-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Au5A6RDh5Kxfw5uNJNl1PBG0/7GUc1GPrXlTOtFYzhOv2FwOtOXO6xjTNXAfSYKa idjpWQowVKZ6riIS3Uoz7A== 0000060251-97-000032.txt : 19980102 0000060251-97-000032.hdr.sgml : 19980102 ACCESSION NUMBER: 0000060251-97-000032 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 ITEM INFORMATION: FILED AS OF DATE: 19971231 SROS: NYSE SROS: PSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: LONG ISLAND LIGHTING CO CENTRAL INDEX KEY: 0000060251 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC & OTHER SERVICES COMBINED [4931] IRS NUMBER: 111019782 STATE OF INCORPORATION: NY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-03571 FILM NUMBER: 97747322 BUSINESS ADDRESS: STREET 1: 175 E OLD COUNTRY RD CITY: HICKSVILLE STATE: NY ZIP: 11801 BUSINESS PHONE: 5165455184 MAIL ADDRESS: STREET 1: 175 E. OLD COUNTRY RD CITY: HICKSVILLE STATE: NY ZIP: 11801 8-K 1 LILCO CURRENT REPORT ON FORM 8-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------------------- FORM 8-K CURRENT REPORT ----------------------------------- Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 DATE OF REPORT (Date of earliest event reported): December 31, 1997 LONG ISLAND LIGHTING COMPANY (Exact name of registrant as specified in charter) New York 1-3571 11-1019782 (State of Incorporation) (Commission File No.) (I.R.S.Employer Identification No.) 175 East Old Country Road, Hicksville, New York 11801 516-755-6650 (Address and telephone number of Principal Executive Offices) Item 5. Other Events The Company is filing this Current Report on Form 8-K to provide unaudited pro forma combined condensed financial information for Long Island Lighting Company ("LILCO") and for KeySpan Energy Corporation ("Keyspan") at September 30, 1997 and for the twelve months ended September 30, 1997 in order to give effect under the purchase method of accounting to the transactions summarized in Exhibit 99.1 hereto and in the assumptions set forth in the notes thereto. Based on current facts and circumstances, LILCO and Keyspan believe that the applicability of the purchase method of accounting is probable. If the transaction contemplated with the Long Island Power Authority is not consummated, it is possible that the combination contemplated between LILCO and Keyspan would qualify for the pooling of interests method of accounting. The unaudited pro forma combined condensed financial information set forth in Exhibit 99.1 to this Current Report on Form 8-K reflects the condensed consolidated financial information of LILCO contained in its Quarterly Report on Form 10-Q filed on November 14, 1997 and of Keyspan contained in its Annual Report on Form 10-K filed on December 19, 1997, which Form 10-K of Keyspan is attached hereto as Exhibit 99.2. Exhibits 99.1 and 99.2 are hereby incorporated by reference in response to this Item 5. Item 7. Financial Statements, Pro Forma Financial Information and Exhibits The unaudited pro forma combined condensed financial information and Keyspan's Annual Report on Form 10-K filed on December 19, 1997, referred to above in Item 5 and incorporated herein by reference, are attached hereto as the following Exhibits: Exhibit Number 10 Agreement and Plan of Merger dated as of June 26, 1997 by and among BL Holding Corp., Long Island Lighting Company, Long Island Power Authority and LIPA Acquisition Corp. (filed as Annex D to Registration Statement on Form S-4, No. 333-30353 on June 30, 1997) and hereby incorporated by reference and made a part of this report with the same effect as if filed herewith. *23 Consent of Independent Public Accountants *99.1 Unaudited pro forma combined condensed financial information for LILCO and Keyspan Energy Corporation at September 30, 1997 and for the twelve months ended September 30, 1997. *99.2 Keyspan Annual Report on Form 10-K for the 12-month period ended September 30, 1997. *Filed Herewith 2 SIGNATURE 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. Dated: December 31, 1997 LONG ISLAND LIGHTING COMPANY Registrant By: /s/ Anthony Nozzolillo ------------------------------- ANTHONY NOZZOLILLO Senior Vice President - Finance 3 Exhibit Index Exhibit Number 10 Agreement and Plan of Merger dated as of June 26, 1997 by and among BL Holding Corp., Long Island Lighting Company, Long Island Power Authority and LIPA Acquisition Corp. (filed as Annex D to Registration Statement on Form S-4, No. 333-30353 on June 30, 1997) and hereby incorporated by reference and made a part of this report with the same effect as if filed herewith. *23 Consent of Independent Public Accountants begins on page 5. *99.1 Unaudited pro forma combined condensed financial information for LILCO and KeySpan Energy Corporation at September 30, 1997 and for the twelve months ended September 30, 1997, begins on page 6. *99.2 KeySpan Energy Corporation Annual Report for the 12-month period ended September 30, 1997 begins on page 13. *Filed Herewith 4 EX-23 2 EX-23 Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------- As independent public accountants, we hereby consent to the incorporation by reference of our report dated October 22, 1997, covering the consolidated financial statements of KeySpan Energy Corporation for the three years ended September 30, 1997, included in this Form 8-K, into Long Island Lighting Company's previously filed Registration Statement Nos. 33-52963 and 2-87427. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP New York, New York December 23, 1997 5 EX-99 3 EX-99.1 Exhibit 99.1 UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL INFORMATION KEYSPAN ENERGY CORP\LILCO COMBINATION AND LIPA TRANSACTION The following unaudited pro forma financial information reflects adjustments to the historical financial statements of LILCO to give effect to the proposed transfer of LILCO's gas and generation business to subsidiaries of the newly formed Holding Company (Holding Company), the proposed stock acquisition of LILCO by a wholly owned subsidiary of LIPA and the proposed combination between KeySpan Energy Corporation (KeySpan) and LILCO (Combination). The unaudited pro forma consolidated condensed balance sheet at September 30, 1997 gives effect to the proposed LIPA Transaction and the Combination as if they had occurred at September 30, 1997. The unaudited pro forma consolidated condensed statement of income for the 12-month period ended September 30, 1997 gives effect to the proposed LIPA Transaction and the Combination as if they had occurred at October 1, 1996. These statements are prepared on the basis of accounting for the Combination under the purchase method of accounting and are based on the assumptions set forth in the notes thereto. In April 1997 LILCO changed its year-end from December 31 to March 31. The following pro forma financial information has been prepared from, and should be read in conjunction with, the LIPA Agreement (Annex D to the Joint Proxy dated June 27, 1997, which is filed as Exhibit 10 to this Current Report on Form 8-K and incorporated herein by reference), and the historical consolidated financial statements and related notes thereto of KeySpan and LILCO. The following information is not necessarily indicative of the financial position or operating results that would have occurred had the proposed LIPA Transaction and the Combination been consummated on the date, or at the beginning of the period, for which the proposed LIPA Transaction and the Combination are being given effect nor is it necessarily indicative of future operating results or financial position. 7
(KEYSPAN/LILCO) HOLDING CORP. UNAUDITED PRO FORMA CONSOLIDATED CONDENSED BALANCE SHEET 9/30/97 (In Millions) Sale LILCO to Pro Forma LILCO Keyspan Pro Forma Pro Forma (Historical) LIPA (1) Adjustments As Adjusted (Historical) Adjustments Consolidated ----------- ----------- ------------ ------------- -------------- ------------- -------------- ASSETS PROPERTY Utility Plant Electric $3,969.6 $2,880.2 $1,089.4 0.0 0.0 $1,089.4 Gas 1,192.5 0.0 0.0 1,192.5 1,848.8 0.0 3,041.3 Common 268.5 0.0 0.0 268.5 0.0 0.0 268.5 Construction work in progress 119.5 38.6 80.9 0.0 0.0 80.9 Nuclear fuel in process and in reactor 15.5 15.5 0.0 0.0 0.0 0.0 Less - Accumulated depreciation 0.0 and amortization (1,823.9) (891.1) (932.8) (458.1) 0.0 (1,390.9) -------- ------ ------ ------ ------ --- -------- Total Net Utility Plant 3,741.7 2,043.2 0.0 1,698.5 1,390.7 0.0 3,089.2 Gas exploration and production, at cost 0.0 0.0 0.0 636.3 0.0 636.3 Less - Accumulated depletion 0.0 0.0 0.0 0.0 (216.4) 0.0 (216.4) ---------- -------- ------- ---------- ---------- ---------- --------- Total Net Plant 3,741.7 2,043.2 0.0 1,698.5 1,810.6 0.0 3,509.1 ---------- -------- ------- ---------- ------------ ---------- --------- Cost In Excess of Net Assets Acquired 308.0 (6) 308.0 REGULATORY ASSETS Base financial component (less accumulated amortization of $808) 3,205.8 3,205.8 0.0 0.0 0.0 0.0 Rate moderation component 402.8 402.8 0.0 0.0 0.0 0.0 Shoreham post-settlement costs 1,004.1 1,004.1 0.0 0.0 0.0 0.0 Regulatory tax asset 1,754.4 1,754.4 0.0 0.0 70.5 (5) 70.5 Postretirement benefits other than pensions 350.5 0.0 (295.7)(2) 54.8 54.8 Other 431.5 330.6 0.0 100.9 0.0 0.0 100.9 ---------- -------- ------- ---------- ---------- ---------- --------- Total Regulatory Assets 7,149.1 6,697.7 (295.7) 155.7 0.0 70.5 226.2 ---------- -------- ------- ---------- ---------- ---------- --------- NONUTILITY PROPERTY AND OTHER INVESTMENTS 50.6 17.1 33.5 166.9 0.0 200.4 ---------- -------- ------- ---------- ---------- ---------- --------- CURRENT ASSETS Cash and cash equivalents 121.5 0.0 2,487.6 (3) 2,609.1 36.9 2,646.0 Deferred tax asset 25.2 25.2 119.0 (4) 119.0 119.0 Accounts receivable and accrued revenues 479.1 333.3 14.4 (2) 160.2 160.2 Other Current Assets 250.6 1.7 0.0 248.9 311.2 0.0 560.1 ---------- -------- ------- ---------- ---------- ---------- --------- TOTAL CURRENT ASSETS 876.4 360.2 2,621.0 3,137.2 348.1 0.0 3,485.3 DEFERRED CHARGES 80.2 47.4 32.8 171.6 (70.5)(5) 133.9 CONTRACTUAL RECIEVABLE FROM LIPA 281.3 (2) 281.3 281.3 ---------- -------- ------- ---------- ---------- ---------- --------- TOTAL ASSETS $11,898.0 $9,165.6 $2,606.6 $5,339.0 $2,497.2 $308.0 $8,144.2 ============ ========= ======== ========== ========== ========== ========= CAPITALIZATION AND LIABILITIES CAPITALIZATION Common Shareowners' Equity $2,614.1 $2,520.6 $2,487.6 (3) $2,581.1 $969.0 $253.9 (6) $3,804.0 Long-term debt 4,458.5 3,293.6 (75.0)(14) 1,089.9 745.1 0.0 1,835.0 Preferred stock 701.0 338.0 75.0 (14) 438.0 0.0 0.0 438.0 ---------- -------- ------- ---------- ---------- ---------- --------- Total Capitalization 7,773.6 6,152.2 2,487.6 4,109.0 1,714.1 253.9 6,077.0 ---------- -------- ------- ---------- ---------- ---------- --------- REGULATORY LIABILITIES 526.3 493.2 0.0 33.1 0.0 0.0 33.1 ---------- -------- ------- ---------- ---------- ---------- --------- CURRENT LIABILITIES Accounts payable and accrued expenses 242.9 121.0 121.9 161.3 54.1 (6) 337.3 Accrued taxes (including Federal income tax) 57.2 399.0 (4) 456.2 4.6 460.8 Other current liabilities 336.5 64.5 272.0 153.6 0.0 425.6 ---------- -------- ------- ----------------------- ---------- --------- 636.6 185.5 399.0 850.1 319.5 54.1 1,223.7 ---------- -------- ------- ----------------------- ---------- --------- DEFERRED CREDITS Deferred federal income tax 2,422.0 2,312.2 (280.0)(4) (170.2) 290.4 0.0 120.2 Other 100.9 29.6 71.3 88.0 0.0 159.3 ---------- -------- ------- ---------- ---------- ---------- --------- Total Deferred Credits 2,522.9 2,341.8 (280.0) (98.9) 378.4 0.0 279.5 ---------- -------- ------- ---------- ---------- ---------- --------- OPERATING RESERVES 438.6 (7.1) 0.0 445.7 0.0 0.0 445.7 COMMITMENTS AND CONTINGENCIES 0.0 0.0 0.0 0.0 0.0 0.0 0.0 ---------- -------- ------- ---------- ---------- ---------- --------- MINORITY INTEREST IN SUBSIDIARY COMPANY 0.0 0.0 0.0 0.0 85.2 0.0 85.2 ---------- -------- ------- ---------- ---------- ---------- --------- TOTAL CAPITALIZATION AND LIABILITIES $11,898.0 $9,165.6 $2,606.6 $5,339.0 $2,497.2 $308.0 $8,144.2 ========== ======== ======= ========== ========== ========== =========
SEE ACCOMPANYING NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS. 8
(KEYSPAN/LILCO) HOLDING CORP. UNAUDITED PRO FORMA CONSOLIDATED CONDENSED STATEMENT OF INCOME FOR THE TWELVE MONTHS ENDED SEPTEMBER 30, 1997 (In Millions Except Per Share Amounts) Sale Pro LILCO to Forma LILCO KeySpan Pro Forma Pro Forma (Historical) LIPA (1) Adjustments As Adjusted (Historical) Adjustments Consolidated ----------- ----------- ----------- ----------- ----------- ----------- ----------- REVENUES Electric $2,458.3 $1,485.0(10) $11.5(7) $984.8 $0.0 $0.0 $984.8 Gas - Utility sales 651.9 651.9 1,363.7 0.00 2,015.6 Gas production and other 0.0 114.5 0.0 114.5 ----------- ----------- --------- ----------- ----------- --------- ----------- Total Revenues 3,110.2 1,485.0 11.5 1,636.7 1,478.2 0.0 3,114.9 OPERATING EXPENSES Operations - fuel and purchased power 946.1 14.4 931.7 594.1 0.0 1,525.8 Operations - other 366.1 216.4 149.7 363.2 0.0 512.9 Maintenance 114.6 65.0 49.6 56.6 0.0 106.2 Depreciation, depletion and amortization 156.8 95.2 61.6 111.0 6.3(6) 178.9 Base financial component amortization 101.0 101.0 0.0 0.0 0.0 0.0 Rate moderation component amortization 33.9 33.9 0.0 0.0 0.0 0.0 Regulatory liability component amortization (88.6) (88.6) 0.0 0.0 0.0 0.0 Other regulatory amortization 46.6 28.4 18.2 0.0 0.0 18.2 Operating taxes 468.4 266.2 202.2 153.5 0.0 355.7 Federal income taxes 218.9 188.6 6.3(8) 36.6 57.2 0.0 93.8 ----------- ----------- --------- ----------- ----------- -------- ----------- Total Operating Expenses 2,363.8 920.5 6.3 1,449.6 1,335.6 6.3 2,791.5 ----------- ----------- --------- ----------- ----------- -------- ----------- Operating Income 746.4 564.5 5.2 187.1 142.6 (6.3) 323.4 OTHER INCOME AND (DEDUCTIONS) 14.3 26.7 (12.4) 16.7 0.0 4.3 ----------- ----------- --------- ----------- ----------- -------- ----------- INCOME BEFORE INTEREST CHARGES 760.7 591.2 5.2 174.7 159.3 (6.3) 327.7 INTEREST CHARGES 419.3 325.1 (1.9)(8) 92.3 44.6 0.0 136.9 ----------- ----------- --------- ----------- ----------- -------- ----------- NET INCOME 341.4 266.1 7.1 82.4 114.7 (6.3) 190.8 ----------- ----------- --------- ----------- ----------- -------- ----------- Preferred stock dividend requirements 51.9 23.1 23.7(10) 52.5 0.3 52.8 ----------- ----------- --------- ----------- ----------- -------- ----------- EARNINGS FOR COMMON STOCK $289.5 $243.0 ($16.6) $29.9 $114.4 ($6.3) $138.0 =========== =========== ========= =========== =========== ======== =========== AVERAGE COMMON SHARES OUTSTANDING 121.1 121.1 121.1 121.1 50.2 (14.5) 156.8 =========== =========== ========= =========== =========== ======== =========== EARNINGS PER COMMON AND EQUIVALENT SHARES $2.39 $2.00 ($0.14) $0.25 $2.28 $0.43 $0.88 =========== =========== ========= =========== =========== ======== ===========
SEE ACCOMPANYING NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS. 9 NOTES TO UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 1. The historical financial statements of LILCO have been adjusted to give effect to the proposed transaction with LIPA, pursuant to which LILCO will distribute certain of its net assets relating to its gas and generation business ("Transferred Assets") to subsidiaries of the Holding Company. LIPA will then acquire LILCO in a stock sale. The adjustments are based upon a disaggregation of LILCO's balance sheet and operations as estimated by the management of LILCO, and are subject to adjustment pursuant to the terms of the LIPA agreement. In connection with this transaction, the principal assets to be acquired by LIPA through its stock acquisition of LILCO include the electric transmission and distribution system ("The LIPA Transmission and Distribution System"), LILCO's 18% interest in Nine Mile Point 2 nuclear power station, certain of LILCO's regulatory assets associated with its electric business and an allocation of accounts receivable and other assets. The principal liabilities to be assumed by LIPA include LILCO's regulatory liabilities associated with its electric business, a portion of LILCO's long-term debt and an allocation of accounts payable, accrued expenses, customer deposits, other deferred credits and claims. 2. In connection with the LIPA Transaction, LIPA is contractually responsible for reimbursing the Holding Company for postretirement benefits other than pension costs, related to employees of LILCO's electric business. A pro forma adjustment has been reflected to reclassify the associated regulatory asset for postretirement benefits other than pensions to current and non-current accounts receivable pursuant to LIPA's obligation to a subsidiary of the Holding Company. 3. The Cash Purchase Price to be paid by LIPA in connection with its stock acquisition of LILCO will be $2,497.5 million. The Cash Purchase Price was determined based upon the estimated net book value of the LILCO Retained Assets of $2,500.8 million as estimated by LILCO in a projected balance sheet as of December 31, 1997. Based upon the balance sheet as of September 30, 1997, the net book value of the LILCO Retained Assets amount to $2,520.6 million. In addition, the LIPA Transaction obligates the Holding Company upon the closing of the transaction to remit to LIPA $15 million associated with the recovery through litigation of certain real estate taxes previously paid. Transaction costs are currently estimated to be $18 million. Assuming the LIPA Transaction was completed on September 30, 1997, the net cash to be received by the Holding Company would amount to: Cash Purchase Price...............................$2,520.6 Cash paid to LIPA....................................(15.0) Transaction Costs................................. (18.0) ----- Net Cash..........................................$2,487.6 ======== 10 4. The distribution of the Transferred Assets from LILCO to subsidiaries of the Holding Company will result in the imposition of federal income taxes on LILCO. Pursuant to the LIPA Agreement, the subsidiaries created by the Holding Company to receive the Transferred Assets will receive the benefit of the increased tax basis of the Transferred Assets and will pay the LILCO tax. If the LIPA Transaction were to have occurred at September 30, 1997, the tax would have amounted to approximately $399 million. The tax is derived from the difference between the estimated fair value of the distributed assets and their existing tax basis. For financial reporting purposes, the subsidiaries reversed the existing deferred tax liability of $280 million relating to the Transferred Assets and recorded a $119 million deferred tax asset reflecting the income tax effect by which the tax basis of the Transferred Assets exceeded their book basis. 5. The unaudited pro forma condensed consolidated balance sheet as of September 30, 1997 reflects the reclassification of $70.5 million of KeySpan regulatory tax assets from deferred charges to regulatory assets in order to consistently present the regulatory assets of KeySpan with LILCO. 6. The purchase price for KeySpan at September 30, 1997, which amounted to approximately $1.245 billion including approximately $54.1 million of transaction costs, has been determined based upon an average of LILCO's opening and closing stock prices for the two trading days before and three trading days after December 29, 1996. The purchase price has been allocated to assets acquired and liabilities assumed based upon their estimated fair values. It is anticipated that the fair value of the utility assets acquired is represented by their book value, which approximates the value of these assets recognized by the New York State Public Service Commission (PSC) in establishing rates which are designed to, among other things, provide for a return on the book value of these assets and the recovery of costs included as depreciation and amortization charges. The estimated fair values of KeySpan non-utility assets approximate their carrying values. Both KeySpan and LILCO will seek PSC approval for recovery of transaction costs. At December 29, 1996, the purchase price, including merger-related transaction costs, exceeded the fair value of the net assets acquired by $308.0 million, which will be amortized to income over 40 years. 7. The agreement with LIPA includes a provision for the Holding Company to earn in the aggregate approximately $11.5 million in annual management service fees from LIPA for the management of the LIPA Transmission and Distribution System and the management of all aspects of fuel and power supply. These agreements also contain certain incentive and penalty provisions which could materially impact earnings from such agreements. 11 8. The pro forma charge of $6.3 million represents the income tax effect associated with the recording of the pro forma adjustments for the $11.5 million management fee (See Note 7), and a reduction in interest expense of approximately $1.9 million associated with the recapitalization of the subsidiary which contains the gas and generation businesses. 9. Revenues for both the assets acquired by LIPA and the Transferred Assets were determined based upon a revenue requirements model which considered the cost of service for these assets and a return on capitalization based upon an imputed allowed rate of return. 10. No adjustments have been made to earnings on common stock to reflect earnings on net available proceeds of approximately $1.7 billion to be received, after remittances to the Holding Company's gas and generation subsidiaries for working capital purposes (see Notes 3 and 11). If these funds were invested at 6.40% (the 30 year US Treasury Bond yield based on average prices), the Holding Company would have realized additional interest income, net of taxes, of approximately $70.7 million, or approximately $.45 per share, on a pro forma consolidated basis. Each one percent change in the assumed interest rate, would increase/decrease interest income, net of taxes, by $11.0 million. LILCO's allowed rate of return on its common equity for its electric business is currently 11%. 11. Subsequent to the sale to LIPA, a portion of the proceeds to be received by the Holding Company will be remitted to LILCO's gas and generation subsidiaries in order to meet the subsidiaries working capital needs. Such proposed transaction has been eliminated in the consolidation process. 12. The allocation between KeySpan and LILCO and their customers of the estimated cost savings resulting from the Combination, net of the costs incurred to achieve such savings, will be subject to regulatory review and approval. None of the estimated cost savings have been reflected in the unaudited pro forma consolidated condensed financial statements. 13. The unaudited pro forma consolidated condensed financial statements reflect the exchange of each share of LILCO Common Stock outstanding into 0.880 shares of Holding Company Common Stock outstanding and each share of KeySpan Common Stock into one share of Holding Company Common Stock, as provided in the KeySpan/LILCO Agreement. 14. As more fully described in the section entitled "The LIPA Transaction-Agreement and Plan of Merger," as described in the Joint Proxy Statement/Prospectus dated June 27, 1997, LILCO will transfer the Transferred Assets to subsidiaries of the Holding Company in exchange for shares of the Holding Company common stock and up to $75 million face amount of Holding Company Preferred Stock. The privately placed Preferred Stock will be non-voting, non-convertible and have a five year term. For purposes of these pro forma financial 12 statements, it is assumed that the Holding Company will issue $75 million of Preferred Stock, LILCO will sell the preferred stock for $75 million in proceeds and will retain the proceeds (i.e. a Retained Asset). With a $75 million increase in the Retained Assets, the LIPA Agreement provides that the Retained Debt will increase by a corresponding amount. The LIPA Agreement also provides that if the Holding Company were to issue an amount other than $75 million of Preferred Stock, the incremental difference between the amount actually issued and $75 million, will result in a corresponding increase or decrease in the amount of accounts payable retained by LILCO. These pro forma financial statements reflect a reduction in interest expense for the reduced level of subsidiary debt, and to reflect an increase in preferred stock dividend requirements. Finally, for purposes of these pro forma financial statements, it is assumed that the dividend rate on this privately place Preferred Stock will be 7.95%, which is equal to the Company's highest cost preferred Stock. 15. KeySpan earnings for the 12 month period ended September 30, 1997 include non-recurring income aggregating to approximately $7.8 million, net of taxes or $0.16 per share, relating to gains on the sale of certain Canadian gas processing properties and on the sale of a fuel management operation. 13 EX-99 4 EX-99.2 Exhibit 99.2 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1997 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-14508 KEYSPAN ENERGY CORPORATION (Exact name of Registrant as specified in its charter) New York 11-3344628 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) ONE METROTECH CENTER, BROOKLYN, NEW YORK 11201-3850 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code 718-403-1000 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange on Title of Each Class Which Registered Common Stock-$.33 1/3 par value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X) On December 11, 1997 the Company had 50,966,673 shares of Common Stock outstanding at an aggregate market value of $1.7 billion. DOCUMENTS INCORPORATED BY REFERENCE Part of Documents Form 10-K Form 8K dated December 19, 1997 Part II PART I Item 1. Business The Company 3 a. Overview of Utility Subsidiary 4 Competition 5 Regulation and Rate Matters 7 Gas Supply 8 Environmental Matters 9 Research and Development 9 b. Overview of Non-Utility Subsidiaries 9 Employees 12 Item 2. Properties 12 Item 3. Legal Proceedings 13 Item 4. Submission of Matters to a Vote of Security Holders 13 PART II Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters 13 Item 6. Selected Financial Data 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 8. Financial Statements and Supplementary Data 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 58 PART III Item 10. Directors and Executive Officers of the Registrant 58 Item 11. Executive Compensation 64 Item 12. Security Ownership of Certain Beneficial Owners and Management 73 Item 13. Certain Relationships and Related Transactions 74 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 74 Signatures 81 Part I Item 1. Business The Company KeySpan Energy Corporation (Company or KeySpan) is filing its first report on Form 10-K herewith as successor to the Brooklyn Union Gas Company (Brooklyn Union). In fiscal 1997, The Brooklyn Union Gas Company and its subsidiaries were reorganized into a holding company structure named KeySpan Energy Corporation. At a special meeting held on August 7, 1997, shareholders approved the reorganization, and after the close of business on September 29, 1997 the reorganization became effective by a share exchange through which each share of Brooklyn Union common stock was converted into one share of KeySpan common stock. (See Part II, Item 8., "Financial Statements and Supplementary Data - Summary of Significant Accounting Policies and Basis for Financial Statement Presentation - 'Reorganization'".) Brooklyn Union is the Company's utility gas distribution subsidiary and its principal subsidiary. In addition to gas distribution, KeySpan subsidiaries are engaged in gas exploration and production operations, gas marketing and energy systems installation and management services. Other subsidiaries participate and own investments in projects involving gas pipeline and storage facilities. Further, certain subsidiaries are in the process of selling their investments in cogeneration facilities and fuel management operations. The scope of energy investments is being expanded to include greater participation in international projects, such as a gas pipeline from Scotland to Northern Ireland and a gas distribution system in Belfast, Northern Ireland which is supplied by the pipeline. Other planned investments include participating in cogeneration projects in selected countries and oil and gas ventures in Mexico. Gas exploration and production, and gas marketing operations are fully consolidated in the financial information presented. All other investments of subsidiaries are accounted for on the equity method. (See Part I, Item 1., "The Company 'Overview of Non-Utility Subsidiaries'".) The Company's executive offices are located at One MetroTech Center, Brooklyn, New York 11201-3850. Its telephone number is (718) 403-1000. Financial and other information is also available through the World Wide Web at http://www.Keyspanenergy.com. The Company has filed an exemption statement with the Securities and Exchange Commission (SEC) to exempt itself and its subsidiaries from all provisions of the Public Utility Holding Company Act of 1935 (except with respect to certain acquisitions and investments) pursuant to the intrastate exemption provided by Section 3(a)(1) of that Act. Also in fiscal 1997, Brooklyn Union (prior to its reorganization) and Long Island Lighting Company entered into an 3 Agreement and Plan of Exchange and Merger pursuant to which the companies would become wholly owned subsidiaries of a new holding company. Based on the terms of the transaction, as the result of the combination of the Company with a newly-formed subsidiary of the new combined holding company, the Company's common shareholders will receive one share of common stock of the new holding company for each common share of the Company they currently own. This agreement was approved by both companies boards of directors and shareholders of both companies approved the transaction on August 7, 1997, the same time at which Brooklyn Union's shareholders also approved its reorganization. In March 1997, Brooklyn Union and LILCO filed a joint petition with the New York State Public Service Commission (PSC) seeking approval under Section 70 of the New York Public Service Law for the combination. It is currently anticipated that the PSC will act on the petition in early calendar year 1998. Also the transaction is conditioned upon receipt of other required regulatory approvals. LILCO has entered into a separate transaction with the Long Island Power Authority involving the sale and transfer of LILCO's electric transmission and distribution assets as well as certain other assets. (See Part II, Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations - 'Utility Rate and Regulatory Matters - Proposed LILCO Transaction'", and Part II, Item 8., "Financial Statements and Supplementary Data, - Note 9 to the Consolidate Financial Statements, 'Combination with Long Island Lighting Company (LILCO Transactions)'".) a. Overview of Utility Subsidiary General Brooklyn Union, KeySpan's gas distribution subsidiary, was incorporated in the State of New York in 1895 as a combination of existing companies, the first of which was granted a franchise in 1849. Brooklyn Union distributes natural gas at retail, primarily in a territory of approximately 187 square miles, which includes the Boroughs of Brooklyn and Staten Island and two-thirds of the Borough of Queens, all in New York City. The population of the territory served is approximately 4,000,000. As of September 30, 1997, Brooklyn Union had approximately 1,128,000 active meters, of which approximately 1,090,000 were residential. Brooklyn Union is subject to the comprehensive regulatory jurisdiction of the PSC. Seasonality The gas distribution business is influenced by seasonal weather conditions. Annual revenues are substantially realized during the heating season (November 1 to April 30) as a result of the large proportion of heating sales, primarily residential, compared to total sales. Accordingly, results of operations historically are most favorable in the second quarter (the three months ended March 31) of the Company's fiscal year, with results 4 of operations being next most favorable in the first quarter. Results for the third quarter are marginally unprofitable, and losses are usually incurred in the fourth quarter. Brooklyn Union's tariff contains a weather normalization adjustment that provides for recovery from or refund to firm customers of material shortfalls or excesses of firm net revenues (revenues less applicable gas costs, if any) during a heating season due to variations from normal weather. (See Part I, Item 1., "Business Overview of Utility Subsidiary, 'Regulation and Rate Matters'" and Part II, Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations - 'Utility'".) Sales For the fiscal year ended September 30, 1997, firm gas and transportation sales were 136,370 MDTH, of which 74% were residential, 11% commercial, 10% governmental and 5% industrial. Other gas and transportation sales and services to off-system and interruptible customers amounted to 54,920 MDTH. Brooklyn Union opened the first New York-based market hub for buyers and sellers of natural gas in the Northeast in fiscal 1994. With interconnections and access to several major pipelines, the New York Market Hub offers transportation, balancing and exchange services to utilities, municipalities, marketers and large-volume customers. In 1997, the Hub placed 33,800 MDTH of gas for delivery to customers in 17 states, Washington, DC and one Canadian province. The heating capacity of gas is measured in therms. One therm equals 100,000 BTUs, the heat content of approximately 100 cubic feet of natural gas. The heat content of approximately 1,000,000 cubic feet of gas represents 10,000 therms or 1 MDTH. Accordingly, one billion cubic feet (BCF) of gas equals approximately 1,000 MDTH. Competition General Within its utility service territory, Brooklyn Union competes with suppliers of oil, electricity and other fuels for cooking, heating, air conditioning and other purposes. Changes in regulatory policies and market forces have shifted the industry from traditional cost-based regulation involving gas sales, transportation, storage and other related services on a bundled basis by the interstate pipelines toward market-based sales on an unbundled basis. These policy changes have made the market more competitive with respect to gas supply and related services. Similar regulatory policy changes are affecting the distribution of gas and electric energy at state and local levels. The PSC set forth a policy framework and issued a series of orders in 1994 5 through 1996 pursuant to which, effective May 1, 1996, customers who choose to do so can arrange to purchase their gas directly from qualified marketers. Brooklyn Union continues to serve as the transporter of gas within its local distribution network, and the related rates provide full margin recovery of all costs of service, other than gas costs. Regardless of whether customers purchase gas from Brooklyn Union or other suppliers, customers pay Brooklyn Union for transporting the gas. Continuing the trend to enhance competition within the gas marketplace, the Staff of the PSC issued a Position Paper, on September 4, 1997, in which it concluded that the most effective way to establish a competitive gas marketplace is to separate the merchant and distribution functions. A five year transition period was suggested in the Position Paper, during which time the local distribution companies would provide the bulk of the merchant function. Further action is not expected until comments to the Position Paper are received and evaluated by the PSC. The Company believes that its holding company structure will provide it with the flexibility for further expansion and diversification in energy-related businesses through investments, acquisitions and strategic alliances. Moreover the pending combination with LILCO will create a new integrated energy company that can offer a broader range of energy services to a larger customer base. Additionally, economies and synergy savings resulting from this combination, will allow the newly created energy company to compete more effectively in an increasingly competitive energy market. (See Part II, Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations - 'Sales Volumes and Analysis of Utility Net Revenues', and 'Utility Rate and Regulatory Matters'".) Markets Brooklyn Union has continually expanded its existing markets and is developing new ones to increase gas sales. In the residential heating market, gas is sold in competition with No. 2 grade fuel oil. During the year, gas at the burner tip locally was competitive with alternate grades of fuel oil. Conversions from oil to gas heat continued during fiscal 1997. Approximately 79% of one- and two-family homes in Brooklyn Union's service area now use gas for space heating. Brooklyn Union's share of the multi-family market is approximately 47%. In this market, gas service under large-volume rates is continuously repriced to be competitive with alternate grades of fuel oil. In the commercial and industrial markets, special area development and business incentive gas rates are also offered by Brooklyn Union to businesses that move to or expand operations in designated areas in Brooklyn Union's territory. 6 Further, as a result of deregulation, a significant market for off-system gas sales, transportation and other services has developed. Competition is expected to intensify in this market as deregulation is more widely implemented in the Northeast. Regulation and Rate Matters General Utility retail sales, which include sales of gas, transportation and balancing services by Brooklyn Union, are made primarily under rate schedules and tariffs filed with and subject to the jurisdiction of the PSC. Amendments have been made to rate schedules and tariffs to reflect the conditions and rates under which delivery and other services are provided to customers who opt to have their gas supplied by third parties. Rate schedules also have been established governing the provision of certain services to such marketers. In general, the schedules provide for block rates that result in reductions in the unit price as use increases. They contain gas cost adjustment provisions that permit Brooklyn Union to pass on to firm customers increases and decreases in the cost of gas currently in billings to firm customers through the operation of a tariff provision, the Gas Adjustment Clause (GAC). Revenue requirements to establish utility rates are based on tariff gas and transportation sales to firm customers. Net revenues from off-system gas sales and tariff gas balancing services and capacity release credits are refunded to firm customers subject to sharing provisions in Brooklyn Union's tariff. Prior to October 1, 1996, net revenues from tariff sales for gas and transportation services to on-system customers made on an interruptible basis were refunded to firm customers subject to sharing provisions. The GAC provision requires an annual reconciliation of recoverable gas costs with GAC revenues. Any difference is deferred pending recovery from or refund to firm customers during a subsequent twelve month period. KeySpan Formation and Current Rate Plan In September 1996, the PSC approved a settlement agreement that authorized Brooklyn Union to pursue its holding company reorganization. That agreement also included a new multi-year rate plan for Brooklyn Union that became effective on October 1, 1996. After an initial rate reduction of approximately $3.5 million in fiscal 1997, the non-gas component in customer bills will be under specific price caps. Hence, subject to limited exceptions, the total amount for this component in rates that Brooklyn Union can charge customers, in the aggregate, will remain constant for the subsequent five years, although rates in certain customer classes may be increased in order to reflect cost responsibility more appropriately. 7 Other Rate Matters For further information regarding the status of other regulatory proceedings, including customer fixed price option and appliance service and, rate orders that became effective in October 1996, see Part II, Item 7., "Management's Discussion, and Analysis of Financial Condition and Results of Operations - 'Sales Volumes and Analysis of Utility Net Revenues', and 'Utility Rate and Regulatory Matters'". Also, for additional information on the effects of rate regulation, see Part II, Item 8,. "Financial Statements and Supplementary Data, Summary of Significant Accounting Policies and Basis for Financial Statement Presentation- 'Regulatory Assets'". Gas Supply General In 1997, 60% of gas supply was purchased from domestic sources under long-term contracts, 22% from Canadian sources under long-term contracts and 18% from spot market sources. Long-Term Sources of Supply Under long-term contracts and regulatory certificates applicable to gas supply and pipeline transportation and storage services, Brooklyn Union's suppliers are authorized and obligated to provide maximum firm daily total deliveries of 994 MDTH of gas for the 1997-98 winter. This supply consists of 380 MDTH per day of firm gas supply from U.S. sources, 100 MDTH per day of firm Canadian gas supply, 489 MDTH per day of storage and winter services related to U.S. sources, and 25 MDTH of on-system peaking supply. Major providers of interstate pipeline capacity and related services are: Transcontinental Gas Pipe Line Corporation, Texas Eastern Transmission Corporation, Iroquois Gas Transmission System, Tennessee Gas Pipeline Company, CNG Transmission Corporation and Texas Gas Transmission Company, which provide unbundled firm transportation and storage services. These pipelines provide delivery of U.S. and Canadian supplies purchased from natural gas sellers to the utility's market. Peak-day Supply Brooklyn Union plans for peak-day demand on the basis of an average temperature of 0oF. Gas demand on such a design peak-day is estimated at 1,122 MDTH during the 1997-98 winter. The highest 24-hour firm sendout experienced by Brooklyn Union was 1,028 MDTH on January 7, 1997, when the average temperature was 12oF. For the 1997-98 winter, Brooklyn Union has the capability to provide a maximum peak-day supply of 1,285 MDTH, consisting of firm 8 flowing supply, pipeline storage supply, seasonal winter supply, and vaporized LNG. The LNG plant has a storage capacity of 1,660 MDTH and peak-day sendout capacity of 291 MDTH, or 23% of peak-day supply. Effective November 1, 1996, a winter peaking service, the Brooklyn Navy Yard Peaking Supply, was added to the gas supply portfolio. It can provide a maximum daily capacity of 25 MDTH and a total available seasonal capacity of 480 MDTH. Gas Costs The average cost of gas purchased for firm customers was $4.19 per DTH in 1997, $3.49 per DTH in 1996 and $3.12 per DTH in 1995. The increase reflects generally higher commodity prices. Such prices within the last three years generally show an upward trend, largely related to more volatile seasonal weather conditions and underlying increases in demand in line with generally favorable economic conditions. Environmental Matters For information regarding environmental matters affecting the Company, see Part II, Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations - 'Environmental Matters'," and Part II, Item 8., "Financial Statements and Supplementary Data, - Note 8 to the Consolidated Financial Statements, 'Environmental Matters'". Research and Development In fiscal 1997, Brooklyn Union spent $8.9 million on research and development (R&D) programs. Of this amount, $2.3 million was spent to support programs of the Gas Research Institute. Brooklyn Union also provided $1.2 million to other research associations, including the New York State Energy Research and Development Authority (NYSERDA) and the New York Gas Group. The balance of $5.4 million was devoted primarily to internal R&D programs relating to efficient gas utilization and operations technologies. These programs covered cogeneration, power stations, refrigeration, and fuel cells, as well as natural gas refueling stations. In addition, Brooklyn Union continues to make significant efforts in developing innovative operation systems which reduce utility costs. b. Overview of Non-Utility Subsidiaries General KeySpan's principal non-utility subsidiaries are engaged in gas exploration and production operations and gas marketing and energy systems installation and management services. Other subsidiaries participate and own investments in projects involving gas pipeline and storage facilities. The scope of energy investments is being expanded to include greater participation in 9 international projects. The Company's total investment in these businesses, computed in accordance with PSC methodology as a percentage of consolidated capitalization, was 18.0%, 13.4% and 14.2% as of September 30, 1997, 1996 and 1995, respectively. For further information regarding the subsidiaries, see Part II, Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations", Part II, Item 8., "Financial Statements and Supplementary Data - Note 10 to the Consolidated Financial Statements, 'Supplemental Gas and Oil Disclosures'". Gas Exploration and Production Subsidiary The Houston Exploration Company (THEC) is an independent natural gas and oil company engaged in the exploration, development and acquisition of domestic natural gas and oil properties. THEC's properties are located in the Gulf of Mexico, Texas, the Arkoma Basin and Appalachia. In September 1996, THEC completed the initial public offering of 8,037,000 shares of its common stock at an offering price of $15.50 per share. The offering reduced the Company's ownership from 100% to approximately 66%. THEC is a registrant under the Securities Act of 1933 and Securities Exchange Act of 1934. Its commission file number is 001-11899 (See Part II, Item 7., "Managements Discussion and Analysis of Financial Condition and Results of Operations - 'Gas Exploration and Production'".) Total gas production was approximately 46.3 BCFe (one billion cubic feet of gas including oil equivalent volumes) during fiscal 1997 and net proved gas reserves at September 30, 1997 were approximately 321 BCFe. For information concerning the gas and oil exploration, development and producing activities of the Company's subsidiaries, see Part II, Item 8., "Financial Statements and Supplementary Data, - Note 10 to the Consolidated Financial Statements, 'Supplemental Gas and Oil Disclosures'". Marketing KeySpan Energy Services Inc. (KES), formed in April 1996, markets gas and arranges for transportation and related services largely to retail customers including those served by the Company's gas distribution subsidiary. KeySpan Energy Management Inc. (KEM), formed in October 1996, provides a variety of technical and maintenance services to customers that operate commercial and industrial facilities located primarily within the New York City metropolitan area. During the year, KEM acquired a well-established engineering firm and a major heating, ventilation and air conditioning contractor. Prior to 1997, gas marketing activities were based in Houston Texas and conducted on a wholesale level by a separate subsidiary operating under a joint venture with a subsidiary of a major independent oil and gas producer. In 1996, the Company's subsidiary sold its interest in the joint venture. 10 Equity Investments in Energy Services Pipeline Storage and Other A subsidiary, North East Transmission Co., Inc. (NETCO) owns a 19.4% interest in the Iroquois Gas Transmission System L.P. (Iroquois), a 374-mile pipeline that currently transports approximately 910 MDTH of Canadian gas supply daily to markets in the northeastern United States. Brooklyn Union currently receives up to 70 MDTH of gas per day through Iroquois. Through a subsidiary, the Company has equity investments in two gas storage facilities located in New York State. During fiscal 1997, the Company's Canadian subsidiary sold its residual interests in certain Canadian gas processing properties for an after-tax gain of $3.3 million. Also in fiscal 1997, KeySpan International Ltd. acquired 24.5% interests in Phoenix Natural Gas in Belfast, Northern Ireland and The Premier Transco Pipeline. Phoenix is refurbishing and expanding the distribution system that serves Belfast and surrounding areas. Premier, an 84-mile pipeline to Northern Ireland from southwest Scotland, is supplying Phoenix and a 1,080 megawatt power station in Ballylumford. Cogeneration Gas Energy Inc. (GEI) participates in the development, operation and ownership of cogeneration projects. A GEI subsidiary is a 50% partner in a 100-megawatt cogeneration facility at John F. Kennedy International Airport (JFK) in Queens, New York. This facility commenced operations in 1995. GEI owns an 11.3% interest in a 174-megawatt gas cogeneration plant located in Lockport, New York. An affiliate is a 50% partner in a 40-megawatt cogeneration facility that serves the State University of New York at Stony Brook, Long Island, which commenced operations in 1995, and is a 45% partner in a 50-megawatt gas cogeneration plant that has been producing heat and power at a Northrop Grumman facility located in Bethpage, Long Island, New York. The scope of cogeneration activities also includes providing fuel-management services. GEI subsidiaries provide such services to the JFK, Stony Brook and Northrop Grumman facilities and to another 50-megawatt facility. In 1997, these subsidiaries, as fuel managers, provided 14,000 MDTH of gas to these cogeneration projects. During fiscal 1997, a fuel management operation was sold for an after-tax gain of $4.5 million. In addition, subsidiaries are in the process of finalizing the sale of domestic cogeneration investments and remaining fuel management operations. The gain 11 will be recorded on closing, which is expected to take place in the first quarter of fiscal 1998. Employees The Company and its subsidiaries employed 2,813 full time employees at September 30, 1997, compared to 3,168 at September 30, 1996. Item 2. Properties General The Company is an occupant in a building leased by Brooklyn Union. Brooklyn Union leases its corporate headquarters at One MetroTech Center in downtown Brooklyn. The lease agreement has a remaining term of 14 years and renewal options. The Company and its subsidiaries own or lease certain other buildings and facilities for use in the conduct of their business. The Company's future minimum lease payments are approximately $15 million per year. Capital Expenditures In fiscal 1997, consolidated capital expenditures were $ 284.8 million, of which $100.9 million was primarily for utility property additions, $125.3 million was related to gas exploration and production development and $58.6 million was related to equity investments in energy services. Consolidated capital expenditures are estimated to be approximately $250 million for fiscal 1998. Gas Distribution Subsidiary Brooklyn Union holds franchises to lay gas mains in the streets, highways and public places in the Boroughs of Brooklyn and Staten Island, and the former Second and Fourth Wards of the Borough of Queens. Brooklyn Union has consents and permits which, with immaterial exceptions, give it the right to carry on its utility operations, substantially as now carried on, in the territory served. The franchises are unlimited in duration, except that a franchise to transmit and distribute gas in the former Fifth Ward of the Borough of Staten Island expires in 2006. Gas sales revenues in the former Fifth Ward are approximately 2.3% of the total gas sales revenues of Brooklyn Union. As of September 30, 1997, the utility distribution pipeline system consisted of approximately 1,979 miles of cast iron main, 1,680 miles of steel main and 331 miles of mains with plastic inserts, with requisite accessory regulating stations. The distribution system for the most part is located under public streets. 12 Brooklyn Union owns and operates an LNG plant, located at its Greenpoint Energy Center in Brooklyn, to liquefy and store gas during the summer months for vaporization and use during the winter months. This plant has a storage capacity of 1,660 MDTH of natural gas in liquid form and a vaporization capacity of 291 MDTH per day. Properties of Other Subsidiaries Principal consolidated properties of other subsidiaries and their affiliates include interests in gas and oil leasehold properties, producing wells and related equipment and structures. For information concerning the gas exploration, production and processing activities of the Company's subsidiaries, see Part II, Item 8., "Financial Statements and Supplementary Data, - Note 10 to the "Consolidated Financial Statements, 'Supplemental Gas and Oil Disclosures'". Item 3. Legal Proceedings For information regarding environmental matters affecting the Company, see Part II, Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations - 'Environmental Matters'" and Part II, Item 8., "Financial Statements and Supplementary Data, - Note 8 to the Consolidated Financial Statements, 'Environmental Matters'". Item 4. Submission of Matters to a Vote of Security Holders At a special shareholder meeting held on August 7, 1997, Brooklyn Union shareholders approved the reorganization of Brooklyn Union and its subsidiaries into a holding company structure under the name KeySpan Energy Corporation. Also during this meeting, shareholders approved the Agreement and Plan of Exchange and Merger pursuant to which KeySpan and LILCO would become wholly owned subsidiaries of a new holding company. (See Part I, Item 1., "Business".) Part II Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters The following is information regarding the Company's common stock. For additional information required by this item, see Part II, Item 6., "Selected Financial Data" and Part II, Item 8., "Financial Statements and Supplementary Data, - Note 4 to the Consolidated Financial Statements, 'Capitalization'". 13 Stock Listings The Company's common stock is traded on the New York Stock Exchange (NYSE) under the trading symbol KSE. The Houston Exploration Company's (THEC) common stock is traded on the NYSE under the trading symbol THX. Daily stock reports are carried by most major newspapers under the headings KeySpan and HoustEX, respectively. Dividends Quarterly dividends on the Company's common stock have been payable on the first of February, May, August and November. All dividends paid by the Company are taxable as ordinary income. The holding company settlement agreement approved by the PSC contains limitations on the level of dividend payments from Brooklyn Union to KeySpan based on the maintenance of certain credit quality ratings. If credit ratings should change significantly, KeySpan may be limited in its ability to pay dividends. 14 Item 6. Selected Financial Data
====================================================================================================== For Year Ended September 30, 1997 1996 1995 1994 1993 ====================================================================================================== (Thousands of Dollars Except Per Share Data) Income Summary Operating revenues Gas sales and transportation $1,313,928 $1,328,392 $1,130,615 $1,257,720 $1,128,475 Other retail services 49,755 23,791 21,716 21,918 16,840 Gas production and other 114,504 79,819 63,953 58,992 60,189 - ------------------------------------------------------------------------------------------------------ Total operating revenues 1,478,187 1,432,002 1,216,284 1,338,630 1,205,504 Operating expenses Cost of gas 594,185 610,053 446,559 560,657 466,573 Operation and maintenance 419,764 428,977 385,654 384,734 366,706 Depreciation and depletion 110,964 79,610 72,020 69,611 64,779 General taxes 153,475 143,296 134,718 150,743 144,827 Federal income tax 57,229 39,508 41,989 40,556 41,413 - ------------------------------------------------------------------------------------------------------ Operating income 142,570 130,558 135,344 132,329 121,206 Income from equity investments 14,395 13,523 9,458 5,689 1,150 Gain on sale of investments 13,755 16,160 - - 20,462 Gain on sale of subsidiary stock - 35,437 - - - Write-off of investment in propane company - - - - (17,617) Other, net 354 (1,188) 151 700 (465) Federal income tax expense (5,127) (19,861) (51) (142) (70) Minority interest in earnings of subsidiary (6,629) - - - - Interest charges (44,585) (51,721) (53,067) (51,192) (48,103) - ------------------------------------------------------------------------------------------------------ Net income 114,733 122,908 91,835 87,384 76,563 Dividends on preferred stock 292 323 337 351 364 - ------------------------------------------------------------------------------------------------------ Income available for common stock $114,441 $122,585 $91,498 $87,033 $76,199 ====================================================================================================== Financial Summary Common stock information Per share Earnings ($) 2.28 2.48 1.90 1.85 1.73 Cash dividends declared ($) 1.46 1.42 1.39 1.35 1.32 Book value, year-end ($) 19.09 18.17 16.94 16.27 15.55 Market value, year-end ($) 33 3/8 27 7/8 24 5/8 24 7/8 25 3/4 Average shares outstanding (000) 50,224 49,365 48,211 46,980 44,042 Shareholders 30,934 33,320 33,669 35,233 30,925 Daily average shares traded 90,900 64,500 49,100 42,100 33,100 Capital expenditures ($) 284,842 302,280 214,006 199,572 204,514 Total assets ($) 2,497,190 2,289,603 2,116,922 2,029,074 1,897,847 Common equity ($) 969,043 905,808 826,290 774,236 721,076 Preferred stock, redeemed ($) - 6,600 6,900 7,200 7,500 Long-term debt ($) 745,091 712,013 720,569 701,377 689,300 Total capitalization ($) 1,714,134 1,624,421 1,553,759 1,482,813 1,417,876 Earnings to fixed charges (times) 4.31 3.99 3.17 3.21 3.19 ====================================================================================================== Utility Operating Statistics Gas data (MDTH) Firm gas and transportation sales 136,370 142,075 123,356 133,513 128,972 Other sales 54,920 42,847 49,910 42,392 25,032 Maximum daily capacity, yr end 1,285 1,284 1,256 1,256 1,258 Maximum daily sendout 1,028 994 963 1,022 915 Total active meters (000) 1,128 1,126 1,125 1,122 1,119 Heating customers (000) 467 461 454 446 441 Degree days 4,715 5,170 4,240 4,974 4,802 Colder (Warmer) than normal (%) (1.2) 7.7 (11.2) 3.1 - ======================================================================================================
15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Earnings Summary In fiscal 1997, consolidated income available for common stock was $114.4 million, or $2.28 per share, compared to $122.6 million, or $2.48 per share, in 1996, and $91.5 million, or $1.90 per share, in 1995. Earnings in all years reflect performance in major areas of operations and investments. The consolidated rate of return on average common equity was 12.2% in 1997, 13.6% in 1996, and 10.9% in 1995. Consolidated income available for common stock, together with the effect of gains and other non-recurring items, is set forth in the following summary:
-------------------------------------------------------------------------- 1997 1996 1995 -------------------------------------------------------------------------- (Thousands of Dollars) Income Available for Common Stock Utility $ 90,540 $ 82,090 $ 78,677 -------------------------------------------------------------------------- Gas Exploration and Production Operations (before reorganization charge) 13,101 7,627 7,843 Reorganization charge - (7,800) - Gain on sale of subsidiary stock - 23,034 - Gain on sale of Canadian plant - 10,505 - ------------------------------------------------------------------------- 13,101 33,366 7,843 ------------------------------------------------------------------------- Marketing Activities (3,700) 1,396 1,329 Equity Investments in Energy Services Pipeline, storage and other 8,100 5,319 979 Cogeneration 6,400 414 2,670 -------------------------------------------------------------------------- 10,800 7,129 4,978 -------------------------------------------------------------------------- Consolidated $114,441 $122,585 $ 91,498 --------------------------------------------------------------------------
Utility In 1997, earnings from utility operations provided an equity return of 13.51%. In the last three years, income available for common stock from utility operations has benefited from additions of new firm gas heating customers, principally as a result of customer conversions from oil to gas for space heating in large 16 apartment buildings; expanded gas sales, transportation and other services both within the local distribution network and through our New York Market Hub; development of ancillary revenue streams from expansion of services to customers; and attainment of cost efficiencies through early retirement programs and reengineering of operations. The effect on utility revenues of variations in weather largely was offset by the weather normalization adjustment included in the utility's tariff. Gas Exploration and Production In 1997, earnings from gas exploration and production reflect the large-scale expansion of operations, primarily in Texas and the Gulf of Mexico, by The Houston Exploration Company (THEC). The expansion of these operations was the result of initiatives taken by the Company last year related to the initial public offering of common stock by THEC. Thus, consolidated earnings in 1997 reflect a 66% interest in THEC compared to a 100% interest in 1996 and 1995. In addition, THEC operates in the Arkoma Basin and Appalachia. In 1996, earnings from gas exploration and production operations included a reorganization charge of $7.8 million, net of federal income taxes, recorded by THEC. Excluding this charge, operating results were comparable in 1996 and 1995. Further, earnings in 1996 also included an after-tax gain of $23.0 million on the issuance by THEC of 8,037,000 shares of its common stock in September 1996 in its initial public offering. Moreover, earnings included an after-tax gain of $10.5 million realized on the sale of a Canadian gas processing plant during the year. Marketing Activities The Company has realigned its non-utility gas marketing operations by forming two new subsidiaries, KeySpan Energy Services Inc. (KES) and KeySpan Energy Management Inc. (KEM). These subsidiaries, which are establishing a market presence primarily in the Northeast, incurred losses related to the startup and development of their operations. KES markets gas and arranges for transportation and related services largely to retail customers including those served by the Company's gas distribution subsidiary. On the other hand, KEM provides a variety of technical and maintenance services to customers that operate commercial and industrial facilities located primarily within the New York City metropolitan area. During the year, KEM acquired a well-established engineering firm and a major heating, ventilation and air conditioning contractor and has integrated these businesses into its strategies for future growth. Looking toward the future, marketing operations will be expanded to include sales of electricity. 17 Prior to 1997, gas marketing activities were conducted on a wholesale level by a separate subsidiary operating under a joint venture with a subsidiary of a major independent oil and gas producer. In 1996, the Company's subsidiary sold its interest in the joint venture. Equity Investments in Energy Services Earnings from equity investments in energy services are attributable to a number of factors related to consolidation and expansion of various interests as the Company further positions itself to take maximum advantage of opportunities arising in energy markets. Earnings in 1997 include after-tax gains on the sale of assets of $7.8 million. Pipeline, Storage and Other Increased income in all years from pipeline and storage investments reflects higher throughput on the Iroquois Pipeline. A Company subsidiary increased its equity interest in the Iroquois Gas Transmission System, L.P. from 11.4% to 19.4% in 1996. In 1995, earnings related to Iroquois were reduced by a provision for the Company's proportionate share of estimated costs of legal matters involving Iroquois. In 1997, earnings from pipeline, storage and other investments include an after-tax gain of $3.3 million related to the sale of residual interests in certain Canadian properties. This gain was offset substantially by higher expenses and amortizations related to new equity investments, such as the refurbishment and expansion of a gas distribution system in Northern Ireland and a transmission pipeline to Northern Ireland from Scotland. Cogeneration The increase in earnings in 1997 is primarily attributable to an after-tax gain of $4.5 million from the sale of a fuel management operation. Subsidiaries of the Company are in the process of finalizing the sale of their domestic cogeneration investments and remaining fuel management operations. The gain will be recorded on closing, which is expected to take place in the first quarter of fiscal 1998. Higher fuel prices caused earnings from cogeneration investments to decrease in 1996. Sales Volumes and Analysis of Utility Net Revenues Firm gas and transportation sales volumes from utility operations in fiscal 1997 were 136,370 MDTH compared to 142,075 MDTH in 1996 and 123,356 MDTH in 1995. Measured by annual degree days, weather was 1.2% warmer than normal in 1997, 7.7% colder than normal in 1996 and 11.2% warmer than normal in 1995. Sales growth in all markets resulted primarily from conversions to natural gas from oil for space heating, especially by large apartment 18 buildings. In 1997, the growth in firm sales normalized for weather was 1%, somewhat lower than that experienced in recent years.
- ----------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------- (Thousands of Dollars) Composition of Utility Gas Revenues: Gas and Transportation Sales $1,313,928 $1,328,392 $1,130,615 Cost of Gas (594,185) (610,053) (446,559) - ----------------------------------------------------------------- Net Gas Revenues $ 719,743 $ 718,339 $ 684,056 - -----------------------------------------------------------------
In 1997, slightly lower gas revenues reflected lower customer usage due to warmer weather, whereas the opposite occurred in 1996 as higher sales primarily reflected colder weather. During the year, gas at the burner tip was competitive locally with alternative grades of fuel oil. Residential heating sales in markets where the competing fuel is No. 2 grade fuel oil and sales to other small-volume customers were approximately 75% of firm sales volume in 1997. Demand in these markets is less sensitive to periodic differences between gas and oil prices. In large-volume heating markets, gas service is provided under rates that are set to compete with prices of alternative fuel, including No. 6 grade heating oil. There is substantial sales potential in these markets, which include large apartment houses, government buildings and schools. Competition with other gas suppliers is expected to continue to increase as a result of deregulation. For additional information regarding regulatory directives affecting utility sales and deregulation, see Part II, Item 7., "Management's Discussion and Analysis of Financial Condition and Results of Operations - 'Utility Rate and Regulatory Matters'". Moreover, a significant market for off-system gas sales, transportation and other services has developed as a result of deregulation. Such services to off-system customers reflect optimal use of available pipeline capacity, which is affected by weather, and our New York Market Hub in balancing on-system requirements to core customers with off-system services to increase total margins. In warmer-than-normal winters, such as 1997, service to off-system customers is higher whereas on-system sales, which generally have higher unit margins, are comparatively lower. 19 As a result, in 1997, gas and transportation sales and service to off-system and interruptible customers amounted to 54,920 MDTH compared with 42,847 MDTH in 1996. Gas Production Revenues The increase in revenues from gas production in 1997 was due primarily to the development of additional natural gas properties acquired by THEC in 1996. In 1997, gas production, including oil equivalents, was approximately 46.3 billion cubic feet (BCFe), or 19.0 BCFe above the level of production last year. In 1997, wellhead prices averaged approximately $2.40 per MCF compared with $2.11 per MCF in 1996 and $1.47 per MCF in 1995. The effective price realized (average wellhead price received for production including recognized hedging gains and losses) was $2.16 per MCF in 1997 compared with $1.82 per MCF in 1996 and $1.77 per MCF in 1995. The effective price increased 34 cents in 1997 compared to the effective price in 1996 and increased 5 cents in 1996 compared to 1995. The effective price in 1997 included a hedging loss of $10.9 million, in 1996 a hedging loss of $7.7 million and in 1995 a hedging gain of $6.6 million. (See Risk Management and Hedging below and, Part II, Item 8., "Financial Statements and Supplementary Data, - Note 10 to the Consolidated Financial Statements, 'Supplemental Gas and Oil Disclosures'", for additional information.) Risk Management and Hedging - Gas Cost and Pricing The Company's utility and gas exploration and production subsidiaries employ derivative financial instruments, such as natural gas and oil futures, options and swaps, for the purpose of managing exposure to commodity price risk. In connection with utility operations, oil and gas futures are used to fix margins on sales to large-volume customers to which gas is sold at a price indexed to the prevailing price of oil, their alternate fuel. Derivative financial instruments, primarily options to establish collars, are used in gas exploration and production operations to manage the risk associated with fluctuations in the price received for natural gas production in order to achieve a more predictable cash flow. Hedging strategies of each company are independently managed. (See Part II, Item 8., "Financial Statements and Supplementary Data, - Note 7B to the Consolidated Financial Statements, 'Derivative Financial Instruments'", for additional information.) The cost of gas for utility customers, $594.2 million in 1997, was $15.9 million, or 2.6% lower than in 1996. The lower cost of gas reflects lower firm sales due to warmer weather offset by higher average gas costs. The cost of gas in 1995 was $446.6 million reflecting lower volumes sold and lower average prices, both of which were primarily the result of very warm weather in that year. The cost of gas for firm customers was $4.19 per DTH 20 (one DTH equals 10 therms) in 1997, compared with $3.49 per DTH in 1996 and $3.12 per DTH in 1995. In fiscal 1997, the utility's cost of gas included a hedging loss of $6.0 million related to its margin fixing strategy compared to a hedging loss of $1.7 million in 1996. Expenses, Other Income and Preferred Dividends Operation and maintenance expense in all years reflects ongoing utility cost reduction efforts. In June 1997, the Company's utility subsidiary completed an early retirement program in which 274 employees participated and a related expense of $22 million was charged to operations. As a result of this program and work process reengineering initiatives, the number of full time Company employees was reduced by more than 10% during the year. Further, utility operation and maintenance expense was lower in 1997 due to warmer weather. Also in 1997, consolidated operation and maintenance expense reflects the effect of the substantial expansion of gas exploration and production operations by THEC. The increase in operation and maintenance expense in 1996 reflects the effect of colder weather on utility operations and the reorganization charge incurred by THEC. The resulting reorganization expense of $12.0 million reflects remuneration paid as part of a reorganization of exploration and production operations. Moreover, consolidated operation expense in 1996 and 1995 included costs related to Canadian gas processing operations, which ceased in July 1996 when the plant was sold. The increases in depreciation and depletion expense in 1997 and 1996 were primarily due to the large increase in gas production during the years. Gas production in 1997 was 46.3 BCFe compared to 27.3 BCFe in 1996 and 22.7 BCFe in 1995. Moreover, depreciation expense reflects utility property additions in all years. General taxes principally include state and city taxes on utility revenues and property. The applicable property base and tax rates generally have increased. Taxes based on revenues reflect the variations in utility revenues each year. Federal income tax expense in all years reflects changes in pre-tax income. In 1997, it also reflects the non-deductibility of certain organization expenses. The increase in earnings from equity investments in 1997 and 1996 is primarily due to the increase in earnings from Iroquois. The gain on sale of investments in 1997 includes gains, before income taxes, of $8.5 million and $5.3 million related to sales of a fuel management operation and a residual interest in a Canadian energy investment, respectively. In 1996, the gain of $16.2 million, before income taxes, was related to the sale of a subsidiary's interest in a Canadian gas processing plant. 21 Interest charges on long-term debt in each of the last three fiscal years generally reflect higher average subsidiary borrowings and lower interest rates on utility gas facilities revenue bonds because of variable rate features and refinancing of debt. In fiscal 1996, interest charges reflected lower utility interest costs also due to debt refinancing. Other interest expense in all years primarily reflects accruals of carrying charges related to regulatory settlement items and, in 1997, includes expense related to commercial paper borrowings for general corporate purposes. There were no commercial paper borrowings in prior years. On September 10, 1997, Brooklyn Union redeemed all outstanding shares of its 4.60% Cumulative Preferred Stock, Series B, $100 par value at the redemption price of $102.00 per share, plus $0.1278 per share representing accrued and unpaid dividends. Prior to the redemption, dividends reflect reductions in the number of shares outstanding due to sinking fund requirements. Capital Expenditures Consolidated capital expenditures were $284.8 million in 1997, $302.3 million in 1996 and $214.0 million in 1995. Capital expenditures related to utility operations were $100.9 million in 1997, $110.8 million in 1996 and $108.7 million in 1995. Utility expenditures in all years principally were for the renewal and replacement of mains and services. Capital expenditures related to gas exploration and production activities were $125.3 million in 1997, $169.0 million in 1996 and $83.0 million in 1995. Expenditures in 1997 reflect, in part, costs related to development of property additions acquired in 1996. Expenditures in 1996 reflect major acquisitions of gas and oil reserves in South Texas and the Gulf of Mexico, as well as on-going exploration and development activities. Net proved gas reserves at September 30, 1997 were approximately 321 BCFe. These reserves are located primarily off-shore in the Gulf of Mexico, and on-shore in Texas and the Arkoma Basin. Capital expenditures related to equity investments in energy services were $58.6 million in 1997, $22.5 million in 1996 and $22.3 million in 1995. Expenditures in 1997 included $49.1 million of equity investments for interests of 24.5% in a gas distribution system in and a transmission pipeline to Northern Ireland. The gas distribution system is being refurbished and expanded. The balance is related to certain other acquisitions. Expenditures in 1996, primarily were for acquisition of an additional interest in Iroquois. Also, in 1996, the cogeneration plant at John F. Kennedy International Airport was refinanced and cash flows from investing activities included a return of capital from the proceeds. In 1995, expenditures were primarily related to construction of cogeneration projects. 22 Moreover, in July 1997, the Company invested $30 million representing its 50% share as a limited partner in a limited partnership with LILCO in which the Long Island Power Authority (LIPA) is the general partner. The purpose of the partnership is to finance an investment in interest rate swap options in order to hedge exposure of LIPA to risks related to higher interest rates on its debt to be issued in connection with its transaction with LILCO. This has been recorded as deferred charges in the Consolidated Balance Sheet and is reflected as partnership investment in the investing activities section in the Consolidated Statement of Cash Flows. The partnership will recover its investment plus carrying charges when the LIPA transaction is consummated. (See Part II, Item 8., "Financial Statements and Supplementary Data, - Note 9 to the Consolidated Financial Statements, 'Combination with Long Island Lighting Company (LILCO Transaction)'", for additional information.) Consolidated capital expenditures for fiscal 1998 are estimated to be approximately $250 million, including $110 million related to utility activities and $125 million for oil and gas exploration and development. The level of such expenditures is reviewed on an ongoing basis and can be affected by timing, scope and changes in investment opportunities. Financing Cash provided by operating activities continues to be strong and is a substantial source for financing ongoing capital expenditures. The increase in cash flow from operating activities of $25.7 million in 1997 as compared to 1996 is largely attributable to higher utility net revenues and operating margins, as well as the significant increase in gas production of THEC. Proceeds from common stock issued through employee and shareholder stock purchase plans have provided additional equity of approximately $22.6 million in 1997, $27.4 million in 1996 and $28.0 million in 1995. In September 1996, THEC issued 8,037,000 shares of its common stock in an initial public offering, providing net proceeds of $101.0 million, which were used to pay down debt and to complete the financing of gas reserve acquisitions and property additions. In January 1997, Brooklyn Union refunded $125.0 million of Gas Facilities Revenue Bonds, including a $62.5 million series of 7% bonds and a $62.5 million series of 7 1/8% bonds. Both series were called for redemption at optional redemption prices equal to 102% of the face amount per bond plus accrued interest. The $125.0 million refunding series, which matures in December 2020, was issued with a variable coupon rate that is reset weekly. The interest rate on these bonds ranged from 2.89% to 4.10% through September 30, 1997 at which time the rate was 3.98%. In 1996, 23 $153.5 million of Gas Facilities Revenue Bonds was refinanced at rates of 5.5% per year. During the year, THEC increased its borrowings by approximately $33 million to finance a portion of its capital expenditures. THEC is planning on issuing $150 million of bonds through a private placement depending on market conditions and interest rates. The proceeds from such issuance would be used, in part, to pay down obligations for borrowings under its revolving loan agreement. The bonds if issued, would be subordinate to borrowings under the line of credit. On September 10, 1997, Brooklyn Union redeemed all 66,000 outstanding shares of its 4.60% Cumulative Preferred Stock Series B at the optional redemption price of $102.00 per share plus $0.1278 per share representing accrued and unpaid dividends. At September 30, 1997, the consolidated annualized cost of long-term debt was 5.8%, compared to 6.3% in 1996 and 7.1% in 1995. Dividends In December 1996, the Board of Directors authorized an increase in the annual dividend on common stock to $1.46 per share from $1.42 per share. This increase became effective on February 1, 1997, when the quarterly dividend was raised to 36 1/2 cents per share from 35 1/2 cents per share. Common dividends have been increased in 21 consecutive years and paid continuously for 49 years. The Amended and Restated Agreement and Plan of Exchange and Merger with Long Island Lighting Company (Amended LILCO Agreement) contains certain covenants of the parties pending the consummation of the LILCO Transaction. Generally, the parties must carry on their businesses in the ordinary course consistent with past practice. Moreover, pursuant to the PSC Order related to Brooklyn Union's reorganization under the holding company structure, Brooklyn Union's ability to pay dividends to the Company is limited to varying degrees upon maintenance of certain credit quality ratings. The principal source of funding for the Company is dividend payments from Brooklyn Union. The Company and LILCO expect to continue their respective current dividend policies until completion of the LILCO Transaction. It is anticipated that the new holding company, will set an initial annual dividend rate of $1.78 per share of its common stock, subject to similar conditions presently applicable to the Company. (See Part II, Item 8., "Financial Statements and Supplementary Data, - Note 9 to the Consolidated Financial Statements, 'Combination with Long Island Lighting Company (LILCO Transaction)'", for additional information.) 24 Financial Flexibility and Liquidity At September 30, 1997, the Company had cash and temporary cash investments of $36.9 million and available bank lines of credit of $100 million, which lines secure the issuance of commercial paper. The lines of credit, which are available to the Company and its principal subsidiary, Brooklyn Union, were increased to $150 million in October 1997. At September 30, 1997, there were $64.2 million in short-term borrowings outstanding at an annualized rate of 5.60%. The borrowings have been used for general corporate purposes. In addition, subsidiaries have lines of credit totaling $160 million, which for the most part support borrowings under revolving loan agreements. (See Part II, Item 8., "Financial Statements and Supplementary Data, - Note 4B to the Consolidated Financial Statements, 'Debt of Subsidiaries' and Note 5 'Short-Term Debt'", for additional information.) At September 30, 1997, the common equity component of the Company's capitalization was 56.5% compared to 55.8% in 1996. Fixed charge coverage ratios were 4.31 times in 1997, 3.99 times in 1996 and 3.17 times in 1995. Utility Rate and Regulatory Matters Proposed LILCO Transaction In 1997, the Company and LILCO filed a joint petition with the New York State Public Service Commission (PSC) seeking PSC approval, under section 70 of the New York Public Service Law, of the LILCO Agreement by which the Company and LILCO each would become subsidiaries of a newly-formed holding company. In addition, the petition calls for $1.0 billion of estimated efficiency savings, excluding gas cost, attributable to operating synergies that are expected to be realized over the 10 year period following the combination, be allocated to ratepayers net of transaction costs for the combination, presently estimated to be approximately $260 million. In the petition, the companies also requested the PSC to otherwise confirm Brooklyn Union's rate plan that became effective in October 1996 pursuant to the holding company settlement agreement, and LILCO requested the PSC to adopt the long term electric rate plan proposed by LILCO in September 1996 in a pending LILCO rate proceeding, and to adopt a long term gas rate plan proposed in the petition. (See Part II, Item 8., "Financial Statements and Supplementary Data, - Note 9 to the Consolidated Financial Statements, 'Combination with Long Island Lighting Company (LILCO Transaction)'",for additional information.) It is currently anticipated that the PSC will act on the joint petition in early calendar year 1998. 25 Rate Settlement Matters In September 1996, the PSC granted Brooklyn Union's petition to restructure into a holding company. The PSC's holding company order approved a settlement agreement among Brooklyn Union, the Staff of the Department of Public Service and several intervenor parties. This agreement contains restrictions and limitations on certain investments by KeySpan, limitations on the level of dividend payments from Brooklyn Union to KeySpan under certain circumstances, prohibitions on certain intercompany loans, guarantees and pledges, and restrictions on transactions among the affiliated holding company group. The settlement agreement reached in connection with the holding company proceeding included a new multi-year rate plan for Brooklyn Union that became effective on October 1, 1996. After an initial rate reduction of approximately $3.5 million in fiscal 1997, the non-gas component in customer bills will be under specific price caps. The total amount of this component in rates that Brooklyn Union can charge customers, in the aggregate, will remain constant for the subsequent five years with certain limited exceptions. In September 1995 and October 1994, the PSC approved Brooklyn Union's filings that provided for no rate increase; however, deferred credits of $7.5 million and $1.3 million were amortized to income in each year, respectively. Appliance Service On April 4, 1997, the PSC issued its "Order Concerning Gas Appliance and Repair Service" by which it determined that non-safety related appliance repair service, other than minor adjustments, should not be performed by regulated gas utilities. In compliance with the order, Brooklyn Union filed tariff revisions with the PSC, which became effective on October 1, 1997, and also filed an application seeking PSC approval to transfer certain assets related to the conduct of the non-safety related appliance repair business to a subsidiary that would conduct and carry on that business after the PSC's approval is secured. PSC approval is pending at this time. Customer Fixed Price Option On June 5, 1997, the PSC issued an order entitled "Order Requiring the Filing of Proposals to Ameliorate Gas Price Volatility and Requesting Comments" (Order). The Order requires each New York State local distribution company to submit proposals for a fixed price option to be available for use by customers effective with the 1997-98 heating season. 26 As a result of this Order, Brooklyn Union will make available to gas sales customers, except residential non-heating customers, seasonal off-peak and large volume customers, a fixed price option, during the period December 1997 through April 1998. Any incremental costs that may be incurred as a result of the program will be recovered from customers in the following year. Industry Restructuring Proceedings The PSC has set forth a policy framework to guide the transition of New York State's gas distribution industry in the deregulated gas industry environment. In March 1996, the PSC issued an order on utility compliance tariff filings, related to this framework. Pursuant to this order, beginning on May 1, 1996, customers in the small-volume market were given the option to purchase their gas supplies from sources other than Brooklyn Union, the gas transporter. Large-volume customers had this option for a number of years. In addition to transporting gas that customers purchase from marketers, utilities will provide billing, meter reading and other services for aggregate rates that match the distribution charge reflected in otherwise applicable sales rates to supply these customers. The PSC order placed a voluntary limit on the amount of gas a utility would be obligated to transport in its core market under aggregation programs to 5% of total core sales in each of the next three years, with no more than 25% of any one service class permitted to convert to transportation service. On September 4, 1997, the Staff of the PSC issued a Staff Position Paper entitled "The Future of the Natural Gas Industry" (Position Paper). The purpose of the study was to identify and propose resolutions to existing and emerging issues in a manner consistent with evolving industry trends and competitive forces. The fundamental conclusion reached by Staff is that the most effective way to establish a competitive gas market is to separate the merchant and distribution functions. The retail gas merchant function would be, in Staff's view, provided by non-regulated entities and LDC's would no longer provide retail sales services. Staff believes that a five year period would be needed for LDC's to transition out of the merchant function. During the transition period LDC's would continue to provide the bulk of the merchant function. Brooklyn Union is not philosophically opposed to the recommendations made in the Position Paper and has forwarded recommendations to the PSC. PSC action is not expected until all comments are evaluated. 27 Environmental Matters The Company is subject to various Federal, state and local laws and regulatory programs related to the environment. These environmental laws govern both the normal, ongoing operations of the Company's subsidiaries, and the cleanup of historically contaminated properties used in utility operations of the past. Ongoing environmental compliance activities, which historically have not been material, are integrated with operations and maintenance activities. As of September 30, 1997, the Company had an accrued liability of $26.8 million representing costs associated with investigation and remediation at certain former manufactured gas plant sites. (See Part II, Item 8., "Financial Statements and Supplementary Data, - Note 8 to the Consolidated Financial Statements, 'Environmental Matters'", for additional information.) Computer Software, Year 2000 Issue The Company has evaluated the extent to which modifications to its computer software and database will be necessary to accommodate the year 2000. The Company's computer systems are generally based on two digits and will require some additional programming to recognize the start of the new millennium. In 1996, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus, EITF Issue No. 96-14, that internal and external costs specifically associated with modifying internal-use computer software for the year 2000 should be charged to expense as incurred. The Company estimates the cost of future modifications, which are expected to be made over the next two years, to be approximately $2.5 million. Forward-Looking Statements This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended. As such, final results could differ from estimates or expectations due to factors such as, information currently available is preliminary and incomplete, government regulation and policies may change from that anticipated in present business decisions and market prices for energy commodities, securities and other financial instruments may change to a degree that existing plans may have to be substantially revised. For any of these factors, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. New Financial Accounting Standards During Fiscal 1997, the Financial Accounting Standards Board issued the following accounting standards: Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128); Statement of Financial Accounting Standards No. 130, "Reporting 28 Comprehensive Income" (SFAS No. 130); and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS No. 131). The Company will adopt SFAS No. 128 in the fiscal year beginning October 1, 1997 and SFAS No. 130 and SFAS No. 131 in the fiscal year beginning October 1, 1998. The Company does not expect any material effect from adoption of these statements. 29 Item 8. Financial Statements and Supplementary Data Financial Statement Responsibility The Consolidated Financial Statements of the Company and its subsidiaries were prepared by management in conformity with generally accepted accounting principles. The Company's system of internal controls is designed to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with management's authorizations and recorded to permit preparation of financial statements that present fairly the financial position and operating results of the Company. The Company's internal auditors evaluate and test the system of internal controls. The Company's Vice President and General Auditor reports directly to the Audit Committee of the Board of Directors, which is composed solely of outside directors. The Audit Committee meets periodically with management, the Vice President and General Auditor and Arthur Andersen LLP to review and discuss internal accounting controls, audit results, accounting principles and practices and financial reporting matters. 30 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To KeySpan Energy Corporation: We have audited the accompanying Consolidated Balance Sheet and Consolidated Statement of Capitalization of KeySpan Energy Corporation (a New York corporation) and subsidiaries as of September 30, 1997 and 1996, and the related Consolidated Statements of Income, Retained Earnings and Cash Flows for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position and capitalization of KeySpan Energy Corporation and subsidiaries as of September 30, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1997, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in Item 14 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP October 22, 1997 New York, New York 31 Summary of Significant Accounting Policies and Basis for Financial Statement Presentation Reorganization On August 7, 1997, Brooklyn Union shareholders approved the reorganization of Brooklyn Union and its subsidiaries into a holding company structure under the name KeySpan Energy Corporation. The reorganization was accomplished by a share exchange through which each share of Brooklyn Union common stock was converted into one share of KeySpan common stock. Brooklyn Union will continue to operate its present utility business as a wholly-owned subsidiary of KeySpan. The reorganization was effective on September 29, 1997 and the Consolidated Financial Statements reflect the establishment of KeySpan. Principles of Consolidation The Consolidated Financial Statements reflect the accounts of the Company and its subsidiaries. All significant intercompany transactions are eliminated. All other adjustments are of a normal, recurring nature and certain reclassifications have been made to amounts in prior periods to conform them with the current period presentation. Further, the preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Utility Gas Property - Depreciation and Maintenance Utility gas property is stated at original cost of construction, which includes allocations of overheads and taxes and an allowance for funds used during construction. Depreciation is provided on a straight-line basis in amounts equivalent to composite rates on average depreciable property of 3.7% in 1997, and 3.4% in 1996 and 1995. The cost of property retired, plus the cost of removal less salvage, is charged to accumulated depreciation. The cost of repair and minor replacement and renewal of property is charged to maintenance expense. 32 Gas Exploration and Production Property - Depletion and Depreciation The full cost method of accounting is used in investments in natural gas and oil properties. Under this method, all costs of acquisition, exploration and development of natural gas and oil reserves are capitalized into a "full cost pool" as incurred, and properties in the pool are depleted and charged to operations using the unit-of-production method based on the ratio of current production to total proved natural gas and oil reserves. To the extent that such capitalized costs (net of accumulated depreciation, depletion and amortization) less deferred taxes exceed the present value (using a 10% discount rate) of estimated future net cash flows from proved natural gas and oil reserves and the lower of cost or fair value of unproved properties, such excess costs are charged to operations. If a writedown of excess costs is required, it would result in a charge to earnings but would not have an impact on cash flows from operating activities. Provisions for depreciation of all other non-utility property are computed on a straight-line basis over useful lives of three to fifteen years. Equity Investments in Energy Services Certain subsidiaries own as their principal assets investments representing ownership interests of 50% or less in energy-related businesses that are accounted for under the equity method. Certain cogeneration investments are expected to be sold in early fiscal 1998. Revenues Utility customers generally are billed bi-monthly on a cycle basis. Revenues include unbilled amounts related to the estimated gas usage that occurred from the last meter reading to the end of each month. Gas costs are recovered as incurred when billed to firm customers through the operation of a tariff provision, the Gas Adjustment Clause (GAC). Net revenues from off-system gas sales and tariff gas balancing services and capacity release credits are refunded to firm customers subject to certain sharing provisions in Brooklyn Union's tariff. The GAC provision requires an annual reconciliation of recoverable gas costs and GAC revenues. Any difference is deferred pending recovery from or refund to firm customers during a subsequent twelve-month period. 33 Derivative Financial Instruments The Company's utility and oil and gas exploration and production subsidiaries use derivative financial instruments primarily to hedge exposures in cash flows due to fluctuations in the price of natural gas. Utility hedging activities also involve use of derivatives related to fuel oil, which in certain markets may strongly influence the selling price for natural gas. Gains and losses on these instruments are recognized concurrently with the recognition of the related physical transactions. The subsidiaries regularly assess the relationship between natural gas commodity prices in "cash" and futures markets. The correlation between prices in these markets has been well within a range generally deemed to be acceptable. If the correlation were not to remain in an acceptable range, the subsidiaries would account for financial instrument positions as trading activities. Federal Income Tax Prior to adoption of SFAS-109, "Accounting for Income Taxes", pursuant to PSC policy, deferred taxes were not provided for certain construction costs incurred before fiscal 1988 and for bases differences related to differences between tax and book depreciation methods. In accordance with SFAS-109, Brooklyn Union recorded a regulatory asset for the net cumulative effect of having to provide deferred Federal income tax expense on all differences between the tax and book bases of assets and liabilities at the current tax rate. Investment tax credits, which were available prior to the Tax Reform Act of 1986, were deferred in operating expense and are amortized as a reduction of Federal income tax in other income over the estimated life of the related property. Regulatory Assets Brooklyn Union is subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation". Regulatory assets arise from the allocation of costs and revenues to accounting periods for utility ratemaking purposes differently from bases generally applied by nonregulated companies. Regulatory assets are recognized in accordance with SFAS-71. With the exception of net tax regulatory assets, all other assets and liabilities created by the ratemaking process are immaterial. At September 30, 1997, there was a net tax regulatory asset of $70,457,000 compared to $74,885,000 at September 30, 1996. 34 In the event that it were no longer subject to the provisions of SFAS-71, the Company estimates that the write-off of this net tax regulatory asset could result in a charge to net income of approximately $45,797,000, which would be classified as an extraordinary item. Subsidiary Common Stock Issuances to Third Parties The Company follows an accounting policy of income statement recognition for parent company gains or losses from issuances of common stock by subsidiaries. Research and Development Costs All research and development costs are expensed as incurred. For the years ended September 30, 1997, 1996 and 1995, these costs were $8.9 million, $12.8 million and $11.9 million, respectively. 35 KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME
=========================================================================== For the Year Ended September 30, 1997 1996 1995 =========================================================================== (Thousands of Dollars) Operating Revenues Gas sales and transportation $1,313,928 $1,328,392 $1,130,615 Other retail services 49,755 23,791 21,716 Gas production and other 114,504 79,819 63,953 - --------------------------------------------------------------------------- 1,478,187 1,432,002 1,216,284 - --------------------------------------------------------------------------- Operating Expenses Cost of gas 594,185 610,053 446,559 Operation and maintenance 419,764 428,977 385,654 Depreciation and depletion 110,964 79,610 72,020 General taxes 153,475 143,296 134,718 Federal income tax (See Note 1) 57,229 39,508 41,989 - --------------------------------------------------------------------------- Operating Income 142,570 130,558 135,344 Other Income (Expense) Income from equity investments 14,395 13,523 9,458 Gain on sale of investments 13,755 16,160 - Gain on sale of subsidiary stock - 35,437 - Other, net 354 (1,188) 151 Federal income tax (See Note 1) (5,127) (19,861) (51) Minority interest in earnings of subsidiary (6,629) - - - --------------------------------------------------------------------------- Income Before Interest Charges 159,318 174,629 144,902 Interest Charges Long-term debt 38,514 46,803 47,939 Other 6,071 4,918 5,128 - --------------------------------------------------------------------------- Net Income 114,733 122,908 91,835 Dividends on Preferred Stock 292 323 337 - --------------------------------------------------------------------------- Income Available for Common Stock $114,441 $122,585 $91,498 - --------------------------------------------------------------------------- Earnings Per Share of Common Stock (Average shares outstanding of 50,223,792, 49,365,435 and 48,211,220, respectively) $2.28 $2.48 $1.90 ===========================================================================
KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF RETAINED EARNINGS
=========================================================================== For the Year Ended September 30, 1997 1996 1995 =========================================================================== (Thousands of Dollars) Balance at Beginning of Year $355,973 $303,709 $279,466 Income Available for Common Stock 114,441 122,585 91,498 - --------------------------------------------------------------------------- 470,414 426,294 370,964 Less: Cash dividends declared ($1.46, $1.42 and $1.39 per common share, respectively) 73,478 70,291 67,229 Other adjustments 350 30 26 - --------------------------------------------------------------------------- Balance at End of Year $396,586 $355,973 $303,709 =========================================================================== The accompanying Summary of Significant Accounting Policies and Basis for Financial Statement Presentation and Notes to Consolidated Financial Statements are integral parts of these statements.
36 KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET
====================================================================================================== September 30, 1997 1996 ====================================================================================================== (Thousands of Dollars) Assets Property Utility, at cost $ 1,848,817 $ 1,782,440 Accumulated depreciation (458,089) (429,476) Gas exploration and production, at cost 636,312 510,568 Accumulated depletion (216,423) (165,414) - ------------------------------------------------------------------------------------------------------ 1,810,617 1,698,118 - ------------------------------------------------------------------------------------------------------ Equity Investments in Energy Services 166,833 115,529 Current Assets Cash and temporary cash investments 36,912 41,921 Accounts receivable 174,321 172,843 Allowance for uncollectible accounts (14,444) (15,616) Gas in storage, at average cost 94,695 91,813 Materials and supplies, at average cost 11,436 12,089 Prepaid gas costs 11,309 11,945 Other 33,886 38,888 - ------------------------------------------------------------------------------------------------------ 348,115 353,883 - ------------------------------------------------------------------------------------------------------ Deferred Charges 171,625 122,073 - ------------------------------------------------------------------------------------------------------ $ 2,497,190 $ 2,289,603 ====================================================================================================== Capitalization and Liabilities Capitalization (See accompanying statement and Note 4) Common stock, $.33 1/3 par value , authorized 210,000,000; outstanding 50,767,041 and 49,857,448 shares, respectively, stated at $ 572,457 $ 549,835 Retained earnings 396,586 355,973 - ------------------------------------------------------------------------------------------------------ Total common equity 969,043 905,808 Preferred stock, redeemed - 6,600 Long-term debt 745,091 712,013 - ------------------------------------------------------------------------------------------------------ 1,714,134 1,624,421 - ------------------------------------------------------------------------------------------------------ Current Liabilities Accounts payable 142,725 143,561 Dividends payable 18,490 18,229 Commercial paper (See Note 5) 64,211 - Taxes accrued 4,602 10,905 Customer deposits 22,829 21,881 Customer budget plan credits 15,956 8,892 Interest accrued and other 50,629 37,244 - ------------------------------------------------------------------------------------------------------ 319,442 240,712 - ------------------------------------------------------------------------------------------------------ Deferred Credits and Other Liabilities Federal income tax 290,458 282,041 Unamortized investment tax credits 19,004 20,007 Other 69,003 43,573 - ------------------------------------------------------------------------------------------------------ 378,465 345,621 - ------------------------------------------------------------------------------------------------------ Minority Interest in Subsidiary Company 85,149 78,849 - ------------------------------------------------------------------------------------------------------ $ 2,497,190 $ 2,289,603 ====================================================================================================== The accompanying Summary of Significant Accounting Policies and Basis for Financial Statement Presentation and Notes to Consolidated Financial Statements are integral parts of these statements.
37 KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CAPITALIZATION
============================================================================================= September 30, 1997 1996 ============================================================================================= (Thousands of Dollars) Common Equity Common stock, $.33 1/3 par value, authorized 210,000,000 shares; outstanding 50,767,041 and 49,857,448 shares, respectively, stated at $ 572,457 $ 549,835 Retained earnings (See accompanying statement) 396,586 355,973 - --------------------------------------------------------------------------------------------- 969,043 905,808 - --------------------------------------------------------------------------------------------- Preferred Stock, Redeemed $100 par value, cumulative, authorized 900,000 shares 4.60% Series B, 69,000 shares outstanding in 1996 - 6,900 Less: Current sinking fund requirements - 300 - --------------------------------------------------------------------------------------------- - 6,600 - --------------------------------------------------------------------------------------------- Long-term Debt -Subsidiaries Brooklyn Union Gas facilities revenue bonds (issued through New York State Energy Research and Development Authority) 6.368% Series 1993A and Series 1993B due April 2020 75,000 75,000 7 1/8% Series 1985 I due December 2020 - 62,500 7% Series 1985 II due December 2020 - 62,500 5.5% Series 1996 due January 2021 153,500 153,500 6.75% Series 1989A due February 2024 45,000 45,000 6.75% Series 1989B due February 2024 45,000 45,000 5.6% Series 1993C due June 2025 55,000 55,000 6.95% Series 1991A and Series 1991B due July 2026 100,000 100,000 5.635% Series 1993D-1 and Series 1993D-2 due July 2026 50,000 50,000 Variable Rate Series 1997 due December 2020 125,000 - - --------------------------------------------------------------------------------------------- 648,500 648,500 Unamortized premium (1,409) (1,489) The Houston Exploration Company 98,000 65,002 - --------------------------------------------------------------------------------------------- 745,091 712,013 - --------------------------------------------------------------------------------------------- $ 1,714,134 $ 1,624,421 ============================================================================================= The accompanying Summary of Significant Accounting Policies and Basis for Financial Statement Presentation and Notes to Consolidated Financial Statements are integral parts of these statements.
38 KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
====================================================================================== For the Year Ended September 30, 1997 1996 1995 ====================================================================================== (Thousands of Dollars) CASH FLOWS FROM OPERATING ACTIVITIES Net income $114,733 $122,908 $91,835 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and depletion 116,129 83,006 77,696 Deferred Federal income tax 6,253 25,985 11,037 Gain on sale of investments (16,052) (16,160) - Gain on sale of subsidiary stock - (35,437) - Income from energy services investments (14,395) (13,523) (9,458) Dividends received from energy services investments 12,938 11,031 3,595 Change in accounts receivable, net (4,260) (24,939) 44,712 Change in accounts payable (1,738) 39,856 (29,283) Gas inventory and prepayments (2,246) 777 6,208 Other 16,677 8,863 14,439 - -------------------------------------------------------------------------------------- Cash provided by operating activities 228,039 202,367 210,781 - -------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Sale of common stock 22,618 27,407 27,974 Proceeds from sale of subsidiary stock - 101,041 - Issuance of long-term debt 157,998 153,500 19,192 Commercial paper and revolving lines of credit, net 64,211 - - Repayments of long-term debt and preferred stock (131,600)(160,867) (300) Dividends paid (73,770) (70,614) (67,566) - -------------------------------------------------------------------------------------- Cash provided by (used for) financing activities 39,457 50,467 (20,700) - -------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (excluding allowance for equity funds used during construction) (284,289)(301,307)(212,732) Proceeds from sale of investments 23,274 26,938 - Partnership (investment) distribution (30,000) 21,704 - Other 18,510 1,210 9,702 - -------------------------------------------------------------------------------------- Cash used in investing activities (272,505)(251,455)(203,030) - -------------------------------------------------------------------------------------- Change in Cash and Temporary Cash Investments ($5,009) $1,379 ($12,949) - -------------------------------------------------------------------------------------- Cash and Temporary Cash Investments at Beginning of Year 41,921 40,542 53,491 - -------------------------------------------------------------------------------------- Cash and Temporary Cash Investments at End of Year $36,912 $41,921 $40,542 ====================================================================================== Temporary cash investments are short-term marketable securities purchased with maturities of three months or less that are carried at cost which approximates their fair value. Supplemental disclosures of cash flows Income taxes $33,392 $37,053 $36,000 Interest $46,061 $53,210 $53,047 ====================================================================================== The accompanying Summary of Significant Accounting Policies and Basis for Financial Statement Presentation and Notes to Consolidated Financial Statements are integral parts of these statements.
39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. FEDERAL INCOME TAX Income tax expense (benefit) is reflected as follows in the Consolidated Statement of Income:
- ------------------------------------------------------------------ Year Ended September 30, 1997 1996 1995 - ------------------------------------------------------------------ (Thousands of Dollars) Operating Expenses Current $ 49,352 $ 27,766 $ 31,676 Deferred 7,877 11,742 10,313 - ------------------------------------------------------------------- 57,229 39,508 41,989 - ------------------------------------------------------------------- Other Income Current 7,729 6,559 379 Deferred (1,599) 14,243 724 Amortization of investment tax credits (1,003) (941) (1,052) - ------------------------------------------------------------------- 5,127 19,861 51 - ------------------------------------------------------------------- Total Federal income tax $ 62,356 $ 59,369 $ 42,040 - -------------------------------------------------------------------
The components of the net deferred income tax liability reflected as Deferred Credits and Other Liabilities - Federal income tax in the Consolidated Balance Sheet are as follows:
- --------------------------------------------------------- September 30, 1997 1996 - --------------------------------------------------------- (Thousands of Dollars) Utility property $181,902 $176,565 Gas production and other property 78,364 69,488 Net tax regulatory asset 24,660 26,210 Other 5,532 9,778 - --------------------------------------------------------- Net deferred income tax liability $290,458 $282,041 - ---------------------------------------------------------
40 The following is a reconciliation between reported income tax and tax computed at the statutory rate of 35%:
- -------------------------------------------------------------------- Year Ended September 30, 1997 1996 1995 - -------------------------------------------------------------------- (Thousands of Dollars) Computed at statutory rate $ 61,981 $ 63,797 $ 46,856 Adjustments related to: Gas production tax credits (1,534) (1,962) (2,730) Minority Interest in THEC 2,320 - - Nontaxable interest income (191) (678) (870) Amortization of investment tax credits (1,003) (941) (1,052) Other, net 783 (847) (164) - -------------------------------------------------------------------- Total Federal income tax $ 62,356 $ 59,369 $ 42,040 - -------------------------------------------------------------------- Effective income tax rate 35% 33% 31% - --------------------------------------------------------------------
2. POSTRETIREMENT BENEFITS A. Pension: The Company has a noncontributory defined benefit pension plan covering substantially all employees. Benefits are based on years of service and compensation. Funding for pensions is in accordance with requirements of Federal law and regulations. There were no pension contributions in 1997, 1996 and 1995. Special retirement programs were completed in 1997 and 1995. The calculation of net periodic pension cost follows:
- ----------------------------------------------------------------- Year Ended September 30, 1997 1996 1995 - ----------------------------------------------------------------- (Thousands of Dollars) Service cost, benefits earned during the year $ 12,125 $ 15,160 $ 11,533 Special retirement charge 21,579 - 5,416 Interest cost on projected benefit obligation 37,467 37,128 35,128 Return on plan assets (159,004) (78,930) (82,626) Net amortization and deferral 93,573 31,745 34,786 - ----------------------------------------------------------------- Total pension cost $ 5,740 $ 5,103 $ 4,237 - -----------------------------------------------------------------
41 The following table sets forth the plan's funded status. Plan assets principally are common stock and fixed income securities:
- ------------------------------------------------------------------ September 30, 1997 1996 - ------------------------------------------------------------------ (Thousands of Dollars) Actuarial present value of benefit obligations: Vested $(465,410) $(414,988) Accumulated $(490,337) $(439,278) Projected $(617,687) $(563,852) Plan assets at fair market value $ 733,922 $ 608,080 - ------------------------------------------------------------------- Plan assets in excess of projected benefit obligation $ 116,235 $ 44,228 Unrecognized net (gain) from past experience different from that assumed and from changes in assumptions $(114,861) $ (32,755) Unrecognized transition asset $ (23,262) $ (27,914) - ------------------------------------------------------------------- Accrued pension liability $ (21,888) $ (16,441) - ------------------------------------------------------------------- Assumptions: Obligation discount 6.75% 7.25% Asset return 7.25% 7.75% Average annual increase in compensation 5.00% 5.50% - ------------------------------------------------------------------
42 B. Other Postretirement Benefits - Retiree Health Care and Life Insurance: The Company sponsors noncontributory defined benefit plans under which it provides certain health care and life insurance benefits for retired utility employees. The Company has been funding a portion of future benefits over employees' active service lives through Voluntary Employee Beneficiary Association (VEBA) trusts. Contributions to VEBA trusts are tax deductible, subject to limitations contained in the Internal Revenue Code. Net periodic other postretirement benefit cost included the following components:
- ------------------------------------------------------------------- Year Ended September 30, 1997 1996 1995 - ------------------------------------------------------------------- (Thousands of Dollars) Service cost, benefits earned during the year $ 2,567 $ 3,178 $ 2,590 Interest cost on accumulated postretirement benefit obligation 10,745 10,673 9,958 Return on plan assets (25,785) (9,382) (6,746) Net amortization and deferral 23,690 10,961 6,752 - -------------------------------------------------------------------- Other postretirement benefit cost $ 11,217 $ 15,430 $ 12,554 - --------------------------------------------------------------------
43 The following table sets forth the plan's funded status:
- -------------------------------------------------------------------- September 30, 1997 1996 - -------------------------------------------------------------------- (Thousands of Dollars) Actuarial present value of accumulated postretirement benefit obligation Retirees $(125,454) $ (88,278) Fully eligible active plan participants (6,202) (18,271) Other active plan participants (64,964) (63,762) - -------------------------------------------------------------------- $(196,620) $(170,311) Plan assets at fair market value, primarily stocks and bonds $ 112,022 $ 93,452 - -------------------------------------------------------------------- Accumulated postretirement benefit obligation in excess of plan assets $ (84,598) $ (76,859) Unrecognized net loss from past experience different from that assumed and from changes in assumptions $ 32,644 $ 29,285 Unrecognized transition obligation $ 60,725 $ 64,015 - -------------------------------------------------------------------- Prepaid other postretirement benefit $ 8,771 $ 16,441 - -------------------------------------------------------------------- Assumptions: Obligation discount 6.75% 7.25% Asset return 7.25% 7.75% - --------------------------------------------------------------------
The measurement of plan liabilities also assumes a health care cost trend rate of 6% annually. A 1% increase in the health care cost trend rate would have the effect of increasing the accumulated postretirement benefit obligation as of September 30, 1997 and the net periodic SFAS-106 expense by approximately $25,074,000 and $1,776,000, respectively. 44 3. FIXED OBLIGATIONS A. Leases: Lease costs included in operation expense were $13,060,000 in 1997, $13,894,000 in 1996 and $14,706,000 in 1995. The future minimum lease payments under various leases, all of which are operating leases, are approximately $15,055,000 per year over the next five years and $136,840,000 in the aggregate for years thereafter. Brooklyn Union has a lease agreement with a remaining term of 14 years for its corporate headquarters. B. Fixed Charges Under Firm Contracts: Brooklyn Union has entered into various contracts for gas delivery and supply services. The contracts have remaining terms that cover from one to sixteen years. Certain of these contracts require payment of monthly charges in the aggregate amount of approximately $3.9 million per month in all events regardless of the level of service available. Such charges are recovered as gas costs under the gas adjustment clause. 4. CAPITALIZATION A. Common Stock: The Consolidated Statement of Capitalization reflects the establishment of KeySpan Energy Corporation as the parent holding company of Brooklyn Union and its subsidiaries. The only transactions recorded by the Company as of September 30, 1997, reflect the initial exchange of stock at the time of the holding company reorganization. Hence, the Company's balance sheet reflects its investment in Brooklyn Union in the amount of $969,043,000; common stock in the amount of $572,457,000; and retained earnings in the amount of $396,586,000. In addition to the share exchange relating to the reorganization into the holding company structure, the Company in 1997 and 1996 issued 909,593 and 1,069,128 shares of common stock for $22,618,000 and $27,407,000, respectively, under the Dividend Reinvestment and Stock Purchase Plan, the Discount Stock Purchase Plan for Employees, and the Employee Savings Plan. At September 30, 1997, 1,567,048 unissued shares of common stock were reserved for issuance under these plans. On September 10, 1997, prior to the reorganization, Brooklyn Union redeemed all 66,000 outstanding shares of its 4.60% Cumulative Preferred Stock Series B at the optional redemption price of $102.00 per share plus $0.1278 per share representing accrued and unpaid dividends. B. Debt of Subsidiaries: Gas Facilities Revenue Bonds and Other: Brooklyn Union can issue tax-exempt bonds through the New York State Energy Research and Development Authority. Whenever bonds are issued for new gas facilities projects, proceeds are deposited in trust and 45 subsequently withdrawn by Brooklyn Union to finance qualified expenditures. There are no sinking fund requirements for any Gas Facilities Revenue Bonds. Other Long-Term Debt: THEC has an available line of credit of $130 million which supports borrowings under a revolving loan agreement. Up to $5 million of this line is available for the issuance of letters of credit to support performance guarantees. This credit facility matures on July 1, 2000. At September 30, 1997, borrowings of $98 million were outstanding under this line of credit and $1.6 million was committed under outstanding letter of credit obligations. Borrowings under this facility bear interest, at THEC's option, at rates indexed at a premium to the Federal Funds rate or LIBOR, or based on the prime rate. The average interest rate on this debt was 7.11% per year at fiscal year-end. Covenants related to this line of credit require the maintenance of certain financial ratios and involve other restrictions regarding cash dividends, the purchase or redemption of stock and the pledging of assets. THEC is planning on issuing $150 million of bonds through a private placement depending on market conditions and interest rates. The proceeds from such issuance would be used, in part, to pay down obligations for borrowings under its revolving loan agreement. The bonds if issued, would be subordinate to borrowings under the line of credit. 5. SHORT-TERM DEBT A. Commercial Paper: At September 30, 1997, the Company had an available bank line of credit of $100 million, which lines secure the issuance of commercial paper. This line of credit was increased to $150 million in October 1997 and applies jointly to the Company and its subsidiary Brooklyn Union. Borrowings were made only in the fourth quarter of fiscal 1997 by Brooklyn Union. The average outstanding balance during the year was $5.6 million at a weighted average annualized rate of 5.59%. At September 30, 1997, Brooklyn Union had $64.2 million in short-term borrowings outstanding at an annualized rate of 5.60%. B. Other Short-Term Debt: KeySpan Energy Management has a $30 million unsecured line of credit which supports borrowings under a revolving loan agreement. This credit facility matures on March 31, 1998. At September 30, 1997, no borrowings were outstanding on this line of credit. Borrowings under this facility bear interest at rates indexed at a premium to LIBOR. Covenants related to this line of credit require the maintenance of certain financial ratios. 6. NONQUALIFIED STOCK OPTIONS At September 30, 1997, the Company, had a stock-based compensation plan that is described below. In addition, under a separate plan THEC has issued 1,684,238 stock options to key THEC 46 employees. The companies apply APB Opinion 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for their plans. Accordingly, no compensation cost has been recognized for fixed stock option plans in the Consolidated Financial Statements. The Company's consolidated net income and earnings per share would not have been materially affected had compensation cost for these plans been determined based on the fair value at the grant dates for awards under the plans consistent with SFAS 123, Accounting for Stock-Based Compensation. Under its plan, the Company has reserved for issuance 1,500,000 shares of nonqualified stock options and has issued 363,500 nonqualified stock options on November 20, 1996 and 202,800 nonqualified stock options on November 15, 1995. The options vest ratably over a three-year period from the grant date, with a ten-year exercise period. The exercise price of each option equals the market price of the Company's stock on the date of grant. The fair values of granted options were $4.27 and $2.78 for grants issued in fiscal years 1997 and 1996, respectively, and were estimated on the date of grant using the Black-Scholes option- pricing model. The following weighted-average assumptions were used for grants in fiscal years 1997 and 1996, respectively: dividend yield of 4.66% and 5.57%; expected volatility of 16.560% and 16.879%; risk free interest rate of 6.00% and 6.28%; and expected lives of 6 years. The exercise prices are $30.50 and $27.00 for grants issued in fiscal years 1997 and 1996, respectively. 7. FINANCIAL INSTRUMENTS A. Fair Value of Financial Instruments: Brooklyn Union's long-term debt consists primarily of publicly traded Gas Facilities Revenue Bonds, the fair value of which is estimated based on quoted market prices for the same or similar issues. The fair values of these bonds at September 30, 1997 and 1996 were $671,041,400 and $660,499,600, respectively, and the carrying values were $648,500,000 in both years. Other subsidiary debt is carried at an amount approximating fair value because interest rates are based on current market rates. All other financial instruments included in the Consolidated Balance Sheet are stated at amounts that approximate fair values. B. Derivative Financial Instruments: Brooklyn Union and THEC employ derivative financial instruments - natural gas futures, options and swaps - for the purpose of managing commodity price risk. The utility tariff applicable to certain large-volume customers permits gas to be sold at prices established monthly within a specified range expressed as a percentage of prevailing alternate fuel oil prices. Brooklyn Union uses standard New York Mercantile 47 Exchange futures contracts to fix profit margins on specified portions of the sales to this market in line with pricing objectives. Implementation of the strategy involves establishment of long (buy) positions in gas futures contracts with offsetting short (sell) positions in oil futures contracts of equivalent energy value. The long gas futures position follows, generally within a range of 80% to 120%, the cost of gas to serve this market while the short oil futures position correspondingly replicates, within the same range, the selling price of gas. Brooklyn Union has developed a strong sense of the relationship between gas and oil prices in the target markets, and the implementation of its strategy has satisfactorily hedged its exposure to the loss of profit margins on the desired portion of anticipated sales. With respect to natural gas production operations, THEC generally uses options to establish collars, swaps and standard New York Mercantile Exchange futures contracts to hedge the price risk related to known production plans and capabilities. These instruments include a fixed price/volume. Swaps are structured as both straight and participating swaps. In all swap instruments, THEC pays the other parties the amount by which the floating variable price (settlement price) exceeds the fixed price and receives the amount by which the settlement price is below the fixed price. The following table summarizes the notional amounts and related fair values of the derivative financial instrument positions outstanding at September 30, 1997. Fair values are based on quotes for the same or similar instruments. Differences between the notional contract amounts and fair values represent implicit gains on gas contracts representing long positions or losses on oil contracts representing short positions if the instruments were settled at market.
- ------------------------------------------------------------------ Gas Type of Fiscal Year Fixed Price Volume Notional Fair Instrument of Maturity per Mcf (Mcf) Amount Value - ---------- ----------- ----------- ------- --------- ------ (in thousands) Futures contracts 1998 $2.22-$2.44 340,000 $ 793 $ 999 Swap contracts 1998 $1.53-$2.09 3,315,000 $ 6,084 $ 2,368 Options contracts Calls 1998 $3.35-$3.78 3,980,000 $14,094 $ 0 Puts 1998 $2.60 4,890,000 $12,179 $ 463 Oil Type of Fiscal Year Fixed Price Volume Notional Fair Instrument of Maturity per Gallon (Gallons) Amount Value - ---------- ----------- ----------- --------- -------- ------ (in thousands) Futures contracts 1998 $0.52-$0.59 18,858,000 $10,701 $11,312 - -----------------------------------------------------------------
48 Futures contracts expire and are renewed monthly. As of September 30, 1997, no such contract extended beyond March 1998. Further, swap contracts are settled monthly and extend through March 1998. Margin deposits with brokers at September 30, 1997 and 1996 amounted to $1,382,000 and $23,619,000, respectively, and are recorded in Other in the Current Assets section of the balance sheet. Deferred gains on closed positions were $567,000 and $1,330,000 at September 30, 1997 and 1996, respectively. Such gains are generally recorded in net income within one month. The Company's subsidiaries are exposed to credit risk in the event of nonperformance by counterparties to derivative contracts, as well as nonperformance by the counterparties of the transactions against which they are hedged. The Company believes that the credit risk related to the futures, options and swap contracts is no greater than that associated with the primary contracts which they hedge, as these contracts are with major investment grade financial institutions, and that elimination of the price risk lowers the Company's overall business risk. 8. ENVIRONMENTAL MATTERS Historically, Brooklyn Union or predecessor entities owned or operated several former manufactured gas plant (MGP) sites. These sites have been identified for the New York State Department of Environmental Conservation (DEC) for inclusion on appropriate waste site inventories. In certain circumstances, former MGP sites can give rise to environmental cleanup responsibilities for the Company. With respect to one former MGP site located on Brooklyn Union property, the Brooklyn Borough Works site in Coney Island, Brooklyn Union executed an administrative consent order (ACO) with the DEC in 1995 addressing the overall remediation of the site. In accordance with the ACO, a schedule of investigative and cleanup activities has been developed, and cleanup over the next several years is expected. Based upon the current estimated range of the costs of compliance with the Coney Island ACO, and the estimated costs of investigation of two other sites, the Company believes the minimum cost of MGP- related environmental cleanup will be approximately $34 million, the majority of which will be expended for the Coney Island plant site. This amount includes approximately $7.2 million of costs expended as of September 30, 1997. The actual MGP- related costs may be substantially higher, depending upon remediation experience, eventual end use of the sites, and environmental conditions not addressed in the ACO or current investigative plans. As of September 30, 1997, the Company had an unpaid liability of $26.8 million. 49 The rate plan that became effective on October 1, 1996, described in 'Utility Rate and Regulatory Matters' of Management's Discussion and Analysis of Results of Operations and Financial Condition, provides, among other things, that if the total cost of investigating and remediating the Coney Island plant site varies from the amount originally accrued for these activities, Brooklyn Union will retain or absorb 10% of the variation. Under the rate plan, similar ratemaking treatment will be available for any additional accrued liabilities for other MGP sites, should such accrual be required. 9. COMBINATION WITH LONG ISLAND LIGHTING COMPANY (LILCO TRANSACTION) AMENDED AGREEMENT WITH LILCO On December 29, 1996, Brooklyn Union and LILCO entered into an Agreement and Plan of Exchange and Merger (LILCO Agreement), pursuant to which the companies would become wholly owned subsidiaries of a new holding company (LILCO Transaction). The LILCO Agreement was amended and restated to reflect certain technical changes as of February 7, 1997 and June 26, 1997 and was amended to substitute KeySpan Energy Corporation (the Company) for Brooklyn Union as of September 29, 1997 (Amended LILCO Agreement). The LILCO Transaction was approved by both companies' boards of directors and shareholders of both companies approved the transaction on August 7, 1997. Under the terms of the LILCO Transaction, as the result of a merger of the Company with a newly-formed subsidiary of the new holding company, the Company's common shareholders will receive one share of common stock of the new holding company for each common share of the Company they currently own. Through a share exchange, LILCO common shareholders will receive 0.803 shares (the Ratio) of the new holding company's common stock for each share of LILCO common stock that they currently own. In the event that the transaction with the Long Island Power Authority (LIPA Transaction) is consummated, the Ratio will be 0.880. See LILCO Agreement with Long Island Power Authority, LIPA Transaction. Based on current facts and circumstances, it is probable that the purchase method of accounting will apply to the LILCO Transaction with LILCO being the acquiring Company for accounting purposes. The Amended LILCO Agreement contains certain covenants of the parties pending the consummation of the LILCO Transaction. Generally, the parties must carry on their businesses in the ordinary course consistent with past practice. The Company and LILCO expect to continue their respective current dividend policies until completion of the LILCO Transaction. It is anticipated that the new holding company will set an initial annual dividend rate of $1.78 per share of its common stock. 50 Following the announcement of the LILCO Agreement, Standard & Poor's Ratings Services placed Brooklyn Union's corporate credit and senior unsecured debt ratings of A, as well as Brooklyn Union's A-1 commercial paper rating, on CreditWatch with negative implications. Similarly, Moody's Investors Service placed Brooklyn Union's A1 senior unsecured and Prime-1 short-term ratings on review for possible downgrade. The LILCO Transaction is conditioned upon the receipt of all required regulatory approvals and other conditions. On July 17, 1997, the Federal Energy Regulatory Commission (FERC) approved the LILCO Transaction. Approval of the PSC is pending. The Company is unable to determine when, or if, all other required regulatory approvals will be obtained. Unaudited pro forma combined condensed financial information for KeySpan Energy Corporation and Long Island Lighting Company at September 30, 1997 and for the twelve months ended September 30, 1997 is contained in the Company's Report on Form 8-K, dated December 19, 1997. LILCO AGREEMENT WITH LONG ISLAND POWER AUTHORITY (LIPA Transaction) On June 26, 1997, LILCO and LIPA entered into definitive agreements pursuant to which, after the transfer of LILCO's gas distribution assets, non-nuclear electric generation assets and certain other assets and liabilities to one or more newly-formed subsidiaries of the new holding company, LILCO's stock will be sold to LIPA for $2.4975 billion in cash. The LIPA Transaction was approved by LILCO's shareholders on August 7, 1997. Upon consummation of the LIPA Transaction, LIPA will own LILCO's electric transmission and distribution system, its 18% interest in the Nine Mile Point 2 Nuclear Power Station, and its electric regulatory assets and liabilities, and will assume or refinance approximately $339 million in preferred stock and approximately $3.6 billion in long term debt. As part of the LIPA Transaction, the definitive agreements contemplate that one or more subsidiaries of the newly-formed holding company will enter into agreements with LIPA, pursuant to which such subsidiaries will provide management and operations services to LIPA with respect to the electric transmission and distribution system, sell power generated by the non-nuclear power plants to LIPA, and manage LIPA's fuel and electric purchases and any off-system electric sales. In addition, three years after the LIPA Transaction is consummated, LIPA will have the right for a one year period to acquire the non-nuclear generating assets. The purchase price for such assets would be the fair market value at the time of the exercise of the right. On July 16, 1997, the New York State Public Authorities Control Board unanimously approved the definitive agreements related to the 51 LIPA Transaction subject to the following conditions: (1) within one year, LIPA must establish a plan for open access to the electric distribution system; (2) LIPA may not purchase the generating facilities, as contemplated in the generation purchase right agreement, at a price greater than book value; (3) the holding company formed in connection with the LIPA Transaction (or the LILCO Transaction) must agree to invest, over a ten year period, at least $1.3 billion in energy-related and economic development projects, and natural gas infrastructure projects on Long Island; (4) LIPA will guarantee that, over a ten year period, average electric rates will be reduced by no less than 14% when measured against LILCO's rates today. As part of this guarantee, no less than 2% cost savings to LIPA customers must result from the savings attributable to the LILCO Transaction; and (5) LIPA will not increase average customer rates by more than 2 1/2% over a twelve month period without approval of the PSC. The LIPA Transaction is subject to the approval of the FERC and other regulatory agencies. In July 1997, the Company, LILCO and LIPA filed requests for private letter rulings with the Internal Revenue Service regarding certain federal income tax issues that require favorable rulings in order for the LIPA Transaction to close. The Company is unable to determine when and if FERC approval and all other consents and approvals required to consummate the LIPA Transaction will be obtained. 52 NOTE 10. SUPPLEMENTAL GAS AND OIL DISCLOSURES (Unaudited) This information includes amounts attributable to a 34% minority interest in THEC at September 30, 1997 and 1996. Gas and oil operations, and reserves, were predominantly located in the United States in all years. CAPITALIZED COSTS RELATING TO GAS AND OIL PRODUCING ACTIVITIES
============================================================================================== September 30, 1997 1996 ============================================================================================== (Thousands of Dollars) Unproved properties not being amortized $103,569 $60,137 Properties being amortized - productive and nonproductive 521,046 441,024 - ---------------------------------------------------------------------------------------------- Total capitalized costs 624,615 501,161 Accumulated depletion (210,333) (160,128) - ---------------------------------------------------------------------------------------------- Net capitalized costs $414,282 $341,033 - ----------------------------------------------------------------------------------------------
The following is a break-out of the costs (in thousands of dollars) which are excluded from the amortization calculation as of September 30, 1997, by year of acquisition: 1997 - $49,135; 1996 - $33,442; and prior years $20,992. The Company cannot accurately predict when these costs will be included in the amortization base, but it is expected that these costs will be evaluated within the next five years. COSTS INCURRED IN PROPERTY ACQUISITION, EXPLORATION AND DEVELOPMENT ACTIVITIES
================================================================================ Year Ended September 30, 1997 1996 1995 ================================================================================ (Thousands of Dollars) Acquisition of properties- Unproved properties $13,486 $24,577 $10,996 Proved properties 11,562 89,828 14,983 Exploration 25,695 20,828 5,907 Development 73,642 31,005 37,953 - -------------------------------------------------------------------------------- Total costs incurred $124,385 $166,238 $69,839 - --------------------------------------------------------------------------------
RESULTS OF OPERATIONS FROM GAS AND OIL PRODUCING ACTIVITIES
================================================================================ Year Ended September 30, 1997 1996 1995 ================================================================================ (Thousands of Dollars) Revenues from gas and oil producing activities- Sales to unaffiliated parties $100,818 $50,431 $40,810 - -------------------------------------------------------------------------------- Revenues 100,818 50,431 40,810 - -------------------------------------------------------------------------------- Production and lifting costs 17,322 8,860 5,762 Depletion 50,415 27,368 22,906 - -------------------------------------------------------------------------------- Total expenses 67,737 36,228 28,668 - -------------------------------------------------------------------------------- Income before taxes 33,081 14,203 12,142 Income taxes 10,393 3,037 1,957 - -------------------------------------------------------------------------------- Results of gas and oil producing activities (excluding corporate overhead and interest costs) $22,688 $11,166 $10,185 ================================================================================
53 10. SUPPLEMENTAL GAS AND OIL DISCLOSURES (CONTINUED) The gas and oil reserves information is based on estimates of proved reserves attributable to THEC's interest as of September 30 for each of the years presented. These estimates principally were prepared by independent petroleum consultants. Proved reserves are estimated quantities of natural gas and crude oil which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. The standardized measure of discounted future net cash flows was prepared by applying year-end prices of gas and oil to the proved reserves, except for those reserves devoted to future production that is hedged. Such reserves are priced at their respective hedged amounts. The standardized measure does not purport, nor should it be interpreted, to present the fair value of THEC's gas and oil reserves. An estimate of fair value would also take into account, among other things, the recovery of reserves not presently classified as proved, anticipated future changes in prices and costs and a discount factor more representative of the time value of money and the risks inherent in reserve estimates. RESERVE QUANTITY INFORMATION Natural Gas (MMcf)
======================================================================================= September 30, 1997 1996 1995 ======================================================================================= Proved Reserves- Beginning of Year 314,541 195,055 142,858 Revisions of previous estimates 16,326 (354) 13,539 Extensions and discoveries 29,254 13,139 38,985 Production (45,353) (26,435) (21,822) Purchases of reserves in place - 134,325 21,495 Sales of reserves in place - (1,189) - - --------------------------------------------------------------------------------------- Proved Reserves- End of Year 314,768 314,541 195,055 - --------------------------------------------------------------------------------------- Proved Developed Reserves- Beginning of Year 222,522 151,594 110,225 - --------------------------------------------------------------------------------------- End of Year 232,200 222,522 151,594 =======================================================================================
Crude Oil, Condensate and Natural Gas Liquids (MBbls)
======================================================================================= September 30, 1997 1996 1995 ======================================================================================= Proved Reserves- Beginning of Year 1,248 1,162 807 Revisions of previous estimates (92) (148) 245 Extensions and discoveries 15 182 155 Production (153) (136) (148) Purchases of reserves in place - 294 103 Sales of reserves in place - (106) - - --------------------------------------------------------------------------------------- Proved Reserves- End of Year 1,018 1,248 1,162 - --------------------------------------------------------------------------------------- Proved Developed Reserves- Beginning of Year 1,040 974 543 - --------------------------------------------------------------------------------------- End of Year 874 1,040 974 =======================================================================================
54 10. SUPPLEMENTAL GAS AND OIL DISCLOSURES (CONTINUED) STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED GAS AND OIL RESERVES
======================================================================= September 30, 1997 1996 ======================================================================= (Thousands of Dollars) Future Cash Flows $827,537 $554,798 Future Costs- Production (136,570) (89,303) Development (53,538) (60,926) - ----------------------------------------------------------------------- Future net inflows before income tax 637,429 404,569 Future income taxes (143,733) (59,623) - ----------------------------------------------------------------------- Future net cash flows 493,696 344,946 10% discount factor (145,782) (85,688) - ----------------------------------------------------------------------- Standardized measure of discounted future net cash flows $347,914 $259,258 =======================================================================
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM PROVED RESERVE QUANTITIES
======================================================================================= Year Ended September 30, 1997 1996 1995 ======================================================================================= (Thousands of Dollars) Standardized measure- beginning of year $259,258 $133,521 $108,134 Sales and transfers, net of production costs (83,496) (41,571) (35,048) Net change in sales and transfer prices, net of production costs 144,463 44,719 (2,786) Extensions and discoveries and improved recovery, net of related costs 44,974 18,894 28,868 Changes in estimated future development costs (5,982) (4,798) (2,351) Development costs incurred during the period that reduced future development costs 15,512 15,056 10,360 Revisions of quantity estimates 25,861 (2,338) 13,858 Accretion of discount 27,528 16,880 11,763 Net change in income taxes (51,851) 21,026 (7,856) Purchases of reserves in place - 94,945 15,176 Changes in production rates (timing) and other (28,353) (37,076) (6,597) - --------------------------------------------------------------------------------------- Standardized measure-end of year $347,914 $259,258 $133,521 =======================================================================================
55 10. SUPPLEMENTAL GAS AND OIL DISCLOSURES (Continued) AVERAGE SALES PRICES AND PRODUCTION COSTS-PER-UNIT
=========================================================================================================== Year Ended September 30, 1997 1996 1995 =========================================================================================================== Average Sales Price* Natural Gas ($/MCF) 2.40 2.11 1.47 Oil, Condensate and Natural Gas Liquid ($/Bbl) 20.06 19.21 16.92 Production Cost Per Equivalent MCF ($) 0.3 0.32 0.25 ===========================================================================================================
ACREAGE
=========================================================================================================== September 30, 1997 Gross Net =========================================================================================================== Producing 285,898 190,402 Undeveloped 212,551 172,078 ===========================================================================================================
NUMBER OF PRODUCING WELLS
=========================================================================================================== September 30, 1997 Gross Net =========================================================================================================== Gas Wells 1,126 696 Oil Wells 11 3 ===========================================================================================================
DRILLING ACTIVITY (Net)
=========================================================================================================== Year Ended September 30, 1997 1996 1995 =========================================================================================================== Producing Dry Total Producing Dry Total Producing Dry Total Net Developmental Wells 22.1 7.7 29.8 10.1 0.8 10.9 10.0 3.4 13.4 Net Exploratory Wells 4.0 3.6 7.6 2.1 3.4 5.5 1.4 0.4 1.8 ===========================================================================================================
WELLS IN PROCESS
=========================================================================================================== September 30, 1997 Gross Net =========================================================================================================== Exploratory 4.0 2.2 Developmental 5.0 3.3 =========================================================================================================== *Represents the cash price received which excludes the effect of any hedging transactions.
56 SUPPLEMENTARY INFORMATION (UNAUDITED) =================================================================== QUARTERLY INFORMATION SUMMARY OF QUARTERLY INFORMATION The following is a table of financial data for each quarter of fiscal 1997 and 1996. The Company's business is influenced by seasonal weather conditions. The effect on utility earnings of variations in revenues caused by abnormal weather is largely mitigated by operation of a weather normalization adjustment contained in Brooklyn Union's tariff.
=================================================================== First Second Third Fourth Quarter Quarter Quarter Quarter =================================================================== (Thousands of Dollars Except Per Share Data) 1997 Operating revenues 446,726 589,282 246,993 195,186 Operating income (loss) 57,458 92,855 9,817 (17,560) Income (loss) applicable to common stock 44,722 80,243 2,233(a) (12,757)(b) Per common share: Earnings (loss) (c) 0.90 1.60 0.04 (0.25) Dividends declared 0.365 0.365 0.365 0.365 - ------------------------------------------------------------------- 1996 Operating revenues 398,083 595,438 254,311 184,170 Operating income (loss) 57,400 88,505 5,495 (20,842)(d) Gains on sale of subsidiary stock and Canadian plant (after taxes) - - - 33,539 Income (loss) applicable to common stock 44,624 74,413 (4,561) 8,109 Per common share: Earnings (loss) (c) 0.91 1.51 (0.09) 0.16 Dividends declared 0.355 0.355 0.355 0.355 - ------------------------------------------------------------------- (a) Includes an after-tax gain of $3.3 million on the sale of certain Canadian properties. (b) Includes an after-tax gain of $4.5 million on the sale of a fuel management operation. (c) Quarterly earnings per share are based on the average number of shares outstanding during the quarter. Because of the increasing number of common shares outstanding in each quarter, the sum of quarterly earnings per share does not equal earnings per share for the year. (d) Includes a subsidiary reorganization charge of $7.8 million after taxes. ===================================================================
SUMMARY OF QUARTERLY STOCK INFORMATION
=================================================================== First Second Third Fourth Quarter Quarter Quarter Quarter =================================================================== 1997 High 32.625 30.500 29.000 33.375 Low 27.875 27.500 26.125 28.438 Close 30.125 27.500 28.625 33.375 Shares traded (000) 6,598 6,795 4,146 5,457 - ------------------------------------------------------------------- 1996 High 29.625 29.875 27.500 28.125 Low 24.625 25.750 24.875 24.875 Close 29.250 26.750 27.250 27.875 Shares traded (000) 3,710 3,884 5,121 3,592 ===================================================================
57 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There have been no changes in accountants. In addition, there have been no disagreements between the Company and its independent public accountants concerning any matter of accounting principles or practices or financial disclosure required to be disclosed by this item. Part III Item 10. Directors and Executive Officers of the Registrant DIRECTORS AND OFFICERS Directors Robert B. Catell, Age 60, Director since 1986 Chairman, President and Chief Executive Officer, KeySpan Energy Corporation Trustee, Brooklyn Botanic Garden, Brooklyn Law School, Independence Savings Bank and Kingsborough Community College Foundation, Inc.; Chairman and Director, Alberta Northeast Inc., Boundary Gas, Inc., Business Council for a Sustainable Energy Future, Energy Association of New York State Executive Committee; Director and Past Chairman, American Gas Association; Director, Brooklyn Academy of Music (ex-officio), Brooklyn Bureau of Community Service Senior Trustee, Brooklyn Public Library, The Business Council of New York State, Inc., Empire State Business Alliance, Gas Research Institute, New York City Investment Fund, New York City Partnership and New York State Energy Research and Development Authority; Member, Brooklyn Chamber of Commerce Executive Committee, CCNY School of Engineering Advisory Board, Chemical Bank Regional Advisory Board, Committee for Economic Development, Council for Environmental Quality, Downtown Brooklyn Development Association, Heartshare for Human Services Advisory Board, Mayor's Private Sector Committee on Information Technology, New York Professional Engineers Society and Society of Gas Lighting Executive Committee. Mr. Catell joined the Company's subsidiary, The Brooklyn Union Gas Company, in 1958 and has been an officer since 1974. He was elected Vice President in 1977, Senior Vice President in 1981 and Executive Vice President in 1984. He was elected Chief Operating Officer in 1986 and President in 1990. He has served as President and Chief Executive Officer from 1991 to 1996 when he was elected Chairman and Chief Executive Officer. Upon the formation of the holding company structure under 58 KeySpan Energy Corporation in 1997, Mr. Catell was elected Chairman, President and Chief Executive Officer. Member, Executive Committee. Kenneth I. Chenault, Age 46, Director since 1988 President and Chief Operating Officer, American Express Company Director, Arthur Ashe Institute for Urban Health, National Center on Addiction and Substance Abuse, National Collegiate Athletic Association, NYU Medical Center, Phoenix House and Quaker Oats Company; Member, Council on Foreign Relations. Mr. Chenault joined American Express Company in 1981 as Director of Strategic Planning. He was named President of the Consumer Card Group in 1989 and President of the Travel Related Services Company in the U.S. in 1993 with responsibility for the Consumer Card Group. He was named Vice Chairman of American Express Company in January 1995 and assumed additional responsibilities for Travel Related Services International in April 1995. Prior to joining American Express, Mr. Chenault was a management consultant with Bain & Co. and an associate with the law firm of Rogers & Wells. Mr Chenault will resign as a director effective December 31, 1997. Member, Organization and Nominating Committee. Alan H. Fishman, Age 51, Director since 1989 Managing Partner, Columbia Financial Partners, L.P. (private investment company) Chairman, Affinity Technology Group, Inc.; Director, Brooklyn Academy of Music; Member, Executive Committee of the Brown University Annual Fund. Mr. Fishman joined Chemical Bank in 1969. He was named Chief Financial Officer in 1979 and was promoted to Senior Executive Vice President responsible for Chemical's Investment Banking activities worldwide in 1983. He became affiliated with Neuberger & Berman in 1988 and was responsible for an investment partnership. He joined American International Group, Inc. in 1989 as a Senior Vice President and became President of AIG Financial Services Group. He joined the firm of Adler & Shaykin in 1990 as a Managing Partner and, in 1992, Mr. Fishman formed the firm of Columbia Financial Partners, L.P. in which he is a Managing Partner. 59 Chairman, Audit Committee; Member, Organization and Nominating Committee and Executive Committee. Craig G. Matthews, Age 54, Director since 1997 Executive Vice President - Utility Division, KeySpan Energy Corporation Director, Brooklyn Philharmonic, Greater Jamaica Development Corporation, The Houston Exploration Company, National and New York City Advisory Board of the Salvation Army, Neighborhood Housing Services, Polytechnic University, Public Utilities Reports, Inc. and Regional Plan Association; Past Chairman, Brooklyn Chamber of Commerce; Treasurer, Society of Gas Lighting; Member, American Gas Association, Brooklyn College Community Advisory Board and New York Gas Group Executive Committee. Mr. Matthews joined the Corporation's subsidiary, The Brooklyn Union Gas Company, in 1965 as a management trainee and has held various management positions in the corporate planning, financial, marketing and engineering areas and has been an officer since 1977. He was elected Vice President in 1981 and Senior Vice President in 1985. In 1991, he was elected Executive Vice President, with responsibilities for the subsidiary's financial, gas supply, information systems, strategic planning functions, and energy-related investments. In May 1996, he was elected to his current position, President and Chief Operating Officer of the subsidiary and in June 1997 to Executive Vice President - Utility Division of the Corporation upon the formation of the holding company structure under KeySpan Energy Corporation. Edward D. Miller, Age 57, Director since 1993 President and Chief Executive Officer, The Equitable Companies Inc. and The Equitable Life Assurance Society of the United States Trustee and Past Chairman, New York Blood Center; Trustee, Pace University; Director, Donaldson, Lufkin & Jenrette, Inc. and Phoenix House. Mr. Miller is President and Chief Executive Officer of The Equitable Companies and The Equitable Life Assurance Society of the U.S., the principal insurance subsidiary of The Equitable Companies. Mr. Miller also serves as a member of the Board of The Equitable Companies and Equitable Life, and is a member of the Board of Alliance Capital, an Equitable investment subsidiary. He also serves on the Executive 60 Committee of the AXA Group, Equitable's majority shareholder. Mr. Miller assumed these positions in August 1997. He had previously served as Senior Vice Chairman of The Chase Manhattan Corporation. In 1988, he was named Vice Chairman of Manufacturers Hanover Trust, a position he held until 1991, when that company merged with Chemical Bank, and he was named Vice Chairman. He was elected President of Chemical Bank in 1994. In 1995, upon the merger with Chase Manhattan, he became Senior Vice Chairman. Chairman, Organization and Nominating Committee; Member Executive Committee. Helmut W. Peter, Age 65, Director since 1997 Consultant and Retired Vice Chairman of The Brooklyn Union Gas Company Trustee, Institute of Gas Technology; Director, American Gas Cooling Center, Inc., Industrial Center Inc., International Gas Center, Phoenix Natural Gas Ltd. and Premier Transco Ltd.; Member, Gas Research Institute Program Executive Committee and World Energy Council/Conference. Mr. Peter joined Brooklyn Union in 1972 as a Senior Engineer and has been an Officer since 1977. In 1977 he was elected Assistant Vice President and Vice President in 1980. He was elected Senior Vice President and Chief Engineer in 1984 and Group Senior Vice President and Chief Engineer in 1988. In 1991 he was elected Executive Vice President. In May 1996, Mr. Peter was elected Vice Chairman and served in this capacity until his retirement in July 1997. Since August 1, 1997, Mr. Peter has served as Senior Executive Advisor/Consultant to The Brooklyn Union Gas Company and KeySpan Energy Corporation in energy and management matters. Member, Audit Committee. James Q. Riordan, Age 70, Director since 1991 Retired Vice Chairman and Chief Financial Officer, Mobil Corp. Director, Dow Jones & Co., Inc., The Houston Exploration Company, Public Broadcasting Service and Tri-Continental Corporation; Director/Trustee of the mutual funds in the Seligman Group of investment companies; Trustee, The Brooklyn Museum and Committee For Economic Development; Member, Policy Council of the Tax Foundation. 61 Mr. Riordan joined Mobil Corp. in 1957 as Tax Counsel. He was named a Director and Chief Financial Officer in 1969. He became Vice Chairman in 1986 and retired from Mobil Corp. in 1989. Mr. Riordan joined Bekaert Corporation in 1989 and was elected its President. He retired from Bekaert Corporation in 1992. Member, Audit Committee, Organization and Nominating Committee and Executive Committee. A listing of Executive Officers of the Registrant appears on page 63. 62 Executive Officers of the Registrant - ------------------------------------- All Executive Officers serve one-year terms.
Age as of Sept. 30, Period Served Name and Position 1997 In Such Capacity Business Experience in Past 5 Years - ------------------------------------------- ---------- ----------------------------------------------------------------------- Robert B. Catell, Chairman, President 60 1997 to Present Chairman, President and Chief Executive Officer and Chief Executive Officer 1996 to 1997 Chairman and Chief Executive Officer 1991 to 1996 President and Chief Executive Officer Craig G. Matthews, Executive Vice President 54 1997 to Present Executive Vice President - Utility Division - - Utility Division 1996 to 1997 President and Chief Operating Officer 1994 to 1996 Executive Vice President 1991 to 1994 Executive Vice President and Chief Financial Officer Vincent D. Enright, Senior Vice President, 53 1997 to Present Senior Vice President, Chief Financial Officer and Chief Financial Officer and Chief Accounting Officer Chief Accounting Officer 1994 to 1997 Senior Vice President and Chief Financial Officer 1992 to 1994 Senior Vice President David L. Phillips, Senior Vice President 41 1997 to Present Senior Vice President Strategic Planning and Strategic Planning and Corporate Development Corporate Development 1996 to 1997 Energy Consultant to Brooklyn Union 1992 to 1996 Executive Committee, Equitable Resources Inc. Maurice K. Shaw, Senior Vice President 58 1993 to Present Senior Vice President and Corporate Affairs Officer and Corporate Affairs Officer 1987 to 1993 Senior Vice President and Chief Marketing Officer William K. Feraudo, Senior Vice President 47 1997 to Present Senior Vice President Energy Marketing Group Energy Marketing Group 1994 to 1997 Senior Vice President 1989 to 1994 Vice President Roger J. Walz, Vice President 52 1990 to Present Vice President and General Auditor and General Auditor Robert R. Wieczorek, Vice President, 55 1994 to Present Vice President, Secretary and Treasurer Secretary and Treasurer 1989 to 1994 Vice President, Treasurer, and Assistant Secretary
63 Item 11. Executive Compensation POLICY FRAMEWORK The Organization and Nominating Committee (the "Committee") of the Board of Directors, composed of six independent, non-employee Directors, administers the executive compensation program. The members of the Committee during fiscal 1997 were Mrs. Christensen and Messrs. Chenault, Elliott, Fishman, Larocca and Miller. No member is or has been an officer or employee of KeySpan or any of its subsidiaries. After review and approval by the Committee, all issues relating to executive compensation are submitted to the entire Board for approval. The philosophy of KeySpan regarding executive compensation is that the Chief Executive Officer and other executives should be compensated at competitive levels to attract, motivate, and retain talented executives needed to achieve KeySpan's vision of becoming the premier energy company in the Northeast. The Committee is committed to implementing a compensation program which furthers the vision. The Committee adheres to the following compensation policies which are intended to facilitate the achievement of KeySpan's business strategies: Executives' total compensation programs should strengthen the relationship between pay and performance by emphasizing variable, at- risk compensation that is dependent upon the level of success in meeting specified corporate and strategic business group performance goals. An appropriate amount of compensation for senior executives should be comprised of long-term, at-risk pay to focus executives on the long-term interests of shareholders. Each program element should target compensation opportunities comparable to the compensation paid to executives of comparable utility companies and at the median of general industry companies nationwide. However, if KeySpan's performance exceeds that of the comparable group, compensation should be above the median; likewise, if KeySpan's performance falls below that of the comparable group, the compensation paid to senior executives should be below the median of the comparable companies. Components of Compensation The Committee compares total compensation levels for KeySpan's senior executives to the compensation paid to executives in comparable utility and general industry companies nationwide. In this connection, the Committee uses analyses prepared by a national compensation consultant to review the competitive compensation levels of executives in the utility industry in the regional and 64 national marketplace. In addition, the Committee reviews compensation data for executive positions comparable in scope to those in general industry companies. The companies analyzed in this process tend to have national business operations and have positions that are similar in scope with comparable revenue size or employment levels. Through this process the Committee identifies the median compensation level, both with respect to base salary and the overall executive compensation program. The Committee ensures that compensation provides for a direct link to strategic financial measures and shareholder value for the executive officers of KeySpan. To achieve this performance linkage, KeySpan has established three programs for the direct compensation of executive officers: the Base Salary Program, the Annual Incentive Compensation Plan and the Long-Term Performance Incentive Compensation Plan. The intent of the programs is to place increased emphasis on performance-based pay and reduced emphasis on fixed base salary in determining total compensation. Each of the three programs is discussed in greater detail below. The Base Salary Program - In setting base salary levels for each executive officer , the Committee considers the competitive market data for executives in comparable positions in other utility and general industry markets. In setting base salary levels KeySpan currently targets the 50th percentile of the comparable labor market. The Committee also considers the experience level and actual performance achieved by the executive as it relates to KeySpan's corporate goals in setting base salary. The base salary level for the Chief Executive Officer compared to competitive market data is generally below the 50th percentile of comparable positions while other executives' base salaries are generally at or above the 50th percentile. Consistent with KeySpan's ongoing effort to align total compensation with the competitive marketplace, in 1997 the company introduced significant pay at risk for all executives, which included an increase to the annual incentive compensation targets for executives. In order to transition executives to the increased targets, the company did not grant merit increases in 1997, and executives were generally subject to a 3% base salary reduction. The compensation of executives has been modified by withholding a portion of base salary increases over the past several years in order to shift part of base salary to incentive awards. This shifting of base salary to incentives is anticipated to continue in the future as more emphasis is placed upon incentive compensation. 65 The Annual Incentive Compensation Plan - The Corporate Incentive Compensation Plan (the "Annual Plan") was adopted by the Board of Directors in fiscal 1989. The Annual Plan was designed to provide annual incentive awards to officers and other key employees who, by the nature and scope of their positions, regularly make significant contribution to the success of KeySpan in the achievement of corporate goals that are important to the shareholders of KeySpan. The specific corporate goals for the Annual Plan are established by management and reviewed and approved by the Committee and the Board of Directors. The goals are intended to improve corporate performance and include objectives which encourage growth in consolidated net income, increases in gross margin, control of operating expenses, improved customer satisfaction and increased commitment to employee excellence. The annual incentive award ranges are established annually by the Committee for executives in the Annual Plan. Incentive award levels are intended to provide awards that are competitive within the industry when performance results are fully achieved. The Annual Plan awards range from zero to a maximum of 200% of target, with a target of 60% of base salary for the Chief Executive Officer, to a maximum of 120%, a target of 50% of base salary for the Executive Vice President, with a maximum of 100%, and a target of 40% of base salary for the Vice Chairman, with a maximum of 80%. The targets for Senior Vice Presidents in 1997 ranged from 30% to 35% of base salary, and from 15% to 25% for Vice Presidents. Awards for the Chief Executive Officer, Executive Vice President, and the Senior Officers are primarily based on corporate performance, whereas awards for the Vice Chairman and Vice Presidents were based upon a mix of corporate and subsidiary or strategic business group performance. Incentive awards to executive officers for achievement in fiscal 1997 (paid in fiscal 1998) reflect overall performance results that exceeded anticipated levels of performance, as each of the objectives in the Plan were met or exceeded, contributing to another year of record earnings. The Long-Term Performance Incentive Compensation Plan - As a result of the Committee's review of the competitiveness of KeySpan's total compensation program, and an independent consultant review of the long-term incentive plans used by the majority of the utilities that comprise the Standard & Poor's Utilities Index, the Committee recommended and the Board of Directors adopted the Long-Term Performance Incentive Compensation Plan (the "Long Term Plan") in fiscal 1996. The Long Term Plan was approved at Brooklyn Union's 1996 Annual Meeting of Shareholders. The Long Term Incentive Plan provides for the award of Incentive Stock Options, Nonqualified Stock Options and Performance Shares to officers of KeySpan and its subsidiaries as determined by the Committee. The purpose of the Long Term Plan is to optimize KeySpan's performance through incentives that directly link the executive's personal interests to those of KeySpan's shareholders and to attract and retain employees 66 who make significant contributions to the success of KeySpan. The stock option component in the Long Term Plan entitles the executive to purchase shares of common stock at an exercise price per share determined by the Committee which is at least equal to the closing price of shares of common stock on the New York Stock Exchange on the date of the grant. In 1997, Mr. Robert B. Catell received options to purchase 100,000 shares with an exercise price of $30.50 as is detailed in the Options Table. The awards for stock options to other executives are also summarized in such table. The Committee believes that this equity interest provides the appropriate link to the interest of the shareholders. The Committee believes that Stock Options can be directly linked to KeySpan's performance. As the value of the common stock is generally considered the strongest indicator of overall corporate performance, stock option awards allow executives to benefit by appreciation in stock price at no immediate cost to KeySpan and provide a strong incentive to executives by linking compensation to the future value of the common stock. Policy with Respect to Section 162(m) Deduction Limit Under Section 162(m) of the Internal Revenue Code, KeySpan cannot deduct compensation in excess of $1,000,000 paid in any year to the chief executive officer or any of the four other most highly compensated executive officers whose compensation must be detailed in the proxy statement. Compensation paid under plans that are performance-based is not subject to the $1,000,000 annual limit if certain requirements are satisfied. Although KeySpan's plans are designed to relate compensation to performance, they do not meet such requirements because they allow the Committee to exercise discretion in setting compensation. The Committee is of the opinion that it is in KeySpan's best interest to have the Committee retain discretion in order to preserve flexibility in compensating such executive officers, especially in light of an increasingly competitive marketplace. 67 SUMMARY COMPENSATION TABLE The following table indicates the annual compensation for the Chairman, President and Chief Executive Officer, and the four other most highly compensated executive officers of the Company. This information is for fiscal years ended on September 30, 1997, 1996 and 1995. No executive officer serves pursuant to an employment agreement.
LONG-TERM NAME AND PRINCIPAL OTHER ANNUAL INCENTIVE PLAN POSITION YEAR SALARY($) COMPENSATION($) PAYOUTS($) (1) (2) (3) - ------------------- ----- --------- --------------- -------------- Robert B. Catell 1997 468,000 495,690 358,096 Chairman, President and 1996 470,811 248,040 376,169 Chief Executive Officer 1995 434,026 152,973 0 Craig G. Matthews 1997 338,333 297,815 261,703 Executive Vice President 1996 322,478 138,000 275,273 Utility Division 1995 283,859 86,749 0 Helmut W. Peter 1997 291,625 205,910 0 Vice Chairman 1996 324,103 111,680 0 (Retired 8/97) 1995 283,859 90,939 0 Vincent D. Enright 1997 208,792 109,798 0 Senior Vice President, 1996 206,436 40,704 0 Chief Financial Officer 1995 180,193 49,817 0 & Chief Accounting Officer David L. Phillips 1997 154,500 128,132 0 Senior Vice President, (*) Strategic Planning & Corporate Development (1) In addition, stock options have been awarded as indicated in the accompanying Options Table. (2) Represents amounts awarded for each fiscal year under the Company's Annual Incentive Compensation Plans. (3) Represents Long-Term Incentive Compensation paid by subsidiaries of KeySpan of $218,096 for Mr. Catell and $163,703 for Mr. Matthews. Also includes cash payments related to a buyout of non-qualified stock options issued under The Houston Exploration Company 1994 Long-Term Incentive Plan. Additional awards of $459,000 related to these Long-Term Incentive Plans were also made to other officers who are not shown in this table. (*) Mr. Phillips was hired 1/1/97.
68 NON QUALIFIED STOCK OPTIONS The following table provides information regarding awards made under the Long-Term Performance Incentive Compensation Plan during the fiscal year ended September 30, 1997 to the Chairman, President and Chief Executive Officer and the four other most highly compensated executive officers of the Company and all current executive officers as a group. OPTIONS TABLE
% of Total # Grant of Shares Date Total Value of Securities Granted Options Present Number In-the-Money Underlying to Exercise Value of Options at Options Employees Price of Unexercised FYE Granted in FY ($/share) Options Options (Unexercised) (1)(2) (3) (4) (5) ---------- ------- ------- -------- -------- --------- R.B. Catell 100,000 0.28 30.50 $427,000 155,000 $638,125 C.G. Matthews 60,000 0.17 30.50 256,200 92,000 376,500 H.W. Peter (*) 24,000 0.07 30.50 102,480 56,000 273,000 V.D. Enright 26,000 0.07 30.50 111,020 42,000 176,750 D.L. Phillips 20,000 0.06 29.50 85,400 20,000 77,500 Executive Officers as a Group 273,000 0.75 30.43 1,165,710 427,600 1,789,560 (*) Retired 8/1/97 (1) Fair Market Value of KeySpan common stock on November 20, 1996, the date of grant. (2) Options vest ratably over a three-year period from the grant date. The expiration date of the options is November 19, 2006. (3) Options have been valued using the Black-Scholes option pricing model adapted to reflect the specific provisions of the Company's Long-Term Performance Incentive Compensation Plan and related assumptions regarding exercisability. The values shown are theoretical and do not necessarily reflect the actual values which may be realized upon the future exercise of the options. Any actual value will result to the extent that the market value of the common shares at a future date exceeds the exercise price. Assumptions for modeling are based on the dividend yield, risk-free rate of return, standard deviation of prices over a relevant period as of the grant date and the expected lives of the options. (4) Represents options granted in fiscal years 1997 and 1996. No options have been exercised. (5) Represents the difference between the fiscal year-end price of $33 3/8 and the exercise price for grants awarded in fiscal years 1997 and 1996.
69 As of December 11, 1997, the number of outstanding shares of KeySpan common stock was 50,966,673. The closing price of a share of the Company's common stock on the New York Stock Exchange on December 11, 1997 was $33.875. The number of shares of KeySpan common stock reserved for issuance under the Long-Term Performance Incentive Compensation Plan is 1,500,000 in the aggregate; however, no more than 750,000 shares of KeySpan common stock will be available for issuance pursuant to the exercise of Incentive Stock Options. The maximum number of shares of KeySpan common stock that may be granted to any participant pursuant to any single award is 125,000. PERFORMANCE GRAPH As shown in the table below, for a period beginning September 30, 1992 through September 30, 1997, a comparison is made of cumulative total shareholder returns for the Company's common stock, the Standard & Poor's Utilities Index and the Standard & Poor's 500 Index.
1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- KeySpan $100 $121 $123 $129 $154 $195 S&P Utilities $100 $124 $108 $138 $148 $169 S&P 500 $100 $113 $117 $152 $183 $257 Assumes $100 invested on September 30, 1992 in shares of KeySpan common stock, the S&P Utilities Index and the S&P 500 Index, and that all dividends were reinvested.
70 COMPENSATION UNDER RETIREMENT PLANS The Company's Employee Retirement Plan provides retirement benefits based upon the individual participant's years of service and final average annual compensation. Final average annual compensation is the average annual compensation for the highest five consecutive years of earnings during the last ten years of credited service. The following table sets forth the estimated annual retirement benefits (exclusive of Social Security payments) payable to participants in the specified compensation and years-of-service categories, assuming continued active service until normal retirement age and that the Retirement Plan is in effect at such time.
YEARS OF SERVICE Remuneration(1) 20 25 30 35 40 45 - --------------- $ 300,000....... $ 90,000 $112,500 $135,000 $157,500 $180,000 $202,500 $ 400,000....... $120,000 $150,000 $180,000 $210,000 $240,000 $270,000 $ 500,000....... $150,000 $187,500 $225,000 $262,500 $300,000 $337,500 $ 600,000....... $180,000 $225,000 $270,000 $315,000 $360,000 $405,000 $ 700,000....... $210,000 $262,500 $315,000 $367,500 $420,000 $472,500 $ 800,000....... $240,000 $300,000 $360,000 $420,000 $480,000 $540,000 $ 900,000....... $270,000 $337,000 $405,000 $472,500 $540,000 $607,500 $1,000,000....... $300,000 $375,000 $450,000 $525,000 $600,000 $675,000 $1,100,000....... $330,000 $412,500 $495,000 $577,500 $660,000 $742,500 $1,200,000....... $360,000 $450,000 $540,000 $630,000 $720,000 $810,000 (1) Calculated as the average of the highest five consecutive years of earnings during the last ten years of credited service.
The number of years of credited service for each of the Chairman, President and Chief Executive Officer and the four other highest paid executive officers based on continued service to normal retirement age will be for R.B. Catell (44 years), C.G. Matthews (42 years), H.W. Peter (25 years), D.L. Phillips, (24 years), and V.D. Enright (43 years). The Internal Revenue Code of 1986, as amended, limits the annual compensation taken into consideration for and the maximum annual retirement benefits payable to a participant under the Employees' Retirement Plan. For fiscal 1997, these limits were $160,000 and $125,000, respectively. Annual retirement benefits attributable to amounts in excess of these limits are provided under the Supplemental Retirement Plan of KeySpan and not under the Employees' Retirement Plan. 71 EXECUTIVE COMPENSATION--1998 On November 21, 1997, the Board of Directors, acting on the recommendation of the Organization and Nominating Committee, approved base salary and incentive compensation plan recommendations for 1998 to further align total compensation of officers with corporate performance measures. The Board elected not to increase the salary of the Chief Executive Officer in contemplation of the combination with LILCO, and approved market based salary adjustments of lump sum increases for most other officers, as KeySpan continues to place less emphasis on base pay. In addition, Nonqualified Stock Options covering 426,000 shares were granted to officers to further align compensation to the interest of the shareholders. SENIOR EXECUTIVE CHANGE OF CONTROL SEVERANCE PLAN Under Senior Executive Change of Control Severance Plan (the "Severance Plan"), participants are entitled to receive certain severance benefits if their employment is terminated under certain circumstances within three years after a transaction that meets the definition of "change of control" under the terms of the Severance Plan. A termination by the employer without "cause" (as defined in the Severance Plan) or by the participants for "good reason" (as defined in the Severance Plan, and including a significant diminution of responsibilities, an assignment to inappropriate duties, a material reduction in compensation or benefits, or a transfer of more than 50 miles), within the later of (i) the end of 15 months after the "change of control" or (ii) 90 days after the "good reason" event occurs, will result in the payment of benefits under the Severance Plan. A participant who becomes entitled to severance benefits will receive the following: a lump sum cash payment of salary, previously deferred compensation and accrued vacation pay through the date of termination to the extent not already paid, a pro rata bonus for the year of termination, and the participant's base salary and bonus for the Severance Period (as defined below); continued employee welfare benefits for the Severance Period; a lump sum payment equal to the actuarial value of the additional benefits under Brooklyn Union's qualified and supplemental retirement plans the participant would have received had he remained employed for the Severance Period; and outplacement services at a cost not more than $30,000. In addition, the participant will receive an additional payment, if necessary, to make such participant whole for any excise tax on excess parachute payments imposed on the participant. The "Severance Period" is a period of either two or three years (as designated by the Organization and Nominating Committee) or, if less, the period remaining until the participant reaches mandatory retirement age. For the purposes of eligibility for retirement, medical, dental and 72 life insurance, the participant will be deemed to remain employed for the entire Severance Period. The designated participants in the Severance Plan are Robert B. Catell, Craig G. Matthews, Helmut W. Peter, Vincent D. Enright, and 7 Senior Vice Presidents of Brooklyn Union (each with three-year Severance Periods) and 12 Vice Presidents of Brooklyn Union (each with two-year Severance Periods). If the Combination occurred on January 1, 1998, and all participants in the plan were terminated immediately thereafter, it is estimated that the aggregate after-tax cost of the severance benefits under the Severance Plan would be approximately $19,833,000. Item 12. Security Ownership of Certain Beneficial Owners and Management SECURITY OWNERSHIP OF DIRECTORS AND CERTAIN EXECUTIVE OFFICERS The following table sets forth information as of September 30, 1997, with respect to the number of shares of common stock beneficially owned and/or Common Stock Equivalents owned by the directors and certain executive officers of the Company.
TOTAL OF COMMON STOCK BENEFICIALLY COMMON STOCK OWNED & BENEFICIALLY COMMON STOCK EQUIVALENTS OWNED EQUIVALENTS (1) ------------- ------------ ----------- R.B. Catell 26,518 18,905 7,613 K.I. Chenault 4,614 1,568 3,046 A.H. Fishman 6,986 2,762 4,224 C.G. Matthews 16,303 11,930 4,373 E.D. Miller 7,874 6,342 1,532 H.W. Peter (*) 15,017 10,630 4,387 J.Q. Riordan 8,586 1,500 7,086 D.L. Phillips 144 144 0 V.D. Enright 6,666 4,633 2,033 All Directors and Executive Officers as a group, including those named above 116,796 78,996 37,800 (1)Certain of the Directors have elected to have deferred Directors' fees invested in Common Stock Equivalents. * Retired 8/1/97
73 Item 13. Certain Relationships and Related Transactions There are no transactions, or series of similar transactions, or contemplated transactions which have occurred since the beginning of the last fiscal year of the Company which exceed $60,000 and involve any director or executive officer of the Company. No executive officer or director of the Company was indebted to the Company or its subsidiaries at any time since the beginning of the last fiscal year of the Company in an amount in excess of $60,000. Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. All Financial Statements Page in Form 10-K ---------- Report of Independent Public Accountants 31 Summary of Significant Accounting Policies and Basis of Financial Statement Presentation 32 Consolidated Statement of Income for the Years Ended September 30, 1997, 1996 and 1995 36 Consolidated Statement of Retained Earnings for the Years Ended September 30, 1997, 1996 and 1995 36 Consolidated Balance Sheet at September 30, 1997 and 1996 37 Consolidated Statement of Capitalization at September 30, 1997 and 1996 38 Consolidated Statement of Cash Flows for the Years Ended September 30, 1997, 1996 and 1995 39 Notes to Consolidated Financial Statements 40 Consolidated Schedule of Valuation and Qualifying Accounts for the Years Ended September 30, 1997, 1996 and 1995 82 (a) 2. Financial Statement Schedules The unaudited pro forma combined condensed financial information for KeySpan Energy Corporation and Long Island Lighting 74 Company at September 30, 1997 and for the twelve months ended September 30, 1997 contained in the Company's Report on Form 8-K, dated December 19, 1997, and LILCO's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997, are filed herewith as exhibits under Exhibit 99, and are incorporated herein and in this Form 10-K by reference. The following additional data should be read in conjunction with the financial statements included in Part II, Item 8. Schedules not included herein have been omitted because they are not applicable or the required information is shown in such financial statements or notes thereto. (a) 3. Exhibits (2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession Amended and Restated Agreement and Plan of Exchange and Merger, dated as of June 26, 1997, by and between The Brooklyn Union Gas Company and Long Island Lighting Company, incorporated by reference from Annex A of Form S-4 Registration Statement No. 333-30407. Amended and Restated LILCO Stock Option Agreement, dated as of June 26, 1997, by and between The Brooklyn Union Gas Company and Long Island Lighting Company, incorporated by reference from Annex B of Form S-4 Registration Statement No. 33-30407. Amended and Restated Brooklyn Union Stock Option Agreement, dated as of June 26, 1997, by and between The Brooklyn Union Gas Company and Long Island Lighting Company, incorporated by reference from Annex C of From S-4 Registration Statement No. 333-30407. Agreement and Plan of Merger, dated as of June 26, 1997, by and among BL Holding Corp., Long Island Lighting Company, Long Island Power Authority and LIPA Acquisition Corp., incorporated by reference from Annex D of Form S-4 Registration Statement No. 333-30407. (3) Articles of Incorporation and By-laws Restated Certificate of Incorporation and By-laws of the Company, incorporated by reference from Annex L of Form S-4 Registration Statement No. 333-30407, as amended to indicate that the annual meeting of shareholders of the Company shall be held at such date and time, on or prior to the end of the fiscal year, as may be designated by the Board of Directors for the election of Directors or for any other proper business which may be transacted at an annual meeting. 75 (4) Instruments defining the rights of security holders, including indentures: Official Statement, dated February 23, 1989, respective of $90,000,000 of the New York State Research and Development Authority Adjustable Rate Gas Facilities Revenue Bonds Series 1989A and Series 1989B, incorporated by reference from Form S-8 Registration Statement No. 33-29898. Participation Agreement, dated as of February 1, 1989, between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to the Adjustable Rate Gas Facilities Revenue Bonds Series 1989A, incorporated by reference from Form 10-K for the year ended September 30, 1989. Participation Agreement, dated as of February 1, 1989, between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to the Adjustable Rate Gas Facilities Revenue Bonds Series 1989B, incorporated by reference from Form 10-K for the year ended September 30, 1989. Indenture of Trust, dated February 1, 1989, between the New York State Energy Research and Development Authority and Manufacturers Hanover Trust Company, as Trustee, relating to the Adjustable Rate Gas Facilities Revenue Bonds Series 1989A, incorporated by reference from Form 10-K for the year ended September 30, 1989. Indenture of Trust, dated February 1, 1989, between the New York State Energy Research and Development Authority and Manufacturers Hanover Trust Company, as Trustee, relating to the Adjustable Rate Gas Facilities Revenue Bonds Series 1989B, incorporated by reference from Form 10-K for the year ended September 30, 1989. Official Statement, dated July 24, 1991, respective of $50,000,000 of the New York State Research and Development Authority Gas Facilities Revenue Bonds Series 1991A and $50,000,000 of the New York State Research and Development Authority Gas Facilities Revenue Bonds Series 1991B, incorporated by reference from Form 10-K for the year ended September 30, 1991. Participation Agreement, dated as of July 1, 1991,between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to the Gas Facilities Revenue Bonds Series 1991A and 1991B, incorporated by reference from Form 10-K for the year ended September 30, 1991. Indenture of Trust, dated as of July 1, 1991, between the New York State Energy Research and Development Authority and Manufacturers Hanover Trust Company, as Trustee, relating to 76 the Gas Facilities Revenue Bonds Series 1991A and 1991B, incorporated by reference from Form 10-K for the year ended September 30, 1991. Official Statement, dated July 23, 1992, respective of $37,500,000 of the New York State Energy Research and Development Authority Gas Facilities Revenue Bonds Series 1993A and $37,500,000 of the New York State Energy Research and Development Authority Gas Facilities Revenue Bonds Series 1993B, incorporated by reference from Form 10-K for the year ended September 30, 1992. Participation Agreement, dated as of July 1, 1992, between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to the Gas Facilities Revenue Bonds Series 1993A and 1993B, incorporated by reference from Form 10-K for the year ended September 30, 1992. Indenture of Trust, dated as of July 1, 1992, between the New York State Energy Research and Development Authority and Chemical Bank, as Trustee, relating to the Gas Facilities Revenue Bonds Form Series 1993A and 1993B, incorporated by reference from Form 10-K for the year ended September 30, 1992. Official Statement, dated April 29, 1992, respective of $90,000,000 of the New York State Energy Research and Development Authority, 6.75% Gas Facilities Revenue Bonds, replacing $45,000,000 Series 1989A and $45,000,000 Series 1989B, incorporated by reference from Form 10-K for the year ended September 30, 1992. First Supplemental Participation Agreement dated as of May 1, 1992 to Participation Agreement dated February 1, 1989 between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to Adjustable Rate Gas Facilities Revenue Bonds, Series 1989A & B, incorporated by reference from Form 10-K for the year ended September 30, 1992. First Supplemental Trust Indenture dated as of May 1, 1992 to Trust Indenture dated February 1, 1989 between the New York State Energy Research and Development Authority and Manufacturers Hanover Trust Company, as Trustee, relating to Adjustable Rate Gas Facilities Revenue Bonds, Series 1989A & B, incorporated by reference from Form 10-K for the year ended September 30, 1992. Official Statement, dated July 15, 1993, respective of $25,000,000 of the New York State Energy Research and Development Authority Gas Facilities Revenue Bonds Series D-1 and $25,000,000 of the New York State Energy Research and Development Authority Gas Facilities Revenue Bonds Series D-2, incorporated by reference from Form S-8 Registration Statement No. 33-66182. 77 Participation Agreement, dated July 15, 1993, between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to the Gas Facilities Revenue Bonds Series D-1 1993 and Series D-2 1993, incorporated by reference from Form S-8 Registration Statement No. 33-66182. Indenture of Trust, dated July 15, 1993, between The New York State Energy Research and Development Authority and Chemical Bank as Trustee, relating to the Gas Facilities Revenue Bonds Series D-1 1993 and Series D-2 1993, incorporated by reference from Form S-8 Registration Statement No. 33-60182. Official Statement, dated July 8, 1993, respective of $55,000,000 of the New York State Energy Research and Development Authority Gas Facilities Revenue Bonds Series C, incorporated by reference from Form 10-K for the year ended September 30, 1993. First Supplemental Participation Agreement dated as of July 1, 1993 to Participation Agreement dated as of June 1, 1990, between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to Gas Facilities Revenue Bonds Series C, incorporated by reference from Form 10-K for the year ended September 30, 1993. First Supplemental Trust Indenture dated as of July 1, 1993 to Trust Indenture dated as of June 1, 1990 between the New York State Energy Research and Development Authority and Chemical Bank, as Trustee, relating to Gas Facilities Revenue Bonds Series C, incorporated by reference from Form 10-K for the year ended September 30, 1993. Official Statement, dated January 15, 1996, respective of $153,500,000 of the New York State Energy Research and Development Authority, 5 1/2% Gas Facilities Revenue Bonds Series 1996, replacing $98,500,000 Series 1985A and $55,000,000 Series 1985, incorporated by reference from Form 10-K for the year ended September 30, 1996. Participation Agreement, dated January 1, 1996, between the New York Energy Research and Development Authority and The Brooklyn Union Gas Company relating to the Gas Facilities Revenue Bonds Series 1996, incorporated by reference from Form 10-K for the year ended September 30, 1996. Indenture of Trust, dated January 1, 1996, between The New York State Energy Research and Development Authority and Chemical Bank, as Trustee, relating to the Gas Facilities Revenue Bonds Series 1996, incorporated by reference from Form 10-K for the year ended September 30, 1996. Official Statement, dated January 10, 1997, respective of $125,000,000 of New York State Energy Research and Development 78 Authority, Gas Facilities Revenue Bonds 1997 Series A. Participation Agreement, dated as of January 1, 1997, between the New York State Energy Research and Development Authority and The Brooklyn Union Gas Company relating to the Gas Facilities Revenue Bonds 1997 Series A. Indenture of Trust, dated January 1, 1997, between the New York State Energy Research and Development Authority and Chase Manhattan Bank, as Trustee, relating to the Gas Facilities Revenue Bonds 1997 Series A. (10) Material contracts Deferred Compensation Plan Preamble, dated, December 17, 1986, incorporated by reference from Form 10-K for the year ended September 30, 1987. Corporate Incentive Compensation Plan Description, incorporated by reference from Form 10-K for the year ended September 30, 1989. Marketing Incentive Compensation Plan Description, incorporated by reference from Form 10-K for the year ended September 30, 1989. Deferral Plan for Incentive Awards Description, incorporated by reference from Form 10-K for the year ended September 30, 1989. Agreement of Lease between Forest City Jay Street Associates and The Brooklyn Union Gas Company dated September 15, 1988, incorporated by reference from Form 10-K for the year ended September 30, 1990. Long-Term Performance Incentive Compensation Plan, dated November 15, 1995 incorporated by reference from Form 10-K/A for the year ended September 30, 1996. (11) Statement re: Computation of per share earnings. See Part II, Item 8., "Financial Statements and Supplementary Data- Consolidated Statement of Income for the Years Ended September 30, 1997, 1996 and 1995," for information required by this item. (12) Statement re: Computation of consolidated ratio of earnings to fixed charges (21) Subsidiaries of the registrant (23) Consents of experts 79 (27) Financial data schedule (99) Additional Exhibits Report on Form 8-K, dated December 19, 1997, incorporated by reference, see (b) below. (b) Reports on Form 8-K: On December 19, 1997, the Company filed a report on Form 8-K providing disclosure applicable to the unaudited pro forma combined condensed financial information for the Company and Long Island Lighting Company at September 30, 1997 and for the twelve months ended September 30, 1997. The unaudited pro forma combined condensed financial information reflects the condensed consolidated financial information of the Company and Long Island Lighting Company contained in their Reports on Form 10-K for the fiscal year ended September 30, 1997 and Form 10-Q for the quarter ended September 30, 1997, respectively. On September 29, 1997, the Company filed a report on Form 8-K providing the disclosure applicable to the effectiveness of KeySpan Energy Corporation becoming the parent holding company in connection with the restructuring of Brooklyn Union. On September 19, 1997, Brooklyn Union filed a report on Form 8-K providing disclosure applicable to the unaudited pro forma combined condensed financial information for Brooklyn Union and Long Island Lighting Company at June 30, 1997 and for the twelve months ended June 30, 1997. The unaudited pro forma combined condensed financial information reflects the condensed consolidated financial information of Brooklyn Union and Long Island Lighting Company contained in their respective Quarterly Reports on Form 10-Q. On September 19, 1997, Brooklyn Union filed a report on Form 8-K providing the disclosure relating to the redemption of all outstanding shares of its 4.60% Cumulative Preferred Stock and the definitive agreement to sell Gas Energy Inc. and Gas Energy Cogeneration Inc. 80 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant, and in the capacities indicated on December 19, 1997. KEYSPAN ENERGY CORPORATION Signature Title s/Robert B. Catell Chairman, President and Chief - --------------------------- Executive Officer and (Robert B. Catell) Director s/Craig G. Matthews Executive Vice President - - --------------------------- Utility Division and (Craig G. Matthews) Director s/Vincent D. Enright Senior Vice President, - --------------------------- Chief Financial Officer (Vincent D. Enright) and Chief Accounting Officer s/Kenneth I. Chenault Director - --------------------------- (Kenneth I. Chenault) s/Alan H. Fishman Director - --------------------------- (Alan H. Fishman) s/Edward D. Miller Director - --------------------------- (Edward D. Miller) s/Helmut W. Peter Director - --------------------------- (Helmut W. Peter) s/James Q. Riordan Director - --------------------------- (James Q. Riordan) 81 KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995 ======================================================================================================== (Thousands of Dollars)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E Balance at Additions Balance at Beginning Charged to End of Description of Period Expense Deductions Period ======================================================================================================== Year Ended September 30, 1997 Allowance for Uncollectible Accounts $15,616 $19,082 $20,370 $14,328 ----------- --------------- --------------- --------------- Reserve for Injuries and Damages Public Liability $8,276 $8,139 $3,415 $13,000 Workers' Compensation 847 600 162 1,285 ------------- --------------- --------------- --------------- $9,123 $8,739 $3,577 $14,285 ============= =============== =============== =============== Year Ended September 30, 1996 Allowance for Uncollectible Accounts $13,730 $20,676 $18,790 $15,616 ------------- --------------- --------------- --------------- Reserve for Injuries and Damages Public Liability $5,900 $5,788 $3,412 $8,276 Workers' Compensation 1,590 450 1,193 847 ------------- --------------- --------------- --------------- $7,490 $6,238 $4,605 $9,123 ============= =============== =============== =============== Year Ended September 30, 1995 Allowance for Uncollectible Accounts $14,963 $17,494 $18,727 $13,730 ------------- --------------- --------------- --------------- Reserve for Injuries and Damages Public Liability $5,350 $4,368 $3,818 $5,900 Workers' Compensation 1,425 500 335 1,590 ------------- --------------- --------------- --------------- $6,775 $4,868 $4,153 $7,490 ============= =============== =============== =============== ========================================================================================================
82 Exhibit 12 KEYSPAN ENERGY CORPORATION AND SUBSIDIARIES Computation of Consolidated Ratio of Earnings to Fixed Charges
========================================================================================== Fiscal Year Ended September 30, 1997 1996 1995 1994 1993 ========================================================================================== (Thousands of Dollars) Earnings Net Income $ 121,362 $ 122,908 $ 91,835 $ 87,384 $ 76,563 Federal Income Tax 62,356 59,369 42,040 40,698 41,483 Interest on Long-Term Debt 38,514 46,803 47,939 48,084 46,353 Other Interest Charges 6,071 4,918 5,128 2,787 2,617 Portion of Rentals Representing Interest 4,353 4,626 4,883 5,196 4,256 Adjustment Related to Equity Investments 330 (1,005) 174 (601) 729 - ------------------------------------------------------------------------------------------ Earnings Available to Cover Fixed Charges $ 232,986 $ 237,619 $ 191,999 $ 183,548 $ 172,001 ========================================================================================== Fixed Charges Interest on Long-Term Debt $ 43,571 $ 50,067 $ 50,521 $ 49,280 $ 47,017 Other Interest Charges 6,071 4,918 5,128 2,787 2,617 Portion of Rentals Representing Interest 4,353 4,626 4,883 5,196 4,256 - ------------------------------------------------------------------------------------------ Total Fixed Charges $ 53,995 $ 59,611 $ 60,532 $ 57,263 $ 53,890 ========================================================================================== Ratio of Earnings to Fixed Charges 4.31 3.99 3.17 3.21 3.19 ==========================================================================================
Exhibit 21 PRINCIPAL OPERATING SUBSIDIARIES AND AFFILIATES THE BROOKLYN UNION GAS COMPANY One MetroTech Center Brooklyn, New York 11201 Robert B. Catell Chairman and Chief Executive Officer Craig G. Matthews President and Chief Operating Officer THE HOUSTON EXPLORATION COMPANY 1100 Louisiana, Suite 2000 Houston, Texas 77002 James G. Floyd President and Chief Executive Officer GAS ENERGY INC. GAS ENERGY COGENERATION INC. 111 Livingston Street Brooklyn, New York 11201 David S. Milne,Jr. President and Chief Executive Officer KEYSPAN ENERGY SERVICES INC. 300 First Stamford Place Stamford, Connecticut 06902 Orlando M. Magnani President KEYSPAN ENERGY MANAGEMENT INC. 30 Jericho Executive Plaza Center Wing Jericho, New York 11753 Stephen E. Martin President Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K into the Company's previously filed Registration Statements File Nos. 33- 66182, 333-04863, 333-03441, 333-06257, 333-18025. ARTHUR ANDERSEN LLP December 19, 1997 New York, New York -----END PRIVACY-ENHANCED MESSAGE-----