EXHIBIT 99.1
ITEM 1. BUSINESS.
ENVIRONMENTAL MATTERS
ASBESTOS
As a result of their age, many of our facilities contain significant
amounts of asbestos insulation, other asbestos-containing materials and
lead-based paint. Existing state and federal rules require the proper management
and disposal of these potentially toxic materials. We have developed a
management plan that includes proper maintenance of existing non-friable
asbestos installations, and removal and abatement of asbestos containing
materials where necessary because of maintenance, repairs, replacement or damage
to the asbestos itself. We have planned for the proper management, abatement and
disposal of asbestos and lead-based paint at our facilities.
Our facilities are the subject of a number of 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 third
party workers who participated in construction of various industrial facilities,
including power plants, and some of the claimants have worked at locations owned
by us. We anticipate that additional claims like those received may be asserted
in the future, and we intend to continue our practice of vigorously contesting
claims that we do not consider to have merit.
RISK FACTORS
MARKET RISKS
OUR REVENUES AND RESULTS OF OPERATIONS ARE IMPACTED BY MARKET RISKS THAT ARE
BEYOND OUR CONTROL.
We sell electric generation capacity, energy and ancillary services in the
ERCOT market. Under the Texas electric restructuring law, we and other power
generators in Texas are not subject to traditional cost-based regulation and
therefore may sell electric generation capacity, energy and ancillary services
to wholesale purchasers at prices determined by the market. As a result, we are
not guaranteed any rate of return on our capital investments through mandated
rates, and our revenues and results of operations depend, in large part, upon
prevailing market prices for electricity in the ERCOT market. Market prices for
electricity, generation capacity, energy and ancillary services may fluctuate
substantially. Our gross margins are primarily derived from the sale of capacity
entitlements associated with our large, solid fuel base-load generating units,
including our Limestone and W. A. Parish facilities and our interest in the
South Texas Project. The gross margins generated from payments associated with
the capacity of these units are directly impacted by natural gas prices. Since
the fuel costs for our base-load units are largely fixed under long-term
contracts, they are generally not subject to significant daily and monthly
fluctuations. Because natural gas is the marginal fuel for facilities serving
the ERCOT market during most hours, gas prices have a significant influence on
the price of electric power. As a result, the price customers are willing to pay
for entitlements to our solid fuel-fired base-load capacity generally rises and
falls with natural gas prices.
Market prices in the ERCOT market may also fluctuate substantially due to
other factors. Such fluctuations may occur over relatively short periods of
time. Volatility in market prices may result from:
- oversupply or undersupply of generation capacity;
- power transmission or fuel transportation constraints or inefficiencies;
- weather conditions;
- seasonality;
- availability and market prices for natural gas, crude oil and refined
products, coal, lignite, enriched uranium and uranium fuels;
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- changes in electricity usage;
- additional supplies of electricity from existing competitors or new
market entrants as a result of the development of new generation
facilities or additional transmission capacity;
- illiquidity in the ERCOT market;
- availability of competitively priced alternative energy sources;
- natural disasters, wars, embargoes, terrorist attacks and other
catastrophic events; and
- federal and state energy and environmental regulation and legislation.
THERE IS CURRENTLY A SURPLUS OF GENERATING CAPACITY IN THE ERCOT MARKET AND WE
EXPECT THE MARKET FOR WHOLESALE POWER TO BE HIGHLY COMPETITIVE.
The reserve margin in the ERCOT market has exceeded 30% since 2001, and the
Texas Utility Commission and the ERCOT ISO have forecasted the reserve margin
for 2004 to continue to exceed 30%. The commencement of commercial operation of
new facilities in the ERCOT market has increased and will continue to increase
the competitiveness of the wholesale power market, which could have a material
adverse effect on our business, results of operations, financial condition and
cash flows and the market value of our assets.
Our competitors include generation companies affiliated with Texas-based
utilities, independent power producers, municipal and co-operative generators
and wholesale power marketers. The unbundling of vertically integrated utilities
into separate generation, transmission and distribution and retail businesses
pursuant to the Texas electric restructuring law could result in a significant
number of additional competitors participating in the ERCOT market. Some of our
competitors may have greater financial resources, lower cost structures, more
effective risk management policies and procedures, greater ability to incur
losses, greater potential for profitability from ancillary services, or greater
flexibility in the timing of their sale of generating capacity and ancillary
services than we do.
WE ARE SUBJECT TO OPERATIONAL AND MARKET RISKS ASSOCIATED WITH OUR CAPACITY
AUCTIONS.
We have sold entitlements to a significant portion of our available 2004
and 2005 generating capacity in our capacity auctions held to date. Although our
obligation to conduct contractually-mandated auctions terminated in January
2004, we currently remain obligated to sell 15% of our installed generation
capacity and related ancillary services pursuant to state-mandated auctions and
we expect to conduct future capacity auctions with respect to all or a part of
our remaining capacity from time to time. In these auctions, we sell firm
entitlements on a forward basis to capacity and ancillary services dispatched
within specified operational constraints. Although we have reserved a portion of
our aggregate net generation capacity from our capacity auctions for planned or
forced outages at our facilities, unanticipated plant outages or other problems
with our generation facilities could result in our firm capacity and ancillary
services commitments exceeding our available generation capacity. As a result,
an unexpected outage at one of our lower cost facilities could require us to run
one of our higher cost plants or obtain replacement power from third parties in
the open market in order to satisfy our obligations even though the energy
payments for the dispatched power are based on the cost of our lower-cost
facilities.
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OPERATING RISKS
THE OPERATION OF OUR POWER GENERATION FACILITIES INVOLVES RISKS THAT COULD
ADVERSELY AFFECT OUR REVENUES, COSTS, RESULTS OF OPERATIONS AND CASH FLOWS.
General. We are subject to various risks associated with operating our
power generation facilities, any of which could adversely affect our revenues,
costs, results of operations, financial condition and cash flows. These risks
include:
- operating performance below expected levels of output or efficiency;
- breakdown or failure of equipment or processes;
- disruptions in the transmission of electricity;
- shortages of equipment, material or labor;
- labor disputes;
- fuel supply interruptions;
- limitations that may be imposed by regulatory requirements, including,
among others, environmental standards;
- limitations imposed by the ERCOT ISO;
- violations of permit limitations;
- operator error; and
- catastrophic events such as fires, hurricanes, explosions, floods,
terrorist attacks or other similar occurrences.
A significant portion of our facilities was constructed many years ago.
Older generation equipment, even if maintained in accordance with good
engineering practices, may require significant capital expenditures to keep it
operating at high efficiency and to meet regulatory requirements. This equipment
is also likely to require periodic upgrading and improvement. Any unexpected
failure to produce power, including failure caused by breakdown or forced
outage, could result in reduced earnings.
The cost of repairing damage to our facilities due to storms, natural
disasters, wars, terrorist acts and other catastrophic events may adversely
impact our results of operations, financial condition and cash flows. The
occurrence or risk of occurrence of future terrorist activity may impact our
results of operations and financial condition in unpredictable ways. These
actions could also result in adverse changes in the insurance markets and
disruptions of power and fuel markets. In addition, our power generation
facilities and fuel supply could be directly or indirectly harmed by future
terrorist activity. The occurrence or risk of occurrence of future terrorist
attacks or related acts of war could also adversely affect the United States
economy. A lower level of economic activity could result in a decline in energy
consumption, which could adversely affect our revenues and margins and limit our
future growth prospects. Also, these risks could cause instability in the
financial markets and adversely affect our ability to access capital.
We employ experienced personnel to maintain and operate our facilities and
carry insurance to mitigate the effects of some of the operating risks described
above. Our insurance policies, however, are subject to certain limits and
deductibles and do not include business interruption coverage. Should one or
more of the events described above occur, revenues from our operations may be
significantly reduced or our costs of operations may significantly increase.
In December 2003, one of the three auxiliary standby diesel generators for
Unit 2 at the South Texas Project failed during a routine test. The NRC allowed
continued operation of Unit 2 while repairs to the generator were made. Repairs
are expected to be completed before the end of a scheduled refueling outage on
the unit in the spring of 2004. Should Unit 2 experience an unplanned shutdown
prior to its scheduled outage, there is a risk that the NRC would not permit
restarting the unit until the diesel generator was fully repaired.
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Our share of the ultimate cost of repairs to the diesel generator is estimated
to be approximately $5 million and is expected to be substantially covered by
insurance.
WE RELY ON POWER TRANSMISSION FACILITIES THAT WE DO NOT OWN OR CONTROL AND ARE
SUBJECT TO TRANSMISSION CONSTRAINTS WITHIN THE ERCOT MARKET. IF THESE
FACILITIES FAIL TO PROVIDE US WITH ADEQUATE TRANSMISSION CAPACITY, WE MAY NOT
BE ABLE TO DELIVER WHOLESALE ELECTRIC POWER TO OUR CUSTOMERS AND WE MAY INCUR
ADDITIONAL COSTS.
We depend on transmission and distribution facilities owned and operated by
our affiliate, CenterPoint Houston, and on transmission and distribution systems
owned by others to deliver the wholesale electric power we sell from our power
generation facilities to our customers, who in turn deliver power to the end
users. If transmission is disrupted, or if transmission capacity infrastructure
is inadequate, our ability to sell and deliver wholesale electric energy may be
adversely impacted.
The single control area of the ERCOT market for 2004 is organized into five
congestion zones, referred to as the North, Northeast, South, West and Houston
zones. These congestion zones are determined by physical constraints on the
ERCOT transmission system that make it difficult or impossible at times to move
power from a zone on one side of the constraint to the zone on the other side of
the constraint. All but two of our facilities are located in the Houston
congestion zone. Our Limestone facility is located in the North congestion zone
and the South Texas Project is located in the South congestion zone. We sell a
portion of the entitlements offered in our state-mandated auctions to customers
located in congestion zones other than the Houston zone. Transmission congestion
between these zones could impair our ability to schedule power for transmission
across zonal boundaries, which are defined by the ERCOT ISO, thereby inhibiting
our efforts to match our facility scheduled outputs with our customer scheduled
requirements.
The ERCOT ISO has instituted rules that directly assign congestion costs to
the parties causing the congestion. Therefore, power generators participating in
the ERCOT market could be liable for the congestion costs associated with
transferring power between zones. We schedule our anticipated requirements based
on our own forecasted needs, which rely in part on demand forecasts made by our
customers. These forecasts may prove to be inaccurate. We could be deemed
responsible for congestion costs if we schedule delivery of power between
congestion zones during times when the ERCOT ISO expects congestion to occur
between the zones. If we are liable for congestion costs, our financial results
could be adversely affected. For more information about the ERCOT market, please
read "Our Business -- The ERCOT Market" above.
OUR RESULTS OF OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS COULD BE
ADVERSELY IMPACTED BY A DISRUPTION OF OUR FUEL SUPPLIES.
We rely primarily on natural gas, coal, lignite and uranium to fuel our
generation facilities. We purchase our fuel from a number of different suppliers
under long-term contracts and on the spot market. We sell firm entitlements to
capacity and ancillary services. Therefore, any disruption in the delivery of
fuel could prevent us from operating our facilities to meet our auction
commitments, which could adversely affect our results of operations, financial
condition and cash flows.
Delivery of natural gas to each of our natural gas-fired facilities
typically depends on the natural gas pipelines or distributors for that
location. As a result, we are subject to the risk that a natural gas pipeline or
distributor may suffer disruptions or curtailments in our ability to deliver
natural gas to it or that the amounts of natural gas we request are curtailed.
These disruptions or curtailments could adversely affect our ability to operate
our natural gas-fired generating facilities. We lease gas storage facilities
capable of storing approximately 6.3 billion cubic feet of natural gas, of which
4.2 billion cubic feet is working capacity.
We purchase coal from a limited number of suppliers. Generally, we seek to
maintain average coal reserves sufficient to operate our coal-fired facilities
for 30 days. We also have long-term rail transportation contracts with two rail
transportation companies to transport coal to our coal-fired facilities. Any
extended disruption in our coal supply, including those caused by transportation
disruptions, adverse weather conditions, labor relations or environmental
regulations affecting our coal suppliers, could adversely affect our ability to
operate our coal-fired facilities. We are also exposed to the risk that
suppliers that have agreed to provide us
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with fuel could breach their obligations. Should these suppliers fail to
perform, we may be forced to enter into alternative arrangements at then-current
market prices. As a result, our results of operations, financial condition and
cash flows could be adversely affected.
TO DATE, WE HAVE SOLD A SUBSTANTIAL PORTION OF OUR AUCTIONED CAPACITY
ENTITLEMENTS TO SUBSIDIARIES OF RELIANT RESOURCES. ACCORDINGLY, OUR RESULTS OF
OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS COULD BE ADVERSELY AFFECTED IF
RELIANT RESOURCES CEASES TO BE A MAJOR CUSTOMER OR FAILS TO MEET ITS
OBLIGATIONS.
By participating in our contractually-mandated auctions, subsidiaries of
Reliant Resources have purchased entitlements to 79% of our sold 2004 capacity
and 68% of our sold 2005 capacity. Reliant Resources has made these purchases
either through the exercise of its contractual rights to purchase 50% of the
entitlements we auctioned in our prior contractually-mandated auctions or
through the submission of bids. In the event Reliant Resources ceases to be a
major customer or fails to meet its obligations to us, our results of
operations, financial condition and cash flows could be adversely affected. As
of December 31, 2003, Reliant Resources' securities ratings are below investment
grade. We have been granted a security interest in accounts receivable and/or
securitization notes associated with the accounts receivable of certain
subsidiaries of Reliant Resources to secure up to $250 million in purchase
obligations.
WE MAY INCUR SUBSTANTIAL COSTS AND LIABILITIES AS A RESULT OF OUR OWNERSHIP OF
NUCLEAR FACILITIES.
We own a 30.8% interest in the South Texas Project, a nuclear powered
generation facility. As a result, we are subject to the risks associated with
the ownership and operation of nuclear facilities. These risks include:
- liabilities associated with the potential harmful effects on the
environment and human health resulting from the operation of nuclear
facilities and the storage, handling and disposal of radioactive
materials;
- limitations on the amounts and types of insurance commercially available
to cover losses that might arise in connection with nuclear operations;
and
- uncertainties with respect to the technological and financial aspects of
decommissioning nuclear plants at the end of their licensed lives.
The NRC has broad authority under federal law to impose licensing and
safety-related requirements for the operation of nuclear generation facilities.
In the event of non-compliance, the NRC has the authority to impose fines, shut
down a unit, or both, depending upon our assessment of the severity of the
situation, until compliance is achieved. Revised safety requirements promulgated
by the NRC could necessitate substantial capital expenditures at nuclear plants.
In addition, although we have no reason to anticipate a serious nuclear incident
at the South Texas Project, if an incident were to occur, it could have a
material adverse effect on our results of operations, financial condition and
cash flows.
OTHER RISKS
OUR HISTORICAL FINANCIAL RESULTS COVERING PERIODS PRIOR TO 2002 REPRESENT OUR
RESULTS AS PART OF AN INTEGRATED UTILITY OPERATING IN A REGULATED MARKET AND
ARE NOT REPRESENTATIVE OF OUR RESULTS AS A SEPARATE COMPANY OPERATING IN THE
DEREGULATED ERCOT MARKET. CONSEQUENTLY, OUR FUTURE FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ARE LIKELY TO VARY MATERIALLY FROM THE FINANCIAL
CONDITION AND RESULTS OF OPERATIONS PRESENTED IN THE HISTORICAL FINANCIAL
INFORMATION INCLUDED HEREIN COVERING PERIODS PRIOR TO 2002.
We have limited experience operating as a stand-alone wholesale electric
power generation company in a deregulated market. Our generation facilities were
formerly owned by Reliant Energy, which conveyed these facilities to us in
accordance with a business separation plan adopted in response to the Texas
electric restructuring law.
The historical financial information covering periods prior to 2002 does
not reflect what our financial position, results of operations and cash flows
would have been had our generation facilities been operated under the current
deregulated ERCOT market. Although our generation facilities had a significant
operating
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history at the time they were conveyed to us, the historical financial
information relating to the operation of these facilities during periods prior
to 2002 reflects the sale of the power generated by the facilities as part of an
integrated utility at regulated rates. We currently sell the power generated by
these facilities at market-based prices, and our revenues currently depend, in
large part, upon prevailing market prices for electricity in the ERCOT market.
To date, our capacity auctions have been consummated at market-based prices that
have resulted in returns substantially below the historical regulated return on
our facilities.
The historical financial information we have included herein also does not
reflect what our financial position, results of operations and cash flows would
have been had we been a separate entity during the periods presented. Our
historical costs and expenses included in our financial statements reflect
charges from Reliant Energy for centralized corporate services and operating
infrastructure costs as well as allocated costs of capital. These allocations
have been determined based on what we and Reliant Energy considered to be
reasonable reflections of the utilization of services provided to us or for the
benefits received by us. We may experience significant changes in our cost
structure, capitalization and operations as a result of our separation from
Reliant Energy, including increased costs associated with reduced economies of
scale and with being a publicly traded company.
WE MAY NOT HAVE ACCESS TO SUFFICIENT CAPITAL IN THE AMOUNTS AND AT THE TIMES
NEEDED TO FINANCE OUR BUSINESS.
To date, our capital has been provided by internally generated cash flows
and borrowings from the CenterPoint Energy money pool. As a result of our
certification by the FERC as an "exempt wholesale generator" under the 1935 Act,
we can no longer participate in this money pool. CenterPoint Energy has
established a second money pool in which Texas Genco and certain other
unregulated subsidiaries of CenterPoint Energy can participate. In December
2003, we entered into a $75 million revolving credit facility. It is anticipated
that we will meet our cash needs with a combination of funds from operations and
borrowings under our revolving credit facility. Except in an emergency situation
(in which CenterPoint Energy could provide funding pursuant to applicable SEC
rules), CenterPoint Energy would be required to obtain approval from the SEC to
issue and sell securities for purposes of funding our operations or for
CenterPoint Energy to guarantee our securities. There is no assurance that
CenterPoint Energy will have sufficient funds to meet our cash needs.
CenterPoint Energy's $2.3 billion bank facility limits our incurrence of
indebtedness for borrowed money to an aggregate principal amount not to exceed
$250 million outstanding at any time and requires that proceeds from the sale of
any material portion of our assets, proportionate to CenterPoint Energy's
ownership interest in us and subject to certain other requirements, be used to
prepay indebtedness under such credit facility. Our new credit facility also
limits our incurrence of additional secured indebtedness for borrowed money to a
maximum of $175 million aggregate principal amount. Although we are not
contractually bound by the limitations in CenterPoint Energy's bank facility, it
is expected that CenterPoint Energy would likely cause its representatives on
our board of directors to direct our business so as not to breach the terms of
its facility.
We can give no assurances that our current and future capital structure,
operating performance, financial condition and cash flows will permit us to
access the capital markets or to obtain other financing as needed to meet our
working capital requirements and projected future capital expenditures on
favorable terms. The amount of any debt issuance by us is expected to be
affected by the market's perception of our creditworthiness, market conditions
and factors affecting our industry. Our projected future capital expenditures
are substantial. Our ability to secure third party credit lines or other debt
financing may be adversely impacted by the factors described in this section,
including the nature of our business, which may lead to volatility in our
financial results and cash flows. Please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources -- Future Sources and Uses of Cash," in Item 7 of this report.
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We are an 81% owned subsidiary of CenterPoint Energy. As a result of this
relationship, the financial condition of CenterPoint Energy could affect our
access to capital, our credit standing and our financial condition.
OUR OPERATIONS ARE SUBJECT TO EXTENSIVE REGULATION, INCLUDING ENVIRONMENTAL
REGULATION. IF WE FAIL TO COMPLY WITH APPLICABLE REGULATIONS OR OBTAIN OR
MAINTAIN ANY NECESSARY GOVERNMENTAL PERMIT OR APPROVAL, WE MAY BE SUBJECT TO
CIVIL, ADMINISTRATIVE AND/OR CRIMINAL PENALTIES THAT COULD ADVERSELY IMPACT
OUR RESULTS OF OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS.
Our operations are subject to complex and stringent energy, environmental
and other governmental laws and regulations. The acquisition, ownership and
operation of power generation facilities require numerous permits, approvals and
certificates from federal, state and local governmental agencies. These
facilities are subject to regulation by the Texas Utility Commission regarding
non-rate matters. Existing regulations may be revised or reinterpreted, new laws
and regulations may be adopted or become applicable to us or any of our
generation facilities or future changes in laws and regulations may have a
detrimental effect on our business.
Operation of the South Texas Project is subject to regulation by the NRC.
This regulation involves testing, evaluation and modification of all aspects of
plant operation in light of NRC safety and environmental requirements.
Continuous demonstrations to the NRC that plant operations meet applicable
requirements are also required. The NRC has the ultimate authority to determine
whether any nuclear powered generating unit may operate.
Water for certain of our facilities is obtained from public water
authorities. New or revised interpretations of existing agreements by those
authorities or changes in price or availability of water may have a detrimental
effect on our business.
Our business is subject to extensive environmental regulation by federal,
state and local authorities. We are required to comply with numerous
environmental laws and regulations and to obtain numerous governmental permits
in operating our facilities. We may incur significant additional costs to comply
with these requirements. If we fail to comply with these requirements or with
any other regulatory requirements that apply to our operations, we could be
subject to administrative, civil and/or criminal liability and fines, and
regulatory agencies could take other actions seeking to curtail our operations.
These liabilities or actions could adversely impact our results of operations,
financial condition and cash flows.
Existing environmental regulations could be revised or reinterpreted, new
laws and regulations could be adopted or become applicable to us or our
facilities, and future changes in environmental laws and regulations could
occur, including potential regulatory and enforcement developments related to
air emissions. If any of these events occurs, our business, results of
operations, financial condition and cash flows could be adversely affected.
We may not be able to obtain or maintain from time to time all required
environmental regulatory approvals. If there is a delay in obtaining any
required environmental regulatory approvals or if we fail to obtain and comply
with them, we may not be able to operate our facilities or we may be required to
incur additional costs. We are generally responsible for all on-site liabilities
associated with the environmental condition of our power generation facilities,
regardless of when the liabilities arose and whether the liabilities are known
or unknown. These liabilities may be substantial.
OUR INSURANCE COVERAGE MAY NOT BE SUFFICIENT. INSUFFICIENT INSURANCE COVERAGE
AND INCREASED INSURANCE COSTS COULD ADVERSELY IMPACT OUR RESULTS OF
OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS.
We have insurance covering certain of our facilities, including property
damage insurance, commercial general liability insurance, boiler and machinery
coverage and available replacement capacity in amounts that we consider
appropriate. However, our insurance policies are subject to certain limits and
deductibles and do not include business interruption coverage. We cannot assure
you that insurance coverage will be available in the future at current costs or
on commercially reasonable terms or that the insurance proceeds received for any
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loss of or any damage to any of our generation facilities will be sufficient to
restore the loss or damage without negative impact on our results of operations,
financial condition and cash flows.
We and the other owners of the South Texas Project maintain nuclear
property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
Under the federal Price Anderson Act, the maximum liability to the public of
owners of nuclear power plants was $10.6 billion as of December 31, 2003. Owners
are required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. We and the other owners of the South Texas
Project currently maintain the required nuclear liability insurance and
participate in the industry retrospective rating plan. In addition, the security
procedures at this facility have recently been enhanced to provide additional
protection against terrorist attacks. All potential losses or liabilities
associated with the South Texas Project may not be insurable, and the amount of
insurance may not be sufficient to cover them.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SEASONAL.
The demand for power in the ERCOT market is seasonal, with higher demand
occurring during the warmer months. Accordingly, our customers are generally
willing to pay higher prices for entitlements to our capacity during warmer
months. As a result, our revenues and results of operations are subject to
seasonality, with revenues being higher during the warmer months.
RISKS RELATED TO OUR RELATIONSHIPS WITH CENTERPOINT ENERGY
CENTERPOINT ENERGY'S PLAN TO MONETIZE ITS INTEREST IN US MAY ADVERSELY IMPACT
OUR OPERATIONS AND FINANCIAL CONDITION, AND THE TRADING PRICE OF TEXAS GENCO'S
COMMON STOCK.
CenterPoint Energy expects to monetize its 81% interest in Texas Genco in
2004 and has engaged a financial advisor to assist them in that pursuit.
CenterPoint Energy plans to fully evaluate this option before seeking another
alternative. CenterPoint Energy and Reliant Resources currently provide a
variety of services to us pursuant to the agreements described under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Related Party Transactions -- Our Relationships with CenterPoint
Energy" and "-- Technical Services Agreement with Reliant Resources" in Item 7
of this report. These services agreements will terminate upon the sale of
CenterPoint Energy's interest in Texas Genco. In such an event, we may be
required to replace the services currently provided under arrangements with less
favorable terms. Also, under the terms of our $75 million 365-day revolving
credit facility, if CenterPoint Energy ceases to own, directly or indirectly, at
least a 50% voting and economic interest in our wholly owned subsidiary Texas
Genco, LP, an event of default will occur and any borrowings thereunder may
become immediately due and payable. In addition, depending on the nature of any
monetization transaction, the trading price of Texas Genco's common stock could
be adversely affected.
WE WILL BE CONTROLLED BY CENTERPOINT ENERGY AS LONG AS IT OWNS A MAJORITY OF
TEXAS GENCO'S COMMON STOCK, AND OUR MINORITY SHAREHOLDERS WILL BE UNABLE TO
AFFECT THE OUTCOME OF SHAREHOLDER VOTING DURING THAT TIME.
As a result of the January 6, 2003 distribution, CenterPoint Energy
indirectly owns approximately 81% of Texas Genco's outstanding common stock. As
long as CenterPoint Energy owns a majority of our outstanding common stock, it
will continue to be able to elect our entire board of directors, and our public
shareholders, by themselves, will not be able to affect the outcome of any
shareholder vote. In addition, CenterPoint Energy has stated that it is pursuing
strategic alternatives for its ownership interest in us, including a possible
sale, which could result in a third party becoming our majority shareholder. Our
majority shareholder, subject to any fiduciary duty owed to our minority
shareholders under Texas law, will be able to control all matters affecting us.
In addition, our majority shareholder may enter into credit agreements,
indentures or other contracts that limit the activities of its subsidiaries.
While we would not likely be contractually bound by these
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limitations, our majority shareholder would likely cause its representatives on
our board to direct our business so as not to breach any of these agreements.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH CENTERPOINT ENERGY
WITH RESPECT TO OUR PAST AND ONGOING RELATIONSHIPS, AND BECAUSE OF CENTERPOINT
ENERGY'S CONTROLLING OWNERSHIP INTEREST, WE MAY NOT BE ABLE TO RESOLVE THESE
CONFLICTS ON TERMS POSSIBLE IN ARM'S LENGTH TRANSACTIONS.
Conflicts of interest may arise between CenterPoint Energy and us in a
number of areas relating to our past and ongoing relationships, including
proceedings, actions and decisions of legislative bodies and administrative
agencies, and our dividend policy. The agreements we have entered into with
CenterPoint Energy may be amended in the future upon agreement of the parties.
While we are controlled by CenterPoint Energy, CenterPoint Energy may be able to
require us to amend these agreements. We may not be able to resolve any
potential conflicts with CenterPoint Energy, and even if we do, the resolution
may be less favorable than if we were dealing with an unaffiliated party.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
Our past earnings and results of operations are not necessarily indicative
of our future earnings and results of operations. Any of the following factors
could adversely affect our business prospects, financial condition, operating
results and cash flows:
- state and federal legislative and regulatory actions or developments,
including deregulation; re-regulation and restructuring of the ERCOT
market; and changes in, or application of, environmental and other laws
or regulations to which we are subject;
- the timing and extent of changes in commodity prices, particularly
natural gas;
- the effects of competition, including the extent and timing of the entry
of additional competitors in the ERCOT market;
- the results of our capacity auctions;
- weather variations and other natural phenomena;
- financial distress of our customers, including Reliant Resources;
- our access to capital and credit; and
- other factors discussed in this report under "Risk Factors" in Item 1 of
this report.
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TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(f) LONG-LIVED ASSETS AND INTANGIBLES
The Company periodically evaluates long-lived assets when events or changes
in circumstances indicate that the carrying value of these assets may not be
recoverable. The determination of whether an impairment has occurred is based on
an estimate of undiscounted cash flows attributable to the assets, as compared
to the carrying value of the assets. An impairment analysis of generating
facilities requires estimates of possible future market prices, load growth,
competition and many other factors over the lives of the facilities. A resulting
impairment loss is highly dependent on these underlying assumptions. No
impairment has been recorded in any of the three years in the period ended
December 31, 2003.
(8) COMMITMENTS AND CONTINGENCIES
(A) FUEL AND PURCHASED POWER COMMITMENTS
Fuel commitments include several long-term coal, lignite and natural gas
contracts, which have various quantity requirements and durations that are not
classified as non-trading derivatives assets and liabilities in the Company's
Consolidated Balance Sheets as of December 31, 2003 as these contracts meet the
SFAS No. 133 exception to be classified as normal purchases contracts or do not
meet the definition of a derivative. Minimum payment obligations related to coal
and transportation agreements and lignite mining and lease agreements that
extend through 2012 are approximately $309 million in 2004, $251 million in
2005, $256 million in 2006, $248 million in 2007 and $162 million in 2008.
Purchase commitments related to purchased power are not material to the
Company's operations. As of December 31, 2003, the pricing provisions in some of
these contracts were above market.
(b) LEASE COMMITMENTS
The following table sets forth information concerning the Company's
obligations under non-cancelable long-term operating leases at December 31,
2003, which primarily consist of rental agreements for building space, data
processing equipment and vehicles, including major work equipment (in millions).
<Table>
2004........................................................ $11
2005........................................................ 11
2006........................................................ 10
2007........................................................ 10
2008........................................................ 10
2009 and beyond............................................. 47
---
Total..................................................... $99
===
</Table>
Total lease expense for all operating leases was $10 million, $11 million
and $11 million during 2001, 2002 and 2003, respectively.
(c) ENVIRONMENTAL, LEGAL AND OTHER
Clean Air Standards. The Texas electric restructuring law and regulations
adopted by the Texas Commission on Environmental Quality (TCEQ) in 2001 require
substantial reductions in emission of oxides of nitrogen (NOx) from electric
generating units. The Company is currently installing cost-effective controls at
its generating plants to comply with these requirements. Through December 31,
2003, the Company has invested $664 million for NOx emission control, and plans
to make expenditures of up to approximately $131 million through 2007. Further
revisions to these NOx standards may result from the TCEQ's future rules,
expected by 2007, implementing more stringent federal eight-hour ozone
standards.
10
Asbestos. The Company 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.
Nuclear Insurance. The Company and the other owners of the South Texas
Project maintain nuclear property and nuclear liability insurance coverage as
required by law and periodically review available limits and coverage for
additional protection. The owners of the South Texas Project currently maintain
$2.75 billion in property damage insurance coverage, which is above the legally
required minimum, but is less than the total amount of insurance currently
available for such losses.
Under the Price Anderson Act, the maximum liability to the public of owners
of nuclear power plants was $10.6 billion as of December 31, 2003. Owners are
required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. The Company and the other owners currently
maintain the required nuclear liability insurance and participate in the
industry retrospective rating plan under which the owners of the South Texas
Project are subject to maximum retrospective assessments in the aggregate per
incident of up to $100.6 million per reactor. The owners are jointly and
severally liable at a rate not to exceed $10 million per incident per year. In
addition, the security procedures at this facility have been enhanced to provide
additional protection against terrorist attacks.
There can be no assurance that all potential losses or liabilities
associated with the South Texas Project will be insurable, or that the amount of
insurance will be sufficient to cover them. Any substantial losses not covered
by insurance would have a material effect on the Company's financial condition,
results of operations and cash flows.
Nuclear Decommissioning. CenterPoint Houston contributed $14.8 million in
2001 to trusts established to fund the Company's share of the decommissioning
costs for the South Texas Project. CenterPoint Houston contributed $2.9 million
in 2002 and 2003 to these trusts. There are various investment restrictions
imposed upon the Company by the Texas Utility Commission and the United States
Nuclear Regulatory Commission (NRC) relating to the Company's nuclear
decommissioning trusts. The Company and CenterPoint Energy have each appointed
two members to the Nuclear Decommissioning Trust Investment Committee which
establishes the investment policy of the trusts and oversees the investment of
the trusts' assets. The securities held by the trusts for decommissioning costs
had an estimated fair value of $189 million as of December 31, 2003, of which
approximately 37% were fixed-rate debt securities and the remaining 63% were
equity securities. In July 1999, an outside consultant estimated the Company's
portion of decommissioning costs to be approximately $363 million. While the
funding levels currently exceed minimum NRC requirements, no assurance can be
given that the amounts held in trust will be adequate to cover the actual
decommissioning costs of the South Texas Project. Such costs may vary because of
changes in the assumed date of decommissioning and changes in regulatory
requirements, technology and costs of labor, materials and equipment. Pursuant
to the Texas electric restructuring law, costs associated with nuclear
decommissioning that have not been recovered as of January 1, 2002, will
continue to be subject to cost-of-service rate regulation and will be included
in a charge to transmission and distribution customers.
Joint Operating Agreement with City of San Antonio. The Company has a
joint operating agreement with the City Public Service Board of San Antonio to
share savings from the joint dispatching of each party's generating assets.
Dispatching the two generating systems jointly results in savings of fuel and
related expenses due to a more efficient utilization of each party's lowest cost
resources. The two parties currently share equally the savings resulting from
joint dispatch. The agreement terminates in 2009.
11