Skip to main content


(DUK) - Get Duke Energy Corporation Report

is hoping that a new accounting trick can solve a familiar problem.

The company is seeking permission for a novel change -- accelerating years' worth of interest payments -- in an effort to dodge a rate cut in its second-largest market. But the company is at the mercy of the same utility regulators who have been burned by Duke's books before.

The Public Service Commission of South Carolina, which last year determined that Duke had been understating its regulated profits for years, is set to decide Tuesday whether it will grant the accounting change and keep Duke's current rates intact. The hearing comes two months after the commission demanded an explanation for soaring profits earned from regulated assets that apparently helped the company at the expense of its customers.

In a response last week to the commission, Duke acknowledged that it had earned profits that were "significantly in excess" of what the state permits. It attributed the fat returns -- which came in at 14.25%, well above the allowed 12.5% -- to a cold snap that boosted demand for its cheap electricity in the wholesale power market. And it asked to book $50 million worth of long-term interest costs in a single quarter to bring its reported profits back under the cap.

Gary Walsh, who serves as executive director of the South Carolina commission, said the agency has granted accounting orders for utilities in the past. But he pointed to Duke's strategy -- which would revise profits that have already been posted -- as a bit unusual.

"The principle

of accounting orders is not foreign to us," Walsh said. "But I do not believe, in my 32 years here, we've ever granted an accelerated write-off of debt costs."

Walsh declined to predict whether the seven-member commission will break that pattern this week.

"We'll just have to see where four votes fall on Tuesday," he said.

Duke shares slipped 20 cents Friday to close at $17.40.

High Stakes

Duke clearly needs a victory.

Duke Power, which ranks as the company's biggest profit center, relies on South Carolina customers for roughly 25% of its income. Even without a rate cut, Duke expects to hit just the low end of its full-year earnings guidance of $1.35 to $1.60 a share. So an unfavorable decision, if implemented soon, almost guarantees an earnings miss.

It also threatens the lavish dividend that helps keep Duke's stock propped up. Already, Duke has shied away from promising the $1.10 dividend much longer.

"We do not anticipate eliminating the dividend in 2004," said Duke spokesman Terry Francisco. "But it's up to the board to set it."

TheStreet Recommends

Francisco expects the board to evaluate the dividend some time in the fourth quarter. In the meantime, the rating agencies -- which could push for a cut before then -- are reportedly focused on the case in South Carolina.

"Gary Walsh gets a phone call once a week from Moody's about the issues going on down there," said one company insider. "They're interested in any change in Duke's outlook from a cash-flow perspective."

Duke itself has indicated that a rate cut would hurt. Indeed, the company has taken extraordinary steps to dodge possible rate cuts before.

Fuzzy Math

Last time around, Duke simply took matters into its own hands.

In late 1998, after the South Carolina commission slashed another utility's rates, Duke took a closer look at its own returns. And it was clearly worried by what it saw.

"A number of Duke mid- to senior-level managers met and developed a plan to identify expense and revenue items which could serve as a basis for accounting adjustments which could be made to 'avoid reporting over-earnings to regulators,'" a 2002 audit, carried out by Grant Thornton on behalf of Carolina regulators, determined.

Particularly damaging was evidence tied to Duke's former manager of rates and regulatory affairs. Throughout the audit, Don Stratton is seen pushing for accounting changes that would have reduced Duke's reported earnings.

"Stratton prepared a three-page spreadsheet entitled 'Analysis of EBIT,' which calculated that Duke needed '$70 million

in additional expense items ... to avoid over-earnings to regulators," the audit states, citing internal interviews and documents. "In

a meeting, at which the two accountants reported to Stratton that they had identified only $48 million in adjustments, Stratton said 'he would have liked $100 million.'"

In the end, the audit found, Duke used a mix of accounting tricks -- some with little or no justification under generally accepted accounting practices -- to shave $64 million from its regulated profits. The company continued to underreport utility profits for the next two years until internal accountant F. Barron Stone finally blew the whistle in 2001.

Duke ultimately paid a modest sum to settle the affair. But federal investigators have since taken over with a criminal probe that could turn up indictments.

In the meantime, some company leaders have already made themselves scarce. Stratton, for instance, was last seen by some fellow employees weeks ago. Although Francisco confirmed Friday that Stratton is still with the company, Stratton's voice mail offers only a vague message saying, "I'll be out of the office until further notice."

Even Duke's top executive, CEO Richard Priory, has been far less visible than usual. He was absent from a recent earnings call that, many observers believe, was badly bungled by his subordinates. He also missed out on follow-up meetings with analysts in Boston and New York, as well as a big utility conference hosted by Lehman Brothers last week.

Francisco downplayed the matter by saying Priory has been tied up with other commitments.

For now, the company itself is focused on the South Carolina hearing. Duke is hoping to convince the Carolina regulators that it has the best interests of its customers -- and not just its shareholders -- in mind.

"South Carolina retail customers will realize long-term benefits because these costs

associated with the proposed accounting change will no longer be included in the company's rate base and expenses after they are written off," wrote Duke Power President Ruth Shaw.

But Stone, for one, has his doubts.

"I believe GAAP says these financing costs follow the debt instruments," he said. "You don't have to be an accountant to figure that out. ... I'd be very surprised if the commission approves an accounting order for Duke."

As originally published, this story contained an error. Please see

Corrections and Clarifications.