-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QHjXbdM/1x6YpMXO/+5oyI73iYVj/39hgIUsKN3JrPR6VoWlv4kEGCq6Y5YZF0FI PmeHstPJDIsJVeFQhA88Rg== 0000950168-00-000516.txt : 20000307 0000950168-00-000516.hdr.sgml : 20000307 ACCESSION NUMBER: 0000950168-00-000516 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 ITEM INFORMATION: FILED AS OF DATE: 20000303 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DUKE ENERGY CORP CENTRAL INDEX KEY: 0000030371 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 560205520 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-04928 FILM NUMBER: 561054 BUSINESS ADDRESS: STREET 1: 526 SOUTH CHURCH STREET CITY: CHARLOTTE STATE: NC ZIP: 28201-1006 BUSINESS PHONE: 7045946200 MAIL ADDRESS: STREET 1: 422 S CHURCH ST CITY: CHARLOTTE STATE: NC ZIP: 28242 FORMER COMPANY: FORMER CONFORMED NAME: DUKE POWER CO /NC/ DATE OF NAME CHANGE: 19920703 8-K 1 FORM 8-K = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest event reported) Not applicable --------------- DUKE ENERGY CORPORATION (Exact name of registrant as specified in its charter) North Carolina 1-4928 56-0205520 (State or other jurisdiction (Commission File (IRS Employer of incorporation) Number) Identification No.) 526 South Church Street Charlotte, North Carolina 28201-1006 (Address of principal executive offices) (Zip Code) (704) 594-6200 (Registrant's telephone number, including area code) --------------- Not applicable (Former name or address, if changed since last report) = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = Item 7. Financial Statements and Exhibits. The registrant files this Form 8-K Current Report for the purpose of filing the exhibits listed below. Exhibits 99(a) and 99(b) are expected to be filed in identical form during March 2000, with the registrant's Form 10-K Annual Report for the year ended December 31, 1999. (c) Exhibits 23(a) Independent Auditors' Consent 99(a) Consolidated Financial Statements: Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 1999, 1998 and 1997 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 Consolidated Balance Sheets as of December 31, 1999 and 1998 Consolidated Statements of Common Stockholders' Equity for the Years Ended December 31, 1999, 1998 and 1997 Notes to Consolidated Financial Statements 99(b) Management's Discussion and Analysis of Results of Operations and Financial Condition SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. DUKE ENERGY CORPORATION By: Name: David L. Hauser Title: Senior Vice President and Treasurer Dated: March 3, 2000 EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 23(a) Independent Auditors' Consent 99(a) Consolidated Financial Statements: Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 1999, 1998 and 1997 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 Consolidated Balance Sheets as of December 31, 1999 and 1998 Consolidated Statements of Common Stockholders' Equity for the Years Ended December 31, 1999, 1998 and 1997 Notes to Consolidated Financial Statements 99(b) Management's Discussion and Analysis of Results of Operations and Financial Condition EX-23 2 EXHIBIT 23(A) Exhibit No. 23(a) INDEPENDENT AUDITOR'S CONSENT We consent to the incorporation by reference in Registration Statement Nos. 333-79065, 333-81573 33-50543, 33-50617, 33-50715, 333-02571, 333-02575, 333-14209, 333-30263, 333-40679 and 333-59327 of Duke Energy Corporation on Form S-3 and Registration Statement Nos. 333-29563, 333-29585, 333-29587, 333-34655, 333-12093, 333-50317 and 333-59279 of Duke Energy Corporation on Form S-8 of our report dated February 11, 2000, appearing in this Form 8-K of Duke Energy Corporation. Deloitte & Touche LLP Charlotte, North Carolina March 3, 2000 EX-99 3 EXHIBIT 99(A) EXHIBIT 99(a) DUKE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Years Ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- In millions, except per share amounts Operating Revenues Sales, trading and marketing of natural gas and petroleum products (Notes 1 and 7).......... $ 10,922 $ 7,854 $ 8,151 Generation, transmission and distribution of electricity (Notes 1 and 4)....................... 4,934 4,586 4,334 Trading and marketing of electricity (Notes 1 and 7)....................... 3,610 2,788 1,665 Transportation and storage of natural gas (Notes 1 and 4)................... 1,139 1,450 1,504 Other (Note 8).............. 1,137 932 655 -------- -------- -------- Total operating revenues................ 21,742 17,610 16,309 -------- -------- -------- Operating Expenses Natural gas and petroleum products purchased (Note 1)....................... 10,636 7,497 7,705 Net interchange and purchased power (Notes 1, 4 and 5)................. 3,507 2,916 1,960 Fuel used in electric generation (Notes 1 and 11)...................... 764 767 743 Other operation and maintenance (Notes 4, 11 and 14).................. 3,701 2,738 2,721 Depreciation and amortization (Notes 1 and 5)....................... 968 909 841 Property and other taxes.. 371 350 369 -------- -------- -------- Total operating expenses................ 19,947 15,177 14,339 -------- -------- -------- Operating Income.......... 1,795 2,433 1,970 -------- -------- -------- Other Income and Expenses Deferred returns and allowance for funds used during construction (Note 1)....................... 82 88 109 Other, net................ 166 126 29 -------- -------- -------- Total other income and expenses................ 248 214 138 -------- -------- -------- Earnings Before Interest and Taxes................ 2,043 2,647 2,108 Interest Expense (Notes 7 and 10).................. 601 514 472 Minority Interests (Note 12)...................... 142 96 23 -------- -------- -------- Earnings Before Income Taxes.................... 1,300 2,037 1,613 Income Taxes (Notes 1 and 6)....................... 453 777 639 -------- -------- -------- Income Before Extraordinary Item....... 847 1,260 974 Extraordinary Gain (Loss), net of tax............... 660 (8) -- -------- -------- -------- Net Income................ 1,507 1,252 974 -------- -------- -------- Dividends and Premiums on Redemptions of Preferred and Preference Stock (Note 13)................ 20 21 72 -------- -------- -------- Earnings Available For Common Stockholders...... 1,487 1,231 902 -------- -------- -------- Other Comprehensive Income, net of tax Foreign currency translation adjustments (Note 1)................. (2) -- -- -------- -------- -------- Total Comprehensive Income.................. $ 1,485 $ 1,231 $ 902 ======== ======== ======== Common Stock Data (Note 1) Weighted average shares outstanding.............. 365 361 360 Earnings per share (before extraordinary item) Basic.................... $ 2.26 $ 3.43 $ 2.51 Dilutive................. $ 2.25 $ 3.42 $ 2.50 Earnings per share Basic.................... $ 4.08 $ 3.41 $ 2.51 Dilutive................. $ 4.07 $ 3.40 $ 2.50 Dividends per share....... $ 2.20 $ 2.20 $ 1.90
See Notes to Consolidated Financial Statements. 1 DUKE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- In millions CASH FLOWS FROM OPERATING ACTIVITIES Net income....................................... $ 1,507 $ 1,252 $ 974 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization................... 1,151 1,055 983 Extraordinary (gain) loss, net of tax........... (660) 8 -- Injuries and damages accrual.................... 800 -- -- Deferred income taxes........................... (210) (35) 99 Purchased capacity levelization................. 104 88 56 Transition cost recoveries (payments), net...... 95 (28) (36) (Increase) decrease in Receivables.................................... (659) (18) (266) Inventory...................................... (89) (104) (7) Other current assets........................... (138) (39) (18) Increase (decrease) in Accounts payable............................... 477 72 239 Taxes accrued.................................. (57) (6) 50 Interest accrued............................... 32 (2) (13) Other current liabilities...................... 73 84 15 Other, net...................................... 258 4 64 -------- -------- -------- Net cash provided by operating activities..... 2,684 2,331 2,140 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Capital and investment expenditures.............. (5,936) (2,500) (2,028) Proceeds from sale of subsidiaries............... 1,900 -- -- Decommissioning, retirements and other........... 236 24 34 -------- -------- -------- Net cash used in investing activities......... (3,800) (2,476) (1,994) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from the issuance of Long-term debt.................................. 3,221 1,357 1,618 Guaranteed preferred beneficial interests in subordinated notes of Duke Energy Corporation or Subsidiaries................................ 484 581 339 Common stock and stock options.................. 162 176 15 Payments for the redemption of Long-term debt.................................. (1,505) (698) (869) Common stock.................................... -- -- (25) Preferred and preference stock.................. (20) (180) (224) Net change in notes payable and commercial paper. 58 (350) (290) Dividends paid................................... (822) (814) (726) Other............................................ 22 6 (41) -------- -------- -------- Net cash provided by (used in) financing activities................................... 1,600 78 (203) -------- -------- -------- Net increase (decrease) in cash and cash equivalents..................................... 484 (67) (57) Cash received from business acquisitions......... 49 38 -- Cash and cash equivalents at beginning of year... 80 109 166 -------- -------- -------- Cash and cash equivalents at end of year......... $ 613 $ 80 $ 109 ======== ======== ======== Supplemental Disclosures Cash paid for interest, net of amount capitalized.................................... $ 541 $ 490 $ 476 Cash paid for income taxes...................... $ 732 $ 733 $ 470
See Notes to Consolidated Financial Statements. 2 DUKE ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS
December 31, --------------- 1999 1998 ------- ------- In millions ASSETS Current Assets (Note 1) Cash and cash equivalents (Note 7)........................... $ 613 $ 80 Receivables (Note 7)......................................... 3,248 2,318 Inventory.................................................... 599 543 Current portion of natural gas transition costs (Note 4)..... 81 100 Current portion of purchased capacity costs (Note 5)......... 146 99 Unrealized gains on mark-to-market transactions (Note 7)..... 1,131 1,457 Other (Note 7)............................................... 353 246 ------- ------- Total current assets....................................... 6,171 4,843 ------- ------- Investments and Other Assets Investments in affiliates (Notes 8 and 14)................... 1,299 902 Nuclear decommissioning trust funds (Note 11)................ 703 580 Pre-funded pension costs (Note 17)........................... 315 332 Goodwill, net (Notes 1 and 2)................................ 844 495 Notes receivable............................................. 154 244 Unrealized gains on mark-to-market transactions (Notes 1 and 7).......................................................... 690 396 Other........................................................ 705 283 ------- ------- Total investments and other assets......................... 4,710 3,232 ------- ------- Property, Plant and Equipment (Notes 1, 5, 9, 10 and 11) Cost......................................................... 30,436 27,128 Less accumulated depreciation and amortization............... 9,441 10,253 ------- ------- Net property, plant and equipment.......................... 20,995 16,875 ------- ------- Regulatory Assets and Deferred Debits (Note 1) Purchased capacity costs (Note 5)............................ 497 648 Debt expense................................................. 223 253 Regulatory asset related to income taxes..................... 500 506 Natural gas transition costs (Note 4)........................ 4 80 Environmental clean-up costs (Note 14)....................... 27 69 Other........................................................ 282 300 ------- ------- Total regulatory assets and deferred debits................ 1,533 1,856 ------- ------- Total Assets............................................. $33,409 $26,806 ======= =======
See Notes to Consolidated Financial Statements. 3 DUKE ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS, continued
December 31, ---------------- 1999 1998 ------- ------- In millions LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable............................................. $ 2,312 $ 1,754 Notes payable and commercial paper (Notes 7 and 10).......... 267 209 Taxes accrued (Note 1)....................................... 685 119 Interest accrued............................................. 139 109 Current maturities of long-term debt and preferred stock (Notes 10 and 13)........................................... 515 707 Unrealized losses on mark-to-market transactions (Notes 1 and 7).......................................................... 1,241 1,387 Other (Notes 1 and 14)....................................... 717 670 ------- ------- Total current liabilities................................. 5,876 4,955 ------- ------- Long-term Debt (Notes 7 and 10)............................... 8,683 6,272 ------- ------- Deferred Credits and Other Liabilities (Note 1) Deferred income taxes (Note 6)............................... 3,402 3,705 Investment tax credit (Note 6)............................... 225 242 Nuclear decommissioning costs externally funded (Note 11).... 703 580 Environmental clean-up liabilities (Note 14)................. 101 148 Unrealized losses on mark-to-market transactions (Note 7).... 438 362 Other (Note 14).............................................. 2,099 907 ------- ------- Total deferred credits and other liabilities............... 6,968 5,944 ------- ------- Minority Interests (Note 2)................................... 1,200 253 ------- ------- Guaranteed Preferred Beneficial Interests in Subordinated Notes of Duke Energy Corporation or Subsidiaries (Notes 7 and 12)......................................................... 1,404 919 ------- ------- Preferred and Preference Stock (Notes 7 and 13) Preferred and preference stock with sinking fund requirements................................................ 71 104 Preferred and preference stock without sinking fund requirements................................................ 209 209 ------- ------- Total preferred and preference stock....................... 280 313 ------- ------- Commitments and Contingencies (Notes 5, 11 and 14) Common Stockholders' Equity (Notes 15 and 16) Common stock, no par, 1 billion shares authorized; 366 million and 363 million shares outstanding at December 31, 1999 and 1998, respectively................................. 4,603 4,449 Retained earnings............................................ 4,397 3,701 Accumulated other comprehensive income....................... (2) -- ------- ------- Total common stockholders' equity.......................... 8,998 8,150 ------- ------- Total Liabilities and Stockholders' Equity................ $33,409 $26,806 ======= =======
See Notes to Consolidated Financial Statements. 4 DUKE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
Years Ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- In millions Common Stock Balance at beginning of year................... $ 4,449 $ 4,284 $ 4,289 Dividend reinvestment and employee benefits.... 154 165 (9) Other capital stock transactions, net.......... -- -- 4 -------- -------- -------- Balance at end of year....................... 4,603 4,449 4,284 -------- -------- -------- Retained Earnings Balance at beginning of year................... 3,701 3,256 3,052 Net income..................................... 1,507 1,252 974 Common stock dividends......................... (802) (794) (682) Preferred and preference stock dividends and premiums on redemptions (Note 13)............. (20) (21) (72) Other capital stock transactions, net.......... 11 8 (16) -------- -------- -------- Balance at end of year....................... 4,397 3,701 3,256 -------- -------- -------- Accumulated Other Comprehensive Income Balance at beginning of year................... -- -- -- Foreign currency translation adjustments (Note 1)............................................ (2) -- -- -------- -------- -------- Balance at end of year....................... (2) -- -- -------- -------- -------- Total Common Stockholders' Equity................ $ 8,998 $ 8,150 $ 7,540 ======== ======== ========
See Notes to Consolidated Financial Statements 5 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements For the Years Ended December 31, 1999, 1998 and 1997 1. Summary of Significant Accounting Policies Consolidation. The consolidated financial statements include the accounts of all of Duke Energy Corporation's majority-owned subsidiaries after the elimi- nation of significant intercompany transactions and balances. Investments in other entities that are not controlled by Duke Energy Corporation, but where it has significant influence over operations, are accounted for using the eq- uity method. The preparation of financial statements in conformity with generally ac- cepted accounting principles requires management to make estimates and assump- tions that affect the amounts reported in the financial statements and accom- panying notes. Although these estimates are based on management's knowledge of current and expected future events, actual results could differ from those es- timates. "Duke Energy" is used in these Notes as a collective reference to Duke En- ergy Corporation and its subsidiaries. Cash and Cash Equivalents. All liquid investments with maturities at date of purchase of three months or less are considered cash equivalents. Inventory. Inventory consists primarily of materials and supplies, gas held for transmission, processing and sales commitments, and coal held for electric generation. Inventory is recorded at the lower of cost or market, primarily using the average cost method. Accounting for Risk Management and Commodity Trading Activities. Duke Ener- gy, primarily through its subsidiaries, manages its exposure to risk from ex- isting contractual commitments and provides risk management services to its customers and suppliers through commodity derivatives, including forward con- tracts, futures, over-the-counter swap agreements and options. Commodity derivatives utilized for trading purposes are accounted for using the mark-to-market method. Under this methodology, these instruments are ad- justed to market value, and the unrealized gains and losses are recognized in current period income and are included in the Consolidated Statements of In- come and Comprehensive Income as Natural Gas and Petroleum Products Purchased or Net Interchange and Purchased Power, and in the Consolidated Balance Sheets as Unrealized Gains or Losses on Mark-to-Market Transactions. Commodity derivatives such as futures, forwards, over-the-counter swap agreements and options are also utilized for non-trading purposes to hedge the impact of market fluctuations in the price of natural gas, electricity and other energy-related products. To qualify as a hedge, the price movements in the commodity derivatives must be highly correlated with the underlying hedged commodity. Under the deferral method of accounting, gains and losses related to commodity derivatives which qualify as hedges are recognized in income when the underlying hedged physical transaction closes and are included in the Con- solidated Statements of Income and Comprehensive Income as Natural Gas and Pe- troleum Products Purchased, or Net Interchange and Purchased Power. If the commodity derivative is no longer sufficiently correlated to the underlying commodity, or if the underlying commodity transaction closes earlier than an- ticipated, the deferred gains or losses are recognized in income. Duke Energy periodically uses interest rate swaps, accounted for under the accrual method, to manage the interest rate characteristics associated with outstanding debt. Interest rate differentials to be paid or received as inter- est rates change are accrued and recognized as an adjustment to interest ex- pense. The amount accrued as either a payable to or receivable from counterparties is included in the Consolidated Balance Sheets as Regulatory Assets and Deferred Debits. 6 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 1. Summary of Significant Accounting Policies -- Continued Duke Energy also periodically utilizes interest rate lock agreements to hedge interest rate risk associated with new debt issuances. Under the defer- ral method of accounting, gains or losses on such agreements, when settled, are deferred in the Consolidated Balance Sheets as Long-term Debt and are am- ortized in the Consolidated Statements of Income and Comprehensive Income as an adjustment to interest expense. Duke Energy is exposed to foreign currency risk from investments in interna- tional affiliates and businesses owned and operated in foreign countries. To mitigate risks associated with foreign currency fluctuations, when possible, contracts are denominated in or indexed to the U.S. dollar or may be hedged through debt denominated in the foreign currency. Duke Energy also uses for- eign currency derivatives, where possible, to hedge its risk related to for- eign currency fluctuations. To qualify as a hedge, there must be a high degree of correlation between price movements in the derivative and the item desig- nated as being hedged. These derivatives are accounted for under the deferral method previously described under commodity derivatives used for non-trading purposes. Duke Energy also enters into foreign currency swap agreements to manage for- eign currency risks associated with energy contracts denominated in foreign currencies. These agreements are accounted for under the mark-to-market method previously described. Goodwill. Goodwill represents the excess of acquisition costs over the fair value of the net assets of an acquired business. The goodwill created by Duke Energy's acquisitions is amortized on a straight-line basis over the useful lives of the assets, ranging from 10 to 40 years. The amount of goodwill re- ported on the Consolidated Balance Sheets as of December 31, 1999 and 1998, respectively, was $844 million and $495 million, net of accumulated amortiza- tion of $218 million and $166 million. See Note 2 to the Consolidated Finan- cial Statements for information on significant goodwill additions. Property, Plant and Equipment. Property, plant and equipment are stated at original cost. Duke Energy capitalizes all construction-related direct labor and material costs, as well as indirect construction costs. Indirect costs in- clude general engineering, taxes and the cost of money. The cost of renewals and betterments that extend the useful life of property, plant and equipment is also capitalized. The cost of repairs and replacements is charged to ex- pense as incurred. Depreciation is generally computed using the straight-line method. The composite weighted-average depreciation rates, excluding nuclear fuel, were 3.73%, 3.82% and 3.67% for 1999, 1998 and 1997, respectively. When property, plant and equipment maintained by Duke Energy's regulated op- erations are retired, the original cost plus the cost of retirement, less sal- vage, is charged to accumulated depreciation and amortization. When entire regulated operating units are sold or non-regulated properties are retired or sold, the property and related accumulated depreciation and amortization ac- counts are reduced, and any gain or loss is recorded in income, unless other- wise required by the Federal Energy Regulatory Commission (FERC). Impairment of Long-Lived Assets. The recoverability of long-lived assets and intangible assets are reviewed whenever events or changes in circumstances in- dicate that the carrying amount of the asset may not be recoverable. Such evaluation is based on various analyses, including undiscounted cash flow pro- jections. Unamortized Debt Premium, Discount and Expense. Premiums, discounts and ex- penses incurred in connection with the issuance of presently outstanding long- term debt are amortized over the terms of the respective issues. Any call pre- miums or unamortized expenses associated with refinancing higher-cost debt ob- ligations used to finance regulated assets and operations are amortized con- sistent with regulatory treatment of those items. Environmental Expenditures. Environmental expenditures that relate to an ex- isting condition caused by past operations and do not contribute to current or future revenue generation are expensed. Environmental 7 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 1. Summary of Significant Accounting Policies -- Continued expenditures relating to current or future revenues are expensed or capital- ized as appropriate. Liabilities are recorded when environmental assessments and/or clean-ups are probable and the costs can be reasonably estimated. Cer- tain of these environmental assessments and clean-up costs are expected to be recovered from Natural Gas Transmission customers and have, therefore, been deferred and are included in the Consolidated Balance Sheets as Environmental Clean-up Costs. Cost-Based Regulation. Duke Energy's regulated operations are subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, "Ac- counting for the Effects of Certain Types of Regulation." Accordingly, certain assets and liabilities that result from the regulated ratemaking process are recorded that would not be recorded under generally accepted accounting prin- ciples for non-regulated entities. These regulatory assets and liabilities are classified in the Consolidated Balance Sheets as Regulatory Assets and De- ferred Debits, and Deferred Credits and Other Liabilities, respectively. The applicability of SFAS No. 71 is routinely evaluated, and factors such as regu- latory changes and the impact of competition are considered. Discontinuing cost-based regulation or increasing competition might require companies to re- duce their asset balances to reflect a market basis less than cost and to write off their associated regulatory assets. Management cannot predict the potential impact, if any, of discontinuing cost-based regulation or increasing competition on future financial position or consolidated results of opera- tions. However, Duke Energy continues to position itself to effectively meet these challenges by maintaining competitive prices. Common Stock Options. Duke Energy accounts for stock-based compensation us- ing the intrinsic method of accounting. Under this method, compensation cost, if any, is measured as the excess of the quoted market price of Duke Energy's stock at the date of the grant over the amount an employee must pay to acquire the stock. Restricted stock is recorded as compensation cost over the requi- site vesting period based on the market value on the date of the grant. Pro forma disclosures utilizing the fair value accounting method are included in Note 16 to the Consolidated Financial Statements. Revenues. Revenues on sales of electricity and transportation and storage of natural gas are recognized as service is provided. Revenues on sales of natu- ral gas and petroleum products, as well as electricity, gas and other energy products marketed, are recognized in the period of delivery. Receivables on the Consolidated Balance Sheets included $207 million and $193 million as of December 31, 1999 and 1998, respectively, for electric service that has been provided but not yet billed to customers. When rate cases are pending final approval, a portion of the revenues is subject to possible refund. Reserves are established where required for such cases. Nuclear Fuel. Amortization of nuclear fuel is included in the Consolidated Statements of Income and Comprehensive Income as Fuel Used in Electric Genera- tion. The amortization is recorded using the units-of-production method. Deferred Returns and Allowance for Funds Used During Construction (AFUDC). Deferred returns represent the estimated financing costs associated with fund- ing certain regulatory assets. These regulatory assets primarily arose from the funding of purchased capacity costs above levels collected in rates. De- ferred returns are non-cash items and are primarily recognized as an addition to Purchased Capacity Costs with an offsetting credit to Other Income and Ex- penses. AFUDC represents the estimated debt and equity costs of capital funds neces- sary to finance the construction of new regulated facilities. AFUDC is a non- cash item and is recognized as a cost of Property, Plant and Equipment, with offsetting credits to Other Income and Expenses and to Interest Expense. After construction is completed, Duke Energy is permitted to recover these costs, including a fair return, through their inclusion in rate base and in the pro- vision for depreciation. 8 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 1. Summary of Significant Accounting Policies -- Continued Rates used for capitalization of deferred returns and AFUDC by Duke Energy's regulated operations are calculated in compliance with FERC rules. Foreign Currency Translation. Assets and liabilities of Duke Energy's inter- national operations, where the local currency is the functional currency, have been translated at year-end exchange rates, and revenues and expenses have been translated using average exchange rates prevailing during the year. Ad- justments resulting from translation are included in the Consolidated State- ments of Income and Comprehensive Income as Foreign Currency Translation Ad- justments. The financial statements of international operations, where the U.S. dollar is the functional currency, reflect certain transactions denomi- nated in the local currency that have been remeasured in U.S. dollars. The remeasurement of local currencies into U.S. dollars creates gains and losses from foreign currency transactions that are included in consolidated net in- come. Income Taxes. Duke Energy and its subsidiaries file a consolidated federal income tax return. Deferred income taxes have been provided for temporary dif- ferences. Temporary differences occur when events and transactions recognized for financial reporting result in taxable or tax-deductible amounts in differ- ent periods. Investment tax credits have been deferred and are being amortized over the estimated useful lives of the related properties. Earnings Per Common Share. Basic earnings per share is based on a simple weighted average of common shares outstanding. Dilutive earnings per share re- flects the potential dilution that could occur if securities or other agree- ments to issue common stock, such as stock options, were exercised or con- verted into common stock. The numerator for the calculation of basic and dilutive earnings per share is earnings available for common stockholders. Denominator for Earnings per Share
1999 1998 1997 ---- ---- ---- in millions Denominator for basic earnings per share (weighted average shares outstanding)............................................ 365 361 360 Assumed exercise of dilutive stock options...................... (a) 1 2 --- --- --- Denominator for dilutive earnings per share..................... 365 362 362 === === ===
- -------- (a) While Duke Energy had dilutive stock options as of December 31, 1999, the amount did not round to one million. Extraordinary Items. In 1999, Duke Energy realized an extraordinary gain of $660 million, or $1.82 per share, relating to the sale of certain pipeline companies. See Note 2 to the Consolidated Financial Statements for additional information on the extraordinary item. In January 1998, TEPPCO Partners, L.P. (TEPPCO), in which a subsidiary of Duke Energy has a 2% general partner interest and a 19.1% limited partner in- terest, redeemed certain First Mortgage Notes. A non-cash extraordinary loss of $8 million, net of income tax of $5 million, was recorded related to costs of the early retirement of debt. Earnings per common share for 1998 were re- duced by $0.02 as a result of this charge. New Accounting Standard. In September 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued. Duke Energy is re- quired to adopt this standard by January 1, 2001. SFAS No. 133 requires that all derivatives be recognized as either assets or liabilities and measured at fair value, and it defines the accounting for changes in the fair value of the derivatives depending on the intended use of the derivative. Duke Energy is currently reviewing the expected impact of SFAS No. 133 on consolidated re- sults of operations and financial position. 9 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 1. Summary of Significant Accounting Policies -- Continued Reclassifications. Certain amounts have been reclassified in the Consoli- dated Financial Statements to conform to the current presentation. 2. Business Combinations, Acquisitions and Dispositions Business Combinations: PanEnergy Corp (PanEnergy). On June 18, 1997, Duke Power Company (Duke Power) changed its name to Duke Energy Corporation and completed a stock-for-stock merger with PanEnergy (the merger). PanEnergy was involved in the gathering, processing, transportation and storage of natural gas; the production of natural gas liquids (NGLs); and the marketing of natural gas, electricity and other energy-related products. Pursuant to the merger agreement, Duke Energy issued 158.3 million shares of its common stock in exchange for all of the outstanding common stock of PanEnergy. Accordingly, each share of PanEnergy common stock outstanding was converted into the right to receive 1.0444 shares of Duke Energy's common stock. In addition, each outstanding option to purchase PanEnergy common stock became an option to purchase common stock of Duke Energy, adjusted accordingly. The merger was accounted for as a pooling of interests; therefore, the Consolidated Financial Statements and other financial information included in this Annual Report for periods prior to the merger include the combined historical financial results of Duke Power and PanEnergy. Business Acquisitions: For acquisitions accounted for using the purchase method, assets and liabilities have been consolidated as of the purchase date and earnings from the acquisitions have been included in consolidated earnings of Duke Energy subsequent to the purchase date. Assets acquired and liabili- ties assumed are recorded at their estimated fair values, and the excess of the purchase price over the estimated fair value of the net identifiable as- sets and liabilities acquired are recorded as goodwill. Dominion Resources' Hydroelectric, Natural Gas and Diesel Power Generation Businesses. In August 1999, Duke Energy, through its wholly owned subsidiary, Duke Energy International, LLC (Duke Energy International) reached a defini- tive agreement with Dominion Resources, Inc. (Dominion Resources) to acquire its portfolio of hydroelectric, natural gas and diesel power generation busi- nesses in Argentina, Belize, Bolivia and Peru for approximately $405 million. In October 1999, Duke Energy International completed the purchase of the busi- nesses in Belize and Peru from Dominion Resources, as well as acquired addi- tional ownership interests in the Peru business (Egenor) from two other par- ties for $152 million in cash and certain other ownership interests in South America. The purchase increased Duke Energy International's ownership in Egenor from approximately 30% to 90%. The completion of the purchases in Ar- gentina and Bolivia are subject to receiving appropriate governmental consents and approvals and are expected to close by mid-2000. Assets and liabilities of the Belize and Peru businesses have been recorded at preliminary fair values along with goodwill of $74 million which is being amortized on a straight-line basis over 35 to 40 years. The final purchase price allocation and estimated life of goodwill are subject to adjustment when additional information concerning asset and liability valuations is finalized and the evaluation of certain pre-acquisition contingent liabilities has been completed. Companhia de Geracao de Energia Eletrica Paranapanema (Paranapanema). In Au- gust 1999, Duke Energy International entered a series of transactions to com- plete a $761 million purchase of a controlling voting interest and an approxi- mate 44% economic interest in Paranapanema, an electric generating company in Brazil. Assets and liabilities have been recorded at preliminary fair values along with goodwill of $134 million which is being amortized on a straight- line basis over 40 years. The final purchase price allocation and estimated life of goodwill are subject to adjustment when additional information con- cerning asset and liability valuations is finalized and the evaluation of cer- tain pre-acquisition contingent liabilities has been completed. In January 2000, Duke Energy completed a tender offer to the minority share- holders of Paranapanema and successfully acquired an additional 51% economic interest in the company for approximately $280 million. This 10 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 2. Business Combinations, Acquisitions and Dispositions -- Continued increased Duke Energy's economic ownership from approximately 44% to approxi- mately 95%. See Note 19 to the Consolidated Financial Statements. Union Pacific Resources' Gathering, Processing and Marketing Operations. On March 31, 1999, Duke Energy through its wholly owned subsidiary, Duke Energy Field Services, Inc., completed the $1.35 billion acquisition of the natural gas gathering, processing, fractionation and NGL pipeline business from Union Pacific Resources (UPR), as well as UPR's NGL marketing activities (collec- tively, "the UPR acquisition"). Goodwill of $135 million has been recorded and is being amortized on a straight-line basis over 15 to 20 years. The final purchase price allocation and estimated life of goodwill are subject to ad- justment pending additional information concerning asset and liability valua- tions and the evaluation of certain pre-acquisition contingent liabilities. Dispositions: PEPL Companies and Trunkline LNG. On March 29, 1999, wholly owned subsidiaries of Duke Energy sold Panhandle Eastern Pipe Line Company (PEPL), Trunkline Gas Company and additional storage related to those systems (collectively, the PEPL Companies), which substantially comprised the Midwest Pipelines, along with Trunkline LNG Company (Trunkline LNG) to CMS Energy Corporation (CMS). The sales price of $2.2 billion involved cash proceeds of $1.9 billion and CMS' assumption of existing PEPL debt of approximately $300 million. The sale resulted in an extraordinary gain of $660 million, net of income tax of $404 million, and an increase in earnings per basic share of $1.82. Under the terms of the agreement with CMS, Duke Energy retained certain assets and liabilities, such as the Houston office building, certain environmental, legal and tax liabilities, and substantially all intercompany balances. Management believes that the retention of these items will not have a material adverse effect on consolidated results of operations or financial position. Combined Operating Results of the PEPL Companies and Trunkline LNG for the Period from January 1, 1999 through March 28, 1999 (a)
In millions Operating Revenues.................................................. $126 Operating Expenses.................................................. 57 Other Income, Net................................................... 4 ---- Earnings Before Interest and Taxes................................. $ 73 ====
- -------- (a) Excludes intercompany building rental revenue, allocated corporate ex- penses, building depreciation and certain other costs retained by Duke Energy. The pro forma results of operations for acquisitions and dispositions do not materially differ from reported results. 3. Business Segments Duke Energy is an integrated energy and energy services provider with the ability to offer physical delivery and management of both electricity and nat- ural gas throughout the U.S. and abroad. Duke Energy provides these and other services through seven business segments: . Electric Operations . Natural Gas Transmission . Field Services . Trading and Marketing . Global Asset Development . Other Energy Services . Real Estate Operations 11 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 3. Business Segments -- Continuted Electric Operations generates, transmits, distributes and sells electric en- ergy in central and western North Carolina and the western portion of South Carolina (doing business as Duke Power or Nantahala Power and Light). These electric operations are subject to the rules and regulations of the FERC, the North Carolina Utilities Commission (NCUC) and the Public Service Commission of South Carolina (PSCSC). Natural Gas Transmission provides interstate transportation and storage of natural gas for customers primarily in the Mid-Atlantic and New England states. Until the sale of the Midwest Pipelines on March 29, 1999, Natural Gas Transmission also provided interstate transportation and storage services in the midwest states. See further discussion of the sale of the Midwest Pipe- lines in Note 2 to the Consolidated Financial Statements. The interstate natu- ral gas transmission and storage operations are subject to the rules and regu- lations of the FERC. Field Services gathers, processes, transports and markets natural gas and produces, transports and markets NGLs. Field Services operates gathering sys- tems in western Canada and ten contiguous states that serve major gas-produc- ing regions in the Rocky Mountain, Permian Basin, Mid-Continent and onshore and offshore Gulf Coast areas. Trading and Marketing markets natural gas, electricity and other energy-re- lated products across North America. Duke Energy owns a 60% interest in Trad- ing and Marketing's energy trading operations, with Mobil Corporation owning a 40% minority interest. This segment also includes certain other trading activ- ities and limited hydrocarbon exploration and production activities that are wholly owned by Duke Energy. Global Asset Development develops, owns and operates energy-related facili- ties worldwide. Global Asset Development conducts its operations primarily through Duke Energy North America, LLC (Duke Energy North America) and Duke Energy International. Other Energy Services provides engineering, consulting, construction and in- tegrated energy solutions worldwide, primarily through Duke Engineering & Services, Inc., Duke/Fluor Daniel and DukeSolutions, Inc. Real Estate Operations conducts its business through Crescent Resources, Inc., which develops high quality commercial and residential real estate pro- jects and manages land holdings in the southeastern U.S. Duke Energy's reportable segments are strategic business units that offer different products and services and are each managed separately. The account- ing policies for the segments are the same as those described in Note 1 to the Consolidated Financial Statements. Management evaluates segment performance based on earnings before interest and taxes (EBIT) after deducting minority interests. EBIT presented in the accompanying table includes intersegment sales accounted for at prices representative of unaffiliated party transac- tions. Segment assets are provided as additional information in the accompany- ing table and are net of intercompany advances, intercompany notes receivable and investments in subsidiaries. Other Operations primarily includes communication services, water services and certain unallocated corporate items. 12 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 3. Business Segments -- Continuted Business Segment Data
Depreciation Capital and Unaffiliated Intersegment Total and Investment Segment Revenues Revenues Revenues EBIT Amortization Expenditures Assets ------------ ------------ -------- ------ ------------ ------------ ------- In millions Year Ended December 31, 1999 Electric Operations..... $ 4,700 $ -- $ 4,700 $ 856 $542 $ 759 $13,133 Natural Gas Transmission........... 1,100 106 1,206 627 126 261 3,897 Field Services.......... 2,883 707 3,590 144 131 1,630 3,565 Trading and Marketing... 11,334 459 11,793 70 12 104 4,060 Global Asset Development............ 612 165 777 181 104 2,703 6,673 Other Energy Services... 886 103 989 (94) 14 94 612 Real Estate Operations.. 233 -- 233 176 9 368 983 Other Operations........ (6) 44 38 (9) 30 17 1,298 Eliminations and Minority Interests..... -- (1,584) (1,584) 92 -- -- (812) ------- ------- ------- ------ ---- ------ ------- Total Consolidated.... $21,742 $ -- $21,742 $2,043 $968 $5,936 $33,409 ======= ======= ======= ====== ==== ====== ======= Year Ended December 31, 1998 Electric Operations..... $ 4,626 $ -- $ 4,626 $1,513 $522 $ 586 $12,953 Natural Gas Transmission........... 1,426 102 1,528 702 215 290 4,996 Field Services.......... 2,094 545 2,639 76 80 304 1,893 Trading and Marketing... 8,614 171 8,785 81 11 8 3,233 Global Asset Development............ 237 82 319 64 31 1,027 2,061 Other Energy Services... 436 85 521 10 12 41 376 Real Estate Operations.. 181 -- 181 142 6 217 724 Other Operations........ (4) 26 22 2 32 27 968 Eliminations and Minority Interests..... -- (1,011) (1,011) 57 -- -- (398) ------- ------- ------- ------ ---- ------ ------- Total Consolidated.... $17,610 $ -- $17,610 $2,647 $909 $2,500 $26,806 ======= ======= ======= ====== ==== ====== ======= Year Ended December 31, 1997 Electric Operations..... $ 4,401 $ -- $ 4,401 $1,282 $498 $ 743 $12,958 Natural Gas Transmission........... 1,468 104 1,572 624 229 247 5,059 Field Services.......... 2,481 574 3,055 157 71 157 1,855 Trading and Marketing... 7,411 78 7,489 23 7 18 1,857 Global Asset Development............ 109 14 123 4 9 348 988 Other Energy Services... 343 33 376 18 6 47 223 Real Estate Operations.. 124 -- 124 98 4 223 594 Other Operations........ (28) -- (28) (120) 17 245 941 Eliminations and Minority Interests..... -- (803) (803) 22 -- -- (446) ------- ------- ------- ------ ---- ------ ------- Total Consolidated.... $16,309 $ -- $16,309 $2,108 $841 $2,028 $24,029 ======= ======= ======= ====== ==== ====== =======
In 1999, foreign operations consisted of 10% of consolidated revenues and 15% of consolidated long-lived assets, primarily in Canada and Latin America. Foreign operations were not material for 1998 and 1997. 13 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 4. Regulatory Matters Electric Operations. The NCUC and the PSCSC approve rates for retail elec- tric sales within their respective states. The FERC approves Electric Opera- tions' rates for electric sales to wholesale customers. Electric sales to the other joint owners of the Catawba Nuclear Station, which represent a majority of Electric Operations' electric wholesale revenues, are set through contrac- tual agreements. In 1997, in conjunction with its merger with PanEnergy, Duke Energy agreed to cap the base electric rates for retail customers at existing levels through 2000, with very limited exceptions. Duke Energy also agreed to freeze rates, except for the market-based rates, for transmission and wholesale electric sales. In addition, Duke Energy agreed to a cap on the rates charged to the other joint owners of Catawba Nuclear Station under the interconnection agree- ments and on the reimbursement of certain costs related to administration and general expenses and general plant costs under operation and fuel agreements. Management believes that these agreements will not have a material adverse ef- fect on consolidated results of operations or financial position. Fuel costs are reviewed semiannually in the wholesale jurisdiction and annu- ally in the South Carolina retail jurisdiction, with provisions for reviewing such costs in base rates. In the North Carolina retail jurisdiction, a review of fuel costs in rates is required annually and during general rate case pro- ceedings. All jurisdictions allow Duke Energy to adjust electric rates for past over- or under-recovery of fuel costs. Therefore, the difference between actual fuel costs incurred for electric operations and fuel costs recovered through rates is reflected in revenues. The stipulation agreements related to the merger do not apply to the fuel cost adjustments. Certain of Electric Operations' electric wholesale customers, excluding the other Catawba Nuclear Station joint owners, initiated proceedings in 1995 be- fore the FERC concerning rate-related matters. Duke Energy and nine of its eleven wholesale customers entered into a settlement in July 1996 which re- duced the customers' electric rates by approximately 9%. These contracts will be in effect through 2001, subject to annual renewals thereafter. Both of the customers that did not enter into the settlement signed agreements and began purchasing electricity from other suppliers in 1997. Management believes that these agreements will not have a material adverse impact on consolidated re- sults of operations or financial position. In December 1997, Duke Energy filed applications with the FERC, NCUC and PSCSC for authority to combine Nantahala Power and Light (a wholly owned sub- sidiary) and Duke Power. Duke Energy received the necessary approvals in June, April and February 1998, respectively. Nantahala Power and Light began opera- tions as a division of Duke Power effective August 3, 1998. On December 20, 1999, the FERC issued Order 2000, which encourages transmis- sion owners to voluntarily join Regional Transmission Organizations (RTOs) to increase access to the nation's power grid. All public utilities that own, op- erate, or control interstate electric transmission are required to file with the FERC by October 15, 2000. This filing must describe the company's proposal to join an RTO, including a description of efforts to participate, reasons for not participating, plans for further work towards participation and/or any ob- stacles in participation. All RTOs are to be operational by December 15, 2001. Natural Gas Transmission. Duke Energy's interstate natural gas pipelines primarily provide transportation and storage services pursuant to FERC Order 636. Order 636 allows pipelines to recover eligible costs resulting from im- plementation of the order (transition costs). In 1994, the FERC approved Texas Eastern Transmission Corporation's (TETCO) settlement resolving regulatory is- sues related primarily to Order 636 transition costs and a number of other is- sues related to services prior to Order 636. Under the 1994 settlement, TETCO's liability for transition costs was estimated based on the amount of producers' natural gas reserves and other factors. In 1998, TETCO favorably resolved all remaining gas purchase contracts, recognizing $39 million of in- come ($24 million after tax). In addition, the FERC approved a settlement filed by TETCO, which accelerates recovery of natural 14 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 4. Regulatory Matters -- Continued gas transition costs. The 1998 settlement is not expected to have a material adverse effect on the consolidated results of operations or financial posi- tion. Global Asset Development. Three California electric generating plants, Moss Landing, South Bay and Oakland, sell electricity under the terms of Reliabil- ity Must Run Agreements with the California Independent System Operator, which purchases electricity at FERC regulated rates. Moss Landing and Oakland have entered into settlement agreements with respect to the rates to be paid to them by the Independent System Operator. Those settlements were approved by the FERC in January 2000. South Bay has not reached a final agreement with re- spect to its electric rates and, therefore, its rates are subject to partial refund or surcharge. Management believes that the final resolution of this matter will not have a material adverse effect on consolidated results of op- erations or financial position. 5. Joint Ownership of Generating Facilities Joint Ownership of Catawba Nuclear Station
Ownership Owner Interest - ----- --------- North Carolina Municipal Power Agency Number 1 (NCMPA)................ 37.5% North Carolina Electric Membership Corporation (NCEMC)................ 28.125% Duke Energy Corporation............................................... 12.5% Piedmont Municipal Power Agency (PMPA)................................ 12.5% Saluda River Electric Cooperative, Inc. (Saluda River)................ 9.375% ------ 100% ======
As of December 31, 1999, $523 million of Property, Plant and Equipment and $243 million of accumulated depreciation and amortization represented Duke Energy's investment in Catawba Nuclear Station Units 1 and 2. Duke Energy's share of operating costs is included in the Consolidated Statements of Income and Comprehensive Income. Duke Energy entered into contractual interconnection agreements with the other joint owners of Catawba Nuclear Station to purchase declining percent- ages of the generating capacity and energy from the station. These purchased power agreements became effective in 1985 and 1986. The purchased power agree- ments were established for fifteen years for NCMPA and PMPA and ten years for NCEMC and Saluda River. The portion of purchased capacity subject to levelization not recovered in rates was deferred. Duke Energy is recovering the accumulated balance, includ- ing returns on the deferred balance, over a period expected to end in 2004. Jurisdictional levelizations are intended to recover total costs, including deferred returns, and are subject to adjustments, including final true-ups. The current levelized approved revenues are approximately $186 million. For the years ended December 31, 1999, 1998 and 1997, purchased capacity and energy costs from the other joint owners was approximately $62 million, $88 million and $120 million, respectively. These amounts, after adjustments for the costs of capacity purchased not reflected in current rates, are included in the Consolidated Statements of Income and Comprehensive Income as Net In- terchange and Purchased Power. As of December 31, 1999 and 1998, $643 million and $747 million, respectively, associated with the cost of capacity purchased but not reflected in current rates have been accumulated in the Consolidated Balance Sheets as Purchased Capacity Costs and Current Portion of Purchased Capacity Costs. The interconnection agreements also provide for supplemental power sales by Duke Energy to the other joint owners of Catawba Nuclear Station to satisfy their capacity and energy needs beyond the capacity and energy which they re- tain from the station or potentially acquire in the form of other resources. The agreements 15 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 5. Joint Ownership of Generating Facilities -- Continued further provide the other joint owners the ability to secure such supplemental requirements outside of these contractual agreements following an appropriate notice period. NCEMC, Saluda River and NCMPA have given such appropriate no- tice effective January 1, 2001. PMPA will continue to receive supplemental power sales from Duke Energy through December 31, 2005. As the other joint owners retain more capacity and energy from the station, or obtain additional capacity and energy from a third party, supplemental power sales are expected to decline. Management believes this will not have a material adverse effect on consolidated results of operations or financial position. 6. Income Taxes Income Tax Expense
For the Years Ended December 31, ---------------------- 1999 1998 1997 ------ ------ ------ in millions Current income taxes Federal............................................... $ 526 $ 673 $ 433 State................................................. 138 138 100 ------ ------ ------ Total current income taxes.......................... 664 811 533 ------ ------ ------ Deferred income taxes, net Federal............................................... (127) (15) 112 State................................................. (65) (4) 9 ------ ------ ------ Total deferred income taxes, net.................... (192) (19) 121 ------ ------ ------ Investment tax credit amortization...................... (19) (15) (15) ------ ------ ------ Total income tax expense................................ $ 453 $ 777 $ 639 ====== ====== ======
Income Tax Expense Reconciliation to Statutory Rate
For the Years Ended December 31, ---------------------- 1999 1998 1997 ------ ------ ------ in millions Income tax, computed at the statutory rate of 35%....... $ 455 $ 713 $ 565 Adjustments resulting from: State income tax, net of federal income tax effect.... 47 90 71 Favorable resolution of tax issues.................... (30) -- -- Other items, net...................................... (19) (26) 3 ------ ------ ------ Total income tax expense............................ $ 453 $ 777 $ 639 ------ ------ ------ Effective tax rate...................................... 34.9% 38.1% 39.6% ====== ====== ======
16 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 6. Income Taxes -- Continued Net Deferred Income Tax Liability Components
December 31, ---------------- 1999 1998 ------- ------- in millions Deferred credits and other liabilities....................... $ 556 $ 268 Alternative minimum tax credit carryforward.................. -- 30 Other........................................................ 8 36 ------- ------- Total deferred income tax assets........................... 564 334 Valuation allowance.......................................... (62) (52) ------- ------- Net deferred income tax assets............................. 502 282 ------- ------- Investments and other assets................................. (245) (207) Property, plant and equipment................................ (2,483) (2,405) Regulatory assets and deferred debits........................ (427) (542) Regulatory asset related to restating to pre-tax basis....... (432) (435) Other........................................................ -- (69) ------- ------- Total deferred income tax liabilities...................... (3,587) (3,658) ------- ------- State deferred income tax, net of federal tax effect......... (340) (357) ------- ------- Net deferred income tax liability............................ $(3,425) $(3,733) ======= =======
The change in the net deferred income tax liability from 1998 to 1999 dif- fers from the 1999 deferred income tax expense as a result of the removal of net deferred income tax liabilities due to the sale of the PEPL Companies and Trunkline LNG. 7. Risk Management and Financial Instruments Commodity Derivatives. Duke Energy, primarily through Trading and Marketing, manages its exposure to risk from existing contractual commitments and pro- vides risk management services to its customers through forward contracts, futures, over-the-counter swap agreements and options (collectively, "commod- ity derivatives"). Energy commodity forward contracts involve physical deliv- ery of an energy commodity. Energy commodity futures involve the buying or selling of natural gas, electricity or other energy-related commodities at a fixed price. Over-the-counter swap agreements require Duke Energy to receive or make payments based on the difference between a specified price and the ac- tual price of the underlying commodity. Energy commodity options held to miti- gate price risk provide the right, but not the requirement, to buy or sell en- ergy-related commodities at a fixed price. Commodity Derivatives -- Trading. Duke Energy engages in the trading of com- modity derivatives, and therefore experiences net open positions. Duke Energy manages open positions with strict policies which limit its exposure to market risk and require daily reporting to management of potential financial expo- sure. These policies include statistical risk tolerance limits using histori- cal price movements to calculate a daily earnings at risk measurement. The weighted-average life of Duke Energy's commodity risk portfolio was approxi- mately 20 months at December 31, 1999. Net Gains Recognized from Trading Commodity Derivatives
1999 1998 1997 ---- ---- ---- in millions Natural gas..................................................... $83 $114 $34 Electricity..................................................... 41 14 (a)
- -------- (a) Not material. 17 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 7. Risk Management and Financial Instruments -- Continued Absolute Notional Contract Quantity of Commodity Derivatives Held for Trading Purposes
December 31, --------------- 1999 1998 ------- ------- Natural gas, in billion cubic feet.............................. 36,285 11,149 Electricity, in gigawatt hours.................................. 469,371 112,867
Fair Values of Commodity Derivatives -- Trading
1999 1998 ------------------ ------------------ Assets Liabilities Assets Liabilities ------ ----------- ------ ----------- in millions Fair value at December 31 Natural gas............................. $2,966 $2,855 $1,275 $1,179 Electricity............................. 1,302 1,271 578 570 Average fair values for the year Natural gas............................. 2,401 2,269 805 757 Electricity............................. 962 900 420 416
Commodity Derivatives -- Non-Trading. At December 31, 1999 and 1998, Duke Energy held or issued several commodity derivatives, primarily in the form of swaps, that reduce exposure to market price fluctuations for certain power and NGL production facilities. At December 31, 1999, these commodity derivatives extended for periods up to ten years. The gains, losses and costs related to non-trading commodity derivatives that qualify as a hedge are not recognized until the underlying physical transaction closes. At December 31, 1999 and 1998, Duke Energy had unrealized net gains (losses) of $(120) million and $10 million, respectively, related to non-trading commodity derivatives. The de- termination of unrealized net gains (losses) requires judgement in interpret- ing market data and developing estimates of fair value. Accordingly, the unrealized net gains (losses) as of December 31, 1999 and 1998 are not neces- sarily indicative of the amounts Duke Energy could have realized in the cur- rent market. Absolute Notional Contract Quantity of Commodity Derivatives Held for Non- Trading Purposes
1999 1998 ------ ------ Natural gas, in billion cubic feet................................ 592 218 Electricity, in gigawatt hours.................................... 45,877 10,618 Power capacity, in megawatt months................................ 25,950 -- Oil, in thousands of barrels...................................... 32,764 4,875
Interest Rate Derivatives. Duke Energy periodically enters into financial derivative instruments including, but not limited to, swaps, options and trea- sury rate agreements to manage and mitigate interest rate risk exposure re- lated to borrowings. The notional amounts shown in the following table serve solely as a basis for the calculation of payment streams to be exchanged. These notional amounts are not a measure of the company's exposure through its use of derivatives. Fair values shown in the following table represent esti- mated amounts that Duke Energy would have received if the swaps had been set- tled at current market rates on the respective dates. Interest Rate Derivatives
December 31, ------------------------------------------------- 1999 1998 ------------------------ ------------------------ Notional Fair Contracts Notional Fair Contracts Amounts Value Expire Amounts Value Expire -------- ----- --------- -------- ----- --------- dollars in millions Interest rate swaps........... $600 $ 2 2000 $300 $ 8 1999-2000
18 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 7. Risk Management and Financial Instruments -- Continued Deferred gains on settled interest rate derivatives were not material in 1999 or 1998. Unrealized gains and losses and exposure to changes in market condition were not material at December 31, 1999 and 1998. As a result of the interest rate swap contracts which swap fixed rate obligations to effective floating rates, interest expense for the relative notional amount on the Con- solidated Statements of Income and Comprehensive Income is recognized at the weighted average London interbank offered rate (LIBOR) for the year plus the applicable margins. Weighted Average Rates for Interest Rate Swaps
For the Years Ended December 31, ---------------- 1999 1998 1997 ---- ---- ---- 8% Series B Swap.............................................. 5.36% 5.69% 5.78% 7.5% Series B Swap............................................ 6.42% 6.74% 6.83% Commercial paper fixed rate swaps............................. 4.95% -- --
Foreign Currency Derivatives. Trading and Marketing enters into foreign cur- rency swap agreements to manage foreign currency risks associated with energy contracts denominated in foreign currencies. As of December 31, 1999, the agreements had a notional contract amount of approximately $762 million, be- ginning in the year 2000 and extending to the year 2005, and had a weighted average fixed exchange rate of 1.470 Canadian dollars to U.S. dollars. As of December 31, 1998, the agreements had a notional contract amount of approxi- mately $120 million, beginning in the year 2000 and extending to the year 2005, and had a weighted average fixed exchange rate of 1.472 Canadian dollars to U.S. dollars. The fair value of foreign currency swap agreements was not material at December 31, 1999 or 1998. In anticipation of the tender offer for Paranapanema (see Note 19 to the Consolidated Financial Statements), Duke Energy entered into foreign currency forward contracts to obtain Brazilian reais. As of December 31, 1999, the for- ward contracts had a notional amount of $280 million at an average exchange rate of 1.8496 Brazilian reais to U.S. dollars which approximated fair value. Market and Credit Risk. New York Mercantile Exchange (Exchange) traded futures and option contracts are guaranteed by the Exchange and have nominal credit risk. On all other transactions previously described, Duke Energy is exposed to credit risk in the event of nonperformance by the counterparties. For each counterparty, Duke Energy analyzes its financial condition prior to entering into an agreement, establishes credit limits and monitors the appro- priateness of these limits on an ongoing basis. The change in market value of exchange-traded futures and options contracts requires daily cash settlement in margin accounts with brokers. Swap contracts and most other over-the- counter instruments are generally settled at the expiration of the contract term and may be subject to margin requirements with the counterparty. Financial Instruments. The fair value of financial instruments is summarized in the following table. Judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates determined as of December 31, 1999 and 1998 are not necessarily indicative of the amounts Duke Energy could have realized in current market exchanges. The majority of the estimated fair value amounts were obtained from independent parties. 19 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 7. Risk Management and Financial Instruments -- Continued Financial Instruments
1999 1998 ---------------------- ---------------------- Approximate Approximate Book Value Fair Value Book Value Fair Value ---------- ----------- ---------- ----------- in millions Long-term debt (a)............... $9,165 $8,891 $6,959 $7,240 Guaranteed preferred beneficial interests in subordinated notes of Duke Energy or subsidiaries.. 1,404 1,207 919 937 Preferred stock (a).............. 313 303 333 346
- -------- (a) Includes current maturities. The fair value of cash and cash equivalents, notes receivable, notes payable and commercial paper are not materially different from their carrying amounts because of the short-term nature of these instruments or because the stated rates approximate market rates. Guarantees made on behalf of affiliates or recourse provisions from affili- ates have no book value associated with them, and there are no fair values readily determinable since quoted market prices are not available. 8. Investment in Affiliates Investments in domestic and international affiliates which are not con- trolled by Duke Energy but where Duke Energy has significant influence over operations are accounted for by the equity method. These investments include undistributed earnings of $6 million and $5 million in 1999 and 1998, respec- tively. Duke Energy's share of net income from these affiliates is reflected in the Consolidated Statements of Income and Comprehensive Income as Other Op- erating Revenues. Natural Gas Transmission. Investments primarily include ownership interests in natural gas pipeline joint ventures which transport gas from Canada to the U.S. Investments include a 37.5% ownership interest in Maritimes & Northeast Pipeline, L.L.C. Field Services. Investments primarily include a 37% interest in a partner- ship which owns natural gas gathering systems in the Gulf of Mexico (Dauphin Island Gathering Partners) and a 21.1% interest in TEPPCO. Global Asset Development. Global Asset Development has investments in vari- ous natural gas and electric generation and transmission facilities in its targeted geographic areas. Significant investments include a 50% indirect in- terest in VMC Generating Company, a merchant electric generating company, a 36.8% indirect interest in American Ref-Fuel Company and a 25% indirect inter- est in National Methanol Company, which owns and operates a methanol and MTBE (methyl tertiary butyl ether) business in Jubail, Saudi Arabia. Other Energy Services. Investments include the participation in various con- struction and support activities for fossil-fueled generating plants. Real Estate Operations. Investments include various real estate development projects. Other Operations. Investments include a 20% interest in the BellSouth PCS L.P. joint venture, which provides wireless personal communication services. 20 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 8. Investment in Affiliates -- Continued Investment in Affiliates
December 31, 1999 December 31, 1998 December 31, 1997 ----------------------------- ---------------------------- ---------------------------- Domestic International Total Domestic International Total Domestic International Total -------- ------------- ------ -------- ------------- ----- -------- ------------- ----- in millions Natural Gas Transmission........... $ 67 $ 83 $ 150 $104 $ 37 $141 $ 67 $ -- $ 67 Field Services.......... 439 -- 439 303 -- 303 160 -- 160 Global Asset Development............ 425 224 649 171 223 394 174 208 382 Other Energy Services... 51 6 57 19 23 42 16 10 26 Real Estate Operations.. 11 -- 11 5 -- 5 2 -- 2 Other Operations........ (7) -- (7) 17 -- 17 36 13 49 ---- ---- ------ ---- ---- ---- ---- ---- ---- Total.................. $986 $313 $1,299 $619 $283 $902 $455 $231 $686 ==== ==== ====== ==== ==== ==== ==== ==== ====
Equity in Earnings of Investment
For the years ended: ---------------------------------------------------------------------------------------- December 31, 1999 December 31, 1998 December 31, 1997 ---------------------------- ---------------------------- ---------------------------- Domestic International Total Domestic International Total Domestic International Total -------- ------------- ----- -------- ------------- ----- -------- ------------- ----- in millions Natural Gas Transmission........... $ 16 $ 9 $ 25 $ 14 $ 3 $ 17 $ 8 $-- $ 8 Field Services.......... 44 -- 44 9 -- 9 19 -- 19 Global Asset Development............ 47 10 57 50 18 68 8 21 29 Other Energy Services... 10 3 13 1 13 14 4 8 12 Real Estate Operations.. 3 -- 3 -- -- -- -- -- -- Other Operations........ (30) -- (30) (29) -- (29) (30) -- (30) ---- --- ---- ---- --- ---- ---- --- ---- Total.................. $ 90 $22 $112 $ 45 $34 $ 79 $ 9 $29 $ 38 ==== === ==== ==== === ==== ==== === ====
Summarized Combined Financial Information of Unconsolidated Subsidiaries
December 31, -------------------- 1999 1998 1997 ------ ------ ------ in millions Balance Sheet Current Assets........................................... $1,544 $ 848 $ 642 Noncurrent Assets........................................ 7,826 7,340 5,868 Current Liabilities...................................... 1,155 1,084 758 Noncurrent Liabilities................................... 4,727 3,884 3,257 ------ ------ ------ Net Assets............................................. $3,488 $3,220 $2,495 ====== ====== ====== Income Statement Operating Revenues....................................... $3,510 $1,667 $ 905 Operating Expenses....................................... 3,104 1,166 703 Net Income............................................. 193 263 72
Duke Energy had outstanding notes receivable from certain affiliates of $72 million and $80 million at December 31, 1999 and 1998, respectively. 21 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 9. Property, Plant and Equipment Property, Plant and Equipment
December 31, --------------- 1999 1998 ------- ------- in millions Electric utility Generation.................................................... $ 7,876 $ 7,670 Transmission and distribution................................. 6,577 6,324 General plant................................................. 1,166 1,127 Nuclear fuel.................................................. 741 554 Construction work in progress................................. 343 328 ------- ------- Total electric utility...................................... 16,703 16,003 ------- ------- Natural gas transmission....................................... 4,473 6,194 Non-regulated generation....................................... 4,457 837 Gathering and processing....................................... 2,428 1,409 Construction work in progress.................................. 881 469 Other property and equipment................................... 1,494 2,216 ------- ------- Total Property, Plant and Equipment......................... $30,436 $27,128 ======= =======
Accumulated Depreciation
December 31, -------------- 1999 1998 ------ ------- in millions Electric utility(a)............................................. $6,950 $ 6,371 Natural gas transmission........................................ 1,217 2,585 Non-regulated generation........................................ 493 26 Other........................................................... 781 1,271 ------ ------- Total Accumulated Depreciation............................... $9,441 $10,253 ====== =======
- -------- (a) Includes amortization of nuclear fuel: 1999--$444 million; 1998--$325 mil- lion. 22 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 10. Debt and Credit Facilities Long-term Debt
December 31, -------------- Year Due 1999 1998 ---------- ------ ------ (in millions) Duke Energy First and refunding mortgage bonds:(a) 7%................................................. 2000 $ 200 $ 200 5 7/8%--6 5/8%..................................... 2001--2008 625 625 6 3/4%--8.30%...................................... 2023--2025 661 678 7%--8.95%.......................................... 2027--2033 165 165 Mortgage bonds matured during 1999................. -- 425 Pollution control debt, 3.85%--7.75%................ 2012--2017 172 172 Notes: 5.38%--9.21%....................................... 2009--2016 264 65 6%--6.6%........................................... 2028--2038 500 300 Commercial paper, 5.84% and 5.28% weighted-average rate at December 31, 1999 and 1998, respectively... 1,000 1,200 Other debt.......................................... 21 23 Duke Capital Corporation Senior Notes: 6 1/4%--7 1/2%..................................... 2004--2009 1,250 250 6 3/4%--8%......................................... 2018--2019 650 150 Commercial paper, 5.91% and 5.73% weighted-average rate at December 31, 1999 and 1998, respectively... 500 500 Note payable to affiliate 5.03% and 4.68% weighted- average rate at December 31, 1999 and 1998, respectively....................................... 83 24 PanEnergy Bonds: 7 3/4%............................................. 2022 328 328 8 5/8% Debentures.................................. 2025 100 100 Notes: 7%--9.9%, maturing serially........................ 2003--2006 395 395 Notes matured during 1999.......................... -- 114 TETCO Notes: 8%--10 3/8%........................................ 2000--2004 500 500 Medium-term, Series A, 7.64% -- 9.07%.............. 2001--2012 51 100 Algonquin Gas Transmission Company 9.13% Notes........................................ 2003 100 100 Crescent Resources, Inc(b) Construction and mortgage loans, 5.86%--7.26%....... 2000--2011 46 69 Revolving credit facilities, 5.98% weighted-average rate at December 31, 1998.......................... 2001 -- 100 Global Asset Development Medium-term note, 7.25%............................. 2004 162 -- Credit facilities, 6.01% weighted-average rate at December 31, 1999.................................. 2002 460 -- Notes: 7.69%--18%......................................... 2000--2005 107 33 7.8%............................................... 2004--2013 161 -- 6%--10%(c)......................................... 2013--2017 485 -- Capital leases...................................... 2009--2028 207 -- Notes matured during 1999........................... -- 78 Other debt of subsidiaries.......................... 34 313 Unamortized debt discount and premium, net.......... (62) (48) ------ ------ Total long-term debt................................ 9,165 6,959 Current maturities of long-term debt................ (482) (687) ------ ------ Total long-term portion............................. $8,683 $6,272 ====== ======
- -------- (a) Substantially all of Electric Operations' electric plant was mortgaged. (b) Substantial amounts of Crescent Resources' real estate development pro- jects, land and buildings were pledged as collateral. (c) Paranapanema (Brazil) debt, principal is indexed annually to inflation. 23 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 10. Debt and Credit Facilities -- Continued Annual Maturities
in millions 2000................................................................ $482 2001................................................................ 306 2002................................................................ 225 2003................................................................ 601 2004................................................................ 958
Annual maturities exclude $1,736 million of long-term debt that matures af- ter 2004 which have call options whereby Duke Energy has the option to repay the debt early. Based on the years in which Duke Energy may first exercise their redemption options, $881 million could potentially be repaid in 2000, $328 million in 2002, $227 million in 2003, $200 million in 2004 and $100 mil- lion thereafter. Credit Facilities
December 31, 1999 December 31, 1998 ---------------------- ---------------------- Credit Credit Facilities Outstanding Facilities Outstanding ---------- ----------- ---------- ----------- in millions 364-day facilities (a)........... $ 823 $ 10 $ 600 $ -- Three-year revolving facilities.. 565 450 -- -- Four-year revolving facilities... 125 -- 125 100 Five-year revolving facilities (a)............................. 2,200 -- 2,200 -- ------ ---- ------ ---- Total Consolidated............. $3,713 $460 $2,925 $100 ====== ==== ====== ====
- -------- (a) Supported commercial paper facilities. Notes Payable and Commercial Paper
December 31, ---------------- 1999 1998 ------- ------- in millions Credit facilities outstanding................................. $ 460 $ 100 Note payable.................................................. 86 4 Commercial paper outstanding.................................. 1,764 1,905 ------- ------- 2,310 2,009 Less portion classified as long-term Credit facilities........................................... (460) (100) Note payable................................................ (83) -- Commercial paper............................................ (1,500) (1,700) ------- ------- Portion classified as short-term.............................. $ 267 $ 209 ======= =======
The weighted average interest rate on outstanding short-term notes payable and commercial paper at December 31, 1999 and 1998 was 5.72% and 5.23%, re- spectively. 24 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 11. Nuclear Decommissioning Costs Nuclear Decommissioning Costs. Estimated site-specific nuclear decommissioning costs, including the cost of decommissioning plant components not subject to radioactive contamination, total approximately $1.9 billion stated in 1999 dollars based on decommissioning studies completed in 1999. This amount includes Duke Energy's 12.5% ownership in the Catawba Nuclear Sta- tion. The other joint owners of Catawba Nuclear Station are responsible for decommissioning costs related to their ownership interests in the station. Both the NCUC and the PSCSC have granted Duke Energy recovery of estimated decommissioning costs through retail rates over the expected remaining service periods of Duke Energy's nuclear stations. Such estimates presume each unit will be decommissioned as soon as possible following the end of its license life. Although subject to extension, the current operating licenses for Duke Energy's nuclear units expire as follows: Oconee 1 and 2 -- 2013, Oconee 3 -- 2014; McGuire 1 -- 2021, McGuire 2 -- 2023; and Catawba 1 -- 2024, Catawba 2 -- 2026. During 1999 and 1998, Duke Energy expensed approximately $57 million which was contributed to the external funds for decommissioning costs and accrued an additional $6 million to the internal reserve. Nuclear units are depreciated at an annual rate of 4.7%, of which 1.61% is for decommissioning. The balance of the external funds as of December 31, 1999 and 1998 was $703 million and $580 million, respectively. The balance of the internal reserve as of December 31, 1999 and 1998 was $223 million and $217 million, respectively, and is re- flected in the Consolidated Balance Sheets as Accumulated Depreciation and Am- ortization. Management believes that the decommissioning costs being recovered through rates, when coupled with assumed after-tax fund earnings of 5.5% to 5.9%, are currently sufficient to provide for the cost of decommissioning. A provision in the Energy Policy Act of 1992 established a fund for the de- contamination and decommissioning of the Department of Energy's (DOE) uranium enrichment plants. Licensees are subject to an annual assessment for 15 years based on their pro rata share of past enrichment services. The annual assess- ment is recorded in the Consolidated Statements of Income and Comprehensive Income as Fuel Used in Electric Generation. Duke Energy paid $10 million dur- ing 1999 and has paid $75 million cumulatively related to its ownership inter- ests in nuclear plants. The remaining liability and regulatory assets of $70 million and $79 million at December 31, 1999 and 1998, respectively, are re- flected in the Consolidated Balance Sheets as Deferred Credits and Other Lia- bilities, and Regulatory Assets and Deferred Debits, respectively. Spent Nuclear Fuel. Under provisions of the Nuclear Waste Policy Act of 1982, Duke Energy has entered into contracts with the DOE for the disposal of spent nuclear fuel. The DOE failed to begin accepting the spent nuclear fuel on January 31, 1998, the date provided by the Nuclear Waste Policy Act and by Duke Energy's contract with the DOE. On June 8, 1998, Duke Energy filed with the United States Court of Federal Claims a claim against the DOE for damages in excess of $1 billion arising out of the DOE's failure to begin accepting commercial spent nuclear fuel by January 31, 1998. Damages claimed in the suit are intended to recover costs that Duke Energy is incurring and will continue to incur as a result of the DOE's partial material breach of its contract with Duke Energy, including costs associated with securing additional spent fuel storage capacity. Duke Energy will continue to safely manage its spent nuclear fuel until the DOE accepts it. Payments made to the DOE for disposal costs are based on nuclear output and are included in the Consolidated Statements of In- come and Comprehensive Income as Fuel Used in Electric Generation. 12. Guaranteed Preferred Beneficial Interests in Subordinated Notes of Duke Energy or Subsidiaries Duke Energy and Duke Capital Corporation (Duke Capital) have each formed business trusts for which they own all the respective common securities. The trusts issue and sell preferred securities and invest the gross proceeds in assets of the trusts. Substantially all the assets of each trust are junior subordinated notes issued by the respective company. 25 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 12. Guaranteed Preferred Beneficial Interests in Subordinated Notes of Duke Energy or Subsidiaries -- Continued Trust Preferred Securities
December 31, --------------- Issued Rate 1999 1998 Junior Subordinated Notes ------ ----- ------- ------ ------------------------- in millions Duke Energy 1997...................... 7.2% $ 350 $ 350 7.2% Series A due 2037 1999...................... 7.2% 250 -- 7.2% Series B due 2039 Duke Capital 1998...................... 7 3/8% 250 250 7 3/8% Series A due 2038 1998...................... 7 3/8% 350 350 7 3/8% Series B due 2038 1999...................... 8 3/8% 250 -- 8 3/8% Series C due 2029 Unamortized debt discount... (46) (31) ------- ----- $ 1,404 $ 919 ======= =====
These trust preferred securities represent preferred undivided beneficial interests in the assets of the respective trusts. Payment of distributions on these preferred securities is guaranteed by the respective company, but only to the extent the trusts have funds legally and immediately available to make such distributions. Dividends of $87 million, $44 million and $15 million re- lated to the trust preferred securities have been included in the Consolidated Statements of Income and Comprehensive Income as Minority Interests for the years ended December 31, 1999, 1998 and 1997, respectively. 13. Preferred and Preference Stock Authorized Shares of Stock as of December 31, 1999 and 1998
Par Value Shares --------- ----------- in millions Preferred Stock........................................ $100 12.5 Preferred Stock A...................................... $ 25 10.0 Preference Stock....................................... $100 1.5
As of December 31, 1999 and 1998, there were no shares of preference stock outstanding. Preferred Stock with Sinking Fund Requirements
December 31, Shares Outstanding ------------------- Rate/Series Year Issued at December 31, 1999 1999 1998 ----------- ----------- -------------------- --------- --------- dollars in millions 6.10% C (Preferred Stock A)..................... 1992 800,000 $ 20 $ 20 6.20% D (Preferred Stock A)..................... 1992 800,000 20 20 6.20% T................. 1992 130,000 13 13 6.30% U................. 1992 130,000 13 13 6.40% V................. 1992 130,000 13 13 6.75% X................. 1993 250,000 25 25 5.95% B (Preferred Stock A) (a)................. 1992 -- -- 20 --------- --------- Total................. $ 104 $ 124 ========= =========
- -------- (a) Preferred stock series redeemed in September 1999. 26 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 13. Preferred and Preference Stock -- Continued The annual sinking fund requirements for 2000 through 2004 are $33 million, $33 million, $13 million, $2 million and $2 million, respectively. Some addi- tional redemptions are permitted at Duke Energy's option. Preferred Stock without Sinking Fund Requirements
December 31, Shares Outstanding ------------------- Rate/Series Year Issued at December 31, 1999 1999 1998 ----------- ----------- -------------------- --------- --------- dollars in millions 4.50% C................... 1964 175,000 $ 18 $ 18 7.85% S................... 1992 300,000 30 30 7.00% W................... 1993 249,989 25 25 7.04% Y................... 1993 299,995 30 30 6.375% (Preferred Stock A)....................... 1993 1,257,185 31 31 Auction Series A.......... 1990 750,000 75 75 --------- --------- Total................... $ 209 $ 209 ========= =========
The call provisions for the outstanding preferred stock specify various re- demption prices not exceeding 104% of par value, plus accumulated dividends to the redemption date. During February 1998, Duke Energy purchased approximately two million shares of its preferred stock for $180 million. During December 1997, Duke Energy re- deemed approximately three million shares of preferred stock for $203 million. The premiums related to these redemptions were included in the Consolidated Statements of Income and Comprehensive Income as Dividends and Premiums on Re- demptions of Preferred and Preference Stock for 1997. 14. Commitments and Contingencies Nuclear Insurance. Duke Energy owns and operates the McGuire and Oconee Nu- clear Stations with two and three nuclear reactors, respectively, and operates and has a partial ownership interest in the Catawba Nuclear Station with two nuclear reactors. Nuclear insurance coverage is maintained in three program areas: liability coverage; property, decontamination and decommissioning cov- erage; and business interruption and/or extra expense coverage. Certain ex- penses associated with nuclear insurance premiums paid by Duke Energy are re- imbursed by the other joint owners of the Catawba Nuclear Station. Pursuant to the Price-Anderson Act, Duke Energy is required to insure against public liability claims resulting from nuclear incidents to the full limit of liability of approximately $9.8 billion. Primary Liability Insurance. The maximum required private primary liability insurance of $200 million has been purchased along with a like amount to cover certain worker tort claims. Excess Liability Insurance. This policy currently provides approximately $9.6 billion of coverage through the Price-Anderson Act's mandatory industry- wide excess secondary insurance program of risk pooling. The $9.6 billion of coverage is the sum of the current potential cumulative retrospective premium assessments of $88 million per licensed commercial nuclear reactor. This $9.6 billion will be increased by $88 million as each additional commercial nuclear reactor is licensed, or reduced by $88 million for certain nuclear reactors that are no longer operational and may be exempted from the risk pooling in- surance program. Under this program, licensees could be assessed retrospective premiums to compensate for damages in the event of a nuclear incident at any licensed facility in the nation. If such an incident occurs and public liabil- ity damages exceed primary insurances, licensees may be assessed up to $88 million for each of their licensed reactors, payable at a rate not 27 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 14. Commitments and Contingencies -- Continued to exceed $10 million a year per licensed reactor for each incident. The $88 million amount is subject to indexing for inflation and may be subject to state premium taxes. Duke Energy is a member of Nuclear Electric Insurance Limited (NEIL), which provides property and business interruption insurance coverage for Duke Energy's nuclear facilities under the following three policy programs: Primary Property Insurance. This policy provides $500 million in primary property damage coverage for each of Duke Energy's nuclear facilities. Excess Property Insurance. This policy provides excess property, decontami- nation and decommissioning liability insurance in the following amounts: $2.25 billion for the Catawba Nuclear Station and $1.5 billion each for the Oconee and McGuire Nuclear Stations. Business Interruption Insurance. This policy provides business interruption and/or extra expense coverage resulting from an accidental outage of a nuclear unit. Each unit of the McGuire and Catawba Nuclear Stations is insured for up to approximately $4 million per week and the Oconee Nuclear Station units are insured for up to approximately $3 million per week. Coverage amounts per unit decline if more than one unit is involved in an accidental outage. Initial coverage begins after a 12-week deductible period and continues at 100% for 52 weeks and 80% for the next 110 weeks. If NEIL's losses ever exceed its reserves for any of the above three pro- grams, Duke Energy will be liable for assessments of up to five times its an- nual premiums. The current potential maximum assessments are as follows: Pri- mary Property Insurance -- $22 million; Excess Property Insurance -- $22 mil- lion; Business Interruption Insurance -- $20 million. The other joint owners of the Catawba Nuclear Station are obligated to as- sume their pro rata share of any liabilities for retrospective premiums and other premium assessments resulting from the Price-Anderson Act's excess sec- ondary insurance program of risk pooling or the NEIL policies. Environmental. Duke Energy is subject to international, federal, state and local regulations regarding air and water quality, hazardous and solid waste disposal and other environmental matters. Manufactured Gas Plants and Superfund Sites. Duke Energy was an operator of manufactured gas plants until the early 1950s and has entered into a coopera- tive effort with the State of North Carolina and other owners of certain for- mer manufactured gas plant sites to investigate and, where necessary, remedi- ate these contaminated sites. The State of South Carolina has expressed inter- est in entering into a similar arrangement. Duke Energy is considered by regu- lators to be a potentially responsible party and may be subject to future lia- bility at seven federal Superfund sites and two state Superfund sites. While the cost of remediation of the remaining sites may be substantial, Duke Energy will share in any liability associated with remediation of contamination at such sites with other potentially responsible parties. Management believes that resolution of these matters will not have a material adverse effect on consolidated results of operations or financial position. PCB (Polychlorinated Biphenyl) Assessment and Clean-up Programs. In June 1999, the Environmental Protection Agency (EPA) certified that TETCO, a wholly owned subsidiary of Duke Energy, had completed clean up of PCB contaminated sites under conditions stipulated by a U.S. Consent Decree in 1989. TETCO is required to continue groundwater monitoring on a number of sites for at least the next two years. The estimated cost of such monitoring is not material. 28 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 14. Commitments and Contingencies -- Continued Under terms of the agreement with CMS discussed in Note 2 to the Consoli- dated Financial Statements, Duke Energy is obligated to complete clean-up of previously identified contamination at certain agreed-upon sites on the PEPL and Trunkline systems. These clean-up programs are expected to continue until 2001. The contamination resulted from the past use of lubricants containing PCBs and the prior use of wastewater collection facilities and other on-site disposal areas. Soil and sediment testing, to date, has detected no signifi- cant off-site contamination. Duke Energy has communicated with the EPA and ap- propriate state regulatory agencies on these matters. At December 31, 1999 and 1998, remaining estimated clean-up costs on the TETCO, PEPL and Trunkline systems have been accrued and are included in the Consolidated Balance Sheets as Other Current Liabilities and Environmental Clean-up Liabilities. These cost estimates represent gross clean-up costs ex- pected to be incurred, have not been discounted or reduced by customer recov- eries and generally do not include fines, penalties or third-party claims. Costs expected to be recovered from customers have been deferred and are in- cluded in the Consolidated Balance Sheets as of December 31, 1999 and 1998, as Environmental Clean-up Costs. The federal and state clean-up programs are not expected to interrupt or di- minish Duke Energy's ability to deliver natural gas to customers. Based on Duke Energy's experience to date and costs incurred for clean-up operations, management believes the resolution of matters relating to the environmental issues discussed above will not have a material adverse effect on consolidated results of operations or financial position. Injury and Damages Claims. Duke Energy has experienced numerous claims re- lating to damages for personal injury alleged to have arisen from the exposure to or use of asbestos in connection with construction and maintenance activi- ties performed by Duke Energy on its electric generation plants during the 1960s and 1970s. During 1999, Duke Energy experienced a significant increase in the number of these claims. This increase, coupled with its cumulative ex- perience in claims received, prompted Duke Energy to conduct a comprehensive review which was completed in late 1999 and to record an $800 million accrual, which is included in Other Deferred Credits and Other Liabilities in the Con- solidated Financial Statements, to reflect the purchase of a third party in- surance policy as well as estimated amounts for future claims not recoverable under such policy. The insurance policy, combined with amounts covered by self-insurance reserves, provides for claims paid up to an aggregate of $1.6 billion. Duke Energy currently believes the estimated claims relating to this exposure will not exceed such amount. While Duke Energy is uncertain as to the timing of when claims will be received, portions of the estimated claims may not be received and paid for 30 or more years. Amounts reserved for injury and damages claims were not material in 1998 and 1997. While Duke Energy has recorded an accrual related to this estimated liabili- ty, such estimates cannot be made with certainty. Factors, such as the fre- quency and magnitude of claims, could result in changes in the estimates of the injury and damages liability and insurance recoveries. Such changes could result in, over time, a difference from the amount currently reflected in the financial statements. However, due to Duke Energy's insurance program related to this liability, management believes that any changes in the estimates would not have a material adverse affect on consolidated results of operations or financial position. Litigation. Duke Energy and its subsidiaries are involved in legal, tax and regulatory proceedings before various courts, regulatory commissions and gov- ernmental agencies regarding performance, contracts and other matters arising in the ordinary course of business, some of which involve substantial amounts. Where appropriate, Duke Energy has made accruals in accordance with SFAS No. 5, "Accounting for Contingencies," to provide for such matters. Management be- lieves that the final disposition of these proceedings will not have a mate- rial adverse effect on consolidated results of operations or financial posi- tion. 28 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 14. Commitments and Contingencies -- Continued Other Commitments and Contingencies. Periodically, Duke Energy may become involved in contractual disputes with natural gas transmission customers in- volving potential or threatened abrogation of contracts by the customers. If the customers are successful, Duke Energy may not receive the full value of anticipated benefits under the contracts. In the normal course of business, certain of Duke Energy's subsidiaries and affiliates enter into various contracts for energy services that contain cer- tain schedule and performance requirements. Certain subsidiaries of Duke En- ergy had guaranteed performance under some of these contracts in the amount of approximately $2.5 billion and $1.2 billion as of December 31, 1999 and 1998, respectively. In addition, certain subsidiaries of Duke Energy have guaranteed debt agreements of affiliates and have provided surety bonds and letters of credit, all of which totaled approximately $853 million and $492 million as of December 31, 1999 and 1998, respectively. The increase in the amount of these obligations is due to the increased construction activities at Duke Energy North America and Duke/Fluor Daniel. Management monitors and approves these obligations and believes it is unlikely that Duke Energy would be required to perform or otherwise incur any material losses associated with the above obli- gations. Management believes that these commitments and contingencies will not have a material adverse effect on consolidated results of operations or financial po- sition. Leases. Duke Energy utilizes assets under operating leases in several areas of operations. Consolidated rental expense amounted to $87 million, $80 mil- lion and $92 million in 1999, 1998 and 1997, respectively. Future minimum rental payments under Duke Energy's various operating leases for the years 2000 through 2004 are $79 million, $68 million, $58 million, $50 million and $45 million, respectively. 15. Common Stock At Duke Energy's annual meeting of shareholders held on April 15, 1999, shareholders approved an amendment to the Articles of Incorporation to in- crease the authorized common stock from 500 million to 1 billion shares. In 1996, the Board of Directors authorized Duke Energy to repurchase up to $1 billion of its common stock during the period beginning February 1996 and ending February 2001. No repurchases of common stock were made in 1999, 1998 or 1997, and none are anticipated in the future. 16. Stock-Based Compensation Under Duke Energy's 1998 Stock Incentive Plan, stock options for up to fif- teen million shares of common stock may be granted to key employees. Under the plan, the exercise price of each option granted equals the market price of Duke Energy's common stock on the date of grant. Vesting periods range from one to five years with a maximum exercise term of ten years. Effective with Duke Energy's merger with PanEnergy Corp, each share of PanEnergy common stock, outstanding immediately prior to the merger, was con- verted into the right to receive 1.0444 shares of Duke Energy common stock. Each option to purchase PanEnergy common stock, outstanding prior to the merg- er, was assumed by Duke Energy and became exercisable upon the same terms as under the applicable PanEnergy stock option plan and option agreement, except that these options became options to purchase shares of Duke Energy common stock, appropriately adjusted. 29 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 16. Stock-Based Compensation -- Continued Stock Option Activity
Weighted Average Options Exercise Price ------------ -------------- in thousands Outstanding at December 31, 1996................. 3,274 $20 Granted........................................ 388 44 Exercised...................................... (873) 19 Forfeited...................................... (60) 27 ----- Outstanding at December 31, 1997................. 2,729 24 Granted........................................ 3,548 57 Exercised...................................... (948) 21 Forfeited...................................... (868) 57 ----- Outstanding at December 31, 1998................. 4,461 45 Granted........................................ 5,154 54 Exercised...................................... (428) 23 Forfeited...................................... (375) 57 ----- Outstanding at December 31, 1999................. 8,812 51 =====
Stock Options at December 31, 1999
Outstanding Exercisable --------------------------------------- ------------------------ Weighted Weighted Weighted Range of Average Average Average Exercise Remaining Exercise Exercise Prices Number Life (Years) Price Number Price -------- ------------ ------------ -------- ------------ -------- in thousands in thousands $10 to $14 36 1.4 $12 36 $12 $15 to $20 728 4.0 19 728 19 $21 to $25 153 4.2 23 153 23 $26 to $31 157 6.1 27 157 27 $42 to $50 2,992 9.8 49 124 44 $51 to $59 4,443 8.6 58 582 57 $60 to $67 303 9.0 65 13 67 ----- ----- Total 8,812 1,793 34 ===== =====
Duke Energy had 1.5 million and 2.4 million options exercisable at December 31, 1998 and 1997, with weighted average exercise prices of $22 and $21 per option, respectively. The weighted-average fair value of options granted was $10, $9 and $10 per option during 1999, 1998 and 1997, respectively. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pric- ing model. Weighted-Average Assumptions for Option-Pricing
1999 1998 1997 ------- ------- ------- Stock dividend yield.............................. 4.1% 4.2% 3.5% Expected stock price volatility................... 18.8% 15.1% 20.7% Risk-free interest rates.......................... 5.9% 5.6% 6.5% Expected option lives............................. 7 years 7 years 7 years
30 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 16. Stock-Based Compensation -- Continued Had compensation expense for stock-based compensation been determined based on the fair value at the grant dates, 1999 net income would have been $1,498 million, or $4.06 per basic share; 1998 net income would have been $1,250 mil- lion, or $3.40 per basic share; and 1997 net income would have been $971 mil- lion, or $2.50 per basic share. Duke Energy has the 1996 Stock Incentive Plan (the 1996 Plan) under which two million shares of common stock were reserved for awards to employees. Re- stricted stock grants made under the 1996 Plan vest over a period ranging be- tween one and five years. Duke Energy awarded 65,850 restricted shares (fair value at grant dates of approximately $4 million) in 1999 and 3,000 restricted shares in 1998. Compensation expense for the grants is charged to earnings over the restriction period and was not material in 1999, 1998 or 1997. In addition, Duke Energy granted Performance Awards under the 1998 Long-Term Incentive Plan (the 1998 Plan), under which fifteen million shares of common stock have been reserved for employee awards. Grants under the 1998 Plan vest over periods ranging between one and seven years. Duke Energy awarded 493,200 shares (fair value at grant dates of $26 million) in 1999. Compensation ex- pense for the stock grants is charged to earnings over the vesting period, and amounted to $3 million in 1999. 17. Employee Benefit Plans Retirement Plans. Duke Energy and its subsidiaries maintain a non-contribu- tory defined benefit retirement plan covering most employees with minimum service requirements using a cash balance formula. Under a cash balance formu- la, a plan participant accumulates a retirement benefit based upon a percent- age, which may vary with age and years of service, of current eligible earn- ings and current interest credits. On December 31, 1998, all defined benefit retirement plans maintained by Duke Energy and its subsidiaries, except for the PanEnergy retirement plan, were merged to form the Duke Energy Retirement Cash Balance Plan (Duke Energy Plan). The plan merger changed the benefit for certain participants, from a formula based primarily on benefit accrual service and highest average earn- ings, to a cash balance formula. Through December 31, 1998, the PanEnergy retirement plan provided retirement benefits (i) for eligible employees of certain subsidiaries that are generally based on an employee's years of benefit accrual service and highest average eligible earnings, and (ii) for eligible employees of certain other subsidiar- ies under a cash balance formula. In 1998, a significant amount of lump sum payouts was made from the PanEnergy plan resulting in a settlement gain of $10 million. Effective January 1, 1999, the benefit formula under the PanEnergy plan, for all eligible employees, was changed to a cash balance formula. In connection with the 1999 sale of the Midwest Pipelines to CMS, benefit accruals under the PanEnergy plan were frozen on December 31, 1998 for all participants who, as a result of the sale, became employees of CMS and its subsidiaries. Once the transfer of the benefit obligation and related assets of the affected participants to CMS was completed, the PanEnergy plan was merged into the Duke Energy Plan. Duke Energy's policy is to fund amounts, as necessary, on an actuarial basis to provide assets sufficient to meet benefits to be paid to plan participants. On December 30, 1997, assets and related liabilities of $236 million and $204 million, respectively, for certain PanEnergy plan participants were trans- ferred to the Duke Power plan. As a result of this transfer, no contributions to the Duke Energy plan were necessary in 1999 or 1998. 31 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 17. Employee Benefit Plans -- Continued Components of Net Periodic Pension Costs
For the Years Ended December 31, ---------------------- 1999 1998 1997 ------ ------ ------ in millions Service cost benefit earned during the year.......... $ 72 $ 63 $ 62 Interest cost on projected benefit obligation........ 165 169 164 Expected return on plan assets....................... (224) (218) (209) Amortization of prior service cost................... (3) (4) (5) Amortization of net transition asset................. (4) (4) (4) Recognized net actuarial loss........................ 12 10 17 Settlement gain...................................... -- (10) -- ------ ------ ------ Net periodic pension costs........................... $ 18 $ 6 $ 25 ====== ====== ======
Reconciliation of Funded Status to Pre-funded Pension Costs
December 31, -------------- 1999 1998 ------ ------ in millions Change in Benefit Obligation Benefit obligation at beginning of year...................... $2,540 $2,372 Service cost................................................. 72 63 Interest cost................................................ 165 169 Plan amendment............................................... -- 5 Actuarial (gain) loss........................................ (41) 141 Transfer to CMS.............................................. (85) -- Benefits paid................................................ (205) (210) ------ ------ Benefit obligation at end of year............................ $2,446 $2,540 ====== ====== Change in Plan Assets Fair value of plan assets at beginning of year (a)........... $2,922 $2,725 Actual return on plan assets................................. 491 406 Employer contributions....................................... (2) 1 Transfer to CMS.............................................. (85) -- Benefits paid................................................ (205) (210) ------ ------ Fair value of plan assets at end of year (a)................. $3,121 $2,922 ====== ====== Funded status................................................ $ 675 $ 382 Unrecognized net experience (gain) loss...................... (315) 2 Unrecognized prior service cost reduction.................... (24) (27) Unrecognized net transition asset............................ (21) (25) ------ ------ Pre-funded pension costs..................................... $ 315 $ 332 ====== ======
-------- (a) Principally equity and fixed income securities. 32 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 17. Employee Benefit Plans -- Continued Assumptions Used for Pension Benefits Accounting (a)
1999 1998 1997 ---- ---- ---- Percent Discount rate................................................. 7.50 6.75 7.25 Salary increase............................................... 4.50 4.67 4.15 Expected long-term rate of return on plan assets.............. 9.25 9.25 9.25
-------- (a) Reflects weighted averages across all plans. Duke Energy also sponsors employee savings plans which cover substantially all employees. Employer matching contributions of $68 million, $53 million and $53 million were expensed in 1999, 1998 and 1997, respectively. Other Postretirement Benefits. Duke Energy and most of its subsidiaries pro- vide certain health care and life insurance benefits for retired employees on a contributory and non-contributory basis. Employees become eligible for these benefits if they have met certain age and service requirements at retirement, as defined in the plans. Under plan amendments effective late 1998 and early 1999, health care benefits for future retirees were changed to limit employer contributions and medical coverage. Such benefit costs are accrued over the active service period of employees to the date of full eligibility for the benefits. The net unrecognized transi- tion obligation, resulting from the implementation of accrual accounting, is being amortized over approximately 20 years. Components of Net Periodic Postretirement Benefit Costs
For the Years Ended December 31, ---------------------- 1999 1998 1997 ------ ------ ------ in millions Service cost benefit earned during the year......... $ 7 $ 10 $ 10 Interest cost on accumulated postretirement benefit obligation......................................... 40 43 46 Expected return on plan assets...................... (21) (18) (19) Amortization of prior service cost.................. 1 7 6 Amortization of net transition obligation........... 18 16 16 Recognized net actuarial (gain) loss................ (1) 1 (1) ------ ------ ------ Net periodic postretirement benefit costs........... $ 44 $ 59 $ 58 ====== ====== ======
33 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 17. Employee Benefit Plans -- Continued Reconciliation of Funded Status to Accrued Postretirement Benefit Costs
December 31, -------------- 1999 1998 ------ ------ in millions Change in Benefit Obligation Accumulated postretirement benefit obligation at beginning of year.................................................... $ 625 $ 667 Service cost................................................ 7 10 Interest cost............................................... 40 43 Plan participants' contributions............................ 7 6 Amendments.................................................. -- (49) Actuarial gain.............................................. (68) (6) Benefits paid............................................... (49) (46) ------ ------ Accumulated postretirement benefit obligation at end of year....................................................... $ 562 $ 625 ------ ------ Change in Plan Assets Fair value of plan assets at beginning of year (a).......... $ 305 $ 266 Actual return on plan assets................................ 41 34 Employer contributions...................................... 23 45 Plan participants' contributions............................ 7 6 Benefits paid............................................... (49) (46) ------ ------ Fair market value of plan assets at end of year (a)......... $ 327 $ 305 ------ ------ Funded status............................................... $ (235) $ (320) Unrecognized prior service cost............................. 8 9 Unrecognized net experience gain............................ (110) (23) Unrecognized transition obligation.......................... 229 239 ------ ------ Accrued postretirement benefit costs........................ $ (108) $ (95) ====== ======
-------- (a) Principally equity and fixed income securities. Assumptions Used for Postretirement Benefits Accounting (a)
1999 1998 1997 ----- ----- ----- percent Discount rate.............................................. 7.50 6.75 7.25 Salary increase............................................ 4.50 4.67 4.33 Expected long-term rate of return on 401(h) assets......... 9.25 9.25 9.25 Expected long-term rate of return on RLR assets............ 6.75 6.75 6.75 Expected long-term rate of return on VEBA assets........... 9.25 9.25 9.25 Assumed tax rate (b)....................................... 39.60 39.60 39.60
-------- (a) Reflects weighted averages across all plans. (b) Health care portion of postretirement benefits in VEBA trusts. For measurement purposes, a 5.0% weighted average rate of increase in the per capita cost of covered health care benefits was assumed for 1999. The rate was assumed to decrease gradually to 4.75% for 2005 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. 34 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 17. Employee Benefit Plans -- Continued Sensitivity to Changes in Assumed Health Care Cost Trend Rates
1-Percentage- 1-Percentage- Point Increase Point Decrease -------------- -------------- in millions Effect on total of service and interest cost components...................................... $ 3 $ (2) Effect on postretirement benefit obligation...... 34 (24)
18. Quarterly Financial Data (Unaudited)
First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ------- In millions, except per share data 1999 Operating revenues................... $4,160 $4,691 $6,694 $6,197 $21,742 Operating income..................... 627 531 884 (247) 1,795 EBIT................................. 683 568 908 (116) 2,043 Income before extraordinary item..... 307 288 441 (189) 847 Net income........................... 967 288 441 (189) 1,507 Earnings per share (before extraordinary item) Basic.............................. $ 0.83 $ 0.77 $ 1.20 $(0.53) $ 2.26 Dilutive........................... $ 0.83 $ 0.77 $ 1.19 $(0.53) $ 2.25 Earnings per share Basic.............................. $ 2.65 $ 0.77 $ 1.20 $(0.53) $ 4.08 Dilutive........................... $ 2.64 $ 0.77 $ 1.19 $(0.53) $ 4.07 1998 Operating revenues................... $4,115 $4,014 $5,298 $4,183 $17,610 Operating income..................... 608 549 826 450 2,433 EBIT................................. 678 582 871 516 2,647 Income before Extraordinary item..... 328 279 429 224 1,260 Net income........................... 320 279 429 224 1,252 Earnings per share before Extraordinary item) Basic.............................. $ 0.89 $ 0.76 $ 1.18 $ 0.60 $ 3.43 Dilutive........................... $ 0.89 $ 0.76 $ 1.17 $ 0.60 $ 3.42 Earnings per share Basic.............................. $ 0.87 $ 0.76 $ 1.18 $ 0.60 $ 3.41 Dilutive........................... $ 0.87 $ 0.76 $ 1.17 $ 0.60 $ 3.40
19. Subsequent Events On December 16, 1999, Duke Energy announced that it had signed definitive agreements to combine Duke Energy's gas gathering and processing businesses with Phillips Petroleum's Gas Processing and Marketing unit to form a new mid- stream company. Under the terms of the agreements, the new company will seek to arrange approximately $2.6 billion of debt financing and, upon closing of the transaction, will make a one-time cash distribution of $1.2 billion to both Duke Energy and Phillips Petroleum. At closing, Duke Energy will own about 70% of the new company and Phillips Petroleum will own about 30%. The new company would then offer approximately 20% of its equity to the public in 2000 to reduce the debt resulting from the transaction. Such an offering is conditional upon completion of the transaction and favorable market condi- tions. On January 4, 2000, Duke Energy announced that it had entered into a defini- tive agreement to purchase, for $386 million, 100% of the stock of El Paso En- ergy Corporation's wholly owned subsidiary, East Tennessee 35 DUKE ENERGY CORPORATION Notes to Consolidated Financial Statements -- Continued 19. Subsequent Events -- Continued Natural Gas Company, a 1,100-mile pipeline that crosses Duke Energy's TETCO pipeline and serves the southeastern region of the U.S. Both transactions are subject to regulatory approval and are expected to close in the first quarter of 2000. In January 2000, Duke Energy completed a tender offer to the minority share- holders of Paranapanema and successfully acquired an additional 51% economic interest in the company for approximately $280 million. This increases Duke Energy's economic ownership from approximately 44% to approximately 95%. 36 Independent Auditors' Report TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF DUKE ENERGY CORPORATION We have audited the consolidated balance sheets of Duke Energy Corporation and subsidiaries (Duke Energy) as of December 31, 1999 and 1998, and the related consolidated statements of income and comprehensive income, common stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of Duke Energy's management. Our responsibility is to express an opinion on the financial statements 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Duke Energy as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP Deloitte & Touche LLP Charlotte, North Carolina February 11, 2000 EX-99 4 EXHIBIT 99(B) EXHIBIT 99(b) MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION INTRODUCTION Management's Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements. Business Segments. Duke Energy Corporation (collectively with its subsidiar- ies, "Duke Energy") is an integrated energy and energy services provider with the ability to offer physical delivery and management of both electricity and natural gas throughout the U.S. and abroad. Duke Energy provides these and other services through seven business segments: .Electric Operations .Natural Gas Transmission .Field Services .Trading and Marketing .Global Asset Development .Other Energy Services .Real Estate Operations Electric Operations generates, transmits, distributes and sells electric en- ergy in central and western North Carolina and the western portion of South Carolina (doing business as Duke Power or Nantahala Power and Light). These electric operations are subject to the rules and regulations of the Federal Energy Regulatory Commission (FERC), the North Carolina Utilities Commission (NCUC) and the Public Service Commission of South Carolina (PSCSC). Natural Gas Transmission provides interstate transportation and storage of natural gas for customers primarily in the Mid-Atlantic and New England states. Until the sale of the Midwest Pipelines on March 29, 1999, Natural Gas Transmission also provided interstate transportation and storage services in the midwest states. See further discussion of the sale of the Midwest Pipe- lines in Note 2 to the Consolidated Financial Statements. The interstate natu- ral gas transmission and storage operations are subject to the rules and regu- lations of the FERC. Field Services gathers, processes, transports and markets natural gas and produces, transports and markets natural gas liquids (NGLs). Field Services operates gathering systems in western Canada and ten contiguous states that serve major gas-producing regions in the Rocky Mountain, Permian Basin, Mid- Continent and onshore and offshore Gulf Coast areas. Trading and Marketing markets natural gas, electricity and other energy-re- lated products across North America. Duke Energy owns a 60% interest in Trad- ing and Marketing's energy trading operations, with Mobil Corporation owning a 40% minority interest. This segment also includes certain other trading activ- ities and limited hydrocarbon exploration and production activities that are wholly owned by Duke Energy. Global Asset Development develops, owns and operates energy-related facili- ties worldwide. Global Asset Development conducts its operations primarily through Duke Energy North America, LLC (Duke Energy North America) and Duke Energy International, LLC (Duke Energy International). Other Energy Services provides engineering, consulting, construction and in- tegrated energy solutions worldwide, primarily through Duke Engineering & Services, Inc. (Duke Engineering & Services), Duke/Fluor Daniel and DukeSolutions, Inc. (DukeSolutions). Real Estate Operations conducts its business through Crescent Resources, Inc., which develops high quality commercial and residential real estate pro- jects and manages land holdings in the southeastern U.S. 1 In 1997, Duke Power Company (Duke Power) merged with PanEnergy Corp (PanEnergy). The merger was accounted for as a pooling of interests; there- fore, the Consolidated Financial Statements and other financial information included in this Annual Report for periods prior to the merger include the combined historical financial results of Duke Power and PanEnergy. See Note 2 to the Consolidated Financial Statements for additional information on the combination. Business Strategy. Duke Energy's business strategy is to develop integrated energy infrastructures in targeted regions where Duke Energy's extensive capa- bilities in developing energy assets, operating electricity, gas and NGL plants, optimizing commercial operations and managing risk can provide compre- hensive energy solutions for customers and create superior value for share- holders. Domestically, Duke Energy is aggressively investing in new merchant power plants throughout the U.S., expanding its natural gas pipeline infra- structure in the eastern U.S., rapidly increasing its leading position in gas processing and NGL marketing and broadening its trading and marketing expert- ise across the energy spectrum. Internationally, Duke Energy is currently fo- cusing on integrated electric and gas opportunities in Australia and Latin America and intends to implement its strategies in Europe. Electric Operations continues to strive to maintain low costs and competi- tive rates for its customers and to provide high quality customer service. Electric Operations is expected to grow moderately, consistent with historical trends. Expansion will primarily result from continued economic growth in its service territory. Natural Gas Transmission provides solid earnings growth and strengthens its competitive position by adhering to a comprehensive strategy of selected ac- quisitions and developing incremental projects that expand services to meet specific customer needs. In January 2000, Natural Gas Transmission announced that it had entered into a definitive agreement to purchase the East Tennessee Natural Gas Company, a pipeline well positioned to serve the rapidly growing southeastern region of the U.S. The transaction is expected to close in the first quarter of 2000, subject to regulatory approval. For more information on this purchase, see Note 19 to the Consolidated Financial Statements. Duke Energy plans to significantly grow several of its business segments: Field Services, Trading and Marketing, Global Asset Development and Other En- ergy Services. Restructuring of energy markets in the U.S. and abroad is pro- viding substantial opportunities for these segments to capitalize on their broad capabilities. Expansion opportunities for Field Services include the planned combination of Duke Energy's gas gathering and processing businesses with Phillips Petro- leum's Gas Processing and Marketing unit to form a new midstream company. The transaction is expected to close by first quarter 2000, subject to regulatory approval. See Note 19 to the Consolidated Financial Statements for further discussion. Trading and marketing activities at Duke Energy continue to expand as Trad- ing and Marketing provides energy supply, output marketing, risk management and commercial optimization services to all of Duke Energy's merchant struc- ture developments. Trading and Marketing continues to increase its customer base for wholesale energy management services to aggregators, distribution companies, large industrials and other marketers. Global Asset Development expects to continue strong earnings growth through acquisitions, divestitures, construction of greenfield projects and expansion of existing facilities as opportunities are extracted, evaluated and realized through the marketplace. Duke Energy's combination of assets and capabilities that span the energy value chain have contributed to Global Asset Develop- ment's successful delivery of natural gas pipeline, power generation, energy marketing and other services as demonstrated both domestically and interna- tionally. To capture the greatest value in North America, Duke Energy North America, through its portfolio management strategy, seeks opportunities to in- vest in markets which have capacity needs and to divest, in whole or in part, when significant value can be realized. Other Energy Services seeks to grow with various types of services including comprehensive energy efficiencies in food, textile and government facilities. 2 The strong real estate market in the Southeast continues to present substan- tial growth opportunities for both the commercial and residential development of Real Estate Operations. In addition to initiating development of signifi- cant office and industrial facilities in each of its established markets, Real Estate Operations entered a new market niche in 1999 to develop moderately priced residential communities in Jacksonville, Florida. Real Estate Opera- tions also announced plans to enter the multi-family market and to signifi- cantly increase its retail development. RESULTS OF OPERATIONS In 1999, earnings available for common stockholders were $1,487 million, or $4.08 per basic share, net of an after-tax extraordinary gain of $660 million, or $1.82 per basic share. In 1998, earnings available for common stockholders were $1,231 million, or $3.41 per basic share, net of an after-tax extraordi- nary loss of $8 million, or $0.02 per basic share. The increase in earnings available for common stockholders was primarily due to the 1999 extraordinary gain resulting from the sale of the Midwest Pipelines. This gain, along with the factors described below that affect segment profit and loss, was partially offset by a pre-tax $800 million charge for estimated injury and damages claims (see Note 14 to the Consolidated Financial Statements), higher interest expense and minority interest expense Earnings available for common stockholders increased $329 million in 1998 from 1997 earnings of $902 million, or $2.51 per basic share. The increase in earnings available for common stockholders was due to the factors described below that affect segment profit and loss. These factors were partially offset by increased interest expense and minority interests. Operating income for 1999 was $1,795 million compared to $2,433 million in 1998 and $1,970 million in 1997. Earnings before interest and taxes (EBIT) were $2,043 million, $2,647 million and $2,108 million for 1999, 1998 and 1997, respectively. Management evaluates each business segment based on an in- ternal measure of earnings before interest and taxes, after deducting minority interests. Operating Income and EBIT are affected by the same fluctuations for Duke Energy and each of its business segments. The only notable difference be- tween Operating Income and EBIT is the inclusion in EBIT of certain non-oper- ating activities. See Note 3 to the Consolidated Financial Statements for ad- ditional information on business segments. EBIT is summarized in the following table and is discussed by business seg- ment thereafter. EBIT by Business Segment
Years Ended December 31, --------------------------- 1999 1998 1997 -------- -------- -------- (in millions) Electric Operations................................ $ 856 $ 1,513 $ 1,282 Natural Gas Transmission........................... 627 702 624 Field Services..................................... 144 76 157 Trading and Marketing.............................. 70 81 23 Global Asset Development........................... 181 64 4 Other Energy Services.............................. (94) 10 18 Real Estate Operations............................. 176 142 98 Other Operations................................... (9) 2 (120) Minority Interests................................. 92 57 22 -------- -------- -------- Consolidated EBIT.................................. $ 2,043 $ 2,647 $ 2,108 ======== ======== ========
Other Operations primarily include communication services, water services and certain unallocated corporate costs. Included in the amounts discussed hereafter are intercompany transactions that are eliminated in the Consoli- dated Financial Statements. 3 Electric Operations
Years Ended December 31, ----------------------------------- 1999 1998 1997 ----------- ----------- ----------- (In millions, except where noted) Operating Revenues......................... $ 4,700 $ 4,626 $ 4,401 Operating Expenses......................... 3,966 3,228 3,221 ----------- ----------- ----------- Operating Income........................... 734 1,398 1,180 Other Income, Net of Expenses.............. 122 115 102 ----------- ----------- ----------- EBIT....................................... $ 856 $ 1,513 $ 1,282 =========== =========== =========== Sales -- GWh (a)........................... 81,548 82,011 77,935
- -------- (a) Gigawatt-hours. In 1999, EBIT for Electric Operations decreased $657 million compared to 1998, primarily due to an $800 million charge for estimated injury and damages claims. See Note 14 to the Consolidated Financial Statements for additional information related to this charge. Partially offsetting this decrease was a 2.8% increase in the number of customers in the Electric Operations' service territory during 1999, and the absence of 1998 severance and other costs re- lated to closing Electric Operations' merchandising business. In 1998, EBIT for Electric Operations increased $231 million as compared to 1997, primarily due to a 5.2% increase in gigawatt-hour sales. Gigawatt-hour sales increased as a result of warmer spring and summer weather conditions during 1998 and a 2.5% growth in the number of customers in the Electric Oper- ations' service territory. EBIT also increased due to the absence of 1997 sev- erance costs, however this was substantially offset by 1998 costs related to the closing of Electric Operations' merchandising business. Natural Gas Transmission
Years Ended December 31, ----------------------------------- 1999 1998 1997 ----------- ----------- ----------- (In millions, except where noted) Operating Revenues......................... $ 1,206 $ 1,528 $ 1,572 Operating Expenses......................... 615 864 964 ----------- ----------- ----------- Operating Income........................... 591 664 608 Other Income, Net of Expenses.............. 36 38 16 ----------- ----------- ----------- EBIT....................................... $ 627 $ 702 $ 624 =========== =========== =========== Throughput -- TBtu (a)..................... 1,893 2,593 2,862
- -------- (a) Trillion British thermal units. EBIT for Natural Gas Transmission decreased $75 million in 1999 compared to 1998. As a result of the sale of the Midwest Pipelines to CMS Energy Corpora- tion (CMS) on March 29, 1999, EBIT for the Midwest Pipelines decreased $156 million compared to 1998's full year of operation. For the Northeast Pipe- lines, EBIT increased $81 million compared to 1998, primarily as a result of increased earnings from market-expansion projects and joint ventures, higher throughput and lower operating expenses. A gain of $24 million resulting from the sale of Duke Energy's interest in the Alliance Pipeline project and bene- fits totaling $38 million related to the completion of certain PCB (polychlo- rinated biphenyl) and soil clean-up programs below estimates also increased EBIT in 1999. Partially offsetting these contributions to EBIT were the non- recurrence of the 1998 favorable resolution of regulatory issues related to gas supply realignment cost issues ("GSR issues") and a 1998 refund from a state property tax ruling. In 1998, EBIT for Natural Gas Transmission increased $78 million compared to 1997. EBIT for the Northeast Pipelines increased $56 million in 1998 over 1997, primarily as a result of the favorable resolution of 4 GSR issues, favorable state property tax rulings and increased market expan- sion projects. These increases were partially offset by a decrease in through- put primarily as a result of mild winter weather. For the Midwest Pipelines, 1998 EBIT increased $22 million compared to 1997, primarily due to a gain on the sale of the general partner interests in North- ern Border Partners, L.P. and non-recurring 1997 litigation expenses. These increases were partially offset by the favorable resolution of certain regula- tory matters in 1997, which was reflected as additional revenue and other in- come. Field Services
Years Ended December 31, ------------------------------------ 1999 1998 1997 ----------- ----------- ----------- (In millions, except where noted) Operating Revenues........................ $ 3,590 $ 2,639 $ 3,055 Operating Expenses........................ 3,444 2,598 2,898 ----------- ----------- ----------- Operating Income.......................... 146 41 157 Other Income, Net of Expenses............. (2) 35 -- ----------- ----------- ----------- EBIT...................................... $ 144 $ 76 $ 157 =========== =========== =========== Natural Gas Gathered and Processed/Transported, TBtu/d (a)........ 5.1 3.6 3.4 NGL Production, MBbl/d (b)................ 192.4 110.2 108.2 Natural Gas Marketed, TBtu/d.............. 0.5 0.4 0.4 Average Natural Gas Price per MMBtu (c)... $ 2.27 $ 2.11 $ 2.59 Average NGL Price per Gallon (d).......... $ 0.34 $ 0.26 $ 0.35
- -------- (a) Trillion British thermal units per day. (b) Thousand barrels per day. (c) Million British thermal units. (d) Does not reflect results of commodity hedges. In 1999, EBIT for Field Services increased $68 million compared to 1998. A significant portion of the increase resulted from the March 31, 1999 acquisi- tion of the natural gas gathering, processing, fractionation and NGL pipeline business from Union Pacific Resources (UPR), (collectively, the "UPR acquisi- tion"). For more information on the UPR acquisition, see Note 2 to the Consol- idated Financial Statements. Improved average NGL prices, which were up $0.08 per gallon, or 30.8% from the prior year, also contributed to the increase in EBIT. Partially offsetting these increases were $34 million in 1998 of gains on sales of assets, which were included in other income. EBIT for Field Services decreased $81 million in 1998 from 1997, primarily due to a decrease in average NGL prices of approximately $0.09 per gallon, or 25.7%. The decrease in EBIT was partially offset by $34 million of gains on sales of assets, which were included in other income. On December 16, 1999, Duke Energy announced that it had signed definitive agreements with Phillips Petroleum to form a new midstream gas gathering and processing company. See Note 19 to the Consolidated Financial Statements for further discussion. 5 Trading and Marketing
Years Ended December 31, ---------------------------------- 1999 1998 1997 ----------- ---------------------- (In millions, except where noted) Operating Revenues........................... $ 11,793 $ 8,785 $ 7,489 Operating Expenses........................... 11,724 8,665 7,446 ----------- ---------- ---------- Operating Income............................. 69 120 43 Other Income, Net of Expenses................ 43 2 1 Minority Interest Expense.................... 42 41 21 ----------- ---------- ---------- EBIT......................................... $ 70 $ 81 $ 23 =========== ========== ========== Natural Gas Marketed, TBtu/d................. 10.5 8.0 6.9 Electricity Marketed, GWh.................... 109,634 98,991 64,650
In 1999, EBIT for Trading and Marketing decreased $11 million from 1998. The decrease resulted primarily from lower natural gas trading margins, partially offset by higher electricity trading margins as well as margins associated with other trading activities and sales of natural gas interests associated with drilling activities. EBIT for Trading and Marketing increased $58 million in 1998 compared to 1997. The increase resulted primarily from increased trading margins and elec- tricity margins, partially offset by increased expenses due to business growth. Electricity volumes marketed increased primarily as a result of ac- quiring the remaining 50% ownership interest in the Duke/Louis Dreyfus, L.L.C. (D/LD) joint venture in June 1997. Global Asset Development
Years Ended December 31, ----------------------------------- 1999 1998 1997 ----------- ----------- ----------- (In millions, except where noted) Operating Revenues........................ $ 777 $ 319 $ 123 Operating Expenses........................ 571 261 129 ----------- ----------- ----------- Operating Income.......................... 206 58 (6) Other Income, Net of Expenses............. 25 22 11 Minority Interest Expense................. 50 16 1 ----------- ----------- ----------- EBIT...................................... $ 181 $ 64 $ 4 =========== =========== =========== Proportional Megawatt Capacity Owned (a).. 8,773 6,041 3,912 Proportional Maximum Pipeline Capacity (a), MMcf/d (b).......................... 309 124 --
- -------- (a) Includes under construction or under contract. (b) Million cubic feet per day. In 1999, EBIT for Global Asset Development increased $117 million compared to 1998. The increase includes $99 million in income from the sale of partial interests in four generating stations in the U.S. as a result of executing its domestic portfolio management strategy. Earnings from new projects in Latin America and Australia also contributed $63 million to the increase. Partially offsetting these increases were higher operating expenses and increased devel- opment costs associated with business expansion. EBIT for Global Asset Development increased $60 million in 1998 over 1997. The increase resulted primarily from business expansion and acquisitions, in- cluding the July 1998 acquisition of three electric generating stations in California and the December 1997 acquisition of an indirect 32.5% ownership interest in American Ref-Fuel Company. An expansion to the PT Puncakjaya power generation facility in Indonesia also contributed to the increase in EBIT dur- ing 1998. The increase in EBIT was partially offset by decreased earnings re- sulting from lower prices at National Methanol Company, a methanol and MTBE (methyl tertiary butyl ether) business in Saudi Arabia. 6 Other Energy Services
Years Ended December 31, --------------------------- 1999 1998 1997 --------- ---------------- In millions Operating Revenues.................................. $ 989 $ 521 $ 376 Operating Expenses.................................. 1,083 511 353 --------- ------- ------- Operating Income.................................... (94) 10 23 Other Income, Net of Expenses....................... -- -- (5) --------- ------- ------- EBIT................................................ $ (94) $ 10 $ 18 ========= ======= =======
In 1999, EBIT for Other Energy Services decreased $104 million compared to 1998. The decrease was primarily due to charges of $38 million and $35 million at Duke Engineering & Services and DukeSolutions, respectively. These charges, which include costs associated with repositioning the companies to focus on growth markets, included expenses related to severance, office closings and write-offs of uncollectable accounts. Increased development activity at DukeSolutions and decreased earnings from projects of Duke Engineering & Serv- ices also contributed to lower EBIT. EBIT for Other Energy Services decreased $8 million in 1998 compared to 1997, primarily due to reduced earnings of Duke Engineering & Services. Real Estate Operations
Years Ended December 31, -------------------------- 1999 1998 1997 -------- -------- -------- In millions Operating Revenues................................... $ 233 $ 181 $ 124 Operating Expenses................................... 57 39 26 -------- -------- -------- EBIT................................................. $ 176 $ 142 $ 98 ======== ======== ========
In 1999, EBIT for Real Estate Operations increased $34 million compared to 1998. The increase was primarily due to increased residential developed lot sales, land sales and commercial project sales, partially offset by decreased lake lot sales. EBIT for Real Estate Operations increased $44 million in 1998 over 1997, primarily as a result of increased commercial project sales, lake lot sales and land sales, including a gain on the sale of land in the Jocassee Gorges region of South Carolina. Other Operations EBIT for Other Operations decreased $11 million in 1999 compared to 1998, primarily as a result of the resolution of certain contingent items during 1998. EBIT for Other Operations increased $122 million in 1998 compared to 1997, primarily as a result of the absence of $71 million of non-recurring 1997 merger-related costs and the favorable resolution of certain contingent items in 1998, partially offset by a 1997 gain on the sale of Duke Energy's ownership interest in the Midland Cogeneration Venture. Other Impacts on Earnings Available for Common Stockholders Interest expense increased $87 million in 1999 compared to 1998, and $42 million in 1998 compared to 1997 due to higher average debt balances outstand- ing, resulting from acquisitions and expansion. Minority interests increased $46 million in 1999 compared to 1998, and $73 million in 1998 compared to 1997. The increases were due primarily to regular distributions paid on new issuances of Duke Energy's trust preferred securi- ties. For more information on issuances of trust preferred securities, see Note 12 to the Consolidated Financial Statements. Excluding these dividends, minority interests related primarily to Global Asset Development's 1999 in- vestments and Trading and Marketing's joint venture with Mobil Corporation. For more information regarding acquisitions and new projects, see Notes 2 and 8 to the Consolidated Financial Statements. 7 Duke Energy's effective income tax rate was approximately 35%, 38% and 40% for 1999, 1998 and 1997, respectively. The decrease in 1999 from 1998 was pri- marily due to the favorable resolution of several income tax issues and the utilization of certain capital loss carryforwards due to the sale of the Mid- west Pipelines. Favorable resolution of income tax issues also resulted in a decline in the effective tax rate in 1998 from 1997. Duke Energy expects its ongoing effective tax rate to approximate 38%. The sale of the Midwest Pipelines to CMS closed on March 29, 1999 and re- sulted in a $660 million extraordinary gain, net of income tax of $404 mil- lion. For further discussion on the sale, see Note 2 to the Consolidated Fi- nancial Statements. In January 1998, TEPPCO Partners, L.P., in which Duke Energy has a 21.1% ownership interest, redeemed certain First Mortgage Notes which resulted in Duke Energy recording a non-cash extraordinary loss of $8 million, net of in- come tax of $5 million, related to its share of costs of the early retirement of debt. In December 1997, Duke Energy redeemed four issues of preferred stock and commenced a tender offer to purchase a portion of six additional issues of preferred stock. Premiums related to these redemptions were included in the Consolidated Statements of Income and Comprehensive Income in 1997 as Divi- dends and Premiums on Redemptions of Preferred and Preference Stock. LIQUIDITY AND CAPITAL RESOURCES Operating Cash Flows Net cash provided by operations was $2,684 million in 1999, $2,331 million in 1998 and $2,140 million in 1997. In each of these years, the increase in cash was primarily due to net income resulting from business expansion. On August 29, 1998, the FERC approved a settlement from Texas Eastern Trans- mission Corporation (TETCO), a subsidiary of Duke Energy, which accelerates recovery of natural gas transition costs. The order was effective October 1, 1998 and includes a rate moratorium until 2004. Net cash flows from operations are not expected to change for the first two years after implementation; how- ever, after the natural gas transition costs are fully recovered, cash flows from operations are expected to decrease on an annual basis. For more informa- tion concerning the settlement, see Note 4 to the Consolidated Financial Statements. In late 1999, Duke Energy established an accrual for estimated injury and damages claims. Duke Energy expects to fund approximately $350 million, which is comprised of an insurance policy premium and estimated claim activity over the next year, primarily through new debt issuances. Management believes that the long-term cash requirements of the projected liability will not have a ma- terial effect on Duke Energy's liquidity or cash flows. See Note 14 to the Consolidated Financial Statements for further discussion. Investing Cash Flows Capital and investment expenditures were approximately $5.9 billion in 1999 compared to approximately $2.5 billion in 1998. The increase primarily re- sulted from business expansion for the Field Services and Global Asset Devel- opment segments. Business expansion for Field Services included the $1.35 bil- lion acquisition of the natural gas gathering, processing, fractionation and NGL pipeline business from UPR along with its natural gas and NGL marketing activities. International business expansion for Global Asset Development in- cluded $1.7 billion for multiple acquisitions in Latin America, western Aus- tralia and New Zealand. In 1999, Global Asset Development also began construc- tion of multiple power generation plants in North America and continued capi- tal expenditures on projects initiated prior to 1999. Expenditures related to these activities were partially funded by $1.9 billion in cash proceeds from the sale of Panhandle Eastern Pipe Line Company (PEPL), Trunkline Gas Company (Trunkline) and additional storage related to those systems, which substan- tially comprised the Midwest Pipelines, along with Trunkline LNG Company. For additional information concerning acquisitions and dispositions, see Note 2 to the Consolidated Financial Statements. 8 Capital and investment expenditures in 1998 increased $472 million from $2.0 billion in 1997 primarily due to business expansion by Global Asset Develop- ment. This included the $501 million purchase of three electric generating stations in California and the completion of the first phase of Bridgeport En- ergy, a power generation plant in Connecticut. Business expansion for Natural Gas Transmission and Field Services also contributed to the increase in capi- tal and investment expenditures. The increase was partially offset by de- creased expenditures for Electric Operations, primarily as a result of steam generator replacements at certain of its nuclear plants in 1997, and by the acquisition of the remaining 50% ownership of the D/LD joint venture in June 1997. Projected 2000 capital and investment expenditures for Electric Operations, including allowance for funds used during construction, are approximately $900 million. These projections include expenditures for existing plants, including refurbishment and upgrades related to the Oconee Nuclear Station's application for a 20-year renewal of its operating license, which is expected to receive approval from the Nuclear Regulatory Commission in 2000. Projected 2000 capital and investment expenditures for Natural Gas Transmis- sion, including allowance for funds used during construction, are approxi- mately $600 million. These projections include expansion of the Maritimes & Northeast Pipeline, which delivers natural gas to markets in the Canadian Maritimes provinces and the northeastern U.S. from a supply basin offshore of Nova Scotia, and the planned $386 million purchase of the East Tennessee Natu- ral Gas Company, which is expected to close in the first quarter of 2000 and is contingent upon regulatory approval. For further discussion on this pur- chase, see Note 19 to the Consolidated Financial Statements. Duke Energy plans to continue to significantly grow several of its business segments: Field Services, Global Asset Development, Trading and Marketing and Other Energy Services. Expansion plans for Field Services include the combina- tion of Duke Energy's gas gathering and processing businesses with Phillips Petroleum's Gas Processing and Marketing unit to form a new midstream company. The transaction is expected to close by first quarter 2000 and is subject to regulatory approval. See Note 19 to the Consolidated Financial Statements for additional information. Projected 2000 capital and investment expenditures for Global Asset Develop- ment are approximately $3.6 billion. Expansion opportunities for Global Asset Development's domestic division, Duke Energy North America, include the con- tinuation of various greenfield projects across the U.S. Expansion plans for Global Asset Development's international division, Duke Energy International, include completing the purchase of Dominion Resources, Inc.'s portfolio of hy- droelectric, natural gas and diesel power generation businesses in Argentina and Bolivia (see Note 2 to the Consolidated Financial Statements) and the Jan- uary 2000 completion of the tender offer for additional ownership interests in Companhia de Geracao de Energia Eletrica Paranapanema (Paranapanema) (see Note 19 to the Consolidated Financial Statements). Duke Energy International will also continue to focus on its regional target areas in Australia and Latin America for further expansion opportunities and intends to implement its strategies in Europe. Projected 2000 capital and investment expenditures for Trading and Marketing are approximately $200 million. This includes expenditures related to Trading and Marketing's new subsidiary, Duke Energy Hydrocarbons, which was formed in the second quarter of 1999 to invest capital in limited hydrocarbon explora- tion and production prospects through non-operating working interests. Duke Energy's intent is to produce natural gas to partially offset the short gas position of Duke Energy's power generation assets and to increase production volumes that will be beneficial to Field Services, Trading and Marketing, and Natural Gas Transmission. Projected 2000 capital and investment expenditures for Other Energy Servic- es, Real Estate Operations and Other Operations are approximately $200 mil- lion, $400 million and $250 million, respectively. All projected capital and investment expenditures for the above segments are subject to periodic review and revision and may vary significantly depending on a number of factors including, but not limited to, industry restructuring, regulatory constraints, acquisition opportunities, market volatility and eco- nomic trends. 9 Financing Cash Flows Duke Energy's consolidated capital structure at December 31, 1999, including short-term debt, was 44% debt, 6% minority interests, 7% trust preferred secu- rities, 1% preferred stock and 42% common equity. Fixed charges coverage, cal- culated using the Securities and Exchange Commission method, was 2.9 times, 4.7 times and 4.1 times for 1999, 1998 and 1997, respectively. Duke Energy's business expansion opportunities, along with dividends, debt repayments and operating and investing requirements, are expected to be funded by cash from operations, external financing, common stock issuances and the proceeds from certain asset sales. During 1999, Duke Energy and its subsidiary, Duke Capital Corporation (Duke Capital), issued a total of $1.9 billion of Senior Notes. The proceeds were used for general corporate purposes, including reducing commercial paper in- debtedness incurred in connection with acquisitions of electric power generat- ing assets in Latin America. Global Asset Development, through its Australian subsidiary, borrowed approximately $450 million under new financing arrange- ments, including a combined commercial paper and medium-term note program, bank facilities and non-recourse financing for certain western Australian as- sets. These new Global Asset Development financings are denominated in either Australian or New Zealand dollars. Issuances from the combined commercial pa- per and medium-term note program and the bank facilities were used to refund bridge financing of assets obtained during 1998 and 1999 and to fund on-going construction expenditures for the Eastern Gas Pipeline and future projects in Australia. Global Asset Development also assumed approximately $430 million of non-recourse debt, denominated in Brazilian reais, in relation to the acquisi- tion of Paranapanema (see Note 2 to the Consolidated Financial Statements) and borrowed $380 million under a new bank facility to refinance the California generating assets. For additional information regarding debt, see Note 10 to the Consolidated Financial Statements. Also during the year, Duke Energy's and Duke Capital's business trusts, which are treated as wholly owned subsidiaries for financial reporting purpos- es, issued a total of $500 million of trust preferred securities. See Note 12 to the Consolidated Financial Statements for additional information on trust preferred securities. Under its commercial paper facilities, Duke Energy had the ability to borrow up to $2.8 billion at both December 31, 1999 and 1998. The commercial paper facilities consisted of $1.25 billion for Duke Energy and $1.55 billion for Duke Capital. At December 31, 1999, Global Asset Development also had avail- able an approximately $500 million combined commercial paper and medium-term note program. Duke Energy's various bank credit facilities totaled approxi- mately $3.7 billion (including approximately $320 million related to foreign facilities) at December 31, 1999 and $2.9 billion at December 31, 1998. At De- cember 31, 1999, approximately $1.8 billion was outstanding under the commer- cial paper facilities and approximately $460 million of borrowings were out- standing under the bank credit facilities. Certain of the credit facilities support the issuance of commercial paper, therefore, the issuance of commer- cial paper reduces the amount available under these credit facilities (see Note 10 to the Consolidated Financial Statements). As of December 31, 1999, Duke Energy and its subsidiaries had the ability to issue up to $2.15 billion aggregate principal amount of debt and other securi- ties under shelf registrations filed with the Securities and Exchange Commis- sion. Effective January 7, 2000, the amount available was increased by $1.5 billion. Such securities may be issued as First and Refunding Mortgage Bonds, Senior Notes, Subordinated Notes or Preferred Securities. On December 16, 1999, Duke Energy announced that it had signed definitive agreements to combine Duke Energy's gas gathering and processing businesses with Phillips Petroleum's Gas Processing and Marketing unit to form a new mid- stream company. The new company will seek to arrange approximately $2.6 bil- lion of debt financing and, upon closing of the transaction, will make a one- time cash distribution of $1.2 billion to both Duke Energy and Phillips Petro- leum. The new company would then offer approximately 20% of its equity to the public in 2000 to reduce the debt resulting from the transaction. Such an of- fering is conditional upon completion of the transaction and favorable market conditions. For additional information, see Note 19 to the Consolidated Finan- cial Statements. 10 To maintain financial flexibility and reduce the amount of financing needed for growth opportunities, Duke Energy's Board of Directors adopted a dividend policy in June 1998 that targets 50% of earnings paid out in dividends on com- mon stock. The Board of Directors intends to maintain dividends at the current quarterly rate of $0.55 per share until the target payout ratio is reached at which time it intends to re-evaluate its dividend policy. In April 1999, Duke Energy's shareholders approved an amendment to the Arti- cles of Incorporation to increase the authorized common stock from 500 million to 1 billion shares. This increase in authorized stock will provide Duke En- ergy with added flexibility in effecting financings, stock splits or stock dividends, stock plans and other transactions and arrangements involving the use of common stock. Duke Energy InvestorChoice Plan, a stock dividend reinvestment plan, allows investors to reinvest dividends in new issuances of common stock and to pur- chase common stock directly from Duke Energy. Issuances under this plan were not material in 1999, 1998 or 1997. Duke Energy used authorized but unissued shares of its common stock to meet 1999 and 1998 employee benefit plan contribution requirements. This practice is expected to continue in 2000. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Risk Policies Duke Energy is exposed to market risks associated with interest rates, com- modity prices, equity prices and foreign exchange rates. Comprehensive risk management policies have been established by the Corporate Risk Management Committee (CRMC) to monitor and control these market risks. The CRMC is chaired by the Chief Financial Officer and is comprised of senior executives. The CRMC has responsibility for oversight of interest rate risk, foreign cur- rency risk, credit risk and energy risk management, including approval of en- ergy financial exposure limits. Interest Rate Risk Duke Energy is exposed to risk resulting from changes in interest rates as a result of its issuance of variable-rate debt, fixed-rate debt and trust pre- ferred securities, commercial paper and auction market preferred stock, as well as interest rate swaps and interest rate lock agreements. Duke Energy manages its interest rate exposure by limiting its variable-rate and fixed- rate exposures to certain percentages of total capitalization, as set by poli- cy, and by monitoring the effects of market changes in interest rates. Duke Energy may also enter into financial derivative instruments including, but not limited to, swaps, options and treasury rate agreements to manage and mitigate interest rate risk exposure. See Notes 1, 7, 10, 12 and 13 to the Consolidated Financial Statements for additional information. Based on a sensitivity analysis as of December 31, 1999, it was estimated that if market interest rates average 1% higher (lower) in 2000 than in 1999, earnings before income taxes would decrease (increase) by approximately $24 million. Comparatively, based on a sensitivity analysis as of December 31, 1998, had interest rates averaged 1% higher (lower) in 1999 than in 1998, it was estimated that earnings before income taxes would have decreased (in- creased) by approximately $23 million. These amounts were determined by con- sidering the impact of the hypothetical interest rates on the variable-rate securities outstanding as of December 31, 1999 and 1998. In the event of a significant change in interest rates, management would likely take actions to manage its exposure to the change. However, due to the uncertainty of the spe- cific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in Duke Energy's financial structure. Commodity Price Risk Duke Energy, substantially through its subsidiaries, is exposed to the im- pact of market fluctuations in the price of natural gas, electricity and natu- ral gas liquid products marketed and purchased. Duke Energy employs 11 established policies and procedures to manage its risks associated with these market fluctuations using various commodity derivatives, including forward contracts, futures, swaps and options. Market risks associated with commodity derivatives held for purposes other than trading were not material at December 31, 1999 and 1998. See Notes 1 and 7 to the Consolidated Financial Statements for additional information. The risk in the commodity trading portfolio is measured on a daily basis utilizing a Value-at-Risk model to determine the maximum potential one-day fa- vorable or unfavorable Daily Earnings at Risk (DER). The DER is monitored daily in comparison to established thresholds. Other measures are also uti- lized to monitor the risk in the commodity trading portfolio on a monthly and annual basis. The DER computations are based on a historical simulation, which utilizes price movements over a specified period to simulate forward price curves in the energy markets to estimate the favorable or unfavorable impact of one- day's price movement on the existing portfolio. The historical simulation em- phasizes the most recent market activity, which is considered the most rele- vant predictor of immediate future market movements for natural gas, electric- ity and petroleum products. The DER computations utilize several key assump- tions, including a 95% confidence level for the resultant price movement and the holding period specified for the calculation. Duke Energy's DER calcula- tion includes commodity derivative instruments held for trading purposes. The estimated potential one-day favorable or unfavorable impact on earnings before income taxes related to commodity derivatives held for trading purposes at De- cember 31, 1999 and 1998 was approximately $10 million. The average estimated potential one-day favorable or unfavorable impact on earnings before income taxes related to commodity derivatives held for trading purposes was approxi- mately $11 million and $5 million during 1999 and 1998, respectively. The in- crease in average 1999 amounts compared to 1998 is a result of an increase in the authorized energy financial exposure limit in 1998, which was approved by the CRMC. Changes in markets inconsistent with historical trends could cause actual results to exceed predicted limits. Subsidiaries of Duke Energy are also exposed to market fluctuations in the prices of NGLs related to their ongoing gathering and processing operating ac- tivities. Duke Energy closely monitors the risks associated with NGL price changes on its future operations, and where appropriate, uses crude oil and natural gas commodity instruments to hedge NGL prices. Based on a sensitivity analysis as of December 31, 1999, it was estimated that if NGL prices average one cent per gallon less in 2000, earnings before income taxes would decrease by approximately $6 million, after considering the effect of Duke Energy's commodity hedge positions. Comparatively, based on sensitivity analysis as of December 31, 1998, if NGL prices would have averaged one cent per gallon less in 1999, it was estimated that earnings before income taxes would have de- creased by approximately $8 million. Equity Price Risk Duke Energy maintains trust funds, as required by the Nuclear Regulatory Commission, to fund certain costs of nuclear decommissioning. (See Note 11 to the Consolidated Financial Statements.) As of December 31, 1999 and 1998, these funds were invested primarily in domestic and international equity secu- rities, fixed-rate, fixed-income securities and cash and cash equivalents. Management believes that its exposure to fluctuations in equity prices or in- terest rates will not materially affect consolidated results of operations. See further discussion in the Current Issues, Nuclear Decommissioning Costs section of Management's Discussion and Analysis. Foreign Operations Risk Duke Energy is exposed to foreign currency risk, sovereign risk and other foreign operations risk that arise from investments in international affili- ates and businesses owned and operated in foreign countries. To mitigate risks associated with foreign currency fluctuations, when possible, contracts are denominated in or indexed to the U.S. dollar or may be hedged through debt de- nominated in the foreign currency. Duke Energy also uses foreign currency de- rivatives, where possible, to manage its risk related to foreign currency fluctuations. To monitor its currency exchange rate risks, Duke Energy uses sensitivity analysis, which measures the impact of a devaluation of the for- eign currencies to which it has exposure. 12 At December 31, 1999, Duke Energy's primary foreign currency exchange rate exposures were the Brazilian real, the Australian dollar and the Canadian dol- lar. Exposures to other foreign currencies were not material. Based on the sensitivity analysis at December 31, 1999, a 10% devaluation in the currency exchange rates in Brazil would reduce Duke Energy's financial position by ap- proximately $65 million and would not significantly affect Duke Energy's con- solidated results of operations or cash flows over the next twelve months. Based on the sensitivity analysis at December 31, 1999, a 10% devaluation in other foreign currencies were insignificant to Duke Energy's consolidated re- sults of operations, financial position or cash flows. Exposures to foreign currency risks were not material to consolidated results of operations, finan- cial position or cash flows during 1998. CURRENT ISSUES Electric Competition. Wholesale Competition. The Energy Policy Act of 1992 (EPACT) and the FERC's subsequent rulemaking activities have established the regulatory framework to open the wholesale energy market to competition. EPACT amended provisions of the Public Utility Holding Company Act of 1935 and the Federal Power Act to remove certain barriers to a competitive wholesale market. EPACT permits utilities to participate in the development of independent electric generating plants for sales to wholesale customers, and also permits the FERC to order transmission access for third parties to transmission facilities owned by another entity. It does not, however, permit the FERC to issue an order requiring transmission access to retail customers. The FERC, responsible in large measure for implementation of EPACT, has moved vigorously to implement its mandate, interpreting the statute broadly and issuing orders for third-party transmission service and a number of rules of general applicability, including Orders 888 and 889. Open-access transmission for wholesale customers as defined by the FERC's final rules provides energy suppliers, including Duke Energy, with opportuni- ties to sell and deliver capacity and energy at market-based prices. Duke En- ergy and several of its non-regulated subsidiaries have been granted authority by the FERC to act as power marketers. Electric Operations obtained from the FERC open-access rule the rights to sell capacity and energy at market-based rates from its own assets. Open access provides another supply option through which Electric Operations can purchase at attractive rates a portion of capac- ity and energy requirements resulting in lower overall costs to customers. Open access also provides Electric Operations' existing wholesale customers with competitive opportunities to seek other suppliers for their capacity and energy requirements. On December 20, 1999, the FERC issued its Order No. 2000 regarding Regional Transmission Organizations (RTOs). In its order, the FERC stressed the volun- tary nature of RTO participation by utilities and sets minimum characteristics and functions that must be met by utilities that participate in an RTO. The order provides for an open, flexible structure for RTOs to meet the needs of the market, and provides for the possibility of incentive ratemaking and other benefits for utilities that participate in an RTO. The characteristics for acceptable RTOs include independence from market participants, operational control over a region of sufficient scope to support efficient and nondiscriminatory markets, and exclusive authority to maintain short-term reliability. The order requires each utility subject to the juris- diction of the FERC and not already in a FERC-approved RTO to make a filing by October 15, 2000, that either proposes participation in an RTO that will be in operation no later than December 15, 2001, or provides a status report on the utility's progress towards participation in an RTO. Because Order No. 2000 has just been issued, and may be revised in certain respects, management cannot estimate its effect on future consolidated results of operations or financial position. Retail Competition. Currently, Electric Operations operates as a vertically integrated, investor-owned utility with exclusive rights to supply electricity in a franchised service territory--a 20,000-square-mile service territory in the Carolinas. In its retail business, the NCUC and the PSCSC regulate Elec- tric Operations' service and rates. 13 Electric industry restructuring is being addressed in all 50 states and in the District of Columbia. These restructurings will likely impact all entities owning electric generating assets. The NCUC and the PSCSC are studying the merits of restructuring the electric utility industry in the Carolinas. During 1999, three electric utility restructuring bills were filed in South Caroli- na's House of Representatives. All three bills would introduce competition while allowing utilities to recover stranded costs, and have transition and phase-in periods ranging from five to six years. A task force formed by the South Carolina Senate is also examining issues related to deregulation of the state's electric utility business. This task force will prepare a report for review, discussion and possible legislative action by the state's Senate Judi- ciary Committee and General Assembly as a whole. In May 1997, North Carolina passed a bill that established a study commis- sion to examine whether competition should be implemented in the state. Mem- bers of this commission include legislators, customers, utilities and a member of an environmental group. The study commission expects to issue its report to the General Assembly in 2000. One of the significant issues the study commission must address is the ap- proximately $6 billion of debt issued by the two North Carolina municipal agencies (North Carolina Municipal Power Agency Number 1 and the North Caro- lina Eastern Municipal Agency). This debt is related to their joint ownership of generation assets with Duke Energy and Carolina Power & Light (CP&L). The municipal power agencies' member municipalities currently have electric rates higher than either Duke Energy or CP&L and are facing significant rate in- creases in the future to service the debt. As a result, the power agencies' debt and electric rates are economic development issues for the 51 power agency municipalities and, by extension, for the state as a whole. On October 26 and 27, 1999, at the request of the study commission, four proposals were submitted to resolve the municipal debt issue, one of which was a joint Duke Energy-CP&L proposal. The study commission expects to include a recommendation to resolve the municipal debt issue in its report to the Gen- eral Assembly in 2000. More than a dozen bills on electric restructuring have been introduced in the last session of Congress. On October 27, 1999 the U.S. House Commerce Sub- committee on Energy and Power voted to move H.R. 2944, "The Electricity Compe- tition and Reliability Act," to the full Commerce Committee. The primary re- structuring issues addressed include repeal of major provisions of the Public Utility Holding Company Act and the Public Utility Regulatory Policies Act, reliability, transmission, nuclear decommissioning and state authority. Currently, the electric utility industry is predominantly regulated on a ba- sis designed to recover the cost of providing electric power to customers. If cost-based regulation were to be discontinued in the industry for any reason, including competitive pressure on the cost-based prices of electricity, prof- its could be reduced and electric utilities might be required to reduce their asset balances to reflect a market basis less than cost. Discontinuance of cost-based regulation would also require affected utilities to write off their associated regulatory assets. Duke Energy's regulatory assets are included in the Consolidated Balance Sheets. The portion of these regulatory assets re- lated to Electric Operations is approximately $1.4 billion, including primar- ily purchased capacity costs, debt expense and deferred taxes related to regu- latory assets. Duke Energy is recovering substantially all of these regulatory assets through its current wholesale and retail electric rates and would at- tempt to continue to recover these assets during a transition to competition. In addition, Duke Energy would seek to recover the costs of its electric gen- erating facilities in excess of the market price of power at the time of tran- sition. Duke Energy supports a properly managed and orderly transition to competi- tive generation and retail services in the electric industry. However, trans- forming the current regulated industry into efficient, competitive generation and retail electric markets is a complex undertaking, which will require a carefully considered transition to a restructured electric industry. The key to effective retail competition is fairness among customers, service providers and investors. Duke Energy intends to continue to work with customers, legis- lators and regulators to address all the important issues. Management cur- rently cannot predict the impact, if any, of these competitive forces on fu- ture consolidated results of operations or financial position. 14 Natural Gas Competition. Wholesale Competition. On July 29, 1998, the FERC issued a Notice of Proposed Rulemaking (NOPR) on short-term natural gas transportation services, which proposed an integrated package of revisions to its regulations governing interstate natural gas pipelines. "Short term" has been defined in the NOPR as all transactions of less than one year. Under the proposed approach, cost-based regulation would be eliminated for short-term transportation and replaced by regulatory policies intended to maximize competition in the short-term transportation market, mitigate the ability of companies to exercise residual monopoly power and provide opportunities for greater flexibility in providing pipeline services. The proposed changes include initiatives to revise pipeline scheduling procedures, receipt and delivery point policies and penalty policies, and require pipelines to auction short-term capacity. Other proposed changes would improve the FERC's reporting requirements, permit pipelines to negotiate rates and terms of services, and revise certain rate and certificate policies that affect competition. In conjunction with the NOPR, the FERC also issued a Notice of Inquiry (NOI) on its pricing policies in the existing long-term market and pricing policies for new capacity. The FERC seeks comments on whether its policies are biased toward either short-term or long-term service, provide accurate price signals and the right incentives for pipelines to provide optimal transportation serv- ices and construct facilities that meet future demand and do not result in over building and excess capacity. Comments on the NOPR and NOI were due in April 1999. On September 15, 1999, the FERC issued a new policy statement on certifying new interstate capacity in response to comments filed on the cer- tificate issues raised in the NOPR. Because the ultimate resolution of these issues is unknown, management can- not estimate the effects of these matters on future consolidated results of operations or financial position. Retail Competition. Changes in regulation to allow retail competition could affect Duke Energy's natural gas transportation contracts with local gas dis- tribution companies. Natural gas retail deregulation is in the very early stages of development and management cannot estimate the effects of this mat- ter on future consolidated results of operations or financial position. Nuclear Decommissioning Costs. Duke Energy's estimated site-specific nuclear decommissioning costs total approximately $1.9 billion stated in 1999 dollars based on decommissioning studies completed in 1999. This estimate includes the cost of decommissioning plant components not subject to radioactive contamina- tion. Duke Energy contributes to an external decommissioning trust fund and maintains an internal reserve to fund these costs. The balance of the external funds as of December 31, 1999 and 1998 was $703 million and $580 million, respectively. The balance of the internal reserve as of December 31, 1999 and 1998 was $223 million and $217 million, respectively, and is reflected in the Consolidated Balance Sheets as Accumulated Deprecia- tion and Amortization. Both the NCUC and the PSCSC have granted Duke Energy recovery of estimated decommissioning costs through retail rates over the expected remaining service periods of its nuclear plants. Management believes that funding of the decommissioning costs will not have a material adverse effect on consolidated results of operations or financial position. See Note 11 to the Consolidated Financial Statements for additional information. As of December 31, 1999 and 1998, the external decommissioning trust fund was invested primarily in domestic and international equity securities, fixed- rate, fixed-income securities and cash and cash equivalents. Maintaining a portfolio that includes long-term equity investments maximizes the returns to be utilized to fund nuclear decommissioning, which in the long-term will bet- ter correlate to inflationary increases in decommissioning costs. However, the equity securities included in Duke Energy's portfolio are exposed to price fluctuations in equity markets, and the fixed-rate, fixed-income securities are exposed to changes in interest rates. Duke Energy actively monitors its portfolio by benchmarking the performance of its investments against certain indexes and by maintaining, and periodi- cally reviewing, established target allocation percentages of the 15 assets in its trusts. Because the accounting for nuclear decommissioning rec- ognizes that costs are recovered through the Electric Operations segment's rates, fluctuations in equity prices or interest rates do not affect consoli- dated results of operations. Environmental. Duke Energy is subject to international, federal, state and local regulations regarding air and water quality, hazardous and solid waste disposal and other environmental matters. Manufactured Gas Plants and Superfund Sites. Duke Energy was an operator of manufactured gas plants until the early 1950s and has entered into a coopera- tive effort with the State of North Carolina and other owners of certain for- mer manufactured gas plant sites to investigate and, where necessary, remedi- ate these contaminated sites. The State of South Carolina has expressed inter- est in entering into a similar arrangement. Duke Energy is considered by regu- lators to be a potentially responsible party and may be subject to future lia- bility at seven federal Superfund sites and two state Superfund sites. While the cost of remediation of the remaining sites may be substantial, Duke Energy will share in any liability associated with remediation of contamination at such sites with other potentially responsible parties. Management believes that resolution of these matters will not have a material adverse effect on consolidated results of operations or financial position. PCB (Polychlorinated Biphenyl) Assessment and Clean-up Programs. In June 1999, the Environmental Protection Agency (EPA) certified that TETCO, a wholly owned subsidiary of Duke Energy, had completed clean up of PCB contaminated sites under conditions stipulated by a U.S. Consent Decree in 1989. TETCO is required to continue groundwater monitoring on a number of sites for at least the next two years. The estimated cost of such monitoring is not material. Under terms of the agreement with CMS discussed in Note 2 to the Consoli- dated Financial Statements, Duke Energy is obligated to complete clean-up of previously identified contamination at certain agreed-upon sites on the PEPL and Trunkline systems. These clean-up programs are expected to continue until 2001. The contamination resulted from the past use of lubricants containing PCBs and the prior use of wastewater collection facilities and other on-site disposal areas. Soil and sediment testing, to date, has detected no signifi- cant off-site contamination. Duke Energy has communicated with the EPA and ap- propriate state regulatory agencies on these matters. At December 31, 1999 and 1998, remaining estimated clean-up costs on the TETCO, PEPL and Trunkline systems were accrued and included in the Consoli- dated Balance Sheets as Other Current Liabilities and Environmental Clean-up Liabilities. These cost estimates represent gross clean-up costs expected to be incurred, have not been discounted or reduced by customer recoveries and generally do not include fines, penalties or third-party claims. Costs ex- pected to be recovered from customers have been deferred and are included in the Consolidated Balance Sheets as Environmental Clean-up Costs. The federal and state clean-up programs are not expected to interrupt or di- minish Duke Energy's ability to deliver natural gas to customers. Based on Duke Energy's experience to date and costs incurred for clean-up operations, management believes the resolution of matters relating to the environmental issues discussed above will not have a material adverse effect on consolidated results of operations or financial position. Air Quality Control. The Clean Air Act Amendments of 1990 require a two- phase reduction by electric utilities in aggregate annual emissions of sulfur dioxide and nitrogen oxide by 2000. Duke Energy currently meets all require- ments of Phase I. Duke Energy supports the national objective of protecting air quality in the most cost-effective manner, and has already reduced emissions by operating plants efficiently, using nuclear and hydroelectric generation and implementing various compliance strategies. To meet Phase II requirements by 2000, Duke Energy's current strategy includes using low-sulfur coal, purchasing sulfur dioxide emission allowances and installing low-nitro- gen oxide burners and emission monitoring equipment. Construction activities needed to comply with Phase II requirements will be completed in the spring of 2000, allowing compliance with year 2000 Phase II requirements. Additional an- nual operating expenses of approximately $25 million for low-sulfur coal pre- miums, emission allowance purchases and other compliance activities will occur after 2000. This 16 strategy is contingent upon developments in future markets for emission allow- ances, low-sulfur coal, future regulatory and legislative actions and advances in clean air technologies. In October 1998, the EPA issued a final ruling on regional ozone control which requires revised State Implementation Plans for 22 eastern states and the District of Columbia. This EPA ruling is being challenged in court by var- ious states, industry and other interests, including the states of North Caro- lina and South Carolina and Duke Energy. In May 1999, the court ordered that no state need submit a plan "pending further order of the court." The EPA has undertaken other ozone-related actions having virtually identical goals. These actions have likewise been challenged by the same or similar parties. The res- olution of the October 1998 action is expected to resolve these other ozone- related actions as well. The North Carolina Environmental Management Commis- sion is considering several competing proposals to reduce utility emissions of nitrogen oxide. A proposed rule is anticipated in March 2000 with a final rule in September 2000. Depending on the resolution of these matters, costs to Duke Energy may range from approximately $100 million to $600 million for addi- tional capital improvements. In October 1999, the EPA sent Duke Energy a request seeking information on Duke Power's repair and maintenance of its coal-fired plants since 1978. This is part of the EPA's New Source Reviews (NSR) enforcement initiative, in which the EPA claims that utilities and others have committed widespread violations of the Clean Air Act permitting requirements for the past quarter century. In November 1999, the EPA filed suit against seven utilities and issued an admin- istrative order to Tennessee Valley Authority alleging numerous NSR permitting violations. The EPA's allegations run counter to previous EPA guidance regard- ing the applicability of the NSR permitting requirements. Duke Power, along with several other utilities, has routinely undertaken the type of repair, re- placement, and maintenance projects that the EPA now claims are illegal. A suit has not been instituted against Duke Energy, and while it is too early to predict any consequences, Duke Energy believes that all of its electric gener- ation units are properly permitted and have been properly maintained. Because this matter is in its most preliminary stage with respect to Duke Energy, man- agement cannot estimate the effects of these matters on future consolidated results of operations or financial position. In December 1997, the United Nations held negotiations in Kyoto, Japan to determine how to minimize global warming caused by, among other things, carbon dioxide emissions from fossil-fired generating facilities and methane from natural gas operations. Further negotiations in November 1998 resulted in a work plan to complete the operational details of the Kyoto agreement by late 2000. If this initiative is adopted in its current form, it could have far reaching implications to Duke Energy and the entire energy industry. Because this matter is in the early stages of discussion, management cannot estimate the effects on future consolidated results of operations or financial posi- tion. Litigation and Contingencies. For information concerning litigation and other commitments and contingencies, see Note 14 to the Consolidated Financial Statements. Year 2000 Readiness Program. Duke Energy did not experience any disruption to its operations resulting from the transition to the year 2000. Duke Energy completed its year 2000 readiness program at all of its business units in No- vember 1999. Systems will continue to be monitored throughout the year, with special attention given to the leap year transition. The total cost of the program, including internal labor as well as incremental costs such as con- sulting and contract costs, was approximately $58 million. These costs exclude replacement systems that, in addition to being Year 2000 ready, provided sig- nificantly enhanced capabilities which benefit operations in future periods. New Accounting Standard. In September 1998, Statement of Financial Account- ing Standard (SFAS) No. 133, "Accounting for Derivative Instruments and Hedg- ing Activities," was issued. Duke Energy is required to adopt this standard by January 1, 2001. SFAS No. 133 requires that all derivatives be recognized as either assets or liabilities and measured at fair value, and it defines the accounting for changes in the fair value of the derivatives depending on the intended use of the derivative. Duke Energy is currently reviewing the ex- pected impact of SFAS No. 133 on consolidated results of operations and finan- cial position. 17 Subsequent Events. On December 16, 1999, Duke Energy announced that it had signed definitive agreements to combine Duke Energy's gas gathering and processing businesses with Phillips Petroleum's Gas Processing and Marketing unit to form a new midstream company. Under the terms of the agreements, the new company will seek to arrange approximately $2.6 billion of debt financing and, upon closing of the transaction, will make a one-time cash distribution of $1.2 billion to both Duke Energy and Phillips Petroleum. At closing, Duke Energy will own about 70% of the new company and Phillips Petroleum will own about 30%. The new company would then offer approximately 20% of its equity to the public in 2000 to reduce the debt resulting from the transaction. Such an offering is conditional upon completion of the transaction and favorable mar- ket conditions. On January 4, 2000, Duke Energy announced that it had entered into a defini- tive agreement to purchase, for $386 million, 100% of the stock of El Paso En- ergy Corporation's wholly owned subsidiary, East Tennessee Natural Gas Compa- ny, a 1,100-mile pipeline that crosses Duke Energy's TETCO pipeline and serves the southeastern region of the U.S. Both transactions are subject to regulatory approval and are expected to close in the first quarter of 2000. In January 2000, Duke Energy completed a tender offer to the minority share- holders of Paranapanema and successfully acquired an additional 51% economic interest in the company for approximately $280 million. This increased Duke Energy's economic ownership from approximately 44% to approximately 95%. Forward-Looking Statements. From time to time, Duke Energy's reports, fil- ings and other public announcements may include assumptions, projections, ex- pectations, intentions or beliefs about future events. These statements are intended as "forward-looking statements" under the Private Securities Litiga- tion Reform Act of 1995. Duke Energy cautions that assumptions, projections, expectations, intentions or beliefs about future events may and often do vary from actual results and the differences between assumptions, projections, ex- pectations, intentions or beliefs and actual results can be material. Accord- ingly, there can be no assurance that actual results will not differ materi- ally from those expressed or implied by the forward-looking statements. Some of the factors that could cause actual achievements and events to differ mate- rially from those expressed or implied in such forward-looking statements in- clude state, federal and foreign legislative and regulatory initiatives that affect cost and investment recovery, have an impact on rate structures and af- fect the speed and degree to which competition enters the electric and natural gas industries; industrial, commercial and residential growth in the service territories of Duke Energy and its subsidiaries; the weather and other natural phenomena; the timing and extent of changes in commodity prices, interest rates and foreign currency exchange rates; changes in environmental and other laws and regulations to which Duke Energy and its subsidiaries are subject or other external factors over which Duke Energy has no control; the results of financing efforts, including Duke Energy's ability to obtain financing on fa- vorable terms, which can be affected by Duke Energy's credit rating and gen- eral economic conditions; growth in opportunities for Duke Energy's business units; and the effect of accounting policies issued periodically by accounting standard-setting bodies. 18 -----END PRIVACY-ENHANCED MESSAGE-----