------------------------------------
Net developmental wells 19.2 4.6 23.8 29.3 8.5 37.8 7.0 1.0 8.0
Net exploratory wells 1.6 4.2 5.8 3.8 2.9 6.7 4.3 4.4 8.7
- ------------------------------------------------------------------------------------------------------------------------------
WELLS IN PROCESS
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 Gross Net
- ------------------------------------------------------------------------------------------------------------------------------
Exploratory 2.0 0.7
Developmental 3.0 0.6
*Represents the cash price received which excludes the effect of any
hedging transactions.
NOTE 15. KEYSPAN GAS EAST CORPORATION SUMMARY FINANCIAL DATA
KeySpan Gas East Corporation d/b/a Brooklyn Union of Long Island, is a wholly
owned subsidiary of KeySpan Corporation. KeySpan Gas East was formed on May 7,
1998 and on May 28, 1998 acquired substantially all of the assets related to the
gas distribution business of LILCO immediately prior to the LIPA Transaction.
KeySpan Gas East provides gas distribution services to customers in the Long
Island counties of Nassau and Suffolk and the Rockaway peninsula of Queens
county. KeySpan Gas East is proposing to issue securities which will be fully
and unconditionally guaranteed by its parent, KeySpan Corporation.
Prior to the LIPA Transaction, the gas distribution operations of LILCO were
included as part of its gas and electric operations. The summarized balance
sheet information for gas operations presented herein at March 31, 1998 has been
derived from LILCO's balance sheet as of that date. Certain of LILCO's balance
sheet accounts were recorded in its books and records as directly related to its
gas operations and include the following: gas utility plant, regulatory assets,
non-utility property, gas in storage, materials and supplies, and accrued
unbilled revenues. These assets represented approximately 85% of the total gas
operations assets.
The following major balance sheet accounts common to both LILCO's gas and
electric operations as of March 31, 1998 have been allocated/determined based on
the following:
Customer Accounts Receivable
Customer accounts receivable were based upon the percentage of revenues
generated by the gas distribution operations as compared to the combined
revenues of both the gas and electric operations for the previous three month
period.
Common Utility Plant
Common utility plant was based upon an annual study of the utilization of common
facilities by the gas and electric operations of LILCO.
Capitalization
Capitalization was based upon an allocation using gas utility plant as a
percentage of total utility plant, (including certain electric related
regulatory assets), adjusted for appropriate deferred federal income taxes.
Accounts Payable and Accrued Expenses
Certain payables and accrued expenses were based on specific identification
where appropriate, such as purchased gas costs, and materials and supplies
associated with gas operations. Employee related payables, such as, employee
welfare expenses and accrued vacation were allocated to gas operations based
upon an analysis of direct labor costs associated with gas operations as a
percentage of total labor costs. Certain miscellaneous accrued expenses were
allocated to gas operations utilizing an administrative and general allocation
methodology, which was based on plant, revenues and payroll.
Operating Reserves
Operating reserves, specifically other postretirement benefits and employee
benefits, and workers compensation were based upon an analysis of direct labor
costs associated with gas operations as a percentage of total labor costs.
Environmental reserves associated with investigation and remediation of MGP
sites formerly owned by LILCO were directly related to gas operations.
Prior to the LIPA Transaction, certain of LILCO's income statement accounts were
recorded in its books and records as directly related to its gas operations.
These items include: revenues, purchased gas costs, certain operations and
maintenance ("O&M") expenses, depreciation of gas utility plant, revenue taxes,
certain other income and deductions, and federal income taxes.
Certain income and expense accounts common to both LILCO's gas and electric
operations prior to the LIPA Transaction have been allocated/determined based on
the following basis, which is consistent with the methodology utilized by the
NYPSC to establish rates:
Common O&M Expenses, Operating Taxes (excluding revenue taxes) and Miscellaneous
Income and Deductions
Based upon methodologies employing: number of active
meters; revenues; utility plant; and labor associated with gas operations, as a
percentage of total operations.
Interest Income, Interest Expense and Preferred Stock Dividend Requirements
These amounts were allocated based upon gas utility plant as a percentage of
total utility plant, (including certain electric related regulatory assets),
adjusted for appropriate deferred federal income taxes.
Depreciation on Common Plant
Based upon an annual study of the utilization of common facilities by the gas
and electric operations of LILCO.
The Company believes that the basis of allocation described above is reasonable.
Reported results of operations and the financial position of LILCO's gas
operations may have been different if such operations were conducted as a
separate subsidiary of LILCO, rather than as part of a combined integrated gas
and electric company.
53
Certain common assets which were previously part of LILCO's operations prior to
May 28, 1998 have been transferred to other subsidiaries of KeySpan (e.g. common
plant, inventory, etc. ). Income and expenses related to these assets prior to
May 28, 1998 have been allocated in the accompanying summarized financial data.
After May 28, 1998, KeySpan Gas East has been charged by affiliated companies
for the use of these assets, resulting in an operating expense of $7.2 million
for the nine months ended December 31, 1998.
The following represents summarized financial data for KeySpan Gas East.
(IN THOUSANDS OF DOLLARS)
December 31, 1998 March 31, 1998
- -------------------------- --------------------- --------------------
Total current assets 256,186 216,051
Total noncurrent assets 1,330,661 1,264,281
Total current liabilities 505,784 173,476
Total noncurrent liabilities
including long-term debt 467,736 881,554
Net Assets (1) 613,327 425,302
- -------------------------- --------------------- --------------------
(IN THOUSANDS OF DOLLARS)
Nine Months Ended 12 Months Ended Three Months Ended 12 Months Ended
December 31, 1998 March 31, 1998 March 31, 1997 December 31, 1996
- ----------------- ---------------- -------------- ---------------- ---------------
Revenues 356,634 645,659 293,391 684,260
Operating Income (2) 24,854 122,651 88,784 124,368
Net (Loss) Income (11,891) 40,558 48,605 44,960
- ----------------- ---------------- -------------- ---------------- ---------------
(1) Net Assets reflect total assets less current and noncurrent liabilities.
Intercompany accounts receivable are included in current assets and
long-term intercompany accounts payable are included in non-current
liabilities.
(2) Operating income reflects revenues less cost of gas and operating
expenses. Operating expenses include the following expenses: operations
and maintenance, depreciation and amortization and operating taxes.
Further, for the nine months ended December 31, 1998 operating income
includes before-tax charges of $8.7 million reflecting KeySpan Gas East's
portion of an early retirement program implemented by the parent.
54
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of MarketSpan Corporation d/b/a
KeySpan Energy:
We have audited the accompanying Consolidated Balance Sheet and Consolidated
Statement of Capitalization of MarketSpan Corporation (a New York corporation)
and subsidiaries as of December 31, 1998 and the related Consolidated Statements
of Income, Retained Earnings and Cash Flows for the nine months ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position and capitalization of MarketSpan
Corporation and subsidiaries as of December 31, 1998 and the results of their
operations and their cash flows for the nine months ended December 31, 1998, in
conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in Item
14 is the responsibility of the Company's management and is presented for the
purpose of complying with the Securities and Exchange Commission's rules and is
not part of the basic consolidated financial statements. This schedule has been
subjected to the auditing procedures applied in the audits of the basic
consolidated financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
February 12, 1999
New York, New York
REPORT OF ERNST & YOUNG LLP, INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of Long Island Lighting Company:
We have audited the accompanying Balance Sheet of Long Island Lighting Company
and the related Statement of Capitalization as of March 31, 1998 and the related
Statements of Income, Retained Earnings and Cash Flows for the twelve months
ended March 31, 1998, the three months ended March 31, 1997 and the year ended
December 31, 1996. Our audits also included the financial statement schedule
listed in the index at Item 14(a). These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Long Island Lighting Company at
March 31, 1998 and the results of its operations and its cash flows for the
twelve months ended March 31, 1998, the three months ended March 31, 1997 and
the year ended December 31, 1996, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
During the year ended March 31, 1998 the Company changed its method of
accounting for revenues provided for under the Rate Moderation Component.
ERNST & YOUNG LLP
May 22, 1998
Melville, New York