CHARLOTTE, N.C., Oct. 24, 2002 — Duke Energy earned 27 cents per share, or $230 million in net income, in third quarter 2002 compared with $1.02 per share, or $796 million in net income, in third quarter 2001.
Before charging certain items related to strategic actions at Duke Energy North America (DENA), Duke Energy International (DEI) and the Franchised Electric business, ongoing EPS was 52 cents, or $441 million in net income.
As previously announced, the company has recorded charges in third quarter related to current market conditions and strategic actions taken to address them. These charges, which are included in 2002 reported results but are not ongoing, have a total impact on earnings before interest and taxes (EBIT) of $163 million and include the following:
— Termination of certain turbines on order plus write-down of other uninstalled turbines, costing $163 million
— Write-off of site development costs, primarily in California and Brazil, costing $80 million
— Demobilization costs related to deferral of three merchant power projects, costing $12 million
— Severance costs associated with reduction in work force, costing $33 million
— Partial impairment of a merchant plant as a result of current market outlook, costing $31 million
Of the $319 million in charges described above, $198 million are non-cash items. The company expects to take additional demobilization charges of approximately $25 million in fourth quarter related to the deferral of three plants in the western United States.
“We are dealing decisively with the consequences of the extremely depressed energy merchant marketplace,” said Richard B. Priory, chairman, president and chief executive officer of Duke Energy. “At the same time, we are experiencing strong earnings growth in Gas Transmission, mainly due to the integration of the Westcoast Energy assets, and our Franchised Electric business continues to produce strong results. The strength of these businesses, which is reflective of our balanced portfolio strategy, will enable Duke Energy to manage effectively through this severe downturn in the energy merchant sector.
“One of Duke Energy’s strengths is our operating efficiency and ability to adapt to rapidly changing market conditions,” Priory continued. “To improve financial performance in the midst of this severe downturn in wholesale energy markets, we have previously announced reductions in capital spending. We have also taken several actions that eliminate costs and realign our organization for the new environment. The company will eliminate more than 1,500 staff positions and more than 400 contract positions in 2002 and 2003. These actions will reduce ongoing operating expenses by more than $100 million annually. Labor reductions related to reduced capital expenditures represent an additional $75 million of capital savings.
“Our current forecast for 2002 full-year ongoing EPS is $1.95 to $2.05,” Priory continued. “This range is achievable, but with current performance and market conditions, we expect our results to be at the low end of the range.
“Our earnings outlook for 2003 is flat, assuming a modest improvement in the current extremely depressed merchant energy market. While we are confident in the performance of our Franchised Electric and Gas Transmission businesses, if the North American merchant energy market does not improve in 2003, earnings may be lower than 2002 ongoing earnings.”
Earnings before interest and taxes were $668 million in third quarter 2002, compared with $1.53 billion in third quarter 2001. Year-to-date 2002 EBIT is $2.48 billion, compared with $3.69 billion year-to-date EBIT in 2001. Excluding third quarter charges described in the table above, year-to-date 2002 ongoing EBIT was $2.8 billion. The reduction is primarily due to substantially lower results at Duke Energy North America.
Duke Energy is complying with recent revisions to generally accepted accounting principles by changing the way it reports energy trading revenue. Beginning in third quarter 2002, Duke Energy is reporting its energy trading revenue on a “net basis,” and has revised the revenue reported for comparative periods. Therefore, third quarter 2002 revenue was $4.21 billion, compared with $4.78 billion in third quarter 2001. Year-to-date 2002 revenue was $11.5 billion, compared with $14.88 billion during the same period in 2001.
At Sept. 30, based on actuarial estimates, the company’s pension plan obligation exceeded the value of the plan assets by $439 million due the erosion of the value of its equities investments. As a result, the company was required to record a pension liability of $772 million, a combination of the $439 million excess obligation and $333 million in pre-paid pension assets. The liability was offset in other comprehensive income, net of deferred income taxes. The amount of this liability will change in future years as the market value of the assets changes.
Liquidity and capital resources
Duke Energy’s consolidated capital structure as of Sept. 30, 2002, including short-term debt, was 56 percent debt, 35 percent common equity, 5 percent minority interests and 4 percent preferred securities. The company had $473 million in cash and cash equivalents as of Sept. 30, 2002.
Under its commercial paper programs, including its letter of credit facility, Duke Energy and Duke Capital had the ability to borrow up to $3.4 billion as of Sept. 30, 2002. The companies had borrowings and letters of credit outstanding under these programs of approximately $1.9 billion as of Sept. 30, 2002, resulting in unused liquidity of approximately $1.5 billion. In addition, Duke Capital has a $500 million bank credit line available through June 2003 which is currently undrawn. For the nine months ending Sept. 30, 2002, cash flow from operations was $3.3 billion, compared to $3.9 billion the same period last year.
In October, Duke Energy raised approximately $1 billion in a public offering of 54,500,000 shares of common stock at $18.35 per share. The net proceeds from the offering were used to repay commercial paper previously issued to fund a portion of the acquisition of Westcoast Energy.
Duke Energy previously announced that as a result of depressed market conditions and lower results at its merchant energy business, it would make significant cuts in planned capital expenditures over the next two years. The company estimates 2002 full-year capital spending of no more than $6.2 billion, excluding the acquisition of Westcoast Energy. Capital expenditure plans for 2003 have been reduced to approximately $3.5 billion, which the company intends to fund through internal cash flow and asset sales, after dividend payments.
Interest expense was $316 million for third quarter 2002, compared to $191 million for third quarter 2001. The increase is primarily due to debt acquired in conjunction with the Westcoast Energy acquisition.
The energy industry has continued to be the focus of government investigations. As reported previously, Duke Energy received and responded to information requests from the Federal Energy Regulatory Commission (FERC), a request for information from the Securities & Exchange Commission, a subpoena from the Commodity Futures Trading Commission and a grand jury subpoena issued by the U.S. attorney’s office in Houston. Duke Energy was advised in mid- October that the SEC has formalized its inquiry regarding so-called “round- trip” trading. All information requests and subpoenas seek documents and information related to trading activities, including “round-trip” trading. Duke Energy is continuing to cooperate with all of the respective governmental agencies.
On Oct. 22, the North Carolina Utilities Commission (NCUC), the Public Service Commission of South Carolina (PSCSC) and Duke Power announced a proposed settlement agreement in response to the previously disclosed audit of certain regulatory accounting matters.
In addition to changes primarily related to nuclear insurance distributions, the proposed agreement calls for Duke Power to record a one-time $25 million credit to its deferred fuels account for the benefit of North Carolina and South Carolina customers. Also, as part of the proposed agreement, Duke Energy would reclassify $52 million of $58 million currently in a suspense account to a nuclear insurance operation reserve account.
The remaining $6 million would be credited to income, which would result in a $19 million net pre-tax charge in fourth quarter 2002. The settlement agreement will be submitted for approval to the NCUC on Oct. 28 and to the PSCSC on Oct. 29. Duke Energy views the proposed settlement as a way to formally and positively resolve all matters within the scope of the review.
Business unit results
The Natural Gas Transmission segment reported third quarter 2002 EBIT of $287 million, a 100-percent increase over the $143 million in third quarter 2001. Results included the second full quarter of earnings from the recently acquired Westcoast Energy natural gas transmission and distribution assets, which contributed $92 million to third quarter 2002 EBIT. The other key drivers of the improved results related to reduced operating and maintenance expenses and the $18 million gain on the sale of limited partnership units in its Northern Border partnership.
Year-to-date 2002 EBIT for Gas Transmission was $867 million, compared to $460 million in 2001.
During the quarter, Gas Transmission gained key regulatory approvals toward completion of two strategically important North American projects. Last month, the Patriot natural gas pipeline project received a Final Environmental Impact Statement from FERC. The Patriot project will expand the company’s existing East Tennessee Natural Gas system in Tennessee and Virginia, and extend the system into southwest Virginia and northern North Carolina through a new 94-mile natural gas pipeline.
FERC also issued a certificate of public convenience and necessity to Islander East, authorizing the construction, operation and maintenance of approximately 50 miles of interstate natural gas pipeline facilities in Connecticut and Long Island, N.Y. Islander East is an equally owned, limited-liability company formed between the subsidiaries of KeySpan Corp. and Duke Energy. The company is working to obtain all remaining timely approvals and authorizations.
Third quarter 2002 EBIT from Duke Energy’s franchised electric business was $585 million, compared to $607 million for third quarter 2001. Included in these results is a charge in third quarter 2002 of $21 million for severance costs related to work force reductions. Furthermore, results were impacted by solid nuclear operations and increased revenues due to favorable weather, offset by lower industrial sales and increased costs for a scheduled nuclear outage. Third quarter 2001 results included a charge of $33 million due to the reclassification of nuclear insurance distributions from income to a balance sheet suspense account as ordered by NCUC.
Year-to-date EBIT for Franchised Electric was $1.36 billion compared to $1.43 billion in 2001.
Duke Energy North America
DENA, which includes Duke Energy’s 60-percent share in Duke Energy Trading & Marketing, reported an EBIT loss of $107 million for the third quarter 2002, compared to positive EBIT of $654 million during third quarter 2001. Results for 2002 include $207 million of charges discussed earlier.
Year-to-date 2002 EBIT for DENA was $143 million compared to $1.31 billion in 2001.
DENA’s results were negatively impacted by the slow economic recovery, continued low price volatility in the merchant energy sector, low spark spreads and decreased trading market liquidity. The market also continues to suffer from the credit weakness of many industry participants and regulatory uncertainty.
DENA has taken actions to effectively deal with the current operating environment, including staff reductions, contraction of daily earnings at risk (DER), reduction in capital investment and the previously announced reorganization of the trading management team.
For third quarter 2002, the International Energy segment, comprised of the Asia-Pacific, Latin American and European regional businesses of Duke Energy International (DEI), delivered an EBIT loss of $25 million, compared to third quarter 2001 EBIT of $74 million. Included in these results were $91 million in charges in the quarter as a result of the write-off of site-development costs and the write-down of uninstalled turbines, primarily related to Brazil. Results were also adversely impacted by lower trading margins and liquidity in Europe, partially offset by the additional contribution from energy assets in Mexico and Indonesia acquired as part of the Westcoast Energy acquisition.
Year-to-date 2002 EBIT for International Energy was $109 million compared to $218 million in 2001.
Other Energy Services
Other Energy Services, the financial reporting unit comprised of Duke/Fluor Daniel (D/FD) and Duke Energy Merchants (DEM), reported EBIT of $9 million for third quarter 2002 versus a $58 million loss in third quarter 2001. Last year’s results were adversely impacted by the write-down of assets at DEM and the company’s former Duke Engineering & Services unit. Year-to- date EBIT for Other Energy Services was $92 million compared to an EBIT loss of $102 million in 2001.
The Field Services business segment, which represents Duke Energy’s majority interest in Duke Energy Field Services (DEFS), reported third quarter 2002 EBIT of $23 million compared to $75 million in third quarter 2001. The decline was due primarily to higher operating and administrative costs, an increase in its provision for gas imbalances with customers and suppliers, and other charges related to its ongoing internal review and reconciliations of balance sheet accounts.
Year-to-date 2002 EBIT for Field Services was $99 million compared to $282 million in 2001.
The Duke Ventures business segment, comprised of Crescent Resources, DukeNet Communications and Duke Capital Partners, reported EBIT of $21 million for third quarter 2002, compared to $51 million in third quarter 2001.
Year-to-date EBIT for Duke Ventures was $83 million compared to $94 million in 2001.
Trading and risk management
Duke Energy released the following metrics for its trading and marketing operations. Daily earnings at risk (DER), a measure of the likely one-day favorable or unfavorable movements in commodity prices and their corresponding effects on EBIT within Duke Energy’s trading portfolio, averaged $12 million in third quarter 2002. The average DER for third quarter 2001 was $16 million.
DENA’s merchant generation portfolio (the “accrual book”) — including merchant generation facilities and hedging contracts held for power and natural gas, crude oil and petroleum products — has forecasted gross margins totaling $5.3 billion as of Sept. 30, 2002. On a cumulative basis, approximately 3 percent of this margin is expected to be realized by the end of 2002, 14 percent through 2003, 23 percent through 2004 and the remainder in 2005 and beyond. The reduction in the accrual book valuation is a result of changes in correlations and volatility.
The expected DENA North American merchant generation economic output hedged for 2003 is 94 percent, for 2004 is 64 percent and for 2005 is 65 percent.
The value of Duke Energy’s mark-to-market trading portfolio was $0.7 billion. On a cumulative basis, approximately 17 percent of the fair value of these contracts is expected to be realized by the end of 2002, 35 percent through 2003, 50 percent through 2004 and the remainder in 2005 and beyond. Under MTM accounting rules, the change in the fair value of trading contracts is recognized in earnings during the current period. The unrealized MTM loss for third quarter 2002 was $161 million compared with a gain of $103 million for second quarter 2002.
Duke Energy is a diversified multinational energy company with an integrated network of energy assets and expertise. The company manages a dynamic portfolio of natural gas and supply, delivery and trading businesses — meeting the energy needs of customers throughout North America and in key markets around the world. Duke Energy, headquartered in Charlotte, N.C., is a Fortune 500 company traded on the New York Stock Exchange under the symbol DUK. More information about the company is available on the Internet at: www.duke-energy.com.
A replay of the conference call will be available until Nov. 5 by dialing 888/203-1112 with a confirmation code of 772948. The international replay number is 719/457-0820, confirmation code 772948. A replay and transcript also will be available by accessing the investors’ section of the company’s Web site.