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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) PRINCIPLES OF CONSOLIDATION. The consolidated financial
statements include the accounts of the Company and its wholly
owned and majority owned subsidiaries. Certain investments in
joint ventures or other entities in which the Company or its
subsidiaries have a 50 percent or less interest are recorded
using the equity method or the cost method. For additional
information regarding investments and advances, see Notes 1(j)
and 4.
All significant intercompany transactions and balances are
eliminated in consolidation.
(b) SYSTEM OF ACCOUNTS AND EFFECTS OF REGULATION. HL&P, the principal
subsidiary of the Company, maintains its accounting records in
accordance with the FERC Uniform System of Accounts. HL&P's
accounting practices are subject to regulation by the Utility
Commission, which has adopted the FERC Uniform System of
Accounts.
As a result of its regulated status, HL&P follows the accounting
policies set forth in SFAS No. 71, "Accounting for the Effects of
Certain Types of Regulation," which allows a utility with
cost-based rates to defer certain costs in concert with rate
recovery that would otherwise be expensed. In accordance with
this statement, HL&P has deferred certain costs pursuant to rate
actions of the Utility Commission and is recovering or expects to
recover such costs in electric rates charged to customers. The
regulatory assets are included in other assets on the Company's
Consolidated and HL&P's Balance Sheets. The regulatory
liabilities are included in deferred credits on the Company's
Consolidated and HL&P's Balance Sheets. The following is a list
of significant regulatory assets and liabilities reflected on the
Company's Consolidated and HL&P's Balance Sheets:
December 31, 1996
-----------------
(Millions of Dollars)
Deferred plant costs - net ............................. $ 587
Malakoff and Trinity mine investments .................. 164
Regulatory tax asset - net ............................. 362
Unamortized loss on reacquired debt .................... 116
Deferred debits ........................................ 102
Unamortized investment tax credit ...................... (374)
Accumulated deferred income taxes-regulatory tax asset . (101)
If, as a result of changes in regulation or competition, HL&P's
ability to recover these assets and/or liabilities would not be
assured, then pursuant to SFAS Nos. 71, 101 (Accounting for the
Discontinuation of Application of SFAS No. 71) and 121 (Accounting
for the Impairment of Long- Lived Assets and for Long-Lived Assets
to be Disposed of) and to the extent that such regulatory assets
or liabilities ultimately were determined not to be recoverable,
HL&P would be required to write off or write down such assets or
liabilities.
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(c) ELECTRIC PLANT. HL&P capitalizes at cost all additions to
electric plant, betterments to existing property and replacements
of units of property. Cost includes the original cost of
contracted services, direct labor and material, indirect charges
for engineering supervision and similar overhead items and AFUDC.
AFUDC represents the estimated debt and equity cost of funds used
to finance construction. Customer payments for construction
reduce additions to electric plant.
HL&P computes depreciation using the straight-line method. The
depreciation provision as a percentage of the depreciable cost of
plant was 3.2 percent for 1994 through 1996.
(d) DEFERRED PLANT COSTS. Under a "deferred accounting" plan
authorized by the Utility Commission, HL&P was permitted for
regulatory purposes to accrue carrying costs in the form of AFUDC
on its investment in the South Texas Project and defer and
capitalize depreciation and other operating costs on its
investment after commercial operation until such costs were
reflected in rates. In addition, the Utility Commission
authorized HL&P under a "qualified phase-in plan" to capitalize
allowable costs (including return) deferred for future recovery
as deferred charges.
In 1991, HL&P ceased all cost deferrals related to the South
Texas Project and began amortizing such amounts on a
straight-line basis. The accumulated deferrals for "deferred
accounting" are being amortized over the estimated depreciable
life of the South Texas Project. The accumulated deferrals for
the "qualified phase-in plan" are being amortized over a ten-year
phase-in period that commenced in 1991. The amortization of all
deferred plant costs (which totaled $25.8 million for each of the
years 1996, 1995 and 1994) is included on the Company's
Statements of Consolidated Income and HL&P's Statements of Income
as depreciation and amortization expense.
(e) REVENUES. HL&P records electricity sales under the full accrual
method, whereby unbilled electricity sales are estimated and
recorded each month. Other revenues include electricity sales of
a majority owned foreign electric utility, which are also
recorded under the full accrual method and the Company's equity
income in unconsolidated investments of HI Energy. Also included
in other revenues are management fees and other sales and
services, which are recorded when earned.
(f) INCOME TAXES. The Company and its subsidiaries file a
consolidated federal income tax return. The Company follows a
policy of comprehensive interperiod income tax allocation.
Investment tax credits were deferred and are being amortized over
the estimated lives of the related property.
(g) EARNINGS PER COMMON SHARE. Earnings per common share for the
Company are computed by dividing net income by the weighted
average number of shares outstanding during the respective
period. All earnings per common share amounts reflect the
two-for-one common stock split effected in the form of a stock
distribution on December 9, 1995.
(h) STATEMENTS OF CONSOLIDATED CASH FLOWS. For purposes of reporting
cash flows, cash equivalents are considered to be short-term,
highly liquid investments readily convertible to cash.
(i) DISCONTINUED OPERATIONS. In July 1995, the Company sold KBLCOM,
its cable television subsidiary. The operations of KBLCOM are
reflected as discontinued operations for all periods presented.
See Note 13.
(j) INVESTMENTS IN DEBT AND EQUITY SECURITIES. The Company owns one
million shares of Time Warner common stock and 11 million shares
of non-publicly traded Time Warner convertible preferred stock.
The Company has recorded its investment in these securities at
a combined value of approximately $1 billion on the Company's
Consolidated Balance Sheets. Investment in the Time Warner common
stock is considered an "available-for-sale" equity security
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under SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." Consequently, the Company excludes
unrealized net changes in the fair value of Time Warner common
stock (exclusive of dividends and write downs) from earnings and,
until realized, reports such changes as a net amount in the
shareholders' equity section of the Company's Consolidated
Balance Sheets. Investment in the Time Warner convertible
preferred stock (which is not subject to the requirements of SFAS
No. 115, since it is a non-publicly traded equity security) is
accounted for under the cost method.
The securities held in the Company's nuclear decommissioning
trust are classified as "available-for-sale" and, in accordance
with SFAS No. 115, are reported at estimated fair value of $67
million as of December 31, 1996 and $44.5 million as of December
31, 1995 on the Company's Consolidated and HL&P's Balance Sheets
under deferred debits. The liability for nuclear decommissioning
is reported on the Company's Consolidated and HL&P's Balance
Sheets under deferred credits. Any unrealized gains or losses are
accounted for in accordance with SFAS No. 71 as a regulatory
asset/liability and reported on the Company's Consolidated and
HL&P's Balance Sheets as a deferred debit.
(k) FUEL STOCK. Gas inventory (at average cost) was $19.6 million at
December 31, 1996. Coal, lignite, and oil inventory balances
(using last-in, first-out) were $27.3 million, $11.8 million and
$3.0 million, respectively.
(l) DEPRECIATION. The Company and HL&P compute depreciation using the
straight-line method. The Company's depreciation expense for 1996
was $360 million compared to $349 million and $338 million for
1995 and 1994, respectively. HL&P's depreciation expense for 1996
was $358 million compared to $347 million and $338 million for
1995 and 1994, respectively.
(m) RECLASSIFICATION. Certain amounts from the previous years have
been reclassified to conform to the 1996 presentation of
financial statements. Such reclassifications do not affect
earnings.
(n) NATURE OF OPERATIONS. The Company is a holding company
operating principally in the electric utility business. HL&P is
engaged in the generation, transmission, distribution and sale of
electric energy. HL&P's service area covers a 5,000 square mile
area in the Texas Gulf Coast, including Houston. Another
subsidiary of the Company, HI Energy, participates in domestic
and foreign power generation projects and invests in the
privatization of foreign electric utilities. The business and
operations of HL&P account for substantially all of the Company's
income from continuing operations and common stock equity. For a
description of the Merger, see Note 16 to the Financial
Statements.
(o) USE OF ESTIMATES. 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.
(p) LONG-LIVED ASSETS. Effective January 1, 1996, the Company and
HL&P adopted SFAS No. 121. SFAS No. 121 requires that long-lived
assets and certain identifiable intangibles to be held and used
or disposed of by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. The Company and HL&P
have determined that no impairment loss need be recognized for
applicable assets of continuing operations as of December 31,
1996. This conclusion, however, may change in the future as
competition influences wholesale and retail pricing in the
electric utility industry.
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(2) JOINTLY-OWNED NUCLEAR PLANT
(a) HL&P INVESTMENT. HL&P is the project manager (and one of four
co-owners) of the South Texas Project, which consists of two
1,250 MW nuclear generating units. HL&P has a 30.8 percent
interest in the project and bears a corresponding share of
capital and operating costs associated with the project. As of
December 31, 1996, HL&P's investment in the South Texas Project
was $2.0 billion (net of $503 million accumulated depreciation).
HL&P's investment in nuclear fuel (including AFUDC) was $65
million (net of $176 million amortization) as of such date.
(b) REGULATORY PROCEEDINGS AND LITIGATION. All litigation and
arbitration claims formerly pending between HL&P and the other
co-owners of the South Texas Project have been settled and
dismissed with prejudice.
On April 30, 1996, HL&P and the City of Austin (Austin), one of
the four co-owners of the South Texas Project, agreed to settle a
lawsuit in which Austin had alleged that outages occurring at the
South Texas Project between early 1993 and early 1994 were due to
HL&P's failure to perform certain obligations it owed Austin
under a Participation Agreement relating to the project. Under
the settlement, HL&P agreed to pay Austin $20 million in cash to
resolve all pending disputes between HL&P and Austin, and Austin
agreed to support the formation of a new operating company to
assume HL&P's role as project manager for the South Texas
Project. The Company and HL&P have recorded the $20 million ($13
million net of tax) payment to Austin on the Company's Statements
of Consolidated Income and HL&P's Statements of Income as
litigation settlements expense.
In July 1996, HL&P and the City of San Antonio, acting through
the City Public Service Board of San Antonio (CPS), entered into
a settlement agreement providing, among other things, for (i) the
dismissal with prejudice of all pending arbitration claims and
lawsuits between HL&P and CPS relating to the South Texas
Project, (ii) a cash payment by HL&P to CPS of $75 million, (iii)
an agreement to support formation of a new operating company to
replace HL&P as project manager for the South Texas Project and
(iv) the execution of a 10-year joint operations agreement under
which HL&P and CPS will share savings resulting from the joint
dispatching of their respective generating assets in order to
take advantage of each system's lower cost resources. Under the
terms of the joint operations agreement entered into between CPS
and HL&P, HL&P guarantees CPS minimum annual savings of $10
million and a minimum cumulative savings of $150 million over the
ten-year term of the agreement. Based on current forecasts and
other assumptions regarding the combined operation of the two
generating systems, HL&P anticipates that the savings resulting
from joint operations will equal or exceed the minimum savings
guaranteed under the joint operating agreement. In 1996, savings
generated for CPS' account for a partial year of joint operations
were approximately $14 million.
The operating company (OPCO) which is being formed to replace
HL&P as project manager of the South Texas Project will be a
Texas non-profit corporation. Regulatory and governmental
approvals are being sought for the implementation of OPCO. Once
this process is completed, HL&P's employees working at the South
Texas Project will become employees of OPCO and OPCO will assume
responsibility for managing the South Texas Project. Oversight
will be provided by an Owners' Committee and OPCO's board of
directors, under the direction of directors appointed by each of
the co-owners.
In 1996, the capability factor at the South Texas Project
improved to 93.9 percent from 87.7 percent in 1995 (the 1995
median capability factor for U.S. nuclear facilities was 75.9
percent).
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In 1996, the Nuclear Regulatory Commission (NRC) graded the South
Texas Project "superior" in the areas of maintenance and support
and "good" in areas of operations and engineering in the NRC's
most recent Systematic Assessment of Licensees Performance.
Between June 1993 and February 1995, the South Texas Project had
been listed on the NRC's "watch list" of plants with weaknesses
that warrant increased NRC regulatory attention.
(c) NUCLEAR INSURANCE. HL&P and the other owners of the South Texas
Project maintain nuclear property and nuclear liability insurance
coverage as required by law and periodically review available
limits and coverage for additional protection. The owners of the
South Texas Project currently maintain $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. This coverage consists of $500 million
in primary property damage insurance and excess property
insurance in the amount of $2.25 billion. Under the excess
property insurance (which became effective in November 1996),
HL&P and the other owners of the South Texas Project are subject
to assessments, the maximum aggregate assessment under current
policies being $14.8 million during any one policy year. The
application of the proceeds of such property insurance is subject
to the priorities established by the NRC regulations relating to
the safety of licensed reactors and decontamination operations.
Pursuant to the Price Anderson Act (Act), the maximum liability
to the public of owners of nuclear power plants, such as the
South Texas Project, was $8.92 billion as of December 1996.
Owners are required under the Act to insure their liability for
nuclear incidents and protective evacuations by maintaining the
maximum amount of financial protection available from private
sources and by maintaining secondary financial protection through
an industry retrospective rating plan. The assessment of deferred
premiums provided by the plan for each nuclear incident is up to
$75.5 million per reactor, subject to indexing for inflation, a
possible 5 percent surcharge (but no more than $10 million per
reactor per incident in any one year) and a 3 percent state
premium tax. HL&P and the other owners of the South Texas Project
currently maintain the required nuclear liability insurance and
participate in the industry retrospective rating plan.
There can be no assurance that all potential losses or
liabilities will be insurable, or that the amount of insurance
will be sufficient to cover them. Any substantial losses not
covered by insurance would have a material effect on HL&P's and
the Company's financial condition and results of operations.
(d) NUCLEAR DECOMMISSIONING. In accordance with the Rate Case
Settlement, HL&P contributes $14.8 million per year to a trust
established to fund HL&P's share of the decommissioning costs for
the South Texas Project. For a discussion of securities held in
the Company's nuclear decommissioning trust, see Note 1(j). In
May 1994, an outside consultant estimated HL&P's portion of
decommissioning costs to be approximately $318 million (1994
dollars). The consultant's calculation of decommissioning costs
for financial planning purposes used the DECON methodology
(prompt removal/dismantling), one of the three alternatives
acceptable to the NRC, and assumed deactivation of Unit Nos. 1
and 2 upon the expiration of their 40-year operating licenses.
While the current and projected 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,
changes in regulatory and accounting requirements, changes in
technology and changes in costs of labor, materials and
equipment.
(3) RATE MATTERS
The Utility Commission has original (or in some cases appellate)
jurisdiction over HL&P's electric rates and services. In Texas,
Utility Commission orders may be appealed to a District Court in
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Travis County, and from that court's decision an appeal may be
taken to the Court of Appeals for the 3rd District at Austin
(Austin Court of Appeals). Discretionary review by the Supreme
Court of Texas may be sought from decisions of the Austin Court
of Appeals. In the event that the courts ultimately reverse
actions of the Utility Commission, such matters are remanded to
the Utility Commission for action in light of the courts' orders.
(a) 1995 RATE CASE. In August 1995, the Utility Commission
unanimously approved the Rate Case Settlement, which resolved
HL&P's 1995 rate case (Docket No. 12065) as well as a separate
proceeding (Docket No. 13126) regarding the prudence of operation
of the South Texas Project. Subject to certain changes in
existing regulation or legislation, the Rate Case Settlement
precludes HL&P from seeking rate increases until after December
31, 1997.
The Rate Case Settlement gives HL&P the option to write down up
to $50 million per year of its investment in the South Texas
Project through December 31, 1999, which write-downs will be
treated under the terms of the Rate Case Settlement as reasonable
and necessary expenses for purposes of reviews of HL&P's earnings
and any rate review proceeding initiated against HL&P. In both
1995 and 1996, HL&P recorded a $50 million pre-tax write down of
its investment in the South Texas Project as amortization
expense. In 1996, HL&P also amortized $50 million (pre-tax) of
its $153 million investment in certain lignite reserves
associated with a canceled generating station. In accordance with
the settlement, HL&P's remaining investment in the canceled
generating station and certain lignite reserves ($164 million
at December 31, 1996) will be amortized fully no later than
December 31, 2002.
(b) RATE CASE APPEALS. The only HL&P rate order currently under
appeal is Docket No. 6668 (the Utility Commission's inquiry into
the prudence of the planning and construction of the South Texas
Project). Review of the Utility Commission's order in Docket No.
6668 is pending before a Travis County district court. In that
order, the Utility Commission determined that $375.5 million of
HL&P's $2.8 billion investment in the South Texas Project had
been imprudently incurred. That ruling was incorporated into
HL&P's 1988 and 1991 rate cases. Unless the order is modified or
reversed on appeal, the amount found imprudent by the Utility
Commission will be sustained.
In June 1996, the Supreme Court of Texas unanimously upheld the
decision of the Utility Commission in Docket No. 8425 (HL&P's
1988 rate case) to include in HL&P's rate base $93 million in
construction costs relating to the canceled generating station.
The Supreme Court also affirmed the Utility Commission's decision
granting deferred accounting treatment for Unit No. 2 of the
South Texas Project and the calculation of HL&P's federal income
tax expenses without taking into account deductions for expenses
paid by the Company's shareholders. As a result of this decision,
HL&P's 1988 rate case has now become final.
(4) INVESTMENTS OF HI ENERGY
(a) GENERAL. HI Energy, a wholly owned subsidiary of the Company
formed in 1993, participates primarily in the development and
acquisition of foreign independent power projects and the
privatization of foreign generating and distribution companies.
The Company generally accounts for affiliate investments of HI
Energy under the equity method of accounting where: (i) HI
Energy's ownership interest in the affiliate ranges from 20
percent to 50 percent or (ii) HI Energy exercises significant
influence over operating and financial policies of such
affiliate. The Company's proportionate share of the equity in net
income/(loss) in these affiliates for the years ended December 31,
1996, 1995 and 1994 was $17.0 million, $0.5 million and $(1.6)
million, respectively. These amounts are included on the
Company's Statement of Consolidated Income as "Other Revenues."
The Company's equity investments in and advances to foreign and
non-regulated affiliates at December 31, 1996 and 1995 were $502
million and $41 million, respectively.
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(b) FOREIGN INVESTMENTS. In May 1996, a subsidiary of HI Energy
acquired 11.35 percent of the common shares of Light, a publicly
held Brazilian corporation, for $392 million. Light is the
operator under a 30-year concession agreement of an integrated
electric power and distribution system that serves a portion of
the state of Rio de Janeiro, Brazil, including the city of Rio de
Janeiro. HI Energy acquired the shares as a bidder in the
government-sponsored auction of 60 percent of Light's outstanding
shares. Subsequent to the auction, the winning bidders, including
a subsidiary of HI Energy, formed a consortium whose aggregate
ownership interest of 50.44 percent represents a controlling
interest in Light.
The Company has accounted for this transaction under purchase
accounting and has recorded its investment and its interest in
Light's operations after June 1, 1996, using the equity method.
The purchase price was allocated on the basis of the estimated
fair market value of the assets acquired and the liabilities
assumed as of the date of acquisition.
A subsidiary of HI Energy has entered into a $167.5 million loan
agreement in order to refinance a portion of the acquisition
costs of Light. The full proceeds of the loan, net of a $17.5
million debt reserve account to be established for the benefit of
the lenders, will not be funded until the satisfaction of various
conditions precedent, including the obtaining of political risk
insurance. The loan is non-recourse to the Company and HL&P. The
loan is secured by, among other things, a pledge of the shares of
Light and a subsidiary of HI Energy that is the indirect holder
of the shares of Light.
In addition to the investment in Brazil, HI Energy had total
equity investments in and advances to affiliates in Argentina of
$81 million and $36 million at December 31, 1996 and 1995,
respectively, representing a 49 percent interest in the capital
stock of an electric utility operating in the Province of Buenos
Aires. In addition, HI Energy owns a 90 percent ownership
interest in an Argentine electric utility distribution system and
is constructing a 160 MW cogeneration facility in San Nicolas,
Argentina. HI Energy's investment in these projects was
approximately $68 million and $22 million at December 31, 1996 and
1995, respectively.
HI Energy also owns a 36 percent interest in a coke calcining and
power generation facility in India with an investment of
approximately $8 million and $5 million at December 31, 1996 and
December 31, 1995, respectively.
(c) VALUATION ALLOWANCE. In 1995, the Company recorded a $28 million
valuation allowance (resulting in an $18 million after-tax charge
in that year) with respect to two waste tire-to-energy projects
that were being developed in reliance on the terms of a state
subsidy intended to encourage development of energy production
facilities for the disposal of solid waste. In March 1996, the
subsidy was repealed. In 1996, the Company recorded an additional
valuation allowance of $7 million with respect to these projects,
which resulted in a $5 million after-tax charge to 1996 earnings.
The valuation allowance reflects the combined amounts lent to the
projects on a subordinated basis by HI Energy. HI Energy also is
a party to two separate note purchase agreements committing it,
under certain circumstances, to lend up to an additional $16
million. The Company has entered into a support agreement to
enable HI Energy to honor its obligation under these note
purchase agreements. In the Company's opinion, it is unlikely
that additional loans would be required to be made under the note
purchase agreements, unless construction activities with respect
to these projects were recommenced at some future date. In March
1996, a subsidiary of HI Energy purchased from a senior lending
bank all notes relating to one of the projects
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