1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------------- ---------------
------------------------------
Commission file number 1-3187
HOUSTON INDUSTRIES INCORPORATED
(Exact name of registrant as specified in its charter)
Texas 74-0694415
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
------------------------------
Commission file number 1-13265
NORAM ENERGY CORP.
(Exact name of registrant as specified in its charter)
Delaware 76-0511406
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
-----------------------------
NORAM ENERGY CORP. MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a)
AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE REDUCED
DISCLOSURE FORMAT.
Indicate by check mark whether the registrants: (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes[X] No[ ]
As of August 7, 1998, Houston Industries Incorporated had 296,097,619 shares of
common stock outstanding, including 11,786,672 ESOP shares not deemed
outstanding for financial statement purposes and excluding 102,291 shares held
as treasury stock. As of August 7, 1998, all 1,000 shares of NorAm Energy
Corp.'s common stock were held by Houston Industries Incorporated.
2
This combined Quarterly Report on Form 10-Q is separately
filed by Houston Industries Incorporated (Company) and NorAm Energy
Corp. (NorAm). Information contained herein relating to NorAm is filed
by the Company and separately by NorAm on its own behalf. NorAm makes
no representation as to information relating to the Company (except as
it may relate to NorAm and its subsidiaries), Houston Industries
Energy, Inc., Houston Industries Power Generation, Inc. or any other
affiliate or subsidiary of the Company.
HOUSTON INDUSTRIES INCORPORATED
AND NORAM ENERGY CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1998
TABLE OF CONTENTS
Part I. Financial Information Page No.
- ------- --------------------- --------
Company
Item 1. Financial Statements
Statements of Consolidated Income
Three Months and Six Months Ended
June 30, 1998 and 1997 (unaudited) 1
Consolidated Balance Sheets
June 30, 1998 and December 31, 1997 (unaudited) 2
Statements of Consolidated Cash Flows
Six Months Ended June 30, 1998 and 1997 (unaudited) 4
Statements of Consolidated Retained Earnings
Three Months and Six Months Ended
June 30, 1998 and 1997 (unaudited) 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations of the Company 16
Item 3. Quantitative and Qualitative Disclosures
About Market Risk of the Company 34
NorAm
Item 1. Financial Statements
Statements of Consolidated Income
Three Months and Six Months Ended
June 30, 1998 and 1997 (unaudited) 35
Consolidated Balance Sheets
June 30, 1998 and December 31, 1997 (unaudited) 36
(i)
3
HOUSTON INDUSTRIES INCORPORATED
AND NORAM ENERGY CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1998
TABLE OF CONTENTS - Continued
Page No.
--------
Statements of Consolidated Cash Flows
Six Months Ended June 30, 1998 and 1997 (unaudited) 38
Consolidated Statements of Stockholders' Equity
Three Months and Six Months Ended
June 30, 1998 and 1997 (unaudited) 39
Notes to Unaudited Consolidated Financial Statements 41
Item 2. Management's Narrative Analysis of the
Results of Operations of NorAm Energy Corp.
and Consolidated Subsidiaries 44
Item 3. Quantitative and Qualitative Disclosure
About Market Risk of NorAm (omitted pursuant
to General Instruction H(2)(c))
Part II. Other Information
Item 1. Legal Proceedings 54
Item 4. Submission of Matters to a Vote of Security-Holders 54
Item 5. Other Information 55
Item 6. Exhibits and Reports on Form 8-K 56
Signature(s)
4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(Thousands of Dollars, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
REVENUES:
Electric Operations .................. $ 1,181,300 $ 1,043,020 $ 2,027,862 $ 1,899,554
Natural Gas Distribution ............. 314,989 1,031,885
Interstate Pipeline .................. 76,516 147,497
Energy Marketing ..................... 1,042,610 2,088,229
International ........................ 169,435 20,401 196,681 39,928
Other ................................ 25,836 1,027 49,942 3,067
Eliminations ......................... (71,955) (166,653)
----------- ----------- ----------- -----------
Total ............................. 2,738,731 1,064,448 5,375,443 1,942,549
----------- ----------- ----------- -----------
EXPENSES:
Fuel and cost of gas sold ............ 1,048,105 253,244 2,334,197 466,362
Purchased power ...................... 489,864 78,632 902,516 179,624
Operation and maintenance ............ 415,056 295,206 807,679 509,536
Taxes other than income taxes ........ 90,578 58,297 179,355 120,752
Depreciation and amortization ........ 235,035 131,897 410,634 262,887
----------- ----------- ----------- -----------
Total ............................ 2,278,638 817,276 4,634,381 1,539,161
----------- ----------- ----------- -----------
OPERATING INCOME ........................ 460,093 247,172 741,062 403,388
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Unrealized loss on ACES .............. (254,458) (443,778)
Time Warner dividend income .......... 10,312 10,312 20,625 20,715
Other - net .......................... 6,295 19 13,509 (1,743)
----------- ----------- ----------- -----------
Total ............................ (237,851) 10,331 (409,644) 18,972
----------- ----------- ----------- -----------
INTEREST AND OTHER CHARGES:
Interest on long-term debt ........... 103,326 60,293 209,355 123,094
Other interest ....................... 23,034 18,682 47,393 35,093
Distributions on trust securities .... 7,302 7,155 14,712 11,673
Allowance for borrowed funds used
during construction .............. (612) (745) (1,569) (1,845)
Preferred dividends of subsidiary .... 97 2,222
----------- ----------- ----------- -----------
Total ............................ 133,050 85,482 269,891 170,237
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES
AND PREFERRED DIVIDENDS ............... 89,192 172,021 61,527 252,123
INCOME TAXES ............................ 44,887 50,558 48,462 71,040
PREFERRED DIVIDENDS ..................... 98 195
----------- ----------- ----------- -----------
NET INCOME .............................. $ 44,207 $ 121,463 $ 12,870 $ 181,083
=========== =========== =========== ===========
BASIC AND DILUTED EARNINGS PER
COMMON SHARE ........................... $ .16 $ .52 $ .05 $ .77
See Notes to Unaudited Consolidated Financial Statements.
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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
ASSETS
June 30, December 31,
1998 1997
----------- -----------
PROPERTY, PLANT AND EQUIPMENT - AT COST:
Electric plant:
Plant in service .................................. $12,990,691 $12,614,000
Construction work in progress ..................... 189,449 224,959
Nuclear fuel ...................................... 262,662 255,567
Plant held for future use ......................... 48,631 48,631
Gas plant and pipelines:
Natural gas distribution .......................... 1,396,145 1,326,442
Interstate pipelines .............................. 1,267,187 1,258,087
Energy marketing .................................. 173,853 162,519
Other property ....................................... 179,542 149,019
----------- -----------
Total ....................................... 16,508,160 16,039,224
Less accumulated depreciation and amortization ....... 5,115,183 4,770,179
----------- -----------
Property, plant and equipment - net ......... 11,392,977 11,269,045
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ............................ 89,554 51,712
Accounts receivable - net ............................ 733,299 962,974
Accrued unbilled revenues ............................ 115,655 205,860
Time Warner dividends receivable ..................... 10,313 10,313
Fuel stock and petroleum products .................... 108,653 88,819
Materials and supplies, at average cost .............. 158,875 156,160
Prepayments and other current assets ................. 48,695 42,169
----------- -----------
Total current assets ........................ 1,265,044 1,518,007
----------- -----------
OTHER ASSETS:
Goodwill--net ........................................ 2,079,320 2,026,395
Investment in Time Warner securities ................. 990,000 990,000
Equity investments in and advances to foreign and
non-rate regulated affiliates - net ............... 777,106 704,102
Deferred plant costs - net ........................... 548,678 561,569
Deferred debits ...................................... 500,258 510,686
Regulatory tax asset - net ........................... 349,746 356,509
Unamortized debt expense and premium on
reacquired debt ................................... 211,129 202,453
Fuel-related debits .................................. 233,421 197,304
Recoverable project costs - net ...................... 57,975 78,485
----------- -----------
Total other assets .......................... 5,747,633 5,627,503
----------- -----------
Total .................................... $18,405,654 $18,414,555
=========== ===========
See Notes to Unaudited Consolidated Financial Statements.
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6
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
CAPITALIZATION AND LIABILITIES
June 30, December 31,
1998 1997
------------ ------------
CAPITALIZATION:
Common stock equity:
Common stock, no par value ............................ $ 3,132,692 $ 3,112,098
Treasury stock, at cost ............................... (2,266) (2,066)
Unearned ESOP shares .................................. (223,012) (229,827)
Retained earnings ..................................... 1,815,435 2,013,055
Cumulative foreign currency translation adjustment .... (5,866) (821)
Unrealized loss on marketable equity securities ....... (10,669) (5,634)
------------ ------------
Total common stock equity ...................... 4,706,314 4,886,805
------------ ------------
Preference stock, none outstanding
Cumulative preferred stock, no par value,
not subject to mandatory redemption ................... 9,740 9,740
------------ ------------
Company/NorAm obligated mandatorily redeemable trust
preferred securities of subsidiary trusts holding
solely subordinated debentures of Company/NorAm ....... 342,814 362,172
------------ ------------
Long-term debt:
Automatic common exchange securities (ACES) ........... 1,617,565 1,173,786
Debentures ............................................ 972,518 669,291
First mortgage bonds .................................. 1,933,197 2,495,459
Notes payable ......................................... 734,204 745,889
Pollution control revenue bonds ....................... 512,685 118,000
Other ................................................. 15,023 15,590
------------ ------------
Total long-term debt ........................... 5,785,192 5,218,015
------------ ------------
Total capitalization ....................... 10,844,060 10,476,732
------------ ------------
CURRENT LIABILITIES:
Notes payable ........................................ 1,796,787 2,124,956
Accounts payable ..................................... 799,016 879,612
Taxes accrued ........................................ 206,838 240,739
Interest accrued ..................................... 119,978 109,901
Dividends declared ................................... 111,017 110,716
Customer deposits .................................... 80,009 82,437
Current portion of long-term debt .................... 382,673 251,169
Other ................................................ 206,379 193,384
------------ ------------
Total current liabilities ......................... 3,702,697 3,992,914
------------ ------------
DEFERRED CREDITS:
Accumulated deferred income taxes ..................... 2,648,709 2,792,781
Benefit obligations ................................... 424,962 397,586
Unamortized investment tax credit ..................... 339,010 349,072
Fuel-related credits .................................. 105,601 75,956
Other ................................................. 340,615 329,514
------------ ------------
Total deferred credits ............................ 3,858,897 3,944,909
------------ ------------
COMMITMENTS AND CONTINGENCIES
Total ............................................. $ 18,405,654 $ 18,414,555
============ ============
See Notes to Unaudited Consolidated Financial Statements.
3
7
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(Thousands of Dollars)
(Unaudited)
Six Months Ended
June 30,
------------------------
1998 1997
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................... $ 12,870 $ 181,083
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization ......................................... 410,634 262,887
Amortization of nuclear fuel .......................................... 13,291 14,856
Deferred income taxes ................................................. (121,510) (16,758)
Investment tax credit ................................................. (10,062) (9,757)
Unrealized loss on ACES ............................................... 443,778
Contribution of marketable equity securities
to charitable trust ................................................ 19,463
Fuel surcharge ........................................................ 46,524 66,245
Fuel cost under recovery .............................................. (90,015) (84,276)
Changes in other assets and liabilities:
Accounts receivable - net .......................................... 179,348 28,962
Accounts receivable - IRS .......................................... 140,532
Inventory .......................................................... (18,315) 36,074
Other current assets ............................................... (6,741) (6,995)
Accounts payable ................................................... (102,394) (22,561)
Interest and taxes accrued ......................................... (31,824) (43,493)
Other current liabilities .......................................... (16,746) (24,666)
Other - net ........................................................ (35,292) 15,384
--------- ---------
Net cash provided by operating activities ...................... 814,078 416,448
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (including allowance for borrowed
funds used during construction) ....................................... (268,567) (93,558)
Acquisitions of non-rate regulated electric power plants ................. (230,462)
Sale of non-rate regulated electric power projects ....................... 242,744
Non-rate regulated electric power project expenditures
(including capitalized interest) ........................................ (175,706) (211,609)
Sale of Time Warner securities ........................................... 25,043
Other - net .............................................................. (19,892) (5,082)
--------- ---------
Net cash used in investing activities .......................... (451,883) (285,206)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of Company obligated mandatorily
redeemable trust preferred securities of subsidiary
trusts holding solely subordinated debentures of
Company - net ......................................................... 340,785
Payment of matured bonds ................................................. (29,000) (190,000)
Proceeds from issuance of debentures ..................................... 298,514
Proceeds from issuance of pollution control revenue bonds ................ 386,634 115,739
Redemption of preferred stock ............................................ (153,628)
Payment of common stock dividends ........................................ (210,376) (175,235)
Increase (decrease) in notes payable - net ............................... (339,854) 120,282
Extinguishment of long-term debt ......................................... (402,587) (190,338)
Conversion of convertible securities ..................................... (10,097)
Other - net .............................................................. (17,587) 2,118
--------- ---------
Net cash used in financing activities .......................... (324,353) (130,277)
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ..................................... 37,842 965
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .............................. 51,712 8,001
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD .................................... $ 89,554 $ 8,966
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) ................................. $ 276,679 $ 178,378
Income taxes .......................................................... 164,655 64,994
See Notes to Unaudited Consolidated Financial Statements.
4
8
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED RETAINED EARNINGS
(Thousands of Dollars)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Balance at Beginning of Period .... $ 1,875,213 $ 1,969,454 $ 2,013,055 $ 1,997,490
Net Income for the Period ......... 44,207 121,463 12,870 181,083
----------- ----------- ----------- -----------
Total .................... 1,919,420 2,090,917 2,025,925 2,178,573
Common Stock Dividends ............ (103,985) (87,723) (210,490) (175,379)
----------- ----------- ----------- -----------
Balance at End of Period .......... $ 1,815,435 $ 2,003,194 $ 1,815,435 $ 2,003,194
=========== =========== =========== ===========
See Notes to Unaudited Consolidated Financial Statements.
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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The unaudited interim financial statements and notes (Company's Interim
Financial Statements) in this joint Form 10-Q (Form 10-Q) include the accounts
of Houston Industries Incorporated (Company) and its wholly owned and majority
owned subsidiaries including, effective as of August 6, 1997 (Acquisition Date),
the accounts of NorAm Energy Corp. (NorAm) and its wholly owned and majority
owned subsidiaries. For information regarding the Company's acquisition of
NorAm, see Note 1(b) to the Company's Consolidated Financial Statements in the
joint Annual Report on Form 10-K (Form 10-K) of the Company (File No. 1-3187)
and NorAm (File No. 1-13265) for the fiscal year ended December 31, 1997. The
Form 10-K includes the consolidated financial statements of the Company
(Company's 10-K Financial Statements) and the consolidated financial statements
of NorAm (NorAm's 10-K Financial Statements) for the year ended December 31,
1997.
The Interim Financial Statements omit certain information included in
financial statements prepared in accordance with generally accepted accounting
principles and should be read in combination with the Form 10-K and the joint
Quarterly Report on Form 10-Q (First Quarter 10-Q) of the Company and NorAm for
the quarter ended March 31, 1998. For additional information regarding the
presentation of interim period results, see Note 12 to the Company's Interim
Financial Statements below.
The following notes to the financial statements in the Form 10-K relate
to material contingencies. These notes, as updated by the notes contained in the
Interim Financial Statements, are incorporated herein by reference:
Company's 10-K Financial Statements: Note 1(c) (Regulatory Assets and Other
Long-Lived Assets), Note 1(n) (Investments in Time Warner Securities), Note
2 (Derivative Financial Instruments (Risk Management)), Note 3 (Rate
Matters), Note 4 (Jointly Owned Electric Utility Plant), Note 5 (Equity
Investments in Foreign Affiliates) and Note 12 (Commitments and
Contingencies).
NorAm's 10-K Financial Statements: Note 1(c) (Regulatory Assets and
Regulation), Note 2 (Derivative Financial Instruments (Risk Management)),
and Note 8 (Commitments and Contingencies).
(2) PRO FORMA COMBINED RESULTS OF OPERATIONS DATA
The Company's results of operations incorporate NorAm's results of
operations for all periods beginning on and after the Acquisition Date. The
following table presents certain unaudited pro forma information for the quarter
and six months ended June 30, 1997, as if the acquisition of NorAm had occurred
on January 1, 1997.
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10
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Combined Results of Operations
(in millions, except per share data)
Three Months Ended
--------------------------------------------------------
June 30,
1998 1997 1997
Actual Actual Pro Forma
-------------- --------------- ---------------
Revenues............................................ $ 2,739 $ 1,064 $ 2,080
Net Income (1)...................................... $ 44 $ 121 $ 105
Basic and Diluted Earnings Per Share (1)............ $ 0.16 $ 0.52 $ 0.37
Six Months Ended
June 30,
--------------------------------------------------------
1998 1997 1997
Actual Actual Pro Forma
-------------- --------------- ---------------
Revenues............................................ $ 5,375 $ 1,943 $ 4,883
Net Income (1)...................................... $ 13 $ 181 $ 216
Basic and Diluted Earnings Per Share (1)............ $ 0.05 $ 0.77 $ 0.77
- ------------------
(1) Includes a $165 million or $.58 per share and a $288 million or $1.02 per
share (after-tax) non-cash unrealized accounting loss recorded in the
second quarter and first six months of 1998, respectively, relating to the
Company's Automatic Common Exchange Securities (ACES). For additional
information on the unrealized accounting loss, see Note 5 to the Company's
Interim Financial Statements.
These and other pro forma results appearing in the Form 10-Q are based
on assumptions deemed appropriate by the Company's management, have been
prepared for informational purposes only and are not necessarily indicative of
the combined results that would have resulted had the acquisition of NorAm
occurred at the beginning of 1997. Purchase related adjustments to results of
operations include amortization of goodwill and the effects on depreciation,
amortization, interest expense and deferred income taxes of the revaluation, on
a preliminary basis, of the fair value of certain NorAm assets and liabilities.
For information regarding the recording of the NorAm acquisition under the
purchase method of accounting, see Note 1(b) to the Company's 10-K Consolidated
Financial Statements.
(3) COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS No.
130). SFAS No. 130 requires that all items that meet the definition of a
component of comprehensive income (as defined below) be reported in the year-end
financial statements for the annual period in which they are recognized and the
total amount of comprehensive income be prominently displayed in those same
financial statements. Comprehensive income is defined to include not only net
income (loss), but also the change in total common stock equity during a period
from transactions and other events and circumstances from non-stockholder
sources.
7
11
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
In the second quarter of 1998, the Company had total comprehensive
income of $33 million compared to $121 million in the corresponding period in
1997. In the first six months of 1998, the Company had total comprehensive
earnings of $3 million compared to $181 million in the corresponding period in
1997.
In addition to net income, comprehensive income in all periods reflects
foreign currency translation adjustments and unrealized gains or losses on the
Company's investment in marketable equity securities.
(4) DEPRECIATION
The Company calculates depreciation using the straight-line method. The
Company's depreciation expense for the second quarter and first six months of
1998 was $125 million and $252 million, respectively, compared to $91 million
and $182 million for the same periods in 1997. For information regarding the
additional depreciation of generating assets under a transition to competition
plan implemented in January 1998, see Note 9(a) to the Company's Interim
Financial Statements.
(5) INVESTMENT IN TIME WARNER SECURITIES
The Company owns 11 million shares of non-publicly traded Time Warner
convertible preferred stock (TW Preferred). The TW Preferred is convertible into
approximately 22.9 million shares of Time Warner common stock. For additional
information regarding TW Preferred (including its dividend rate, liquidation
preference and voting rights), see Note 1(n) to the Company's 10-K Financial
Statements.
The Company has recorded its $990 million investment in the TW
Preferred under the cost method. Dividends on these securities are recognized as
income at the time they are earned. The Company recorded pre-tax dividend income
with respect to these securities of $10 million and $21 million, respectively,
in the second quarter and first six months of both 1998 and 1997.
To monetize its investment in the TW Preferred, the Company sold in
July 1997, 22.9 million of its unsecured 7% ACES. As a result of the issuance of
the ACES, a portion of the increase in the market value above $55.5844 per share
of Time Warner common stock (the security into which the TW Preferred is
convertible) results in unrealized accounting losses to the Company for the
ACES, pending the conversion of the Company's TW Preferred into Time Warner
common stock. For example, prior to the conversion of the TW Preferred into Time
Warner common stock, when the market price of Time Warner common stock increases
above $55.5844, the Company records in Other Income (Expense) an accounting loss
for the ACES equal to (i) the aggregate amount of such increase as applicable to
all ACES multiplied by (ii) 0.8264. In accordance with generally accepted
accounting principles, this accounting loss (which reflects the unrealized
increase in the Company's indebtedness with respect to the ACES) may not be
offset by accounting recognition of the increase in the market value of the Time
Warner common stock that underlies the TW Preferred. Upon conversion of the TW
Preferred, the Company will begin recording unrealized net changes in the market
prices of the Time Warner common stock and the ACES as a component of common
stock equity and other comprehensive income.
8
12
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
As of June 30, 1998, the market price of Time Warner common stock was
$85.438 per share. Accordingly, the Company recognized an increase of $254
million and $444 million during the second quarter and first six months of 1998,
respectively, in the unrealized liability relating to its ACES indebtedness
(which resulted in an after-tax earnings reduction for such periods of $165
million or $.58 per share and $288 million or $1.02 per share, respectively).
The Company believes that the cumulative unrealized loss for the ACES of $565
million is more than economically offset by the approximately $967 million
unrecorded unrealized gain at June 30, 1998 relating to the increase in the fair
value of the Time Warner common stock underlying the investment in TW Preferred
since the date of its acquisition. For the quarter ended June 30, 1998, there
was an increase in the unrecorded unrealized gain in the fair value of Time
Warner common stock underlying the investment in TW Preferred of $308 million.
Any gain related to the increase in the fair value of Time Warner common stock
would be recognized as a component of net income upon the sale of the TW
Preferred or the shares of common stock into which such TW Preferred is
converted.
(6) CAPITAL STOCK
(a) Common Stock.
At June 30, 1998, the Company had 284,299,099 shares of common stock
issued and outstanding (out of a total of 700,000,000 authorized shares). At
December 31, 1997, the Company had 282,875,266 shares of common stock issued and
outstanding. Outstanding common shares excluded (i) shares pledged to secure a
loan to the Company's Employee Stock Ownership Plan (11,786,672 and 12,388,551
at June 30, 1998 and December 31, 1997, respectively) and (ii) treasury shares
(102,291 and 93,459 at June 30, 1998 and December 31, 1997, respectively).
In 1996, the Board of Directors of Houston Industries Incorporated (the
former parent corporation of the Company) approved the repurchase of $450
million of its common stock. In December 1996, the Board of Directors of the
Company approved and ratified the adoption of the former parent corporation's
repurchase program. At June 30, 1998, the remaining amount authorized by the
Company for repurchases of its common stock under this program was approximately
$89 million. Future repurchases of the Company's common stock, which may not be
preceded by public announcement, may be made in open market or privately
negotiated transactions from time to time as determined by management. Such
repurchases are subject to market conditions, applicable legal requirements,
available cash and other factors.
(b) Earnings Per Share.
Effective December 31, 1997, the Company adopted SFAS No. 128,
"Earnings per Share" (SFAS No. 128). This statement requires restatement of all
prior period earnings per share (EPS) data presented herein. SFAS No. 128
requires dual presentation of basic and diluted EPS on the face of the
Statements of Consolidated Income and requires a reconciliation of the
numerators and denominators used in the basic and diluted earnings per share
calculations.
9
13
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
The following table presents a reconciliation of the Company's
numerators and denominators of basic and diluted earnings per share
calculations:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------------------------
1998(1) 1997 1998(2) 1997
------------ ----------- ----------- ------------
(In thousands, except per share amounts)
Basic EPS Calculation:
Income before preferred dividends........................ $ 44,305 $ 121,463 $ 13,065 $ 181,083
Less: Preferred dividends................................ 98 195
------------ ----------- ----------- ------------
Net income attributable to common stock.................. $ 44,207 $ 121,463 $ 12,870 $ 181,083
============ =========== =========== ============
Weighted average shares outstanding...................... 284,015 233,919 283,773 233,805
Basic EPS:
Income before preferred dividends........................ $ 0.16 $ 0.52 $ 0.05 $ 0.77
Less: Preferred dividends................................ 0.00 0.00 0.00 0.00
------------ ----------- ----------- ------------
Net income attributable to common stock.................. $ 0.16 $ 0.52 $ 0.05 $ 0.77
============ =========== =========== ============
Diluted EPS Calculation:
Income before preferred dividends........................ $ 44,305 $ 121,463 $ 13,065 $ 181,083
Plus: Income impact of assumed conversions:
Interest on 6 1/4% convertible debentures............. 14 29
------------ ----------- ----------- ------------
Income before preferred dividends assuming dilution...... 44,319 121,463 13,094 181,083
Less: Preferred dividends................................ 98 195
------------ ----------- ----------- ------------
Net income attributable to common stock.................. $ 44,221 $ 121,463 $ 12,899 $ 181,083
============ =========== =========== ============
Weighted average shares outstanding...................... 284,015 233,919 283,773 233,805
Plus: Incremental shares from assumed conversions:
Stock options......................................... 186 19 164 23
Restricted stock...................................... 492 369 492 369
6 1/4% convertible debentures......................... 44 44
------------ ----------- ----------- ------------
Weighted average shares assuming dilution................ 284,737 234,307 284,473 234,197
============ =========== =========== ============
Diluted EPS:
Income before preferred dividends........................ $ 0.16 $ 0.52 $ 0.05 $ 0.77
Less: Preferred dividends................................ 0.00 0.00 0.00 0.00
------------ ----------- ----------- ------------
Net income attributable to common stock.................. $ 0.16 $ 0.52 $ 0.05 $ 0.77
============ =========== =========== ============
- ------------------
(1) For the three months ended June 30, 1998, the computation of
diluted EPS excludes purchase options for 379 shares of common stock, because
the exercise prices for such shares (ranging from $30.18 to $35.18 per share)
were greater than the $29.28 per share average market price for the period and
would thus be anti-dilutive if exercised.
(2) For the six months ended June 30, 1998, the computation of diluted
EPS excludes purchase options for 60,837 shares of common stock, because the
exercise prices for such shares (ranging from $29.13 to $35.18 per share) were
greater than the $27.87 per share average market price for the period and would
thus be anti-dilutive if exercised.
10
14
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(c) Preferred Stock.
At June 30, 1998 and December 31, 1997, the Company had 10,000,000
authorized shares of preferred stock, of which 97,397 shares of $4.00 Preferred
Stock were outstanding. The $4.00 Preferred Stock pays an annual dividend of
$4.00 per share, is redeemable at $105 per share and has a liquidation price of
$100 per share.
(d) Preference Stock.
At June 30, 1998 and December 31, 1997, the Company had 10,000,000
authorized shares of preference stock. Of the authorized shares of preference
stock, the Company has designated 700,000 shares as Series A Preference Stock,
27,000 shares as Series B Preference Stock and 1,575 shares as Series C
Preference Stock.
As of June 30, 1998, the number of shares of Series B Preference Stock
and Series C Preference Stock issued and outstanding was 17,000 and 1,575,
respectively. The shares of Series B and Series C Preference stock are not
deemed outstanding for financial reporting purposes, because the sole holders of
such series are wholly owned financing subsidiaries of the Company (see Note
7(b) to the Company's 10-K Financial Statements with respect to Series B
Preference Stock and Note 6(d) to the Company's Interim Financial Statements in
the First Quarter 10-Q with respect to Series C Preference Stock). The shares of
Series A Preference Stock are issuable only pursuant to the Company's
Shareholder Rights Agreement and there were no shares of Series A Preference
Stock outstanding at June 30, 1998.
(7) COMPANY/NORAM OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED
SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY SUBORDINATED DEBENTURES
OF THE COMPANY AND NORAM
For information regarding (i) $250 million of preferred securities and
$100 million of capital securities issued by two statutory business trusts
formed by the Company and (ii) $177.8 million of convertible preferred
securities (of which $1.4 million was outstanding at June 30, 1998) issued by
a statutory business trust formed by NorAm, see Note 9 to the Company's
10-K Financial Statements. The sole asset of each trust consists of junior
subordinated debentures of the Company or NorAm having interest rates and
maturity dates corresponding to each issue of preferred or capital securities,
and the principal amounts corresponding to the common and preferred or capital
securities issued by such trust.
(8) LONG-TERM DEBT AND SHORT-TERM FINANCING
(a) Consolidated Debt.
The Company's consolidated long-term and short-term debt outstanding is
summarized in the following table. Of the amount of long-term and short-term
debt outstanding as of June 30, 1998, $1.7 billion represents debt of NorAm. The
Company adjusted the recorded value of NorAm debt to fair market value as of the
Acquisition Date.
11
15
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Consolidated Long-Term Debt and Short-Term Borrowings
(in millions)
June 30, 1998 December 31, 1997
----------------------------------- ----------------------------------
Long-Term Current (1) Long-Term Current (1)
--------------- --------------- -------------- --------------
Short-Term Borrowings:
Commercial Paper........................... $ 1,344 $ 1,435
Lines of Credit............................ 150 390
NorAm Receivables Facility................. 300 300
Notes Payable.............................. 3
--------------- --------------- -------------- --------------
Total Short-Term Borrowings.................. 1,797 2,125
--------------- --------------- -------------- --------------
Long-Term Debt - net:
ACES....................................... $ 1,618 $ 1,174
Debentures(2)(3)........................... 973 669
First Mortgage Bonds(2).................... 1,933 170 2,495
Pollution Control Bonds.................... 513 118 5
NorAm Medium-Term Notes(3)................. 180 48 182 79
Notes Payable(3)........................... 554 164 565 166
Capital Leases............................. 14 1 15 1
--------------- --------------- -------------- --------------
Total Long-Term Debt......................... 5,785 383 5,218 251
--------------- --------------- -------------- --------------
Total Long-Term and Short-Term Debt........ $ 5,785 $ 2,180 $ 5,218 $ 2,376
=============== =============== ============== ==============
- --------------
(1) Current includes amounts due within one year of the date noted.
(2) Includes unamortized discount related to debentures of approximately $1
million at June 30, 1998 and December 31, 1997 and unamortized discount related
to first mortgage bonds of approximately $11 million and $14 million at June 30,
1998 and December 31, 1997, respectively.
(3) Includes unamortized premium related to fair value adjustments of
approximately $19 million and $16 million for debentures at June 30, 1998 and
December 31, 1997, respectively. The unamortized premium for NorAm long-term and
current medium-term notes at June 30, 1998 was approximately $14 million and $1
million, respectively, and $17 million and $3 million at December 31, 1997,
respectively. The unamortized premium for long-term and current notes payable
was approximately $9 million and $2 million, respectively, at June 30, 1998 and
$14 million and $3 million at December 31, 1997.
Consolidated maturities of long-term debt and sinking fund requirements
for the Company (including NorAm) are $205 million for the remainder of 1998.
(b) Second Quarter Financing Developments
Company: At June 30, 1998, a financing subsidiary of the Company had
$1.344 billion in commercial paper borrowings supported by a $1.644 billion
revolving credit facility. At such date, such commercial paper borrowings had a
weighted average interest rate of 5.89%. At June 30,1998, another financing
subsidiary of the Company had $150 million in borrowings under another credit
facility. The
12
16
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
weighted average interest rate of borrowings under this facility was 5.91%. At
June 30, 1998, the Company had no commercial paper outstanding and there were
no outstanding borrowings under its $200 million bank facility. For information
regarding these facilities, see Notes 8(c) and (d) to the Company's 10-K
Financial Statements and Note 8(b) to the Company's Interim Financial Statements
in the First Quarter 10-Q.
In June 1998, the Company repaid at maturity $5 million of its
floating-rate pollution control revenue bonds. In May 1998, all outstanding
8.25% Brazos River Authority (BRA) Series 1988A pollution control revenue bonds
($100 million), 8.25% BRA Series 1988B pollution control revenue bonds ($90
million), and 8.10% BRA Series 1988C pollution control revenue ($100 million)
were redeemed at a redemption price of 102% of the aggregate principal amount of
each series. The proceeds for the redemption of these bonds were derived from
the issuance of $290 million aggregate principal amount of pollution control
revenue refunding bonds in February 1998 on behalf of the Company by the BRA.
For additional information regarding these issuances, see Note 8(c) the
Company's Interim Financial Statements in the First Quarter 10-Q.
NorAm: In May 1998, NorAm repaid at maturity $28 million of medium-term
notes carrying an average interest rate of 8.74%.
For information regarding NorAm's $350 million revolving credit
facility (NorAm Credit Facility), see Note 8(d) to the Company's Interim
Financial Statements in the First Quarter 10-Q. At June 30, 1998, there were no
commercial paper borrowings and no loans outstanding under the facility. For
information regarding NorAm's $300 million receivables facility, see Note 8(g)
to the Company's 10-K Financial Statements. At June 30, 1998, NorAm had sold
$300 million of receivables under the facility. For information regarding (i)
NorAm's issuance of $300 million principal amount of 6.5% debentures due
February 1, 2008, (ii) NorAm's repayment in the first quarter of 1998 of $1
million of its 9.30% medium-term notes and (iii) NorAm's satisfaction of the
$6.5 million sinking fund requirement for its 6% convertible subordinated
debentures due 2012 using debentures purchased in 1996 and 1997, see Note 8(d)
to the Company's Interim Financial Statements in the First Quarter 10-Q.
(9) REGULATORY MATTERS
(a) Transition Plan
In June 1998, the Public Utility Commission of Texas (Texas Utility
Commission) issued an order approving the transition to competition plan
(Transition Plan) filed by the Company's electric operations division (Electric
Operations) in December 1997. The order also approved the implementation of base
rate credits to residential customers of 4% in 1998 and an additional 2% in
1999. Commercial customers whose monthly billing is 1000 kva or less receive
base rate credits of 2% in each of 1998 and 1999. The Company implemented the
Transition Plan effective January 1, 1998.
In order to reduce the Company's exposure to potential stranded costs
related to generating assets, the Transition Plan permits the Company to
redirect depreciation expenses that otherwise would have been applied to
transmission, distribution and general plant assets to generation assets. In
addition, the Transition Plan provides that all earnings by Electric Operations
above a 9.844% overall annual rate of return on invested capital formula will be
used to write-down Electric Operation's investment in generation assets. The
$67.5 million in additional depreciation recorded in the second quarter of 1998
is an estimate of the amount of additional depreciation
13
17
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
necessary under the earnings cap, given the uncertainty of weather and the level
of revenues and expenses during the remainder of the year and the level of year
end invested capital.
For additional information regarding the Transition Plan, see Note 3(b)
to the Company's 10-K Financial Statements.
(b) Nuclear Insurance
In July 1998, the Nuclear Regulatory Commission increased, effective
August 1998, the maximum secondary retrospective deferred premium, currently
established at $75.5 million per reactor per incident (but not to exceed $10
million in any one year), to $88.09 million per reactor per incident (but not to
exceed $10 million in any one year), for liability insurance coverage in the
event of nuclear incidents at licensed, operating commercial nuclear power
plants. The change was based on inflation adjustment required by the
Price-Anderson Amendments Act of 1988. For additional information on nuclear
insurance and other nuclear regulatory matters, see Note 4(c) to the Company's
10-K Financial Statements.
(10) ACQUISITIONS AND DISPOSITIONS
(a) International
On June 30, 1998, Houston Industries Energy, Inc. (HI Energy) sold its
63% ownership interest in Empresa Distribuidora La Plata S.A. (EDELAP) and
certain related assets for approximately $243 million. EDELAP, an electric
utility serving the city of La Plata, Argentina, was initially acquired by HI
Energy in 1992. The Company has recorded the proceeds from the sale of EDELAP as
an $80 million after tax gain in the second quarter of 1998.
In June 1998, a subsidiary of HI Energy acquired for $150 million,
equity interests (ranging from approximately 24% to 45%) in three distribution
systems located in northern and eastern El Salvador, including the city of El
Salvador. The transaction closed on June 30, 1998. HI Energy has accounted for
this transaction under purchase accounting and recorded its investment and its
interest in the affiliate's earnings after the acquisition date using the equity
method.
(b) Domestic Power Generation
14
18
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
In April 1998, Houston Industries Power Generation, Inc. (HIPG, Inc.)
acquired four natural gas-fired, electric generating plants (2,276 MW) from
Southern California Edison Company (SCE) for approximately $230 million. The
acquisition was recorded under the purchase method of accounting with assets and
liabilities reflected at their estimated fair values as of the Acquisition Date.
Goodwill was recorded on this acquisition by HIPG, Inc. in the amount of
approximately $47 million.
(11) SUBSEQUENT EVENTS
In August 1998, a holding company, jointly owned by HI Energy and
Electricidad de Caracas, was awarded through a competitive bid the right to
purchase from the government of Colombia, 65% of the outstanding shares in each
of two electrical distribution companies, collectively CORELCA. The purchase
price for CORELCA was approximately $550 million, plus acquisition costs. HI
Energy's share of the purchase price is $275 million. HI Energy will account
for this transaction under purchase accounting. HI Energy will fund its share of
the purchase price with proceeds from the sale of EDELAP and additional bank
borrowings. CORELCA serves approximately 1.2 million customers in the Atlantic
costal region of Colombia, including the cities of Santa Marta, Barranquilla and
Cartagena.
In July 1998, HIPG, Inc. purchased from Southern California Edison
Company a 1500 mw generating plant for $43 million.
(12) INTERIM PERIOD RESULTS: RECLASSIFICATIONS
The Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position and results of operations for the respective periods.
Amounts reported in the Consolidated Statements of Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (i) the acquisition of NorAm, (ii) seasonal temperature
variations affecting energy consumption, (iii) the timing of maintenance and
other expenditures and (iv) acquisitions and dispositions of assets and other
interests. In addition, certain amounts from the prior year have been
reclassified to conform to the Company's presentation of financial statements in
the current year. Such reclassifications do not affect earnings.
15
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF THE COMPANY.
The following discussion and analysis should be read in combination
with Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company in Item 7 of the Form 10-K, Management's Narrative
Analysis of the Results of Operations of NorAm and Consolidated Subsidiaries in
Item 7 of the Form 10-K, the Company's consolidated financial statements and
notes contained in Item 8 of the Form 10-K and Item 1 of this Form 10-Q. The
Company from time to time makes use in its presentations and other
communications of projections, forecasts and other non-historical information.
For a discussion of the qualifications and assumptions underlying the use of
such forward looking information, see Item 5 of this Form 10-Q.
HOUSTON INDUSTRIES INCORPORATED
Houston Industries Incorporated (Company), together with various
divisions and subsidiaries, including NorAm Energy Corp. (NorAm), is a
diversified international energy services company.
The Company's electric operations segment (Electric Operations)
operates the nation's tenth largest electric utility in terms of kilowatt-hour
(KWH) sales, and its natural gas distribution segment (Natural Gas Distribution)
operates the nation's third largest natural gas distribution operation in terms
of customers served. The Company, through its interstate pipeline segment
(Interstate Pipeline), operates two interstate natural gas pipelines. The
Company provides natural gas transportation, supply, gathering and storage, and
wholesale natural gas and electric power marketing services through its energy
marketing segment (Energy Marketing) and invests, through its international
(International) and corporate (Corporate) segments, in foreign electric and gas
utility operations and domestic non-rate regulated power generation projects.
CONSOLIDATED RESULTS OF OPERATIONS
The Company's actual and pro forma results of operations for the second
quarter and first six months of 1998 are summarized in the following table. The
Company's actual results of operations include results of operations for NorAm
for periods on and after August 6, 1997 (Acquisition Date). The Company's pro
forma results of operations give effect to the acquisition of NorAm as if it had
occurred as of January 1, 1997. The pro forma information is not necessarily
indicative of the results of operations of the Company and its business segments
that would have occurred had the acquisition of NorAm occurred at the beginning
of such period. In general, the effects of the acquisition of NorAm include
(i) significant increases in amortization attributable to purchase accounting,
(ii) increases in shares outstanding and interest expense and (iii) inclusion of
additional revenues and operating expenses from the newly acquired NorAm
business.
16
20
Three Months Ended Three Months Ended
June 30, June 30,
---------------------------- -------------------------------- Percent
1998 1997 1998 1997 Change
------------ ----------- ------------ ------------ ---------------
(Actual) (Actual) (Actual) (Pro Forma) (1998 Actual
to 1997 Pro
Forma)
(in millions, except per share data)
Revenues.............................. $ 2,739 $ 1,064 $ 2,739 $ 2,080 32%
Operating Expenses.................... 2,279 817 2,279 1,806 26%
Operating Income...................... 460 247 460 275 67%
Other Expenses, Net (1)............... 371 75 371 124 199%
Income Taxes.......................... 45 51 45 46 (2%)
Net Income (1)........................ 44 121 44 105 (58%)
Basic and Diluted Earnings Per
Share (1)........................... 0.16 0.52 0.16 0.37 (57%)
Six Months Ended Six Months Ended
June 30, June 30,
---------------------------- ------------------------------- Percent
1998 1997 1998 1997 Change
------------ ----------- ------------ ------------ ---------------
(Actual) (Actual) (Actual) (Pro Forma) (1998 Actual
to 1997 Pro
Forma)
(in millions, except per share data)
Revenues.............................. $ 5,375 $ 1,943 $ 5,375 $ 4,883 10%
Operating Expenses.................... 4,634 1,539 4,634 4,315 7%
Operating Income...................... 741 403 741 567 31%
Other Expenses, Net (2)............... 680 151 680 245 178%
Income Taxes.......................... 48 71 48 106 (55%)
Net Income (2)........................ 13 181 13 216 (94%)
Basic and Diluted Earnings Per
Share (2)........................... 0.05 0.77 0.05 0.77 (94%)
- ----------------
(1) Includes a $254 million ($165 million after-tax) or $.58 per share
non-cash unrealized accounting loss recorded in the second quarter of 1998
relating to the Company's 7% Automatic Common Exchange Securities (ACES). See
Note 5 to the Company's Interim Financial Statements.
(2) Includes a $444 million ($288 million after-tax) or $1.02 per share
non-cash unrealized accounting loss recorded in the first six months of 1998
relating to the ACES.
Second Quarter of 1998 Compared to Second Quarter of 1997 (Actual). The
Company had consolidated net income of $44 million for the second quarter of
1998 ($0.16 per share) compared to consolidated net income of $121 million
($0.52 per share) in the same period in 1997. The Company's results of
operations for the second quarter of 1998 reflect a $165 million (after-tax)
non-cash, unrealized accounting loss on the ACES. For a discussion of the
accounting loss in connection with the ACES, see Note 5 to the Company's Interim
Financial Statements.
Excluding the ACES accounting loss, the Company would have had
consolidated earnings of $210
17
21
million ($0.74 per share) for the second quarter of 1998. The increase in
earnings is primarily attributable to an $80 million ($0.28 per share) after-tax
gain recorded in connection with the sale of an investment in an Argentine
electric utility system. For further discussion of the sale, see Note 10(a) to
the Company's Interim Financial Statements. Another factor contributing to the
increase in net income was an increase in sales by Electric Operations due to
record hot weather. These effects were partially offset by additional
depreciation of Electric Operations' generation assets of $67.5 million ($55
million over the prior year), base rate credits resulting from the Transition
Plan (as described below) and increased interest expense primarily related to
the NorAm acquisition.
The consolidated tax expense in the second quarter of 1998 takes into
account the impact of non-deductible goodwill expense, higher state tax expense
arising from the NorAm acquisition, and the loss of the dividends received tax
deduction formerly applicable to the Company's investment in Time Warner, Inc.
preferred securities (TW Preferred).
Second Quarter of 1998 Actual Compared to Second Quarter of 1997 Pro
Forma. The Company's consolidated net income for the second quarter of 1998 was
$44 million ($0.16 per share) compared to pro forma net income of $105 million
($0.37 per share) in the second quarter of 1997.
Excluding the ACES accounting loss described above, the Company's
second quarter of 1998 adjusted net income would have been $210 million ($0.74
per share) compared to $105 million ($0.37 per share). The increase in earnings
is primarily a result of the gain recorded in connection with the sale of an
interest in an Argentine electric utility system. Another factor contributing to
the increase in net income was an increase in sales by Electric Operations due
to record hot weather. These effects were partially offset by $67.5 million in
additional depreciation ($55 million over the prior year) of Electric
Operation's generation assets and the implementation of base rate credits under
the Transition Plan (as described below), decreased operating income at Natural
Gas Distribution due to warmer weather, and decreased operating income at Energy
Marketing primarily due to increased operating expenses.
First Six Months of 1998 Compared to First Six Months of 1997 (Actual).
The Company had consolidated net income of $13 million for the first six months
of 1998 ($0.05 per share) compared to net income of $181 million ($0.77 per
share) for the same period in 1997. The Company's results of operations for the
first six months of 1998 reflect a $288 million (after-tax) non-cash, unrealized
accounting loss on the ACES as described above. Excluding the ACES accounting
loss, the Company would have had consolidated earnings of $301 million ($1.06
per share). The increase in earnings is primarily a result of the factors
affecting the second quarter results (as discussed above) plus the additional
earnings from the business segments acquired in the NorAm acquisition.
The consolidated tax expense in the first six months of 1998 takes into
account the impact of non-deductible goodwill expense, higher state tax expense
arising from the NorAm acquisition and the loss of the dividends received
tax deductions formerly applicable to the Company's investment in TW Preferred.
First Six Months of 1998 Actual Compared to First Six Months of 1997
Pro Forma. The Company's consolidated net income for the first six months of
1998 was $13 million ($0.05 per share) compared to pro forma net income of $216
million ($0.77 per share) in the first six months of 1997.
Excluding the ACES accounting loss described above, the Company's
adjusted net income for the first six months of 1998 would have been $301
million ($1.06 per share) compared to pro forma net income of $216 million
($0.77
18
22
per share) for the first six months of 1997. The increase in adjusted earnings
is due to (i) the gain on the sale of an investment in an Argentine electric
distribution system and increased equity earnings at International; (ii)
increased sales at Electric Operations due to record hot weather during the
second quarter of 1998 partially offset by additional depreciation and the
implementation of base rate credits. Partially offsetting the increase in
earnings is decreased operating income at Natural Gas Distribution due to warmer
weather.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income on (i) an actual basis
for the quarters and six months ended June 30, 1998 and 1997 and (ii) a pro
forma basis for the quarter and first six months ended June 30, 1997 (assuming
the NorAm acquisition had occurred on January 1, 1997) for each of the Company's
business segments (other than Electric Operations, which is an actual basis for
all periods):
OPERATING INCOME (LOSS) BY BUSINESS SEGMENT
Three Months Ended June 30,
------------------------------------------------------
1998 1997 1997
---------------- -------------- ----------------
(Actual) (Actual) (Pro Forma)(1)
(in millions)
Electric Operations................................ $ 294 $ 267 $ 267
Natural Gas Distribution........................... (6) 0
Interstate Pipeline................................ 33 27
Energy Marketing................................... (6) 5
International...................................... 151 5 4
Corporate.......................................... (6) (25) (28)
---------------- -------------- ----------------
Total Consolidated........................... $ 460 $ 247 $ 275
================ ============== ================
Six Months Ended June 30,
-----------------------------------------------------
1998 1997 1997
---------------- -------------- ---------------
(Actual) (Actual) (Pro Forma) (1)
(in millions)
Electric Operations................................ $ 436 $ 427 $ 427
Natural Gas Distribution........................... 96 107
Interstate Pipeline................................ 65 62
Energy Marketing................................... 3 4
International...................................... 162 8 6
Corporate.......................................... (21) (32) (39)
---------------- -------------- ---------------
Total Consolidated........................... $ 741 $ 403 $ 567
================ ============== ===============
- ---------------
(1) Pro forma adjustments give retroactive effect to purchase-related
adjustments, including amortization of goodwill and the revaluation on a
preliminary basis of the fair market value of certain NorAm assets and
liabilities.
ELECTRIC OPERATIONS
Electric Operations are conducted under the name "Houston Lighting &
Power Company" or "HL&P" (HL&P), an unincorporated division of the Company.
Electric Operations provides electric generation, transmission, distribution and
sales to approximately 1.6 million customers in a 5,000 square mile area on the
Texas Gulf Coast, including Houston (the nation's fourth largest city).
19
23
The following table provides summary data regarding the actual results
of operations of Electric Operations, including operating statistics, for the
quarters and first six months ended June 30, 1998 and 1997.
Three Months Ended June 30, Percent
1998 1997 Change
--------------- -------------- -------------
(Actual) (Actual)
(in millions)
Base Revenues (1)........................................... $ 781 $ 695 12%
Transmission Revenues....................................... 21 40 (48%)
Reconcilable Fuel Revenues (2).............................. 379 308 23%
Operating Expenses:
Fuel................................................... 302 248 22%
Purchased Power........................................ 93 78 19%
Operation and Maintenance.............................. 243 261 (7%)
Depreciation and Amortization.......................... 185 131 41%
Other Taxes................................................. 64 58 10%
--------------- --------------
Operating Income............................................ $ 294 $ 267 10%
=============== ==============
Electric Sales (MWH):
Residential............................................ 4,475,019 3,691,822 21%
Commercial............................................. 3,897,340 3,605,471 8%
Industrial - Firm ..................................... 6,773,768 6,248,653 8%
Municipal & Public Utilities........................... 76,521 81,849 (7%)
Total Firm Sales...................................... 15,222,648 13,627,795 12%
Average Cost of Fuel (Cents/MMBtu):......................... 183.7 172.6 6%
Six Months Ended June 30, Percent
1998 1997 Change
--------------- -------------- -------------
(Actual) (Actual)
(in millions)
Base Revenues (1)........................................... $ 1,314 $ 1,247 5%
Transmission Revenues....................................... 43 40 8%
Reconcilable Fuel Revenues (2).............................. 671 613 9%
Operating Expenses:
Fuel................................................... 495 466 6%
Purchased Power........................................ 205 180 14%
Operation and Maintenance.............................. 458 445 3%
Depreciation and Amortization.......................... 315 261 21%
Other Taxes................................................. 119 121 (2%)
--------------- --------------
Operating Income............................................ $ 436 $ 427 2%
=============== ==============
20
24
Electric Sales (MWH):
Residential............................................ 8,072,040 7,647,080 6%
Commercial............................................. 7,321,690 7,004,267 5%
Industrial - Firm .................................... 13,141,747 12,705,324 3%
Municipal & Public Utilities.......................... 157,909 158,454 --
Total Firm Sales...................................... 28,693,386 27,515,125 4%
Average Cost of Fuel (Cents/MMBtu):......................... 179.2 179.3 --
- --------------------
(1) Includes miscellaneous revenues, certain non-reconcilable fuel revenues
and certain purchased power-related revenues.
(2) Includes revenues collected through a fixed fuel factor and surcharge,
net of over/under recovery. See "--Operating Revenues - Electric
Operations."
Operating Income - Electric Operations. In the three and six months
ended June 30, 1998, operating income increased by $27 million and $9 million,
respectively, over operating income for the same periods in 1997. The increase
in operating income was due to increases in base revenues attributed to record
hot weather in the second quarter of 1998. The impact of increased base revenues
on operating income was partially offset by (i) the implementation of base rate
credits under the Transition Plan and (ii) $55 million of additional
depreciation, as described below.
Operating Revenues - Electric Operations. Electric Operations' increase
in base revenue of $86 million and $67 million for the three and six months
ended June 30, 1998, respectively, compared to the same periods of 1997 is
primarily the result of weather. Partially offsetting these revenue increases
were base rate credits implemented under the Transition Plan beginning in
January 1998, which resulted in lower base revenues of $16 million for the three
months and $28 million for the six months ended June 30, 1998. For information
regarding the Transition Plan, see Note 9 to the first quarter Form 10-Q.
Electric Operations' transmission revenues in the three and six months
ended June 30, 1998 were $21 million and $43 million, respectively, but were
offset by transmission expenses of $22 million and $44 million. In the three and
six months ended June 30, 1997, transmission revenues were $40 million offset by
transmission expenses of $44 million. Electric Operations began recording
transmission revenues and expenses in the second quarter of 1997 as a result of
the implementation of wholesale transmission tariffs within Electric Reliability
Council of Texas (ERCOT). For information regarding these transmission revenues,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company-Certain Factors Affecting Future Earnings of the
Company and its Subsidiaries--Competition--Electric Operations--Competition in
Wholesale Market" in the Form 10-K.
Firm KWH sales for the three and six months ended June 30, 1998
increased 12% and 4%, respectively, compared to the same periods in 1997 due to
weather related factors.
Electric Operations reconcilable fuel revenues for the three months
ended June 30, 1998 increased 23% over the same period in 1997 primarily as a
result of higher sales due to the hot weather in its service territory. The
increase in reconcilable fuel revenues also reflects an increase in under
recovery of fuel revenue
21
25
in Electric Operations' current rates. The increase in under recovery of fuel
revenue resulted from an increase in natural gas and lignite prices. Electric
Operation's reconcilable fuel revenue for the six months ended June 30, 1998
increased 9% over the same period in 1997 as a result of increased sales.
The Texas Utility Commission provides for recovery of certain fuel and
purchased power costs through a fixed fuel factor included in electric rates.
The fixed fuel factor is established during either a utility's general rate
proceeding or its fuel factor proceeding and is generally effective for a
minimum of six months. Revenues collected through such factor are adjusted
monthly to equal expenses; therefore, such revenues and expenses have no effect
on earnings unless fuel costs are determined not to be recoverable. The adjusted
over/under recovery of fuel costs is recorded on the Company's Consolidated
Balance Sheets as fuel- related credits or fuel-related debits, respectively.
Fuel costs are reviewed during periodic fuel reconciliation proceedings, which
are required at least every three years. Electric Operations filed a fuel
reconciliation proceeding with the Texas Utility Commission on January 30, 1998
for the three year period ending July 31, 1997. A final order in this proceeding
is anticipated on or about February 1999. For additional information regarding
the recovery of fuel costs, see "Business - Electric Operations - Fuel -
Recovery of Fuel Costs" in Item 1 of the Company's Form 10-K.
In January 1998, Electric Operations implemented a $102 million
fuel surcharge (inclusive of interest) for under recoveries that occurred from
March 1997 through August 1997, with recovery extending from 8 months to 16
months depending on the customer class. In April 1998, Electric Operations filed
a petition to revise the fuel factor and implement a surcharge for
under-collected fuel costs. The Texas Utility Commission approved implementation
of a new fixed fuel factor and a fuel surcharge in the amount of $125 million
(inclusive of the previously existing fuel surcharge balance) to be recovered
over a period of 12 to 18 months. This surcharge will replace the one
implemented in January 1998, and includes recovery of the additional
under-recoveries from September 1997 through February 1998. Implementation for
customer billings is effective July 1, 1998. As of June 30, 1998, Electric
Operations cumulative under-recovery of fuel costs was $218 million, including
interest.
Fuel and Purchased Power Expense - Electric Operations. Fuel expense
for the three and six months ended June 30, 1998 increased by $54 million or 22%
and $29 million or 6%, respectively, compared to the same periods in 1997.
Purchased power expense for the three and six months ended June 30, 1998
increased by $15 million and $25 million, respectively, compared to the same
periods in 1997. The increase in fuel expense for the three month period
reflects increased demand due to unusually hot weather, an increase in the cost
of purchased power plus increases in the average unit cost of natural gas and
lignite. The average unit cost of natural gas was $2.31 per MMBtu for the second
quarter of 1998 compared to $2.22 per MMBtu in the second quarter of 1997. The
average unit cost of lignite was $1.36 per MMBtu for the second quarter of 1998
compared to $1.12 per MMBtu for the second quarter of 1997. The increases for
the six months ended June 30, 1998 were due primarily to increased sales from
weather related factors. See Note 12(c) to the Company's 10-K Financial
Statements for information on Electric Operations' joint dispatching agreement
with the City of San Antonio for purchased power.
Operation and Maintenance Expenses and Other - Electric Operations.
Operation and maintenance expense decreased $18 million for the three months
ended June 30, 1998 and increased $13 million for the six months ended in 1998
compared to the same periods in 1997.
Operation expense decreased $27 million or 15% for the three months
ended June 30, 1998 due to a $20 million timing difference in transmission cost
of service expense plus a $7 million reduction in administrative and general
expenses. The reduction in administrative and general expenses is a result of
lower employee benefit expense offset by increased franchise fee expenses due to
higher revenue. For the six months ended June 30, 1998, operation
22
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expense decreased $2 million or 1%, comparatively. A reduction in post
retirement benefits was offset by increased franchise fees due to higher
revenue.
Maintenance expense increased $6 million or 10% and $8 million or 7%
for the three months and six months ended June 30, 1998, respectively, over the
same periods in 1997. The increase in maintenance expense between the periods is
due to differences in the scheduling of routine plant maintenance and inspection
outages.
For the three months and six months ended June 30, 1998, additional
depreciation of $67.5 million and $80 million, respectively, was recorded as
provided in the Transition Plan. The Transition Plan requires that calendar year
earnings be capped at a 9.844% overall rate of return on a defined invested
capital. Earnings in excess of this cap must be used to write-down the
investment in generation assets. This additional depreciation is being recorded
throughout the year in order to provide a more constant overall rate of return
and to avoid the potential for a year end cumulative charge to earnings for such
additional depreciation. For information regarding the Transition Plan, see
Note 9(a) to the Company's Interim Financial Statements.
NATURAL GAS DISTRIBUTION
Domestic natural gas distribution operations (Natural Gas Distribution)
are conducted through the Arkla, Entex and Minnegasco divisions of NorAm. These
operations consist of natural gas sales to, and natural gas transportation for,
residential, commercial and certain industrial customers in six states:
Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma and Texas.
The following table provides summary data regarding the results of
operations of Natural Gas Distribution, including operating statistics, on an
actual basis for the second quarter and first six months of 1998 and on a pro
forma basis for the second quarter and first six months of 1997 (as if the
acquisition of NorAm had occurred as of January 1, 1997).
Three Months Ended June 30, Percent
1998 1997 Change
--------------- ------------- -----------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 315 $ 337 (7%)
Operating Expenses:
Natural Gas............................................ 174 186 (6%)
Operation and Maintenance.............................. 93 96 (3%)
Depreciation and Amortization.......................... 32 31 3%
Other Operating Expenses............................... 22 24 (8%)
--------------- -------------
Total Operating Expenses........................... 321 337 (5%)
--------------- -------------
Operating Income............................................ $ (6) $ 0 --
=============== =============
Throughput Data (in Bcf):
Residential and Commercial Sales....................... 43 51 (16%)
Industrial Sales....................................... 13 13 --
Transportation......................................... 10 10 --
--------------- -------------
Total Throughput.................................... 66 74 (11%)
=============== =============
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27
Six Months Ended June 30, Percent
1998 1997 Change
--------------- ------------- -----------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 1,032 $ 1,218 (15%)
Operating Expenses:
Natural Gas............................................ 632 803 (21%)
Operation and Maintenance.............................. 191 193 (1%)
Depreciation and Amortization.......................... 63 61 3%
Other Operating Expenses............................... 50 54 (7%)
--------------- -------------
Total Operating Expenses........................... 936 1,111 (16%)
--------------- -------------
Operating Income............................................ $ 96 $ 107 (10%)
=============== =============
Throughput Data (in Bcf):
Residential and Commercial Sales....................... 169 188 (10%)
Industrial Sales....................................... 29 29 --
Transportation......................................... 22 22 --
--------------- -------------
Total Throughput.................................... 220 239 (8%)
=============== =============
Natural Gas Distribution operating income decreased $6 million and $11
million in the second quarter and first six months of 1998, respectively,
compared to pro forma operating income in the same periods in 1997 due primarily
to the lower demand for natural gas heating in the second quarter of 1998 and
milder winter weather in the first three months of 1998. This decrease in
operating income was partially offset by reduced charges at Arkla associated
with the methodology of calculating the price of gas charged to customers (the
purchased gas adjustment) in the second quarter and first six months of 1998 as
compared to the same periods in 1997.
Natural Gas Distribution operating revenue decreased $22 million and
$186 million for the second quarter and first six months of 1998, respectively,
compared to pro forma operating revenue for the corresponding periods of 1997
due principally to the weather-related factors discussed above, which resulted
in lower customer usage at Entex and Minnegasco. A decrease in gas prices for
the six months ended June 30, 1998 compared to the same period in the prior year
also contributed to the decline in operating revenues for that period.
Operating expenses decreased $16 million and $175 million in the second
quarter and first six months of 1998, respectively, compared to pro forma
operating expenses in the same periods of 1997 due to the same factors that
affected operating revenues.
Interstate Pipeline
Interstate natural gas pipeline operations (Interstate Pipeline) are
conducted primarily through NorAm Gas Transmission Company (NGT) and Mississippi
River Transmission Corporation (MRT), two wholly owned subsidiaries of NorAm.
The NGT system consists of approximately 6,200 miles of natural gas transmission
lines located in portions of Arkansas, Kansas, Louisiana, Mississippi, Missouri,
Oklahoma, Tennessee and Texas. The MRT system consists of approximately 2,000
miles of pipeline serving principally the greater St. Louis area in Missouri and
Illinois.
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28
The following table provides summary data regarding the results of
operations of Interstate Pipeline, including operating statistics, on an actual
basis for the three and six months ended June 30, 1998 and on a pro forma basis
for the three and six months ended June 30, 1997 (as if the acquisition of NorAm
had occurred as of January 1, 1997).
Three Months Ended June 30, Percent
1998 1997 Change
------------- ------------- --------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 77 $ 74 4%
Operating Expenses:
Natural Gas............................................ 8 8 --
Operation and Maintenance.............................. 22 23 (4%)
Depreciation and Amortization.......................... 10 12 (17%)
Other Operating Expenses............................... 4 4 --
------------- -------------
Total Operating Expenses.......................... 44 47 (6%)
------------- -------------
Operating Income............................................ $ 33 $ 27 22%
============= =============
Throughput Data (in million MMBtu):
Natural Gas Sales........................................ 4 5 (20%)
Transportation........................................... 187 212 (12%)
Elimination (1)..................................... (4) (4) --
------------- -------------
Total Throughput............................................ 187 213 (12%)
============= =============
Six Months Ended June 30, Percent
1998 1997 Change
------------- ------------- ---------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 148 $ 158 (6%)
Operating Expenses:
Natural Gas............................................ 16 19 (16%)
Operation and Maintenance.............................. 40 45 (11%)
Depreciation and Amortization.......................... 19 25 (24%)
Other Operating Expenses............................... 8 7 14%
------------- -------------
Total Operating Expenses.......................... 83 96 (14%)
------------- -------------
Operating Income............................................ $ 65 $ 62 5%
============= =============
Throughput Data (in million MMBtu):
Natural Gas Sales........................................ 8 9 (11%)
Transportation........................................... 424 462 (8%)
Elimination (1)..................................... (7) (9) 22%
------------- -------------
Total Throughput............................................ 425 462 (8%)
============= =============
- -------------
(1) Elimination refers to volumes of natural gas both transported and sold
by Interstate Pipeline and, therefore, excluded from total throughput.
Interstate Pipeline operating income increased $6 million and $3
million in the second quarter and first
25
29
six months of 1998, respectively, compared to pro forma operating income for the
same periods in 1997. The increase for the three months ended June 1998 is due
primarily to $6 million recorded in connection with the settlement of certain
litigation and lower operating expenses in the second quarter of 1998. The
increase for the first six months is attributable to $5 million recorded in the
first quarter of 1998 in connection with the settlement of an MRT rate case, as
well as the items mentioned above, offset by $7 million of non-recurring
transportation revenues in the first quarter of 1997, discussed below.
Operating revenues for Interstate Pipeline increased by $3 million for
the second quarter of 1998 compared to pro forma operating revenues for the same
period in 1997. The increase in revenues is primarily due to the settlement of
outstanding litigation related to certain gas purchase contracts which resulted
in the recognition of approximately $6 million of revenues in April 1998, offset
by a decrease in sales volumes.
Interstate Pipeline operating revenues decreased $10 million for the
first six months of 1998 compared to pro forma operating revenues for the same
period in 1997. The decrease in revenues is in part due to $7 million of
non-recurring transportation revenues recognized in the first quarter of 1997.
The revenues were recognized following a settlement with the Arkla division of
NorAm related to service provided in several of Arkla's operating jurisdictions.
The settlement with Arkla also resulted in reduced transportation rates which
reduced revenues for the period. These decreases were partially offset by the
increase in revenues due to the litigation settlement in the second quarter of
1998, mentioned above.
Operation and maintenance expense decreased $1 million and $5 million
in the second quarter and first six months of 1998, respectively, compared to
pro forma operation and maintenance expense for the same periods in 1997. The
decreases were primarily due to lower costs resulting from cost control
initiatives and decreased maintenance due to milder weather in the first quarter
of 1998.
Depreciation and amortization expenses decreased $2 million and $6
million in the second quarter and first six months of 1998, respectively, in
comparison to pro forma depreciation and amortization expenses for the same
periods of 1997 due to a $5 million rate settlement recorded in the first
quarter of 1998. The rate settlement, effective January 1998, provided for a
reduction of MRT's depreciation rates retroactive to July 1996.
ENERGY MARKETING
Energy marketing and gathering business (Energy Marketing) includes the
operations of NorAm's wholesale and retail energy marketing businesses and
natural gas gathering activities of NorAm (conducted, respectively, by NorAm
Energy Services, Inc. (NES), NorAm Energy Management, Inc. and NorAm Field
Services Corp., three wholly owned subsidiaries of NorAm).
The following table provides summary data regarding the results of
operations of Energy Marketing, including operating statistics, on an actual
basis for the three and six months ended June 30,1998 and on a pro forma basis
for the three and six months ended June 30, 1997 (as if the acquisition of NorAm
had occurred as of January 1, 1997).
26
30
Three Months Ended June 30, Percent
1998 1997 Change
-------------------------------- ---------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 1,043 $ 648 61%
Operating Expenses:
Natural Gas............................................ 618 524 18%
Purchased Power........................................ 396 97 308%
Operation and Maintenance.............................. 30 18 67%
Depreciation and Amortization.......................... 3 3 --
Other Operating Expenses............................... 2 1 100%
-------------- -------------
Total Operating Expenses.......................... 1,049 643 63%
-------------- -------------
Operating Income (Loss)..................................... $ (6) $ 5 --
============== =============
Operations Data:
Natural Gas (in Bcf):
Sales................................................ 310 272 14%
Transportation....................................... 6 5 20%
Gathering............................................ 57 62 (8%)
-------------- -------------
Total........................................... 373 339 10%
-------------- -------------
Electricity:
Wholesale Power Sales (in thousand MWH).............. 16,348 4,977 228%
-------------- -------------
Six Months Ended June 30, Percent
1998 1997 Change
----------------------------------- ----------
(Actual) (Pro forma)
(in millions)
Operating Revenues........................................... $ 2,088 $ 1,693 23%
Operating Expenses:
Natural Gas............................................. 1,326 1,435 (8%)
Purchased Power......................................... 697 209 233%
Operation and Maintenance............................... 53 38 39%
Depreciation and Amortization........................... 6 5 20%
Other Operating Expenses................................ 3 2 50%
------------- ----------------
Total Operating Expenses........................... 2,085 1,689 23%
------------- ----------------
Operating Income ............................................ $ 3 $ 4 (25%)
============= ================
Operations Data:
Natural Gas (in Bcf):
Sales................................................. 647 591 9%
Transportation........................................ 12 12 --
Gathering............................................. 115 122 (6%)
------------- ----------------
Total............................................ 774 725 7%
------------- ----------------
Electricity:
Wholesale Power Sales (in thousand MWH)............... 30,118 9,561 215%
-------------- ----------------
Energy Marketing operating income decreased $11 million and $1 million
in the second quarter and first six months of 1998, respectively, in comparison
to pro forma operating income for the same periods in 1997. The $11 million
decrease for the second quarter is primarily due to increased operating expenses
(including a $4 million expense associated with an increase in reserves
as discussed below) and decreased margins at NES compared to the same period in
1997. Operating income for the first six months of 1997 included $17 million in
27
31
hedging losses associated with sales under peaking contracts and losses from the
sale of natural gas held in storage and unhedged in the first quarter of 1997.
Operating Revenues. Operating revenues for Energy Marketing increased
$395 million for each of the second quarter and first six months of 1998
compared to pro forma operating revenues for the same periods in 1997. For the
second quarter, wholesale power sales increased $300 million due to increased
trading activity. For the first six months, wholesale power sales increased
$490 million due to increased trading activity, offset by a reduction in gas
sales of approximately $120 million primarily due to a decrease in the sales
price of natural gas.
Operating Expenses. Natural gas expenses increased $94 million for the
second quarter of 1998 and decreased $109 million for the first six months of
1998 compared to the same periods in 1997. The increase for the three month
period is attributable to increased gas marketing activities. The decrease for
the six month period in 1998 is due to the decrease in the price of natural gas
in that period and the hedging losses in 1997 mentioned above.
Purchased power expenses increased $299 million and $488 million for
the second quarter of 1998 and first six months of 1998 due to increased
marketing activities.
Operation and maintenance expenses increased $12 million and $15
million when compared to pro forma operation expenses for the second quarter and
first six months of 1997, respectively. This increase is largely due to
increased staffing and marketing activities made in support of the increased
sales and expanded marketing efforts at NES. The Company believes that NES'
energy marketing and risk management services have the potential of
complementing the Company's strategy of developing and/or acquiring unregulated
generation assets in other markets. As a result, the Company has made, and
expects to continue to make, significant investments in developing NES' internal
software, trading and personnel resources. The increase in operation and
maintenance expenses is also due to a $4 million expense associated with an
increase in NES's reserve due to increased counter party credit and performance
risk associated with higher prices and higher volatility in the electric power
market.
To minimize fluctuations in the price of natural gas and
transportation, the Company, primarily through NES, enters into futures
transactions, swaps and options in order to hedge against market price changes
affecting (i) certain commitments to buy, sell and transport natural gas, (ii)
existing gas storage inventory and (iii) certain anticipated transactions, some
of which carry off-balance sheet risk. NES also enters into natural gas
derivatives for trading purposes and electricity derivatives for hedging and
trading purposes. For a discussion about the Company's accounting treatment of
derivative instruments, see Note 2 to the Company's 10-K Financial Statements,
Item 7A (Quantitative and Qualitative Disclosure About Market Risk) in the
Form 10-K, and Item 3 (Quantitative and Qualitative Disclosures About Market
Risk) in this Form 10-Q.
INTERNATIONAL
The Company's international business segment (International) includes
the results of operations of HI Energy, a wholly owned subsidiary of the Company
that participates in the development and acquisition of foreign independent
power projects and the privatization of foreign generation and distribution
facilities, and the international operations of NorAm. Substantially all of
International's operations to date have been in Central and South America.
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Results of operations data for International are presented in the
following table on an actual basis for the three and six months ended June 30,
1998 and on a pro forma basis for the three and six months ended June 30, 1997
as if the NorAm acquisition had occurred as of January 1, 1997. The primary pro
forma adjustment gives effect to project development costs and other
expenditures incurred by NorAm prior to the Acquisition Date. The adjustment had
no effect on operating revenues.
Three Months Ended June 30, Percent
1998 1997 Change
---- ---- -------
(Actual) (Pro Forma)
(in millions)
Operating Revenues .................... $169 $ 20 --
Operating Expenses:
Fuel ................................ 5 6 (17%)
Operation and Maintenance ........... 12 9 33%
Depreciation and Amortization ....... 1 1 --
---- ----
Total Operating Expenses .... 18 16 13%
---- ----
Operating Income ...................... $151 $ 4 --
==== ====
Six Months Ended June 30, Percent
1998 1997 Change
---- ---- -------
(Actual) (Pro Forma)
(in millions)
Operating Revenues:......................... $197 $40 --
Operating Expenses:
Fuel...................................... 10 11 (9%)
Operation and Maintenance................. 23 22 5%
Depreciation and Amortization............. 2 1 100%
---- ---
Total Operating Expenses.......... 35 34 3%
---- ---
Operating Income............................ $162 $ 6 --
==== ===
International operating income increased $147 million and $156 million
for the second quarter and first six months of 1998, respectively, compared to
pro forma operating income for the same periods in 1997. The increase in
operating income in both periods is due primarily to the $138 million pre-tax
gain on the sale of its 63 percent interest in EDELAP. Excluding the sale of its
investment in EDELAP, International's operating income for the second quarter
and six months ended June 30, 1998 would have been $13 million (compared to $4
million on a pro forma basis in the prior period) and $24 million (compared to
$6 million on a pro forma basis in the prior period), respectively. These
increases in operating income reflect increased equity earnings from
International's investments in Light, the electric utility serving Rio de
Janeiro, Brazil and EPSA, a Colombian electric utility. HI Energy acquired its
investment in EPSA in June 1997.
In June 1998, International acquired equity interests (ranging from
approximately 38% to 45%) in three distribution systems located in northern and
eastern El Salvador, including the city of San Salvador. The aggregate purchase
price was approximately $150 million.
For additional information regarding the sale of EDELAP, the
investments in the El Salvador
29
33
systems and the August 1998 investment in two Colombian electrical distribution
companies, see Note 10(a) and 11 to the Company's Interim Financial Statements.
For information regarding International's foreign investments and investment
strategies, see Note 10(a) to the Company's Interim Financial Statements in the
First Quarter 10-Q, Note 5 to the Company's 10-K Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company--Results of Operations by Business
Segment--International," "--Certain Factors Affecting Future Earnings of the
Company and its Subsidiaries--Risks of Overseas Operations," and "--Liquidity
and Capital Resources--Company Consolidated Sources of Capital Resources and
Liquidity" in the Form 10-K.
CORPORATE
General. The Company's corporate and other business segment (Corporate)
includes corporate costs, certain of the Company's real estate holdings and
inter-unit eliminations. In addition, Corporate includes the results of
operations of (i) Houston Industries Power Generation, Inc. (HIPG, Inc.), a
wholly owned subsidiary of the Company which is engaged in the acquisition,
development and operation of domestic non-rate regulated power generation
facilities, and (ii) the Company's consumer and retail customer services
operations. The Company's consumer and retail customer services operations
provide energy products and services to a variety of industrial and commercial
customers, including energy efficiency services and space-conditioning services.
In the second quarter of 1998, Corporate had an operating loss of $6
million compared to a pro forma operating loss of $28 million for the same
period in 1997. Corporate's operating loss for the six months ended June 30,
1998 was $21 million compared to a pro forma operating loss of $39 million for
the same period in 1997. The decreases in operating losses are primarily due to
the non-recurring costs associated with the 1997 irrevocable contribution of
450,000 shares of Time Warner common stock (having a market value of $21.9
million and a book value of $19.5 million) to a charitable foundation
established by the Company. Partially offsetting these decreases are (i) losses
associated with the Company's consumer services business; (ii) start-up costs
associated with the Company's non-rate regulated retail electric services
business; and (iii) expenses related to the development of domestic power
generation projects.
HIPG, Inc. HIPG, Inc. seeks to participate in the domestic independent
power markets through the acquisition of existing power plants and the
development of new power plants (greenfield projects). HIPG, Inc.'s business
strategy is to develop a commercial generation portfolio that complements the
Company's other operations, including the electric and natural gas trading and
marketing operations of NES.
In April 1998, HIPG, Inc. acquired four natural gas-fired, electric
generating plants (2,276 MW) from Southern California Edison Company (SCE) for
approximately $230 million. In July 1998, HIPG, Inc. acquired another generating
plant (1,500 MW) from SCE for approximately $43 million. All of the plants are
located in southern California. Certain units of the plants have been designated
as "must-run facilities" under California's Independent System Operator's (ISO)
electric restructuring law. These units operate, in part, under agreements that
allow the ISO to call upon them to provide voltage support. NES, an affiliate of
HIPG, Inc. is acting as the plants' exclusive power marketer and supplier of
natural gas. HIPG, Inc. has contracted with SCE to operate and maintain the
plants with existing plant employees through April 2000. HIPG, Inc. however,
exercises management authority over the plants' operations. HIPG, Inc. financed
the purchase price of these generating plants with intercompany advances. The
funds for such advances were obtained by a financing subsidiary of the Company
under a $150 million bridge loan and from the issuance of commercial paper. For
30
34
information regarding the bridge loan, see Note 8(b) to the Company's First
Quarter 10-Q.
HIPG Inc. through its subsidiaries is currently developing the
following power projects: a 480 MW gas-fired merchant plant located in Boulder
City, Nevada (El Dorado Project) and a 100 MW cogeneration plant located in
Orange, Texas (Sabine Cogeneration Project). HIPG, Inc. will own a 50% interest
in each of these projects. Construction of the El Dorado Project began in April
1998, and construction of the Sabine Cogeneration Project will begin in October
1998. The projected completion date for the El Dorado Project and the Sabine
Cogeneration Project is the fourth quarter of 1999. HIPG Inc.'s share of the
electric output of the El Dorado Project will be sold to NES for resale in the
California and Nevada power markets. With regard to the Sabine Cogeneration
Project, a portion of the electric output of the project will be sold to the
Bayer Corporation, the project's industrial host. The excess electric output of
the Sabine Cogeneration Project will be marketed by NES. As of June 30, 1998,
capitalized costs for these projects under construction or under development
were approximately $32 million.
For information regarding expenditures made or to be made by HIPG, Inc.
under existing commitments, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations of the Company -- Results of
Operations by Business Segment -- Corporate" in the First Quarter 10-Q.
The Company expects that HIPG Inc. will continue to participate
actively in non-rate regulated power projects, including greenfield projects,
competitive auctions, and other acquisitions of generation assets. The amount of
expenditures associated with these activities is dependent upon the nature and
extent of future project commitments; however, some of these expenditures could
be substantial. HIPG Inc. intends to finance a portion of its non-rate regulated
power projects through the proceeds from project financings (financings secured
primarily by a project's revenues, capital stock and physical assets), and
through equity investment and loans from the Company.
The successful completion of greenfield and other non-rate regulated
power projects is dependent upon a number of factors, which include, among other
things, risks associated with failures of siting, financing, construction,
permitting, governmental approvals or termination of power sales contracts (if
any) as a result of a failure to meet certain construction milestones. Because
many of the facilities being acquired or developed by HIPG, Inc. are "merchant"
plants without a dedicated offtake customer, such facilities are sensitive to
market and regulatory factors and other considerations.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
OF THE COMPANY AND ITS SUBSIDIARIES
For information on developments, factors and trends that may have an
impact on the Company's future earnings, reference is made to Item 7 of the Form
10-K, "Management's Discussion and Analysis of Financial Condition and Results
of Operations of the Company--Certain Factors Affecting Future Earnings of the
Company and its Subsidiaries."
RATE PROCEEDINGS -- ELECTRIC OPERATIONS
The Texas Utility Commission has jurisdiction (or, in some cases,
appellate jurisdiction) over the electric rates of Electric Operations and, as
such, monitors Electric Operations' earnings to ensure that Electric Operations
is not earning in excess of a reasonable rate of return. For information
regarding the Transition Plan, see Note 9(a) to the Company's Interim Financial
Statements.
ACCOUNTING TREATMENT OF ACES
The Company accounts for its investment in TW Preferred under the cost
method. As a result of the Company's issuance of the ACES, certain increases in
the market value of Time Warner common stock (the security into which the TW
Preferred is convertible) could result in an accounting loss to the Company,
31
35
pending the conversion of the Company's TW Preferred into Time Warner common
stock. For additional information regarding the accounting treatment of the TW
Preferred, see Note 5 to the Company's Interim Financial Statements.
IMPACT OF YEAR 2000 COMPUTER SOFTWARE ISSUES
Year 2000 Problem. At midnight on December 31, 1999, unless the proper
modifications have been made, the program logic in many of the world's computer
systems will start to produce erroneous results because, among other things,
the systems will incorrectly read the date "01/01/00" as being January 1 of the
year 1900 or another incorrect date. In addition, certain systems may fail to
detect that the year 2000 is a leap year. Problems can also arise earlier than
January 1, 2000, as dates in the next millennium are entered into non-Year 2000
compliant programs.
Compliance Program. In 1997, the Company initiated a corporate wide
Year 2000 project to address mainframe application systems, information
technology (IT) related equipment, system software, client-developed
applications, building controls, and non-IT embedded systems such as process
controls for energy production and delivery. Incorporated into this project
were NorAm and other Company subsidiary mainframe applications, infrastructures,
embedded systems and client developed applications that will not be migrated
into existing or planned Company systems prior to the year 2000. The evaluation
of Year 2000 issues included significant customers, key vendors, service
suppliers and other parties material to the Company's operations. In the course
of this evaluation, the Company has sought written assurances from such third
parties as to their state of Year 2000 readiness.
Company's State of Readiness. Work has been prioritized in accordance
with business risk. The highest priority has been assigned to activities that
would disrupt the physical delivery of energy; next are activities that would
impact back office activities such as customer service and billing; and finally,
the lowest priority has been assigned to activities that would cause
inconvenience or productivity loss in normal business operations (e.g. air
conditioning systems and elevators). All business units have completed an
analysis of critical systems and equipment that control the production and
delivery of energy, as well as corporate, departmental and personnel systems and
equipment. The remediation and replacement work on the majority of IT systems,
non-IT systems and infrastructure began in the first quarter of 1998 and is
expected to be completed by the second quarter of 1999. Testing of these systems
began in the second quarter of 1998 and is scheduled to be completed in third
quarter of 1999.
Costs to Address Year 2000 Compliance Issues. Based on current
internal studies, as well as, recently solicited bids from various computer
software vendors, the Company estimates that the total direct cost of resolving
the Year 2000 issue will be between $35 and $40 million. This estimate includes
approximately $6 million related to salaries and expenses of existing employees
and approximately $3 million in hardware purchases that the Company expects to
capitalize. In addition, the $35 to $40 million estimate includes approximately
$2 million spent prior to 1998 and approximately $2 million expended so far in
1998. The majority of the costs related to resolving the Year 2000 issue are
expected to be expended in 1999. The Company expects to fund these expenditures
through internal sources.
In September 1997, the Company entered into an agreement with SAP
America, Inc. (SAP) to license SAP proprietary R/3 enterprise software. The
licensed software includes finance, accounting, human resources, materials
management and service delivery components. The Company's purchase of this
software license and related computer hardware is part of its response to
changes in the electric utility and energy services industries as well as
changes in the Company's businesses and operations resulting from the
acquisition of NorAm and the Company's expansion into energy trading and
marketing business. Although it is anticipated that the implementation of the
SAP system will have the incidental effect of negating the need to modify many
of the Company's computer systems to accommodate the year 2000 problem, the
Company does not deem the costs of the SAP system as directly related to its
Year 2000 compliance program. The estimated costs of implementing the SAP
system is approximately $182 million, inclusive of internal costs. For
additional information, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Company - Certain Factors Affecting
Future Earnings of the Company and its Subsidiaries - Impact of the Year 2000
and Other System Implementation Issues", in Item 7 of the Form 10-K.
The estimated costs of, and timetable for, becoming Year 2000
compliant as well as the implementation of the SAP system constitute "forward
looking statements" as defined in the Private Securities Litigation Reform Act
of 1995 (see Item 5 of this Form 10-Q). Investors are cautioned that such
estimates are based on numerous assumptions by management, including
assumptions regarding the continued availability of certain resources, the
accuracy of representations made by third parties concerning their compliance
with Year 2000 issues, and other factors. The estimated costs of Year 2000
compliance also do not give effect to any future corporate acquisitions or
divestitures made by the Company or its subsidiaries.
Risks of Non-Compliance and Contingency Plans. The major applications
which pose the greatest Year 2000 risks for the Company if implementation of
the Year 2000 compliance program is not successful are the transmission and
distribution automation systems; the time in use, demand and recorder metering
system for commercial and industrial customers; and the power billing systems.
The potential problems related to these systems are electric service
interruptions to customers, interrupted revenue data gathering and poor
customer relations resulting from delayed billing, respectively.
Although the Company intends to complete all Year 2000 remediation and
testing activities by the end of the third quarter 1999, and although the
Company has initiated Year 2000 communications with significant customers, key
vendors, service suppliers and other parties material to the Company's
operations and is diligently monitoring the progress of such third parties in
Year 2000 compliance, such third parties nonetheless represent a risk that
cannot be assessed with precision or controlled with certainty. For that reason,
the Company intends to develop contingency plans to address alternatives in the
event that Year 2000 failures of automatic systems and equipment occur.
Preliminary discussions have been held regarding the contingency plan and a
final contingency plan is scheduled to be completed prior to mid-year 1999.
LIQUIDITY AND CAPITAL RESOURCES
COMPANY CONSOLIDATED SOURCES OF CAPITAL RESOURCES AND LIQUIDITY
Company. At June 30, 1998, the Company, exclusive of subsidiaries, had
a revolving credit facility of $200 million used to support the issuance of up
to $200 million of commercial paper. There were no commercial paper borrowings
and no loans outstanding under this facility at June 30, 1998. In addition, at
June 30, 1998, the Company had shelf registration statements providing for the
future issuance, subject to market and other conditions, of $230 million
aggregate liquidation value of its preferred stock and $580 million aggregate
principal amount of its debt securities.
In January 1998, pollution control revenue refunding bonds
aggregating $104.7 million with $29.7 million bearing an interest rate of 5.25%
and $75 million bearing an interest rate of 5.15%, were issued on behalf of the
Company by the Matagorda County Navigation District Number One (MCND). The bonds
will mature in 2029. Proceeds from the issuances were used in February 1998 to
redeem, at 102% of the aggregate principal amount, pollution control revenue
bonds aggregating $104.7 million.
In February 1998, pollution control revenue refunding bonds aggregating
$290 million were issued on behalf of the Company by the Brazos River Authority
(BRA). The BRA bonds bear an interest rate of 5 1/8% and mature in May 2019
($200 million) and November 2020 ($90 million). Proceeds from the issuances were
used in May 1998 to redeem, at 102% of the aggregate principal amount, pollution
control revenue bonds aggregating $290 million.
NorAm. In February 1998, NorAm issued $300 million principal amount of
6.5% debentures due February 1, 2008. The proceeds from the sale of the
debentures were used to repay short-term indebtedness of NorAm, including the
indebtedness incurred in connection with the purchase of $101.4 million
aggregate principal amount of its 10% debentures and the repayment of $53
million aggregate principal amount of NorAm debt that matured in December 1997
and January 1998.
In the first quarter of 1998, NorAm repaid at maturity $1 million of
its 9.3% medium-term notes and satisfied the $6.5 million sinking fund
requirement for its 6% convertible subordinated debentures due March 2012 using
debentures purchased in 1996 and 1997. In May 1998, NorAm repaid at maturity $28
million of medium-term notes carrying an average interest rate of 8.74%.
In March 1998, NorAm replaced its $400 million revolving credit
facility with a five-year $350 million revolving credit facility. Borrowings
under the NorAm credit facility are unsecured. There were no loans outstanding
under the NorAm credit facility at June 30, 1998. The NorAm credit facility
supports NorAm's issuance of up to $350 million of commercial paper, but no
commercial paper was outstanding at June 30, 1998. At June 30, 1998, NorAm also
had a $300 million trade receivables facility under which receivables of $300
million
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36
had been sold and a shelf registration statement providing for the future
issuance of debt securities of up to $200 million aggregate principal amount.
Financing Subsidiaries. At June 30, 1998, Houston Industries FinanceCo
LP's (FinanceCo) $1.6 billion revolving credit facility supported $1.3 billion
in commercial paper borrowings having a weighted average interest rate of 5.89%.
Proceeds from the initial issuances of commercial paper by FinanceCo in 1997
were used to fund the cash portion of the consideration paid to stockholders of
the former NorAm Energy Corp. For additional information regarding the FinanceCo
Facility, see Note 8(c) to the Company's 10-K Consolidated Financial Statements.
In March 1998, FinanceCo II, a limited partnership subsidiary of the
Company, entered into the FinanceCo II Facility, a six-month $150 million credit
facility. At June 30, 1998, borrowings from the FinanceCo II Facility totaled
$150 million. Proceeds from borrowings under the FinanceCo II Facility were used
to fund a portion of HIPG, Inc.'s April 1998 purchase of four electric
generation plants. For additional information regarding the FinanceCo II
Facility, see Note 8(b) to the Company's Interim Financial Statements in the
First Quarter 10-Q.
General. The Company has established a "money fund" through which its
subsidiaries can borrow or invest on a short-term basis. The funding
requirements of individual subsidiaries are aggregated, and borrowing or
investing is based on the net cash position. The money fund's net funding
requirements are generally met with commercial paper issued by a financing
subsidiary.
The Company believes that its current level of cash and borrowing
capability along with future cash flows from operations are sufficient to meet
the needs of its existing businesses. However, to achieve its objectives, the
Company may, when necessary, supplement its available cash resources by seeking
funds in the equity or debt markets.
NEW ACCOUNTING ISSUES
For calendar year 1998, the Company and NorAm will adopt SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" (SFAS No.
131) and SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" (SFAS No. 132). SFAS No. 131 requires that companies
report in their financial statements financial and descriptive information about
reportable operating segments, defined by reference to the way in which
management reviews its operations in order to assess performance and allocate
its resources. SFAS No. 132 revises employers' disclosures about pension and
other post- retirement benefit plans.
In 2000, the Company and NorAm expect to adopt SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133).
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
For information regarding the Company's adoption effective January 1,
1998 of SFAS No. 130, "Reporting Comprehensive Income" (SFAS No. 130), see Note
3 to the Company's Interim Financial Statements.
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37
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK OF THE
COMPANY
The Company and its subsidiaries have financial instruments that
involve various market risks and uncertainties. For information regarding the
Company's exposure to risks associated with interest rates, equity market prices
and energy commodity prices see Item 7A in the Form 10-K.
In the second quarter and first six months of 1998, the Company
recorded an additional $165 million and $288 million, respectively, unrealized
loss (net of tax) related to the ACES. For further discussion of this loss see
Note 5 to the Company's Interim Financial Statements. The Company believes that
this additional unrealized loss for the ACES is more than economically hedged by
the unrecorded unrealized gain relating to the increase in the fair value of the
Time Warner common stock underlying the investment in TW Preferred since the
date of its acquisition. An increase of 10% in the price of the Time Warner
common stock above its June 30, 1998 market value of $85.438 per share would
result in the recognition of an additional unrealized accounting loss (net of
tax) of approximately $105 million.
The Company's risk associated with interest rates, equity market prices
(other than those related to ACES) and energy commodity prices have not
materially changed from the market risks faced by the Company at December 31,
1997.
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38
ITEM 1. FINANCIAL STATEMENTS.
NORAM ENERGY CORP. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(Thousands of Dollars)
(Unaudited)
Current Current Former Former
NorAm NorAm NorAm NorAm
------------------ ------------------ ------------------ ------------------
Three Six Months Three Six Months
Months Ended Months Ended
Ended June 30, Ended June 30,
June 30, 1998 June 30, 1997
1998 1997
------------------ ---------------- ------------------ ----------------
Revenues: $ 1,382,575 $ 3,142,506 $ 1,015,998 $ 2,940,180
------------------ ---------------- ------------------ ----------------
Expenses:
Natural gas and purchased power, net....... 1,138,339 2,526,688 787,047 2,366,224
Operation and maintenance.................. 149,686 301,295 127,311 254,951
Depreciation and amortization.............. 46,335 91,065 36,457 72,445
Taxes other than income taxes.............. 28,197 61,869 28,568 64,723
------------------ ---------------- ------------------ ----------------
1,362,557 2,980,917 979,383 2,758,343
------------------ ---------------- ------------------ ----------------
Operating Income............................. 20,018 161,589 36,615 181,837
Other Income (Expense):
Interest expense, net...................... (25,479) (52,379) (32,523) (67,995)
Distributions on trust securities.......... (159) (427) (2,709) (5,414)
Other - net................................ 1,980 4,536 (213) 6,095
------------------ ---------------- ------------------ ----------------
(23,658) (48,270) (35,445) (67,314)
------------------ ---------------- ------------------ ----------------
Income (loss) Before Income Taxes............ (3,640) 113,319 1,170 114,523
Income Tax Expense (Benefit)................ (1,490) 54,863 468 45,411
------------------ ---------------- ------------------ ----------------
Income (loss) Before Extraordinary Item...... (2,150) 58,456 702 69,112
Extraordinary gain on early retirement of debt,
less taxes.............................. 237
------------------ ---------------- ------------------ ----------------
Net Income (loss)............................. $ (2,150) $ 58,456 $ 702 $ 69,349
================== ================ ================== ================
See Notes to NorAm's Unaudited Consolidated Financial Statements.
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39
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
ASSETS
June 30, December 31,
1998 1997
-------------------- --------------------
Property, Plant and Equipment
Natural gas distribution............................................... $ 1,396,145 $ 1,326,442
Interstate pipeline.................................................... 1,267,187 1,258,087
Energy marketing....................................................... 173,853 162,519
Other.................................................................. 13,537 14,972
-------------------- --------------------
Total.......................................................... 2,850,722 2,762,020
Less accumulated depreciation and amortization......................... 124,330 59,531
-------------------- --------------------
Property, plant and equipment-- net.................................... 2,726,392 2,702,489
-------------------- --------------------
Current Assets
Cash and cash equivalents.............................................. 29,957 35,682
Accounts and notes receivable, principally customer.................... 737,077 969,248
Accounts receivable - affiliated companies............................. 52,408 10,161
Income tax receivable.................................................. 45,131
Gas in underground storage............................................. 68,507 63,702
Materials and supplies................................................. 36,849 29,611
Gas purchased in advance of delivery................................... 6,200 6,200
Other current assets................................................... 15,889 24,386
-------------------- --------------------
Total current assets........................................... 992,018 1,138,990
-------------------- --------------------
Other Assets
Goodwill, net.......................................................... 2,032,701 2,026,395
Prepaid pension asset.................................................. 91,026 92,064
Investment in marketable equity securities............................. 19,157 27,046
Regulatory asset for environmental costs............................... 20,998 21,745
Gas purchased in advance of delivery................................... 21,675 29,048
Deferred debits, net................................................... 74,003 93,010
-------------------- --------------------
Total other assets............................................. 2,259,560 2,289,308
-------------------- --------------------
Total Assets............................................................. $ 5,977,970 $ 6,130,787
==================== ====================
See Notes to NorAm's Unaudited Consolidated Financial Statements
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40
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
LIABILITIES AND STOCKHOLDER'S EQUITY
June 30, December 31,
1998 1997
-------------------- --------------------
Stockholder's Equity:
Common stock........................................................... $ 1 $ 1
Paid-in capital........................................................ 2,463,831 2,463,831
Retained earnings...................................................... 79,303 20,847
Unrealized loss on marketable equity securities, net of tax............ (10,669) (5,634)
-------------------- --------------------
Total stockholder's equity..................................... 2,532,466 2,479,045
-------------------- --------------------
NorAm-Obligated Mandatorily Redeemable Convertible Trust Preferred
Securities of Subsidiary Trust Holding Solely
Subordinated Debentures of NorAm, net.................................. 1,836 21,290
Long-Term Debt, less Current Maturities.................................. 1,212,157 916,703
Current Liabilities:
Current maturities of long-term debt................................... 199,860 232,145
Notes payable to banks................................................. 390,000
Notes payable to parent................................................ 22,100
Receivables facility................................................... 300,000 300,000
Accounts payable, principally trade.................................... 597,564 668,269
Accounts payable - affiliated companies................................ 9,041
Interest payable....................................................... 40,911 27,273
General taxes.......................................................... 30,876 41,315
Customer deposits...................................................... 35,858 36,626
Other current liabilities.............................................. 134,137 133,278
-------------------- --------------------
Total current liabilities...................................... 1,348,247 1,851,006
-------------------- --------------------
Deferred Credits and Other Liabilities:
Accumulated deferred income taxes...................................... 497,042 488,299
Estimated environmental remediation costs.............................. 20,998 21,745
Payable under capacity lease agreement................................. 41,000 41,000
Benefit obligations.................................................... 183,669 182,687
Estimated obligations under indemnification provisions of sale
agreements.......................................................... 7,352 11,391
Other.................................................................. 133,203 117,621
-------------------- --------------------
Total deferred credits and other liabilities................... 883,264 862,743
-------------------- --------------------
Commitments and Contingencies............................................
Total Liabilities and Stockholder's Equity............................... $ 5,977,970 $ 6,130,787
==================== ====================
See Notes to NorAm's Unaudited Consolidated Financial Statements
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NORAM ENERGY CORP. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(Thousands of Dollars)
(Unaudited)
Current Former
NorAm NorAm
-------------------- --------------------
Six Months Six Months
Ended Ended
June 30, June 30,
1998 1997
-------------------- --------------------
Cash Flows from Operating Activities:
Net income............................................................ $ 58,456 $ 69,349
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization...................................... 91,065 72,445
Deferred income taxes.............................................. 30,594 16,972
Extraordinary (gain), less taxes................................... (237)
Changes in other assets and liabilities, net of the effects of the
acquisition:
Accounts and notes receivable-net................................ 189,924 342,855
Inventories...................................................... (12,591) 14,381
Other current assets............................................. 23,110 666
Accounts payable................................................. (83,462) (268,658)
Interest and taxes accrued....................................... (41,932) (9,667)
Other current liabilities........................................ (11,909) (34,227)
Other - net...................................................... 28,628 3,675
-------------------- --------------------
Net cash provided by operating activities..................... 271,883 207,554
-------------------- --------------------
Cash Flows from Investing Activities:
Capital expenditures.................................................. (106,267) (67,400)
Other - net........................................................... 1,147 (31,245)
-------------------- --------------------
Net cash used in investing activities......................... (105,120) (98,645)
-------------------- --------------------
Cash Flows from Financing Activities:
Retirements and reacquisitions of long-term debt..................... (29,000) (230,515)
Issuance of bank term loan, due 1998 150,000
Proceeds from sale of debentures..................................... 298,514
Decrease in notes payable............................................ (419,779) (43,000)
Increase in receivables facility..................................... 35,000
Common and preferred stock dividends................................. (19,281)
Conversion of convertible securities................................. (10,097)
Other-net............................................................ (12,126) (17,689)
-------------------- --------------------
Net cash used in financing activities.......................... (172,488) (125,485)
-------------------- --------------------
Net (decrease) in Cash and Cash Equivalents............................. (5,725) (16,576)
Cash and Cash Equivalents at Beginning of the Period.................... 35,682 27,981
-------------------- --------------------
Cash and Cash Equivalents at End of the Period.......................... $ 29,957 $ 11,405
==================== ====================
Supplemental Disclosure of Cash Flow Information:
Interest (net of amounts capitalized)................................. $ 63,798 $ 75,300
Income taxes, net..................................................... 75,129 14,900
See Notes to NorAm's Unaudited Consolidated Financial Statements.
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42
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Thousands of Dollars)
(Unaudited)
Unrealized
Gain (Loss)
Common Stock(1) Retained on Marketable
--------------------------------- Paid-in Earnings Securities
Shares Amount Capital (Deficit) Net of Tax Total
---------------- ------------ ------------- ------------- ------------ ---------------
Former NorAm:
Balance at January 1, 1997..... 137,908,173 $ 86,193 $ 1,001,053 $ (286,703) $ 5 $ 800,548
Net Income..................... 69,349 69,349
Cash Dividends:
Common stock -- $0.07
per share.................. (19,281) (19,281)
Change in Market Value of
Marketable Equity
Securities, net of tax....... 7,792 7,792
Other Issuances................ 407,180 254 3,836 4,090
---------------- ------------ ------------- ------------- ------------ ---------------
Balance at June 30, 1997....... 138,315,353 86,447 1,004,889 (236,635) 7,797 862,498
---------------- ------------ ------------- ------------- ------------ ---------------
Net Income..................... (23,237) (23,237)
Cash Dividends:
Change in Market Value of
Marketable Equity
Securities, net of tax....... (1,918) (1,918)
Conversion of
NorAm-Obligated
Mandatorily Redeemable
Convertible Trust Preferred
Securities of Subsidiary
Trust Holding Solely
Subordinated Debentures
of NorAm to Common
Stock........................ 11,428,262 7,143 131,425 138,568
Other Issuances................ (59,653) (38) 1,960 1,922
---------------- ------------ ------------- ------------- ------------ ---------------
Balance at July 31,
1997.......................... 149,683,962 93,552 1,138,274 (259,872) 5,879 977,833
---------------- ------------ ------------- ------------- ------------ ---------------
Current NorAm (Post
Merger):
Adjustments due to Merger:
Eliminate Former NorAm
Balances................... (149,683,962) (93,552) (1,138,274) 259,872 (5,879) (977,833)
Capital Contribution from
Parent....................... 1,000 1 2,463,831 2,463,832
Net Income..................... 20,847 20,847
Change in Market Value of
Marketable Equity
Securities, net of tax....... (5,634) (5,634)
---------------- ------------ ------------- ------------- ------------ ---------------
Balance at December 31,
1997......................... 1,000 $ 1 $ 2,463,831 $ 20,847 $ (5,634) $ 2,479,045
---------------- ------------ ------------- ------------- ------------ ---------------
(continued on next page)
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NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - (Continued)
(Thousands of Dollars)
(Unaudited)
Unrealized
Gain (Loss)
Retained on Marketable
Common Stock (1) Paid-in Earnings Securities
--------------------------- ------------- ------------ ------------- --------------
Shares Amount Capital (Deficit) Net of Tax Total
------------- ---------- ------------- ------------ ------------- --------------
Net Income.................... $ 58,456 $ 58,456
Change in Market
Value of Marketable Equity
Securities, net of tax (5,035) (5,035)
------------- ---------- ------------- ------------ ------------- --------------
Balance at June 30, 1998...... 1,000 $ 1 $ 2,463,831 $ 79,303 $ (10,669) $ 2,532,466
============= ========== ============= ============ ============= ==============
----------
(1) $.625 par, authorized 250,000,000 shares. On the Acquisition
Date, NorAm's pre-merger common stock was canceled and replaced
with 1,000 shares of common stock (all of which are owned by
Houston Industries).
See Notes to NorAm's Unaudited Consolidated Financial Statements.
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44
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
On August 6, 1997 (Acquisition Date), Houston Industries Incorporated
(Former HI) merged with and into Houston Lighting & Power Company, which was
renamed "Houston Industries Incorporated" (Houston Industries), and NorAm Energy
Corp. (Former NorAm) merged with and into a subsidiary of Houston Industries, HI
Merger, Inc., which was renamed "NorAm Energy Corp." (NorAm). Effective upon the
mergers (collectively, the Merger), each outstanding share of common stock of
Former NorAm was converted into the right to receive $16.3051 cash or 0.74963
shares of common stock of Houston Industries. For more information regarding the
Merger, see Note 2 below.
The unaudited interim financial statements and notes (NorAm's Interim
Financial Statements) in this Form 10-Q (Form 10-Q) include the accounts of
NorAm and its wholly owned subsidiaries. NorAm's Interim Financial Statements
omit certain information included in financial statements prepared in accordance
with generally accepted accounting principles and should be read in combination
with the joint Annual Report on Form 10-K (Form 10-K) of Houston Industries
(File No. 1-3187) and NorAm (File No. 1-13265) for the year ended December 31,
1997. The Form 10-K includes the consolidated financial statements of Houston
Industries (Houston Industries' 10-K Financial Statements) and the consolidated
financial statements of NorAm (NorAm's 10-K Financial Statements) for the year
ended December 31, 1997. For additional information regarding the presentation
of interim period results, see Note 6 below.
The following notes to NorAm's Form 10-K Financial Statements relate
to material contingencies. These notes, as updated by the notes contained in
NorAm's Interim Financial Statements, are incorporated herein by reference and
include the following:
Note 1(c) (Regulatory Assets and Regulation), Note 2 (Derivative
Financial Instruments (Risk Management)) and Note 8 (Commitments and
Contingencies).
(2) ACQUISITION OF NORAM
The aggregate consideration paid to Former NorAm stockholders in
connection with the Merger consisted of $1.4 billion in cash and 47.8 million
shares of Houston Industries common stock valued at approximately $1.0 billion.
The overall transaction was valued at $4.0 billion consisting of $2.4 billion
paid for Former NorAm's common stock and common stock equivalents and $1.6
billion of Former NorAm's debt ($1.3 billion of which was long-term debt).
The Merger was recorded under the purchase method of accounting with
assets and liabilities of NorAm reflected at their estimated fair values as of
the Acquisition Date, resulting in a "new basis" of accounting. In NorAm's
Interim Financial Statements, periods which reflect the new basis of accounting
are labeled as "Current NorAm" and periods which do not reflect the new basis of
accounting are labeled as "Former NorAm."
NorAm's Consolidated Balance Sheets for periods after the Acquisition
Date reflect adjustments associated with Houston Industries' assignment of the
purchase price, principally consisting of (1) the revaluation of certain
property, plant and equipment and long-term debt to their estimated fair market
value,
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(2) the recognition of certain pension and postretirement benefit obligations
previously being recognized through amortization, (3) the recognition of
goodwill as described above, (4) the elimination of NorAm's historical goodwill,
(5) the elimination of NorAm's historical stockholders' equity balances and
accumulated depreciation and amortization as of the Acquisition Date and (6) the
recognition of the associated deferred income tax effects. In addition, NorAm's
pre-merger common stock was canceled and replaced with 1,000 shares of common
stock (all of which are owned by Houston Industries), rendering presentation of
per share data no longer meaningful. Houston Industries' debt to fund the cash
portion of the purchase consideration has not been allocated or "pushed down" to
NorAm and is not reflected on NorAm's Interim Financial Statements.
NorAm's Statements of Consolidated Income for periods after the
Acquisition Date are principally affected by (1) the amortization (over 40
years) of the newly-recognized goodwill, partially offset by the elimination of
the amortization of NorAm's historical goodwill, (2) the amortization (to
interest expense) of the revaluation of long-term debt, (3) the removal of the
amortization (to operating expense) previously associated with the pension and
postretirement obligations as described above and (4) the deferred income tax
expense associated with these adjustments. Interest expense on Houston
Industries' debt which was used to fund the cash portion of the acquisition has
not been allocated or "pushed down" to NorAm and is not reflected on NorAm's
Interim Financial Statements. For these reasons, among others, certain financial
information for periods before and after the Acquisition Date is not comparable.
Assuming the Merger occurred on January 1, 1997, NorAm's unaudited pro
forma results for the second quarter of 1997 were a net loss of $3 million and
NorAm's unaudited pro forma net income for the first six months of 1997 were $62
million. Pro forma results are based on assumptions deemed appropriate by
NorAm's management, have been prepared for informational purposes only and are
not necessarily indicative of the results which would have resulted had the
Merger actually taken place on the date indicated.
(3) COMPREHENSIVE INCOME
Effective January 1, 1998, NorAm adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS No.
130). SFAS No. 130 requires that the total amount of comprehensive income and
all items that meet the definition of a component of comprehensive income (as
defined below) be reported in the year-end financial statements for the annual
period in which they are recognized and the total amount of comprehensive income
be prominently displayed in those same financial statements. Comprehensive
income is defined, to include not only net income (loss) but also the change in
stockholder's equity during a period from transactions and other events and
circumstances from non-stockholder sources.
In the second quarter of 1998, NorAm had a total comprehensive loss of
$9 million compared to comprehensive income of $7 million in the corresponding
period in 1997. In the first six months of 1998, NorAm had total comprehensive
income of $53 million compared to $77 million in the corresponding period in
1997.
In addition to net income, comprehensive income in all periods reflects
unrealized gains or losses on NorAm's investment in marketable equity
securities.
(4) DEPRECIATION
NorAm calculates depreciation using the straight-line method. NorAm's
depreciation expense for the second quarter and first six months of 1998 was $30
million and $63 million, respectively.
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(5) LONG-TERM DEBT AND SHORT-TERM FINANCINGS
In May 1998, NorAm repaid at maturity $28 million of medium-term notes
carrying an average interest rate of 8.74%. For information regarding NorAm's
$350 million revolving credit facility (NorAm Credit Facility), see Note 5 to
NorAm's Interim Financial Statements in the First Quarter 10-Q. At June 30,
1998, there were no commercial paper borrowings and no loans outstanding under
the facility. For information regarding NorAm's $300 million receivables
facility, see Note 4(a) to NorAm's 10-K Financial Statements. At June 30, 1998,
NorAm had sold $300 million of receivables under this facility. For information
regarding (i) the issuance of $300 million principal amount of 6.5% debentures
due February 1, 2008,(ii) the repayment in the first quarter of 1998 of $1
million of its 9.30% medium-term notes and (iii) the satisfaction of the $6.5
million sinking fund requirement for its 6% convertible subordinated debentures
due 2012 using debentures purchased in 1996 and 1997, see Note 5 to NorAm's
Interim Financial Statements in the First Quarter 10-Q.
(6) NORAM OBLIGATED MANDATORILY REDEEMABLE TRUST SECURITIES OF SUBSIDIARY
TRUSTS HOLDING SOLELY SUBORDINATED DEBENTURES OF NORAM.
For information regarding $177.8 million of convertible preferred
securities issued by a statutory business trust formed by Former NorAm, of which
$1.4 million were outstanding at June 30, 1998, see Note 5 to NorAm's Form 10-K
Financial Statements. The sole asset of the trust consists of junior
subordinated debentures of NorAm having interest rates and maturity dates
corresponding to the preferred securities, and the principal amount
corresponding to the common and preferred securities issued by the trust.
(7) INTERIM PERIOD RESULTS: RECLASSIFICATIONS
NorAm's Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position and results of operations for the respective periods.
Amounts reported in the Consolidated Statements of Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (i) the Merger, (ii) seasonal temperature variations
affecting energy consumption and (iii) the timing of maintenance and other
expenditures. In addition, certain amounts from the prior year have been
reclassified to conform to NorAm's presentation of financial statements in the
current year. Such reclassifications do not affect earnings.
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ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS OF NORAM
ENERGY CORP. AND CONSOLIDATED SUBSIDIARIES.
NorAm meets the conditions specified in General Instruction H to Form
10-Q and is thereby permitted to use the reduced disclosure format for wholly
owned subsidiaries of reporting companies specified therein. Accordingly, NorAm
has omitted from this Form 10-Q the information called for by Item 3
(Quantitative and Qualitative Disclosures about Market Risk) of Part I and the
following Part II items of Form 10-Q: Item 2 (changes in securities and use of
proceeds), Item 3 (defaults upon senior securities), and Item 4 (submission of
matters to a vote of security holders). In lieu of the information called for by
Item 2 (management's discussion and analysis of financial condition and results
of operations) of Form 10-Q, NorAm has included the following Management's
Narrative Analysis of the Results of Operations of NorAm Energy Corp. and
Consolidated Subsidiaries to explain material changes in the amount of revenue
and expense items of NorAm between the second quarter and first six months of
1998 and the first quarter and first six months of 1997, respectively. Reference
is made to Management's Narrative Analysis of the Results of Operations of NorAm
and consolidated subsidiaries in Item 7 of the Form 10-K, NorAm's consolidated
financial statements and notes contained in Item 8 of the Form 10-K and NorAm's
Interim Financial Statements contained in this Form 10-Q. For a discussion of
the qualifications and assumptions underlying the use of forward looking
information, see Item 5 of this Form 10-Q.
NORAM ENERGY CORP.
NorAm conducts operations primarily in the natural gas industry,
including gathering, transmission, marketing, storage and distribution.
Collectively, these operations accounted for in excess of 93% of NorAm's total
revenues, income or loss and identifiable assets in the second quarter and first
six months of 1998. Accordingly, NorAm is not required to report on a "segment"
basis, although NorAm is organized into, and the following business description
focuses on, the operating units described below. NorAm also makes sales of
electricity, non-energy sales and provides certain non-energy services,
primarily to retail gas distribution customers. In recognition of the manner in
which NorAm manages its portfolio of businesses, NorAm has segregated its
results of operations into: Natural Gas Distribution, Interstate Pipeline,
Energy Marketing and Corporate.
On August 6, 1997 (Acquisition Date), NorAm became a wholly owned
subsidiary of Houston Industries Incorporated (Houston Industries) in a
transaction involving the merger (Merger) of NorAm Energy Corp. (Former NorAm)
with and into a subsidiary of Houston Industries. For additional information
regarding Houston Industries' acquisition of NorAm, see Note 2 to NorAm's
Interim Financial Statements.
CONSOLIDATED RESULTS OF OPERATIONS
Seasonality and Other Factors. NorAm's results of operations are
seasonal due to fluctuations in the demand for and, to a lesser extent, the
price of natural gas. NorAm's results of operations are also affected by, among
other things, the actions of various federal and state governmental authorities
having jurisdiction over rates charged by NorAm and its subsidiaries,
competition in NorAm's various business operations, debt service costs and
income tax expense. For a discussion of certain other factors that may affect
NorAm's future earnings see "Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Company--Certain Factors affecting
Future Earnings of the Company and its Subsidiaries" in the Form 10-K.
Accounting Impact of the Merger. The Merger created a new basis of
accounting for NorAm, resulting in new carrying values for certain of NorAm's
assets, liabilities and equity commencing upon the
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Acquisition Date. NorAm's Statements of Consolidated Income for periods after
the Acquisition Date are principally affected by (1) the amortization (over 40
years) of the newly-recognized goodwill, partially offset by the elimination of
the amortization of NorAm's historical goodwill, (2) the amortization (to
interest expense) of the revaluation of long-term debt, (3) the removal of the
amortization (to operating expense) previously associated with the pension and
post-retirement obligations and (4) the deferred income tax expense associated
with these adjustments. Interest expense on Houston Industries' debt which was
used to fund the cash portion of the acquisition has not been allocated or
"pushed down" to NorAm and is not reflected on NorAm's Interim Financial
Statements. For these reasons, among others, certain financial information for
periods before and after the Acquisition Date is not comparable.
Because results of operations and other financial information for
periods before and after the Acquisition Date are not comparable, NorAm is
presenting certain financial data on an actual basis and on a pro forma basis as
if the Merger had taken place at the beginning of the period presented. These
results do not necessarily reflect the results which would have been obtained if
the Merger had actually occurred on the dates indicated or the results that may
be expected in the future.
The following table sets forth selected financial and operating data on
an actual basis for the second quarters and six months ended June 30, 1998 and
1997 and on a pro forma basis for the second quarter and six months ended June
30, 1997, followed by a discussion of significant variances in period-to-period
results:
Selected Financial Results:
Three Months Ended June 30,
---------------------------------------------
1998 1997 1997 Percentage
(Actual) (Actual) (Pro forma)(1) Change
----------- ----------- -------------- -----------------------
(Thousands of dollars) (1998 Actual to
1997 Pro forma)
Operating Revenues:
Natural Gas Distribution ...................... $ 314,989 $ 336,568 $ 336,568 (6%)
Interstate Pipeline ........................... 76,516 77,048 77,048 (1%)
Energy Marketing .............................. 1,042,609 647,848 647,848 61%
Corporate and Other ............................ 14,610 18,671 18,671 (22%)
Elimination of Intersegment Revenue (2) ....... (66,149) (64,137) (64,137) (3%)
----------- ------------ --------------
$ 1,382,575 $ 1,015,998 $ 1,015,998 36%
=========== ============ ==============
Operating Income (Loss):
Natural Gas Distribution ..................... (6,156) 5,778 (18) --
Interstate Pipeline .......................... 32,849 30,526 26,590 24%
Energy Marketing ............................. (6,186) 6,532 4,808 --
Corporate and Other .......................... (489) (6,221) (3,842) 87%
----------- ------------ --------------
Consolidated ................................. 20,018 36,615 27,538 (27%)
Interest Expense, Net ........................... 25,479 32,523 26,507 (4%)
Distributions on Subsidiary Trust Securities .... 159 2,709 515 (69%)
Other (Income) and Deductions ................... (1,980) 213 213 --
Income Tax Expense (Benefit)..................... (1,490) 468 3,318 --
----------- ------------ --------------
Net Income (loss)................................ $ (2,150) $ 702 $ (3,015) 29%
=========== ============ ==============
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Six Months Ended June 30,
-----------------------------------------------
1998 1997 1997 Percentage
(Actual) (Actual) Pro forma(1) Change
------------ ----------- ------------ -----------------------
(Thousands of dollars) (1998 Actual to
1997 Pro forma)
Operating Revenues:
Natural Gas Distribution ................. $ 1,031,885 $ 1,217,819 $ 1,217,819 (15%)
Interstate Pipeline ...................... 147,497 162,698 162,698 (9%)
Energy Marketing ......................... 2,088,228 1,693,314 1,693,314 23%
Corporate and Other ...................... 35,726 35,430 35,430 1%
Elimination of Intersegment Revenues(2) .. (160,830) (169,081) (169,081) 5%
----------- ----------- ------------
$ 3,142,506 $ 2,940,180 $ 2,940,18 7%
=========== =========== ============
Operating Income (Loss):
Natural Gas Distribution .................. 95,448 118,430 106,876 (11%)
Interstate Pipeline ....................... 64,922 69,377 61,220 6%
Energy Marketing .......................... 3,395 7,213 3,745 (9%)
Corporate and Other ....................... (2,176) (13,183) (8,641) 75%
----------- ----------- ------------
Consolidated .............................. 161,589 181,837 163,200 (1%)
Interest Expense, Net ....................... 52,379 67,995 55,787 (6%)
Distributions on Subsidiary Trust ........... 427 5,414 1,029 (59%)
Other (Income) and Deductions ............... (4,536) (6,095) (6,094) 26%
Income Tax Expense .......................... 54,863 45,411 50,551 9%
----------- ----------- ------------
Income Before Extraordinary Item ............ 58,456 69,112 61,927 (6%)
Extraordinary Item 237 --
----------- ----------- ------------
Net Income $ 58,456 $ 69,349 $ 61,927 (6%)
=========== =========== ============
(1) Pro forma results reflect purchase accounting adjustments as if the
Merger had occurred on January 1, 1997. Adjustments for goodwill have
been allocated to the respective business units.
(2) Elimination of operating revenues derived from sales to affiliated
business units.
Second Quarter of 1998 Compared to Second Quarter of 1997 (Actual).
NorAm had a consolidated net loss of $2 million for the second quarter of 1998
compared to net income of $0.7 million in the same period in 1997. The decrease
in earnings is primarily attributable to the purchase accounting effects of the
Merger including the amortization of goodwill and adjustments to interest
expense.
Second Quarter of 1998 Actual Compared to Second Quarter of 1997 Pro
Forma. NorAm had a consolidated net loss of $2 million for the second quarter of
1998 compared to a pro forma consolidated loss of $3 million in the same period
in 1997. The consolidated net loss was due to decreased operating income at
Natural Gas Distribution and Energy Marketing offset by increased operating
income at Interstate Pipeline and decreased interest expense, as described
below.
First Six Months of 1998 Compared to First Six Months of 1997 (Actual).
NorAm had consolidated net income of $58 million for the first six months of
1998 compared to net income of $69 million in the same period in 1997. The
decrease in earnings is primarily attributable to the purchase accounting
effects of the merger described above.
First Six Months of 1998 Actual Compared to First Six Months of 1997 Pro
Forma. NorAm had consolidated net income of $58 million for the first six months
of 1998 compared to pro forma net income of $62 million in the first six months
of 1997. Net income decreased primarily due to decreased operating income at
Natural Gas Distribution due to warmer weather. The decrease was partially
offset by increased operating income at Interstate Pipeline (described below)
and decreased interest expense.
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RESULTS OF OPERATIONS BY BUSINESS UNIT
NATURAL GAS DISTRIBUTION
Domestic natural gas distribution operations (Natural Gas Distribution)
are conducted through the Arkla, Entex and Minnegasco divisions of NorAm. These
operations consist of natural gas sales to, and natural gas transportation for,
residential, commercial and certain industrial customers in six states:
Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma and Texas.
The following table provides summary data regarding the results of
operations of Natural Gas Distribution, including operating statistics, on an
actual basis for the second quarter and first six months of 1998 and on a pro
forma basis for the second quarter and first six months of 1997 (as if the
acquisition of NorAm by Houston Industries had occurred as of January 1, 1997).
Three Months Ended June 30, Percent
1998 1997 Change
--------------- ------------- -----------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 315 $ 337 (7%)
Operating Expenses:
Natural Gas............................................ 174 186 (6%)
Operation and Maintenance.............................. 93 96 (3%)
Depreciation and Amortization.......................... 32 31 3%
Other Operating Expenses............................... 22 24 (8%)
--------------- -------------
Total Operating Expenses........................... 321 337 (5%)
--------------- -------------
Operating Income............................................ $ (6) $ 0 --
=============== =============
Throughput Data (in Bcf):
Residential and Commercial Sales....................... 43 51 (16%)
Industrial Sales....................................... 13 13 --
Transportation......................................... 10 10 --
--------------- -------------
Total Throughput.................................... 66 74 (11%)
=============== =============
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Six Months Ended June 30, Percent
1998 1997 Change
--------------- ------------- -----------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 1,032 $ 1,218 (15%)
Operating Expenses:
Natural Gas............................................ 632 803 (21%)
Operation and Maintenance.............................. 191 193 (1%)
Depreciation and Amortization.......................... 63 61 3%
Other Operating Expenses............................... 50 54 (7%)
--------------- -------------
Total Operating Expenses........................... 936 1,111 (16%)
--------------- -------------
Operating Income............................................ $ 96 $ 107 (10%)
=============== =============
Throughput Data (in Bcf):
Residential and Commercial Sales....................... 169 188 (10%)
Industrial Sales....................................... 29 29 --
Transportation......................................... 22 22 --
--------------- -------------
Total Throughput.................................... $ 220 $ 239 (8%)
=============== =============
Natural Gas Distribution operating income decreased $6 million and $11
million in the second quarter and first six months of 1998, respectively,
compared to pro forma operating income in the same periods in 1997 due primarily
to the lower demand for natural gas heating in the second quarter of 1998 and
milder winter weather in the first three months of 1998. This decrease in
operating income was partially offset by reduced charges at Arkla associated
with the methodology of calculating the price of gas charged to customers (the
purchased gas adjustment) in the second quarter and first six months of 1998 as
compared to the same periods in 1997.
Natural Gas Distribution operating revenue decreased $22 million and
$186 million for the second quarter and first six months of 1998, respectively,
compared to pro forma operating revenue for the corresponding periods of 1997
due principally to the weather-related factors discussed above, which resulted
in lower customer usage at Entex and Minnegasco. A decrease in gas prices for
the six months ended June 30, 1998 compared to the same period in the prior year
also contributed to the decline in operating revenues for that period.
Operating expenses decreased $16 million and $175 million in the second
quarter and first six months of 1998, respectively, compared to pro forma
operating expenses in the same periods of 1997 due to the same factors that
affected operating revenues.
INTERSTATE PIPELINE
Interstate natural gas pipeline operations (Interstate Pipeline) are
conducted primarily through NorAm Gas Transmission Company (NGT) and Mississippi
River Transmission Corporation (MRT), two wholly owned subsidiaries of NorAm.
The NGT system consists of approximately 6,200 miles of natural gas transmission
lines located in portions of Arkansas, Kansas, Louisiana, Mississippi, Missouri,
Oklahoma, Tennessee and Texas. The MRT system consists of approximately 2,000
miles of pipeline serving principally the greater St. Louis area in Missouri and
Illinois.
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The following table provides summary data regarding the results of
operations of Interstate Pipeline, including operating statistics, on an actual
basis for the three and six months ended June 30, 1998 and on a pro forma basis
for the three and six months ended June 30, 1997 (as if the acquisition of NorAm
by Houston Industries had occurred as of January 1, 1997).
Three Months Ended June 30, Percent
1998 1997 Change
------------- ------------- --------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 77 $ 74 4%
Operating Expenses:
Natural Gas............................................ 8 8 --
Operation and Maintenance.............................. 22 23 (4%)
Depreciation and Amortization.......................... 10 12 (17%)
Other Operating Expenses............................... 4 4 --
------------- -------------
Total Operating Expenses.......................... 44 47 (6%)
------------- -------------
Operating Income............................................ $ 33 $ 27 22%
============= =============
Throughput Data (in million MMBtu):
Natural Gas Sales........................................ 4 5 (20%)
Transportation........................................... 187 212 (12%)
Elimination (1)..................................... (4) (4) --
------------- -------------
Total Throughput............................................ 187 213 (12%)
============= =============
Six Months Ended June 30, Percent
1998 1997 Change
------------- ------------- ---------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 148 $ 158 (6%)
Operating Expenses:
Natural Gas............................................ 16 19 (16%)
Operation and Maintenance.............................. 40 45 (11%)
Depreciation and Amortization.......................... 19 25 (24%)
Other Operating Expenses............................... 8 7 14%
------------- -------------
Total Operating Expenses.......................... 83 96 (14%)
------------- -------------
Operating Income............................................ $ 65 $ 62 5%
============= =============
Throughput Data (in million MMBtu):
Natural Gas Sales........................................ 8 9 (11%)
Transportation........................................... 424 462 (8%)
Elimination (1)..................................... (7) (9) 22%
------------- -------------
Total Throughput............................................ 425 462 (8%)
============= =============
- -------------
(1) Elimination refers to volumes of natural gas both transported and sold
by Interstate Pipeline and, therefore, excluded from total throughput.
Interstate Pipeline operating income increased $6 million and $3
million in the second quarter and first six months of 1998, respectively,
compared to pro forma operating income for the same periods in 1997. The
increase for the three months ended June 1998 is due primarily to $6 million
recorded in connection with the settlement of certain litigation and
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53
lower operating expenses in the second quarter of 1998. The increase for the
first six months is attributable to $5 million recorded in the first quarter of
1998 in connection with the settlement of an MRT rate case, as well as the
items mentioned above, offset by $7 million of non-recurring transportation
revenues in the first quarter of 1997, discussed below.
Operating revenues for Interstate Pipeline increased by $3 million for
the second quarter of 1998 compared to pro forma operating revenues for the same
period in 1997. The increase in revenues is primarily due to the settlement of
outstanding litigation related to certain gas purchase contracts which resulted
in the recognition of approximately $6 million of revenues in April 1998, offset
by a decrease in sales volumes.
Interstate Pipeline operating revenues decreased $10 million for the
first six months of 1998 compared to pro forma operating revenues for the same
period in 1997. The decrease in revenues is in part due to $7 million of
non-recurring transportation revenues recognized in the first quarter of 1997.
The revenues were recognized following a settlement with the Arkla division of
NorAm related to service provided in several of Arkla's operating jurisdictions.
The settlement with Arkla also resulted in reduced transportation rates which
reduced revenues for the period. These decreases were partially offset by the
increase in revenues due to the litigation settlement in the second quarter of
1998, mentioned above.
Operation and maintenance expense decreased $1 million and $5 million
in the second quarter and first six months of 1998, respectively, compared to
pro forma operation and maintenance expense for the same periods in 1997. The
decreases were primarily due to lower costs resulting from cost control
initiatives and decreased maintenance due to milder weather in the first quarter
of 1998.
Depreciation and amortization expenses decreased $2 million and $6
million in the second quarter and first six months of 1998, respectively, in
comparison to pro forma depreciation and amortization expenses for the same
periods of 1997 due to a $5 million rate settlement recorded in the first
quarter of 1998. The rate settlement, effective January 1998, provided for a
reduction of MRT's depreciation rates retroactive to July 1996.
ENERGY MARKETING
Energy marketing and gathering business (Energy Marketing) includes the
operations of NorAm's wholesale and retail energy marketing businesses and
natural gas gathering activities of NorAm (conducted, respectively, by NorAm
Energy Services, Inc. (NES), NorAm Energy Management, Inc. and NorAm Field
Services Corp., three wholly owned subsidiaries of NorAm).
The following table provides summary data regarding the results of
operations of Energy Marketing, including operating statistics, on an actual
basis for the three and six months ended June 30,1998 and on a pro forma basis
for the three and six months ended June 30, 1997 (as if the acquisition of NorAm
had occurred as of January 1, 1997).
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Three Months Ended June 30, Percent
1998 1997 Change
-------------------------------- ---------------
(Actual) (Pro forma)
(in millions)
Operating Revenues.......................................... $ 1,043 $ 648 61%
Operating Expenses:
Natural Gas............................................ 618 524 18%
Purchased Power........................................ 396 97 308%
Operation and Maintenance.............................. 30 18 67%
Depreciation and Amortization.......................... 3 3 --
Other Operating Expenses............................... 2 1 100%
-------------- -------------
Total Operating Expenses.......................... 1,049 643 63%
-------------- -------------
Operating Income (Loss)..................................... $ (6) $ 5 --
============== =============
Operations Data:
Natural Gas (in Bcf):
Sales................................................ 310 272 14%
Transportation....................................... 6 5 20%
Gathering............................................ 57 62 (8%)
-------------- -------------
Total........................................... 373 339 10%
-------------- -------------
Electricity:
Wholesale Power Sales (in thousand MWH).............. 16,348 4,977 228%
-------------- -------------
Six Months Ended June 30, Percent
1998 1997 Change
------------- ------------- ---------
(Actual) (Pro forma)
(in millions)
Operating Revenues........................................... $ 2,088 $ 1,693 23%
Operating Expenses:
Natural Gas............................................. 1,326 1,435 (8%)
Purchased Power......................................... 697 209 233%
Operation and Maintenance............................... 53 38 39%
Depreciation and Amortization........................... 6 5 20%
Other Operating Expenses................................ 3 2 50%
------------- -------------
Total Operating Expenses........................... 2,085 1,689 23%
------------- -------------
Operating Income ............................................ $ 3 $ 4 (25%)
============= =============
Operations Data:
Natural Gas (in Bcf):
Sales................................................. 647 591 9%
Transportation........................................ 12 12 --
Gathering............................................. 115 122 (6%)
============= =============
Total............................................ 774 725 7%
------------- -------------
Electricity:
Wholesale Power Sales (in thousand MWH)............... 30,118 9,561 215%
------------- -------------
Energy Marketing operating income decreased $11 million and $1 million
in the second quarter and first six months of 1998, respectively, in comparison
to pro forma operating income for the same periods in 1997. The $11 million
decrease for the second quarter is primarily due to increased operating expenses
(including a $4 million expense associated with an increase in reserves as
discussed below) and decreased margins at NES compared to the same period in
1997. Operating income for the first six months of 1997 included $17 million in
hedging losses associated with sales under peaking contracts and losses from the
sale of natural gas held in storage and unhedged in the first quarter of 1997.
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Operating Revenues. Operating revenues for Energy Marketing increased
$395 million for each of the second quarter and first six months of 1998
compared to pro forma operating revenues for the same periods in 1997. For the
second quarter, wholesale power sales increased $300 million due to increased
trading activity. For the first six months, wholesale power sales increased $490
million due to increased trading activity, offset by a reduction in gas sales of
approximately $120 million primarily due to a decrease in the sales price of
natural gas.
Operating Expenses. Natural gas expenses increased $94 million for the
second quarter of 1998 and decreased $109 million for the first six months of
1998 compared to the same periods in 1997. The increase for the three month
period is attributable to increased gas marketing activities. The decrease for
the six month period in 1998 is due to the decrease in the price of natural gas
in that period and the hedging losses in 1997 mentioned above.
Purchased power expenses increased $299 million and $488 million for
the second quarter of 1998 and first six months of 1998 due to increased
marketing activities.
Operation and maintenance expenses increased $12 million and $15
million when compared to pro forma operation expenses for the second quarter and
first six months of 1997, respectively. This increase is largely due to
increased staffing and marketing activities made in support of the increased
sales and expanded marketing efforts at NES. NorAm believes that NES' energy
marketing and risk management services have the potential of complementing
Houston Industries' strategy of developing and/or acquiring unregulated
generation assets in other markets. As a result, NorAm has made, and expects to
continue to make, significant investments in developing NES' internal software,
trading and personnel resources. The increase in operation and maintenance
expenses is also due to a $4 million expense associated with an increase in
NES's credit reserve due to increased counter party credit and performance risk
associated with higher prices and higher volatility in the electric power
market.
To minimize fluctuations in the price of natural gas and
transportation, NorAm, primarily through NES, enters into futures
transactions, swaps and options in order to hedge against market price changes
affecting (i) certain commitments to buy, sell and transport natural gas, (ii)
existing gas storage inventory and (iii) certain anticipated transactions, some
of which carry off-balance sheet risk. NES also enters into natural gas
derivatives for trading purposes and electricity derivatives for hedging and
trading purposes. For a discussion about the Company's accounting treatment of
derivative instruments, see Note 2 to NorAm's 10-K Financial Statements,
Item 7A (Quantitative and Qualitative Disclosure About Market Risk) in the
Form 10-K, and Item 3 (Quantitative and Qualitative Disclosures About
Market Risk) in this Form 10-Q.
CORPORATE
NorAm's corporate and other business (Corporate) includes the
operations of NorAm's unregulated retail services business, international
operations, certain real estate investments, corporate costs and elimination of
transactions between affiliated business units.
Corporate operating loss decreased $3 million and $6 million,
respectively, in the second quarter and first six months of 1998 compared to the
same periods of 1997. The decreases are primarily attributable to reduced
corporate expenses.
52
56
NEW ACCOUNTING ISSUES
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Company - New Accounting Issues" in
Item 2 (Houston Industries) in the Form 10-Q for a discussion of certain new
accounting issues.
53
57
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For a description of legal proceedings affecting the Company
and its subsidiaries, including NorAm, see (i) Part I, Item 3,
of the Form 10-K, Notes 3, 5 and 12 to the Company's 10-K
Financial Statements and Note 8 to NorAm's 10-K Financial
Statements and (ii) Part II, Item 1, of the First Quarter
10-Q. The information contained in these sections, which is
incorporated herein by reference, is updated by the following
information:
In June 1998, the lawsuit, Dumes, et al. v. Houston Lighting &
Power Company, was dismissed, with prejudice, by the U.S.
District Court for the Southern District of Texas, Corpus
Christi Division. The lawsuit, which had been filed by
landowners claiming $70 million in compensatory damages for
alleged environmental contamination, was settled by the
Company for a total of $84,500. For additional information
regarding the lawsuit, reference is made to Part I, Item 3
(Company) of the Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
Company
At the annual meeting of the Company's shareholders held on
May 6, 1998, the matters voted upon and the number of votes
cast for, against or withheld, as well as the number of
abstentions and broker non-votes as to such matters (including
a separate tabulation with respect to each nominee for office)
were as stated below:
For Item 1, the election of four nominees for Class II
directors to serve three-year terms expiring in 2001:
Broker
For Against Abstain Non-Vote
----------- --------- ------- --------
Milton Carroll 254,444,791 4,377,921 -0- -0-
John T. Cater 254,453,523 4,369,189 -0- -0-
Robert C. Hanna 254,421,332 4,401,380 -0- -0-
R. Steve Letbetter 254,261,821 4,560,891 -0- -0-
For Item 2, the proposal to amend the 1994 Houston Industries
Incorporated Long- Term Incentive Compensation Plan to
increase the number of shares of Common
54
58
Stock subject to the plan by ten million and to increase the
limitation on grants of stock options to any one individual
during any calendar year:
Broker
For Against Abstain Non-Vote
----------- ---------- --------- ----------
233,223,502 21,435,968 4,163,242 -0-
For Item 3, the ratification of the appointment of Deloitte &
Touche LLP as independent accountants and auditors for the
Company for 1998:
Broker
For Against Abstain Non-Vote
----------- ---------- --------- ----------
255,489,758 1,921,898 1,411,056 -0-
NorAm
Omitted pursuant to Instruction H(2)(b).
In accordance with recent amendments to the shareholder proposal rules
set forth in Rules 14a-4 and 14a-8 under the Securities Exchange Act of
1934, as amended, written notice of shareholder proposals submitted
outside the processes of Rule 14a-8 for consideration at the 1999
Annual Meeting of Shareholders must be received by the Company on or
before February 10, 1999, in order to be considered timely for purposes
of Rule 14a-4. The persons designated in the Company's proxy statement
shall be granted discretionary authority with respect to any
shareholder proposal of which the Company does not receive timely
notice.
ITEM 5. OTHER INFORMATION.
From time to time, the Company and NorAm may make statements regarding
their assumptions, projections, expectations, intentions, or beliefs
about future events. These statements and other statements that are not
historical facts are intended as "forward-looking statements" under the
Private Securities Litigation Reform Act of 1995. The Company and NorAm
caution that assumptions, projections, expectations, intentions or
beliefs about future events may and often do vary materially from
actual results and the differences between assumptions, projections,
expectations, intentions or beliefs and actual results can be material.
Accordingly, there can be no assurance that actual results will not
differ materially from those expressed or implied by the forward
looking statements.
The following are some of the factors that could cause actual results
to differ from those expressed or implied in forward looking
statements: (i) state and federal legislative and regulatory
initiatives that affect cost and investment recovery, have an impact on
rate restructures and affect the speed and degree to which competition
enters the electric and natural gas industries; (ii) industrial,
commercial and residential growth in service territories of the Company
and NorAm; (iv) the weather and other natural phenomena; (v) the timing
and extent of changes in commodity prices and interest rates, (vi)
changes in environmental and other laws and regulations to which the
Company, NorAm and their respective subsidiaries are subject or other
external factors over which the Company and NorAm
55
59
have no control; (vii) the results of financing efforts, (viii) growth
in opportunities for the Company's and NorAm's subsidiaries and
diversified operations; (ix) the effect of the Company's and NorAm's
accounting policies and (x) other factors discussed in this and other
filings by the Company and NorAm with the Securities and Exchange
Commission.
When used in the Company's or NorAm's documents or oral presentations,
the words "anticipate," "estimate," "expect," "objective,"
"projection," "forecast," "goal" or similar words are intended to
identify forward-looking statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Company:
Exhibit 10 - Amendment to the Houston Industries
Incorporated Executive Deferred Compensation
Trust, effective as of August 6, 1997, by
and among the Company, HI Energy and The Bank
of New York, as Trustee, effective as of August
6, 1997.
Exhibit 12 - Ratio of Earnings to Fixed Charges and
Preferred Dividend
Exhibit 27 - Financial Data Schedule (included in
electronic filing only).
Exhibit 99(a) - Notes 3, 5 and 12 to the Company's Consolidated
Financial Statements included on pages 72
through 77 and 92 through 94 of the Form 10-K.
NorAm:
Exhibit 12 - Ratio of Earnings to Fixed Charges
Exhibit 27 - Financial Data Schedule (included in
electronic filing only) .
Exhibit 99(a) - Note 8 to the NorAm Financial Statements
included on pages 132 through 135 of the Form
10-K.
(b) Reports on Form 8-K.
Company
None
NorAm
None
56
60
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOUSTON INDUSTRIES INCORPORATED
(Registrant)
/s/ Mary P. Ricciardello
---------------------------------------------
Mary P. Ricciardello
Vice President and Comptroller
(Principal Accounting Officer)
Date: August 13, 1998
57
61
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NORAM ENERGY CORP.
(Registrant)
/s/ Mary P. Ricciardello
---------------------------------------------
Mary P. Ricciardello
Vice President and Comptroller
(Principal Accounting Officer)
Date: August 13, 1998
58
62
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
HOUSTON INDUSTRIES INCORPORATED:
10 Amendment to the Houston Industries Incorporated Executive
Deferred Compensation Trust, effective as of August 6, 1997,
by and among the Company, HI Energy and The Bank of New York,
as Trustee, effective as of August 6, 1997.
12 Ratio of Earnings to Fixed Charges and Preferred Dividends
27 Financial Data Schedule for Houston Industries
99(a) Notes 3, 5, and 12 to the Company's Consolidated Financial
Statements included on pages 72 through 77 and 92 through
94 of the Form 10-K
NORAM ENERGY CORP.:
12 Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
99(a) Note 8 to the NorAm Financial Statements included
on pages 132 through 135 of the Form 10-K
1
EXHIBIT 10
AMENDMENT TO THE
HOUSTON INDUSTRIES INCORPORATED
EXECUTIVE DEFERRED COMPENSATION TRUST
THIS AGREEMENT, made and entered, effective as of August 6, 1997, by and
among HOUSTON INDUSTRIES INCORPORATED, a Texas corporation ("Houston"), and
HOUSTON INDUSTRIES ENERGY, INC., a Delaware corporation ("HI Energy"), as
settlors, and THE BANK OF NEW YORK, as Trustee ( "Trustee");
W I T N E S S E T H:
WHEREAS, the Houston Industries Incorporated, a Texas Corporation
("HI"), Houston Lighting & Power Company, a Texas Corporation ("HL&P"), HI
Energy and Trustee established a grantor trust for the purpose of setting aside
and providing a specialized funding mechanism for the deferred compensation
provided under certain executive compensation plans (the "Trust"), through the
Houston Industries Incorporated Executive Deferred Compensation Trust, effective
December 19, 1995 (the "Trust Agreement");
WHEREAS, effective August 6, 1997, HI merged into HL&P to form
Houston; WHEREAS, effective as of said merger, Houston has adopted the
Trust and the underlying plans and agreed to assume all duties, rights and
responsibilities of the "Company" thereunder as a party to the Trust Agreement
as successor to HI and HL&P; and
WHEREAS, pursuant to Section 3.4, Houston, HI Energy and Trustee desire
to amend the Trust Agreement, effective as of August 6, 1997.
NOW, THEREFORE, in consideration of the premises, the parties hereto
agree that the Trust Agreement shall be and hereby is amended as set forth
below, effective as of August 6, 1997:
-1-
2
1. The definition of "Company" in Article II of the Plan is hereby
amended in its entirety to read as follows:
"COMPANY: The term 'Company' shall mean Houston Industries Incorporated,
a Texas corporation, and any successor thereto."
2. As amended hereby, the Trust Agreement is hereby specifically
ratified, assumed, adopted and reaffirmed.
IN WITNESS WHEREOF, Houston, HI Energy and Trustee have caused these
presents to be executed by their duly authorized officers in a number of copies,
all of which shall constitute one and the same instrument, which may be
sufficiently evidenced by any executed copy hereof, this _____ day of
__________________, 1998, but effective as of August 6, 1997.
HOUSTON INDUSTRIES INCORPORATED
By________________________________
Name:___________________________
Title:__________________________
ATTEST:
_________________________________
Assistant Corporate Secretary
HOUSTON INDUSTRIES ENERGY, INC.
By________________________________
Name:___________________________
Title:__________________________
ATTEST:
_________________________________
Assistant Corporate Secretary
-2-
3
THE BANK OF NEW YORK
By________________________________
Name:___________________________
Title:__________________________
ATTEST:
________________________________
-3-
4
THE STATE OF TEXAS )
)
COUNTY OF HARRIS )
BEFORE ME, the undersigned authority, on this day personally appeared
____________________________________, ______________________________________ of
HOUSTON INDUSTRIES INCORPORATED, known to me to be the person and officer whose
name is subscribed to the foregoing instrument, and acknowledged to me that he
executed the same as the act of the said HOUSTON INDUSTRIES INCORPORATED, a
corporation, and that he executed the same as the act and deed of such
corporation for the purposes and consideration therein expressed, and in the
capacity therein stated.
GIVEN UNDER MY HAND AND SEAL OF OFFICE this the _____ day of
___________________, 1998.
______________________________________
Notary Public, State of Texas
THE STATE OF __________ )
)
COUNTY OF _____________ )
BEFORE ME, the undersigned authority, on this day personally appeared
__________________________________, ________________________________________ of
HOUSTON INDUSTRIES ENERGY, INC., known to me to be the person and officer whose
name is subscribed to the foregoing instrument, and acknowledged to me that he
executed the same as the act of the said HOUSTON INDUSTRIES ENERGY, INC., a
corporation, and that he executed the same as the act and deed of such
corporation for the purposes and consideration therein expressed, and in the
capacity therein stated.
GIVEN UNDER MY HAND AND SEAL OF OFFICE this the _____ day of
_____________________, 1998.
______________________________________
Notary Public, State of Texas
-4-
5
THE STATE OF NEW YORK )
)
COUNTY OF NEW YORK )
BEFORE ME, the undersigned authority, on this day personally appeared
____________________________, ___________________________ of THE BANK OF NEW
YORK, known to me to be the person and officer whose name is subscribed to the
foregoing instrument, and acknowledged to me that he executed the same as the
act of the said THE BANK OF NEW YORK, a _________________, and that he executed
the same as the act and deed of such _______________ for the purposes and
consideration therein expressed, and in the capacity therein stated.
GIVEN UNDER MY HAND AND SEAL OF OFFICE this the _____ day of
______________________, 1998.
______________________________________
Notary Public, State of Texas
-5-
1
EXHIBIT 12
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
Six Twelve
Months Ended Months Ended
June 30, June 30,
1998 1998
------------ ------------
Fixed Charges as Defined:
(1) Interest on Long-Term Debt............................... $ 209,355 $ 407,106
(2) Other Interest........................................... 47,393 89,412
(3) Capitalized Interest..................................... 4,746 9,034
(4) Distribution on Trust Securities......................... 14,712 29,269
(5) Interest Component of Rentals Charged to
Operating Expense........................................ 5,365 9,952
--------- ----------
(6) Total Fixed Charges...................................... $ 281,571 $ 544,773
========= =========
Earnings as Defined:
(7) Income from Continuing Operations........................ $ 13,065 $ 253,092
(8) Income Taxes for Continuing Operations .................. 48,462 183,796
(9) Fixed Charges (line 6)................................... 281,571 544,773
(10) Capitalized Interest.................................... (4,746) (9,034)
-------- ----------
(11) Income from Continuing Operations
Before Income Taxes and Fixed Charges................... $ 338,352 $ 972,627
========= ==========
Ratio of Earnings to Fixed Charges (line 11 divided
by line 6).................................................. 1.20 1.79
Preferred Dividends Requirements:
(12) Preferred Stock Dividends................................ $ 195 $ 357
(13) Less Tax Deduction for Preferred Dividends............... 27 54
--------- ---------
(14) Total.................................................... $ 168 $ 303
========= =========
(15) Ratio of Pre-Tax Income from continuing operations
to Net Income (line 7 plus line 8 divided by line 7)..... 4.71 1.73
(16) Line 14 times line 15.................................... $ 791 $ 524
(17) Add Back Tax Deduction (line 13)......................... 27 54
--------- ---------
(18) Preferred Dividends Factor............................... $ 818 $ 578
========= =========
(19) Total Fixed Charges (line 6)............................. $ 281,571 $ 544,773
(20) Preferred Dividends Factor (line 18)..................... 818 578
--------- ---------
(21) Total.................................................... $ 282,389 $ 545,351
========= =========
Ratios of Earnings to Fixed Charges and Preferred
Dividends (line 11 divided by line 21)...................... 1.20 1.78
========= =========
2
EXHIBIT 12
NORAM ENERGY CORP. AND SUBSIDIARIES Exhibit 12
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
Six Twelve
Months Ended Months Ended
June 30, June 30,
1998 1998
------------ ------------
Income from Continuing Operations............................. $ 58,456 $ 56,066
Income Taxes for Continuing Operations........................ 54,863 65,233
Non-Utility Interest Capitalized.............................. 0 0
----------- -----------
Income from Continuing Operations Before
Income Taxes................................................ 113,319 121,299
Fixed Charges:
Interest.................................................... 52,379 110,534
Distribution on Trust Securities............................ 427 1,609
Interest Component of Rentals Charged to Operating
Expenses.................................................. 4,630 9,455
----------- -----------
Total Fixed Charges.................................... 57,436 121,598
----------- -----------
Income from Continuing Operations Before Income
Taxes and Fixed Charges..................................... $ 170,755 $ 242,897
=========== ===========
Ratio of Earnings to Fixed Charges............................ 2.97 2.00
=========== ===========
UT
0000048732
HOUSTON INDUSTRIES INCORPORATED
6-MOS
DEC-31-1998
JUN-30-1998
PER-BOOK
9,629,828
3,530,255
1,265,044
3,980,527
0
18,405,654
2,890,879
0
1,815,435
4,706,314
0
9,740
6,112,983
0
452,800
1,343,987
381,526
0
15,023
1,147
5,382,134
18,405,654
5,375,443
48,462
4,634,381
4,634,381
741,062
(409,644)
331,418
269,891
13,065
195
12,870
210,490
172,521
814,078
$0.05
$0.05
TOTAL ANNUAL INTEREST CHARGES ON ALL BONDS IS AS OF YEAR-TO-DATE 6/30/98.
1
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
2
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
3
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.
4
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.
6
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
====
- ---------------
(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.
8
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.
1
EXHIBIT 12
NORAM ENERGY CORP. AND SUBSIDIARIES Exhibit 12
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
Six Twelve
Months Ended Months Ended
June 30, June 30,
1998 1998
------------ ------------
Income from Continuing Operations............................. $ 58,456 $ 56,066
Income Taxes for Continuing Operations........................ 54,863 65,233
Non-Utility Interest Capitalized.............................. 0 0
----------- -----------
Income from Continuing Operations Before
Income Taxes................................................ 113,319 121,299
Fixed Charges:
Interest.................................................... 52,379 110,534
Distribution on Trust Securities............................ 427 1,609
Interest Component of Rentals Charged to Operating
Expenses.................................................. 4,630 9,455
----------- -----------
Total Fixed Charges.................................... 57,436 121,598
----------- -----------
Income from Continuing Operations Before Income
Taxes and Fixed Charges..................................... $ 170,755 $ 242,897
=========== ===========
Ratio of Earnings to Fixed Charges............................ 2.97 2.00
=========== ===========
UT
0001042773
NORAM ENERGY CORP. AND SUBSIDIARIES
6-MOS
DEC-31-1998
JUN-30-1998
PER-BOOK
1,316,141
1,429,408
992,018
2,240,403
0
5,977,970
1
2,453,162
79,303
2,532,466
0
0
1,213,993
0
300,000
0
199,860
0
0
0
1,731,651
5,977,970
3,142,506
54,863
2,980,917
2,980,917
161,589
4,536
166,125
52,806
58,456
0
58,456
0
52,379
271,883
0
0
TOTAL ANNUAL INTEREST CHARGES ON ALL BONDS IS AS OF YEAR-TO-DATE 6/30/98.
1
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES
(a) 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
====
- ---------------
(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 leasing agreements are included in the
preceding table for only their basic term. Total rental expense for all leases
was $24.0 million, $33.4 million and $48.9 million in 1997, 1996 and 1995,
respectively.
(b) Letters of Credit.
At December 31, 1997, NorAm had letters of credit incidental to its
ordinary business operations totaling approximately $42 million under which
NorAm is obligated to reimburse drawings, if any.
(c) Indemnity Provisions.
At December 31, 1997, NorAm has an $11.4 million accounting reserve on its
Consolidated Balance Sheets in "Estimated obligations under indemnification
provisions of sale agreements" for possible indemnity claims asserted in
connection with its disposition of former subsidiaries or divisions, including
the sale of (i) Louisiana Intrastate Gas Corporation, a former subsidiary
engaged in the intrastate pipeline and liquids extraction business (1992); (ii)
Arkla Exploration Company, a former subsidiary engaged in oil and gas
exploration and production activities (June 1991); and (iii) Dyco Petroleum
Company, a former subsidiary engaged in oil and gas exploration and production
(1991).
(d) Sale of Receivables.
Certain of NorAm's receivables are collateral for receivables which have
been sold pursuant to the terms of NorAm's receivables facility, see
"Receivables Facility" included in Note 4(a).
2
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(e) Gas Purchase Claims.
In conjunction with settlements of "take-or-pay" claims, NorAm has prepaid
for certain volumes of gas, which prepayments have been recorded at their net
realizable value and, to the extent that NorAm is unable to realize at least the
carrying amount as the gas is delivered and sold, NorAm's earnings will be
reduced, although such reduction is not expected to be material. In addition to
these prepayments, NorAm is a party to a number of agreements which require it
to either purchase or sell gas in the future at prices which may differ from
then prevailing market prices or which require it to deliver gas at a point
other than the expected receipt point for volumes to be purchased. To the extent
that NorAm expects that these commitments will result in losses over the
contract term, NorAm has established reserves equal to such expected losses.
(f) Transportation Agreement.
NorAm had an agreement (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 capacity of 250 Mmcf/day, and pursuant
to which ANR had advanced $125 million to NorAm. The ANR Agreement has been
restructured and, after refunds of $50 million and $34 million in 1995 and 1993,
respectively, 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.
(g) Environmental Matters.
To the extent that potential environmental remediation costs are quantified
within a range, NorAm establishes reserves equal to the most likely level of
costs within the range and adjusts such accruals as better information becomes
available. In determining the amount of the liability, future costs are not
discounted to their present value and the liability is not offset by expected
insurance recoveries. If justified by circumstances within NorAm's business
subject to SFAS No. 71, corresponding regulatory assets are recorded in
anticipation of recovery through the rate making process.
Manufactured Gas Plant Sites. NorAm and its predecessors operated a
manufactured gas plant (MGP) adjacent to the Mississippi River in Minnesota
formerly known as Minneapolis Gas Works (FMGW) until 1960. NorAm has completed
remediation of the main site other than ongoing water monitoring and treatment.
There are six other former MGP sites in the Minnesota service territory.
Remediation has been completed on one site. Of the remaining five sites, NorAm
believes that two were neither owned nor operated by NorAm; two were owned by
NorAm at one time but were operated by others and are currently owned by others;
and one site was previously operated by NorAm but was owned by others. NorAm
believes it has no liability with respect to the sites it neither owned nor
operated.
At December 31, 1997, NorAm had estimated a range of $15 million to $77
million for possible remediation of the Minnesota sites. The low end of the
range was determined based on only those sites presently owned or known to have
been operated by NorAm, assuming use of NorAm's proposed remediation methods.
The upper end of the range was determined based on the sites once owned by
NorAm, whether or not operated by NorAm. The cost estimates for the FMGW site
are based on studies of that site. The remediation costs for other sites are
based on industry average costs for remediation of sites of similar size. The
actual remediation costs will be dependent upon the number of sites remediated,
the participation of other potentially responsible parties, if any, and the
remediation methods used.
In its 1995 rate case, NorAm's Minnegasco division was allowed to recover
approximately $7 million annually for remediation costs. Such costs are subject
to a true-up mechanism whereby any over or under recovered amounts, net of
certain insurance recoveries, plus carrying charges, would be deferred for
recovery
3
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
or refund in the next rate case. At December 31, 1997 and 1996, Minnegasco had
recorded a liability of $20.6 million and $35.9 million, respectively, to cover
the cost of future remediation. In addition, at December 31, 1997, Minnegasco
had receivables from insurance settlements of $2.9 million. These insurance
settlements will be collected through 1999. Minnegasco expects that
approximately half of its accrual as of December 31, 1997 will be expended
within the next five years. The remainder will be expended on an ongoing basis
for an estimated 40 years. In accordance with the provisions of SFAS No. 71, a
regulatory asset has been recorded equal to the liability accrued. Minnegasco is
continuing to pursue recovery of at least a portion of these costs from
insurers. Minnegasco believes the difference between any cash expenditures for
these costs and the amount recovered in rates during any year will not be
material to NorAm's overall cash requirements, results of operations or cash
flows.
At December 31, 1997 and 1996, NorAm had recorded an accrual of $3.3
million (with a maximum estimated exposure of approximately $18 million) and an
offsetting regulatory asset for environmental matters in connection with a
former fire training facility and a landfill for which future remediation may be
required. This accrual is in addition to the accrual for MGP sites as previously
discussed.
Issues relating to the identification and remediation of MGPs are common in
the natural gas distribution industry. NorAm has received notices from the EPA
and others regarding its status as a potentially responsible party for other
sites. Based on current information, NorAm has not been able to quantify a range
of environmental expenditures for potential remediation expenditures with
respect to other MGP sites.
Mercury Contamination. Like other natural gas pipelines, NorAm's pipeline
operations have in the past employed elemental mercury in meters used on its
pipelines. Although the mercury has now been removed from the meters, it is
possible that small amounts of mercury have been spilled at some of those sites
in the course of normal maintenance and replacement operations and that such
spills have contaminated the immediate area around the meters with elemental
mercury. Such contamination has been found by NorAm at some sites in the past,
and NorAm has conducted remediation at sites found to be contaminated. Although
NorAm is not aware of additional specific sites, it is possible that other
contaminated sites exist and that remediation costs will be incurred for such
sites. Although the total amount of such costs cannot be known at this time,
based on experience by NorAm and others in the natural gas industry to date and
on the current regulations regarding remediation of such sites, NorAm believes
that the cost of any remediation of such sites will not be material to NorAm's
financial position, results of operation or cash flows.
Potentially Responsible Party Notifications. From time to time NorAm and
its subsidiaries have been notified that they are potentially responsible
parties with respect to properties which environmental authorities have
determined warrant remediation under state or federal environmental laws and
regulations. In October 1994 the United States Environmental Protection Agency
issued such a notice with respect to a landfill site in West Memphis, Arkansas,
and in December 1995, the Louisiana Department of Environmental Quality advised
that one of NorAm subsidiaries had been identified as a potentially responsible
party with respect to a hazardous waste site in Shreveport, Louisiana.
Considering the information currently known about such sites and the involvement
of NorAm or its subsidiaries in activities at these sites, NorAm does not
believe that these matters will have a material adverse effect on NorAm's
financial position, results of operation or cash flows.
(h) Other
NorAm Merger Lawsuit. In August 1996, a purported NorAm stockholder filed a
lawsuit, Shaw v. NorAm Energy Corp., et al., in the District Court of Harris
County, Texas, against NorAm, certain of its officers and directors and the
Company to enjoin the Merger or to rescind the Merger and/or to recover damages
in the event that the Merger was consummated. In February 1998, the plaintiffs
withdrew their lawsuit and the court issued an order of non-suit dismissing the
litigation.
4
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NorAm 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
NorAm's financial statements, if any, from the disposition of these matters will
not be material.
