10-Q 1 d10q.txt DUKE ENERGY CORPORATION ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended March 31, 2002 Commission File Number 1-4928 DUKE ENERGY CORPORATION (Exact name of Registrant as Specified in its Charter) North Carolina 56-0205520 (State or Other Jurisdiction of Incorporation) (IRS Employer Identification No.) 526 South Church Street Charlotte, NC 28202-1904 (Address of Principal Executive Offices) (Zip code) 704-594-6200 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Number of shares of Common Stock, without par value, outstanding at April 30, 2002......829,808,849 ================================================================================ DUKE ENERGY CORPORATION FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2002 INDEX
Item Page ---- ---- PART I. FINANCIAL INFORMATION 1. Financial Statements................................................................................................1 Consolidated Statements of Income for the Three Months Ended March 31, 2002 and 2001.............................1 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2002 and 2001.........................2 Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001...........................................3 Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2002 and 2001........5 Notes to Consolidated Financial Statements.......................................................................6 2. Management's Discussion and Analysis of Results of Operations and Financial Condition..............................16 PART II. OTHER INFORMATION 1. Legal Proceedings..................................................................................................32 4. Submission of Matters to a Vote of Security Holders................................................................32 6. Exhibits and Reports on Form 8-K...................................................................................32 Signatures.........................................................................................................33
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Duke Energy's reports, filings and other public announcements may include statements that reflect assumptions, projections, expectations, intentions or beliefs about future events. These statements are intended as "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Generally, the words "may," "could," "project," "believe," "anticipate," "expect," "estimate," "plan," "forecast," "intend" and similar words identify forward-looking statements, which generally are not historical in nature. All such statements (other than statements of historical facts), including statements regarding operating performance, financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations and events or developments that we expect or anticipate will occur in the future, are forward looking. Forward-looking statements are subject to certain risks and uncertainties that could, and often do, cause actual results to differ from Duke Energy's historical experience and our present expectations or projections. Accordingly, there can be no assurance that actual results will not differ materially from those expressed or implied by the forward-looking statements. Caution should be taken not to place undue reliance on any such forward-looking statements. Factors that could cause actual results to differ materially from the expectations expressed or implied in such forward-looking statements include, but are not limited to: state, federal and foreign legislative and regulatory initiatives that affect cost and investment recovery, have an impact on rate structures and affect the speed and degree at 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 favorable terms, which can be affected by Duke Energy's credit rating and general economic conditions; level of creditworthiness of counterparties to transactions; growth opportunities for Duke Energy's business units; and the effect of accounting policies issued periodically by accounting standard-setting bodies. i PART I. FINANCIAL INFORMATION Item 1. Financial Statements. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In millions, except per share amounts)
Three Months Ended March 31, ------------------ 2002 2001 ------- ------- Operating Revenues Sales, trading and marketing of natural gas and petroleum products $ 5,629 $11,451 Trading and marketing of electricity 4,027 3,303 Generation, transmission and distribution of electricity 1,703 1,260 Transportation and storage of natural gas 326 246 Other 200 231 ------- ------- Total operating revenues 11,885 16,491 ------- ------- Operating Expenses Natural gas and petroleum products purchased 5,462 11,080 Net interchange and purchased power 4,194 2,679 Fuel used in electric generation 215 242 Other operation and maintenance 852 877 Depreciation and amortization 344 316 Property and other taxes 127 115 ------- ------- Total operating expenses 11,194 15,309 ------- ------- Operating Income 691 1,182 Other Income and Expenses 70 72 Interest Expense 189 213 Minority Interest Expense 32 160 ------- ------- Earnings Before Income Taxes 540 881 Income Taxes 158 327 ------- ------- Income Before Cumulative Effect of Change in Accounting Principle 382 554 Cumulative Effect of Change in Accounting Principle, net of tax -- (96) ------- ------- Net Income 382 458 Preferred and Preference Stock Dividends 3 4 ------- ------- Earnings Available For Common Stockholders $ 379 $ 454 ======= ======= Common Stock Data Weighted-average shares outstanding 788 745 Earnings per share (before cumulative effect of change in accounting principle) Basic $ 0.48 $ 0.74 Diluted $ 0.48 $ 0.73 Earnings per share Basic $ 0.48 $ 0.61 Diluted $ 0.48 $ 0.60 Dividends per share $ 0.275 $ 0.275
See Notes to Consolidated Financial Statements 1 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In millions)
Three Months Ended March 31, ------------------ 2002 2001 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 382 $ 458 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 379 357 Cumulative effect of change in accounting principle -- 96 Deferred income taxes (53) 214 Purchased capacity levelization 67 38 (Increase) decrease in Net unrealized mark-to-market and hedging transactions 179 (609) Receivables 1,021 (112) Inventory 30 103 Other current assets (200) (486) Increase (decrease) in Accounts payable (444) 178 Taxes accrued 176 (27) Interest accrued 1 7 Other current liabilities (647) (161) Other, assets 73 83 Other, liabilities (144) (120) ------- ------- Net cash provided by operating activities 820 19 ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures, net of cash acquired (1,274) (723) Investment expenditures (320) (324) Acquisition of Westcoast Energy, Inc., net of cash acquired (1,690) -- Other 8 117 ------- ------- Net cash used in investing activities (3,276) (930) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from the issuance of Long-term debt 2,346 1,339 Common stock and stock options 77 1,193 Payments for the redemption of long-term debt (407) (64) Net change in notes payable and commercial paper 650 (1,415) Distributions to minority interests (84) -- Dividends paid (222) (208) Other (43) (67) ------- ------- Net cash provided by financing activities 2,317 778 ------- ------- Net decrease in cash and cash equivalents (139) (133) Cash and cash equivalents at beginning of period 290 622 ------- ------- Cash and cash equivalents at end of period $ 151 $ 489 ======= ======= Supplemental Disclosures Cash paid for interest, net of amount capitalized $ 135 $ 204 Cash paid for income taxes $ 12 $ 105 Acquisition of Westcoast Energy, Inc. Fair value of assets acquired $ 9,487 Liabilities assumed, including debt and minority interests 8,382 Issuance of common stock 1,797
See Notes to Consolidated Financial Statements 2 CONSOLIDATED BALANCE SHEETS (In millions)
March 31, December 31, 2002 2001 (Unaudited) ----------- ------------ ASSETS Current Assets Cash and cash equivalents $ 151 $ 290 Receivables 5,647 5,301 Inventory 1,149 1,017 Current portion of purchased capacity costs 170 160 Unrealized gains on mark-to-market and hedging transactions 3,918 2,326 Other 659 451 ------- ------- Total current assets 11,694 9,545 ------- ------- Investments and Other Assets Investments in affiliates 2,067 1,480 Nuclear decommissioning trust funds 696 716 Pre-funded pension costs 334 313 Goodwill, net of accumulated amortization 4,085 1,730 Notes receivable 628 576 Unrealized gains on mark-to-market and hedging transactions 4,490 3,117 Other 1,385 1,299 ------- ------- Total investments and other assets 13,685 9,231 ------- ------- Property, Plant and Equipment Cost 46,921 39,464 Less accumulated depreciation and amortization 11,617 11,049 ------- ------- Net property, plant and equipment 35,304 28,415 ------- ------- Regulatory Assets and Deferred Debits Purchased capacity costs 112 189 Deferred debt expense 229 203 Regulatory asset related to income taxes 543 510 Other 979 282 ------- ------- Total regulatory assets and deferred debits 1,863 1,184 ------- ------- Total Assets $62,546 $48,375 ======= =======
See Notes to Consolidated Financial Statements 3 CONSOLIDATED BALANCE SHEETS (In millions)
March 31, December 31, 2002 2001 ----------- ------------ (Unaudited) LIABILITIES AND COMMON STOCKHOLDERS' EQUITY Current Liabilities Accounts payable $ 4,234 $ 4,231 Notes payable and commercial paper 2,615 1,603 Taxes accrued 670 443 Interest accrued 288 239 Current maturities of long-term debt and preferred stock 566 274 Unrealized losses on mark-to-market and hedging transactions 3,186 1,519 Other 1,373 2,118 ------- ------- Total current liabilities 12,932 10,427 ------- ------- Long-term Debt 18,323 12,321 ------- ------- Deferred Credits and Other Liabilities Deferred income taxes 4,544 4,307 Investment tax credit 185 189 Nuclear decommissioning costs externally funded 696 716 Environmental cleanup liabilities 84 85 Unrealized losses on mark-to-market and hedging transactions 3,434 2,212 Other 3,175 1,542 ------- ------- Total deferred credits and other liabilities 12,118 9,051 ------- ------- Commitments and Contingencies Guaranteed Preferred Beneficial Interests in Subordinated Notes of Duke Energy Corporation or Subsidiaries 1,407 1,407 ------- ------- Minority Interests in Financing Subsidiary 1,025 1,025 ------- ------- Minority Interests 1,641 1,221 ------- ------- Preferred and Preference Stock Preferred and preference stock with sinking fund requirements 25 25 Preferred and preference stock without sinking fund requirements 209 209 ------- ------- Total preferred and preference stock 234 234 ------- ------- Common Stockholders' Equity Common stock, no par, 2 billion shares authorized; 829 million and 777 million shares outstanding at March 31, 2002 and December 31, 2001, respectively 8,084 6,217 Retained earnings 6,475 6,292 Accumulated other comprehensive income 307 180 ------- ------- Total common stockholders' equity 14,866 12,689 ------- ------- Total Liabilities and Common Stockholders' Equity $62,546 $48,375 ======= =======
See Notes to Consolidated Financial Statements. 4 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited) (In millions) Three Months Ended March 31, ------------------ 2002 2001 ------ -------- Net Income $ 382 $ 458 Other comprehensive income, net of tax Cumulative effect of change in accounting principle -- (921) Foreign currency translation adjustment (24) (141) Net unrealized gains (losses) on cash flow hedges 263 (356) Reclassification into earnings (112) 178 ----- ------- Total other comprehensive income 127 (1,240) ----- ------- Total Comprehensive Income (Loss) $ 509 $ (782) ===== ======= See Notes to Consolidated Financial Statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. General Duke Energy Corporation (collectively with its subsidiaries, Duke Energy), an integrated provider of energy and energy services, offers physical delivery and management of both electricity and natural gas throughout the U.S. and abroad. Duke Energy provides these and other services through the seven business segments described below. Franchised Electric generates, transmits, distributes and sells electricity in central and western North Carolina and western South Carolina. It conducts operations primarily through Duke Power and 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 and the Public Service Commission of South Carolina. Natural Gas Transmission provides transportation, storage and distribution of natural gas for customers throughout the east coast and southern portion of the U.S. and Canada. Natural Gas Transmission provides gas gathering, processing and transportation services to customers located in British Columbia, Canada and in the Pacific northwest region of the U.S. Natural Gas Transmission does business primarily through Duke Energy Gas Transmission Corporation. Duke Energy acquired Westcoast Energy, Inc. (Westcoast) on March 14, 2002 (see Note 3). Interstate natural gas transmission and storage operations in the U.S. are subject to the FERC's rules and regulations while natural gas gathering, processing, transmission, distribution and storage operations in Canada are subject to the National Energy Board, Ontario Energy Board and British Columbia Utilities Commission rules and regulations. Field Services gathers, processes, transports, markets and stores natural gas and produces, transports, markets and stores natural gas liquids (NGLs). It conducts operations primarily through Duke Energy Field Services, LLC, which is approximately 30% owned by Phillips Petroleum. Field Services operates gathering systems in western Canada and 11 contiguous states in the U.S. Those systems serve major natural gas-producing regions in the Rocky Mountain, Permian Basin, Mid-Continent, East Texas-Austin Chalk-North Louisiana, and onshore and offshore Gulf Coast areas. North American Wholesale Energy (NAWE) develops, operates and manages merchant generation facilities and engages in commodity sales and services related to natural gas and electric power. NAWE conducts these operations primarily through Duke Energy North America, LLC (DENA) and Duke Energy Trading and Marketing, LLC (DETM). DETM is approximately 40% owned by Exxon Mobil Corporation. NAWE also includes Duke Energy Merchants Holdings, LLC, which develops new business lines in the evolving energy commodity markets other than natural gas and power. NAWE conducts business primarily throughout the U.S. and Canada. International Energy develops, operates and manages natural gas transportation and power generation facilities and engages in energy trading and marketing of natural gas and electric power. It conducts operations primarily through Duke Energy International, LLC and its activities target the Latin American, Asia-Pacific and European regions. Other Energy Services is a combination of businesses that provide engineering, consulting, construction and integrated energy solutions worldwide, primarily through Duke Engineering & Services, Inc. (DE&S), Duke/Fluor Daniel (D/FD) and DukeSolutions, Inc. (DukeSolutions). D/FD is a 50/50 partnership between Duke Energy and Fluor Enterprises, Inc., a wholly owned subsidiary of Fluor Corporation. On April 30, 2002, Duke Energy completed the sale of DE&S to Framatome ANP, Inc. and, on May 1, 2002, Duke Energy completed the sale of DukeSolutions to Ameresco, Inc. (See Note 3). Duke Ventures is composed of other diverse businesses, operating primarily through Crescent Resources, LLC (Crescent), DukeNet Communications, LLC (DukeNet) and Duke Capital Partners, LLC (DCP). 6 Crescent develops high-quality commercial, residential and multi-family real estate projects and manages land holdings primarily in the southeastern and southwestern U.S. DukeNet provides fiber optic networks for industrial, commercial and residential customers. DCP, a wholly owned merchant banking company, provides debt and equity capital and financial advisory services to the energy industry. 2. Summary of Significant Accounting Policies Consolidation. The Consolidated Financial Statements include the accounts of Duke Energy and all majority-owned subsidiaries, after eliminating significant intercompany transactions and balances. These Consolidated Financial Statements reflect all normal recurring adjustments that are, in the opinion of management, necessary to present fairly the financial position and results of operations for the respective periods. Amounts reported in the Consolidated Statements of Income are not necessarily indicative of amounts expected for the respective annual periods due to the effects of seasonal temperature variations on energy consumption and the timing of maintenance on electric generating units. Earnings Per Common Share. Basic earnings per share is based on a simple weighted average of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if securities or other agreements to issue common stock, such as stock options and equity units, were exercised or converted into common stock. The numerator for the calculation of both basic and diluted earnings per share is earnings available for common stockholders. The following table shows the denominator for basic and diluted earnings per share. ================================================================================ Denominator for Earnings per Share (in millions) -------------------------------------------------------------------------------- Three Months Ended March 31, ------------------ 2002 2001 ------------------ Denominator for basic earnings per share (weighted average shares outstanding)/a/ 787.7 745.3 Assumed exercise of dilutive securities or other agreements to issue common stock 3.9 6.7 ------------------ Denominator for diluted earnings per share 791.6 752.0 ================================================================================ /a/ Increase in shares due primarily to Westcoast acquisition (See Note 3) Options, restricted stock awards, performance awards and phantom stock awards to purchase 19 million shares of common stock as of March 31, 2002, and 6 million as of March 31, 2001, were not included in the computation of diluted earnings per share because the option exercise prices were greater than the average market price of the common shares during the periods. Accounting for Hedges and Trading Activities. All derivatives not qualifying for the normal purchases and sales exemption under Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," are recorded on the Consolidated Balance Sheets at their fair value as Unrealized Gains or Unrealized Losses on Mark-to-Market and Hedging Transactions. On the date that swaps, futures, forwards or option contracts are entered into, Duke Energy designates the derivative as either held for trading (trading instrument); as a hedge of a forecasted transaction or future cash flows (cash flow hedge); as a hedge of a recognized asset, liability or firm commitment (fair value hedge); as a normal purchase or sale contract; or leaves the derivative undesignated and marks it to market. For hedge contracts, Duke Energy formally assesses, both at the hedge contract's inception and on an ongoing basis, whether the hedge contract is highly effective in offsetting changes in fair values or cash flows of hedged items. A loss on the time value of options of $2 million was excluded in the assessment and measurement of hedge effectiveness for the three months ended March 31, 2002. When available, quoted market prices or prices obtained through external sources are used to verify a contract's fair value. For contracts with a delivery location or duration for which quoted market prices are 7 not available, fair value is determined based on pricing models developed primarily from historical and expected correlations with quoted market prices. Values are adjusted to reflect the potential impact of liquidating the positions held in an orderly manner over a reasonable time period under current conditions. Changes in market price and management estimates directly affect the estimated fair value of these contracts. Accordingly, it is reasonably possible that such estimates may change in the near term. Trading. Prior to settlement of any energy contract held for trading purposes, a favorable or unfavorable price movement is reported as Natural Gas and Petroleum Products Purchased, or Net Interchange and Purchased Power, in the Consolidated Statements of Income. An offsetting amount is recorded on the Consolidated Balance Sheets as Unrealized Gains or Unrealized Losses on Mark-to-Market and Hedging Transactions. When a contract to sell is physically settled, the fair value entries are reversed and the gross amount invoiced to the customer is included as Sales, Trading and Marketing of Natural Gas and Petroleum Products, or Trading and Marketing of Electricity, in the Consolidated Statements of Income. Similarly, when a contract to purchase is physically settled, the purchase price is included as Natural Gas and Petroleum Products Purchased, or Net Interchange and Purchased Power, in the Consolidated Statements of Income. If a contract is not financially settled, the unrealized gain or loss on the Consolidated Balance Sheets is reversed and reclassified to a receivable or payable account. For income statement purposes, financial settlement has no revenue presentation effect on the Consolidated Statements of Income. Cash Flow Hedges. Changes in the fair value of a derivative designated and qualified as a cash flow hedge are included in the Consolidated Statements of Comprehensive Income as Other Comprehensive Income (OCI) until earnings are affected by the hedged item. Settlement amounts and ineffective portions of cash flow hedges are removed from OCI and recorded in the Consolidated Statements of Income in the same accounts as the item being hedged. Duke Energy discontinues hedge accounting prospectively when it is determined that the derivative no longer qualifies as an effective hedge, or when it is no longer probable that the hedged transaction will occur. When hedge accounting is discontinued because the derivative no longer qualifies as an effective hedge, the derivative continues to be carried on the Consolidated Balance Sheets at its fair value, with subsequent changes in its fair value recognized in current-period earnings. Gains and losses related to discontinued hedges that were previously accumulated in OCI will remain in OCI until earnings are affected by the hedged item, unless it is no longer probable that the hedged transaction will occur. Gains and losses that were accumulated in OCI will be immediately recognized in current-period earnings in those instances. Fair Value Hedges. Duke Energy enters into interest rate swaps to convert some of its fixed-rate long-term debt to floating-rate long-term debt and designates such interest rate swaps as fair value hedges. Duke Energy also enters into electricity derivative instruments such as swaps, futures and forwards to manage the fair value risk associated with some of its unrecognized firm commitments to sell generated power due to changes in the market price of power. Upon designation of such derivatives as fair value hedges, prospective changes in the fair value of the derivative and the hedged item are recognized in current earnings in a manner consistent with the earnings effect of the hedged risk. All components of each derivative gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. New Accounting Standards. Duke Energy adopted SFAS No. 142, "Goodwill and Other Intangible Assets," as of January 1, 2002. SFAS No. 142 requires that goodwill no longer be amortized over an estimated useful life, as previously required. Instead, goodwill amounts are subject to a fair-value-based annual impairment assessment. Duke Energy did not recognize any material impairment due to the implementation of SFAS No. 142. The standard also requires certain identifiable intangible assets to be recognized separately and amortized as appropriate upon reassessment. No adjustments to intangibles were identified at Duke Energy at transition. The following table shows what net income and earnings per share would have been if amortization (including any related tax effects) related to goodwill that is no longer being amortized had been excluded from prior periods. 8 ================================================================================ Goodwill - Adoption of SFAS No. 142 ================================================================================ Three Months Ended March 31, ------------------ (in millions, except per share amounts) 2002 2001 -------------------------------------------------------------------------------- Net Income Reported net income $ 382 $ 458 Add back: Goodwill amortization, net of tax -- 14 ----- ----- Adjusted net income $ 382 $ 472 Basic earnings per share Reported earnings per share $0.48 $0.61 Goodwill amortization -- 0.02 Adjusted earnings per share 0.48 0.63 Diluted earnings per share Reported earnings per share $0.48 $0.60 Goodwill amortization -- 0.02 Adjusted earnings per share 0.48 0.62 ================================================================================ The changes in the carrying amount of goodwill for the three months ended March 31, 2002 and March 31, 2001 are as follows: ================================================================================ Goodwill (in millions) -------------------------------------------------------------------------------- Balance Balance December 31, Acquired March 31, 2001 Goodwill Other 2002 -------------------------------------------- Natural Gas Transmission $ 481 $2,459 $ -- $2,940 Field Services 571 -- (106) 465 North American Wholesale Energy 92 -- 9 101 International Energy 427 -- (4) 423 Other Energy Services 5 -- (3) 2 Other Operations 154 -- -- 154 -------------------------------------------- Total consolidated $1,730 $2,459 $(104) $4,085 ================================================================================ Balance Balance December 31, Acquired March 31, 2000 Goodwill Other 2001 -------------------------------------------- Natural Gas Transmission $ 299 $-- $ 5 $ 304 Field Services 507 -- (15) 492 North American Wholesale Energy 74 -- (2) 72 International Energy 457 6 (37) 426 Other Energy Services 46 -- (1) 45 Other Operations 183 -- (8) 175 -------------------------------------------- Total consolidated $1,566 $ 6 $(58) $1,514 ================================================================================ Duke Energy adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" on January 1, 2002. The new rules supersede SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The new rules retain many of the fundamental recognition and measurement provisions, but significantly change the criteria for classifying an asset as held-for-sale. Adoption of the new standard had no material adverse effect on Duke Energy's consolidated results of operations or financial position. 9 Reclassifications. Certain prior period amounts have been reclassified in the Consolidated Financial Statements and Note 5 to conform to the current presentation. 3. Business Acquisitions and Dispositions Business Acquisitions. Using the purchase method for acquisitions, Duke Energy consolidates assets and liabilities as of the purchase date, and includes earnings from acquisitions in consolidated earnings after the purchase date. Assets acquired and liabilities assumed are recorded at estimated fair values on the date of acquisition. The purchase price minus the estimated fair value of the acquired assets and liabilities is recorded as goodwill. The allocation of the purchase price may be adjusted if additional information on asset and liability valuations becomes available within one year after the acquisition. Acquisition of Westcoast Energy Inc. On March 14, 2002, Duke Energy acquired Westcoast for approximately $8 billion, including the assumption of $4.7 billion of debt. The assumed debt consists of debt of Westcoast, Union Gas Limited (a wholly-owned subsidiary of Westcoast) and various project entities that are wholly-owned or consolidated by Duke Energy. The interest rates on the assumed debt range from 2.53% to 15.0%, with maturity dates ranging from 2002 through 2027. Westcoast, headquartered in Vancouver, British Columbia, is a North American energy company with interests in natural gas gathering, processing, transmission, storage and distribution, as well as power generation and international energy businesses. In the transaction, a Duke Energy subsidiary acquired all of the outstanding common shares of Westcoast in exchange for approximately 49.9 million shares of Duke Energy common stock (including exchangeable shares of a Duke Energy Canadian subsidiary that are substantially equivalent to and exchangeable on a one-for-one basis for Duke Energy common stock), and approximately $1.8 billion in cash. Under prorating provisions that ensured that approximately 50% of the total consideration was paid in cash and 50% in stock, each common share of Westcoast entitled the holder to elect to receive 43.80 in Canadian dollars, 0.7711 of a share of Duke Energy common stock or of an exchangeable share of a Duke Energy Canadian subsidiary, or a combination thereof. The cash portion of the consideration was funded with the proceeds from the issuance of $750 million in mandatory convertible securities in November 2001 along with incremental commercial paper. Duke Energy plans to retire the commercial paper later in 2002 and replace it with permanent capital in the form of mandatory convertible equity. The timing for the mandatory convertible equity financing will be dependent on the market opportunities presented and favorable market conditions. The Westcoast acquisition was accounted for using the purchase method of accounting, and goodwill totaling approximately $2.5 billion was recorded in the transaction. The following unaudited pro forma consolidated financial results for the period ended March 31, 2002 and March 31, 2001 are presented as if the acquisition had taken place at the beginning of the periods presented. -------------------------------------------------------------------------------- Westcoast Pro Forma Consolidated Results (in millions, except per share amounts) --------------------------------------------------------------------------------
Three Months Ended March 31, ------------------------ 2002 2001 ------------------------ Income Statement Data Operating revenues $ 13,167 $ 19,871 Income before cumulative effect of change in accounting principle 419 607 Cumulative effect of change in accounting principle, net of tax - (96) Preferred and preference stock dividends 3 4 Earnings available to common stockholders 416 507 Common Stock Data Weighted-average shares outstanding 828 795 Earnings per share (before cumulative effect of change in accounting principle) Basic $ 0.50 $ 0.76 Diluted $ 0.50 $ 0.75 Earnings per share Basic $ 0.50 $ 0.64 Diluted $ 0.50 $ 0.63 --------------------------------------------------------------------------------
Dispositions. DE&S. On April 30, 2002, Duke Energy completed the sale of portions of its DE&S business unit to Framatome ANP, Inc. (a nuclear supplier). Two components of DE&S are not part of the sale and will remain as components of Other Energy Services. Duke Energy will establish Duke Energy - Energy Delivery Services, formed by the power delivery services component of DE&S, which will continue to supply power delivery solutions to customers. Leadership of the U.S. Department of Energy Mixed Oxide Fuel project will also remain with Duke Energy. DukeSolutions. On May 1, 2002, Duke Energy completed the sale of portions of DukeSolutions to Ameresco. Inc. The remaining portions will remain as a component of Other Energy Services. During the first quarter of 2002, Duke Energy recorded a reserve of $15 million for the expected loss associated with the sale of DukeSolutions. 10 4. Derivative Instruments, Hedging Activities and Credit Risk Commodity Cash Flow Hedges. Some Duke Energy subsidiaries are exposed to market fluctuations in the prices of various commodities related to their ongoing power generating and natural gas gathering, processing and marketing activities. Duke Energy closely monitors the potential impacts of commodity price changes and, where appropriate, enters into contracts to protect margins for a portion of its future sales and generation revenues. Duke Energy uses commodity instruments, consisting of swaps, futures, forwards and collared options, as cash flow hedges for natural gas, electricity and NGL transactions. Duke Energy is hedging exposures to the price variability of these commodities for a maximum of 20 years. For the three months ended March 31, 2002, the ineffective portion of commodity cash flow hedges and the amount recognized for transactions that no longer qualified as cash flow hedges were not material. As of March 31, 2002, $370 million of after-tax deferred net gains on derivative instruments were accumulated on the balance sheet in a separate component of stockholders equity, OCI, and are expected to be recognized in earnings during the next 12 months as the hedged transactions occur. However, due to the volatility of the commodities markets, the corresponding value in OCI will likely change prior to its reclassification into earnings. Commodity Fair Value Hedges. Some Duke Energy subsidiaries are exposed to changes in the fair value of some unrecognized firm commitments to sell generated power or natural gas due to market fluctuations in the underlying commodity prices. Duke Energy actively evaluates changes in the fair value of such unrecognized firm commitments due to commodity price changes and, where appropriate, uses various instruments to hedge its market risk. These commodity instruments, consisting of swaps, futures and forwards, serve as fair value hedges for the firm commitments associated with generated power and natural gas sales. Duke Energy is hedging exposures to the market risk of such items for a maximum of 23 years. For the three months ended March 31, 2002, the ineffective portion of commodity fair value hedges was not material. Trading Contracts. Duke Energy provides energy supply, structured origination, trading and marketing, risk management and commercial optimization services to large energy customers, energy aggregators and other wholesale companies. These services require Duke Energy to use natural gas, electricity, NGL and transportation derivatives and contracts that expose it to a variety of market risks. Duke Energy manages its trading exposure with strict policies that limit its market risk and require daily reporting of potential financial exposure to management. These policies include statistical risk tolerance limits using historical price movements to calculate a daily earnings at risk measurement. Interest Rate (Fair Value or Cash Flow) Hedges. Changes in interest rates expose Duke Energy to risk as a result of its issuance of variable-rate debt, fixed-to-floating interest rate swaps, commercial paper and auction rate preferred stock. Duke Energy manages its interest rate exposure by limiting its variable-rate and fixed-rate exposures to percentages of total capitalization, as set by policy, and by monitoring the effects of market changes in interest rates. Duke Energy also enters into financial derivative instruments, including, but not limited to, interest rate swaps, options, swaptions and lock agreements to manage and mitigate interest rate risk exposure. For the three months ended March 31, 2002 and 2001, Duke Energy's existing interest rate derivative instruments and related ineffectiveness were not material to its consolidated results of operations, cash flows or financial position. Foreign Currency (Fair Value or Cash Flow) Hedges. Duke Energy is exposed to foreign currency risk from investments in international 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 and/or local inflation rates, or investments may be hedged through debt denominated or issued in the foreign currency. Duke Energy also uses foreign currency derivatives, where possible, to manage its risk related to foreign currency fluctuations. For the three months ended March 31, 2002 and 2001, the impact of Duke Energy's foreign currency derivative instruments was not material to its consolidated results of operations, cash flows or financial position. 11 Credit Risk. Duke Energy's principal customers for power and natural gas marketing services are industrial end-users and utilities located throughout the U.S., Canada, Asia Pacific, Europe and Latin America. Duke Energy has concentrations of receivables from natural gas and electric utilities and their affiliates, as well as industrial customers throughout these regions. These concentrations of customers may affect Duke Energy's overall credit risk in that some customers may be similarly affected by changes in economic, regulatory or other factors. Where exposed to credit risk, Duke Energy analyzes the counterparties' financial condition prior to entering into an agreement, establishes credit limits and monitors the appropriateness of those limits on an ongoing basis. Duke Energy frequently uses master collateral agreements to mitigate credit exposure. The collateral agreement provides for a counterparty to post cash or letters of credit for exposure in excess of the established threshold. The threshold amount represents an open credit limit, determined in accordance with the corporate credit policy. The collateral agreement also provides that the inability to post collateral is sufficient cause to terminate a contract and liquidate all positions. The change in market value of New York Mercantile Exchange-traded futures and options contracts requires daily cash settlement in margin accounts with brokers. Financial derivatives are generally cash settled periodically throughout the contract term. However, these transactions are also generally subject to margin agreements with many of Duke Energy's counterparties. As of March 31, 2002, Duke Energy had a pre-tax bad debt provision of $90 million related to receivables for energy sales in California. Following the bankruptcy of Enron Corporation, Duke Energy terminated substantially all contracts with Enron Corporation and its affiliated companies (collectively, Enron). As a result, in 2001 Duke Energy recorded, as a charge, a non-collateralized accounting exposure of $43 million. The $43 million non-collateralized accounting exposure was composed of charges of $36 million at NAWE, $3 million at International Energy, $3 million at Field Services and $1 million at Natural Gas Transmission. These amounts were stated on a pre-tax basis as charges against the reporting segment's earnings in 2001. Duke Energy's determination of its bankruptcy claims against Enron is still under review, and its claims made in the bankruptcy case are likely to exceed $43 million. Any bankruptcy claims that exceed this amount would primarily relate to termination and settlement rights under contracts and transactions with Enron that would have been recognized in future periods, and not in the historical periods covered by the financial statements to which the $43 million charge relates. Substantially all contracts with Enron were completed or terminated prior to December 31, 2001. Duke Energy has continuing contractual relationships with certain Enron affiliates, which are not in bankruptcy. In Brazil, a power purchase agreement between a Duke Energy affiliate, Companhia de Geracao de Energia Electrica Paranapanema (Paranapanema), and Elektro Eletricidade e Servicos S/A (Elektro), a distribution company 40% owned by Enron, will expire December 31, 2005. The contract was executed by Duke Energy's predecessor in interest in Paranapanema, and obligates Paranapanema to provide energy to Elektro on an irrevocable basis for the contract period. In addition, a purchase/sale agreement expiring September 1, 2005 between a Duke Energy affiliate and Citrus Trading Corporation (Citrus), a 50/50 joint venture between Enron and El Paso Corporation, continues to be in effect. The contract requires the Duke Energy affiliate to provide liquefied natural gas to Citrus. Citrus has provided a letter of credit in favor of Duke Energy to cover its exposure. 5. Business Segments Duke Energy's reportable segments offer different products and services and are managed separately as strategic business units. Their accounting policies are the same as those described in Note 2. Management evaluates segment performance based on earnings before interest and taxes (EBIT) after deducting minority interests. The following table shows how EBIT is calculated. 12 ==================================================================== Reconciliation of Operating Income to EBIT (in millions) -------------------------------------------------------------------- Three Months Ended March 31, ------------------ 2002 2001 ------------------ Operating income $691 $1,182 Plus: Other income and expenses 70 72 ------------------ EBIT $761 $1,254 ==================================================================== EBIT is the main performance measure used by management to evaluate segment performance. As an indicator of Duke Energy's operating performance or liquidity, EBIT should not be considered an alternative to, or more meaningful than, net income or cash flow as determined in accordance with generally accepted accounting principles. Duke Energy's EBIT may not be comparable to a similarly titled measure of another company. In the accompanying table, EBIT includes intersegment sales at prices representative of unaffiliated party transactions. Capital and investment expenditures are gross of cash received from acquisitions.
======================================================================================================== Business Segment Data (in millions) -------------------------------------------------------------------------------------------------------- Depreciation Capital and Unaffiliated Intersegment Total and Investment Revenues Revenues Revenues EBIT Amortization Expenditures ----------------------------------------------------------------------------- Three Months Ended March 31, 2002 Franchised Electric $ 1,113 $ -- $ 1,113 $ 385 $153 $ 244 Natural Gas Transmission 456 28 484 268 54 2,020 Field Services 1,336 230 1,566 35 74 110 North American Wholesale Energy 7,914 50 7,964 67 32 744 International Energy 984 2 986 67 23 81 Other Energy Services 43 93 136 (2) 1 1 Duke Ventures 39 -- 39 6 4 125 Other Operations /a/ -- (35) (35) (79) 3 36 Eliminations and minority interests -- (368) (368) 14 -- -- ----------------------------------------------------------------------------- Total consolidated $11,885 $ -- $11,885 $ 761 $344 $3,361 -------------------------------------------------------------------------------------------------------- Three Months Ended March 31, 2001 Franchised Electric $ 1,157 $ -- $ 1,157 $ 460 $146 $ 177 Natural Gas Transmission 245 37 282 175 35 79 Field Services 2,616 782 3,398 123 68 46 North American Wholesale Energy 11,858 157 12,015 348 27 518 International Energy 497 5 502 76 25 23 Other Energy Services 81 37 118 4 3 5 Duke Ventures 37 -- 37 7 4 174 Other Operations /a/ -- 91 91 (70) 8 25 Eliminations and minority interests -- (1,109) (1,109) 131 -- -- ----------------------------------------------------------------------------- Total consolidated $16,491 $ -- $16,491 $1,254 $316 $1,047 ========================================================================================================
/a/ Other operations primarily includes certain unallocated corporate costs. 13 Segment assets in the accompanying table are net of intercompany advances, intercompany notes receivable, intercompany current assets, intercompany derivative assets and investments in subsidiaries. ================================================================================ Segment Assets (in millions) -------------------------------------------------------------------------------- March 31, December 31, 2002 2001 ------------------------ Franchised Electric $13,238 $12,964 Natural Gas Transmission 15,394 5,027 Field Services 6,636 7,113 North American Wholesale Energy 19,242 14,562 International Energy 5,665 5,115 Other Energy Services 234 145 Duke Ventures 2,062 1,926 Other Operations and eliminations /a/ 75 1,523 ------------------------ Total consolidated $62,546 $48,375 ================================================================================ /a/ Other operations primarily includes certain unallocated corporate costs. 6. Debt In January 2002, Duke Energy issued $750 million of 6.25% senior unsecured bonds due in 2012 and $250 million of floating rate (based on the three-month London Interbank Offered Rate (LIBOR) plus 0.35%) senior unsecured bonds due in 2005. The proceeds from these issuances were used to manage working capital needs. In February 2002, Duke Capital Corporation, a wholly owned subsidiary of Duke Energy issued $500 million of 6.25% senior unsecured bonds due in 2013 and $250 million of 6.75% senior unsecured bonds due in 2032. In addition, Duke Capital Corporation, through a private placement transaction, issued $500 million of floating rate (based on the one-month LIBOR plus 0.65%) senior unsecured bonds due in 2003. The proceeds from these issuances were used to manage working capital needs and to fund a portion of the cash consideration for the Westcoast acquisition. In March 2002, a wholly owned subsidiary of Duke Energy, Duke Australia Pipeline Finance Pty Ltd., closed a syndicated bank debt facility for $450 million with various banks to fund its pipeline business in Australia. The facility is split between a Duke Capital Corporation-guaranteed tranche and a non-recourse project finance tranche that is secured by liens over existing Australian pipeline assets. Proceeds from the project finance tranche were used to repay inter-company loans. In April 2002, Duke Energy issued $250 million of 6.60% retail bonds due in 2022. The senior unsecured bonds were insured to obtain an `AAA' credit rating. Duke Energy subsequently swapped the bonds to a floating rate (based on the three-month LIBOR). The proceeds from this issuance were used for general corporate purposes. In addition, Duke Capital Corporation, through a private placement transaction, issued $100 million of floating rate (based on the one-month LIBOR plus 0.85%) senior unsecured bonds due in 2004. The proceeds from this issuance were used to repay commercial paper. On March 14, 2002, Duke Energy acquired Westcoast for approximately $8 billion, including the assumption of $4.7 billion of debt. The assumed debt consists of debt of Westcoast, Union Gas Limited (a wholly-owned subsidiary of Westcoast) and various project entities that are wholly-owned or consolidated by Duke Energy. The interest rates on the assumed debt range from 2.53% to 15.0%, with maturity dates ranging from 2002 through 2027. (See Note 3.) 7. Commitments and Contingencies Environmental. In 2001, legislation was introduced in the North Carolina General Assembly that would require North Carolina electric utilities, including Duke Energy, to make significant reductions in emissions of sulfur dioxide and nitrogen oxides from its North Carolina coal-fired power plants over the next seven to 11 years. Management estimates the cost to Duke Energy of achieving the specified emission reductions in 14 the proposed legislation to be approximately $1.5 billion. The proposed North Carolina legislation included a provision that allows Duke Energy to recover some or all of these costs from customers through an environmental compliance expenditure-recovery factor that would have been separate from the utility's base rates. In April 2002, Governor Easley of North Carolina announced his Clean Air Initiative which is intended to supersede the proposed legislation introduced in 2001. Through discussions with Duke Energy and other stakeholders, the Governor developed a plan to implement the emission reductions introduced in 2001, but without any increase in costs to consumers. Instead, North Carolina electric utilities would freeze their rates for five years and use the money collected during that period to pay for controls to meet the required emission reductions. This plan has not yet been introduced as legislation, but is expected to be introduced and acted upon quickly in late May 2002 or early June 2002. The final legislation, if passed into law, could differ significantly from the Governor's announced initiative. California Issues. Duke Energy, some of its subsidiaries and three current or former executives have been named as defendants, among other corporate and individual defendants, in one or more of a total of six lawsuits brought by or on behalf of electricity consumers in the State of California. The plaintiffs seek damages as a result of the defendants' alleged unlawful manipulation of the California wholesale electricity markets. DENA and DETM are among 16 defendants in a class-action lawsuit (the Gordon lawsuit) filed against generators and traders of electricity in California markets. DETM was also named as one of numerous defendants in four additional lawsuits, including two class actions (the Hendricks and Pier 23 Restaurant lawsuits), filed against generators, marketers, traders and other unnamed providers of electricity in California markets. A sixth lawsuit (the Bustamante lawsuit) was brought by the Lieutenant Governor of the State of California and a State Assemblywoman, on their own behalf as citizens and on behalf of the general public, and includes Duke Energy, some of its subsidiaries and three current or former executives of Duke Energy among other corporate and individual defendants. The Gordon and Hendricks class-action lawsuits were filed in the Superior Court of the State of California, San Diego County, in November 2000. Three other lawsuits were filed in January 2001, one in Superior Court, San Diego County, and the other two in Superior Court, County of San Francisco. The Bustamante lawsuit was filed in May 2001 in Superior Court, Los Angeles County. These lawsuits generally allege that the defendants manipulated the wholesale electricity markets in violation of state laws against unfair and unlawful business practices and state antitrust laws. The plaintiffs seek aggregate damages of billions of dollars. The lawsuits seek the refund of alleged unlawfully obtained revenues for electricity sales and, in four lawsuits, an award of treble damages. These suits have been consolidated before a state court judge in San Diego. The plaintiffs in the six lawsuits filed a joint Master Amended Complaint on March 8, 2002, which adds additional defendants. The claims against the defendants are similar to those in the original complaints. The court has approved a schedule which calls for class certification motions to be filed by October 1, 2002 in the class action lawsuits. Trial has been scheduled for March 1, 2004. While these matters are in their earliest stages, management believes, based on its analysis of the facts and the asserted claims, that their resolution will have no material adverse effect on Duke Energy's consolidated results of operations, cash flows or financial position. Duke Energy and its subsidiaries are involved in other legal and regulatory proceedings and investigations related to activities in California. These other activities were disclosed in Duke Energy's Form 10-K for the year ended December 31, 2001, and there have been no new material developments in relation to these issues. Regulatory Matters. In November 2001, Nevada Power Company and Sierra Pacific Power Company (collectively, the Companies) filed a complaint with the FERC against DETM. The complaint requests the FERC to mitigate prices in sales contracts between Duke Energy and Nevada Power, and Duke Energy and Sierra Pacific that were entered into between December 7, 2000 and June 20, 2001. The Companies allege that the contract prices are unjust and unreasonable because they were entered into during a period that the FERC determined the California market to be dysfunctional and uncompetitive, and that the California market influenced the contract prices. In April 2002, the FERC issued an order which provides for an evidentiary hearing, establishes refund dates, and requires the parties to participate in settlement negotiations. In the order, the FERC also estimated a final decision by July 2003. While this matter is in its 15 earliest stages, management believes, based on its analysis of facts and the asserted claims, that the resolution will have no material adverse effect on Duke Energy's consolidated results of operations, cash flows or financial position. 8. Subsequent Event On April 17, 2002, Duke Energy completed the sale of the Anderson Water Company to the Anderson County Joint Municipal Water System and the City of Anderson. The agreements for closing are two-fold. The first part represents the sale of the water treatment facility and the related water transmission system to the traditional wholesale customers forming the Anderson County Joint Municipal Water System. The second relates to the sale of the retail water system to the City of Anderson. As a result, the City of Anderson becomes a wholesale customer participant in and a member of the joint system. Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition. Introduction Duke Energy Corporation (collectively with its subsidiaries, Duke Energy), an integrated provider of energy and energy services, offers 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. See Note 1 to the Consolidated Financial Statements for descriptions of Duke Energy's business segments. Management's Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements. RESULTS OF OPERATIONS For the three months ended March 31, 2002, earnings available for common stockholders were $379 million, or $0.48 per basic share. For the comparable 2001 period, earnings available for common stockholders were $454 million, or $0.61 per basic share. The decrease was due primarily to a 39% decrease in earnings before interest and taxes (EBIT), as described below. The current-year EBIT decrease on a comparative basis was partially offset by the prior year's one-time net-of-tax charge of $96 million, or $0.13 per basic share. This one-time charge was the cumulative effect of change in accounting principle for the January 1, 2001 adoption of Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." Also offsetting the comparative decrease in EBIT was a $128 million decrease in minority interest expense, as discussed in the following sections, and a decrease in the effective tax rate due to tax savings initiatives. Operating income was $691 million and EBIT was $761 million for the three months ended March 31, 2002. This compares to operating income of $1,182 million and EBIT of $1,254 million for the same period in 2001. Operating income and EBIT are affected by the same fluctuations for Duke Energy and each of its business segments. The following table shows the components of EBIT and reconciles EBIT to net income. 16 ============================================================== Reconciliation of Operating Income to Net Income (in millions) -------------------------------------------------------------- Three Months Ended March 31, ------------------ 2002 2001 ------------------ Operating income $691 $1,182 Other income and expenses 70 72 ------------------ EBIT 761 1,254 Interest expense 189 213 Minority interest expense 32 160 ------------------ Earnings before income taxes 540 881 Income taxes 158 327 ------------------ Income before cumulative effect of change in accounting Principle 382 554 Cumulative effect of change in accounting principle, net of tax -- (96) ------------------ Net income $382 $ 458 ============================================================== EBIT is the main performance measure used by management to evaluate segment performance. As an indicator of Duke Energy's operating performance or liquidity, EBIT should not be considered an alternative to, or more meaningful than, net income or cash flow as determined in accordance with generally accepted accounting principles. Duke Energy's EBIT may not be comparable to a similarly titled measure of another company. Business segment EBIT is summarized in the following table, and detailed discussions follow. ============================================================== EBIT by Business Segment (in millions) -------------------------------------------------------------- Three Months Ended March 31, ------------------ 2002 2001 ------------------ Franchised Electric $385 $ 460 Natural Gas Transmission 268 175 Field Services 35 123 North American Wholesale Energy 67 348 International Energy 67 76 Other Energy Services (2) 4 Duke Ventures 6 7 Other Operations (79) (70) EBIT attributable to minority interests 14 131 ------------------ Consolidated EBIT $761 $1,254 ============================================================== Other Operations primarily includes certain unallocated corporate costs. The amounts discussed below include intercompany transactions that are eliminated in the Consolidated Financial Statements. 17 Franchised Electric ================================================================ Three Months Ended March 31, ------------------ (in millions, except where noted) 2002 2001 ---------------------------------------------------------------- Operating revenues $ 1,113 $ 1,157 Operating expenses 746 748 ------------------ Operating income 367 409 Other income, net of expenses 18 51 ------------------ EBIT $ 385 $ 460 ================== Sales, GWh /a/ 19,521 19,362 ================================================================ /a/ Gigawatt-hours Franchised Electric's EBIT decreased $75 million for the three months ended March 31, 2002 as compared to the same period in 2001. The decrease was due primarily to $33 million in mutual insurance distributions recorded as income in the first quarter of 2001 and the favorable settlement of forward power sales contracts used to manage price risk for Franchised Electric's wholesale market-rate sales in first quarter of 2001. Since the third quarter of 2001, the mutual insurance distributions have been reclassified from earnings to a deferred credit account as required by the North Carolina Utilities Commission, pending final outcome of a regulatory audit which will likely determine the treatment of those distributions. Earnings also decreased as a result of lower sales, primarily in the industrial class, due to the slowing economy and warmer weather in the first quarter of 2002, partially offset by continued growth in the average number of customers in Franchised Electric's service territory. The following table shows the changes in GWh sales and average number of customers. ============================================================== Increase (decrease) over prior year Three Months Ended -------------------------------------------------------------- Residential sales (6.0)% General service sales (0.8)% Industrial sales (9.5)% Total Franchised Electric sales 0.8% Average number of customers 1.3% ============================================================== Natural Gas Transmission ============================================================== Three Months Ended March 31, ------------------ (in millions, except where noted) 2002 2001 -------------------------------------------------------------- Operating revenues $484 $282 Operating expenses 218 107 ------------------ Operating income 266 175 Other income, net of expenses 5 -- Minority interest expense 3 -- ------------------ EBIT $268 $175 ================== Proportional throughput, TBtu /a/ 759 548 ============================================================== /a/ Trillion British thermal units For the three months ended March 31, 2002, EBIT for Natural Gas Transmission increased $93 million compared to the same period in 2001. This increase primarily resulted from $62 million in earnings from the natural gas transmission and distribution assets acquired as a part of the acquisition of Westcoast 18 Energy, Inc. (Westcoast) in March 2002. (See Note 3 to the Consolidated Financial Statements.) Also contributing to the increase in EBIT was a $14 million gain on the sale of a portion of Natural Gas Transmission's limited partnership interest in Northern Border Partners, LP, which owns a general partnership interest in Northern Border Pipeline Company. Field Services =============================================================================== Three Months Ended March 31, ------------------ (in millions, except where noted) 2002 2001 ------------------------------------------------------------------------------- Operating revenues $1,566 $3,398 Operating expenses 1,523 3,219 ------------------ Operating income 43 179 Other income, net of expenses -- -- Minority interest expense 8 56 ------------------ EBIT $ 35 $ 123 ================== Natural gas gathered and processed/transported, TBtu/d /a/ 8.4 8.2 Natural gas liquid (NGL) production, MBbl/d /b/ 388.6 371.1 Natural gas marketed, TBtu/d 1.6 1.6 Average natural gas price per MMBtu /c/ $ 2.32 $ 7.09 Average NGL price per gallon /d/ $ 0.31 $ 0.60 =============================================================================== /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 EBIT for Field Services decreased $88 million for the three months ended March 31, 2002 compared to the same period in 2001, due primarily to the decrease in commodity prices. The decrease was driven by a $4.77 per MMBtu decrease in the average natural gas prices and a $0.29 per gallon decrease in the average NGL prices. Partially offsetting the decrease in commodity prices were increased contributions of approximately $15 million from the 2001 acquisitions of Canadian Midstream Services, Ltd., northeast propane terminal and marketing assets, and additional interests in three offshore Gulf of Mexico partnerships. North American Wholesale Energy (NAWE) ================================================================ Three Months Ended March 31, ------------------ (in millions, except where noted) 2002 2001 ---------------------------------------------------------------- Operating revenues $ 7,964 $12,015 Operating expenses 7,897 11,589 ------------------ Operating income 67 426 Other income (loss), net of expenses (1) (10) Minority interest (benefit) expense (1) 68 ------------------ EBIT $ 67 $ 348 ================== Natural gas marketed, TBtu/d 13.8 13.6 Electricity marketed and traded, GWh 108,220 44,617 Proportional megawatt capacity in operation 7,515 5,064 Proportional megawatt capacity owned /a/ 18,605 10,054 ================================================================ /a/ Includes under construction or under contract at period end 19 For the three months ended March 31, 2002, NAWE's EBIT decreased $281 million compared to the same period in 2001. Increases of 48% in the proportional megawatt capacity of generation assets in operation and 143% in the marketing and trading of electricity volumes were significantly offset by decreased origination activities and trading margins. Last year's results were driven by unusually high natural gas and power prices and volatility levels, especially in the western U.S. This year's results reflect a return to more normal commodity pricing and volatility. In 2002, NAWE also held several short positions during a period of rising market prices (contracts under which a trader has agreed to sell a commodity at a future date for a specific price) which also contributed to the decrease in EBIT. Partially offsetting these decreases were lower variable compensation costs related to the trading activities. Changes in the ownership percentage of NAWE's waste-to-energy plants and decreased earnings at Duke Energy Trading and Marketing, LLC (DETM) resulted in a $69 million decrease in minority interest expense compared to the prior year. International Energy ================================================================================ Three Months Ended March 31, ------------------ (in millions, except where noted) 2002 2001 ------------------------------------------------------------------------------- Operating revenues $ 986 $ 502 Operating expenses 927 428 ------------------ Operating income 59 74 Other income, net of expenses 13 9 Minority interest expense 5 7 ------------------ EBIT $ 67 $ 76 ================== Proportional megawatt capacity in operation 4,705 4,199 Proportional megawatt capacity owned /a/ 5,748 4,847 Proportional maximum pipeline capacity in operation /a/, MMcf/d /b/ 363 255 Proportional maximum pipeline capacity owned /a/, MMcf/d /b/ 363 363 ================================================================================ /a/ Includes under construction or under contract at period end /b/ Million cubic feet per day International Energy's EBIT decreased $9 million for the three months ended March 31, 2002 compared to the same period in 2001, due primarily to decreased earnings from Latin America investments and European operations. The Latin American operations were affected by lower demand in Brazil due to the government's mandatory energy rationing, which was in effect until mid-March 2002. The European operations were affected by lower trading margins and lower product prices. The corresponding increases in International Energy's operating revenues and expenses for 2002 are due primarily to its increased trading and marketing activities in Europe. Other Energy Services ===================================================================== Three Months Ended March 31, ------------------ (in millions) 2002 2001 --------------------------------------------------------------------- Operating revenues $136 $118 Operating expenses 138 114 ------------------ EBIT $ (2) $ 4 ===================================================================== 20 For the three months ended March 31, 2002, EBIT for Other Energy Services decreased $6 million compared to the same period in 2001. On April 30, 2002, Duke Energy completed the sale of Duke Engineering & Services, Inc. to Framatome ANP, Inc. and, on May 1, 2002, Duke Energy completed the sale of DukeSolutions, Inc. to Ameresco, Inc. (See Note 3 to the Consolidated Financial Statements). The decrease in EBIT as compared to the prior year was due primarily to a current-year $15 million reserve for the expected loss associated with the sale of DukeSolutions, Inc. This loss was partially offset by project income at Duke/Fluor Daniel. Duke Ventures ================================================================================ Three Months Ended March 31, ------------------- (in millions) 2002 2001 -------------------------------------------------------------------------------- Operating revenues $39 $37 Operating expenses 34 30 ------------------- Operating income 5 7 Minority interest benefit (1) -- ------------------- EBIT $ 6 $ 7 ================================================================================ EBIT for Duke Ventures decreased $1 million for the three months ended March 31, 2002 compared to the same period in 2001. On April 17, 2002, Duke Energy completed the sale of Anderson Water Company to Anderson County Joint Municipal Water System and the City of Anderson. (See Note 8 to the Consolidated Financial Statements.) Other Impacts on Earnings Available for Common Stockholders For the three months ended March 31, 2002, interest expense decreased $24 million compared to the same period in 2001, due primarily to lower interest rates on commercial paper. Minority interest expense decreased $128 million for the three months ended March 31, 2002 compared to the same period in 2001. Minority interest expense includes expense related to regular distributions on preferred securities of Duke Energy and its subsidiaries. This expense decreased $11 million for the three months ended March 31, 2002 due to lower distributions related to Catawba River Associates, LLC (Catawba). Catawba is a fully consolidated financing entity formed by Duke Energy in September 2000 and is managed by a Duke Energy subsidiary. Minority interest expense as shown and discussed in the preceding business segment EBIT discussions includes only minority interest expense related to EBIT of Duke Energy's joint ventures. It does not include minority interest expense related to interest and taxes of the joint ventures. Total minority interest expense related to the joint ventures (including the portion related to interest and taxes) decreased $117 million for the three month period due to decreased income from Field Services' joint venture with Phillips Petroleum, changes in the ownership percentage of NAWE's waste-to-energy plants and decreased earnings at DETM, NAWE's joint venture with Exxon Mobil Corporation. A state tax settlement finalized during the three months ended March 31, 2002, as well as the optimization of tax savings benefits, resulted in an effective tax rate of 29%, compared to 37% for the same period in 2001. Duke Energy's overall effective tax rate for 2002 is expected to be in the range of 35%-36%. During the first quarter of 2001, Duke Energy recorded a one time net-of-tax charge of $96 million related to the cumulative effect of change in accounting principle for the January 1, 2001 adoption of SFAS No. 133. This charge related to contracts that either did not meet the definition of a derivative under previous accounting guidance or do not qualify as hedges under new accounting requirements. 21 LIQUIDITY AND CAPITAL RESOURCES Operating Cash Flows Net cash provided by operations increased $801 million in 2002 when compared to the same period in 2001. The increase is due primarily to the change in the net unrealized mark-to-market and hedging transactions resulting from increased cash earnings in first quarter 2002 versus the same period in 2001. As a result of the increased volatility and higher prices in the western U.S. for power in the first quarter 2001, Duke Energy experienced a higher level of non-cash earnings from mark-to-market transactions as compared to first quarter 2002. Investing Cash Flows Net cash used in investing activities increased $2,346 million in 2002 when compared to the same period in 2001, primarily due to the acquisition of Westcoast for $1,690 million in cash, net of cash acquired (see Note 3 to the Consolidated Financial Statements). Capital and investment expenditures increased $547 million in 2002 compared to 2001. The increase reflects additional expansion and development expenditures (especially related to NAWE's generating facilities), refurbishment and upgrades to existing assets and minor acquisitions of businesses and assets. Financing Cash Flows Duke Energy's consolidated capital structure at March 31, 2002, including short-term debt, was 53% debt, 36% common equity, 7% minority interests, 3% trust preferred securities and 1% preferred stock. Fixed charges coverage, calculated using the Securities and Exchange Commission (SEC) guidelines, was 2.7 for the three months ended March 31, 2002 and 4.3 times for the three months ended March 31, 2001. The decrease in the fixed charges coverage is attributed primarily to decreased net income and decreased tax expenses. Duke Energy's growth initiatives, along with dividends, debt repayments and operating requirements are expected to be funded by cash from operations, debt and capital market financings, project financings, common stock issuances through its InvestorDirect Choice Plan and employee benefit plans, and proceeds from the sale of assets. These financing opportunities are dependent upon the market opportunities presented and favorable market conditions. Additionally, internal cash generation should fund approximately half of the capital needs. Management believes Duke Energy has adequate financial resources to meet its future needs. In January 2002, Duke Energy issued $750 million of 6.25% senior unsecured bonds due in 2012 and $250 million of floating rate (based on the three-month London Interbank Offered Rate (LIBOR) plus 0.35%) senior unsecured bonds due in 2005. The proceeds from these issuances were used to manage working capital needs. In February 2002, Duke Capital Corporation, a wholly owned subsidiary of Duke Energy, issued $500 million of 6.25% senior unsecured bonds due in 2013 and $250 million of 6.75% senior unsecured bonds due in 2032. In addition, Duke Capital Corporation, through a private placement transaction, issued $500 million of floating rate (based on the one-month LIBOR plus 0.65%) senior unsecured bonds due in 2003. The proceeds from these issuances were used to manage working capital needs and to fund a portion of the cash consideration for the Westcoast acquisition. In March 2002, a wholly owned subsidiary of Duke Energy, Duke Australia Pipeline Finance Pty Ltd., closed a syndicated bank debt facility for $450 million with various banks to fund its pipeline business in Australia. The facility is split between a Duke Capital Corporation-guaranteed tranche and a non-recourse project finance tranche that is secured by liens over existing Australian pipeline assets. Proceeds from the project finance tranche were used to repay inter-company loans. In April 2002, Duke Energy issued $250 million of 6.60% retail bonds due in 2022. The senior unsecured bonds were insured to obtain an `AAA' credit rating. Duke Energy subsequently swapped the bonds to a floating rate (based on the three-month LIBOR). The proceeds from this issuance were used for general corporate purposes. In addition, Duke Capital Corporation, through a private placement transaction, issued 22 $100 million of floating rate (based on the one-month LIBOR plus 0.85%) senior unsecured bonds due in 2004. The proceeds from this issuance were used to repay commercial paper. On March 14, 2002, Duke Energy acquired Westcoast for approximately $8 billion, including the assumption of $4.7 billion of debt. The assumed debt consists of debt of Westcoast. Union Gas Limited (a wholly-owned subsidiary of Westcoast) and various project entities that are wholly-owned or consolidated by Duke Energy. The interest rates on the assumed debt range from 2.53% to 15.0%, with maturity dates ranging from 2002 through 2027. In addition to the debt assumed, Westcoast and Union Gas Limited have operating credit facilities of 600 million Canadian dollars and 715 million Canadian dollars, respectively. Borrowings under each of these facilities are subject to and dependent upon the senior unsecured ratings of Westcoast (currently rated A for Dominion Bond Rating Service (DBRS) and A+ for Standard & Poor's) and Union Gas (currently rated A(low) for DBRS and A+ for Standard & Poor's). For the Westcoast credit facility, a material adverse change could occur if the ratings for Westcoast fall below a BBB(low) at DBRS or a BB+ at Standard & Poor's, although a change in ratings is not in and of itself a material adverse change. For Union Gas Limited's facility, no material adverse change can be declared if Union Gas Limited maintains a rating of BBB or greater by either DBRS or Standard & Poor's. For both facilities, any outstanding debt would not become due and payable as a result of the change in ratings. Westcoast, headquartered in Vancouver, British Columbia, is a North American energy company with interests in natural gas gathering, processing, transmission, storage and distribution, as well as power generation and international energy businesses. In the transaction, a Duke Energy subsidiary acquired all of the outstanding common shares of Westcoast in exchange for approximately 49.9 million shares of Duke Energy common stock (including exchangeable shares of a Duke Energy Canadian subsidiary that are substantially equivalent to and exchangeable on a one-for-one basis for Duke Energy common stock), and approximately $1.8 billion in cash. Under prorating provisions of the acquisition agreement that ensured that approximately 50% of the total consideration was paid in cash and 50% in stock, each common share of Westcoast entitled the holder to elect to receive 43.80 in Canadian dollars, 0.7711 of a share of Duke Energy common stock or of an exchangeable share of a Duke Energy Canadian subsidiary, or a combination thereof. The cash portion of the consideration was funded with the proceeds from the issuance of $750 million in mandatory convertible securities in November 2001 along with incremental commercial paper. Duke Energy plans to retire the commercial paper later in 2002 and replace it with permanent capital in the form of mandatory convertible market equity. The timing for the mandatory convertible equity will be dependent on the market opportunities presented and favorable market conditions. The Westcoast acquisition was accounted for using the purchase method of accounting, and goodwill totaling approximately $2.5 billion was recorded in the transaction. Under its commercial paper, medium-term notes and extendible commercial notes (ECNs) programs, Duke Energy had the ability to borrow up to $7,917 million at March 31, 2002 compared with $5,358 million at December 31, 2001. These programs do not have termination dates. The following table summarizes the commercial paper, medium-term notes and ECNs as of March 31, 2002.
============================================================================================================== Duke Duke Duke Capital Duke Energy Energy Westcoast Union Gas (in millions) Energy Corporationa/a/ Field Services International Energy Limited Total -------------------------------------------------------------------------------------------------------------- Commercial Paper $1,250 $2,550 $650 $400/b/ $376 $470 $5,696 Medium-term notes -- -- -- -- 470 251 721 ECNs 500 1,000 -- -- -- -- 1,500 ------------------------------------------------------------------------------------------ Total $1,750 $3,550 $650 $400 $846 $721 $7,917 ==============================================================================================================
/a/ Duke Capital Corporation provides financing and credit enhancement services for its subsidiaries. /b/ Includes ability to issue medium term notes The total amount of Duke Energy's bank credit facilities was $7,136 million as of March 31, 2002 compared with $4,606 million as of December 31, 2001. Some of the credit facilities support the issuance of commercial paper and as a result, the issuance of commercial paper reduces the amount available under these credit facilities. As of March 31, 2002, $4,460 million was outstanding in the form of commercial paper, medium-term notes and ECNs, and $40 million of borrowings were outstanding under the bank credit facilities. The credit facilities expire from 2002 to 2005 and are not subject to minimum cash requirements. As of March 31, 2002, Duke Energy and its subsidiaries had effective SEC shelf registrations for up to $1,750 million in gross proceeds from debt and other securities. Effective April 2002, the amount available was increased by $1,750 million. Such securities may be issued as senior notes, first and refunding mortgage bonds, subordinated notes, trust preferred securities, Duke Energy common stock, stock purchase contracts or stock purchase units. In addition, Westcoast and its subsidiaries had $439 million of unused Canadian debt capacity. 23 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Risk and Accounting Policies Duke Energy is exposed to market risks associated with commodity prices, credit exposure, interest rates, equity prices and foreign currency exchange rates. Management has established comprehensive risk management policies to monitor and manage these market risks. Duke Energy's Policy Committee is responsible for the overall approval of market risk management policies and the delegation of approval and authorization levels. The Policy Committee is composed of senior executives who receive periodic updates from the Chief Risk Officer (CRO) on market risk positions, corporate exposures, credit exposures and overall risk management activities. The CRO is responsible for the overall management of credit risk and commodity price risk, including monitoring exposure limits. Mark-to-Market Accounting (MTM accounting). Under the MTM accounting method, an asset or liability is recognized at fair value and the change in the fair value of that asset or liability is recognized in earnings during the current period. This accounting method has been used by other industries for many years, and in 1998 the Financial Accounting Standards Board's (FASB) Emerging Issues Task Force (EITF) issued guidance that required MTM accounting for energy trading contracts. MTM accounting reports contracts at their "fair value," (the value a willing third party would pay for the particular contract at the time a valuation is made). When available, quoted market prices are used to record a contract's fair value. However, market values for energy trading contracts may not be readily determinable because the duration of the contracts exceeds the liquid activity in a particular market. If no active trading market exists for a commodity or for a contract's duration, holders of these contracts must calculate fair value using pricing models or matrix pricing based on contracts with similar terms and risks. This is validated by an internal group independent of Duke Energy's trading area. Holders of thinly traded securities or investments (mutual funds, for example) use similar techniques to price such holdings. Correlation and volatility are two significant factors used in the computation of fair values. Duke Energy validates its internally developed fair values by comparing locations/durations that are highly correlated, using market intelligence and mathematical extrapolation techniques. While Duke Energy uses industry best practices to develop its pricing models, changes in Duke Energy's pricing methodologies or the underlying assumptions could result in significantly different fair values, income recognition and realization in future periods. Hedge Accounting. Hedging typically refers to the mechanism that Duke Energy uses to mitigate the impact of volatility associated with price fluctuations. Hedge accounting treatment is used when Duke Energy contracts to buy or sell a commodity such as natural gas or electricity at a fixed price for future delivery corresponding with anticipated physical sales or purchases of natural gas and power (cash flow hedge). In addition, hedge accounting treatment is used when Duke Energy holds firm commitments or asset positions, and enters into transactions that "hedge" the risk that the price of natural gas or power may change between the contract's inception and the physical delivery date of the commodity ultimately affecting the underlying value of the firm commitment or position (fair value hedge). While the majority of Duke Energy's hedging transactions are used to protect the value of future cash flows related to its physical assets, to the extent the hedge is effective, Duke Energy recognizes in earnings the value of the contract when the commodity is purchased or sold, or the hedged transaction occurs or settles. Normal Purchases and Normal Sales, Special Exemption. A unique characteristic of the electric power industry is that electricity cannot be readily stored in significant quantities. As a result, some of the contracts to buy and sell electricity allow the buyer some flexibility in determining when to take electricity and in what quantity to match fluctuating demand. These contracts would normally meet the definition of a derivative requiring MTM or hedge accounting. However, because electricity cannot be readily stored in significant quantities and an entity engaged in selling electricity is obligated to maintain sufficient capacity to meet the electricity needs of its customer base, an option contract for the purchase of electricity qualifies 24 for the normal purchases and sales exemption described in Paragraph 10 of SFAS No. 133 and Derivative Implementation Group (DIG) Issue No. C15, "Scope Exceptions: Normal Purchases and Normal Sales Exception for Option-Type Contracts and Forward Contracts in Electricity." Therefore, contracts that Duke Energy holds for the sale of power in future periods that meet the criteria in DIG Issue No. C15 have been designated as "normal purchases, normal sales" contracts, and are exempted from recognition in the Consolidated Financial Statements until power is delivered. Duke Energy tracks these contracts separately in its hedge portfolio, but no value for these contracts is included in the Consolidated Financial Statements until power is actually delivered. North American Merchant Generation Duke Energy's wholesale energy portfolio in North America includes the merchant generation facilities and trading contracts held for power, natural gas, crude oil and petroleum products. Of the total estimated value of this portfolio, approximately 80% is attributed to the anticipated value of merchant generation facility capacity owned or controlled by Duke Energy. This portion of the value of the merchant generation portfolio is anticipated to be realized in future periods as the generation facilities are dispatched. A portion of this future value is secured by hedge contracts. Of the unhedged capacity, dispatch performance, and in some cases price, has been further secured through contracts designated as normal purchases and normal sales. Only the contracts designated and effective as qualifying hedges are reflected on Duke Energy's Consolidated Balance Sheets at fair value. Changes in the fair value of qualifying hedging contracts do not affect current-period earnings. Normal purchases and normal sales contracts are not subject to accounting recognition until contract performance occurs. The remaining percentage of the total estimated value of the merchant generation portfolio is attributed to the current value of trading contracts. These contracts are subject to MTM accounting and changes in the contract fair value are recorded as part of current-period earnings. The table below represents the value by year of Duke Energy's North American merchant generation portfolio. It does not include the value of trading positions, or hedges of other commodity risks or exposures.
============================================================================================= North American Merchant Generation Portfolio Value as of March 31, 2002 (in millions) --------------------------------------------------------------------------------------------- Maturity in 2005 Total Maturity in 2002 Maturity in 2003 Maturity in 2004 and Thereafter /a/ Portfolio Value --------------------------------------------------------------------------------------------- $747 $785 $895 $4,378 $6,805 =============================================================================================
/a/ For purposes of calculating total portfolio value, model valuations were calculated through March 2010. As of March 31, 2002, the portion hedged of NAWE's expected output of its merchant generation portfolio was 74% for 2003, 60% for 2004 and 59% for 2005, through derivative contracts such as forward natural gas purchases and forward power sales. Commodity Price Risk Duke Energy, substantially through its subsidiaries, is exposed to the impact of market fluctuations in the price of natural gas, electricity and other energy-related products marketed and purchased. Duke Energy employs established policies and procedures to manage its risks associated with these market fluctuations using various commodity derivatives, including forward contracts, futures, swaps and options for trading purposes and for activity other than trading activity (primarily hedge strategies). (See Notes 2 and 4 to the Consolidated Financial Statements.) Trading. The risk in the trading portfolio is measured and monitored on a daily basis utilizing a Value-at-Risk base model to determine the potential one-day favorable or unfavorable Daily Earnings at Risk (DER) as described below. DER is monitored daily in comparison to established thresholds. Other measures are also used to limit and monitor risk in the trading portfolio (which includes all trading contracts not designated as hedge positions) on monthly and annual bases. These measures include limits on the nominal size of positions and periodic loss limits. 25 DER computations are based on historical simulation, which uses price movements over a specified period (generally ranging from seven to 14 days) to simulate forward price curves in the energy markets to estimate the potential favorable or unfavorable impact of one day's price movement on the existing portfolio. The historical simulation emphasizes the most recent market activity, which is considered the most relevant predictor of immediate future market movements for natural gas, electricity and other energy-related products. DER computations use several key assumptions, including a 95% confidence level for the resultant price movement and the holding period specified for the calculation. Duke Energy's DER amounts for instruments held for trading purposes are shown in the following table.
======================================================================================================= Daily Earnings at Risk (in millions) ------------------------------------------------------------------------------------------------------- Estimated Average Estimated Average One-Day Impact on One-Day Impact on High One-Day Impact Low One-Day Impact EBIT for 1st Quarter EBIT for 1st Quarter on EBIT for 1st on EBIT for 1st 2002 /a/ 2001 Quarter 2002 Quarter 2002 ------------------------------------------------------------------------------------------------------- Calculated DER $17 $30 $24 $10 =======================================================================================================
/a/ Amount does not include the impact of Westcoast's trading activity. DER is an estimate based on historical price volatility. Actual volatility can exceed assumed results. DER also assumes a normal distribution of price changes; thus, if the actual distribution is not normal, the DER may understate or overstate actual results. DER is used to estimate the risk of the entire portfolio, and for locations that do not have daily trading activity, it may not accurately estimate risk due to limited price information. Stress tests are employed in addition to DER to measure risk where market data information is limited. In the current DER methodology, options are modeled in a manner equivalent to forward contracts which may understate the risk. Duke Energy's exposure to commodity price risk is influenced by a number of factors, including contract size, length, market liquidity, location and unique or specific contract terms. The following table illustrates the movements in the fair value of Duke Energy's trading instruments during the first quarter of 2002.
======================================================================================= Changes in Fair Value of Trading Contracts (in millions) --------------------------------------------------------------------------------------- Fair value of contracts outstanding at the beginning of the year $1,069 Contracts realized or otherwise settled during the period (93) Fair value of contracts entered into during the period 70 Changes in fair value amounts attributable to changes in valuation techniques 36 Other changes in fair values (63) ------- Fair value of contracts outstanding at the end of the period $1,019 =======================================================================================
For the quarter ended March 31, 2002, the unrealized net loss recognized in operating income was $68 million, compared to a $557 million gain for the first quarter of 2001. The fair value of these contracts is expected to be realized in future periods, as detailed in the following table. The amount of cash ultimately realized for these contracts will differ from the amounts shown in the following table due to factors such as market volatility, counterparty default and other unforeseen events that could impact the amount and/or realization of these values. At March 31, 2002, Duke Energy held cash or letters of credit of $798 million to secure such future performance, and had deposited with counterparties $96 million of such collateral to secure its obligations to provide such future services. Collateral amounts held or posted vary depending on the value of the underlying contracts and cover trading, normal purchases and normal sales, and hedging contracts outstanding. Duke Energy may be required to return held collateral and post additional collateral should price movements adversely impact the value of open contracts or positions. When available, Duke Energy uses observable market prices for valuing its trading instruments. When quoted market prices are not available, management uses established guidelines for the valuation of these contracts. Management may use a variety of reasonable methods to assist in determining the valuation of a trading instrument, including analogy to reliable quotations of similar trading instruments, pricing models, 26 matrix pricing and other formula-based pricing methods. These methodologies incorporate factors for which published market data may be available. All valuation methods employed by Duke Energy are approved by an independent internal corporate risk management organization. The following table shows the fair value of Duke Energy's trading portfolio as of March 31, 2002.
========================================================================================================= Fair Value of Trading Contracts as of March 31, 2002 (in millions) --------------------------------------------------------------------------------------------------------- Maturity in Maturity in Maturity in Maturity in 2005 and Total Fair Sources of Fair Value 2002 2003 2004 Thereafter Value --------------------------------------------------------------------------------------------------------- Prices supported by quoted market prices and other external sources $210 $148 $ 83 $ 32 $ 473 Prices based on models and other valuation methods 27 20 63 436 546 --------------------------------------------------------------------------------------------------------- Total $237 $168 $146 $468 $1,019 =========================================================================================================
The "prices supported by quoted market prices and other external sources" category includes Duke Energy's New York Mercantile Exchange (NYMEX) futures positions in natural gas and crude oil. The NYMEX has currently quoted prices for the next 32 months. In addition, this category includes Duke Energy's forward positions and options in natural gas and power and natural gas basis swaps at points for which over-the-counter (OTC) broker quotes are available. On average, OTC quotes for natural gas and power forwards and swaps extend 22 and 32 months into the future, respectively. OTC quotes for natural gas and power options extend 12 months into the future, on average. Duke Energy values these positions against internally developed forward market price curves that are constantly validated and recalibrated against OTC broker quotes. This category also includes "strip" transactions whose prices are obtained from external sources and then modeled to daily or monthly prices as appropriate. The "prices based on models and other valuation methods" category includes (i) the value of options not quoted by an exchange or OTC broker, (ii) the value of transactions for which an internally developed price curve was constructed as a result of the long dated nature of the transaction or the illiquidity of the market point, and (iii) the value of structured transactions. It is important to understand that in certain instances structured transactions can be decomposed and modeled by Duke Energy as simple forwards and options based on prices actively quoted. Although the valuation of the simple structures might not be different from the valuation of contracts in other categories, the effective model price for any given period is a combination of prices from two or more different instruments and therefore have been included in this category due to the complex nature of these transactions. The value of Duke Energy's trading portfolio valuation adjustments for liquidity, credit and cost of service is reflected in the above amounts. Hedging Strategies. Some Duke Energy subsidiaries are exposed to market fluctuations in the prices of energy commodities related to their power generating and natural gas gathering, processing and marketing activities. Duke Energy closely monitors the risks associated with these commodity price changes on its future operations and, where appropriate, uses various commodity instruments such as electricity, natural gas, crude oil and NGL contracts to hedge the value of its assets and operations from such price risks. In accordance with SFAS No. 133, Duke Energy's primary use of energy commodity derivatives is to hedge the output and production of assets it physically owns. Contract terms are up to 23 years; however, since these contracts are designated and qualify as effective hedge positions of future cash flows, or fair values of assets owned by Duke Energy, to the extent that the hedge relationships are effective, their market value change impacts are not recognized in current earnings. The unrealized gains or losses on these contracts are deferred in Other Comprehensive Income (OCI) for cash flow hedges or included in Other Current or 27 Noncurrent Assets or Liabilities on the Consolidated Balance Sheets for fair value hedges of firm commitments, in accordance with SFAS No. 133. Amounts deferred in OCI are realized in earnings concurrently with the transaction being hedged. (See Notes 2 and 4 to the Consolidated Financial Statements.) However, in instances where the hedging contract no longer qualifies for hedge accounting, amounts included in OCI through the date of de-designation remain in OCI until the underlying transaction actually occurs. The derivative contract (if continued as an open position) will be marked to market currently through earnings. Several factors influence the effectiveness of a hedge contract, including counterparty credit risk and using contracts with different commodities or unmatched terms. Hedge effectiveness is monitored regularly and measured each month. The following table shows when gains and losses deferred on the Consolidated Balance Sheets for derivative instruments qualifying as effective hedges of firm commitments or anticipated future transactions will be recognized into earnings. Contracts with terms extending several years are generally valued using models and assumptions developed internally or by industry standards. However, as mentioned previously, the gains and losses for these contracts are not recognized in earnings until settlement at their then market price. Therefore, assumptions and valuation techniques for these contracts have no impact on reported earnings prior to settlement. The fair value of Duke Energy's qualifying hedge positions at a point in time is not necessarily indicative of the value realized when such contracts settle.
========================================================================================== Fair Value of Hedge Position Contracts as of March 31, 2002 (in millions) ------------------------------------------------------------------------------------------ Maturity in 2005 Total Maturity in 2002 Maturity in 2003 Maturity in 2004 and Thereafter Contract Value ------------------------------------------------------------------------------------------ $408 $136 $100 $150 $794 ==========================================================================================
In addition to the hedge contracts described above and recorded on the Consolidated Balance Sheets, Duke Energy enters into other contracts that qualify for the normal purchases and sales exemption described in Paragraph 10 of SFAS No. 133 and DIG Issue No. C15. These contracts, generally forward agreements to sell power, bear the same counterparty credit risk as the hedge contracts described above. Under the same risk reduction guidelines used for other contracts, normal purchases and sales contracts are also subject to collateral requirements. Income recognition and realization related to these contracts coincide with the physical delivery of power. Credit Risk Duke Energy's principal customers for power and natural gas marketing services are industrial end-users and utilities located throughout the U.S., Canada, Asia Pacific, Europe and Latin America. Duke Energy has concentrations of receivables from natural gas and electric utilities and their affiliates, as well as industrial customers throughout these regions. These concentrations of customers may affect Duke Energy's overall credit risk in that some customers may be similarly affected by changes in economic, regulatory or other factors. Where exposed to credit risk, Duke Energy analyzes the counterparties' financial condition prior to entering into an agreement, establishes credit limits and monitors the appropriateness of those limits on an ongoing basis. Duke Energy frequently uses master collateral agreements to mitigate credit exposure. The collateral agreement provides for a counterparty to post cash or letters of credit for exposure in excess of the established threshold. The threshold amount represents an open credit limit, determined in accordance with the corporate credit policy. The collateral agreement also provides that the inability to post collateral is sufficient cause to terminate a contract and liquidate all positions. The change in market value of New York Mercantile Exchange-traded futures and options contracts requires daily cash settlement in margin accounts with brokers. Financial derivatives are generally cash settled periodically throughout the contract term. However, these transactions are also generally subject to margin agreements with many of Duke Energy's counterparties. 28 As of March 31, 2002, Duke Energy had a pre-tax bad debt provision of $90 million related to receivables for energy sales in California. Following the bankruptcy of Enron Corporation, Duke Energy terminated substantially all contracts with Enron Corporation and its affiliated companies (collectively, Enron). As a result, in 2001Duke Energy recorded, as a charge, a non-collateralized accounting exposure of $43 million. The $43 million non-collateralized accounting exposure was composed of charges of $36 million at NAWE, $3 million at International Energy, $3 million at Field Services and $1 million at Natural Gas Transmission. These amounts were stated on a pre-tax basis as charges against the reporting segment's earnings in 2001. Duke Energy's determination of its bankruptcy claims against Enron is still under review, and its claims made in the bankruptcy case are likely to exceed $43 million. Any bankruptcy claims that exceed this amount would primarily relate to termination and settlement rights under contracts and transactions with Enron that would have been recognized in future periods, and not in the historical periods covered by the financial statements to which the $43 million charge relates. Substantially all contracts with Enron were completed or terminated prior to December 31, 2001. Duke Energy has continuing contractual relationships with certain Enron affiliates, which are not in bankruptcy. In Brazil, a power purchase agreement between a Duke Energy affiliate, Companhia de Geracao de Energia Electrica Paranapanema (Paranapanema), and Elektro Eletricidade e Servicos S/A (Elektro), a distribution company 40% owned by Enron, will expire December 31, 2005. The contract was executed by Duke Energy's predecessor in interest in Paranapanema, and obligates Paranapanema to provide energy to Elektro on an irrevocable basis for the contract period. In addition, a purchase/sale agreement expiring September 1, 2005 between a Duke Energy affiliate and Citrus Trading Corporation (Citrus), a 50/50 joint venture between Enron and El Paso Corporation, continues to be in effect. The contract requires the Duke Energy affiliate to provide liquefied natural gas to Citrus. Citrus has provided a letter of credit in favor of Duke Energy to cover its exposure. 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-to-floating interest rate swaps, commercial paper and auction rate preferred stock. Duke Energy manages its interest rate exposure by limiting its variable-rate and fixed-rate exposures to percentages of total capitalization, as set by policy, and by monitoring the effects of market changes in interest rates. Duke Energy also enters into financial derivative instruments, including, but not limited to, interest rate swaps, options, swaptions and lock agreements to manage and mitigate interest rate risk exposure. (See Notes 2, 4, and 6 to the Consolidated Financial Statements.) Equity Price Risk Duke Energy maintains trust funds, as required by the Nuclear Regulatory Commission (NRC), to fund certain costs of nuclear decommissioning. As of December 31, 2001 and 2000, these funds were invested primarily in domestic and international equity securities, fixed-rate, fixed-income securities and cash and cash equivalents. Duke Energy has an agreement with the NRC that these funds will only be used for activities relating to nuclear decommissioning. Because the accounting for nuclear decommissioning recognizes that costs are recovered through Franchised Electric's rates, fluctuations in equity prices or interest rates do not affect consolidated results of operations, cash flows or financial position. Foreign Currency Risk Duke Energy is exposed to foreign currency risk from investments in international affiliates and businesses owned and operated in foreign countries. To mitigate risks associated with foreign currency fluctuations, when possible, transactions are denominated in or indexed to the U.S. dollar and/or local inflation rates, or investments may be hedged through debt denominated or issued in the foreign currency. Duke Energy also uses foreign currency derivatives, 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 devaluation of the foreign currencies to which it has exposure. 29 Since 1991, the Argentine peso had been pegged to the U.S. dollar at a fixed 1:1 exchange ratio. In December 2001, the Argentine government imposed a restriction that limited cash withdrawals above a certain amount and foreign money transfers. Financial institutions were allowed to conduct limited activity as a bank and exchange holiday was announced, and currency exchange activity was essentially halted. In January 2002, the Argentine government announced the creation of a dual-currency system. Subsequently, however, the Argentine government has decided to use a free-floating currency. Duke Energy's investment in Argentina was U.S. dollar functional as of December 31, 2001. Once a functional currency determination has been made, that determination must be adhered to consistently, unless significant changes in economic factors indicate that the entity's functional currency has changed. The events in Argentina required a change. In January 2002, the functional currency of Duke Energy's investment in Argentina changed from the U.S. dollar to the Argentine peso. In compliance with SFAS No. 52, "Foreign Currency Translation," the change in functional currency will be made prospectively. Management believes that the events in Argentina will have no material adverse effect on Duke Energy's future consolidated results of operations, cash flows or financial position. CURRENT ISSUES Environmental. In 2001, legislation was introduced in the North Carolina General Assembly that would require North Carolina electric utilities, including Duke Energy, to make significant reductions in emissions of sulfur dioxide and nitrogen oxides from its North Carolina coal-fired power plants over the next seven to 11 years. Management estimates the cost to Duke Energy of achieving the specified emission reductions in the proposed legislation to be approximately $1.5 billion. The proposed North Carolina legislation included a provision that allows Duke Energy to recover some or all of these costs from customers through an environmental compliance expenditure-recovery factor that would have been separate from the utility's base rates. In April 2002, Governor Easley of North Carolina announced his Clean Air Initiative which is intended to supersede the proposed legislation introduced in 2001. Through discussions with Duke Energy and other stakeholders, the Governor developed a plan to implement the emission reductions introduced in 2001, but without any increase in costs to consumers. Instead, North Carolina electric utilities would freeze their rates for five years and use the money collected during that period to pay for controls to meet the required emission reductions. This plan has not yet been introduced as legislation, but is expected to be introduced and acted upon quickly in late May 2002 or early June 2002. The final legislation, if passed into law, could differ significantly from the Governor's announced initiative. California Issues. Duke Energy, some of its subsidiaries and three current or former executives have been named as defendants, among other corporate and individual defendants, in one or more of a total of six lawsuits brought by or on behalf of electricity consumers in the State of California. The plaintiffs seek damages as a result of the defendants' alleged unlawful manipulation of the California wholesale electricity markets. Duke Energy North America, LLC (DENA) and DETM are among 16 defendants in a class-action lawsuit (the Gordon lawsuit) filed against generators and traders of electricity in California markets. DETM was also named as one of numerous defendants in four additional lawsuits, including two class actions (the Hendricks and Pier 23 Restaurant lawsuits), filed against generators, marketers, traders and other unnamed providers of electricity in California markets. A sixth lawsuit (the Bustamante lawsuit) was brought by the Lieutenant Governor of the State of California and a State Assemblywoman, on their own behalf as citizens and on behalf of the general public, and includes Duke Energy, some of its subsidiaries and three current or former executives of Duke Energy among other corporate and individual defendants. The Gordon and Hendricks class-action lawsuits were filed in the Superior Court of the State of California, San Diego County, in November 2000. Three other lawsuits were filed in January 2001, one in Superior Court, San Diego County, and the other two in Superior Court, County of San Francisco. The Bustamante lawsuit was filed in May 2001 in Superior Court, Los Angeles County. These lawsuits generally allege that the defendants manipulated the wholesale electricity markets in violation of state laws against unfair and unlawful business practices and state antitrust laws. The plaintiffs seek aggregate damages of billions of 30 dollars. The lawsuits seek the refund of alleged unlawfully obtained revenues for electricity sales and, in four lawsuits, an award of treble damages. These suits have been consolidated before a state court judge in San Diego. The plaintiffs in the six lawsuits filed a joint Master Amended Complaint on March 8, 2002, which adds additional defendants. The claims against the defendants are similar to those in the original complaints. The court has approved a schedule which calls for class certification motions to be filed by October 1, 2002 in the class action lawsuits. Trial has been scheduled for March 1, 2004. While these matters are in their earliest stages, management believes, based on its analysis of the facts and the asserted claims, that their resolution will have no material adverse effect on Duke Energy's consolidated results of operations, cash flows or financial position. Duke Energy and its subsidiaries are involved in other legal and regulatory proceedings and investigations related to activities in California. These other activities were disclosed in Duke Energy's Form 10-K for the year ended December 31, 2001, and there have been no new material developments in relation to these issues. Regulatory Matters. In November 2001, Nevada Power Company and Sierra Pacific Power Company (collectively, the Companies) filed a complaint with the Federal Energy Regulatory Commission (FERC) against DETM. The complaint requests the FERC to mitigate prices in sales contracts between Duke Energy and Nevada Power, and Duke Energy and Sierra Pacific that were entered into between December 7, 2000 and June 20, 2001. The Companies allege that the contract prices are unjust and unreasonable because they were entered into during a period that the FERC determined the California market to be dysfunctional and uncompetitive, and that the California market influenced the contract prices. In April 2002, the FERC issued an order which provides for an evidentiary hearing, establishes refund dates, and requires the parties to participate in settlement negotiations. In the order, the FERC also estimated a final decision by July 2003. While this matter is in its earliest stages, management believes, based on its analysis of facts and the asserted claims, that the resolution will have no material adverse effect on Duke Energy's consolidated results of operations, cash flows or financial position. Subsequent Event. On April 17, 2002, Duke Energy completed the sale of the Anderson Water Company to the Anderson County Joint Municipal Water System and the City of Anderson. The agreements for closing are two-fold. The first part represents the sale of the water treatment facility and the related water transmission system to the traditional wholesale customers forming the Anderson County Joint Municipal Water System. The second relates to the sale of the retail water system to the City of Anderson. As a result, the City of Anderson becomes a wholesale customer participant in and a member of the joint system. 31 PART II. OTHER INFORMATION Item 1. Legal Proceedings. For information concerning litigation and other contingencies, see Note 7 to the Consolidated Financial Statements, "Commitments and Contingencies," and Item 3, "Legal Proceedings," included in Duke Energy's Form 10-K for December 31, 2001, which are incorporated herein by reference. Management believes that the final disposition of these proceedings will have no material adverse effect on Duke Energy's consolidated results of operations, cash flows or financial position. Item 4. Submission of Matters to a Vote of Security Holders. There were no matters submitted to a vote of the security holders of Duke Energy during the first quarter of 2002. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit Number ------- 3 Articles of Amendment to Restated Articles of Incorporation of registrant. 10 $500,000,000 364-Day Credit Agreement dated as of April 18, 2002, among Duke Capital Corporation, the Banks listed therein and Bank One, NA, as Administrative Agent. (b) Reports on Form 8-K A Current Report on Form 8-K filed on January 9, 2002 contained disclosures under Item 9, Regulation FD Disclosure. A Current Report on Form 8-K filed on March 29, 2002 contained disclosures under Item 2, Acquisition or Disposition of Assets and Item 7, Financial Statements, Pro forma Financial Information and Exhibits. 32 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 May 15, 2002 /s/ Robert P. Brace ----------------------------------- Robert P. Brace Executive Vice President and Chief Financial Officer May 15, 2002 /s/ Keith G. Butler ----------------------------------- Keith G. Butler Senior Vice President and Controller 33