EXHIBIT 99(b)
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1994
(2) JOINTLY-OWNED NUCLEAR PLANT
(a) HL&P INVESTMENT. HL&P is the project manager (and one of four co-owners)
of the South Texas Project, which consists of two 1,250 megawatt nuclear
generating units. HL&P has a 30.8 percent interest in the project and
bears a corresponding share of capital and operating
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costs associated with the project. As of December 31, 1994, HL&P's
investments (net of accumulated depreciation and amortization) in the
South Texas Project and in nuclear fuel, including AFUDC, were $2.1
billion and $99 million, respectively.
(b) UNITED STATES NUCLEAR REGULATORY COMMISSION (NRC) INSPECTIONS AND
OPERATIONS. Both generating units at the South Texas Project were out of
service from February 1993 to February 1994, when Unit No. 1 was
returned to service. Unit No. 2 was returned to service in May 1994.
HL&P removed the units from service in February 1993 when a problem was
encountered with certain of the units' auxiliary feedwater pumps.
In February 1995, the NRC removed the South Texas Project from its
"watch list" of plants with weaknesses that warranted increased NRC
attention. The NRC placed the South Texas Project on the "watch list" in
June 1993, following the issuance of a report by an NRC Diagnostic
Evaluation Team (DET) which conducted a review of the South Texas
Project operations.
Certain current and former employees of HL&P or contractors of HL&P have
asserted claims that their employment was terminated or disrupted in
retaliation for their having made safety-related complaints to the NRC.
Civil proceedings by the complaining personnel and administrative
proceedings by the Department of Labor remain pending against HL&P, and
the NRC has jurisdiction to take enforcement action against HL&P and/or
individual employees with respect to these matters. Based on its own
internal investigation, in October 1994 the NRC issued a notice of
violation and proposed a $100,000 civil penalty against HL&P in one such
case in which HL&P had terminated the site access of a former contractor
employee. In that action, the NRC also requested information relating to
possible further enforcement action in this matter against two HL&P
managers involved in such termination. HL&P strongly disagrees with the
NRC's conclusions, and has requested the NRC to give further
consideration of its notice. In February 1995, the NRC conducted an
enforcement conference with respect to that matter, but no result has
been received.
HL&P has provided documents and other assistance to a subcommittee of
the U. S. House of Representatives (Subcommittee) that is conducting an
inquiry related to the South Texas Project. Although the precise focus
and timing of the inquiry has not been identified by the Subcommittee,
it is anticipated that the Subcommittee will inquire into matters
related to HL&P's handling of employee concerns and to issues related to
the NRC's 1993 DET review of the South Texas Project. In connection with
that inquiry, HL&P has been advised that the U. S. General Accounting
Office (GAO) is conducting a review of the NRC's inspection process as
it relates to the South Texas Project and other plants, and HL&P is
cooperating with the GAO in its investigation and with the NRC in a
similar review it has initiated. While no prediction can be made at this
time as to the ultimate outcome of these matters, the Company and HL&P
do not believe that they will have a material adverse effect on the
Company's or HL&P's financial condition or results of operations.
(c) LITIGATION WITH CO-OWNERS OF THE SOUTH TEXAS PROJECT. In February 1994,
the City of Austin (Austin), one of the four co-owners of the South
Texas Project, filed suit (Austin II Litigation) against HL&P. That suit
is pending in the 152nd District Court for Harris County, Texas, which
has set a trial date for October 1995. Austin alleges that the outages
at the South Texas
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Project from early 1993 to early 1994 were due to HL&P's failure to
perform obligations it owed to Austin under the Participation Agreement
among the four co-owners of the South Texas Project (Participation
Agreement). Austin also asserts that HL&P breached certain undertakings
voluntarily assumed by HL&P under the terms and conditions of the
Operating Licenses and Technical Specifications relating to the South
Texas Project. Austin claims that such failures have caused Austin
damages of at least $125 million due to the incurrence of increased
operating and maintenance costs, the cost of replacement power and lost
profits on wholesale transactions that did not occur. In May 1994, the
City of San Antonio (San Antonio), another co-owner of the South Texas
Project, intervened in the litigation filed by Austin against HL&P and
asserted claims similar to those asserted by Austin. San Antonio has not
identified the amount of damages it intends to seek from HL&P. HL&P is
contesting San Antonio's intervention and has called for arbitration of
San Antonio's claim under the arbitration provisions of the
Participation Agreement. The trial court has denied HL&P's requests, but
review of these decisions is currently pending before the 1st Court of
Appeals in Houston.
In a previous lawsuit (Austin I Litigation) filed in 1983 against the
Company and HL&P, Austin alleged that it had been fraudulently induced
to participate in the South Texas Project and that HL&P had failed to
perform properly its duties as project manager. In May 1993, the courts
entered a judgement in favor of the Company and HL&P, concluding, among
other things, that the Participation Agreement did not impose on HL&P a
duty to exercise reasonable skill and care as project manager. During
the course of the Austin I Litigation, San Antonio and Central Power and
Light Company (CPL), a subsidiary of Central and South West Corporation,
two of the co-owners in the South Texas Project, also asserted claims
for unspecified damages against HL&P as project manager of the South
Texas Project, alleging HL&P breached its duties and obligations. San
Antonio and CPL requested arbitration of their claims under the
Participation Agreement. In 1992, the Company and HL&P entered into a
settlement agreement with CPL (CPL Settlement) providing for CPL's
withdrawal of its demand for arbitration. San Antonio's claims for
arbitration remain pending. Under the Participation Agreement, San
Antonio's arbitration claims will be heard by a panel of five
arbitrators consisting of four arbitrators named by each co-owner and a
fifth arbitrator selected by the four appointed arbitrators.
Although the CPL Settlement did not directly affect San Antonio's
pending demand for arbitration, HL&P and CPL reached certain
understandings in such agreement which contemplated that: (i) CPL's
previously appointed arbitrator would be replaced by CPL; (ii)
arbitrators approved by CPL or HL&P in any future arbitrations would be
mutually acceptable to HL&P and CPL; and (iii) HL&P and CPL would
resolve any future disputes between them concerning the South Texas
Project without resorting to the arbitration provision of the
Participation Agreement. Austin and San Antonio have asserted in the
pending Austin II Litigation that such understandings have rendered the
arbitration provisions of the Participation Agreement void and that
neither Austin nor San Antonio should be required to participate in or
be bound by such proceedings.
Although HL&P and the Company do not believe there is merit to either
Austin's or San Antonio's claims and have opposed San Antonio's
intervention in the Austin II Litigation, there can be no assurance as
to the ultimate outcome of these matters.
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(d) NUCLEAR INSURANCE. HL&P and the other owners of the South Texas Project
maintain nuclear property and nuclear liability insurance coverage as
required by law and periodically review available limits and coverage
for additional protection. The owners of the South Texas Project
currently maintain the maximum amount of property damage insurance
currently available through the insurance industry, consisting of $500
million in primary property damage insurance and excess property
insurance in the amount of $2.25 billion. Under the excess property
insurance which became effective on March 1, 1995 and under portions of
the excess property insurance coverage in effect prior to March 1, 1995,
HL&P and the other owners of the South Texas Project are subject to
assessments, the maximum aggregate assessment under current policies
being $26.9 million during any one policy year. The application of the
proceeds of such property insurance is subject to the priorities
established by the NRC regulations relating to the safety of licensed
reactors and decontamination operations.
Pursuant to the Price Anderson Act (Act), the maximum liability to the
public for owners of nuclear power plants, such as the South Texas
Project, was decreased from $9.0 billion to $8.92 billion effective in
November 1994. Owners are required under the Act to insure their
liability for nuclear incidents and protective evacuations by
maintaining the maximum amount of financial protection available from
private sources and by maintaining secondary financial protection
through an industry retrospective rating plan. The assessment of
deferred premiums provided by the plan for each nuclear incident is up
to $75.5 million per reactor subject to indexing for inflation, a
possible 5 percent surcharge (but no more than $10 million per reactor
per incident in any one year) and a 3 percent state premium tax. HL&P
and the other owners of the South Texas Project currently maintain the
required nuclear liability insurance and participate in the industry
retrospective rating plan.
There can be no assurance that all potential losses or liabilities will
be insurable, or that the amount of insurance will be sufficient to
cover them. Any substantial losses not covered by insurance would have a
material effect on HL&P's and the Company's financial condition.
(e) NUCLEAR DECOMMISSIONING. HL&P and the other co-owners of the South Texas
Project are required by the NRC to meet minimum decommissioning funding
requirements to pay the costs of decommissioning the South Texas
Project. Pursuant to the terms of the order of the Utility Commission in
Docket No. 9850, HL&P is currently funding decommissioning costs for the
South Texas Project with an independent trustee at an annual amount of
$6 million, which is recorded in depreciation and amortization expense.
HL&P's funding level is estimated to provide approximately $146 million,
in 1989 dollars, an amount which exceeds the current NRC minimum.
The Company adopted SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," effective January 1, 1994. At December 31,
1994, the securities held in the Company's nuclear decommissioning trust
totaling $25.1 million (reflected on the Company's Consolidated and
HL&P's Balance Sheets in deferred debits and deferred credits) are
classified as available for sale. Such securities are reported on the
balance sheets at fair value, which at December 31, 1994 approximates
cost, and any unrealized gains or losses will be reported as a separate
component of common stock equity. Earnings, net of taxes and
administrative costs, are reinvested in the funds.
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In May 1994, an outside consultant estimated HL&P's portion of
decommissioning costs to be approximately $318 million, in 1994 dollars.
The consultant's calculation of decommissioning costs for financial
planning purposes used the DECON methodology (prompt
removal/dismantling), one of the three alternatives acceptable to the
NRC, and assumed deactivation of Unit Nos. 1 and 2 upon the expiration
of their 40 year operating licenses. Under the terms of the Proposed
Settlement, HL&P would increase funding of decommissioning costs to an
annual amount of approximately $14.8 million consistent with such study.
While the current and projected funding levels presently exceed minimum
NRC requirements, no assurance can be given that the amounts held in
trust will be adequate to cover the actual decommissioning costs of the
South Texas Project or the assumptions used in estimating
decommissioning costs will ultimately prove to be correct.
(3) RATE REVIEW, FUEL RECONCILIATION AND OTHER PROCEEDINGS
In February 1994, the Utility Commission initiated a proceeding (Docket
No. 12065) to determine whether HL&P's existing rates are just and
reasonable. Subsequently, the scope of the docket was expanded to
include reconciliation of HL&P's fuel costs from April 1, 1990 to July
31, 1994. The Utility Commission also initiated a separate proceeding
(Docket No. 13126) to review issues regarding the prudence of operation
of the South Texas Project from the date of commercial operation through
the present. That review would encompass the outage at the South Texas
Project during 1993 through 1994.
Hearings began in Docket No. 12065 in January 1995, and the Utility
Commission has retained a consultant to review the South Texas Project
for the purpose of providing testimony in Docket No. 13126 regarding the
prudence of HL&P's management of operation of the South Texas Project.
In February 1995, all major parties to these proceedings signed the
Proposed Settlement resolving the issues with respect to HL&P, including
the prudence issues related to operation of the South Texas Project.
Approval of the Proposed Settlement by the Utility Commission will be
required. To that end, the parties have established procedural dates for
a hearing on issues raised by the parties who are opposed to the
Proposed Settlement. A decision by the Utility Commission on the
Proposed Settlement is not anticipated before early summer.
Under the Proposed Settlement, HL&P's base rates would be reduced by
approximately $62 million per year, effective retroactively to January
1, 1995, and rates would be frozen for three years, subject to certain
conditions. Under the Proposed Settlement, HL&P would amortize its
remaining investment of $218 million in the cancelled Malakoff plant
over a period not to exceed seven years. HL&P also would increase its
decommissioning expense for the South Texas Project by $9 million per
year.
Under the Proposed Settlement, approximately $70 million of fuel
expenditures and related interest incurred by HL&P during the fuel
reconciliation period would not be recoverable from ratepayers. This $70
million was recorded as a one-time, pre-tax charge to reconcilable fuel
revenues to reflect the anticipation of approval of the Proposed
Settlement. HL&P also would establish a new fuel factor approximately 17
percent below that currently in effect and would
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refund to customers the balance in its fuel over-recovery account,
estimated to be approximately $180 million after giving effect to the
amounts not recoverable from ratepayers.
HL&P recovers fuel costs incurred in electric generation through a fixed
fuel factor that is set by the Utility Commission. The difference
between fuel revenues billed pursuant to such factor and fuel expense
incurred is recorded as an addition to or a reduction of revenue, with a
corresponding entry to under- or over-recovered fuel, as appropriate.
Amounts collected pursuant to the fixed fuel factor must be reconciled
periodically against actual, reasonable costs as determined by the
Utility Commission. Currently, HL&P has an over-recovery fuel account
balance that will be refunded pursuant to the Proposed Settlement.
In the event that the Proposed Settlement is not approved by the Utility
Commission, including issues related to the South Texas Project, Docket
No. 12065 will be remanded to an Administrative Law Judge (ALJ) to
resume detailed hearings in this docket. Prior to reaching agreement on
the terms of the Proposed Settlement, HL&P argued that its existing
rates were just and reasonable and should not be reduced. Other parties
argued that rate decreases in annual amounts ranging from $26 million to
$173 million were required and that additional decreases might be
justified following an examination of the prudence of the management of
the South Texas Project and the costs incurred in connection with the
outages at the South Texas Project. Testimony filed by the Utility
Commission staff included a recommendation to remove from rate base $515
million of HL&P's investment in the South Texas Project to reflect the
staff's view that such investment was not fully "used and useful" in
providing service, a position HL&P vigorously disputes.
In the event the Proposed Settlement is not approved by the Utility
Commission, the fuel reconciliation issues in Docket Nos. 12065 and
13126 would be remanded to an ALJ for additional proceedings. A major
issue in Docket No. 13126 will be whether the incremental fuel costs
incurred as a result of outages at the South Texas Project represent
reasonable costs. HL&P filed testimony in Docket No. 13126, which
testimony concluded that the outages at the South Texas Project did not
result from imprudent management. HL&P also filed testimony analyzing
the extent to which regulatory issues extended the outages. In that
testimony an outside consultant retained by HL&P concluded that the
duration of the outages was controlled by both the resolution of NRC
regulatory issues as well as necessary equipment repairs unrelated to
NRC regulatory issues and that the incremental effect of NRC regulatory
issues on the duration of the outages was only 39 days per unit.
Estimates as to the cost of replacement power may vary significantly
based on a number of factors, including the capacity factor at which the
South Texas Project might be assumed to have operated had it not been
out of service due to the outages. However, HL&P believes that applying
a reasonable range of assumptions would result in replacement fuel costs
of less than $10 million for the 39 day periods identified by HL&P's
consultant and less than $100 million for the entire length of the
outages. Any fuel costs determined to have been unreasonably incurred
would not be recoverable from customers and would be charged against the
Company's earnings.
Although the Company and HL&P believe that the Proposed Settlement is in
the best interest of HL&P, its ratepayers, and the Company and its
shareholders, no assurance can be given that (i) the Utility Commission
ultimately will approve the terms of the Proposed Settlement or
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(ii) in the event the Proposed Settlement is not approved and
proceedings against HL&P resumed, that the outcome of such proceedings
would be favorable to HL&P.
(4) APPEALS OF PRIOR UTILITY COMMISSION RATE ORDERS
Pursuant to a series of applications filed by HL&P in recent years, the
Utility Commission has granted HL&P rate increases to reflect in
electric rates HL&P's substantial investment in new plant construction,
including the South Texas Project. Although Utility Commission action on
those applications has been completed, judicial review of a number of
the Utility Commission orders is pending. In Texas, Utility Commission
orders may be appealed to a District Court in Travis County, and from
that Court's decision an appeal may be taken to the Court of Appeals for
the 3rd District at Austin (Austin Court of Appeals). Discretionary
review by the Supreme Court of Texas may be sought from decisions of the
Austin Court of Appeals. The pending appeals from the Utility Commission
orders are in various stages. In the event the courts ultimately reverse
actions of the Utility Commission in any of these proceedings, such
matters would be remanded to the Utility Commission for action in light
of the courts' orders. Because of the number of variables which can
affect the ultimate resolution of such matters on remand, the Company
and HL&P generally are not in a position at this time to predict the
outcome of the matters on appeal or the ultimate effect that adverse
action by the courts could have on the Company and HL&P. On remand, the
Utility Commission's action could range from granting rate relief
substantially equal to the rates previously approved to a reduction in
the revenues to which HL&P was entitled during the time the applicable
rates were in effect, which could require a refund to customers of
amounts collected pursuant to such rates. Judicial review has been
concluded or currently is pending on the final orders of the Utility
Commission described below.
(a) 1991 RATE CASE. In HL&P's 1991 rate case (Docket No. 9850), the Utility
Commission approved a non-unanimous settlement agreement providing for a
$313 million increase in HL&P's base rates, termination of deferrals
granted with respect to Unit No. 2 of the South Texas Project and of the
qualified phase-in plan deferrals granted with respect to Unit No. 1 of
the South Texas Project, and recovery of deferred plant costs. The
settlement authorized a 12.55 percent return on common equity for HL&P.
Rates contemplated by the settlement agreement were implemented in May
1991 and remain in effect (subject to the outcome of the current rate
proceeding described in Note 3).
The Utility Commission's order in Docket No. 9850 was affirmed on review
by a District Court, and the Austin Court of Appeals affirmed that
decision on procedural grounds due to the failure of the appellant to
file the record with the court in a timely manner. On review, the Texas
Supreme Court has remanded the case to the Austin Court of Appeals for
consideration of the appellant's challenges to the Utility Commission's
order, which include issues regarding deferred accounting, the treatment
of federal income tax expense and certain other matters. As to federal
tax issues, a recent decision of the Austin Court of Appeals, in an
appeal involving GTE-SW (and to which HL&P was not a party), held that
when a utility pays federal income taxes as part of a consolidated
group, the utility's ratepayers are entitled to a fair share of the tax
savings actually realized, which can include savings resulting from
unregulated activities. The
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Texas Supreme Court has agreed to hear an appeal of that decision, but
on points not involving the federal income tax issues, though tax issues
could be decided in such opinion.
Because the Utility Commission's order in Docket No. 9850 found that
HL&P would have been entitled to rate relief greater than the $313
million agreed to in the settlement, HL&P believes that any disallowance
that might be required if the court's ruling in the GTE decision were
applied in Docket No. 9850 would be offset by that greater amount.
However, that amount may not be sufficient if the Austin Court of
Appeals also concludes that the Utility Commission's inclusion of
deferred accounting costs in the settlement was improper. For a
discussion of the Texas Supreme Court's decision on deferred accounting
treatment, see Note 4(c). Although HL&P believes that it could
demonstrate entitlement to rate relief equal to that agreed to in the
stipulation in Docket No. 9850, HL&P cannot rule out the possibility
that a remand and reopening of that settlement would be required if
decisions unfavorable to HL&P are rendered on both the deferred
accounting treatment and the calculation of tax expense for rate making
purposes.
The parties to the Proposed Settlement have agreed to withdraw their
appeals of the Utility Commission's orders in such docket, subject to
HL&P's dismissing its appeal in Docket No. 6668.
(b) 1988 RATE CASE. In HL&P's 1988 rate case (Docket No. 8425), the Utility
Commission granted HL&P a $227 million increase in base revenues,
allowed a 12.92 percent return on common equity, authorized a qualified
phase-in plan for Unit No. 1 of the South Texas Project (including
approximately 72 percent of HL&P's investment in Unit No. 1 of the South
Texas Project in rate base) and authorized HL&P to use deferred
accounting for Unit No. 2 of the South Texas Project. Rates
substantially corresponding to the increase granted were implemented by
HL&P in June 1989 and remained in effect until May 1991.
In August 1994, the Austin Court of Appeals affirmed the Utility
Commission's order in Docket No. 8425 on all matters other than the
Utility Commission's treatment of tax savings associated with deductions
taken for expenses disallowed in cost of service. The court held that
the Utility Commission had failed to require that such tax savings be
passed on to ratepayers, and ordered that the case be remanded to the
Utility Commission with instructions to adjust HL&P's cost of service
accordingly. Discretionary review is being sought from the Texas Supreme
Court by all parties to the proceeding.
The parties to the Proposed Settlement have agreed to dismiss their
respective appeals of Docket No. 8425, subject to HL&P's dismissing its
appeal in Docket No. 6668. A separate party to this appeal, however, has
not agreed to dismiss its appeal.
(c) DEFERRED ACCOUNTING. Deferred accounting treatment for certain costs
associated with Unit No. 1 of the South Texas Project was authorized by
the Utility Commission in Docket No. 8230 and was extended in Docket No.
9010. Similar deferred accounting treatment with respect to Unit No. 2
of the South Texas Project was authorized in Docket No. 8425. For a
discussion of the deferred accounting treatment granted, see Note 1(f).
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In June 1994, the Texas Supreme Court decided the appeal of Docket Nos.
8230 and 9010, as well as all other pending deferred accounting cases
involving other utilities, upholding deferred accounting treatment for
both carrying costs and operation and maintenance expenses as within the
Utility Commission's statutory authority and reversed the Austin Court
of Appeals decision to the extent that the Austin Court of Appeals had
rejected deferred accounting treatment for carrying charges. Because the
lower appellate court had upheld deferred accounting only as to
operation and maintenance expenses, the Texas Supreme Court remanded
Docket Nos. 8230 and 9010 to the Austin Court of Appeals to consider the
points of error challenging the granting of deferred accounting for
carrying costs which it had not reached in its earlier consideration of
the case. The Texas Supreme Court opinion did state, however, that when
deferred costs are considered for addition to the utility's rate base in
an ensuing rate case, the Utility Commission must then determine to what
extent inclusion of the deferred costs is necessary to preserve the
utility's financial integrity. Under the terms of the Proposed
Settlement, South Texas Project deferrals will continue to be amortized
under the schedule previously established.
The Office of the Public Utility Counsel (OPUC) has agreed, pursuant to
the Proposed Settlement, to withdraw and dismiss its appeal if the
Proposed Settlement becomes effective and on the condition that HL&P
dismisses its appeal in Docket No. 6668. However, the appeal of the
State of Texas remains pending.
(d) PRUDENCE REVIEW OF THE CONSTRUCTION OF THE SOUTH TEXAS PROJECT. In June
1990, the Utility Commission ruled in a separate docket (Docket No.
6668) that had been created to review the prudence of HL&P's planning
and construction of the South Texas Project that $375.5 million out of
HL&P's $2.8 billion investment in the two units of the South Texas
Project had been imprudently incurred. That ruling was incorporated into
HL&P's 1988 and 1991 rate cases and resulted in HL&P's recording an
after-tax charge of $15 million in 1990. Several parties appealed the
Utility Commission's decision, but a District Court dismissed these
appeals on procedural grounds. The Austin Court of Appeals reversed and
directed consideration of the appeals, and the Texas Supreme Court
denied discretionary review in 1994. At this time, no action has been
taken by the appellants to proceed with the appeals. Unless the order in
Docket No. 6668 is modified or reversed on appeal, the amount found
imprudent by the Utility Commission will be sustained.
Under the Proposed Settlement, OPUC, HL&P and the City of Houston each
has agreed to dismiss its respective appeals of Docket No. 6668. A
separate party to this appeal, however, has not agreed to dismiss its
appeal. If this party does not elect to dismiss its appeal, HL&P may
elect to maintain its appeal, whereupon OPUC and City of Houston shall
also be entitled to maintain their appeals.
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