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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) RATE MATTERS
(a) Electric Proceedings.
The Texas Utility Commission has original (or in some cases appellate)
jurisdiction over Electric Operations' electric rates and services. Texas
Utility Commission orders may be appealed to a District Court in Travis County,
and from that court's decision an appeal may be taken to the Court of Appeals
for the 3rd District at Austin (Austin Court of Appeals). Discretionary review
by the Supreme Court of Texas may be sought from decisions of the Austin Court
of Appeals. In the event that the courts ultimately reverse actions of the Texas
Utility Commission, such matters are remanded to the Texas Utility Commission
for action in light of the courts' orders.
(b) Transition and Price Reduction Plan.
In 1997, the Texas legislature considered but did not pass legislation
intended to address various issues concerning the restructuring of the electric
utility industry, including proposals that would permit Texas retail electric
customers to choose their own electric suppliers beginning on December 31, 2001.
The legislative proposals included provisions relating to full stranded cost
recovery; rate reductions; rate freezes; the
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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
unbundling of generation operations, transmission and distribution and customer
service operations; securitization of regulatory assets; and consumer
protections. Although the Company and certain other parties (including the Texas
Utility Commission) supported the bill, it was not enacted prior to the
expiration of the legislative session.
In October 1997, the Company announced a proposed transition to competition
plan intended to address certain aspects of the proposals contained in the
legislation formerly pending before the Texas legislature. By mid December 1997,
negotiations resulted in a settlement agreement (Settlement Agreement) executed
by the Company, the staffs of the Texas Utility Commission and the City of
Houston, representatives of the state's principal consumer and industrial groups
and others. The Settlement Agreement was subsequently filed with the Texas
Utility Commission, where it is currently under consideration.
Under the terms of the Settlement Agreement, residential customers will
receive a 4% credit to the base cost of electricity in 1998, increasing to 6% in
1999. Small and mid-sized businesses will receive a 2% credit to their base
costs beginning in 1998. The combined effect of these reductions is expected to
decrease base revenues by $166 million over a two year period. In addition, the
Company (over the next two years) will be permitted, as a way to assist the
Company in mitigating its potentially stranded costs, to (i) redirect to
production property all of its current depreciation expenses that would
otherwise be credited to accumulated depreciation for transmission and
distribution property, and (ii) apply any and all earnings above a rate of
return cap of 9.95% to increase the depreciation of production property. The
Company estimates that redirected depreciation over the two-year period of 1998
and 1999 will be approximately $364 million. As part of the Settlement
Agreement, the Company agreed to support proposed legislation in the 1999 Texas
legislative session that includes provisions providing for retail customer
choice effective December 31, 2001 and other provisions consistent with those in
the 1997 proposed legislation.
The Settlement Agreement is currently under consideration by the Texas
Utility Commission, the City of Houston and other cities served by HL&P. In
December 1997, the Texas Utility Commission approved the petition filed by the
Company to implement the requested base rate credits on a temporary basis
beginning January 1, 1998, and pending final Texas Utility Commission
consideration. The approval also included the accounting order necessary to
permit the Company to begin redirecting depreciation from its transmission and
distribution facilities to production property on a temporary basis pending
final Texas Utility Commission consideration. A procedural schedule has been
developed by the Texas Utility Commission whereby a final decision regarding the
Settlement Agreement would be reached by the end of March 1998.
(c) 1995 Rate Case.
In August 1995, the Texas Utility Commission unanimously approved a
settlement resolving the Company's most recent rate case (Docket No. 12065) as
well as a separate proceeding (Docket No. 13126) regarding the prudence of
operation of the South Texas Project.
See Note 1(f) regarding additional depreciation and amortization that is
permitted under the 1995 Rate Case Settlement with respect to the South Texas
Project and the Company's investment in certain lignite reserves associated with
a canceled generating station.
(d) Docket No. 6668.
In September 1997, the Company received a judgment dismissing all
outstanding appeals of the Texas Utility Commission's order in Docket No. 6668,
an inquiry into the prudence of the planning and construction of the South Texas
Project. In that order, the Texas Utility Commission had determined that $375.5
million of the Company's $2.8 billion investment in the South Texas Project had
been imprudently incurred. That ruling was incorporated into Electric
Operations' 1988 and 1991 rate cases. As a result of this judgment, all
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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outstanding appeals of prior rate cases involving the Company have now been
dismissed and the orders granted in such cases are now final.
(5) EQUITY INVESTMENTS IN FOREIGN AFFILIATES
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 accounts for affiliate investments of its subsidiaries under
the equity method of accounting where: (i) the subsidiary's ownership interest
in the affiliate ranges from 20% to 50%, (ii) the ownership interest is less
than 20% but the subsidiary exercises significant influence over operating and
financial policies of such affiliate or (iii) the subsidiary's ownership
interest in the affiliate exceeds 50% but the subsidiary does not exercise
control over the affiliate. The Company's proportionate share of the equity in
net income in these affiliates for the years ended December 31, 1997, 1996 and
1995 was $48.6 million, $17 million and $.5 million, respectively, which amounts
are included on the Company's Statements of Consolidated Income in
Revenues -- International.
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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's and its subsidiaries' equity investments in foreign and
non-regulated affiliates at December 31, 1997 and 1996 were $704 million and
$502 million, respectively.
(a) Acquisitions.
In May 1996, a subsidiary of HI Energy acquired 11.35% of the common stock
of Light, a publicly held Brazilian corporation, for $393 million which includes
the direct costs of the acquisition. 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. The winning bidders in the government-sponsored auction of
Light, including a subsidiary of HI Energy, formed a consortium whose aggregate
ownership interest of 50.44% represents a controlling interest in Light.
In June 1997, a consortium of investors which included a subsidiary of HI
Energy, acquired for $496 million a 56.7% controlling ownership interest in
Empresa de Energia del Pacifico S.A.E.S.P. (EPSA), an electric utility system
serving the Valle de Cauca region of Colombia, including the area surrounding
the city of Cali. HI Energy contributed $152 million of the purchase price for a
28% ownership interest in EPSA. In addition to its distribution facilities, EPSA
owns 850 MW of electric generation capacity.
In May 1997, HI Energy increased its indirect ownership interest in Empresa
de la Plata S.A. (EDELAP), an Argentina electric utility, from 48% to 63%. The
purchase price of the additional interest was $28 million. HI Energy has
recorded its investment in EDELAP using the equity method because of the
significance of the participatory rights held by a minority shareholder.
HI Energy has accounted for these transactions under purchase accounting
and has recorded its investments and its interest in the affiliates' earnings
after the acquisition dates using the equity method. The purchase prices were
allocated on the basis of the estimated fair market values of the assets
acquired and the liabilities assumed as of the dates of acquisition. The
differences between the amounts paid and the underlying fair values of the net
assets acquired are being amortized as a component of earnings attributable to
unconsolidated affiliates over the estimated lives of the projects ranging from
30 to 40 years. Purchase price adjustments to fixed assets are being amortized
over the underlying assets' estimated useful lives.
(b) Valuation Allowance.
HI Energy is an investor in two waste tire-to-energy projects in the State
of Illinois. The projects had been developed by HI Energy in reliance upon a
state subsidy intended to encourage development of energy project facilities for
the disposal of solid waste. In March 1996, the State of Illinois repealed the
subsidy. As a result of the loss of the subsidy, the Company recorded (i) a $28
million valuation allowance effective in the fourth quarter of 1995 (resulting
in an $18 million after-tax charge in that year) and (ii) an additional $8
million valuation allowance in the first quarter of 1996 (resulting in a $5
million after-tax charge in that year). At the time of the Illinois
legislature's actions, construction work on one of the waste-to-energy projects
had been substantially completed.
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 relating to the
facility for which construction had been substantially completed (Ford Heights
Project). In March 1996, a subsidiary of HI Energy purchased from a senior
lending bank all notes relating to the project for which construction had not
yet commenced (Fulton Project) (approximately $4.1 million). As a consequence,
HI Energy has discretion over when, if ever, the construction activities for the
Fulton project will
5
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
resume and, in turn, control over future obligations of HI Energy to acquire
additional subordinated notes for the Fulton project.
The Company and HI Energy are defendants in various lawsuits filed in
connection with the Ford Heights Project. CGE Ford Heights, L.L.C., (CGE Ford
Heights) the owner of the project, has filed for reorganization under Chapter 11
of the Federal Bankruptcy Code. In October 1997, CGE Ford Heights filed a
lawsuit against First Trust National Association, HI Energy and Zurn Industries,
Inc. (Zurn). CGE Ford Heights is seeking a determination of the funding
obligations of HI Energy and Zurn. In addition, the trustee for the holders of
the bonds issued to finance the project has filed suit against the Company, HI
Energy and Zurn. The trustee alleges that the Company and HI Energy are
obligated to contribute to CGE Ford Heights approximately $15 million in the
form of subordinated debt obligations. The Company and HI Energy are vigorously
contesting the matter. The Company does not believe that the litigation will
have a material adverse impact on the Company's or HI Energy's financial
statements.
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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) COMMITMENTS AND CONTINGENCIES
(a) Commitments.
The Company has various commitments for capital expenditures, fuel,
purchased power, cooling water and operating leases. Commitments in connection
with Electric Operations' capital program are generally revocable by the
Company, subject to reimbursement to manufacturers for expenditures incurred or
other cancellation penalties. The Company's and its subsidiaries' other
commitments have various quantity requirements and durations. However, if these
requirements could not be met, various alternatives are available to mitigate
the cost associated with the contracts' commitments.
(b) Fuel and Purchased Power.
The Company is a party to several long-term coal, lignite and natural gas
contracts which have various quantity requirements and durations. Minimum
payment obligations for coal and transportation agreements are approximately
$200 million in 1998, $203 million in 1999 and $177 million in 2000.
Additionally, minimum payment obligations for lignite mining and lease
agreements are approximately $9 million for 1998, $9 million for 1999 and $10
million for 2000. Minimum payment obligations for both natural gas purchase and
storage contracts associated with Electric Operations are approximately $9
million annually in 1998, 1999 and 2000.
The Company also has commitments to purchase firm capacity from
cogenerators of approximately $22 million in both 1998 and 1999. Texas Utility
Commission rules currently allow recovery of these costs through Electric
Operations' base rates for electric service and additionally authorize the
Company to charge or credit customers through a purchased power cost recovery
factor for any variation in actual purchased power costs from the cost utilized
to determine its base rates. In the event that the Texas Utility Commission, at
some future date, does not allow recovery through rates of any amount of
purchased power payments, the two principal firm capacity contracts contain
provisions allowing the Company to suspend or reduce payments and seek repayment
for amounts disallowed.
(c) Operations Agreement with City of San Antonio.
As part of the settlement with the City of San Antonio, the Company entered
into a 10-year joint operations agreement under which the Company and the City
of San Antonio, acting through the City Public Service Board of San Antonio
(CPS), 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 Electric Operations, the Company has guaranteed CPS minimum
annual savings of $10 million and a minimum cumulative savings of $150 million
over the 10-year term of the agreement. Based on current forecasts and other
assumptions regarding the combined operation of the two generating systems, the
Company 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. In 1997, savings generated for CPS' account for
a full year of operation were approximately $22 million.
(d) Transportation Agreement.
NorAm had an agreement (the ANR Agreement) with ANR Pipeline Company (ANR)
which contemplated a transfer to ANR of an interest in certain of NorAm's
pipeline and related assets, representing
7
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
capacity of 250 Mmcf/day, and pursuant to which ANR had advanced $125 million to
the Company. The ANR Agreement has been restructured and, after refunds of $84
million through December 31, 1997, NorAm currently retains $41 million (recorded
as a liability) in exchange for ANR's or its affiliates' use of 130 Mmcf/ day of
capacity in certain of NorAm's transportation facilities. The level of
transportation will decline to 100 Mmcf/day in the year 2003 with a refund of $5
million to ANR and the ANR Agreement will terminate in 2005 with a refund of the
remaining balance.
(e) Lease Commitments.
The following table sets forth certain information concerning NorAm's
obligations under operating leases:
Minimum Lease Commitments at December 31, 1997(1)
(MILLIONS OF DOLLARS)
---------------------
1998....................................................... $ 24
1999....................................................... 19
2000....................................................... 16
2001....................................................... 15
2002....................................................... 9
2003 and beyond............................................ 22
----
Total............................................ $105
====
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(1) Principally consisting of rental agreements for building space and data
processing equipment and vehicles (including major work equipment).
NorAm has a master leasing agreement which provides for the lease of
vehicles, construction equipment, office furniture, data processing equipment
and other property. For accounting purposes, the lease is treated as an
operating lease. At December 31, 1997, NorAm had leased assets with a value of
approximately $58.1 million under this lease with a basic term of one year.
NorAm does not expect to lease additional property under this lease agreement.
Lease payments related to NorAm's master leasing agreement are included in
the preceding table for only their basic term. Total rental expense for all
leases since the Acquisition Date was approximately $15 million in 1997.
(f) Letters of Credit.
At December 31, 1997, NorAm had letters of credit incidental with its
ordinary business operations totaling approximately $42 million under which
NorAm is obligated to reimburse drawings, if any.
(g) Indemnity Provisions.
At December 31, 1997, NorAm has $11.4 million accounting reserve on the
Company's Consolidated Balance Sheet in Other Deferred Credits for possible
indemnity claims asserted in connection with its disposition of NorAm's former
subsidiaries or divisions, including the sale of (i) Louisiana Intrastate Gas
Corporation, a former NorAm subsidiary engaged in the intrastate pipeline and
liquids extraction business; (ii) Arkla Exploration Company, a former NorAm
subsidiary engaged in oil and gas exploration and production activities; and
(iii) Dyco Petroleum Company, a former NorAm subsidiary engaged in oil and gas
exploration and production.
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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(h) Other.
Electric Operations' service area is heavily dependent on oil, gas, refined
products, petrochemicals and related businesses. Significant adverse events
affecting these industries would negatively affect the revenues of the Company.
The Company and NorAm are involved in legal, tax and regulatory proceedings
before various courts, regulatory commissions and governmental agencies
regarding matters arising in the ordinary course of business, some of which
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 effect on the Company's and NorAm's respective financial statements, if any,
from the disposition of these matters will not be material.
In February 1996, the cities of Wharton, Galveston and Pasadena filed suit,
for themselves and a proposed class, against the Company and Houston Industries
Finance Inc. (formerly a wholly owned subsidiary of the Company) citing
underpayment of municipal franchise fees. The plaintiffs claim, among other
things, that from 1957 to the present, franchise fees should have been paid on
sales taxes collected by HL&P on non-electric receipts as well as electric
sales. Plaintiffs advance their claims notwithstanding their failure to notice
such claims over the previous four decades. Because all of the franchise
ordinances affecting HL&P expressly impose fees only on electric sales, the
Company regards plaintiffs' allegations as spurious and is vigorously contesting
the matter. The plaintiffs' pleadings assert that their damages exceed $250
million. No trial date is currently set. Although the Company believes the
claims to be without merit, the Company cannot at this time estimate a range of
possible loss, if any, from the lawsuit, nor can any assurance be given as to
its ultimate outcome
The Company 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 effect on the Company's financial statements, if any, from the
disposition of these matters will not be material.