1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
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 1-3187
RELIANT ENERGY, INCORPORATED
(Exact name of registrant as specified in its charter)
Texas 74-0694415
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
Commission file number 1-13265
RELIANT ENERGY RESOURCES CORP.
(Exact name of registrant as specified in its charter)
Delaware 76-0511406
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
-----------------------------
RELIANT ENERGY RESOURCES CORP. MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q
WITH THE REDUCED DISCLOSURE FORMAT.
Indicate by check mark whether the registrants: (1) have 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
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
As of May 8, 2001, Reliant Energy, Incorporated had 297,464,776 shares of common
stock outstanding, including 7,658,889 ESOP shares not deemed outstanding for
financial statement purposes and excluding 4,511,691 shares held as treasury
stock. As of May 8, 2001, all 1,000 shares of Reliant Energy Resources Corp.
common stock were held by Reliant Energy, Incorporated.
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THIS COMBINED QUARTERLY REPORT ON FORM 10-Q IS SEPARATELY FILED BY RELIANT
ENERGY, INCORPORATED (RELIANT ENERGY) AND RELIANT ENERGY RESOURCES CORP. (RERC
CORP). INFORMATION CONTAINED HEREIN RELATING TO RERC CORP. IS FILED BY RELIANT
ENERGY AND SEPARATELY BY RERC CORP. ON ITS OWN BEHALF. RERC CORP. MAKES NO
REPRESENTATION AS TO INFORMATION RELATING TO RELIANT ENERGY OR ANY OTHER
AFFILIATE OR SUBSIDIARY OF RELIANT ENERGY (EXCEPT AS IT MAY RELATE TO RERC CORP.
AND ITS SUBSIDIARIES).
RELIANT ENERGY, INCORPORATED
AND RELIANT ENERGY RESOURCES CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2001
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Reliant Energy:
Item 1. Financial Statements.................................................................1
Statements of Consolidated Income
Three Months Ended March 31, 2000 and 2001 (unaudited)...................................1
Consolidated Balance Sheets
December 31, 2000 and March 31, 2001 (unaudited).........................................2
Statements of Consolidated Cash Flows
Three Months Ended March 31, 2000 and 2001 (unaudited)...................................4
Notes to Unaudited Consolidated Financial Statements.....................................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations of Reliant Energy and Subsidiaries...................................22
Item 3. Quantitative and Qualitative Disclosures about Market Risk..........................34
RERC Corp.:
Item 1. Financial Statements................................................................36
Statements of Consolidated Income
Three Months Ended March 31, 2000 and 2001 (unaudited)..................................36
Consolidated Balance Sheets
December 31, 2000 and March 31, 2001 (unaudited)........................................37
Statements of Consolidated Cash Flows
Three Months Ended March 31, 2000 and 2001 (unaudited)..................................39
Notes to Unaudited Consolidated Financial Statements....................................40
Item 2. Management's Narrative Analysis of the Results of Operations of
RERC Corp. and Subsidiaries .......................................................47
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................II-1
Item 5. Other Information.................................................................II-1
Item 6. Exhibits and Reports on Form 8-K..................................................II-2
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PART I. FINANCIAL INFORMATION
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
2000 2001
------------ ------------
REVENUES ..................................................................... $ 4,213,006 $ 13,284,321
EXPENSES:
Fuel and cost of gas sold .................................................. 2,332,589 7,667,139
Purchased power ............................................................ 784,934 4,107,623
Operation and maintenance .................................................. 464,948 715,014
Taxes other than income taxes .............................................. 110,565 139,688
Depreciation and amortization .............................................. 178,616 195,054
------------ ------------
Total .................................................................. 3,871,652 12,824,518
------------ ------------
OPERATING INCOME ............................................................. 341,354 459,803
------------ ------------
OTHER INCOME (EXPENSE):
Unrealized gain on AOL Time Warner investment .............................. 1,523,683 137,082
Unrealized loss on indexed debt securities ................................. (1,523,625) (135,047)
Income from equity investment of unconsolidated subsidiaries ............... 485 12,778
Other, net ................................................................. 20,401 35,608
------------ ------------
Total .................................................................. 20,944 50,421
------------ ------------
INTEREST AND OTHER CHARGES:
Interest ................................................................... 160,054 177,952
Distribution on trust preferred securities ................................. 13,892 13,900
------------ ------------
Total .................................................................. 173,946 191,852
------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES,
CUMULATIVE EFFECT OF ACCOUNTING CHANGE AND PREFERRED DIVIDENDS ............. 188,352 318,372
Income Tax Expense ........................................................ 54,536 110,150
------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF ACCOUNTING ..... 133,816 208,222
CHANGE AND PREFERRED DIVIDENDS
Loss from Discontinued Operations, net of tax of $(1,400) ................. (663) --
Loss on Disposal of Discontinued Operations, net of tax of $(1,640) ....... -- (7,294)
Cumulative Effect of Accounting Change, net of tax of $33,205 ............. -- 61,666
------------ ------------
INCOME BEFORE PREFERRED DIVIDENDS ............................................ 133,153 262,594
Preferred Dividends ...................................................... 97 97
------------ ------------
NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS ............................... $ 133,056 $ 262,497
============ ============
BASIC EARNINGS PER SHARE:
Income from Continuing Operations before Cumulative Effect of Accounting
Change ................................................................... $ 0.47 $ 0.72
Loss on Disposal of Discontinued Operations, net of tax ................... -- (0.03)
Cumulative Effect of Accounting Change, net of tax ........................ -- 0.22
------------ ------------
Net Income Attributable to Common Stockholders ............................ $ 0.47 $ 0.91
============ ============
DILUTED EARNINGS PER SHARE:
Income from Continuing Operations before Cumulative Effect of Accounting
Change ................................................................... $ 0.47 $ 0.72
Loss on Disposal of Discontinued Operations, net of tax ................... -- (0.03)
Cumulative Effect of Accounting Change, net of tax ........................ -- 0.21
------------ ------------
Net Income Attributable to Common Stockholders ............................ $ 0.47 $ 0.90
============ ============
See Notes to the Company's Interim Financial Statements
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, MARCH 31,
2000 2001
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents ........................... $ 175,972 $ 63,572
Investment in AOL Time Warner common stock .......... 896,824 1,033,906
Accounts receivable, net ............................ 2,623,492 2,653,633
Accrued unbilled revenues ........................... 592,618 405,381
Fuel stock and petroleum products ................... 269,729 268,085
Materials and supplies .............................. 213,484 163,217
Price risk management assets ........................ 4,460,843 2,680,741
Non-trading derivative assets ....................... -- 1,211,827
Margin deposits on energy trading activities ........ 521,004 370,144
Other ............................................... 253,335 289,076
------------ ------------
Total current assets .............................. 10,007,301 9,139,582
------------ ------------
Property, plant and equipment .......................... 22,391,874 22,708,162
Less accumulated depreciation and amortization ......... (7,131,719) (7,226,040)
------------ ------------
Property, plant and equipment, net .................. 15,260,155 15,482,122
------------ ------------
OTHER ASSETS:
Goodwill and other intangibles, net ................. 3,080,707 2,998,033
Regulatory assets ................................... 1,926,103 2,049,026
Price risk management assets ........................ 752,186 846,793
Non-trading derivative assets ....................... -- 447,653
Equity investments in unconsolidated subsidiaries ... 108,727 107,133
Stranded costs indemnification receivable ........... -- 544,182
Net assets of discontinued operations ............... 194,858 120,591
Other ............................................... 746,709 733,247
------------ ------------
Total other assets ................................ 6,809,290 7,846,658
------------ ------------
TOTAL ASSETS .................................... $ 32,076,746 $ 32,468,362
============ ============
See Notes to the Company's Interim Financial Statements
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, MARCH 31,
2000 2001
------------ ------------
CURRENT LIABILITIES:
Short-term borrowings .................................................. $ 5,004,494 $ 4,737,242
Current portion of long-term debt ...................................... 1,623,202 721,092
Indexed debt securities derivative ..................................... -- 922,983
Accounts payable ....................................................... 3,077,926 2,299,913
Taxes accrued .......................................................... 172,449 266,373
Interest accrued ....................................................... 103,489 121,373
Dividends declared ..................................................... 110,893 111,592
Price risk management liabilities ...................................... 4,442,811 2,622,656
Non-trading derivative liabilities ..................................... -- 1,259,378
Margin deposits from customers on energy trading activities ............ 284,603 339,900
Accumulated deferred income taxes ...................................... 309,008 317,450
Other .................................................................. 610,379 537,465
------------ ------------
Total current liabilities ............................................ 15,739,254 14,257,417
------------ ------------
OTHER LIABILITIES:
Accumulated deferred income taxes ...................................... 2,548,891 2,619,991
Unamortized investment tax credits ..................................... 265,737 261,154
Price risk management liabilities ...................................... 737,540 829,078
Non-trading derivative liabilities ..................................... -- 817,380
Benefit obligations .................................................... 491,964 512,871
Other .................................................................. 1,109,850 1,280,980
------------ ------------
Total other liabilities .............................................. 5,153,982 6,321,454
------------ ------------
LONG-TERM DEBT ............................................................ 4,996,095 5,539,184
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 11)
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF THE
COMPANY ................................................................ 705,355 705,458
------------ ------------
STOCKHOLDERS' EQUITY:
Cumulative preferred stock ............................................. 9,740 9,740
Common stock ........................................................... 3,257,190 3,309,571
Treasury stock ......................................................... (120,856) (113,336)
Unearned ESOP stock .................................................... (161,158) (147,359)
Retained earnings ...................................................... 2,520,350 2,674,164
Accumulated other comprehensive loss ................................... (23,206) (87,931)
------------ ------------
Total stockholders' equity ........................................... 5,482,060 5,644,849
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ......................... $ 32,076,746 $ 32,468,362
============ ============
See Notes to the Company's Interim Financial Statements
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
2000 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income attributable to common stockholders ......................... $ 133,056 $ 262,497
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization ........................................ 178,616 195,054
Deferred income taxes ................................................ 7,737 53,809
Investment tax credits ............................................... (763) (4,583)
Cumulative effect of accounting change ............................... -- (61,666)
Unrealized gain on AOL Time Warner investment ........................ (1,523,683) (137,082)
Unrealized loss on indexed debt securities ........................... 1,523,625 135,047
Undistributed earnings of unconsolidated subsidiaries ................ (485) 2,269
Impairment of marketable equity securities ........................... 22,185 --
Net cash provided by discontinued operations ......................... 4,065 77,102
Changes in other assets and liabilities:
Accounts receivable, net ........................................... 15,961 148,147
Inventory .......................................................... 54,581 61,264
Accounts payable ................................................... 4,389 (775,167)
Federal tax refund ................................................. 52,817 --
Fuel cost under-recovery ........................................... (23,229) (164,602)
Margin deposits on energy trading activities, net .................. (20,570) 206,157
Other assets ....................................................... (31,978) 63,922
Other liabilities .................................................. 51,513 5,896
Other, net ........................................................... 27,985 40,347
----------- -----------
Net cash provided by operating activities ........................ 475,822 108,411
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ................................................... (400,893) (491,558)
Business acquisitions, net of cash acquired ............................ (4,750) --
Payment of business purchase obligation ................................ (981,789) --
Investments in unconsolidated subsidiaries ............................. (2,636) (675)
Net cash used in discontinued operations ............................... (2,443) (2,802)
Other, net ............................................................. 18,886 5,330
----------- -----------
Net cash used in investing activities ............................ (1,373,625) (489,705)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt, net ...................................... 41,967 544,632
Increase (decrease) in short-term borrowing, net ....................... 1,146,848 (168,902)
Payments of long-term debt ............................................. (157,537) (26,556)
Payment of common stock dividends ...................................... (105,890) (107,597)
Proceeds from issuance of stock ........................................ 10,431 36,895
Purchase of treasury stock ............................................. (27,306) --
Net cash provided by discontinued operations ........................... 704 --
Other, net ............................................................. 309 (1,338)
----------- -----------
Net cash provided by financing activities ........................ 909,526 277,134
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH .................................. 2,247 (8,240)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..................... 13,970 (112,400)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ......................... 80,767 175,972
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............................... $ 94,737 $ 63,572
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) .................................. $ 111,309 $ 181,091
Income taxes ........................................................... 94 53,757
See Notes to the Company's Interim Financial Statements
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Included in this combined Quarterly Report on Form 10-Q (Form 10-Q) for
Reliant Energy, Incorporated (Reliant Energy), together with its subsidiaries
(the Company), and for Reliant Energy Resources Corp. (RERC Corp.) and its
subsidiaries (collectively, RERC) are Reliant Energy's and RERC's consolidated
interim financial statements and notes (Interim Financial Statements) including
these companies' wholly owned and majority owned subsidiaries. The Interim
Financial Statements are unaudited, omit certain financial statement disclosures
and should be read with the combined Annual Report on Form 10-K of Reliant
Energy (Reliant Energy Form 10-K) and RERC Corp. (RERC Corp. Form 10-K) for the
year ended December 31, 2000.
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.
The Interim Financial Statements reflect all normal recurring adjustments
that are, in the opinion of management, necessary to present fairly the
financial position and results of operations for the respective periods. Amounts
reported in the Company's Statements of Consolidated Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (a) seasonal fluctuations in demand for energy and energy
services, (b) changes in energy commodity prices, (c) timing of maintenance and
other expenditures and (d) acquisitions and dispositions of businesses, assets
and other interests. In addition, certain amounts from the prior year have been
reclassified to conform to the Company's presentation of financial statements in
the current year. These reclassifications do not affect the earnings of the
Company.
The following notes to the consolidated financial statements in the Reliant
Energy Form 10-K relate to certain contingencies. These notes, as updated
herein, are incorporated herein by reference:
Notes to Consolidated Financial Statements of Reliant Energy (Reliant
Energy 10-K Notes): Note 2(f) (Regulatory Assets), Note 3 (Business
Acquisitions), Note 4 (Regulatory Matters), Note 5 (Derivative Financial
Instruments), Note 8 (Indexed Debt Securities (ACES and ZENS) and AOL Time
Warner Securities), Note 14 (Commitments and Contingencies) and Note 20
(Subsequent Events).
For information regarding certain legal, tax and regulatory proceedings and
environmental matters, see Note 11.
(2) DERIVATIVE FINANCIAL INSTRUMENTS
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended (SFAS No. 133), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. This
statement requires that derivatives be recognized at fair value in the balance
sheet and that changes in fair value be recognized either currently in earnings
or deferred as a component of other comprehensive income, depending on the
intended use of the derivative, its resulting designation and its effectiveness.
If certain conditions are met, an entity may designate a derivative instrument
as hedging (a) the exposure to changes in the fair value of an asset or
liability (Fair Value Hedge), (b) the exposure to variability in expected future
cash flows (Cash Flow Hedge) or (c) the foreign currency exposure of a net
investment in a foreign operation. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in earnings in the period it occurs.
Adoption of SFAS No. 133 on January 1, 2001 resulted in an after-tax
increase in net income of $61 million and a cumulative after-tax increase in
accumulated other comprehensive loss of $252 million. The adoption also
increased current assets, long-term assets, current liabilities and long-term
liabilities by $703 million, $252 million, $805 million and $340 million,
respectively, in the Company's Consolidated Balance Sheet. The Company also
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reclassified $788 million related to the Company's Zero-Premium Exchangeable
Subordinated Notes (ZENS) due to the adoption from the current portion of
long-term debt to indexed debt securities derivative. During the three months
ended March 31, 2001, less than $1 million of the initial transition adjustment
recognized in other comprehensive income was realized in net income.
The application of SFAS No. 133 is still evolving and further guidance
from the Financial Accounting Standards Board (FASB) is expected. The FASB
released tentative guidance in April 2001 on three issues that impact our
industry. The FASB concluded in its tentative guidance that contracts subject to
"bookouts," a scheduling convenience used when two utilities have offsetting
transactions, cannot qualify for the normal purchases and sales exception. The
FASB also released tentative guidance that will prohibit option contracts on
electricity to qualify for the normal purchases and normal sales exception.
Lastly, the FASB issued tentative guidance that forward contracts containing
optionality features which modify the quantity delivered cannot qualify for the
normal purchases and sales exception. The tentative guidance issued by the FASB
is subject to a comment period which ends on June 1, 2001. If the tentative
guidance is unchanged, the Company is required to adopt this guidance as of July
1, 2001. The Company is in the process of determining the effect of adoption.
The Company is exposed to various market risks. These risks are inherent in
the Company's financial statements and arise from transactions entered into in
the normal course of business. The Company utilizes derivative financial
instruments to mitigate the impact of changes in electricity, natural gas and
fuel prices on its operating results and cash flows. The Company utilizes
cross-currency swaps and options to hedge its net investments in foreign
subsidiaries, interest rate swaps to mitigate the impact of changes in interest
rates and other financial instruments to manage various other market risks.
Trading and marketing operations often involve market risks associated with
managing energy commodities and establishing open positions in the energy
markets, primarily on a short-term basis. These risks fall into three different
categories: price and volume volatility, credit risk of trading counterparties
and adequacy of the control environment for trading. The Company routinely
enters into futures, forward contracts, swaps and options to hedge purchase and
sale commitments, fuel requirements and inventories of natural gas, coal,
electricity, oil, emission allowances, weather derivatives and other commodities
and to minimize the risk of market fluctuations in its trading, marketing, power
origination and risk management operations.
(a) Energy Trading, Marketing and Price Risk Management Activities.
The Company offers energy price risk management services primarily related
to natural gas, electric power and other energy related commodities. The Company
provides these services by utilizing a variety of derivative financial
instruments, including (a) fixed and variable-priced physical forward contracts,
(b) fixed and variable-priced swap agreements, (c) options traded in the
over-the-counter financial markets and (d) exchange-traded energy futures and
option contracts (Trading Derivatives). Fixed-price swap agreements require
payments to, or receipts of payments from, counterparties based on the
differential between a fixed and variable price for the commodity.
Variable-price swap agreements require payments to, or receipts of payments
from, counterparties based on the differential between industry pricing
publications or exchange quotations.
The Company applies mark-to-market accounting for all of its energy
trading, marketing and price risk management operations. Accordingly, these
Trading Derivatives are recorded at fair value with net realized and unrealized
gains (losses) recorded as a component of revenues. The recognized, unrealized
balances are included in price risk management assets/liabilities.
(b) Non-Trading Activities.
Cash Flow Hedges. To reduce the risk from market fluctuations in revenues
and the resulting cash flows derived from the sale of electric power and natural
gas and related transportation, the Company enters into futures transactions,
forward contracts, swaps and options (Energy Derivatives) in order to hedge some
expected purchases of electric power, natural gas and other commodities and
sales of electric power and natural gas (a portion of which are firm commitments
at the inception of the hedge). Energy Derivatives are also utilized to fix the
price of compressor fuel or other future operational gas requirements and to
protect natural gas distribution earnings and cash flows against unseasonably
warm weather during peak gas heating months, although usage to date for this
purpose
6
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has not been material. The Energy Derivative portfolios are managed to
complement the physical transaction portfolio, reducing overall risks within
management-prescribed limits.
During the three months ended March 31, 2001, the Company entered into
interest-rate swaps in order to adjust the interest rate on $375 million of its
floating rate debt. In addition, as of March 31, 2001, the Company's European
Energy segment has entered into financial instruments to purchase approximately
$120 million to hedge future fuel purchases payable in U.S. dollars.
The Company applies hedge accounting for its derivative financial
instruments utilized in non-trading activities only if there is a high
correlation between price movements in the derivative and the item designated as
being hedged. This correlation, a measure of hedge effectiveness, is measured
both at the inception of the hedge and on an ongoing basis, with an acceptable
level of correlation of at least 80% for hedge designation. If and when
correlation ceases to exist at an acceptable level, hedge accounting ceases and
mark-to-market accounting is applied. During the three months ended March 31,
2001, the amount of hedge ineffectiveness recognized in earnings from
derivatives that are designated and qualify as cash flow hedges was immaterial.
No component of the derivative instruments' gain or loss was excluded from the
assessment of effectiveness. If it becomes probable that an anticipated
transaction will not occur, the Company realizes in net income the deferred
gains and losses recognized in accumulated other comprehensive loss. During the
three months ended March 31, 2001, there were no deferred gains or losses
recognized in earnings as a result of the discontinuance of cash flow hedges
because it was no longer probable that the forecasted transaction would occur.
Once the anticipated transaction occurs, the accumulated deferred gain or loss
recognized in accumulated other comprehensive loss is reclassified to net income
and included in the Company's Statements of Consolidated Income under the
captions (a) fuel expenses, in the case of natural gas transactions, (b)
purchased power, in the case of electric power purchase transactions, (c)
revenues, in the case of electric power sales transactions and (d) interest
expense, in the case of interest rate swap transactions. Cash flows resulting
from these transactions in Energy Derivatives are included in the Company's
Statements of Consolidated Cash Flows in the same category as the item being
hedged. As of March 31, 2001, current non-trading derivative assets and
liabilities and corresponding amounts in accumulated other comprehensive loss
are expected to be reclassified to net income during the next twelve months.
The maximum length of time the Company is hedging its exposure to the
variability in future cash flows for forecasted transactions excluding the
payment of variable interest on existing financial instruments is five years.
The maximum length of time the Company is hedging its exposure to the payment of
variable interest rates is approximately five years.
Hedge of Net Investment in Foreign Subsidiaries. The Company has
substantially hedged its net investment in its European subsidiaries through a
combination of Euro-denominated borrowings, foreign currency swaps and foreign
currency forward contracts to reduce the Company's exposure to changes in
foreign currency rates. During the normal course of business, the Company
reviews its currency hedging strategies and determines the hedging approach
deemed appropriate based upon the circumstances of each situation.
The Company records the changes in the value of the foreign currency
hedging instruments and Euro-denominated borrowings as foreign currency
translation adjustments as a component of stockholders' equity and accumulated
other comprehensive loss. The effectiveness of the hedging instruments can be
measured by the net change in foreign currency translation adjustments
attributed to the Company's net investment in its European subsidiaries. These
amounts generally offset amounts recorded in stockholders' equity as adjustments
resulting from translation of the hedged investment into U.S. dollars. During
the three months ended March 31, 2001, the derivative and nonderivative
instruments designated as hedging the net investment in its European
subsidiaries resulted in a gain of $155 million which is included in the balance
of the cumulative translation adjustment.
Other Derivatives. Upon adoption of SFAS No. 133 effective January 1, 2001,
the Company's indexed debt securities obligations related to its ZENS obligation
was bifurcated into a debt component valued at $122 million and an embedded
derivative component valued at $788 million. Changes in the fair value of the
derivative component are recorded in the Company's Statements of Consolidated
Income. Changes in the fair value of the Company's Investment in AOL Time Warner
Inc. common stock should substantially offset changes in the fair value of the
derivative component of the ZENS.
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In December 2000, the Dutch parliament adopted legislation allocating to
the Dutch generation sector, including a subsidiary of the Company, N.V. UNA
(UNA), financial responsibility for various stranded costs contracts and other
liabilities. The legislation became effective in all material respects on
January 1, 2001. In particular, the legislation allocated to the four Dutch
generation companies, including UNA, financial responsibility to purchase
electricity and gas under an import gas supply contract and three electricity
import contracts. The gas import contract expires in 2015 and provides for gas
imports aggregating 2.283 billion cubic meters per year. These contracts are
derivatives pursuant to SFAS No. 133 due to the pricing indices. As of March 31,
2001, the Company has recognized $326 million in long-term non-trading
derivative liabilities for UNA's portion of these stranded costs contracts. For
additional information regarding UNA's stranded costs and the related
indemnification by former shareholders of these stranded costs, see Note 11(e).
Subsequent to March 31, 2001, the Company has entered into interest rate
swaps to fix the rate on $1.3 billion of the Company's floating rate debt, which
expire in 2002. The Company has not designated these derivative instruments as
hedges. Changes in the fair value of the swaps will be recorded in the Company's
Statements of Consolidated Income.
(3) ACQUISITION OF RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
On May 12, 2000, a subsidiary of the Company purchased entities owning
electric power generating assets and development sites located in Pennsylvania,
New Jersey and Maryland having an aggregate net generating capacity of
approximately 4,262 megawatts (MW). With the exception of development entities
that were sold to another subsidiary of the Company in July 2000, the assets of
the entities acquired are held by Reliant Energy Mid-Atlantic Power Holdings,
LLC (REMA) an indirect wholly owned subsidiary of Reliant Resources, Inc.
(Reliant Resources). The purchase price for the May 2000 transaction was $2.1
billion, subject to post-closing adjustments which management does not believe
will be material. The Company accounted for the acquisition as a purchase with
assets and liabilities of REMA reflected at their estimated fair values. The
Company's fair value adjustments related to the acquisition primarily included
adjustments in property, plant and equipment, air emissions regulatory
allowances, materials and supplies inventory, environmental reserves and related
deferred taxes. The Company finalized these fair value adjustments in May 2001.
There were no additional material modifications to the preliminary adjustments
from December 31, 2000. For additional information regarding the acquisition of
REMA, see Note 3(a) to Reliant Energy 10-K Notes.
The Company's results of operations include the results of REMA only for the
period beginning May 12, 2000. The following table presents selected unaudited
actual financial information and unaudited pro forma financial information for
the three months ended March 31, 2000, as if the acquisition had occurred on
January 1, 2000. Pro forma amounts also give effect to the sale and leaseback of
interests in three of the REMA generating plants, consummated in August 2000.
For additional information regarding the sale and leaseback transactions, see
Note 14(c) to Reliant Energy 10-K Notes.
THREE MONTHS ENDED
MARCH 31, 2000
---------------------------------
ACTUAL PRO FORMA
---------------- --------------
(IN MILLIONS, EXCEPT PER
SHARE AMOUNTS)
Revenues ....................................... $ 4,213 $ 4,320
Income from continuing operations .............. 134 118
Net income attributable to common stockholders . 133 117
Basic and diluted earnings per share ........... 0.47 0.42
These unaudited pro forma results, based on assumptions deemed appropriate
by the Company's management, have been prepared for informational purposes only
and are not necessarily indicative of the amounts that would have resulted if
the acquisition of the REMA entities had occurred on January 1, 2000.
Purchase-related adjustments to the results of operations include the effects on
depreciation and amortization, interest expense and income taxes.
(4) DISCONTINUED OPERATIONS
Effective December 1, 2000, Reliant Energy's Board of Directors approved a
plan to dispose of the Company's Latin American segment through sales of its
assets. Accordingly, the Company is reporting the results of its Latin American
segment as discontinued operations for all periods presented in the Interim
Financial Statements in
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accordance with Accounting Principles Board Opinion No. 30. During the three
months ended March 31, 2001, the Company recorded an additional loss on disposal
of $7 million (after-tax) related to its Latin American segment.
(5) DEPRECIATION AND AMORTIZATION
The Company's depreciation expense for the first quarter of 2000 was $89
million, compared to $101 million for the same period in 2001. Goodwill
amortization related to acquisitions was $22 million for the first quarter of
2000, compared to $23 million for the same period in 2001. Other amortization
expense, including amortization of regulatory assets, was $68 million for the
first quarter of 2000 compared to $71 million for the same period in 2001.
In June 1998, the Public Utility Commission of Texas (Texas Utility
Commission) issued an order approving a transition to competition plan
(Transition Plan) filed by Reliant Energy HL&P in December 1997. For information
regarding the additional depreciation of electric utility generating assets and
the redirection of transmission and distribution (T&D) depreciation to
generation assets under the Transition Plan, see Note 2(g) to Reliant Energy
10-K Notes. In June 1999, the Texas legislature adopted the Texas Electric
Choice Plan (Legislation), which substantially amended the regulatory structure
governing electric utilities in Texas in order to allow retail electric
competition beginning on January 1, 2002. The Legislation provides that
depreciation expense for T&D related assets may be redirected to generation
assets from 1999 through 2001 for regulatory purposes. Because the electric
generation operations portion of Reliant Energy HL&P discontinued application of
SFAS No. 71 effective June 30, 1999, such operations can no longer record
additional or redirected depreciation for financial reporting purposes. However,
for regulatory purposes, the Company continues to redirect T&D depreciation to
generation assets. As of December 31, 2000 and March 31, 2001, the cumulative
amount of redirected depreciation for regulatory purposes was $611 million and
$668 million, respectively.
In 1999, the Company determined that approximately $800 million of Reliant
Energy HL&P's electric generation assets were impaired. The Legislation provides
for recovery of this impairment through regulated cash flows. Therefore, a
regulatory asset was recorded for an amount equal to the impairment in the
Company's Consolidated Balance Sheets. The Company amortizes this regulatory
asset as it is recovered from regulated cash flows. During the first quarter of
2000 and 2001, the Company recorded $52 million and $37 million, respectively,
of amortization expense related to the recoverable impaired plant costs and
other deferred debits created from discontinuing SFAS No. 71.
(6) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------
2000 2001
---------- ----------
(IN MILLIONS)
Net income attributable to common stockholders ........................ $ 133 $ 262
Other comprehensive income (loss):
Foreign currency translation adjustments from continuing operations . (10) (1)
Additional minimum non-qualified pension liability adjustment ....... -- (2)
Cumulative effect of adoption of SFAS No. 133 ....................... -- (252)
Net deferred gains from cash flow hedges ............................ -- 183
Unrealized gain on available-for-sale securities .................... 1 7
Plus: Reclassification adjustment for impairment loss on
available-for-sale securities realized in net income .............. 14 --
---------- ----------
Comprehensive income .................................................. $ 138 $ 197
========== ==========
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(7) LONG-TERM DEBT AND SHORT-TERM BORROWINGS
(a) Short-term Borrowings.
As of March 31, 2001, the Company had credit facilities, which included the
facilities of various financing subsidiaries, Reliant Resources, UNA and RERC
Corp., with financial institutions which provide for an aggregate of $9.1
billion in committed credit, of which $2.5 billion was unused. As of March 31,
2001, borrowings of $5.5 billion were outstanding or supported under these
credit facilities of which $829 million were classified as long-term debt, based
on availability of committed credit with expiration dates exceeding one year and
management's intention to borrow these amounts in excess of one year. Various
credit facilities aggregating $2.6 billion may be used for letters of credit of
which $1.1 billion were outstanding as of March 31, 2001. In addition, one of
the credit facilities includes a $65 million sub-facility under which letters of
credit may be obtained. Letters of credit under this sub-facility aggregate $3
million as of March 31, 2001. Interest rates on borrowings are based on the
London interbank offered rate (LIBOR) plus a margin, Euro interbank deposits
plus a margin, a base rate or a rate determined through a bidding process.
Credit facilities aggregating $3.8 billion are unsecured. The credit facilities
contain covenants and requirements which must be met to borrow funds and obtain
letters of credit, as applicable. Such covenants are not anticipated to
materially restrict the borrowers from borrowing funds or obtaining letters of
credit, as applicable, under such facilities. The borrowers are in compliance
with the covenants under all of these credit agreements.
(b) Long-term Debt.
In February 2001, RERC Corp. issued $550 million aggregate principal amount
of unsecured unsubordinated notes that bear interest at 7.75% per year and
mature in February 2011. Net proceeds to RERC Corp. were $545 million. RERC
Corp. used the net proceeds from the sale of the notes to pay a $400 million
dividend to Reliant Energy, and for general corporate purposes. Reliant Energy
used the $400 million proceeds from the dividend for general corporate purposes,
including the repayment of short-term debt.
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(8) EARNINGS PER SHARE
The following table presents Reliant Energy's basic and diluted earnings
per share (EPS) calculation:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------
2000 2001
------------- -------------
(IN MILLIONS, EXCEPT SHARE AND
PER SHARE AMOUNTS)
Basic EPS Calculation:
Income from continuing operations before cumulative effect of accounting
change .................................................................. $ 134 $ 208
Loss from discontinued operations, net of tax ............................. (1) --
Loss on disposal of discontinued operations, net of tax ................... -- (7)
Cumulative effect of accounting change, net of tax ........................ -- 61
------------- -------------
Net income attributable to common stockholders ............................ $ 133 $ 262
============= =============
Weighted average shares outstanding ......................................... 283,078,000 287,336,000
============= =============
Basic EPS:
Income from continuing operations before cumulative effect of accounting
change .................................................................. $ 0.47 $ 0.72
Loss on disposal of discontinued operations, net of tax ................... -- (0.03)
Cumulative effect of accounting change, net of tax ........................ -- 0.22
------------- -------------
Net income attributable to common stockholders ............................ $ 0.47 $ 0.91
============= =============
Diluted EPS Calculation:
Net income attributable to common stockholders ............................ $ 133 $ 262
Plus: Income impact of assumed conversions:
Interest on 6 1/4% convertible trust preferred securities ............... -- --
------------- -------------
Total earnings effect assuming dilution ................................... $ 133 $ 262
============= =============
Weighted average shares outstanding ......................................... 283,078,000 287,336,000
Plus: Incremental shares from assumed conversions (1):
Stock options ........................................................... 466,000 2,337,000
Restricted stock ........................................................ 684,000 486,000
6 1/4% convertible trust preferred securities ........................... 23,000 14,000
------------- -------------
Weighted average shares assuming dilution ................................. 284,251,000 290,173,000
============= =============
Diluted EPS:
Income from continuing operations before cumulative effect of accounting
change .................................................................. $ 0.47 $ 0.72
Loss on disposal of discontinued operations, net of tax ................... -- (0.03)
Cumulative effect of accounting change, net of tax ........................ -- 0.21
------------- -------------
Net income attributable to common stockholders ............................ $ 0.47 $ 0.90
============= =============
- ----------
(1) For the three months ended March 31, 2000 and 2001, the computation of
diluted EPS excludes 5,920,622 and 191,266 purchase options, respectively,
for shares of common stock that have exercise prices (ranging from $22.28
to $32.22 per share and $41.69 to $47.22 per share for the first quarter
2000 and 2001, respectively) greater than the per share average market
price for the period and would thus be anti-dilutive if exercised.
(9) CAPITAL STOCK
Common Stock. Reliant Energy has 700,000,000 authorized shares of common
stock. At December 31, 2000, 299,914,791 shares of Reliant Energy common stock
were issued and 286,464,709 shares of Reliant Energy common stock were
outstanding. At March 31, 2001, 301,139,797 shares of Reliant Energy common
stock were issued and 288,969,217 shares of Reliant Energy common stock were
outstanding. Outstanding common shares exclude (a) shares pledged to secure a
loan to Reliant Energy's Employee Stock Ownership Plan (8,638,889 and 7,658,889
at December 31, 2000 and March 31, 2001, respectively) and (b) treasury shares
(4,811,193 and 4,511,691 at December 31, 2000 and March 31, 2001, respectively).
Reliant Energy declared dividends of $0.375 per share in the first quarter of
2000 and 2001.
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During the first three months of 2001, Reliant Energy issued 300,000 shares
of Reliant Energy common stock out of its treasury stock. As of March 31, 2001,
Reliant Energy was authorized to purchase up to $271 million of Reliant Energy
common stock under its stock repurchase program.
(10) TRUST PREFERRED SECURITIES
(a) Reliant Energy.
Statutory business trusts created by Reliant Energy have issued trust
preferred securities, the terms of which, and the related series of junior
subordinated debentures, are described below (in millions):
AGGREGATE LIQUIDATION
AMOUNT
--------------------------- MANDATORY
DECEMBER 31, MARCH 31, DISTRIBUTION RATE/ REDEMPTION DATE/ JUNIOR SUBORDINATED
TRUST 2000 2001 INTEREST RATE MATURITY DATE DEBENTURES
- ------------------------ ------------- ------------- ----------------- ----------------- -----------------------------
REI Trust I $ 375 $ 375 7.20% March 2048 7.20% Junior Subordinated
Debentures due 2048
HL&P Capital Trust I $ 250 $ 250 8.125% March 2048 8.125% Junior Subordinated
Deferrable Interest
Debentures Series A
HL&P Capital Trust II $ 100 $ 100 8.257% February 2037 8.257% Junior Subordinated
Deferrable Interest
Debentures Series B
For additional information regarding the $625 million of preferred
securities and the $100 million of capital securities, see Note 11 to Reliant
Energy 10-K Notes. The sole asset of each trust consists of junior subordinated
debentures of Reliant Energy having interest rates and maturity dates
corresponding to each issue of preferred or capital securities, and the
principal amounts corresponding to the common and preferred or capital
securities issued by that trust.
(b) RERC Corp.
A statutory business trust created by RERC Corp. has issued convertible
trust preferred securities, the terms of which, and the related series of
convertible junior subordinated debentures, are described below (in millions):
AGGREGATE LIQUIDATION
AMOUNT
--------------------------- MANDATORY
DECEMBER 31, MARCH 31, DISTRIBUTION RATE/ REDEMPTION DATE/ JUNIOR SUBORDINATED
TRUST 2000 2001 INTEREST RATE MATURITY DATE DEBENTURES
- ------------------------ ------------- ------------- ----------------- ----------------- -----------------------------
Resources Trust $ 1 $ 1 6.25% June 2026 6.25% Convertible Junior
Subordinated Debentures due 2026
For additional information regarding the convertible preferred securities,
see Note 11 to Reliant Energy 10-K Notes and Note 6 to RERC Corp. 10-K Notes.
The sole asset of the trust consists of convertible junior subordinated
debentures of RERC Corp. having an interest rate and maturity date corresponding
to the convertible preferred securities, and the principal amount corresponding
to the common and convertible preferred securities issued by the trust.
(11) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
Reliant Energy HL&P Municipal Franchise Fee Lawsuits. In February 1996, the
cities of Wharton, Galveston and Pasadena filed suit, for themselves and a
proposed class of all similarly situated cities in Reliant Energy HL&P's
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service area, against Reliant Energy and Houston Industries Finance, Inc.
(formerly a wholly owned subsidiary of Reliant Energy) alleging underpayment of
municipal franchise fees. Plaintiffs claim that they are entitled to 4% of all
receipts of any kind for business conducted within these cities over the
previous four decades. Because the franchise ordinances at issue affecting
Reliant Energy HL&P expressly impose fees only on its own receipts and only from
sales of electricity for consumption within a city, the Company regards all of
plaintiffs' allegations as spurious and is vigorously contesting the case. The
plaintiffs' pleadings asserted that their damages exceeded $250 million. The
269th Judicial District Court for Harris County granted partial summary judgment
in favor of Reliant Energy dismissing all claims for franchise fees based on
sales tax collections. Other motions for partial summary judgment were denied. A
six-week jury trial of the original claimant cities (but not the class of
cities) ended on April 4, 2000 (three cities case). Although the jury found for
Reliant Energy on many issues, they found in favor of the original claimant
cities on three issues, and assessed a total of $4 million in actual and $30
million in punitive damages. However, the jury also found in favor of Reliant
Energy on the affirmative defense of laches, a defense similar to a statute of
limitations defense, due to the original claimant cities having unreasonably
delayed bringing their claims during the 43 years since the alleged wrongs
began.
The trial court in the three cities case granted most of Reliant Energy's
motions to disregard the jury's findings. The trial court's rulings reduced the
judgment to $1.7 million, including interest, plus an award of $13.7 million in
legal fees. In addition, the trial court granted Reliant Energy's motion to
decertify the class and vacated its prior orders certifying a class. Following
this ruling, 45 cities filed individual suits against Reliant Energy in the
District Court of Harris County.
The extent to which issues in the three cities case may affect the claims
of the other cities served by Reliant Energy HL&P cannot be assessed until
judgments are final and no longer subject to appeal. However, the trial court's
rulings disregarding most of the jury's findings are consistent with Texas
Supreme Court opinions over the past decade. The Company estimates the range of
possible outcomes for the plaintiffs to be between zero and $17 million
inclusive of interest and attorneys' fees.
The three cities case has been appealed. The Company believes that the $1.7
million damage award resulted from serious errors of law and that it will be set
aside by the Texas appellate courts. In addition, the Company believes that
because of an agreement between the parties limiting fees to a percentage of the
damages, reversal of the award of $13.7 million in attorneys' fees in the three
cities case is probable.
California Wholesale Market. Reliant Energy, Reliant Energy Services, Inc.,
Reliant Energy Power Generation, Inc. and several other indirect subsidiaries
have been named as defendants in class action lawsuits and other lawsuits filed
against a number of companies that own generation plants in California and other
sellers of electricity in California markets. RERC Corp. has also been named as
a defendant in one of the lawsuits. Pursuant to the terms of the master
separation agreement between Reliant Energy and Reliant Resources (see Note 4(b)
to Reliant Energy 10-K Notes), Reliant Resources has agreed to indemnify Reliant
Energy and RERC Corp. for any damages arising under these lawsuits, and may
elect to defend these lawsuits at its own expense. Three of these lawsuits were
filed in the Superior Court of the State of California, San Diego County; two
were filed in the Superior Court in San Francisco County; one was filed in the
Superior Court in Los Angeles County. While the plaintiffs allege various
violations by the defendants of state antitrust laws and state laws against
unfair and unlawful business practices, each of the lawsuits is grounded on the
central allegation that defendants conspired to drive up the wholesale price of
electricity. In addition to injunctive relief, the plaintiffs in these lawsuits
seek treble the amount of damages alleged, restitution of alleged overpayments,
disgorgement of alleged unlawful profits for sales of electricity, costs of suit
and attorneys' fees. In one of the cases the plaintiffs allege aggregate damages
of over $4 billion. Defendants have filed petitions to remove some of these
cases to federal court. Furthermore, defendants have filed a motion with the
Panel on Multidistrict Litigation seeking transfer and consolidation of some of
these cases. Defendants seek consolidation and transfer of these cases to a
jurisdiction outside California, noting that the federal judges in California
are potentially disqualified because they are ratepayers. The judges assigned to
the cases in San Diego and San Francisco have recused themselves on these
grounds. These lawsuits have only recently been filed. Therefore, the ultimate
outcome of the lawsuits cannot be predicted with any degree of certainty at this
time. However, the Company believes, based on its analysis to date of the claims
asserted in these lawsuits and the underlying facts, that resolution of these
lawsuits will not have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
13
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(b) Environmental Matters.
Manufactured Gas Plant Sites. RERC and its predecessors operated a
manufactured gas plant (MGP) adjacent to the Mississippi River in Minnesota,
formerly known as Minneapolis Gas Works (MGW) until 1960. RERC has substantially
completed remediation of the main site other than ongoing water monitoring and
treatment. The manufactured gas was stored in separate holders. RERC is
negotiating clean-up of one such holder. There are six other former MGP sites in
the Minnesota service territory. Remediation has been completed on one site. Of
the remaining five sites, RERC believes that two were neither owned nor operated
by RERC. RERC believes it has no liability with respect to the sites it neither
owned nor operated.
At March 31, 2001, RERC had accrued $19 million for remediation of the
Minnesota sites. At March 31, 2001, the estimated range of possible remediation
costs was $8 million to $36 million. The cost estimates of the MGW site are
based on studies of that site. The remediation costs for the other sites are
based on industry average costs for remediation of sites of similar size. The
actual remediation costs will be dependent upon the number of sites remediated,
the participation of other potentially responsible parties, if any, and the
remediation methods used.
Issues relating to the identification and remediation of MGPs are common in
the natural gas distribution industry. The Company has received notices from the
United States Environmental Protection Agency and others regarding its status as
a potentially responsible party (PRP) for other sites. Based on current
information, the Company has not been able to quantify a range of environmental
expenditures for potential remediation expenditures with respect to other MGP
sites.
Other Minnesota Matters. At March 31, 2001, RERC had recorded accruals of
$4 million (with a maximum estimated exposure of approximately $17 million at
March 31, 2001) for other environmental matters in Minnesota for which
remediation may be required.
Mercury Contamination. The Company's pipeline and distribution operations
have in the past employed elemental mercury in measuring and regulating
equipment. It is possible that small amounts of mercury may have been spilled in
the course of normal maintenance and replacement operations and that these
spills may have contaminated the immediate area with elemental mercury. This
type of contamination has been found by the Company at some sites in the past,
and the Company has conducted remediation at these sites. It is possible that
other contaminated sites may exist and that remediation costs may be incurred
for these sites. Although the total amount of these costs cannot be known at
this time, based on experience by the Company and that of others in the natural
gas industry to date and on the current regulations regarding remediation of
these sites, the Company believes that the costs of any remediation of these
sites will not be material to the Company's financial position, results of
operations or cash flows.
REMA Ash Disposal Site Closures and Site Contaminations. Under the
agreement to acquire REMA (see Note 3(a) to Reliant Energy 10-K Notes), the
Company became responsible for liabilities associated with ash disposal site
closures and site contamination at the acquired facilities in Pennsylvania and
New Jersey prior to a plant closing, except for the first $6 million of
remediation costs at the Seward Generating Station. A prior owner retained
liabilities associated with the disposal of hazardous substances to off-site
locations prior to November 24, 1999. As of March 31, 2001, REMA has liabilities
associated with six ash disposal site closures and six site investigations and
environmental remediations. The Company has recorded its estimate of these
environmental liabilities in the amount of $36 million as of March 31, 2001. The
Company expects approximately $13 million will be paid over the next five years.
UNA Asbestos Abatement and Soil Remediation. Prior to the Company's
acquisition of UNA (see Note 3(b) to Reliant Energy 10-K Notes), UNA had a $25
million obligation primarily related to asbestos abatement, as required by Dutch
law, and soil remediation at six sites. During 2000, the Company initiated a
review of potential environmental matters associated with UNA's properties. UNA
began remediation in 2000 of the properties identified to have exposed asbestos
and soil contamination, as required by Dutch law and the terms of some leasehold
agreements with municipalities in which the contaminated properties are located.
All remediation efforts are to be fully completed by 2005. As of March 31, 2001,
the estimated undiscounted liability for this asbestos abatement and soil
remediation was $22 million.
Other. From time to time the Company has received notices from regulatory
authorities or others regarding its status as a PRP in connection with sites
found to require remediation due to the presence of environmental
14
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contaminants. In addition, the Company has been named as a defendant in
litigation related to such sites and in recent years has been named, along with
numerous others, as a defendant in several lawsuits filed by a large number of
individuals who claim injury due to exposure to asbestos while working at sites
along the Texas Gulf Coast. Most of these claimants have been workers who
participated in construction of various industrial facilities, including power
plants, and some of the claimants have worked at locations owned by the Company.
The Company anticipates that additional claims like those received may be
asserted in the future and intends to continue vigorously contesting claims
which it does not consider to have merit. Although their ultimate outcome cannot
be predicted at this time, the Company does not believe, based on its experience
to date, that these matters, either individually or in the aggregate, will have
a material adverse effect on the Company's financial position, results of
operations or cash flows.
(c) Other Legal and Environmental Matters.
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management believes that the disposition of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
(d) California Wholesale Market Uncertainty.
During the summer and fall of 2000, and continuing into early 2001, prices
for wholesale electricity in California increased dramatically as a result of a
combination of factors, including higher natural gas prices and emission
allowance costs, reduction in available hydroelectric generation resources,
increased demand, decreases in net electric imports, structural market flaws
including over-reliance on the electric spot market, and limitations on supply
as a result of maintenance and other outages. Although wholesale prices
increased, California's deregulation legislation kept retail rates frozen below
1996 levels, until rates were raised, with certain limitations discussed below,
by the California Public Utilities Commission (CPUC) on January 4, 2001 and
March 27, 2001. This caused two of California's public utilities, which are the
Company's customers based on its deliveries to the California Power Exchange
(Cal PX) and the California Independent System Operator (Cal ISO), to accrue
billions of dollars of unrecovered wholesale power costs and to ultimately
default in January and February 2001 on payments owed for wholesale power
purchased through the Cal PX and from the Cal ISO and, in the case of Pacific
Gas and Electric Company (PG&E), to file a voluntary petition for bankruptcy.
As of December 31, 2000, the Company was owed $101 million by the Cal PX
and $181 million by the Cal ISO. In the fourth quarter of 2000, the Company
recorded a pre-tax provision of $39 million against receivable balances related
to energy sales in the California market. From January 1, 2001 through March 31,
2001, the Company has collected $110 million of these receivable balances. As of
March 31, 2001, the Company was owed a total of $337 million by the Cal ISO, the
Cal PX, the California Department of Water Resources (CDWR) and California
Energy Resource Scheduling for energy sales in the California wholesale market
during the fourth quarter of 2000 through March 31, 2001. In the first quarter
of 2001, the Company recorded a pre-tax provision of $38 million against
receivable balances related to energy sales from January 1, 2001 through March
31, 2001 in the California market. Management will continue to assess the
collectibility of these receivables based on further developments affecting the
California electricity market and the market participants described herein.
Additional provisions to the allowance may be warranted in the future.
Nevertheless, on May 9, 2001, at the request of California Governor Gray
Davis, representatives of a number of generation and/or marketing companies
doing business in California met with Governor Davis to discuss the California
situation. At this meeting, Governor Davis suggested that he felt it would be
appropriate for the entities owed money by the two defaulting California
utilities to accept $.70 on the dollar in settlement of the receivables. No
basis for this proposal was expressed. The Company does not believe that such a
settlement is acceptable and intends to continue to pursue collection of all
amounts owed to the Company by the two defaulting California utilities.
In response to the filing of a number of complaints challenging the level
of wholesale prices, the Federal Energy Regulatory Commission (FERC) initiated a
staff investigation and issued an order on December 15, 2000 implementing a
series of wholesale market reforms, including an interim price review procedure
for prices above a $150/MWh "breakpoint" on sales to the Cal ISO and through the
Cal PX. The order did not prohibit sales above the "breakpoint," but the seller
was subject to weekly reporting and monitoring requirements. For each reported
transaction, potential refund liability extends for a period of 60 days
following the date any such transaction is reported to the FERC. No notice has
been issued for April 2001, but given the FERC methodology for determining
refund amounts, the Company does not expect any potential refund obligation
associated with sales for April. On March 9, 2001, the FERC issued a further
order establishing a proxy market clearing price of $273/MWh for January 2001,
and on March 16, 2001 the FERC issued a notice setting the proxy market clearing
price at $430/MWh for
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February 2001. On April 16, 2001, the FERC issued a notice setting the proxy
market clearing price at $300/MWh for March 2001.
In the FERC's March 9 and March 16 orders, the FERC outlined criteria for
determining amounts subject to possible refund based on the proxy market
clearing price for January and February 2001 and indicated that approximately
$12 million of the $125 million charged by the Company in January 2001 for sales
in California to the Cal ISO and the Cal PX and approximately $7 million of the
$47 million charged by the Company in February 2001 for sales in California to
the Cal ISO were subject to possible refunds. In an order issued April 16, 2001,
the FERC found that the Company did not have any potential refund obligations
associated with its sales in March 2001. In the March 9 and March 16 orders, the
FERC set forth procedures for challenging possible refund obligations. On April
11 and 13, the Company submitted cost or other justification for most of the
prices charged above the proxy market clearing prices established in the March 9
and March 16 orders. On May 4, 2001, the FERC notified the Company that its
price justification was insufficient and additional justification would be
required to avoid refund. Any refunds the Company may ultimately be obligated to
pay are to be credited against unpaid amounts owed to the Company for its sales
in the Cal PX or to the Cal ISO. While the December 15 order established that a
refund condition would be in place for the period beginning October 2, 2000
through December 31, 2002, this refund condition for January, February and March
2001 sales is limited to the amounts identified for possible refund. The balance
of sales in these months, representing the vast majority of the Company's
California sales in such months, are no longer subject to refund since they were
not challenged during the 60-day period following the reporting of such sales.
Sales prior to January 2001 and subsequent to October 2, 2000 remain subject to
refund under the FERC's December 15 order. The December 15 order also eliminated
the requirement that California's public utilities sell all of their generation
into and purchase all of their power from the Cal PX and directed that the Cal
PX wholesale tariffs be terminated effective April 2001. The Cal PX has since
suspended its day-ahead and day-of markets and filed for bankruptcy protection
on March 9, 2001. Motions for rehearing have been filed on a number of issues
related to the December 15 order and such motions are still pending before the
FERC.
On April 26, 2001, the FERC issued an order establishing a market
monitoring and mitigation plan for the California markets to replace the
$150/MWh breakpoint plan, which will begin on May 29, 2001 and be effective for
no more than one year. The plan retains the "breakpoint" approach to price
mitigation, for bids in the real-time market during periods when power reserves
fall below 7.5 percent (i.e., Stages 1, 2 and 3 emergencies). The plan's
breakpoint amount will be based on variable cost calculations using data
submitted confidentially by each gas-fired generator to the FERC and the Cal
ISO. The Cal ISO will use this data and daily indices of natural gas and
emissions allowance costs to establish the market-clearing price in real-time
based on the marginal cost of the highest-cost generator called to run. The plan
also increases the Cal ISO's authority to coordinate and control generating
facility outages, subject to periodic reports to and review by the FERC;
requires generators in California to offer all their available capacity for sale
in the real-time market, and conditions sellers' market-based rate authority
such that sellers violating certain conditions on their bids will be subject to
increased scrutiny by the FERC, potential refunds and even revocation of their
market-based rate authority. The FERC conditioned implementation of the market
monitoring and mitigation plan on the Cal ISO and the three California public
utilities filing a regional transmission organization proposal by June 1, 2001.
In addition to the FERC investigation discussed above, several state and
other federal regulatory investigations and complaints have commenced in
connection with the wholesale electricity prices in California and other
neighboring Western states to determine the causes of the high prices and
potentially to recommend remedial action. In California, the CPUC, the
California Electricity Oversight Board, the California Bureau of State Audits
and the California Office of the Attorney General all have separate ongoing
investigations into the high prices and their causes. With the exception of a
report by the California Bureau of State Audits, none of these investigations
have been completed and no findings have been made in connection with any of
them. The recently released California state audit report concluded that the
foremost cause of the market disruptions in California was fundamental flaws in
the structure of the power market.
Despite the market restructuring ordered under the December 15 order, the
California public utilities have continued to accrue unrecovered wholesale
costs. As a result, the credit ratings of two of these public utilities were
severely downgraded to below investment grade in January 2001. As their credit
lines became unavailable, the two utilities defaulted on payments due to the Cal
PX and the Cal ISO, which operate financially as pass-through entities,
coordinating payments from buyers and sellers of electricity. As a result, the
Cal PX and Cal ISO were not able to pay final invoices to market participants
totaling over $1 billion. The default of two of California's public utilities on
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amounts owed the Cal PX and the Cal ISO for purchased power, and the filing of
a voluntary petition for bankruptcy by PG&E, have further exacerbated the
current crisis in the California wholesale markets and resulted in substantial
uncollected receivables owed to the Company by the Cal ISO and the Cal PX. The
Cal PX's efforts to recover the available collateral of the utilities, in the
form of block forward contracts, were frustrated by the emergency acts of
California's Governor, who seized control of the contracts upon the expiration
of temporary restraining orders prohibiting such action. Although obligated to
pay reasonable value for the contracts, the state of California has not yet made
any payment to the Company for the contracts. Various actions have been filed
and are still pending challenging the Governor's ability to seize these
contracts and seeking to impose an obligation to pay the fair market value of
the contracts as of the date seized.
Upon the default of the two utilities on amounts due to the Cal PX, the Cal
PX issued "charge-backs" allocating the utilities' defaults to the other market
participants. Proceedings were brought both in federal court and at the FERC
seeking a suspension of the charge-backs and challenging the reasonableness of
the Cal PX's actions. The Cal PX agreed to a preliminary injunction suspending
any of its charge-back activities and on April 16, 2001, the FERC issued an
order finding the charge-backs to be unjust and unreasonable under the
circumstances but deferred further action pending resolution of certain state
proceedings. Amounts owed to the Company were debited in invoices by the Cal PX
for charge-backs in the amount of $29 million and, on February 14, 2001, the
Company filed its own lawsuit against the Cal PX in the United States District
Court for the Central District of California, seeking a recovery of those
amounts and a stay of any further charge-backs by the Cal PX, to which the
parties agreed. The filing of bankruptcy by the Cal PX has automatically stayed
for some period the various court and administrative cases against the Cal PX.
However, in its April 16 order, the FERC asserted its regulatory power to
address the charge-back issues.
The two defaulting utilities have both filed lawsuits challenging the
refusal of state regulators to allow wholesale power costs to be passed through
to retail customers under the "filed rate doctrine." The suit brought by PG&E
was dismissed without prejudice on May 2, 2001, on ripeness grounds because PG&E
based its claims in part on non-final interim orders of the CPUC, but may be
refiled once the challenged CPUC interim orders become final decisions. In the
suit brought by Southern California Edison Company (SCE), the judge has denied
SCE's request for preliminary relief, and an immediate retail rate increase, but
is expected to issued a decision on the merits. The filed rate doctrine provides
that wholesale power costs approved by the FERC are entitled to be recovered
through rates. Additionally, to address the failing financial condition of the
two defaulting utilities and the utilities' potential bankruptcy, the California
Legislature passed emergency legislation, effective January 18, 2001 and
February 2, 2001, appropriating funds to be used by the CDWR for the purchase of
wholesale electricity on behalf of the utilities and authorizing the sale of
bonds to fund future purchases under long-term power contracts with wholesale
generators. The CDWR has solicited bids and has reported that it has entered
into some long-term contracts with generators and continued the purchasing of
short-term power contracts. No bonds have yet been issued by the CDWR to support
long-term power purchases or to provide credit support for short-term
purchases. However, on May 10, 2001, California Governor Davis signed
legislation into law that allows the CDWR to issue up to $13.4 billion in bonds
to cover the purchase of power. The proceeds from this bond issuance, however,
may not be used to pay for any undercollections or existing debt of the
utilities.
As noted above, two of California's public utilities have defaulted in
their payment obligations to the Cal PX and the Cal ISO as a result of the
refusal of state regulators to allow them to recover their wholesale power
costs. This refusal by state regulators has also caused the utilities to default
on numerous other financial obligations, and in the case of Pacific Gas and
Electric Company, to file a voluntary petition for bankruptcy under Chapter 11
of the U.S. Bankruptcy Code. On March 27, 2001, the CPUC approved an increase in
the retail rates of the two defaulting California utilities but ordered the
utilities to apply the increase to pay the CDWR for power purchased by the CDWR
on the utilities' behalf. Because the CPUC order attempts to prevent use of the
increased revenue to pay suppliers for electricity delivered before the date of
the decision, the rate increase does not address the existing indebtedness of
the utilities. While the bankruptcy filing will result in further post-petition
purchases of wholesale electricity being considered administrative expenses of
the debtor, a substantial delay could be experienced in the payment of
pre-petition receivables pending the confirmation of a reorganization plan. The
California Legislature is currently considering legislation under which a state
entity would be formed to purchase and operate a substantial share of the
transmission lines in California in an effort to provide cash to the utilities.
A number of the creditors for one of the other troubled California public
utilities, SCE, have indicated, however, that unless there is more action on a
plan to restore the utility's solvency, an involuntary bankruptcy filing may be
made by such creditors. SCE's April 9, 2001 memorandum of understanding with the
state of California, which would transfer the utility's transmission system to
the CDWR or another state agency for approximately $2.76 billion, is intended to
address these issues. The closing of this type of transaction is subject to
numerous factors including the completion of documentation and extensive
regulatory approvals including approval by the FERC.
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Because California's power reserves remained at low levels, in part as a
result of the lack of creditworthy buyers of power given the defaults of the
California utilities, the Cal ISO relied on emergency dispatch orders requiring
generators to provide at the Cal ISO's direction all power not already under
contract. The power supplied to the Cal ISO was used to meet the needs of the
customers of the utilities, even though two of those utilities did not have the
credit required to receive such power under the Cal ISO's tariff and were unable
to pay for it. The Cal ISO had previously obtained a preliminary injunction on
March 21, 2001 from a federal district court in California compelling the
Company to comply with emergency dispatch orders despite the utilities' failure
to meet credit standards, based on the court's conclusion that the Cal ISO's
tariff provisions regarding credit were not applicable to emergency dispatch
orders. On March 22, 2001, the Company filed a notice of appeal of the district
court's injunction with the Ninth Circuit Court of Appeals and on March 23, 2001
the Company filed an emergency motion for stay of injunction. Because the
Company showed a "high likelihood of success on the merits" of the appeal, the
Ninth Circuit Court of Appeals granted the stay on April 5, 2001, suspending the
district court's preliminary injunction pending its final ruling in the appeal.
On April 6, 2001, the FERC issued an order confirming that the credit provisions
of the Cal ISO's tariff apply to all sales of electricity under the tariff,
including the emergency dispatch orders. As a result of the FERC's order, the
district court's preliminary injunction expired in accordance with its terms and
the district court dismissed the Cal ISO's complaint. Therefore, the Company did
not pursue its appeal to the Ninth Circuit and is no longer compelled to comply
with the emergency dispatch orders in the absence of a creditworthy
counterparty. As of March 31, 2001, the Company was owed $108 million for power
provided in compliance with the emergency dispatch orders.
In May 2001, a bill was passed by the California Senate that proposed a tax
on "windfall profits" earned by electric generators in California. The bill
would impose a 100% tax on any electricity sold by California generators that
exceeds a "just and reasonable price," such price to be set by the CPUC.
Initially, the rate would be set at $80 per MWh. The bill must still be voted on
and passed by the California Assembly, and signed by the Governor, before it
will become law. At this time, the Company cannot predict whether this
legislation will be enacted into law, or if enacted, what form it will take or
whether it may be legally applied to the Company's operations. If the bill in
its current form is enacted into law, such a tax could significantly increase
the cost of operating power generation facilities serving the California market
and could have a material adverse effect on the Company's financial condition,
results of operators and cash flows.
(e) Indemnification of Dutch Stranded Costs.
The stranded costs in the Dutch electricity market are considered to be the
liabilities, uneconomical contractual commitments, and other costs associated
with obligations entered into by the coordinating body for the Dutch electricity
generating sector, N.V. Samenwerkende elecktriciteits-produktiebedrijven (SEP),
plus some district heating contracts with some municipalities in Holland. As of
December 29, 2000, SEP changed its name to BV Nederlands Elektriciteit
Administratiekantoor.
Under the Cooperation Agreement (OvS Agreement), UNA and the other Dutch
generators agreed to sell their generating output through SEP. Over the years,
SEP incurred stranded costs as a result of a perceived need to cover anticipated
shortages in energy production supply. SEP stranded costs consist primarily of
investments in alternative energy sources and fuel and power purchase contracts
currently estimated to be uneconomical.
In December 2000, the Dutch parliament adopted legislation, The Electricity
Production Sector Transitional Arrangements Act (Transition Act), allocating to
the Dutch generation sector, including UNA, financial responsibility for various
stranded costs contracts and other liabilities of SEP. The Transition Act also
authorizes the government to purchase from SEP at least a majority of the shares
in the Dutch national transmission grid company. The legislation became
effective in all material respects on January 1, 2001.
The Transition Act allocates financial responsibility to the individual
Dutch generators based on their average share in the costs and revenues under
the OvS Agreement during the past ten years. UNA's allocated share of these
costs has been set at 22.5%. Among other things, the Transition Act allocates to
the four Dutch generation companies, including UNA, financial responsibility for
SEP's obligations to purchase electricity and gas under an import gas supply
contract, three electricity import contracts and experimental coal facility and
district heating contracts. The gas import contract expires in 2015 and provides
for gas imports aggregating 2.283 billion cubic meters per year. The three
electricity contracts have the following capacities and terms: (a) 300 MW
through 2005, (b) 600 MW through 2005 and (c) 600 MW through 2002 and 750 MW
through 2009. The generators have the option of assuming their pro rata
interests in the contracts or, subject to the assignment terms of the contracts,
selling their interests to third parties.
In connection with the acquisition of UNA, the selling shareholders of UNA
agreed to indemnify UNA for some stranded costs in an amount not to exceed NLG
1.4 billion (approximately $558 million based on an exchange rate of 2.51 NLG
per U.S. dollar as of March 31, 2001), which may be increased in some
circumstances at the option of the Company up to NLG 1.9 billion (approximately
$757 million). Of the total consideration paid by the Company for the shares of
UNA, NLG 900 million (approximately $359 million) has been placed by the selling
shareholders in an escrow account under the direction of the Dutch Ministry of
Economic Affairs to secure indemnity obligations.
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Although the Company's management believes that the indemnity provision will be
sufficient to fully satisfy UNA's ultimate share of any stranded costs
obligation, this judgment is based on numerous assumptions regarding the
ultimate outcome and timing of the resolution of the stranded cost issue and the
selling shareholders' timely performance of their obligations under the
indemnity arrangement, among other factors.
The Transition Act provides also that, subject to the approval of the
European Commission, the Dutch government will make financial compensations to
the Dutch generation sector for the out of market costs associated with two
stranded cost items: an experimental coal facility and district heating
contracts.
As a result of the above, UNA recorded an out-of-market, net stranded cost
liability of $544 million at March 31, 2001 for its statutorily allocated share
of these contracts. In addition, UNA recorded a corresponding asset of equal
amount for the indemnification of this obligation from UNA's former
shareholders.
The four Dutch generation companies and SEP are in discussions with the
Dutch Ministry of Economic Affairs regarding the implementation of the
Transition Act. In the first quarter of 2001, the parties have reached an
agreement in principle with the Dutch Ministry of Economic Affairs regarding the
compensation to be paid to SEP for the national transmission grid company. The
proposed compensation amount is NLG 2.55 billion (approximately $1.0 billion
based on an exchange rate of 2.51 NLG per U.S. dollar as of March 31, 2001).
Although the Transition Act clarifies many issues regarding the anticipated
resolution of the stranded costs debate in the Netherlands, there remain
considerable uncertainties regarding the exact manner in which the Transition
Act will be implemented and the potential for third parties to challenge the
Transition Act on legal and constitutional grounds.
(f) Reliant Energy HL&P Rate Matters.
The Texas Utility Commission has issued rulings at its April 2001 meeting
requiring Reliant Energy HL&P to reverse the amount of redirected depreciation
and accelerated depreciation if, in the Texas Utility Commission's estimation,
the utility has overmitigated its stranded costs. At March 31, 2001, cumulative
redirected depreciation and cumulative accelerated depreciation for regulatory
purposes totaled $668 million and approximately $900 million, respectively. The
preliminary reversal of redirected depreciation would result in a lower rate for
the transmission and distribution utility and the accelerated depreciation being
returned through credits over ten years as offsets to the transmission and
distribution utility's non-bypassable charges. The rates derived from the Texas
Utility Commission's April 2001 ruling are interim and will be used during the
retail electric pilot project that begins on June 1, 2001. The Company does not
expect the final Reliant Energy HL&P transmission and distribution rate to be
established until August 2001 and those rates will be implemented on January 1,
2002. The credits related to accelerated depreciation will begin on January 1,
2002. For information regarding redirected depreciation and accelerated
depreciation, see Note 4(a) to Reliant Energy 10-K Notes.
(12) BENEFIT CURTAILMENT AND ENHANCEMENT CHARGE
During the three months ended March 31, 2001, the Company recognized a
pre-tax, non-cash charge of $101 million relating to the redesign of some of
Reliant Energy's benefit plans in anticipation of distributing to Reliant
Energy's or its successor's shareholders the remaining common stock of its
unregulated subsidiary, Reliant Resources. For information regarding this
anticipated transaction, see Note 4(b) to Reliant Energy 10-K Notes.
Effective March 1, 2001, the Company will no longer accrue benefits under a
noncontributory pension plan for its domestic non-union employees of Reliant
Resources and Reliant Energy Tegco, Inc. (Resources Participants). Effective
March 1, 2001, each non-union Resources Participant's unvested pension account
balance became fully vested and a one-time benefit enhancement was provided to
some qualifying participants. During the first quarter of 2001, the Company
incurred a charge to earnings of $84 million (pre-tax) for a one-time benefit
enhancement and a gain of $23 million (pre-tax) related to the curtailment of
Reliant Energy's pension plan.
Effective March 1, 2001, the Company discontinued providing subsidized
postretirement benefits to its domestic non-union employees of Reliant Resources
and its participating subsidiaries and Reliant Energy Tegco, Inc. The Company
incurred a pre-tax charge of $40 million during the first quarter of 2001
related to the curtailment of the Company's postretirement obligation. For
additional information regarding these benefit plans, see Notes 12(b) and 12(d)
to Reliant Energy 10-K Notes.
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(13) REPORTABLE SEGMENTS
The Company's determination of reportable segments considers the strategic
operating units under which the Company manages sales, allocates resources and
assesses performance of various products and services to wholesale or retail
customers in differing regulatory environments. The Company has identified the
following reportable segments: Electric Operations, Natural Gas Distribution,
Pipelines and Gathering, Wholesale Energy, European Energy and Other Operations.
For descriptions of these reporting segments, see Note 1 to Reliant Energy 10-K
Notes. Financial data for the business segments are as follows:
AS OF
FOR THE THREE MONTHS ENDED MARCH 31, 2000 DECEMBER 31, 2000
---------------------------------------------- -----------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS) TOTAL ASSETS
--------------- --------------- -------------- ---------------
(IN MILLIONS)
Electric Operations................................. $ 947 $ -- $ 202 $ 10,691
Natural Gas Distribution............................ 1,044 7 105 4,509
Pipelines and Gathering............................. 47 43 32 2,358
Wholesale Energy.................................... 2,014 142 (22) 11,172
European Energy..................................... 150 -- 33 2,521
Other Operations.................................... 11 4 (9) 2,296
Discontinued Operations(1).......................... -- -- -- 195
Reconciling Elimination............................. -- (196) -- (1,665)
----------- ----------- ----------- -----------
Consolidated........................................ $ 4,213 $ -- $ 341 $ 32,077
=========== =========== =========== ===========
AS OF
FOR THE THREE MONTHS ENDED MARCH 31, 2001 MARCH 31, 2001
---------------------------------------------- -----------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS) TOTAL ASSETS
--------------- --------------- -------------- ---------------
(IN MILLIONS)
Electric Operations................................. $ 1,390 $ -- $ 186 $ 10,933
Natural Gas Distribution............................ 2,269 54 135 4,089
Pipelines and Gathering............................. 75 55 39 2,302
Wholesale Energy.................................... 9,284 309 216 10,903
European Energy..................................... 248 -- 18 3,079
Other Operations.................................... 18 13 (134) 2,342
Discontinued Operations(1).......................... -- -- -- 121
Reconciling Elimination............................. -- (431) -- (1,301)
----------- ----------- ----------- -----------
Consolidated........................................ $ 13,284 $ -- $ 460 $ 32,468
=========== =========== =========== ===========
- ---------
(1) Effective December 1, 2000, Reliant Energy's Board of Directors approved a
plan to dispose of its Latin American segment, through sales of its assets.
Accordingly, the Company is reporting the results of its Latin American
segment as discontinued operations for all periods presented in the Interim
Financial Statements in accordance with Accounting Principles Board Opinion
No. 30.
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Reconciliation of Operating Income to Net Income Attributable to Common
Stockholders:
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Operating Income.......................................................... $ 341 $ 460
Other Income.............................................................. 21 50
Interest Expense.......................................................... (160) (178)
Distribution on Trust Preferred Securities................................ (14) (14)
Income Tax Expense........................................................ (55) (110)
Loss on Disposal of Discontinued Operations, net of tax.................... -- (7)
Cumulative Effect of Accounting Change, net of tax........................... -- 61
-------------- --------------
Net Income Attributable to Common Stockholders............................. $ 133 $ 262
============== ==============
(14) SUBSEQUENT EVENTS
(a) Construction Agency Agreement.
In April 2001, Reliant Resources, through several of its subsidiaries,
entered into operative documents with special purpose entities to facilitate the
development, construction, financing and leasing of several power generation
projects. The special purpose entities have an aggregate financing commitment
from equity and debt participants (the Investors) of $2.5 billion. Reliant
Resources, through several of its subsidiaries, acts as construction agent for
the special purpose entities, and is responsible for completing construction of
these projects by August 31, 2004, but has generally limited its risk related to
construction completion to less than 90% of costs incurred to date, except in
certain events. Upon completion of an individual project and exercise of the
lease option, Reliant Resources' subsidiaries will be required to make lease
payments in an amount sufficient to provide a return to the Investors. If
Reliant Resources does not exercise its option to lease any project at
completion, Reliant Resources must purchase the project or remarket the project
on behalf of the special purpose entities. At the end of an individual project's
operating lease term (approximately five years from construction completion),
the lessees have the option to extend the lease at fair market value, purchase
the project at a fixed amount equal to the original construction cost, or act as
a remarketing agent and sell the project to an independent third party. If the
lessees elect the remarketing option, they may be required to make a payment of
up to 85% of the project cost if the proceeds from remarketing are deficient to
repay the Investors. Reliant Resources has guaranteed the performance and
payment of its subsidiaries' obligations during the construction periods and if
the lease option is exercised, the lessee's obligations during the lease period.
(b) Initial Public Offering of Reliant Resources.
On July 27, 2000, Reliant Energy announced its intention to form Reliant
Resources to own and operate a substantial portion of Reliant Energy's
unregulated operations, and to offer no more than 20% of the common stock of
Reliant Resources in an initial public offering (Offering) in connection with
the Company's business separation plan. On May 4, 2001, Reliant Resources
completed its initial public offering of 52 million shares of its common stock
and received net proceeds of $1.5 billion. On May 11, 2001, the underwriters of
the Offering exercised an option to buy an additional 7.8 million shares of
Reliant Resources common stock, resulting in net proceeds of $222 million.
Reliant Resources used these net proceeds to increase its working capital.
Reliant Energy expects the Offering to be followed by a distribution of the
remaining common stock of Reliant Resources owned by Reliant Energy to Reliant
Energy's or its successor's shareholders within 12 months of the Offering
(Distribution). For additional information regarding the Company's business
separation plan, please read Note 4(b) to Reliant Energy 10-K Notes.
The Distribution is subject to further corporate approvals, market and
other conditions, and government actions, including receipt of a favorable
Internal Revenue Service ruling that the Distribution would be tax-free to
Reliant Energy or its successor and its shareholders for U.S. federal income tax
purposes, as applicable. There can be no assurance that the Distribution will be
completed as described or within the time periods outlined above.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF RELIANT ENERGY AND SUBSIDIARIES
The following discussion and analysis should be read in combination with
our Interim Financial Statements contained in this Form 10-Q.
We are a diversified international energy services and energy delivery
company that provides energy and energy services in North America and Western
Europe. We operate one of the nation's largest electric utilities in terms of
kilowatt-hour (KWh) sales, and our three natural gas distribution divisions
together form one of the United States' largest natural gas distribution
operations in terms of customers served. We invest in the acquisition,
development and operation of international and domestic non-rate regulated power
generation facilities. We own two interstate natural gas pipelines that provides
gas transportation, supply, gathering and storage services, and we also engage
in wholesale energy marketing and trading.
In this section we discuss our results of operation on a consolidated basis
and individually for each of our business segments. We also discuss our
liquidity and capital resources. Our financial reporting segments include
Electric Operations, Natural Gas Distribution, Pipelines and Gathering,
Wholesale Energy, European Energy and Other Operations. For segment reporting
information, please read Note 13 to our Interim Financial Statements.
Effective December 1, 2000, our Board of Directors approved a plan to
dispose of our Latin American business segment and sale of its assets.
Accordingly, we are reporting the results of our Latin American business segment
as discontinued operations for all periods presented in our Interim Financial
Statements in accordance with Accounting Principles Board Opinion No. 30. For
additional information regarding the disposal of our Latin American business
segment, please read Note 19 to Reliant Energy 10-K Notes.
In 2000, we submitted a business separation plan to the Texas Utility
Commission that was later amended during the year to restructure our businesses
into two separate publicly traded companies in order to separate our unregulated
businesses from our regulated businesses. In December 2000, the plan was
substantially approved by the Texas Utility Commission in its entirety and a
final order was issued on April 10, 2001. For additional information regarding
the business separation plan, please read Note 4(b) to Reliant Energy 10-K
Notes.
As part of the separation, our parent company, Reliant Energy will undergo
a restructuring of its corporate organization to achieve a new holding company
structure. The new holding company will hold our regulated businesses. In
connection with the formation of the new holding company, we will seek an
exemption from the registration requirements of the Public Utility Holding
Company Act of 1935 (1935 Act) or, if no exemption is available, the new holding
company will register as a public utility holding company under the 1935 Act.
The restructuring will require approval of the Securities and Exchange
Commission, certain of the affected state commissions and the Nuclear Regulatory
Commission.
In connection with the separation, we formed Reliant Resources, which owns
and operates a substantial portion of our unregulated operations. In May 2001,
Reliant Resources offered 59.8 million shares of its common stock to the public
at an initial public offering price of $30 per share and received net proceeds
from the offering of $1.7 billion. Reliant Energy expects to distribute the
remaining common stock of Reliant Resources it owns to Reliant Energy's or its
successor's shareholders within 12 months of the closing of the Reliant
Resources initial public offering (Offering). For additional information
regarding our business separation plan, please read Note 4(b) to Reliant Energy
10-K Notes.
On May 12, 2000, one of our subsidiaries purchased entities owning electric
power generating assets and development sites located in Pennsylvania, New
Jersey, and Maryland having an aggregate net generating capacity of
approximately 4,262 MW. With the exception of development entities that were
sold to another Reliant Energy subsidiary in July 2000, the assets of the
entities acquired are held by REMA. The purchase price for the May 2000
transaction was $2.1 billion. We accounted for the acquisition as a purchase,
and accordingly, our results of operations include the results of operations for
REMA only for the period after the acquisition date. For additional information
about this acquisition, including our accounting treatment of the acquisition,
please read Note 3(a) to Reliant Energy 10-K Notes and Note 3 to our Interim
Financial Statements.
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CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
Revenues..................................................................... $ 4,213 $ 13,284
Operating Expenses........................................................... (3,872) (12,824)
-------------- --------------
Operating Income............................................................. 341 460
Other Income ................................................................ 21 50
Interest Expense and Other Charges........................................... (174) (192)
Income Tax Expense .......................................................... (55) (110)
Loss on Disposal of Discontinued Operations, net of tax...................... -- (7)
Cumulative Effect of Accounting Change, net of tax........................... -- 61
-------------- --------------
Net Income Attributable to Common Stockholders............................... $ 133 $ 262
============== ==============
Basic Earnings Per Share..................................................... $ 0.47 $ 0.91
Diluted Earnings Per Share................................................... $ 0.47 $ 0.90
Three months ended March 31, 2001 compared to three months ended March 31, 2000
We reported consolidated net income of $262 million ($0.90 per diluted
share) for the three months ended March 31, 2001 compared to $133 million ($0.47
per diluted share) for the three months ended March 31, 2000. The 2001 results
reflect a $7 million, after-tax non-cash loss on the disposal of discontinued
operations in Latin America, a $61 million after-tax non-cash gain from the
adoption of SFAS No. 133 and a $65 million after-tax non-cash charge relating to
the redesign of the company's benefits for employees of our unregulated
businesses. The 2000 results include a $1 million loss from discontinued
operations in Latin America.
For information regarding the adoption of SFAS No. 133, the discontinuance
of our Latin American segment and the benefit charge incurred in the first
quarter of 2001, see Notes 2, 4 and 12 to our Interim Financial Statements.
Our consolidated net income, after adjusting for the charges described
above, was $274 million ($0.94 per diluted share) for three months ended March
31, 2001 compared to $134 million ($0.47 per diluted share) for the three months
ended March 31, 2000. The $140 million increase was primarily due to increased
earnings from our Wholesale Energy, Natural Gas Distribution and Pipelines and
Gathering segments.
For an explanation of changes in operating income for the first quarter of
2001 versus 2000, see the discussion below of operating income (loss) by
segment. Other income increased by $29 million during the first quarter of 2001
compared to 2000 primarily due to increased earnings from unconsolidated
subsidiaries of our Wholesale Energy segment and increased interest income from
our Electric Operations and Wholesale Energy segments. In addition, during the
first quarter of 2000, the Company realized interest income related to a tax
refund of $26 million which was partially offset by a pre-tax impairment loss of
$22 million related to certain marketable securities. For additional information
regarding our investment in the equity securities noted above, see Note 2(l) to
Reliant Energy 10-K Notes.
Our Wholesale Energy segment reported income from equity investments for
the three months ended March 31, 2001 of $13 million compared to $0.5 million in
the same period in 2000. The equity income in 2001 primarily resulted from an
investment in an electric generation plant in Boulder City, Nevada. The plant
became operational in May 2000.
We incurred interest expense and other charges of $192 million and $174
million for the first quarters of 2001 and 2000, respectively. The increase was
a result of higher levels of short-term borrowing and long-term debt in 2001
compared to 2000.
The effective tax rate for the first quarter of 2000 and 2001 was 29% and
35%, respectively.
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The table below shows operating income (loss) by segment:
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Electric Operations.......................................................... $ 202 $ 186
Natural Gas Distribution..................................................... 105 135
Pipelines and Gathering...................................................... 32 39
Wholesale Energy............................................................. (22) 216
European Energy.............................................................. 33 18
Other Operations............................................................. (9) (134)
-------------- --------------
Total Consolidated..................................................... $ 341 $ 460
============== ==============
ELECTRIC OPERATIONS
Our Electric Operations segment conducts operations under the name "Reliant
Energy HL&P," an unincorporated division of Reliant Energy. Electric Operations
generates, purchases, transmits and distributes electricity to approximately 1.7
million customers in a 5,000 square mile area on the Texas Gulf Coast, including
Houston, Texas.
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Operating Revenues:
Base Revenues.............................................................. $ 602 $ 617
Reconcilable Fuel Revenues................................................. 345 773
-------------- --------------
Total Operating Revenues................................................. 947 1,390
-------------- --------------
Operating Expenses:
Fuel and Purchased Power................................................... 358 786
Operation and Maintenance.................................................. 210 248
Depreciation and Amortization.............................................. 99 79
Other Operating Expenses................................................... 78 91
-------------- --------------
Total Operating Expenses................................................. 745 1,204
-------------- --------------
Operating Income............................................................. $ 202 $ 186
============== ==============
Electric Sales Including Unbilled (GWh(1)):
Residential................................................................ 3,446 3,951
Commercial................................................................. 3,737 3,969
Industrial................................................................. 7,009 6,804
Industrial - Interruptible................................................. 1,313 634
Other 721 296
-------------- --------------
Total Sales Including Unbilled............................................. 16,226 15,654
============== ==============
Average Cost of Fuel (Cents/MMBtu (2))....................................... 192.1 302.5
============== ==============
- ----------
(1) Gigawatt hours
(2) Million British thermal units
Our Electric Operations segment operating income for the three months ended
March 31, 2001 decreased $16 million compared to the three months ended March
31, 2000. The decline was primarily due to increased operation and maintenance
expenses and increased taxes, partially offset by strong demand from residential
and commercial customers and reduced depreciation and amortization expense.
Base revenues increased $15 million for the first quarter of 2001 primarily
due to increased customer growth and demand.
Reconcilable fuel revenues and fuel and purchased power expenses for the
first quarter of 2001 increased as a result of the higher cost of natural gas
($2.67 and $7.50 per MMBtu in the first quarters of 2000 and 2001,
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respectively), higher costs per unit for purchased power ($26.43 and $71.01 per
megawatt hour (MWh) in the first quarters of 2000 and 2001, respectively) and
higher volumes due to customer growth, which led to increased production.
Operation and maintenance expenses and other operating expenses for the
first quarter of 2001 increased by $38 million and $13 million, respectively,
when compared to the same period in 2000. The increases were largely due to
higher revenue related taxes, increased benefits costs, and increased
information technology costs.
Depreciation and amortization expense in the first quarter of 2001
decreased $20 million compared to the same period in 2000. The decrease was
primarily due to a decrease in amortization of the book impairment loss recorded
in June 1999 and decreased amortization expense due to regulatory assets related
to cancelled projects being fully amortized in June 2000. For information
regarding items that affect depreciation and amortization expense of Electric
Operations pursuant to the Legislation and the Transition Plan, see Notes 2(g)
and 4(a) to Reliant Energy 10-K Notes.
NATURAL GAS DISTRIBUTION
Our Natural Gas Distribution segment's operations consist of intrastate
natural gas sales to, and natural gas transportation for residential, commercial
and industrial customers in Arkansas, Louisiana, Minnesota, Mississippi,
Oklahoma and Texas and some non-rate regulated retail marketing of natural gas.
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Operating Revenues........................................................... $ 1,051 $ 2,323
Operating Expenses:
Natural Gas................................................................ 758 1,977
Operation and Maintenance.................................................. 124 133
Depreciation and Amortization.............................................. 36 36
Other Operating Expenses................................................... 28 42
-------------- --------------
Total Operating Expenses................................................. 946 2,188
-------------- --------------
Operating Income............................................................. $ 105 $ 135
============== ==============
Throughput Data (in Bcf(1)):
Residential and Commercial Sales........................................... 121 153
Industrial Sales........................................................... 13 11
Transportation............................................................. 15 15
Retail..................................................................... 140 132
-------------- --------------
Total Throughput......................................................... 289 311
============== ==============
- ---------------
(1) Billion cubic feet.
Our Natural Gas Distribution segment's operating income increased $30
million for the first quarter of 2001 as compared to the same period in 2000.
The substantial rise was largely due to improved margins from cooler weather,
partially offset by increased operating expenses. In addition, operating
revenues for the first quarter of 2000 included a $12 million gain from the
effect of a financial hedge of our Natural Gas Distribution segment's earnings
against unseasonably warm weather during peak gas heating months, while for the
first quarter of 2001, there was a $1 million loss. Increased operating margins
(revenues less fuel costs) were slightly offset by higher operating expenses.
Operating expenses increased primarily as a result of increased information
system-related costs and employee benefit costs.
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PIPELINES AND GATHERING
Our Pipelines and Gathering segment operates two interstate natural gas
pipelines as well as provides gathering and pipeline services.
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Operating Revenues.......................................................... $ 90 $ 130
Operating Expenses:
Natural Gas............................................................... 15 45
Operation and Maintenance................................................. 25 28
Depreciation and Amortization............................................. 14 14
Other Operating Expenses.................................................. 4 4
-------------- --------------
Total Operating Expenses................................................ 58 91
-------------- --------------
Operating Income............................................................ $ 32 $ 39
============== ==============
Throughput Data (in MMBtu):
Natural Gas Sales......................................................... 4 6
Transportation............................................................ 261 246
Gathering................................................................. 70 70
Elimination(1)............................................................ (3) (1)
-------------- --------------
Total Throughput............................................................ 332 321
============== ==============
- ----------
(1) Elimination of volumes both transported and sold.
Our Pipelines and Gathering segment operating income for the first quarter
of 2001 increased $7 million compared to the same period in 2000. Improved
operating margins (revenues less natural gas costs) from both the pipelines and
gas gathering businesses contributed to the increase.
WHOLESALE ENERGY
Our Wholesale Energy segment includes our non-rate regulated power
generation operations in the United States and our wholesale energy trading,
marketing, power origination and risk management operations in North America.
Trading and marketing purchases fuel to supply existing generation assets, sells
the electricity produced by these assets, and manages the day-to-day trading and
dispatch associated with these portfolios. As a result, we have made, and expect
to continue to make, significant investments in developing the trading and
marketing infrastructure including software, trading and risk control resources.
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Operating Revenues.......................................................... $ 2,156 $ 9,593
Operating Expenses:
Fuel and Cost of Gas Sold................................................. 1,420 5,654
Purchased Power........................................................... 687 3,547
Operation and Maintenance................................................. 62 133
Depreciation and Amortization............................................. 7 41
Other Operating Expenses.................................................. 2 2
-------------- --------------
Total Operating Expenses................................................ 2,178 9,377
-------------- --------------
Operating (Loss) Income..................................................... $ (22) $ 216
============== ==============
Operations Data:
Natural Gas (in Bcf):
Sales .................................................................... 549 767
============== ==============
Electricity (MMWh):
Wholesale Power Sales..................................................... 28 76
============== ==============
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Our Wholesale Energy segment's operating income increased $238 million for
first quarter of 2001 compared to the same period in 2000. The increase was
primarily due to increased revenues from energy and ancillary services, the
addition of our Mid-Atlantic assets and strong commercial and operational
performance in other regions. These results were partially offset by higher
general and administrative and air emissions regulatory allowance expenses and a
$38 million provision taken against receivable balances related to energy sales
in the West region. Gross margins (revenues less fuel and cost of gas sold and
purchased power) for the Wholesale Energy segment rose by $343 million from the
same quarter of last year.
For information regarding the reserve against receivables and uncertainties
in the California wholesale energy market, see Notes 11(a) and 11(d) to our
Interim Financial Statements.
Our Wholesale Energy segment's operating revenues increased $7.4 billion
for the first quarter 2001 compared to the same period in 2000. The increase was
primarily due to increases in prices for gas and power sales and to a lesser
extent higher volumes of both power and gas sales. Our fuel and gas costs
increased $4.2 billion in the first quarter of 2001 compared to the same period
in 2000, largely due to a higher average cost of gas and increased volume. Our
purchased power expense increased $2.9 billion in the first quarter of 2001,
primarily due to higher power sales volumes and higher average cost of power.
Operation and maintenance expenses increased $71 million in the first quarter of
2001 compared to the same period in 2000, primarily due to costs associated with
the operation and maintenance of generating plants acquired or placed into
service after the first quarter of 2000, lease expense associated with the
Mid-Atlantic generating facilities' sale/leaseback transactions and higher
staffing levels to support increased sales and expanded trading and marketing
efforts. Depreciation and amortization expense for the first quarter of 2001
compared to the same period in 2000 increased as a result of higher expense
related to the amortization of air emissions regulatory allowances, primarily in
the West region, and depreciation of our Mid-Atlantic plants, which were
acquired after the first quarter of 2000.
EUROPEAN ENERGY
Our European Energy segment includes the operations of UNA and its
subsidiaries and our European trading, marketing and risk management operations.
Our European Energy segment generates and sells power from its generation
facilities in the Netherlands and participates in the emerging wholesale energy
trading and marketing industry in Northwest Europe.
Beginning January 1, 2001, the Dutch wholesale electric market was
completely opened to competition. Consistent with our expectations at the time
we made the acquisition, we anticipate that UNA will experience a significant
decline in electric margins in 2001 attributable to the deregulation of the
market. For additional information on these and other factors that may affect
the future results of operations of European Energy, please read "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Certain Factors Affecting Our Future Earnings - Competitive, Regulatory and
Other Factors Affecting Our European Energy Operations" in the Reliant Energy
Form 10-K, which information is incorporated herein by reference.
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Operating Revenues........................................................... $ 150 $ 248
Operating Expenses:
Fuel and Purchased Power................................................... 69 182
Operation and Maintenance and Other........................................ 28 29
Depreciation and Amortization.............................................. 20 19
-------------- --------------
Total Operating Expenses................................................. 117 230
-------------- --------------
Operating Income............................................................. $ 33 $ 18
============== ==============
Our European Energy segment operating income decreased $15 million for the
first quarter of 2001 compared to the same period in 2000. The decrease was
primarily due to a decrease in margins (revenues less fuel and purchased power)
as the Dutch wholesale electric market was completely opened to competition on
January 1, 2001. Increased margins from ancillary services and district heating
partially offset this decline.
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Our European Energy segment operating revenues increased $98 million for
the first quarter of 2001 compared to the same period in 2000. This increase was
primarily due to increased trading revenues associated with our participation in
the now fully deregulated Dutch wholesale electric market. Fuel and purchased
power costs increased $113 million in the first quarter of 2001 compared to same
period in 2000 primarily due to increased purchased power for trading
activities, cost of natural gas and other fuels.
OTHER OPERATIONS
Our Other Operations segment includes the operations of our unregulated
retail electric operations, a communications business offering enhanced data,
voice and other services to customers in Texas, an eBusiness group,
non-operating investments, certain real estate holdings and unallocated
corporate costs.
Our Other Operations segment's operating loss increased $125 million for
the first quarter of 2001 compared to the same period in 2000. The increase was
primarily due to a $101 million pre-tax, non-cash charge related to the redesign
of certain of our benefit plans in anticipation of the separation of our
regulated businesses and our unregulated businesses. In addition, the increased
operating loss was due to the timing of certain legal expenses, as well as costs
related to our communications operations. For information regarding the benefit
charge incurred in the first quarter of 2001, see Note 12 to our Interim
Financial Statements.
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CERTAIN FACTORS AFFECTING OUR FUTURE EARNINGS
GENERAL
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Certain Factors Affecting
Our Future Earnings" in the Reliant Energy Form 10-K, which is incorporated
herein by reference. For additional information regarding the California
wholesale market and related litigation, please read Notes 11(a) and 11(d) to
our Interim Financial Statements.
ELECTRIC OPERATIONS
In contemplation of open competition, our Electric Operations segment has
been allowed since 1998 under our Transition Plan approved by the Texas Utility
Commission and the Legislation to earn base revenues which produced earnings in
excess of traditional regulated levels. These excess earnings have been utilized
to mitigate stranded cost of generation plants by accelerating the depreciation
of these assets for regulatory purposes.
This transition to competition period is scheduled to end on December 31,
2001. At that time, and in accordance with the Legislation, our Electric
Operations segment will be unbundled pursuant to our business separation plan
(please read Notes 4(a) and 4(b) to Reliant Energy 10-K Notes) into three
distinct businesses: a transmission and distribution company, a power generation
company and a retail company. New rates based on the allowed invested capital,
or "rate base", of the transmission and distribution business will be
implemented beginning on January 1, 2002. For more information regarding the
interim rulings in the transmission and distribution company's rate case, please
read Note 11(f) to our Interim Financial Statements. The retail business will be
conducted by a subsidiary of Reliant Resources. The generation business will
sell power via capacity auctions at market rates. However, the Legislation
provides that during the 2004 stranded cost true-up (please read Note 4(a) to
Reliant Energy 10-K Notes), a true-up amount will be calculated which will be
recovered from or returned to customers to adjust the market revenues earned
from the capacity auctions to a level that would approximate a regulated return
on the invested capital of the generation business. Thus, beginning in 2002,
earnings of our Electric Operations segment will be reduced to near traditional
regulated returns independent of any additional positive or negative cash flows
which may result from implementation of competitive transition charges received
from customers or other credits to customers, as applicable. Accordingly, the
results of operations of our Electric Operations segment post-competition will
significantly decline.
FINANCIAL CONDITION
The following table summarizes the net cash provided by (used in)
operating, investing and financing activities for the three months ended March
31, 2000 and 2001.
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Cash provided by (used in):
Operating activities..................................................... $ 476 $ 108
Investing activities..................................................... (1,374) (490)
Financing activities..................................................... 910 277
Net cash provided by operating activities during the three months ended
March 31, 2001 decreased $368 million compared to the same period in 2000
primarily due to a net $780 million decrease in accounts payables. This decrease
was partially offset by (a) a $238 million increase in operating income for the
Wholesale Energy segment due to increased revenues from energy and ancillary
services, the addition of our Mid-Atlantic assets and strong commercial and
operational performance in other regions, and (b) a $227 million increase in
margin deposits.
Net cash used in investing activities decreased $884 million during the
three months ended March 31, 2001 compared to the same period in 2000 primarily
due to the funding of the remaining purchase obligation for UNA for $982 million
on March 1, 2000 partially offset by increased capital expenditures during the
three months ended March 31, 2001.
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Cash flows provided by financing activities decreased $633 million during
the three months ended March 31, 2001 compared to the same period in 2000
primarily due to a decrease in cash received from short-term borrowings. The
Company utilized the net borrowings incurred during the first three months of
2000 to fund the remaining UNA purchase obligation, to support increased capital
expenditures by our Wholesale Energy segment and for general corporate purposes,
including the repayment of indebtedness. The issuance of $550 million of
unsecured long-term debt during the first three months of 2001 partially offset
the decrease.
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FUTURE SOURCES AND USES OF CASH FLOWS
Credit Facilities. As of March 31, 2001, we had credit facilities in
effect, including facilities of various financing subsidiaries and operating
subsidiaries, that provided for an aggregate of $9.1 billion in committed
credit. As of March 31, 2001, $6.6 billion was outstanding under these
facilities including commercial paper of $3.2 billion, other borrowings of $2.3
billion and letters of credit of $1.1 billion. The remaining unused credit
facilities totaled $2.5 billion.
Of the $9.1 billion of committed credit facilities described above, $5.7
billion will expire in 2001. To the extent that we continue to need access to
this amount of committed credit, we expect to extend or replace these facilities
on normal commercial terms on a timely basis.
Between December 2000 and March 2001, Reliant Resources entered into
thirteen bilateral credit facilities with financial institutions, which provide
for an aggregate of $1.8 billion in committed credit. In May 2001, Reliant
Resources entered into an additional bilateral credit facility which
provide for an aggregate of $150 million in committed credit. These facilities
became effective subsequent to December 31, 2000 and expire on October 2, 2001.
During the first quarter of 2001, bilateral credit facilities totaling $275
million were terminated and credit facilities totaling $250 million were
transferred from a financing subsidiary to Reliant Resources. Interest rates on
the borrowings are based on LIBOR plus a margin, a base rate or a rate
determined through a bidding process. These facilities contain various business
and financial covenants requiring Reliant Resources to, among other things,
maintain a ratio of net debt to the sum of net debt, subordinated affiliate debt
and shareholders' equity not to exceed 0.60 to 1.00. These covenants are not
anticipated to materially restrict Reliant Resources from borrowing funds or
obtaining letters of credit under these facilities. The credit facilities are
subject to facility and usage fees that are calculated based on the amount of
the facility commitments and on the amounts outstanding under the facilities,
respectively.
In May 2001, aggregate bank facilities and aggregate amount of commercial
paper that can be offered were reduced by $1.5 billion, the amount of net
proceeds from the Offering.
Shelf Registrations. At March 31, 2001, Reliant Energy had shelf
registration statements providing for the issuance of $230 million aggregate
liquidation value of our preferred stock, $580 million aggregate principal
amount of our debt securities and $125 million of trust preferred securities and
related junior subordinated debt securities. In addition, Reliant Energy had a
shelf registration for 15 million shares of its common stock, which would have
been worth $679 million as of March 31, 2001 based on the closing price of its
common stock as of that date. In January 2001, RERC Corp. filed a shelf
registration statement for $600 million of unsecured unsubordinated debt
securities of which $550 million was issued in February 2001.
RERC Corp. Debt Issuance. In February 2001, RERC Corp. issued $550
million aggregate principal amount of unsecured unsubordinated notes that bear
interest at 7.75% per year and mature in February 2011. Net proceeds to RERC
Corp. were $545 million. RERC Corp. used the net proceeds from the sale of the
notes to pay a $400 million dividend to Reliant Energy, and for general
corporate purposes. Reliant Energy used the $400 million proceeds from the
dividend for general corporate purposes, including the repayment of short-term
borrowings.
Securitization. Reliant Energy HL&P filed an application with the Texas
Utility Commission requesting a financing order authorizing the issuance by a
special purpose entity organized by us, of transition bonds relating to Reliant
Energy HL&P's generation related regulatory assets. In May 2000, the Texas
Utility Commission issued a financing order to Reliant Energy authorizing the
issuance of transition bonds in an amount not to exceed $740 million plus actual
up-front qualified costs. Payments on the transition bonds will be made out of
funds derived from non-bypassable transition charges assessed to Reliant Energy
HL&P's transmission and distribution customers. The offering of the transition
bonds will be registered under the Securities Act of 1933 and is expected to be
consummated during 2001.
The expected timing of the transition bond offering assumes that the Texas
Supreme Court will have rejected a constitutional challenge to the statute
permitting the financing orders. That challenge was raised in a court challenge
to a different financing order, issued by the Texas Utility Commission to
another utility. The district court affirmed the constitutionality of the
statute, but a direct appeal to the Texas Supreme Court under a statute
providing for
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expedited judicial review. The Texas Supreme Court heard oral argument on
November 29, 2000, and to date, a decision has not been rendered.
Fuel Filing. As of March 31, 2001, Reliant Energy HL&P was under-collected
on fuel recovery by approximately $694 million. In two separate filings in 2000,
Reliant Energy HL&P received approval to implement fuel surcharges to collect
the under-recovery of fuel expenses, as well as to adjust the fuel factor to
compensate for significant increases in the price of natural gas.
On March 15, 2001, Reliant Energy HL&P filed to revise its fuel factor and
address its undercollected fuel costs of $389 million, which is the accumulated
amount since September 2000 through February 2001, plus estimates for March and
April 2001. Reliant Energy HL&P is requesting to revise its fixed fuel factor to
be implemented with the May 2001 billing cycle and has proposed to defer the
collection of the $389 million until 2004 stranded costs true-up proceeding. On
April 16, 2001, the Texas Utility Commission issued an order approving interim
rates effective with the May 2001 billing cycle. As of May 10, 2001, a final
Order has not been issued in this proceeding.
Initial Public Offering of Reliant Resources. On July 27, 2000, Reliant
Energy announced its intention to form Reliant Resources to own and operate a
substantial portion of Reliant Energy's unregulated operations, and to offer no
more than 20% of the common stock of Reliant Resources in the Offering in
connection with the Company's business separation plan. On May 4, 2001, Reliant
Resources completed its initial public offering of 52 million shares of its
common stock and received net proceeds of $1.5 billion. On May 11, 2001, the
underwriters of the Offering exercised an option to buy an additional 7.8
million shares of Reliant Resources common stock, resulting in net proceeds of
$222 million. Reliant Resources used these net proceeds to increase its working
capital. Reliant Energy expects the Offering to be followed by a distribution of
the remaining common stock of Reliant Resources owned by Reliant Energy to
Reliant Energy's or its successor's shareholders within 12 months of the
Offering. For additional information regarding the Company's business separation
plan, please read Note 4(b) to Reliant Energy 10-K Notes.
Acquisition of Mid-Atlantic Assets. On May 12, 2000, we completed the
acquisition of our Mid-Atlantic assets from Sithe Energies, Inc. for an
aggregate purchase price of $2.1 billion. The acquisition was originally
financed through commercial paper borrowings at one of our financing
subsidiaries. In August 2000, we entered into separate sale/leaseback
transactions with each of the three owner-lessors for our respective 16.45%,
16.67% and 100% interests in the Conemaugh, Keystone and Shawville generating
stations, respectively, which we acquired as part of the Mid-Atlantic
acquisition. For additional discussion of these lease transactions, please read
Notes 3(a) and 14(c) to Reliant Energy 10-K Notes. As consideration for the sale
of our interest in the facilities, we received a total of $1.0 billion in cash
that was used to repay commercial paper borrowings at one of our financing
subsidiaries. We will continue to make lease payments through 2029. The lease
terms expire in 2034.
Channelview Project. Our 781 MW gas-fired, combined cycle, cogeneration
plant located in Channelview, Texas, which is currently under construction, is
expected to cost $463 million, including $129 million in commitments for the
purchase of combustion turbines. Of this amount, $315 million had been incurred
as of March 31, 2001. The project continues to be financed through funds
received under the terms of a committed equity bridge facility, which totals $92
million, a non-recourse debt facility aggregating $369 million and projected
construction revenues of $2 million.
Other Generating Projects. As of March 31, 2001, we had three additional
non-rate regulated generating facilities under construction. Total estimated
costs of constructing these facilities are $870 million, including $372 million
in commitments for the purchase of combustion turbines. As of March 31, 2001, we
had incurred $753 million of the total projected costs of these projects, which
were funded primarily through short-term borrowings from various financing
subsidiaries of Reliant Energy. We believe that our level of cash, our borrowing
capability and proceeds from the initial public offering of Reliant Resources as
discussed above will be sufficient to fund these commitments. In addition, we
have options to purchase additional combustion turbines for a total estimated
cost of $483 million for future generation projects. We believe that our current
level of cash, our borrowing capability and proceeds from the initial public
offering will be sufficient to fund these options should we choose to exercise
them.
Construction Agency Agreement. In April 2001, Reliant Resources, through
several of its subsidiaries, entered into operative documents with special
purpose entities to facilitate the development, construction, financing and
leasing of several power generation projects. The special purpose entities have
an aggregate financing commitment
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from equity and debt participants, or the "investors," of $2.5 billion. Reliant
Resources, through several of its subsidiaries, acts as construction agent for
the special purpose entities, and is responsible for completing construction of
these projects by August 31, 2004, but have generally limited Reliant Resources'
risk related to construction completion to less than 90% of project costs
incurred to date, except in certain events. Upon completion of an individual
project and exercise of the lease option, its subsidiaries will be required to
make lease payments in an amount sufficient to provide a return to the
investors. If Reliant Resources does not exercise its option to lease any
project at our completion, we must purchase the project or remarket the project
on behalf of the special purpose entities. At the end of an individual project's
operating lease term (approximately five years from construction completion),
the lessees have the option to extend the lease at fair market value, purchase
the project at a fixed amount equal to the original construction cost, or act as
remarketing agent and sell the project to an independent third party. If the
lessees elect the remarketing option, they may be required to make a payment, up
to 85% of the project cost, if the proceeds from remarketing are deficient to
repay the investors. Reliant Resources has guaranteed the performance and
payment of its subsidiaries' obligations during the construction periods and if
the lease option is exercised, the lessee's obligations during the lease period.
California Trade Receivables. During the summer and fall of 2000, prices
for wholesale electricity in California increased dramatically as a result of a
combination of factors, including higher natural gas prices and emissions
allowance costs, reduction in available hydroelectric generation resources,
increased demand, decreases in net electric imports, structural market flaws
including over-reliance on the spot market, and limitations on supply as a
result of maintenance and other outages. Although wholesale prices increased,
California's deregulation legislation kept retail rates frozen below 1996
levels. This caused two of California's public utilities, which are our
customers based on our deliveries to the Cal PX and the Cal ISO, to accrue
billions of dollars of unrecovered wholesale power costs and ultimately default
in January and February 2001 on payments owed for wholesale power purchased
through the Cal PX and from the Cal ISO, and in the case of Pacific Gas and
Electric Company, to file a voluntary petition for bankruptcy. As of March 31,
2001, we were owed $337 million by the Cal ISO, the Cal PX, the CDWR and
California Energy Resource Scheduling for energy sales in the California
wholesale market, during the fourth quarter of 2000 through March 31, 2001 and
have recorded an allowance against such receivables of $77 million. From April
1, 2001 through May 7, 2001, we have collected $1.1 million of these receivable
balances. For additional information regarding uncertainties in the California
wholesale market, please read Notes 11(a) and 11(d) to our Interim Financial
Statements and Notes 14(g) and 14(h) to Reliant Energy 10-K Notes.
Reliant Energy HL&P Rate Matters. The Texas Utility Commission has issued
rulings at its April 2001 meeting requiring Reliant Energy HL&P to reverse the
amount of redirected depreciation and accelerated depreciation if, in the Texas
Utility Commission's estimation, the utility has overmitigated its stranded
costs. At March 31, 2001, cumulative redirected depreciation and cumulative
accelerated depreciation for regulatory purposes totaled $668 million and
approximately $900 million, respectively. The preliminary reversal of redirected
depreciation would result in a lower rate for the transmission and distribution
utility and the accelerated depreciation being returned through credits over ten
years as offsets to the transmission and distribution utility's non-bypassable
charges. The rates derived from the Texas Utility Commission's April 2001 ruling
are interim and will be used during the retail electric pilot project that
begins on June 1, 2001. We do not expect the final Reliant Energy HL&P
transmission and distribution rate to be established until August 2001 and those
rates will be implemented on January 1, 2002. The credits related to accelerated
depreciation will begin on January 1, 2002. For information regarding redirected
depreciation and accelerated depreciation, please read Note 4(a) to Reliant
Energy 10-K Notes.
Other Sources/Uses of Cash. Our liquidity and capital requirements are
affected primarily by capital expenditures, debt service requirements and
various working capital needs. We expect to continue to participate as a bidder
in future acquisitions of independent power projects and privatizations of
generation facilities. We expect any resulting capital requirements to be met
with excess cash flows from operations, as well as proceeds from debt and equity
offerings, project financings and other borrowings. Additional capital
expenditures depend upon the nature and extent of future project commitments,
some of which may be substantial. We believe that our current level of cash and
anticipated borrowing capability and proceeds from the Reliant Resources initial
public offering discussed above, along with future cash flows from operations,
will be sufficient to meet the existing operational needs of our businesses for
the next 12 months.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
At March 31, 2001, we had issued fixed-rate debt and Trust Preferred
Securities aggregating $6.0 billion in principal amount having a fair value of
$6.1 billion. The fair value of these instruments would increase by
approximately $458 million if interest rates were to decline by 10% from their
levels at March 31, 2001.
Our floating-rate obligations aggregated $5.7 billion at March 31, 2001
(please read Note 10 to Reliant Energy 10-K Notes) inclusive of (a) amounts
borrowed under our short-term and long-term credit facilities (including the
issuance of commercial paper supported by these facilities), (b) borrowings
underlying a receivables facility and (c) amounts subject to a master leasing
agreement under which lease payments vary depending on short-term interest
rates. If the floating rates were to increase by 10% from March 31, 2001 levels,
our consolidated interest expense and expense under operating leases would
increase by a total of approximately $3 million each month in which such
increase continued.
In November 1998, RERC Corp. sold $500 million aggregate principal amount of
its 6 3/8% Term Enhanced Remarketable Securities (TERM Notes) which included an
embedded option to remarket the securities. The option is expected to be
exercised in the event that the ten-year Treasury rate in 2003 is below 5.66%.
At March 31, 2001, we could terminate the option at a cost of $29 million. A
decrease of 10% in the March 31, 2001 level of interest rates would increase the
cost of termination of the option by approximately $14 million.
As discussed in Note 8(c) to Reliant Energy 10-K Notes, upon adoption of
SFAS No. 133 effective January 1, 2001, the ZENS obligation was bifurcated into
a debt component of $122 million and a derivative component of $788 million.
Changes in the fair value of the derivative component will be recorded in our
statements of consolidated income and, therefore, we are exposed to changes in
the fair value of the derivative component as a result of changes in the
underlying risk-free interest rate. If the risk-free interest rate were to
increase by 10% from March 31, 2001 levels, the fair value of the derivative
component would increase by approximately $14 million, which would be recorded
as a loss in our statements of consolidated income.
During the three months ended March 31, 2001, we entered into interest rate
swaps for the purpose of decreasing the amount of debt subject to interest rate
fluctuations. At March 31, 2001, these interest rate swaps had an aggregate
notional amount of $375 million and a nominal fair value. An increase of 10% in
the March 31, 2001 level of interest rates would not increase the cost of
termination of the swaps by a material amount. For information regarding the
accounting for these interest rate swaps, see Note 2 to our Interim Financial
Statements.
EQUITY MARKET RISK
As discussed in Note 8 to Reliant Energy 10-K Notes, we own approximately 26
million shares of AOL Time Warner Inc. common stock (AOL TW Common), which we
hold to facilitate our ability to meet our obligations under the ZENS. Please
read Note 8 to Reliant Energy 10-K Notes for a discussion of the effect of
adoption of SFAS No. 133 on our ZENS obligation and our historical accounting
treatment of our ZENS obligation. Subsequent to adoption of SFAS No. 133, a
decrease of 10% from the March 31, 2001 market value of AOL TW Common would
result in a loss of approximately $6 million, which would be recorded as a loss
in our statements of consolidated income.
FOREIGN CURRENCY EXCHANGE RATE RISK
As of March 31, 2001, we have entered into foreign currency swaps and
foreign exchange forward contracts and have issued Euro-denominated debt to
hedge our net European investment. Changes in the value of the swaps, forwards
and debt are recorded as foreign currency translation adjustments as a component
of accumulated other comprehensive income (loss) in stockholders' equity. As of
March 31, 2001, we had recorded a $2 million loss in cumulative net translation
adjustments. The cumulative translation adjustments will be realized in earnings
and cash flows only upon the disposition of the related investments.
As of March 31, 2001, our European Energy segment has entered into financial
instruments to purchase approximately $120 million to hedge future fuel
purchases payable in U.S. dollars. As of March 31, 2001, the fair
34
37
value of these financial instruments was a $4 million liability. An increase in
the value of the Euro of 10% compared to the U.S. dollar from its March 31, 2001
level would result in an additional loss in the fair value of these foreign
currency financial instruments of $12 million. For information regarding the
accounting for these financial instruments, see Note 2 to our Interim Financial
Statements.
COMMODITY PRICE RISK
We assess the risk of our non-trading derivatives (Energy Derivatives) using
a sensitivity analysis method, and we assess the risk of our trading derivatives
(Trading Derivatives) using the value-at-risk (VAR) method, in order to maintain
our total exposure within management-prescribed limits.
The sensitivity analysis performed on our Energy Derivatives measures the
potential loss in earnings based on a hypothetical 10% movement in energy
prices. An increase of 10% in the market prices of energy commodities from their
March 31, 2001 levels would have decreased the fair value of our Energy
Derivatives from their levels on those respective dates by $197 million.
We utilize the variance/covariance model of VAR, which is a probabilistic
model that measures the risk of loss to earnings in market sensitive
instruments. With respect to Trading Derivatives, our highest, lowest and
average monthly VAR during the first quarter of 2001 was $12 million, $5 million
and $8 million, respectively, based on a 95% confidence level and a one day
holding period. During 2000, our highest, lowest and average monthly VAR was $15
million, $1 million and $6 million, respectively, based on a 95% confidence
level and a one day holding period.
We cannot assure you that market volatility, failure of counterparties to
meet their contractual obligations, transactions entered into after the date of
this Form 10-Q or a failure of risk controls will not lead to significant losses
from our marketing and risk management activities.
35
38
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
REVENUES..................................................................... $ 3,098,731 $ 2,422,853
EXPENSES:
Natural gas and purchased power............................................ 2,704,349 1,991,523
Operation and maintenance.................................................. 156,519 159,745
Depreciation and amortization.............................................. 52,107 51,221
Taxes other than income taxes.............................................. 31,219 46,433
-------------- --------------
Total.................................................................. 2,944,194 2,248,922
-------------- --------------
OPERATING INCOME............................................................. 154,537 173,931
-------------- --------------
OTHER INCOME (EXPENSE):
Interest expense, net...................................................... (31,697) (38,134)
Distribution on trust preferred securities................................. (8) (7)
Other, net................................................................. (17,106) 3,395
-------------- --------------
Total.................................................................. (48,811) (34,746)
-------------- --------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES........................ 105,726 139,185
Income Tax Expense......................................................... 46,786 58,828
-------------- --------------
INCOME FROM CONTINUING OPERATIONS............................................ 58,940 80,357
Loss from Discontinued Operations, net of tax of zero...................... (3,804) --
-------------- --------------
NET INCOME................................................................... $ 55,136 $ 80,357
============== ==============
See Notes to RERC's Interim Financial Statements
36
39
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, MARCH 31,
2000 2001
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 22,576 $ 28,674
Accounts and notes receivable, principally customer, net.................. 794,904 787,354
Accrued unbilled revenue.................................................. 550,183 393,039
Materials and supplies.................................................... 33,394 33,255
Fuel and petroleum products............................................... 82,707 28,725
Non-trading derivative assets............................................. -- 24,367
Other 45,926 20,250
-------------- --------------
Total current assets.................................................... 1,529,690 1,315,664
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment............................................. 3,429,304 3,434,563
Less accumulated depreciation............................................. (399,947) (424,323)
-------------- --------------
Property, plant and equipment, net...................................... 3,029,357 3,010,240
-------------- --------------
OTHER ASSETS:
Goodwill, net............................................................. 1,787,015 1,774,655
Prepaid pension asset..................................................... 141,882 56,945
Non-trading derivative assets............................................. -- 7,926
Other 87,821 46,484
-------------- --------------
Total other assets...................................................... 2,016,718 1,886,010
-------------- --------------
TOTAL ASSETS................................................................ $ 6,575,765 $ 6,211,914
============== ==============
See Notes to RERC's Interim Financial Statements
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40
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS) -- (CONTINUED)
(UNAUDITED)
LIABILITIES AND STOCKHOLDER'S EQUITY
DECEMBER 31, MARCH 31,
2000 2001
-------------- --------------
CURRENT LIABILITIES:
Current portion of long-term debt......................................... $ 146,252 $ 120,238
Short-term borrowings..................................................... 635,000 350,000
Accounts payable.......................................................... 704,524 403,344
Accounts and notes payable - affiliated companies, net.................... 134,707 174,272
Interest accrued.......................................................... 35,725 33,686
Taxes accrued............................................................. 69,877 136,601
Customer deposits......................................................... 33,357 32,970
Non-trading derivative liabilities........................................ -- 7,392
Other 96,375 75,485
-------------- --------------
Total current liabilities........................................... 1,855,817 1,333,988
-------------- --------------
OTHER LIABILITIES:
Accumulated deferred income taxes......................................... 583,857 557,140
Benefit obligations....................................................... 175,144 181,921
Non-trading derivative liabilities........................................ -- 1,947
Notes payable - affiliated companies, net................................. 21,718 27,302
Other 144,853 133,686
-------------- --------------
Total other liabilities............................................... 925,572 901,996
-------------- --------------
LONG-TERM DEBT.............................................................. 1,392,798 1,940,363
-------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 10)
RERC OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF RERC.... 608 601
-------------- --------------
STOCKHOLDER'S EQUITY:
Common stock.............................................................. 1 1
Paid-in capital........................................................... 2,410,716 2,014,043
Retained earnings......................................................... -- 14,950
Accumulated other comprehensive (loss) income............................. (9,747) 5,972
-------------- --------------
Total stockholder's equity............................................ 2,400,970 2,034,966
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY............................... $ 6,575,765 $ 6,211,914
============== ==============
See Notes to RERC's Interim Financial Statements
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41
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................... $ 55,136 $ 80,357
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.......................................... 52,107 51,221
Deferred income taxes.................................................. 9,673 (2,550)
Net cash used in discontinued operations............................... (6,283) --
Impairment of marketable equity securities............................. 22,185 --
Changes in other assets and liabilities:
Accounts and notes receivable........................................ 61,559 164,694
Accounts receivable/payable, affiliates.............................. 35,458 (20,677)
Inventory............................................................ 49,498 63,711
Other current assets................................................. 9,090 25,676
Accounts payable..................................................... 31,717 (301,180)
Interest and taxes accrued........................................... 58,119 64,685
Other current liabilities............................................ (19,712) (21,277)
Net price risk management assets..................................... (18,424) --
Margin deposits on energy trading activities, net.................... (20,570) --
Fuel cost recovery................................................... 5,629 71,393
Other, net............................................................. (12,985) (42)
-------------- --------------
Net cash provided by operating activities.......................... 312,197 176,011
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................................... (57,469) (45,033)
Other, net............................................................... 10,254 (18,461)
-------------- --------------
Net cash used in investing activities.............................. (47,215) (63,494)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt............................................... -- (25,000)
Proceeds from long-term debt............................................. -- 544,632
Decrease in short-term borrowings, net................................... (166,384) (285,000)
(Decrease) increase in notes with affiliates, net........................ (107,270) 60,612
Dividend................................................................. -- (400,000)
Other, net............................................................... (2,570) (1,663)
-------------- --------------
Net cash used in financing activities.............................. (276,224) (106,419)
-------------- --------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........................ (11,242) 6,098
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD........................ 80,127 22,576
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD.............................. $ 68,885 $ 28,674
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized).................................... $ 33,922 $ 39,110
Income taxes............................................................. 93 57,043
See Notes to RERC's Interim Financial Statements
39
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RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
See Note 1 to Reliant Energy's Interim Financial Statements.
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.
RERC's Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position and results of operations for the respective periods.
Amounts reported in RERC's Statements of Consolidated Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (a) seasonal variations in energy consumption, (b) timing of
maintenance and other expenditures and (c) acquisitions and dispositions of
assets and other interests. In addition, certain amounts from the prior year
have been reclassified to conform to RERC's presentation of financial statements
in the current year. These reclassifications do not affect earnings of RERC.
RERC's Interim Financial Statements are unaudited, omit certain financial
statement disclosures and should be read with the Reliant Energy Form 10-K and
the RERC Corp. Form 10-K for the year ended December 31, 2000.
The following notes to the financial statements in the RERC Corp. Form 10-K
relate to certain contingencies. These notes, as updated herein, are
incorporated herein by reference:
Notes to Consolidated Financial Statements (RERC Corp. 10-K Notes): Note
2(f) (Regulatory Assets), Note 4 (Derivative Financial Instruments) and
Note 9 (Commitments and Contingencies).
For information regarding environmental matters and legal proceedings, see
Note 10.
(2) DERIVATIVE FINANCIAL INSTRUMENTS
Effective January 1, 2001, RERC adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended (SFAS No. 133), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. This
statement requires that derivatives be recognized at fair value in the balance
sheet and that changes in fair value be recognized either currently in earnings
or deferred as a component of other comprehensive income, depending on the
intended use of the derivative, its resulting designation and its effectiveness.
If certain conditions are met, an entity may designate a derivative instrument
as hedging (a) the exposure to changes in the fair value of an asset or
liability (Fair Value Hedge), (b) the exposure to variability in expected future
cash flows (Cash Flow Hedge) or (c) the foreign currency exposure of a net
investment in a foreign operation. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in earnings in the period it occurs.
Adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative
after-tax decrease in accumulated other comprehensive loss of $38 million. The
adoption also increased current assets, long-term assets, current liabilities
and long-term liabilities by $88 million, $5 million, $53 million and $2
million, respectively, in RERC's Consolidated Balance Sheet. During the three
months ended March 31, 2001, $20 million of the initial transition adjustment
recognized in other comprehensive income was realized in net income.
The application of SFAS No. 133 is still evolving and further guidance
from the Financial Accounting Standards Board (FASB) is expected. The FASB
released tentative guidance in April 2001 on three issues that impact our
industry. The FASB concluded in its tentative guidance that contracts subject to
"bookouts," a scheduling convenience used when two utilities have offsetting
transactions, cannot qualify for the normal purchases and sales exception. The
FASB also released tentative guidance that will prohibit option contracts on
electricity to qualify for the normal purchases and normal sales exception.
Lastly, the FASB issued tentative guidance that
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forward contracts containing optionality features which modify the quantity
delivered cannot qualify for the normal purchases and sales exception. The
tentative guidance issued by the FASB is subject to a comment period which ends
on June 1, 2001. If the tentative guidance is unchanged, RERC is required to
adopt this guidance as of July 1, 2001. RERC is in the process of determining
the effect of adoption.
RERC is exposed to various market risks. These risks are inherent in RERC's
financial statements and arise from transactions entered into in the normal
course of business. RERC utilizes derivative financial instruments to mitigate
the impact of changes in natural gas and natural gas transportation prices on
its operating results and cash flows. RERC utilizes other financial instruments
to manage various other market risks.
Cash Flow Hedges. To reduce the risk from market fluctuations in revenues
and the resulting cash flows derived from the sale of natural gas and related
transportation, RERC enters into futures transactions, forward contracts, swaps
and options (Energy Derivatives) in order to hedge some expected purchases of
natural gas and other commodities and sales of natural gas (a portion of which
are firm commitments at the inception of the hedge). Energy Derivatives are also
utilized to fix the price of compressor fuel or other future operational gas
requirements and to protect natural gas distribution earnings and cash flows
against unseasonably warm weather during peak gas heating months, although usage
to date for this purpose has not been material. The Energy Derivative portfolios
are managed to complement the physical transaction portfolio, reducing overall
risks within management-prescribed limits.
RERC applies hedge accounting for its derivative financial instruments
utilized in non-trading activities only if there is a high correlation between
price movements in the derivative and the item designated as being hedged. This
correlation, a measure of hedge effectiveness, is measured both at the inception
of the hedge and on an ongoing basis, with an acceptable level of correlation of
at least 80% for hedge designation. If and when correlation ceases to exist at
an acceptable level, hedge accounting ceases and mark-to-market accounting is
applied. During the three months ended March 31, 2001, the amount of hedge
ineffectiveness recognized in earnings from derivatives that are designated and
qualify as cash flow hedges was immaterial. No component of the derivative
instruments' gain or loss was excluded from the assessment of effectiveness. If
it becomes probable that an anticipated transaction will not occur, RERC
realizes in net income the deferred gains and losses recognized in accumulated
other comprehensive loss. During the three months ended March 31, 2001, there
were no deferred gains or losses recognized in earnings as a result of the
discontinuance of cash flow hedges because it was no longer probable that the
forecasted transaction would occur. Once the anticipated transaction occurs, the
accumulated deferred gain or loss recognized in accumulated other comprehensive
loss is reclassified to net income and included in RERC's Statements of
Consolidated Income under the captions (a) fuel expenses, in the case of natural
gas transactions and (b) revenues, in the case of natural gas and transportation
sales transactions. Cash flows resulting from these transactions in Energy
Derivatives are included in RERC's Statements of Consolidated Cash Flows in the
same category as the item being hedged. As of March 31, 2001, current
non-trading derivative assets and current non-trading derivative liabilities and
corresponding amounts in accumulated other comprehensive loss are expected to be
recognized into net income during the next twelve months.
The maximum length of time RERC is hedging its exposure to the variability
in future cash flows for forecasted transactions is five years.
(3) RELIANT ENERGY'S SEPARATION PLAN
In 2000, Reliant Energy announced its intention to divide into two publicly
traded companies in order to separate its unregulated businesses from its
regulated businesses. In August 2000, Reliant Energy formed Reliant Resources to
own and operate a substantial portion of Reliant Energy's unregulated operations
and to offer no more than 20% of Reliant Resources' common stock in an initial
public offering. Reliant Resources completed its initial public offering of 59.8
million shares of its common stock in May 2001. Reliant Energy expects to
distribute the remaining common stock of Reliant Resources it owns to Reliant
Energy's or its successor's shareholders within twelve months after the
completion of Reliant Resources' initial public offering.
On December 31, 2000, RERC Corp. transferred all of the outstanding stock
of Reliant Energy Services International, Inc. (RESI), Arkla Finance Corporation
(Arkla Finance) and Reliant Energy Europe Trading & Marketing, Inc. (RE Europe
Trading), all wholly owned subsidiaries of RERC Corp., to Reliant Resources
(collectively, the Stock Transfer). Both RERC Corp. and Reliant Resources are
subsidiaries of Reliant Energy. As
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a result of the Stock Transfer, RESI, Arkla Finance and RE Europe Trading each
became a wholly owned subsidiary of Reliant Resources.
Also, on December 31, 2000, a wholly owned subsidiary of Reliant Resources
merged with and into Reliant Energy Services, Inc. (Reliant Energy Services), a
wholly owned subsidiary of RERC Corp., with Reliant Energy Services as the
surviving corporation (Merger). As a result of the Merger, Reliant Energy
Services became a wholly owned subsidiary of Reliant Resources. As consideration
for the Merger, Reliant Resources paid $94 million to RERC Corp.
Prior to January 1, 2001, Reliant Energy Services, RESI and RE Europe
Trading, conducted the trading, marketing, power origination and risk management
business and operations of RERC. Arkla Finance is a company that holds an
investment in marketable equity securities. The Stock Transfer and the Merger
are part of Reliant Energy's previously announced restructuring.
RERC is reporting the results of RE Europe Trading as discontinued
operations for all periods presented in RERC's Interim Financial Statements in
accordance with Accounting Principles Board Opinion No. 30 (APB No. 30).
(4) DISCONTINUED OPERATIONS
As discussed in Note 3, on December 31, 2000, RERC transferred all of the
outstanding stock of RE Europe Trading to Reliant Resources. As a result of the
transfer, RERC is reporting the results of RE Europe Trading as discontinued
operations for all periods presented in RERC's Interim Financial Statements in
accordance with APB No. 30. Below is a table of the operating results of RE
Europe Trading for the three months ended March 31, 2000.
THREE MONTHS
ENDED
MARCH 31, 2000
------------------
(IN MILLIONS)
Revenues.................................................................... $ 1
Operating expenses.......................................................... 5
Operating loss.............................................................. (4)
Net loss.................................................................... (4)
In addition to RE Europe Trading, RERC transferred its interests in RESI,
Arkla Finance and Reliant Energy Services to Reliant Resources as described in
Note 3. The transfer of these operations did not result in the disposal of a
segment of business as defined under APB No. 30. Revenues and net income for
these operations were $2 billion and $4 million, respectively, for the three
months ended March 31, 2000.
(5) DEPRECIATION AND AMORTIZATION
RERC's depreciation expense for the first quarter of 2000 was $37 million,
compared to $36 million for the same period in 2001. Amortization expense,
primarily relating to goodwill amortization, was $15 million for the first
quarter of 2000 and 2001.
(6) LONG-TERM DEBT
In February 2001, RERC Corp. issued $550 million aggregate principal
amount of unsecured unsubordinated notes that bear interest at 7.75% per year
and mature in February 2011. Net proceeds to RERC Corp. were $545 million. RERC
Corp. used the net proceeds from the sale of the notes to pay a $400 million
dividend to Reliant Energy and for general corporate purposes.
(7) RERC OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE TRUST PREFERRED
SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF
RERC -- see Note 10 to Reliant Energy's Interim Financial Statements.
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(8) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income.
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Net income.................................................................. $ 55 $ 80
Other comprehensive income:
Additional minimum non-qualified pension liability adjustment............. -- 1
Cumulative effect of adoption of SFAS No. 133............................. -- 38
Net deferred loss from cash flow hedges................................... -- (3)
Plus: Reclassification of deferred gain on derivatives realized in net
income.................................................................. -- (20)
Unrealized gain on available-for-sale securities.......................... 1 --
Plus: Reclassification adjustment for impairment loss on
available-for-sale securities realized in net income.................... 14 --
-------------- --------------
Comprehensive income........................................................ $ 70 $ 96
============== ==============
(9) RELATED PARTY TRANSACTIONS
From time to time, RERC has advanced or borrowed monies to/from Reliant
Energy or it's subsidiaries. As of December 31, 2000 and March 31, 2001, RERC
had net borrowings, included in accounts and notes payable-affiliated companies,
totaling $81 million and $147 million, respectively. Net interest expense on
these borrowings for the three months ended March 31, 2000, was immaterial. For
the three months ended March 31, 2001, RERC had net interest income of $2
million.
In 2000, Reliant Energy Services supplied natural gas to, purchased
electricity for resale from, and provided marketing and risk management services
to, unregulated power plants in deregulated markets acquired or operated by
Reliant Energy Power Generation, Inc., an indirect subsidiary of Reliant Energy,
or its subsidiaries. In 2001, RERC supplies natural gas to Reliant Energy
Services, now a subsidiary of Reliant Resources (see Note 3). For the three
months ended March 31, 2000 and 2001, the sales and services to Reliant Energy
and its affiliates totaled $44 million and $79 million, respectively. Purchases
from Reliant Energy and its affiliates were $29 million and $302 million for the
three months ended March 31, 2000 and 2001, respectively.
Reliant Energy provides some corporate services to RERC, including various
corporate support services (including accounting, finance, investor relations,
planning, legal, communications, governmental and regulatory affairs and human
resources), information technology services and other shared services such as
corporate security, facilities management, accounts receivable, accounts payable
and payroll, office support services and purchasing and logistics. The costs of
services have been directly charged or allocated to RERC using methods that
management believes are reasonable. These methods include negotiated usage
rates, dedicated asset assignment, and proportionate corporate formulas based on
assets, operating expenses and employees. These charges and allocations are not
necessarily indicative of what would have been incurred had RERC been a separate
entity. Amounts charged and allocated to RERC for these services were $6 million
and $7 million for the three months ended March 31, 2000 and 2001, respectively,
and are included primarily in operation and maintenance expenses.
As of December 31, 2000 and March 31, 2001, net accounts payable to Reliant
Energy and its subsidiaries, which are not owned by RERC, was $75 million and
$55 million, respectively.
(10) ENVIRONMENTAL MATTERS AND LEGAL PROCEEDINGS
(a) Environmental Matters.
Manufactured Gas Plant Sites. RERC and its predecessors operated a
manufactured gas plant (MGP) adjacent to the Mississippi River in Minnesota
formerly known as Minneapolis Gas Works (MGW) until 1960. RERC has substantially
completed remediation of the main site other than ongoing water monitoring and
treatment. The manufactured gas was stored in separate holders. RERC is
negotiating cleanup of one such holder. There are six
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46
other former MGP sites in the Minnesota service territory. Remediation has been
completed on one site. Of the remaining five sites, RERC believes that two were
neither owned nor operated by RERC. RERC believes it has no liability with
respect to the sites it neither owned nor operated.
At March 31, 2001, RERC had accrued $19 million for remediation of the
Minnesota sites. At March 31, 2001, the estimated range of possible remediation
costs was $8 million to $36 million. The cost estimates of the MGW site are
based on studies of that site. The remediation costs for the other sites are
based on industry average costs for remediation of sites of similar size. The
actual remediation costs will be dependent upon the number of sites remediated,
the participation of other potentially responsible parties, if any, and the
remediation methods used.
Issues relating to the identification and remediation of MGPs are common in
the natural gas distribution industry. RERC has received notices from the United
States Environmental Protection Agency and others regarding its status as a
potentially responsible party (PRP) for other sites. Based on current
information, RERC has not been able to quantify a range of environmental
expenditures for potential remediation expenditures with respect to other MGP
sites.
Other Minnesota Matters. At March 31, 2001, RERC had recorded accruals of
$4 million (with a maximum estimated exposure for these accruals of
approximately $17 million at March 31, 2001), for other environmental matters in
Minnesota for which remediation may be required.
Mercury Contamination. RERC's pipeline and distribution operations have in
the past employed elemental mercury in measuring and regulating equipment. It is
possible that small amounts of mercury may have been spilled in the course of
normal maintenance and replacement operations and that these spills may have
contaminated the immediate area with elemental mercury. This type of
contamination has been found by RERC at some sites in the past, and RERC has
conducted remediation at these sites. It is possible that other contaminated
sites may exist and that remediation costs may be incurred for these sites.
Although the total amount of these costs cannot be known at this time, based on
experience by RERC and that of others in the natural gas industry to date and on
the current regulations regarding remediation of these sites, RERC believes that
the costs of any remediation of these sites will not be material to RERC's
financial position, results of operations or cash flows.
Potentially Responsible Party Notifications. From time to time RERC has
received notices from regulatory authorities or others regarding its status as a
PRP in connection with sites found to require remediation due to the presence of
environmental contaminants. Considering the information currently known about
such sites and the involvement of RERC in activities at these sites, RERC does
not believe that these matters will have a material adverse effect on RERC's
financial position, results of operations or cash flows.
(b) Other Legal Matters.
California Wholesale Market. Reliant Energy, Reliant Energy Services,
Reliant Energy Power Generation, Inc. and several other indirect subsidiaries of
Reliant Energy have been named as defendants in class action lawsuits and other
lawsuits filed against a number of companies that own generation plants in
California and other sellers of electricity in California markets. RERC Corp.
has also been named as a defendant in one of the lawsuits. Pursuant to the terms
of the master separation agreement between Reliant Energy and Reliant Resources
(see Note 4(b) to Reliant Energy 10-K Notes), Reliant Resources has agreed to
indemnify Reliant Energy and RERC Corp. for any damages arising under these
lawsuits, and may elect to defend these lawsuits at its own expense. Three of
these lawsuits were filed in the Superior Court of the State of California, San
Diego County; two were filed in the Superior Court in San Francisco County; one
was filed in the Superior Court in Los Angeles County. While the plaintiffs
allege various violations by the defendants of state antitrust laws and state
laws against unfair and unlawful business practices, each of the lawsuits is
grounded on the central allegation that defendants conspired to drive up the
wholesale price of electricity. In addition to injunctive relief, the plaintiffs
in these lawsuits seek treble the amount of damages alleged, restitution of
alleged overpayments, disgorgement of alleged unlawful profits for sales of
electricity, costs of suit and attorneys' fees. In one of the cases, the
plaintiffs allege aggregate damages of over $4 billion. Defendants have filed
petitions to remove some of these cases to federal court. Furthermore,
defendants have filed a motion with the Panel on Multidistrict Litigation
seeking transfer and consolidation of some of these cases. Defendants seek
consolidation and transfer of these cases to a jurisdiction outside California,
noting that the federal judges in California are potentially disqualified
because they are ratepayers. The judges assigned to the cases in San Diego and
San Francisco have recused themselves on these grounds. These lawsuits have only
recently been filed.
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Therefore, the ultimate outcome of the lawsuits cannot be predicted with any
degree of certainty at this time. However, RERC believes, based on its analysis
to date of the claims asserted in these lawsuits and the underlying facts, that
resolution of these lawsuits will not have a material adverse effect on the
RERC's financial condition, results of operations or cash flows.
Other. RERC is a party to litigation (other than that specifically noted)
which arises in the normal course of business. Management regularly analyzes
current information and, as necessary, provides accruals for probable
liabilities on the eventual disposition of these matters. Management believes
that the effects, if any, from the disposition of these matters will not have a
material adverse effect on RERC's financial position, results of operations or
cash flows.
(11) TRANSFER OF BENEFIT ASSETS AND LIABILITIES
During the three months ended March 31, 2001, RERC Corp. had net
distributions to Reliant Energy related to benefit assets and obligations, net
of deferred taxes, of $62 million.
(12) REPORTABLE SEGMENTS
Because RERC Corp. is a wholly owned subsidiary of Reliant Energy, RERC's
determination of reportable segments considers the strategic operating units
under which Reliant Energy manages sales, allocates resources and assesses
performance of various products and services to wholesale or retail customers in
differing regulatory environments. Segment financial data includes information
for Reliant Energy and RERC on a combined basis, except for Reliant Energy
segments which have no RERC operations in the applicable period. Reconciling
items included under the caption "Elimination of Non-RERC Operations" reduce the
consolidated Reliant Energy amounts by those operations not conducted within the
RERC legal entity. Operations not owned or operated by RERC, but included in
segment information before elimination include primarily the operations and
assets of Reliant Energy's non-rate regulated power generation business in 2000
and Reliant Energy's investment in AOL Time Warner securities, retail electric
start-up business and non-RERC corporate expenses in 2000 and 2001.
Reliant Energy has identified the following reportable segments in which
RERC has operations: Wholesale Energy, Natural Gas Distribution, Pipelines and
Gathering and Other Operations. For descriptions of the financial reporting
segments, see Note 12 to RERC Corp. 10-K Notes. The following table summarizes
financial data for the business segments:
AS OF
FOR THE THREE MONTHS ENDED MARCH 31, 2000 DECEMBER 31, 2000
--------------------------------------------- -----------------
NET
INTERSEGMENT
REVENUES FROM REVENUES OPERATING
NON-AFFILIATES (EXPENSES) INCOME TOTAL ASSETS
-------------- ------------ ----------- ------------
(IN MILLIONS)
Wholesale Energy.................................... $ 2,014 $ 142 $ (22) $ 11,172
Natural Gas Distribution............................ 1,044 7 105 4,509
Pipelines and Gathering............................. 47 43 32 2,358
Other Operations.................................... 11 4 (9) 2,296
Reconciling Elimination............................. -- (196) -- (1,665)
Elimination of Non-RERC Operations.................. (17) -- 49 (12,094)
----------- ----------- ----------- -----------
Consolidated........................................ $ 3,099 $ -- $ 155 $ 6,576
=========== =========== =========== ===========
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AS OF
FOR THE THREE MONTHS ENDED MARCH 31, 2001 MARCH 31, 2001
--------------------------------------------- --------------
NET
INTERSEGMENT
REVENUES FROM REVENUES OPERATING
NON-AFFILIATES (EXPENSES) INCOME TOTAL ASSETS
-------------- ------------ ----------- ------------
(IN MILLIONS)
Natural Gas Distribution........................... $ 2,269 $ 54 $ 135 $ 4,089
Pipelines and Gathering............................ 75 55 39 2,302
Other Operations................................... 18 13 (134) 2,342
Reconciling Elimination............................ -- (122) -- (1,301)
Elimination of Non-RERC Operations................. 61 -- 134 (1,220)
----------- ----------- ----------- -----------
Consolidated....................................... $ 2,423 $ -- $ 174 $ 6,212
=========== =========== =========== ===========
(13) SUBSEQUENT EVENT
In May 2001, Reliant Energy made a $236 million capital contribution to
RERC Corp. and RERC Corp. subsequently advanced the $236 million to a financing
subsidiary of Reliant Energy which is not a subsidiary of RERC.
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MANAGEMENT'S NARRATIVE ANALYSIS OF
THE RESULTS OF OPERATIONS OF RERC CORP. AND SUBSIDIARIES
The following narrative analysis should be read in combination with RERC
Corp.'s Interim Financial Statements and notes contained in this Form 10-Q.
RERC Corp. meets the conditions specified in General Instruction H(1)(a)
and (b) to Form 10-Q and is therefore permitted to use the reduced disclosure
format for wholly owned subsidiaries of reporting companies. Accordingly, RERC
Corp. has omitted from this report the information called for by Item 3
(Quantitative and Qualitative Disclosures About Market Risk) of Part I and the
following Part II items of Form 10-Q: Item 2 (Changes in Securities and Use of
Proceeds), Item 3 (Defaults Upon Senior Securities) and Item 4 (Submission of
Matters to a Vote of Security Holders). The following discussion explains
material changes in the amount of revenue and expense items of RERC between the
first quarter of 2001 and the first quarter of 2000. Reference is made to
Management's Narrative Analysis of the Results of Operations in Item 7 of the
RERC Corp. Form 10-K and the RERC Corp. 10-K Notes referred to herein.
On July 27, 2000, Reliant Energy announced its intention to form Reliant
Resources to own and operate a substantial portion of Reliant Energy's
unregulated operations, and to offer no more than 20% of the common stock of
Reliant Resources in an initial public offering (Offering) in connection with
the Company's business separation plan. In May 2001, Reliant Resources completed
its initial public offering of 59.8 million shares of its common stock and
received net proceeds of $1.7 billion. Reliant Energy expects the Offering to be
followed by a distribution of the remaining common stock of Reliant Resources
owned by Reliant Energy to Reliant Energy's or its successor's stockholders
within 12 months of the Offering (Distribution).
As part of the separation, our parent company, Reliant Energy will undergo
a restructuring of its corporate organization to achieve a new holding company
structure. The new holding company will hold our regulated businesses. In
connection with the formation of the new holding company, Reliant Energy will
seek an exemption from the registration requirements of the 1935 Act or, if no
exemption is available, the new holding company will register as a public
utility holding company under the 1935 Act. The restructuring will require
approval of the Securities and Exchange Commission, certain of the affected
state commissions and the Nuclear Regulatory Commission.
The Distribution is subject to further corporate approvals, market and
other conditions, and government actions, including receipt of a favorable
Internal Revenue Service ruling that the Distribution would be tax-free to
Reliant Energy or its successor and its shareholders for U.S. federal income tax
purposes, as applicable. There can be no assurance that the Distribution will be
completed as described or within the time periods outlined above.
On December 31, 2000, RERC Corp. transferred all of the outstanding stock
of RESI, Arkla Finance and RE Europe Trading, all wholly owned subsidiaries of
RERC Corp., to Reliant Resources (Stock Transfer). Both RERC Corp. and Reliant
Resources are subsidiaries of Reliant Energy. As a result of the Stock Transfer,
RESI, Arkla Finance and RE Europe Trading each became a wholly owned subsidiary
of Reliant Resources.
Also, on December 31, 2000, a wholly owned subsidiary of Reliant Resources
merged with and into Reliant Energy Services, a wholly owned subsidiary of RERC
Corp., with Reliant Energy Services as the surviving corporation (Merger). As a
result of the Merger, Reliant Energy Services became a wholly owned subsidiary
of Reliant Resources. As consideration of the Merger, Reliant Resources paid $94
million to RERC Corp.
Reliant Energy Services, together with RESI and RE Europe Trading, conduct
the trading, marketing, power origination and risk management business and
operations of Reliant Energy. Arkla Finance is a company that held an investment
in marketable equity securities.
The Stock Transfer and the Merger are part of Reliant Energy's previously
announced restructuring.
RERC is reporting the results of RE Europe Trading as discontinued
operations for all periods presented in the consolidated financial statements in
accordance with APB No. 30.
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CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31,
---------------------------------
2000 2001
-------------- --------------
(IN MILLIONS)
Operating Revenues.......................................................... $ 3,099 $ 2,423
Operating Expenses.......................................................... (2,944) (2,249)
-------------- --------------
Operating Income, net....................................................... 155 174
Interest Expense ........................................................... (32) (38)
Other (Expense) Income, net................................................. (17) 3
Income Tax Expense.......................................................... (47) (59)
-------------- --------------
Income From Continuing Operations........................................... 59 80
Loss From Discontinued Operations, net of tax............................... (4) --
-------------- --------------
Net Income................................................................ $ 55 $ 80
============== ==============
For the first quarter 2001, RERC's net income was $80 million compared to
net income of $55 million for the same period in 2000. The $25 million increase
was primarily due to:
o an increase in operating income of the Natural Gas Distribution
segment primarily due to improved margins from the effect of cooler
weather, partially offset by increased operating costs related to
information system-related costs and employee benefit expenses;
o an increase in operating margins (revenues less natural gas costs)
from the pipelines and gathering businesses;
o an after-tax impairment loss of $14 million on marketable equity
securities classified as "available-for-sale" incurred during the
three months ended March 31, 2000 by the Other Operations segment;
o an increase in third-party interest expense primarily resulting from
higher levels of long-term debt during the three months ended March
31, 2001 compared to the same period in 2000; and
o start-up costs of the RE Europe Trading operations in 2000 included in
loss from discontinued operations.
During the three months ended March 31, 2000, RERC incurred a pre-tax
impairment loss of $22 million on marketable equity securities classified as
"available-for-sale" by its Other Operations segment. Management's determination
to recognize this impairment resulted from a combination of events occurring in
2000 related to this investment. For additional information regarding this
impairment loss, see Note 2(l) to RERC Corp. 10-K Notes. This investment is held
by Arkla Finance which was transferred to Reliant Resources effective December
31, 2000.
RERC's operating revenues for three months ended March 31, 2001 were $2.4
billion compared to $3.1 billion for the same period in 2000. The $676 million,
or 22%, decrease was primarily due the transfer of Reliant Energy Services to
Reliant Resources pursuant to the Merger discussed above. This decrease was
partially offset by an increase in revenues related to the Natural Gas
Distribution and Pipelines and Gathering segments resulting from an increase in
the costs of natural gas and to a lesser extent the effect of cooler weather on
the operations of the Natural Gas Distribution segment.
RERC's operating expenses for the three months ended March 31, 2001 were
$2.2 billion compared to $2.9 billion for the same period in 2000. The $695
million, or 24%, decrease was primarily due to the same reasons for the
decreases in revenues discussed above.
RERC's effective tax rate in first quarter of 2000 was 44% compared to 42%
in the same period in 2001.
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RERC is reporting the results of RE Europe Trading as discontinued
operations for all periods presented in RERC's consolidated financial statements
in accordance with APB No. 30. For additional information regarding the
operating results of the other entities transferred to Reliant Resources, please
read Note 13 to RERC Corp. 10-K Notes and Notes 3 and 4 to RERC's Interim
Financial Statements.
Seasonality and Other Factors. RERC's results of operations are affected by
seasonal fluctuations in the demand for and, to a lesser extent, the price of
natural gas. RERC's results of operations are also affected by, among other
things, the actions of various federal and state governmental authorities having
jurisdiction over rates charged by RERC, competition in RERC's various business
operations, debt service costs and income tax expense.
For a discussion of certain other factors that may affect RERC's future
earnings please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Factors Affecting Our Future
Earnings -- Competitive and Other Factors Affecting RERC Operations"
"--Environmental Expenditures" and "-- Other Contingencies " in the Reliant
Energy Form 10-K.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Reliant Energy:
For a description of legal proceedings affecting Reliant Energy, please
review Note 11 to Reliant Energy Interim Financial Statements, Item 3 of the
Reliant Energy Form 10-K and Notes 4 and 14 to Reliant Energy 10-K Notes, all of
which are incorporated herein by reference.
RERC:
For a description of legal proceedings affecting RERC, please review Note
10 to RERC's Interim Financial Statements, Item 3 of the RERC Corp. Form 10-K
and Note 11 to RERC Corp. 10-K Notes, which are incorporated herein by
reference.
ITEM 5. OTHER INFORMATION.
Forward-Looking Statements. From time to time, Reliant Energy and RERC
Corp. make statements concerning their respective expectations, beliefs, plans,
objectives, goals, strategies, future events or performance and underlying
assumptions and other statements, which are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Although Reliant Energy and RERC Corp.
believe that the expectations and the underlying assumptions reflected in their
respective forward-looking statements are reasonable, they cannot assure you
that these expectations will prove to be correct. Forward-looking statements
involve a number of risks and uncertainties, and actual results may differ
materially from the results discussed in the forward-looking statements.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:
o state, federal and international legislative and regulatory
developments, including deregulation; re-regulation and restructuring
of the electric utility industry; and changes in, or application of
environmental and other laws and regulations to which we are subject,
o the timing of the implementation of our business separation plan,
o the effects of competition, including the extent and timing of the
entry of additional competitors in our markets,
o industrial, commercial and residential growth in our service
territories,
o our pursuit of potential business strategies, including acquisitions
or dispositions of assets or the development of additional power
generation facilities,
o state, federal and other rate regulations in the United States and in
foreign countries in which we operate or into which we might expand
our operations,
o the timing and extent of changes in commodity prices and interest
rates,
o weather variations and other natural phenomena,
o political, legal and economic conditions and developments in the
United States and in foreign countries in which we operate or into
which we might expand our operations, including the effects of
fluctuations in foreign currency exchange rates,
o financial market conditions and the results of our financing efforts,
o the performance of our projects, and
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53
o other factors we discuss in this and other filings by Reliant Energy
and RERC Corp. with the Securities and Exchange Commission.
When used in Reliant Energy's or RERC Corp.'s documents or oral
presentations, the words "anticipate," "estimate," "believe," "continue,"
"could," "intend," "may," "plan," "potential," "predict," "should," "will,"
"expect," "objective," "projection," "forecast," "goal" and similar words are
intended to identify forward-looking statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Reliant Energy:
Exhibit 10.1 Master Separation Agreement entered into as of
December 31, 2000 between Reliant Energy, Incorporated
and Reliant Resources, Inc.
Exhibit 10.2 Transition Services Agreement, dated as of
December 31, 2000, between Reliant Energy, Incorporated
and Reliant Resources, Inc.
Exhibit 10.3 Technical Services Agreement, dated as of December 31,
2000, between Reliant Energy, Incorporated and Reliant
Resources, Inc.
Exhibit 10.4 Texas Genco Option Agreement, dated as of December 31,
2000, between Reliant Energy, Incorporated and Reliant
Resources, Inc.
Exhibit 10.5 Employee Matters Agreement, entered into as of
December 31, 2000, between Reliant Energy, Incorporated
and Reliant Resources, Inc.
Exhibit 10.6 Retail Agreement, entered into as of December 31, 2000,
between Reliant Energy, Incorporated and Reliant
Resources, Inc.
Exhibit 10.7 Registration Rights Agreement, dated as of December
31, 2000, between Reliant Energy, Incorporated and
Reliant Resources, Inc.
Exhibit 10.8 Tax Allocation Agreement, entered into as of December
31, 2000, between Reliant Energy, Incorporated and
Reliant Resources, Inc.
Exhibit 12 Ratio of Earnings to Fixed Charges.
Exhibit 99 Items incorporated by reference from the Reliant
Energy Form 10-K: Item 3 "Legal Proceedings," Item 7
"Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Factors
Affecting Our Future Earnings" and Notes 2(f)
(Regulatory Assets), 3 (Business Acquisitions), 4
(Regulatory Matters), 5 (Derivative Financial
Instruments), 8 (Indexed Debt Securities (ACES and
ZENS) and AOL Time Warner Securities), 14 (Commitments
and Contingencies) and 20 (Subsequent Events) of the
Reliant Energy 10-K Notes.
RERC:
Exhibit 12 Ratio of Earnings to Fixed Charges.
Exhibit 99 Items incorporated by reference from the Reliant
Energy Form 10-K: Item 7 "Management's Discussion and
Analysis of Financial Condition and Results of
Operations - Certain Factors Affecting Our Future
Earnings." Items incorporated by reference from the
RERC Corp. Form 10-K: Item 3 "Legal Proceedings," Item
7 "Management's Narrative Analysis of the Results of
Operations of RERC and its Consolidated Subsidiaries"
and
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54
Notes 2(f) (Regulatory Assets), 4 (Derivative
Financial Instruments) and 9 (Commitments and
Contingencies) of the RERC Corp. 10-K Notes.
(b) Reports on Form 8-K.
Reliant Energy:
On January 26, 2001, a report on Form 8-K was filed reporting on the
Company's earnings for the year 2000.
On April 16, 2001, a report on Form 8-K was filed reporting on Reliant
Energy's first quarter earnings.
RERC:
On January 26, 2001, a report on Form 8-K was filed reporting on the
Company's earnings for the year 2000.
On April 16, 2001, a report on Form 8-K was filed reporting on RERC's first
quarter earnings.
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55
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.
RELIANT ENERGY, INCORPORATED
(Registrant)
By: /s/ Mary P. Ricciardello
--------------------------------------------------
Mary P. Ricciardello
Senior Vice President and Chief Accounting Officer
Date: May 14, 2001
II-4
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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.
RELIANT ENERGY RESOURCES CORP.
(Registrant)
By: /s/ Mary P. Ricciardello
---------------------------------------
Mary P. Ricciardello
Senior Vice President
Date: May 14, 2001
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
Exhibit 10.1 Master Separation Agreement entered into as of
December 31, 2000 between Reliant Energy, Incorporated
and Reliant Resources, Inc.
Exhibit 10.2 Transition Services Agreement, dated as of
December 31, 2000, between Reliant Energy, Incorporated
and Reliant Resources, Inc.
Exhibit 10.3 Technical Services Agreement, dated as of December 31,
2000, between Reliant Energy, Incorporated and Reliant
Resources, Inc.
Exhibit 10.4 Texas Genco Option Agreement, dated as of December 31,
2000, between Reliant Energy, Incorporated and Reliant
Resources, Inc.
Exhibit 10.5 Employee Matters Agreement, entered into as of
December 31, 2000, between Reliant Energy, Incorporated
and Reliant Resources, Inc.
Exhibit 10.6 Retail Agreement, entered into as of December 31, 2000,
between Reliant Energy, Incorporated and Reliant
Resources, Inc.
Exhibit 10.7 Registration Rights Agreement, dated as of December
31, 2000, between Reliant Energy, Incorporated and
Reliant Resources, Inc.
Exhibit 10.8 Tax Allocation Agreement, entered into as of December
31, 2000, between Reliant Energy, Incorporated and
Reliant Resources, Inc.
Exhibit 12 Ratio of Earnings to Fixed Charges.
Exhibit 99 Items incorporated by reference from the Reliant
Energy Form 10-K: Item 3 "Legal Proceedings," Item 7
"Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Factors
Affecting Our Future Earnings" and Notes 2(f)
(Regulatory Assets), 3 (Business Acquisitions), 4
(Regulatory Matters), 5 (Derivative Financial
Instruments), 8 (Indexed Debt Securities (ACES and
ZENS) and AOL Time Warner Securities), 14 (Commitments
and Contingencies) and 20 (Subsequent Events) of the
Reliant Energy 10-K Notes.
RERC:
Exhibit 12 Ratio of Earnings to Fixed Charges.
Exhibit 99 Items incorporated by reference from the Reliant
Energy Form 10-K: Item 7 "Management's Discussion and
Analysis of Financial Condition and Results of
Operations - Certain Factors Affecting Our Future
Earnings." Items incorporated by reference from the
RERC Corp. Form 10-K: Item 3 "Legal Proceedings," Item
7 "Management's Narrative Analysis of the Results of
Operations of RERC and its Consolidated Subsidiaries"
and Notes 2(f) (Regulatory Assets), 4 (Derivative
Financial Instruments) and 9 (Commitments and
Contingencies) of the RERC Corp. 10-K Notes.