1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
------------------------------
Commission file number 1-3187
RELIANT ENERGY, INCORPORATED
(Exact name of registrant as specified in its charter)
Texas 74-0694415
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
HOUSTON INDUSTRIES INCORPORATED
(Former name, if changed since last report)
Commission file number 1-13265
RELIANT ENERGY RESOURCES CORP.
(Exact name of registrant as specified in its charter)
Delaware 76-0511406
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
-----------------------------
RELIANT ENERGY RESOURCES CORP. MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q
WITH THE REDUCED DISCLOSURE FORMAT.
Indicate by check mark whether the registrants: (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
As of May 7, 1999, Reliant Energy, Incorporated had 296,330,151 shares of common
stock outstanding, including 11,027,326 ESOP shares not deemed outstanding for
financial statement purposes and excluding 91,521 shares held as treasury stock.
As of May 7, 1999, all 1,000 shares of Reliant Energy Resources Corp. common
stock were held by Reliant Energy, Incorporated.
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THIS COMBINED QUARTERLY REPORT ON FORM 10-Q IS SEPARATELY FILED BY RELIANT
ENERGY, INCORPORATED (COMPANY) AND RELIANT ENERGY RESOURCES CORP. (RESOURCES).
INFORMATION CONTAINED HEREIN RELATING TO RESOURCES IS FILED BY THE COMPANY AND
SEPARATELY BY RESOURCES ON ITS OWN BEHALF. RESOURCES MAKES NO REPRESENTATION AS
TO INFORMATION RELATING TO THE COMPANY (EXCEPT AS IT MAY RELATE TO RESOURCES AND
ITS SUBSIDIARIES) OR ANY OTHER AFFILIATE OR SUBSIDIARY OF THE COMPANY.
RELIANT ENERGY, INCORPORATED
AND RELIANT ENERGY RESOURCES CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Company:
Financial Statements............................................................................1
Statements of Consolidated Operations
Three Months Ended March 31, 1999 and 1998 (Unaudited) .....................................1
Consolidated Balance Sheets
March 31, 1999 (Unaudited) and December 31, 1998............................................2
Statements of Consolidated Cash Flows
Three Months Ended March 31, 1999 and 1998 (Unaudited)......................................4
Statements of Consolidated Retained Earnings and Comprehensive Loss
Three Months Ended March 31, 1999 and 1998 (Unaudited) .....................................6
Notes to Unaudited Consolidated Financial Statements........................................7
Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company......................................................................16
Quantitative and Qualitative Disclosures about Market Risk of the Company......................25
Resources:
Financial Statements...........................................................................27
Statements of Consolidated Income
Three Months Ended March 31, 1999 and 1998 (Unaudited).....................................27
Consolidated Balance Sheets
March 31, 1999 (Unaudited) and December 31, 1998...........................................28
Statements of Consolidated Cash Flows
Three Months Ended March 31, 1999 and 1998 (Unaudited).....................................30
Consolidated Statements of Stockholder's Equity and Comprehensive Income
Three Months Ended March 31, 1999 and 1998 (Unaudited).....................................31
Notes to Unaudited Consolidated Financial Statements.......................................32
Management's Narrative Analysis of the Results of Operations of Resources......................34
PART II. OTHER INFORMATION
Legal Proceeding...............................................................................36
Other Information .............................................................................36
Exhibits and Reports on Form 8-K...............................................................37
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PART I. FINANCIAL INFORMATION
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
----------- -----------
REVENUES:
Electric Operations ................................. $ 849,906 $ 846,562
Natural Gas Distribution ............................ 663,164 716,896
Interstate Pipelines ................................ 66,105 70,981
Wholesale Energy .................................... 1,008,103 891,373
International ....................................... (51,484) 27,246
Corporate ........................................... 235,385 202,833
Eliminations ........................................ (128,275) (124,569)
----------- -----------
Total ............................................. 2,642,904 2,631,322
----------- -----------
EXPENSES:
Fuel and cost of gas sold ........................... 1,417,364 1,278,394
Purchased power ..................................... 328,507 413,037
Operation and maintenance ........................... 399,012 371,640
Taxes other than income taxes ....................... 117,321 109,760
Depreciation and amortization ....................... 190,585 175,599
----------- -----------
Total ............................................. 2,452,789 2,348,430
----------- -----------
OPERATING INCOME ...................................... 190,115 282,892
----------- -----------
OTHER INCOME (EXPENSE):
Unrealized loss on ACES ............................. (331,311) (189,320)
Time Warner dividend income ......................... 10,313 10,313
Other - net ......................................... 702 7,214
----------- -----------
Total ............................................. (320,296) (171,793)
----------- -----------
INTEREST AND OTHER CHARGES:
Interest on long-term debt .......................... 103,854 106,029
Other interest ...................................... 23,339 24,359
Distributions on trust securities ................... 9,791 7,410
Allowance for borrowed funds used during construction (930) (957)
----------- -----------
Total ............................................. 136,054 136,841
----------- -----------
LOSS BEFORE INCOME TAXES AND PREFERRED DIVIDENDS ...... (266,235) (25,742)
INCOME TAX EXPENSE (BENEFIT) .......................... (56,543) 4,276
----------- -----------
NET LOSS .............................................. (209,692) (30,018)
PREFERRED DIVIDENDS ................................... 97 97
----------- -----------
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS .......... $ (209,789) $ (30,115)
=========== ===========
BASIC AND DILUTED LOSS PER COMMON SHARE ............... $ (0.74) $ (0.11)
=========== ===========
See Notes to the Company's Consolidated Financial Statements.
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
MARCH 31, DECEMBER 31,
1999 1998
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents .................................... $ 83,795 $ 29,673
Accounts receivable - net .................................... 768,109 726,377
Accrued unbilled revenues .................................... 104,286 175,515
Time Warner dividends receivable ............................. 10,313 10,313
Fuel stock and petroleum products ............................ 94,737 211,750
Materials and supplies, at average cost ...................... 172,174 171,998
Price risk management assets ................................. 274,390 265,203
Prepayments and other current assets ......................... 50,806 78,342
-------------- --------------
Total current assets ....................................... 1,558,610 1,669,171
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT - AT COST:
Electric ..................................................... 14,088,627 13,969,302
Natural gas distribution and gathering systems ............... 1,732,598 1,686,159
Interstate pipelines ......................................... 1,303,180 1,302,829
Other property ............................................... 85,911 72,299
-------------- --------------
Total ...................................................... 17,210,316 17,030,589
Less accumulated depreciation and amortization ............... 5,661,537 5,499,448
-------------- --------------
Property, plant and equipment - net ........................ 11,548,779 11,531,141
-------------- --------------
OTHER ASSETS:
Goodwill - net ............................................... 2,105,349 2,098,890
Equity investments and advances to unconsolidated affiliates . 906,874 1,051,600
Investment in Time Warner securities ......................... 990,000 990,000
Deferred plant costs - net ................................... 529,341 535,787
Deferred debits .............................................. 426,193 391,495
Unamortized debt expense and premium on reacquired debt ...... 214,420 208,350
Regulatory tax asset - net ................................... 333,130 418,339
Prepaid pension asset ........................................ 104,184 102,021
Price risk management assets ................................. 69,624 21,414
Fuel-related debits .......................................... 53,585 65,278
Recoverable project costs - net .............................. 46,436 55,036
-------------- --------------
Total other assets ......................................... 5,779,136 5,938,210
-------------- --------------
Total .................................................... $ 18,886,525 $ 19,138,522
============== ==============
See Notes to the Company's Consolidated Financial Statements.
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
CAPITALIZATION AND LIABILITIES
MARCH 31, DECEMBER 31,
1999 1998
------------ ------------
CURRENT LIABILITIES:
Notes payable ........................................................ $ 1,738,003 $ 1,812,739
Accounts payable ..................................................... 715,445 807,977
Taxes accrued ........................................................ 205,402 252,581
Interest accrued ..................................................... 117,953 115,201
Dividends declared ................................................... 111,124 111,058
Customer deposits .................................................... 77,847 77,937
Price risk management liabilities .................................... 231,003 227,652
Current portion of long-term debt .................................... 375,497 397,454
Other ................................................................ 218,871 268,343
------------ ------------
Total current liabilities ...................................... 3,791,145 4,070,942
------------ ------------
DEFERRED CREDITS:
Accumulated deferred income taxes .................................... 2,149,360 2,364,036
Benefit obligations .................................................. 340,913 378,747
Unamortized investment tax credit .................................... 323,927 328,949
Price risk management liabilities .................................... 64,892 29,108
Fuel-related credits ................................................. 131,978 88,639
Other ................................................................ 422,575 413,253
------------ ------------
Total deferred credits ......................................... 3,433,645 3,602,732
------------ ------------
CAPITALIZATION:
Long-term debt:
Automatic common exchange securities (ACES) ........................ 2,681,307 2,349,997
Debentures ......................................................... 1,475,492 1,482,050
First mortgage bonds ............................................... 1,715,928 1,865,784
Notes payable ...................................................... 506,083 507,789
Pollution control revenue bonds .................................... 581,385 581,385
Other .............................................................. 13,502 13,743
------------ ------------
Total long-term debt ............................................. 6,973,697 6,800,748
------------ ------------
Company/Resources obligated mandatorily redeemable trust preferred
securities of subsidiary trusts holding solely junior subordinated
debentures of Company/Resources .................................... 717,268 342,232
------------ ------------
Preference stock, none outstanding
Cumulative preferred stock, not subject to mandatory redemption ...... 9,740 9,740
------------ ------------
Common Stock Equity:
Common stock, no par value ......................................... 3,146,137 3,136,826
Treasury stock, at cost ............................................ (2,384) (2,384)
Unearned ESOP shares ............................................... (212,615) (217,780)
Retained earnings .................................................. 1,128,387 1,445,081
Accumulated other comprehensive loss ............................... (98,495) (49,615)
------------ ------------
Total common stock equity ........................................ 3,961,030 4,312,128
------------ ------------
Total capitalization ........................................... 11,661,735 11,464,848
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 1)
Total .......................................................... $ 18,886,525 $ 19,138,522
============ ============
See Notes to the Company's Consolidated Financial Statements.
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------------
1999 1998
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss attributable to common shareholders ............................. $ (209,789) $ (30,115)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation and amortization .......................................... 190,585 175,599
Amortization of nuclear fuel ........................................... 5,811 6,714
Deferred income taxes .................................................. (123,153) (54,104)
Investment tax credit .................................................. (5,022) (5,031)
Unrealized loss on ACES ................................................ 331,311 189,320
Undistributed loss (earnings) of equity investments in unconsolidated
affiliates ........................................................... 74,362 (13,103)
Fuel cost over (under) recovery ........................................ 23,632 (28,381)
Changes in other assets and liabilities:
Accounts receivable - net ............................................ 25,001 193,598
Accounts receivable - IRS ............................................ 140,532
Fuel surcharge ....................................................... 18,837 21,966
Inventory ............................................................ 117,537 31,389
Other current assets ................................................. 27,536 35,222
Accounts payable ..................................................... (92,532) (154,132)
Interest and taxes accrued ........................................... (44,427) (75,694)
Other current liabilities ............................................ (53,415) (51,188)
Net price risk management assets ..................................... (18,262) (6,670)
Other - net .......................................................... (65,786) 48,147
-------------- --------------
Net cash provided by operating activities .......................... 202,226 424,069
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (including allowance for borrowed funds used
during construction) ................................................... (179,039) (108,497)
Equity investment and advances to unconsolidated affiliates .............. 19,361 (4,926)
Other - net .............................................................. (1,716) (9,225)
-------------- --------------
Net cash used in investing activities .............................. $ (161,394) $ (122,648)
-------------- --------------
(Continued on next page)
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------------
1999 1998
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of matured bonds ............................................. $ (1,000)
Proceeds from issuance of trust preferred securities ................. $ 375,000
Proceeds from issuance of debentures ................................. 300,000
Payment of debentures ................................................ (6,042)
Restricted deposit for bond redemption ............................... (290,000)
Proceeds from issuance of pollution control revenue refunding bonds .. 386,757
Payment of common stock dividends .................................... (106,767) (106,448)
Decrease in notes payable - net ...................................... (74,736) (390,307)
Extinguishment of long-term debt ..................................... (170,500) (107,263)
Conversion of convertible securities ................................. (7) (3,255)
Other - net .......................................................... (3,658) (2,551)
-------------- --------------
Net cash provided by (used in) financing activities ............. 13,290 (214,067)
-------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS .............................. 54,122 87,354
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ....................... 29,673 51,712
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............................. $ 83,795 $ 139,066
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) ................................ $ 122,517 $ 145,348
Income taxes ......................................................... 28,308 15,158
See Notes to the Company's Consolidated Financial Statements.
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED RETAINED EARNINGS
AND COMPREHENSIVE LOSS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------
1999 1998
------------------------------ -------------------------------
RETAINED EARNINGS:
Balance at beginning of period............. $ 1,445,081 $ 2,013,055
Net loss................................... (209,789) $ (209,789) (30,115) $ (30,115)
------------- -------------
Total.................................. 1,235,292 1,982,940
Common stock dividends..................... (106,905) (106,505)
------------- -------------
Balance at end of period................... $ 1,128,387 $ 1,876,435
============= =============
ACCUMULATED OTHER COMPREHENSIVE INCOME
(LOSS), NET OF TAX:
Balance at beginning of period............. $ (49,615) $ (6,455)
Foreign currency translation adjustments... (50,978) (50,978) 119 119
Unrealized gain on available for sale
securities.............................. 2,098 2,098 1,379 1,379
------------- -------------
Balance at end of period................... $ (98,495) $ (4,957)
============= =============
------------- -------------
COMPREHENSIVE LOSS........................... $ (258,669) $ (28,617)
============= =============
See Notes to the Company's Consolidated Financial Statements.
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RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Included in this combined Form 10-Q (Form 10-Q) for Reliant Energy,
Incorporated (Company) and for Reliant Energy Resources Corp. (Resources) are
the Company's and Resources' consolidated interim financial statements and notes
(Interim Financial Statements) including such companies' wholly owned and
majority owned subsidiaries. The Interim Financial Statements are unaudited,
omit certain financial statement disclosures and should be read with the
combined Form 10-K of the Company (Company Form 10-K) and Resources (Resources
Form 10-K) for the year ended December 31, 1998. For additional information
regarding the presentation of interim period results, see Note 14 below.
The financial statements for the three months ended March 31, 1998 have
been restated to reflect the Company's and Resources' adoption of mark-to-market
accounting in the fourth quarter of 1998, retroactively to January 1, 1998. See
Note 1(r) of the Company 10-K Notes (as defined below).
The following notes to the financial statements in the Form 10-K relate
to material contingencies. These notes, as updated herein, are incorporated
herein by reference:
Notes to Consolidated Financial Statements of the Company (Company 10-K
Notes): Note 1(c) (Regulatory Assets and Other Long-Lived Assets), Note
1(n) (Investments in Time Warner Securities), Note 1(p) (Foreign
Currency Adjustments), Note 2 (Derivative Financial Instruments), Note
3 (Rate Matters), Note 4 (Jointly Owned Electric Utility Plant), Note 5
(Equity Investments and Advances to Unconsolidated Subsidiaries), Note
12 (Commitments and Contingencies) and Note 16(a) (Foreign Currency
Devaluation).
Notes to Consolidated Financial Statements of Resources (Resources
10-K Notes): Note 1(c) (Regulatory Assets and Regulation), Note 2
(Derivative Financial Instruments) and Note 8 (Commitments and
Contingencies).
(2) FOREIGN CURRENCY ADJUSTMENTS
For information about the Company's foreign currency adjustments, see
Note 1(p) of the Company 10-K Notes. The Company has an indirect 11.69% common
stock interest in Light Servicos de Eletricidade S.A. (Light) and through its
investment in Light, has an 8.753% common stock interest in Metropolitana
Eletricidade de Sao Paulo S.A. (Metropolitana), both in Brazil. The Company
accounts for its investment in Light under the equity method of accounting and
records its proportionate share, based on stock ownership, in the net income of
Light and its affiliates (including Metropolitana) as part of the Company's
consolidated net income.
As of March 31, 1999, Light and Metropolitana had total borrowings of
$2.9 billion in non-local currencies. During the first quarter of 1999, the
Brazilian real was devalued and allowed to float against other major currencies.
The effects of this devaluation on the non-local currency denominated borrowings
caused the Company to record a non-cash, after-tax charge of $91 million in the
first quarter of 1999 as a result of foreign currency transaction losses
recorded by both Light and Metropolitana during the quarter. At March 31, 1999,
one U.S. dollar could be exchanged for 1.72 Brazilian reais. Because the Company
uses the Brazilian real as the functional currency in which it reports Light's
equity earnings, any further decrease in the value of the Brazilian real below
its March 31, 1999 level will increase the liability represented by the
non-local currency denominated borrowings which will also be reflected in the
Company's consolidated earnings, to the extent of the Company's 11.69% ownership
interest in Light. Similarly, any increase in the value of the Brazilian real
above its March 31, 1999 level will decrease the liability represented by such
borrowings.
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As of March 31, 1999, the charge to other comprehensive income was $51 million,
net of tax of $34 million; this $51 million amount reflects the translation
effect of the devaluation on the local currency denominated net assets
underlying the Company's investment in Light.
(3) DEPRECIATION
(a) Company.
The Company calculates depreciation using the straight-line method. The
Company's depreciation expense for the first quarter of 1999 was $139 million,
compared to $127 million for the same period in 1998. For information regarding
the additional depreciation of electric utility generating assets under a
transition to competition plan, see Note 3(b) of the Company 10-K Notes.
(b) Resources.
Resources calculates depreciation using the straight-line method.
Resources' depreciation expense for the first quarter of 1999 and 1998 was $36
million and $34 million, respectively.
(4) COMBINED FINANCIAL STATEMENT DATA OF EQUITY INVESTMENTS AND ADVANCES TO
UNCONSOLIDATED AFFILIATES
The following table sets forth summarized financial information for the
Company's unconsolidated affiliates for the three months ended March 31, 1999
and 1998.
THREE MONTHS ENDED MARCH 31,
---------------- --- ----------------
1999 1998
---------------- ----------------
(IN MILLIONS)
Revenues.................................................................. $ 1,143 $ $635
Operating Expenses........................................................ 831 442
Net Income (Loss)......................................................... (673) 131
Dividends received from these affiliates equaled $2.1 million and $3.6
million for the first quarter of 1999 and 1998, respectively.
(5) CHANGE IN ACCOUNTING PRINCIPLE
The Company and Resources adopted Emerging Issues Task Force 98-10,
"Accounting for Contracts Involved in Energy Trading and Risk Management
Activities" (EITF 98-10) on January 1, 1999 for the energy trading activities of
Reliant Energy Services, Inc. The adoption of EITF 98-10 had no material impact
on the Company's or Resources' consolidated financial statements.
(6) TIME WARNER SECURITIES INVESTMENT
The Company owns 11 million shares of Time Warner Inc. (Time Warner)
convertible preferred stock (TW Preferred). The Company has the right to convert
the TW Preferred at any time into 45.8 million shares of Time Warner common
stock (TW Common).
The TW Preferred historically has paid the Company a quarterly pre-tax
dividend of $10.3 million. On July 6, 1999, the TW Preferred will cease to pay a
preferred dividend. After that date, the Company expects to convert the TW
Preferred into TW Common.
In 1997, in order to monetize a portion of the cash value of its investment
in TW Preferred, the Company sold 22.9 million of its unsecured 7% Automatic
Common Exchange Securities (ACES). The
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market value of ACES is linked to the market value of TW Common. In July 2000,
the ACES will be mandatorily exchangeable for, at the Company's option, either
shares of TW Common or an equivalent amount in cash. The exchange rates are
determined as follows:
TW WARNER COMMON PRICE ACES PAYMENT AMOUNT
- -------------------------------------- --------------------------------------
Below $ 22.96875.......................... 1.0 share of TW Common
$22.96875 - $27.7922......................$ 22.96875, or the fractional
share equivalent
Above $27.7922............................ 1.6528 shares of TW Common
By issuing the ACES, the Company effectively eliminated its economic
exposure to decreases in the price of TW Common below $22.96875. In addition,
the Company retained 100% of any increase in TW Common price up to $27.7922 per
share and 17% of any increase in market price above $27.7922. The closing price
per share of TW Common on March 31, 1999, was $70.81.
Prior to the conversion of the TW Preferred, any increase in the market
value of TW Common above $27.7922 is treated for accounting purposes as an
increase in the payment amount of the ACES equal to 83% of the increase in the
market price per share and is recorded by the Company as a non-cash expense.
This expense is not offset, however, by the change in the economic value of the
TW Common underlying the TW Preferred. As a result, the Company recorded in the
first quarter of 1999 a non-cash, unrealized accounting loss of $331 million
(which resulted in an after-tax earnings reduction of $215 million, or $0.76 per
share); this correlates to the $401 million increase in the market value of TW
Common during the quarter. The Company believes the combined unrealized loss for
the ACES of $1.6 billion is more than economically hedged by the approximately
$2.3 billion unrecorded unrealized gain at March 31, 1999 relating to the
increase in market value of the TW Common since the acquisition of the TW
Preferred.
Following the conversion of TW Preferred into TW Common, the current
accounting treatment of the ACES and the Company's investment in the TW Common
will change. After conversion, the Company will begin to record changes in the
market price of the TW Common and the related changes in the market value of the
ACES as a component of common stock equity and other comprehensive income. Upon
the sale or other disposition of the TW Common, the Company is expected to
record a gain equal to the amount realized on the sale less the book value of
the TW Preferred recorded on its balance sheet. The book value is $990 million
or approximately $21 per share of TW Common.
(7) CAPITAL STOCK
(a) Common Stock.
The Company has 700,000,000 authorized shares of common stock. At March
31, 1999, the Company had 296,421,672, shares of common stock issued
(285,302,825 outstanding). At December 31, 1998, the Company had 296,271,063
shares of common stock issued (284,494,195 outstanding). Outstanding common
shares exclude (i) shares pledged to secure a loan to the Company's Employee
Stock Ownership Plan (11,027,326 and 11,674,063 at March 31, 1999 and December
31, 1998, respectively) and (ii) treasury shares (91,521 and 102,805 at March
31, 1999 and December 31, 1998, respectively), which are shares received by the
Company in partial payment of exercised options.
Subject to market and other conditions, the Company has the authority
to repurchase up to $89 million of its common stock under a repurchase program
approved in 1996. Any repurchase depends on market conditions, might not be
announced in advance and may be made in open market or privately negotiated
transactions.
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(b) Earnings Per Share.
The following table presents the Company's basic and diluted earnings
per share (EPS) calculation:
FOR THE THREE MONTHS ENDED MARCH 31,
------------------------------------
1999 1998
------------- -------------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
Basic and Diluted EPS Calculation:
Loss before preferred dividends....................................... $ (209,692) $ (30,018)
Less: preferred dividends............................................. 97 97
------------- -------------
Net loss attributable to common shareholders......................... $ (209,789) $ (30,115)
============= =============
Weighted average shares outstanding (1)............................... 284,967 283,528
Loss per share before preferred dividends............................. $ (0.74) $ (0.11)
------------- -------------
Net loss per share attributable to common shareholders................ $ (0.74) $ (0.11)
============= =============
- ----------
(1) Assumed conversions were not included in the computation of diluted
earnings per share because additional shares outstanding would result
in an anti-dilutive per share amount. The computation for the 1999
period excludes 730,000 shares of restricted stock, 27,000 shares for
assumed conversion of debentures and purchase options for 661,000
shares of common stock, which would be anti-dilutive if exercised. The
computation for the 1998 period excludes 492,000 shares of restricted
stock, 359,000 shares for assumed conversion of debentures and purchase
options for 235,000 shares of common stock, which would be
anti-dilutive if exercised.
(c) Preferred Stock.
At March 31, 1999 and December 31, 1998, the Company had 10,000,000
authorized shares of preferred stock, of which 97,397 shares of $4.00 Preferred
Stock were outstanding. The 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 March 31, 1999 and December 31, 1998, the Company had 10,000,000
authorized shares of preference stock, of which 700,000 shares are classified as
Series A Preference Stock, 27,000 shares are classified as Series B Preference
Stock and 1,575 are classified as Series C Preference Stock. At March 31, 1999
and December 31, 1998, there were no shares of Series A Preference Stock issued
and outstanding (such shares being issuable in accordance with the Company's
Shareholder Rights Agreement upon the occurrence of certain events) and 17,000
shares of Series B Preference Stock issued and outstanding. At March 31, 1999,
there were no shares of Series C Preference Stock issued and outstanding (due to
a redemption of 1,575 shares in March 1999). The Series B Preference Stock is
not deemed outstanding for financial reporting purposes, because the sole holder
of such series is a wholly owned financing subsidiary of the Company.
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13
(8) COMPANY/RESOURCES OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED
SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED
DEBENTURES OF THE COMPANY/RESOURCES
(a) Company.
In the first quarter of 1999, the Company, through the use of a
Delaware statutory business trust (REI Trust I), registered $500 million of
trust preferred securities and related junior subordinated debt securities. In
February 1999, REI Trust I issued $375 million of preferred securities to the
public and $11.6 million of common securities to the Company. The preferred
securities have a distribution rate of 7.20% payable quarterly in arrears, a
stated liquidation amount of $25 per preferred security and must be redeemed by
March 2048. REI Trust I used the proceeds to purchase $386.6 million aggregate
principal amount of subordinated debentures (REI Debentures) from the Company
having an interest rate and maturity date that correspond to the distribution
rate and mandatory redemption date of the preferred securities. The Company used
the proceeds from the sale of the REI Debentures for general corporate purposes,
including the repayment of short-term debt. The Company accounts for REI Trust I
as a wholly owned consolidated subsidiary. The REI Debentures are the trust's
sole asset and its entire operations. The Company has fully and unconditionally
guaranteed, on a subordinated basis, all of REI Trust I's obligations with
respect to the preferred securities. The preferred securities are mandatorily
redeemable upon the repayment of the REI Debentures at their stated maturity or
earlier redemption. Subject to certain limitations, the Company has the option
of deferring payments of interest on the REI Debentures. During any period of
deferral or event of default, the Company may not pay dividends on its capital
stock. Under the registration statement, $125 million of these securities remain
available for issuance. The issuance of all securities registered by the Company
and its affiliates is subject to market and other conditions.
For information regarding $250 million of preferred securities and $100
million of capital securities previously issued by statutory business trusts
formed by the Company, see Note 9(a) of the Company 10-K Notes. The sole asset
of each trust consists of junior subordinated debentures of the Company 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.
(b) Resources.
For information regarding $177.8 million of convertible preferred
securities previously issued by a statutory business trust formed by Resources,
of which $1.0 million was outstanding at March 31, 1999, see Note 5 of Resources
10-K Notes. The sole asset of the trust consists of junior subordinated
debentures of Resources having an interest rate and maturity date corresponding
to the preferred securities, and the principal amount corresponding to the
common and preferred securities issued by the trust.
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14
(9) LONG-TERM DEBT AND SHORT-TERM FINANCING
(a) Company.
(i) Consolidated Debt.
The Company's consolidated long-term and short-term debt outstanding is
summarized in the following table.
MARCH 31, 1999 DECEMBER 31, 1998
------------------------------- -------------------------------
LONG-TERM CURRENT LONG-TERM CURRENT
------------- ------------- ------------- -------------
(IN MILLIONS)
Short-Term Borrowings (1):
Commercial Paper............................ $ 1,436 $ 1,360
Lines of Credit............................. 150
Resources Receivables Facility.............. 300 300
Notes Payable............................... 2 3
------------- ------------- ------------- -------------
Total Short-Term Borrowings................... 1,738 1,813
------------- ------------- ------------- -------------
Long-Term Debt - net:
ACES $ 2,681 $ 2,350
Debentures (2)(3)........................... 1,476 1,482
First Mortgage Bonds (2).................... 1,716 150 1,866 170
Pollution Control Bonds..................... 581 581
Resources Medium-Term Notes (3)............. 176 178
Notes Payable (3)........................... 330 224 330 226
Capital Leases.............................. 14 1 14 1
------------- ------------- ------------- -------------
Total Long-Term Debt.......................... 6,974 375 6,801 397
------------- ------------- ------------- -------------
Total Long-Term and Short-Term Debt......... $ 6,974 $ 2,113 $ 6,801 $ 2,210
============= ============= ============= =============
- ----------
(1) Includes amounts due within one year of the date noted.
(2) Includes unamortized discount related to debentures of approximately
$0.5 million at March 31, 1999 and $1 million at December 31, 1998 and
unamortized premium related to debentures of approximately $17 million
at March 31, 1999 and December 31, 1998, respectively. The unamortized
discount related to first mortgage bonds was approximately $10 million
at March 31, 1999 and $10 million at December 31, 1998.
(3) Includes unamortized premium related to fair value adjustments of
approximately $17.6 million and $18.1 million for debentures at March
31, 1999 and December 31, 1998, respectively. The unamortized premium
for Resources long-term notes was approximately $11 million and $12
million at March 31, 1999 and December 31, 1998, respectively. The
unamortized premium for long-term and current notes payable was
approximately $3 million and $2 million at March 31, 1999 and $3
million each at December 31, 1998, respectively.
Consolidated maturities of long-term debt and sinking fund requirements
for the Company (including Resources) are approximately $222 million for the
remainder of 1999.
(ii) Financing Developments.
At March 31, 1999, a financing subsidiary of the Company had $1.293
billion in commercial paper borrowings supported by a $1.644 billion revolving
credit facility. At March 31, 1999, the weighted average interest rate of these
commercial paper borrowings was 5.12%. On March 2, 1999, another financing
subsidiary of the Company terminated a credit agreement under which it had
borrowed $150 million. Funds for the repayment of the loan were indirectly
obtained from the issuance of commercial
12
15
paper by a separate financing subsidiary. For additional information regarding
the Company's and its subsidiaries' financings, see Note 8(c) and (d) of the
Company 10-K Notes.
In February 1999, the Company repaid at maturity $25.4 million and
$145.1 million of its Series A medium-term notes with interest rates of 9.85%
and 9.80%, respectively.
(b) Resources.
As of March 31, 1999, Resources had outstanding $2.0 billion of
long-term and short-term debt. Consolidated maturities of long-term debt and
sinking fund requirements for Resources are approximately $200 million for the
remainder of 1999.
In the first quarter of 1999, Resources purchased $6.04 million of its
6% convertible subordinated debentures due 2012 at an average purchase price of
98.3% of the aggregate principal amount, plus accrued interest. Resources plans
to use the purchased debentures to satisfy March 2000 and 2001 sinking fund
requirements of the 6% convertible subordinated debentures. For more information
regarding Resources' financing arrangements, lease commitments and letters of
credit, see Notes 4 and 8 (a) and (b) of the Resources 10-K Notes.
For information regarding Resources' $300 million receivables facility,
see Note 4(a) of the Resources 10-K Notes. At March 31, 1999, Resources had sold
$300 million of receivables under the facility. The weighted average interest
rate was 4.88%.
For information regarding Resources' $350 million revolving credit
facility, see Note 4(a) of the Resources 10-K Notes. In March 1999, this
facility was amended to include a $65 million sub-facility under which letters
of credit may be obtained. At March 31, 1999, there were no commercial paper
borrowings or loans outstanding under the facility and letters of credit issued
under the facility aggregated $14.6 million.
(10) RATE MATTERS
For information about regulatory matters affecting the Company's
electric utility operations, including information about the Company's current
rate caps and depreciation schedules (Transition Plan) and a pending appeal
regarding part of the Transition Plan, see Note 3 of the Company 10-K Notes.
Under the terms of the Transition Plan, if in the current session of the Texas
legislature no legislation is adopted setting electric utility rates for the
year 2000, the Company will be required to file a rate case no later than May 1,
2000, with rates to be effective as of June 1, 2000, unless prior to that date a
rate settlement is negotiated. For information regarding legislative proposals
before the Texas legislature, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations of the Company - Certain Factors
Affecting Future Earnings - Legislative Proposals."
(11) ACQUISITIONS
On March 29, 1999, the Company and one of its subsidiaries, N.V.
Energieproduktiebedrijf UNA, a Dutch electric generating company (UNA), and the
shareholders of UNA entered into an agreement providing for the initial
acquisition of 40% of the capital stock of UNA by a subsidiary of the Company.
The purchase price for the initial 40% interest is Dutch guilders (NLG) 1.6
billion (U.S. $840 million). The purchase price for the remaining 60% of UNA is
approximately NLG 2.7 billion (U.S. $1.4 billion) and is expected to be paid no
later than December 31, 2006. Depending on the timing of regulatory approvals
and other conditions, the acquisition of the remaining interest could occur
significantly earlier than 2006.
All purchase price obligations are denominated in Dutch guilders. The
amounts shown above are subject to adjustment and assume a conversion rate of
NLG 1.88 per U.S. Dollar. It is
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16
anticipated that the closing of the initial 40% interest will occur in June
1999, subject to receipt of various Dutch regulatory approvals and the
satisfaction of other closing conditions.
UNA is one of four large Dutch generators with approximately 3,400
megawatts of generating capacity, representing nearly 20% of the Dutch market.
It operates a mix of gas, coal and cogeneration plants in the Amsterdam and
Utrecht areas.
(12) REPORTABLE SEGMENTS
In accordance with SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," the Company has identified the following
reportable segments: Electric Operations, Natural Gas Distribution, Interstate
Pipelines, Wholesale Energy, International and Corporate. Electric Operations
provides electric utility generation, transmission, distribution and sales to
customers. Natural Gas Distribution operations consist of natural gas utility
sales to, and natural gas utility transportation for, residential, commercial
and industrial customers. Interstate Pipelines operates two interstate natural
gas pipelines. Wholesale Energy is engaged in the acquisition, development and
operation of, and sale of capacity and energy from, non-utility power generation
facilities and in the wholesale energy trading and marketing and natural gas
gathering businesses. International invests in foreign electric and gas utility
operations, to date primarily in Latin America. Corporate includes a non-rate
regulated retail service business, certain real estate holdings and corporate
expenses.
Financial data for business segments, products and services and
geographic areas are as follows:
ELECTRIC NATURAL GAS INTERSTATE WHOLESALE INTER- RECONCILING
OPERATIONS DISTRIBUTION PIPELINES ENERGY NATIONAL CORPORATE ELIMINATIONS CONSOLIDATED
---------- ------------ --------- ------ -------- --------- ------------ ------------
(IN THOUSANDS)
For the Three Months Ended
March 31, 1999:
Revenues from non-affiliates... $ 849,906 $ 662,876 $ 26,481 $ 938,882 $ (51,484)$ 216,243 $ 2,642,904
Intersegment revenues.......... 288 39,624 69,221 19,142 $ (128,275)
Operating income (loss)........ 144,480 98,100 27,893 1,178 (77,900) (3,636) 190,115
For the Three Months Ended
March 31, 1998:
Revenues from non-affiliates... 846,562 716,575 33,232 828,165 27,246 179,542 2,631,322
Intersegment revenues.......... 321 37,748 63,209 23,291 (124,569)
Operating income (loss)........ 142,611 101,604 32,073 513 10,980 (4,889) 282,892
Reconciliation of Operating Income to Net Income (in thousands):
THREE MONTHS ENDED MARCH 31,
-------------------------------------
1999 1998
---------------- ----------------
Operating income.......................................................... $ 190,115 $ 282,892
Dividend income........................................................... 10,313 10,313
Interest expense.......................................................... (127,193) (130,388)
Unrealized loss on ACES................................................... (331,311) (189,320)
Distribution on trust securities.......................................... (9,791) (7,410)
Income tax benefit (expense).............................................. 56,543 (4,276)
Other income ............................................................. 1,535 8,074
--------------- ---------------
Net loss attributable to common shareholders.............................. $ (209,789) $ (30,115)
=============== ===============
(13) SUBSEQUENT EVENTS
In April 1999, the Gulf Coast Waste Disposal Authority (GCWDA) issued
on behalf of the Company $19.2 million of revenue refunding bonds having an
annual interest rate of 4.70%. The
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17
GCWDA bonds will mature in 2011, and proceeds from the issuance will be used on
June 1, 1999 to redeem all outstanding 7.0% GCWDA Series 1989A collateralized
revenue refunding bonds ($19.2 million) at a redemption price of 102% of their
aggregate principal amount.
In April 1999, the Matagorda County Navigation District Number One
(MCND) issued on behalf of the Company $100 million of revenue refunding bonds
having an annual interest rate of 5.25%. The MCND bonds will mature in 2026, and
proceeds from the issuance will be used on July 1, 1999 to redeem all
outstanding 7.125% MCND Series 1989C collateralized revenue refunding bonds
($100 million) at a redemption price of 102% of their aggregate principal
amount.
In April 1999, the Brazos River Authority (BRA) issued on behalf of the
Company $100 million of revenue refunding bonds having an annual interest rate
of 5.375%. The BRA bonds will mature in 2019, and proceeds from the issuance
will be used on July 1, 1999 to redeem all outstanding 7.625% BRA Series 1989A
collateralized revenue refunding bonds ($100 million) at a redemption price of
102% of their aggregate principal amount.
(14) COMPANY/RESOURCES INTERIM PERIOD RESULTS; RECLASSIFICATIONS
The Company's and Resources' Interim Financial Statements reflect all
normal recurring adjustments that are, in the opinion of management, necessary
to present fairly the financial position and results of operations for the
respective periods. Amounts reported in the Company Consolidated Statements of
Operations and Resources 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) seasonal variations in energy consumption, (ii) timing
of maintenance and other expenditures and (iii) 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 and Resources' presentation
of financial statements in the current year. These reclassifications do not
affect their respective earnings.
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18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY
The following should be read in combination with the unaudited
consolidated financial statements and notes thereto.
Reliant Energy, Incorporated (Company), together with various divisions
and subsidiaries, including Reliant Energy Resources Corp. (Resources), is a
diversified international energy services company. The Company reports its
financial information in six segments. The Company's Electric Operations segment
operates the nation's tenth largest utility in terms of kilowatt-hour (KWH)
sales. The Natural Gas Distribution segment includes the gas utility operations
of Resources and is the third largest such operation in the U.S. in terms of
number of customers served. The Interstate Pipelines segment operates two
interstate natural gas pipelines. The Wholesale Energy segment is engaged in the
acquisition, development and operation of, and sale of capacity and energy from,
non-utility power generation facilities, and in the wholesale energy trading and
marketing and natural gas gathering businesses. The International segment
invests in foreign electric and gas utility operations, to date primarily in
Latin America. The Corporate segment includes a non-rate regulated retail
service business, certain real estate holdings and corporate expenses.
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- ----------------
(in millions, except per share data)
Revenues............................................. $ 2,643 $ 2,631 --
Operating Expenses................................... 2,453 2,348 4%
Operating Income..................................... 190 283 (33%)
Other Expenses (1)................................... 320 172 86%
Interest and Other Charges........................... 136 137 (1%)
Income Tax Expense (Benefit)......................... (57) 4 --
Net Loss (1)......................................... (210) (30) --
Basic and Diluted Loss Per Share (1) ................ (.74) (.11) --
- ----------------
(1) Other Expenses and Net Loss reflect the after-tax effect of a $331 million
non-cash, unrealized accounting loss recorded in the three months ended
March 31, 1999 compared to a $189 million non-cash, unrealized accounting
loss in the three months ended March 31, 1998 relating to the Company's 7%
Automatic Common Exchange Securities (ACES). See Note 6 to the Company's
Interim Financial Statements.
First Quarter of 1999 Compared to First Quarter of 1998. The Company
reported a consolidated net loss of $210 million ($0.74 per share) for the first
quarter of 1999 compared to a consolidated net loss of $30 million ($0.11 per
share) in the first quarter of 1998. The 1999 results reflect a $215 million
after-tax, non-cash, unrealized accounting loss on the ACES and a $91 million
after-tax, non-cash loss due to the devaluation of the Brazilian real. The 1998
results reflect a $123 million, after-tax, non-cash unrealized accounting loss
on the ACES.
After adjusting for the charges described above, the Company would have
had consolidated net income of $97 million ($0.34 per share) in the first
quarter of 1999 and $92 million ($0.33 per share) in the first quarter of 1998.
The $5 million increase was primarily due to improved results from trading
activities at Wholesale Energy and increased revenues from customer growth and
higher energy usage at the Electric Operations segment. These effects were
partially offset by milder weather at the Natural Gas Distribution segment and
base rate credits at Electric Operations.
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The Company's income tax benefit for the first quarter of 1999 was $57
million. In addition, an income tax benefit of $49 million is reflected in
International's revenues relating to the Company's interest in its Brazilian
subsidiaries' foreign currency transaction losses resulting from the devaluation
described above.
The table below shows operating income (loss) by segment.
THREE MONTHS ENDED MARCH 31,
-------------------------------------
1999 1998
---------------- ----------------
(IN MILLIONS)
Electric Operations....................................................... $ 144 $ 143
Natural Gas Distribution.................................................. 98 102
Interstate Pipelines...................................................... 28 32
Wholesale Energy.......................................................... 1 1
International............................................................. (78) 11
Corporate................................................................. (3) (6)
--------------- ---------------
Total Consolidated.................................................. $ 190 $ 283
=============== ===============
ELECTRIC OPERATIONS
Electric Operations are conducted under the name Reliant Energy 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.
THREE MONTHS ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- ----------------
(IN MILLIONS)
Operating Revenues:
Base Revenues (1)................................. $ 568 $ 555 2%
Reconcilable Fuel Revenues (2).................... 282 292 (3%)
--------------- ---------------
Total Operating Revenues........................ 850 847 --
--------------- ---------------
Operating Expenses:
Fuel and Purchased Power Expense.................. 292 305 (4%)
Operation and Maintenance Expense................. 220 214 3%
Depreciation and Amortization Expense............. 136 130 5%
Other Operating Expenses.......................... 58 55 5%
--------------- ---------------
Total Operating Expenses........................ 706 704 --
--------------- ---------------
Operating Income.................................... $ 144 $ 143 1%
=============== ===============
Electric Sales (MWH):
Residential....................................... 3,825,764 3,597,021 6%
Commercial ....................................... 3,616,675 3,424,350 6%
Industrial - Firm................................. 6,167,900 6,367,979 (3%)
Municipal and Public Utilities.................... 75,295 81,389 (7%)
--------------- ---------------
Total Firm Billed Sales........................... 13,685,634 13,470,739 2%
--------------- ---------------
Average Cost of Fuel (Cents/MMBtu) ................. 171.5 172.6 (1%)
- ----------
(1) Includes miscellaneous revenues (including transmission revenues) and
certain purchased power-related revenues.
(2) Includes revenues collected through a fixed fuel factor and surcharge, net
of over/under recovery.
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20
In the first quarter of 1999, Electric Operations' operating income
increased $1 million over the same period of 1998. This increase was primarily
due to higher revenues from customer growth, offset by additional base rate
credits under Reliant Energy HL&P's transition to competition plan. Reliant
Energy HL&P's earnings are capped at an overall rate of return on a calendar
year basis as part of its transition plan approved by the Public Utility
Commission of Texas in June 1998. As a result of this plan, any earnings above
the maximum allowed return cap of 9.844 percent on invested capital will be
offset by additional depreciation of Reliant Energy HL&P's generation assets.
Electric Operations recorded additional depreciation expense of $12.5 million
for each of the first quarters of 1999 and 1998, as provided by the plan.
Electric Operations' increase in base revenues of $13 million for the
three months ended March 31, 1999, compared to the same period of 1998, is
primarily the result of customer growth. The increase in revenues was partially
offset by $6 million of additional base rate credits compared to the first
quarter of 1998. For information regarding the transition plan, see Note 3(b) of
the Company 10-K Notes.
As approved by the Texas Public Utility Commission, effective July 1,
1998, the Company implemented a fixed fuel factor and a temporary fuel surcharge
in the amount of $125 million to be collected over 12 to 18 months. As of March
31, 1999, Electric Operations' cumulative under-recovery of fuel costs was $1
million, including interest.
Fuel and purchased power expenses for the three months ended March 31,
1999 decreased by $13 million over the 1998 period primarily due to a decline in
the average unit cost of natural gas (from $2.43 to $1.95 per MMBtu), coal (from
$1.94 to $1.89 per MMBtu), and nuclear fuel (from $.49 to $.46 per MMBtu).
Operation and maintenance, and other operating expenses for the first
quarter of 1999 increased by $9 million compared to the 1998 period. The
increase is largely due to the timing of employee benefit expense and increased
material and supply expense.
NATURAL GAS DISTRIBUTION
Natural Gas Distribution operations are conducted through three
divisions of Resources: Reliant Energy Arkla, Reliant Energy Entex and Reliant
Energy Minnegasco. These operations consist of intrastate 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.
QUARTER ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- ----------------
(IN MILLIONS)
Operating Revenues:
Base Revenues..................................... $ 252 $ 262 (4%)
Recovered Gas Revenues............................ 411 455 (10%)
--------------- ---------------
Total Operating Revenues........................ 663 717 (8%)
--------------- ---------------
Operating Expenses:
Natural Gas....................................... 414 458 (10%)
Operation and Maintenance......................... 93 98 (5%)
Depreciation and Amortization..................... 33 32 3%
Other Operating Expenses.......................... 25 27 (7%)
--------------- ---------------
Total Operating Expenses........................ 565 615 (8%)
--------------- ---------------
Operating Income.................................... $ 98 $ 102 (4%)
=============== ===============
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21
QUARTER ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- ----------------
Throughput Data (in Bcf):
Residential and Commercial Sales.................. 124 126 (2%)
Industrial Sales.................................. 14 15 (7%)
Transportation.................................... 13 13 --
--------------- ---------------
Total Throughput................................ 151 154 (2%)
=============== ===============
Natural Gas Distribution operating income decreased by $4 million in
the first quarter of 1999 compared to the 1998 period due primarily to milder
weather partially offset by reduced operation and maintenance expenses.
The decreases in recovered gas revenues and purchased gas costs reflect
a lower average cost of gas and decreased sales volume due to milder weather in
1999. The decrease in operation and maintenance expense is primarily the result
of cost control initiatives at Natural Gas Distribution.
INTERSTATE PIPELINES
The Interstate Pipelines segment provides interstate gas transportation
and related services to customers. These operations are conducted by Reliant
Energy Gas Transmission Company and Mississippi River Transmission Corporation,
two wholly owned subsidiaries of Resources.
QUARTER ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- ----------------
(IN MILLIONS)
Operating Revenues.................................. $ 66 $ 71 (7%)
Operating Expenses:
Natural Gas....................................... 5 8 (38%)
Operation and Maintenance......................... 17 17 --
Depreciation and Amortization..................... 12 9 33%
Other Operating Expenses.......................... 4 5 (20%)
--------------- ---------------
Total Operating Expenses........................ 38 39 (3%)
--------------- ---------------
Operating Income.................................... 28 32 (13%)
=============== ===============
Throughput Data (in MMBtu):
Natural Gas Sales................................. 4 4 --
Transportation.................................... 231 237 (3%)
Elimination (1)................................. (4) (4) --
--------------- ---------------
Total Throughput.................................... 231 237 (3%)
=============== ===============
- ------------------
(1) Elimination of volumes both transported and sold.
Interstate Pipelines operating income decreased by $4 million in the
first quarter of 1999 compared to the 1998 period due to a rate settlement,
reflected in the 1998 quarter as a $5 million reduction of depreciation rates
retroactive to July 1996. Operating income declined $4 million over the 1998
period primarily due to decreased volumes due to mild weather and reduced
transportation margins. Expenses, other than purchased gas, were $2 million
higher in the 1999 period as a result of the net effect of the rate settlement
described above.
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22
WHOLESALE ENERGY
Wholesale Energy includes the acquisition, development and operation
of, and sales of capacity and energy from, non-utility power generation
facilities; wholesale energy trading and marketing; and natural gas gathering
activities. This segment includes operations owned by the Company and Resources.
QUARTER ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- ----------------
(IN MILLIONS)
Operating Revenues.................................. $ 1,008 $ 891 13%
Operating Expenses:
Natural Gas....................................... 706 565 25%
Purchased Power................................... 241 301 (20%)
Operation and Maintenance......................... 52 21 148%
Depreciation and Amortization..................... 6 2 200%
Other Operating Expenses.......................... 2 1 100%
--------------- ---------------
Total Operating Expenses........................ 1,007 890 13%
--------------- ---------------
Operating Income.................................... $ 1 $ 1 --
=============== ===============
Operations Data:
Natural Gas (in Bcf):
Sales 363 264 38%
Gathering......................................... 61 58 5%
--------------- ---------------
Total........................................... 424 322 32%
=============== ===============
Electricity (in thousand MWH):
Wholesale Power Sales............................. 10,268 13,770 (25%)
=============== ===============
Wholesale Energy experienced significantly higher operating income from
its trading and marketing activities, offset by increased operating and
maintenance expenses of the California power plants, which began operations
after the first quarter of 1998. The operations of the California plants are
seasonal with the plants running primarily in the third quarter of the year.
Wholesale Energy operating revenues increased $117 million primarily
due to an increase in gas sales volume partially offset by a decrease in the
average sales price of gas and lower power sales volumes.
Wholesale Energy purchased natural gas costs increased $141 million in
the first quarter of 1999 due to an increase in gas sales volume in 1999,
partially offset by a lower average sales price of gas. Wholesale Energy's
purchased power expense decreased $60 million primarily due to lower power sales
volume.
Operation and maintenance expense for Wholesale Energy increased $31
million due to operating expenses of the California plants and staffing
increases.
To minimize the Company's risks associated with fluctuations in the
price of natural gas and transportation, the Company, primarily through Reliant
Energy Services, Inc. (a subsidiary of Resources), enters into futures
transactions, swaps and options relating to (i) certain commitments to buy, sell
and transport natural gas, (ii) existing natural gas and heating oil inventory,
(iii) future power sales and natural gas purchases by generation facilities,
(iv) crude oil and refined products and (v) certain anticipated transactions,
some of which carry off-balance sheet risk. Reliant Energy Services also enters
into commodity derivatives in its trading and price risk management activities.
For a discussion of the Company's accounting treatment of derivative
instruments, see Note 2 of the Company 10-K Notes and Item 7A (Quantitative and
Qualitative Disclosure About Market Risk) in the Company's Form 10-K.
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23
INTERNATIONAL
The International segment includes Reliant Energy International, Inc. (a
wholly owned subsidiary of the Company) and the international operations of
Resources. Substantially all of International's operations to date have been
in Latin America.
QUARTER ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- ----------------
(IN MILLIONS)
Operating Revenues.................................. (51) 27 -
Operating Expenses:
Fuel.............................................. 12 5 140%
Operation and Maintenance......................... 14 10 40%
Depreciation and Amortization..................... 1 1 -
--------------- ---------------
Total Operating Expenses........................ 27 16 69%
--------------- ---------------
Operating Income (Loss)............................. $ (78) $ 11 -
=============== ===============
International had an operating loss of $78 million in the first quarter
of 1999 compared to operating income of $11 million in the same period of 1998.
The 1999 loss reflects a $91 million after-tax, non-cash charge relating to the
Company's share of foreign exchange losses incurred by its Brazilian affiliates,
Light and Metropolitana, with respect to their non-local currency denominated
borrowings. Such devaluation losses stem from the Brazilian government's January
1999 decision to allow the Brazilian real to float against other foreign
currencies. Excluding the devaluation loss, operating income for the first
quarter of 1999 would have been $13 million. This increase in operating income
was primarily due to increased earnings from equity investments and the
completion of a 160-megawatt cogeneration facility in Argentina which commenced
operation in November 1998. For more information regarding risks of the
Company's international operations, see "Certain Factors Affecting Future
Earnings - Risks of International Operations" below.
Fuel expenses and operation and maintenance expenses were higher in the
first quarter of 1999 compared to the 1998 period primarily due to the
completion of the facility in Argentina described above.
CORPORATE
In the first quarter of 1999, Corporate had an operating loss of $3 million
compared to a loss of $6 million in 1998, reflecting improved results from
non-rate regulated retail and consumer services.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on developments, factors and trends that may have an
impact on the Company's future earnings, please read "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 Company's Form 10-K, which is incorporated herein by reference. Among the
factors discussed are: "Competition and Restructuring of the Electric Utility
Industry," "Competition - Other Operations," "Fluctuation In Commodity Prices
and Derivative Instruments," "Accounting Treatment of ACES," "Impact of the Year
2000 Issue and Other System Implementation Issues," "Risks of International
Operations," "Environmental Expenditures" and "Other Contingencies." Certain
updated information contained in the Notes to the Company's Interim Financial
Statements is referenced below.
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, a portion of the
increase in the market value above $27.7922 per
21
24
share of Time Warner common stock (the security into which the TW Preferred is
convertible) results in unrealized accounting losses to the Company, pending the
conversion of the Company's TW Preferred into Time Warner common stock.
Excluding the unrealized, non-cash accounting loss for ACES, the Company's
retained earnings and total common stock equity would have been $2.2 billion and
$5.0 billion, respectively, at March 31, 1999. For additional information
regarding the accounting treatment of the ACES and the TW Preferred, see Note 6
to the Company's Interim Financial Statements.
LEGISLATIVE PROPOSALS
A number of proposals to restructure the electric utility industry have
been introduced in the 1999 session of the Texas legislature. Many of these
proposals would result in, among other things, the legislature freezing rates
through 2001 and requiring a reduction in rates in 2002. For more information,
see Note 10 to the Company's Interim Financial Statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Certain Factors Affecting Future Earnings of the Company and its Subsidiaries -
Competition and Restructuring of the Electric Utility Industry" in the Company
Form 10-K. To date, no legislation has been passed and the Company cannot
predict what, if any, action the Texas legislature may take or the ultimate form
in which such proposals may be adopted, if at all. The Texas legislative session
is scheduled to end in May 1999. Because the proposed legislation is intended
to fundamentally restructure electric utility operations, it is likely that
enactment of any of the proposed legislation would have a material impact on
Electric Operations and the Company.
IMPACT OF THE YEAR 2000 AND OTHER SYSTEM IMPLEMENTATION ISSUES
For a description of the Company's Year 2000 and other system
implementation issues, 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 the Company Form 10-K.
All of the Company's and its subsidiaries' business units have
completed a Year 2000 Project 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. The following table illustrates the Company's completion percentages for
the Year 2000 activities as of April 30, 1999:
PRIORITY 1 PRIORITY 2 PRIORITY 3
---------- ---------- ----------
Assessment............................... 99% 96% 96%
Conversion............................... 99% 76% 91%
Testing.................................. 91% 69% 87%
Implementation........................... 90% 59% 75%
Total direct costs of resolving the Year 2000 issue with respect to the Company
and its subsidiaries are expected to be between $35 and $40 million and include
approximately $16 million spent through the first quarter of 1999.
The Company is in the process of implementing SAP America, Inc.'s (SAP)
proprietary R/3 enterprise software. 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. Portions of the SAP system were
implemented in December 1998 and March 1999, and it is expected that the final
portion of the SAP system will be fully implemented by August 2000. The cost of
implementing the SAP system is currently estimated to be approximately $182
million, inclusive of internal costs, but that estimate could be revised upward
by 10% to 25%. As of March 31, 1999, $136 million has been spent on the
implementation.
RISKS OF INTERNATIONAL OPERATIONS
The Company's international operations are subject to various risks
incidental to investing or operating in emerging market countries. These risks
include political risks, such as government instability, and economic risks,
such as fluctuations in currency exchange rates, restrictions on the
repatriation of foreign earnings and/or restrictions on the conversion of local
currency earnings into U.S. dollars. The Company's international operations are
also highly capital intensive and significantly dependent on the availability of
bank financing and other sources of capital on commercially acceptable terms.
For more information on the risks of international operations, see "Qualitative
and Quantitative Disclosures About Market Risk of the Company" herein and Note 2
to the Company's Interim Financial Statements and "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-Risks of
International Operations" in the Company form 10-K.
LIQUIDITY AND CAPITAL RESOURCES
For the first quarter of 1999, the Company's net cash provided by
operating activities decreased $222 million over the same period in 1998
primarily due to a $141 million tax refund received in the 1998 period.
22
25
Net cash used in investing activities increased $39 million in the
first quarter of 1999 compared to the same period of 1998, primarily due to
increased capital expenditures in Electric Operations related to an acceleration
of capital projects performed during maintenance outages.
Net cash used in financing activities for the first quarter of 1999
reflected a $13 million inflow compared to a $214 million outflow for the same
period of 1998. The cash inflow in 1999 included the proceeds from the issuance
of trust preferred securities offset by the payment of long-term debt, notes
payable and common stock dividends.
The following tables provide information about the Company's and
Resources' unused sources of capital at March 31, 1999 and repayments and
financings that occurred in the first quarter of 1999.
UNUSED SOURCES OF CAPITAL AT MARCH 31, 1999
SOURCE AVAILABILITY
------ ------------
(IN MILLIONS)
COMPANY:
Revolving Credit Facility (1)...................................... $ 200
Shelf registration statements (2).................................. 230 preferred stock
580 debt securities
125 trust preferred securities and
related junior subordinated debt
securities
FINANCECO LP:
$1.6 billion revolving credit facility (3)......................... 351
RESOURCES:
Revolving credit facility (4)...................................... 335
- ----------------
(1) Supports up to $200 million of commercial paper borrowings.
(2) Issuance of securities under the shelf registration statements is subject
to market and other conditions.
(3) Supports up to $1.6 billion of commercial paper borrowings.
(4) Supports commercial paper borrowings and has a $65 million subfacility,
which may be used for letters of credit. At March 31, 1999, there were
$14.6 million of letters of credit issued.
23
26
FIRST QUARTER 1999 REPAYMENTS AND REPURCHASES
TYPE OF DEBT AMOUNT
----------------
(IN MILLIONS)
COMPANY:
9.85% Series A medium term notes............................................................... $ 25.4
9.80% Series A medium term notes............................................................... 145.1
FINANCECO LP:
Credit agreement (1)........................................................................... 150.0
RESOURCES:
6.0% Convertible subordinated debentures due 2012 (2).......................................... 6.0
- ------------------
(1) This credit facility was repaid and terminated on March 2, 1999.
(2) The average purchase price was 98.3%. These debentures will be used to
partially fund the sinking fund for the 6% convertible subordinated
debentures in March 2000 and March 2001. In the first quarter of 1999,
Resources satisfied the $6.5 million sinking fund requirement using
debentures purchased in 1998.
FIRST QUARTER 1999 FINANCINGS
DISTRIBUTION/
ENTITY AMOUNT INTEREST RATE
- ------ ------------- -------------
(IN MILLIONS)
COMPANY:
REI Trust I(1) $375 preferred securities 7.2%
$11.6 common securities
RESOURCES:
Receivables facility $300 receivables sold 4.88% (2)
- ------------------
(1) This trust is a Delaware statutory business trust established by the
Company. Proceeds from the sale were used to purchase $386.6 million of
7.2% subordinated debentures due March 2048 from the Company. Proceeds
from the sale of the debentures were used for general corporate
purposes, including repayment of short-term debt.
(2) Weighted average rate on sale proceeds as of March 31, 1999.
As of March 31, 1999, Light and Metropolitana had $2.9 billion in
non-local currency denominated borrowings. In April 1999, approximately $1.2
billion was refinanced in U.S. Dollar denominated loans, which expire within one
year to 14 months, and $300 million was funded through a 60-day local currency
loan. The short-term loan is guaranteed by a subsidiary of the Company and
certain other shareholders of Light and is expected to be repaid through capital
contributions. The Company expects that its portion of the capital contributions
will be approximately $30 million to $35 million and will be made in the second
quarter of 1999.
The Company has a "money fund" through which it and its subsidiaries
can borrow or invest on a short-term basis. Funding needs 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. At March 31, 1999, Resources had $214.1 million in
investments in this fund.
In April 1999, the Company completed the following financings:
24
27
ENTITY AMOUNT INTEREST RATE MATURITY DATE
------ ------ ------------- -------------
(MILLIONS)
Gulf Coast Waste Disposal Authority
(GCWDA)(1) $19.2 revenue refunding bonds 4.70% 2011
Matagorda County Navigation District Number
One (MCND)(2) $100 revenue refunding bonds 5.25% 2026
Brazos River Authority (BRA)(3) $100 revenue refunding bonds 5.375% 2019
- ---------------
(1 On behalf of the Company. Proceeds will be used June 1, 1999 to redeem
$19.2 million 7% GCWDA Series 1989A collateralized revenue refunding bonds
at a price of 102%.
(2) On behalf of the Company. Proceeds will be used July 1, 1999 to redeem $100
million 7.125% MCND Series 1989C collateralized revenue refunding bonds at
a price of 102%.
(3) On behalf of the Company. Proceeds will be used July 1, 1999 to redeem $100
million 7.625% BRA Series 1989A collateralized revenue refunding bonds at a
price of 102%.
In July 1999, $200 million of Resources' 8.875% Notes will mature.
Resources will repay the notes with proceeds from the liquidation of
investments, cash generated by operations and/or newly issued commercial paper.
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
In the first quarter of 1999, the Company and Resources adopted the
Emerging Issues Task Force of the Financial Accounting Standards Board Issue No.
98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management
Activities" (EITF Issue 98-10). EITF Issue 98-10 requires energy trading
contracts to be recorded at fair value on the balance sheet, with the changes in
fair value included in earnings. The implementation of EITF Issue 98-10 did not
have an effect on the Company's or Resources' consolidated financial statements
since Reliant Energy Services adopted mark-to-market accounting in 1998.
In 2000, the Company and Resources expect to adopt SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133),
which establishes accounting and reporting standards for derivative instruments,
including certain hedging instruments embedded in other contracts (collectively
referred to as derivatives) and for hedging activities. The Company and
Resources are in the process of determining the effect of adoption of SFAS No.
133 on its consolidated financial statements.
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, foreign currency exchange rate risk and energy commodity prices, see
Item 7A of the Company's Form 10-K. These risks have not materially changed from
the market risks disclosed in the Company's Form 10-K. As described in
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations of the Company," the Company reported a $91 million charge to net
income and a $51 million charge to other comprehensive income, due to the
devaluation of the Brazilian real. The charge to net income reflects increases
in the liabilities at Light and Metropolitana for their non-local currency
denominated borrowings using the exchange rate in effect at March 31, 1999
25
28
and an average exchange rate for the quarter. The charge to other comprehensive
income reflects the translation effect on the local currency denominated net
assets underlying the Company's investment in Light. As of March 31, 1999, the
Brazilian real exchange rate was 1.72 per U.S. dollar. An increase of 10% from
the March 31, 1999 exchange rate would result in the Company recording an
additional charge of $21 million and $12 million to net income and other
comprehensive income, respectively.
In the first quarter of 1999, the Company recorded an additional $215
million unrealized loss (net of tax) related to the ACES. For further discussion
of this loss, see Note 6 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 March 31, 1999 market value of $70.81
per share would result in the recognition of an additional unrealized accounting
loss (net of tax) of approximately $174 million.
26
29
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------------
1999 1998
------------- -------------
REVENUES.................................................................. $ 1,828,064 $ 1,754,541
------------- -------------
EXPENSES:
Natural gas and purchased power, net.................................... 1,443,683 1,381,036
Operation and maintenance............................................... 153,914 151,609
Depreciation and amortization........................................... 50,018 44,730
Taxes other than income taxes........................................... 30,272 33,672
------------- -------------
1,677,887 1,611,047
------------- -------------
OPERATING INCOME.......................................................... 150,177 143,494
------------- -------------
OTHER INCOME (EXPENSE):
Interest expense, net................................................... (29,662) (26,900)
Dividend requirement on preferred securities of subsidiary trust........ (99) (268)
Other -- net............................................................ 3,031 2,556
------------- -------------
(26,730) (24,612)
------------- -------------
INCOME BEFORE INCOME TAXES................................................ 123,447 118,882
INCOME TAX EXPENSE........................................................ 52,474 57,054
------------- -------------
NET INCOME................................................................ $ 70,973 $ 61,828
============= =============
See Notes to Resources' Consolidated Financial Statements.
27
30
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
MARCH 31, DECEMBER 31,
1999 1998
------------- -------------
CURRENT ASSETS:
Cash and cash equivalents............................................. $ 50,407 $ 26,576
Accounts and notes receivable, principally customer................... 738,326 682,552
Unbilled revenue...................................................... 73,505 145,131
Accounts and notes receivable - affiliated companies.................. 264,170 193,177
Gas in underground storage............................................ 20,267 79,855
Materials and supplies................................................ 33,245 33,947
Gas purchased in advance of delivery.................................. 6,200 6,200
Fuel stock and petroleum products..................................... 81,230
Price risk management assets.......................................... 274,390 265,203
Other current assets.................................................. 32,971 33,034
------------- -------------
Total current assets................................................ 1,493,481 1,546,905
------------- -------------
PROPERTY, PLANT AND EQUIPMENT:
Natural gas distribution and gathering systems........................ 1,732,598 1,686,159
Interstate pipelines.................................................. 1,303,180 1,302,829
Other 13,406 13,976
------------- -------------
Total............................................................... 3,049,184 3,002,964
Less accumulated depreciation and amortization........................ 220,854 187,936
------------- -------------
Property, plant and equipment -- net.................................. 2,828,330 2,815,028
------------- -------------
OTHER ASSETS:
Goodwill, net......................................................... 2,037,101 2,050,386
Prepaid pension asset................................................. 104,184 102,021
Investment in marketable equity securities............................ 14,086 10,800
Regulatory asset for environmental costs.............................. 20,529 20,695
Gas purchased in advance of delivery.................................. 20,791 22,207
Price risk management assets.......................................... 69,624 21,414
Deferred debits, net.................................................. 89,178 66,065
------------- -------------
Total other assets.................................................. 2,355,493 2,293,588
------------- -------------
TOTAL ASSETS............................................................ $ 6,677,304 $ 6,655,521
============= =============
See Notes to Resources' Consolidated Financial Statements.
28
31
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS) -- (CONTINUED)
(UNAUDITED)
LIABILITIES AND STOCKHOLDER'S EQUITY
MARCH 31, DECEMBER 31,
1999 1998
------------- -------------
CURRENT LIABILITIES:
Current maturities of long-term debt.................................. $ 201,965 $ 203,438
Receivables facility.................................................. 300,000 300,000
Accounts payable, principally trade................................... 501,743 622,262
Accounts payable - affiliated companies............................... 47,286
Interest payable...................................................... 29,673 36,197
Other taxes........................................................... 40,277 42,107
Customer deposits..................................................... 36,903 36,985
Price risk management liabilities..................................... 231,003 227,652
Other current liabilities............................................. 176,015 172,616
------------- -------------
Total current liabilities....................................... 1,564,865 1,641,257
------------- -------------
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes..................................... 518,622 511,070
Estimated environmental remediation costs............................. 20,529 20,695
Payable under capacity lease agreement................................ 41,000 41,000
Benefit obligations................................................... 154,224 158,762
Refundable excess deferred income taxes............................... 12,009 12,246
Price risk management liabilities..................................... 64,892 29,108
Other 159,472 164,438
------------- -------------
Total deferred credits and other liabilities...................... 970,748 937,319
------------- -------------
RESOURCES-OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED
SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED
DEBENTURES OF RESOURCES, NET......................................... 1,144 1,157
------------- -------------
LONG-TERM DEBT, LESS CURRENT MATURITIES................................. 1,504,977 1,513,289
------------- -------------
STOCKHOLDER'S EQUITY:
Common stock.......................................................... 1 1
Paid-in capital....................................................... 2,463,831 2,463,831
Retained earnings..................................................... 185,644 114,671
Accumulated other comprehensive income................................ (13,906) (16,004)
------------- -------------
Total stockholder's equity........................................ 2,635,570 2,562,499
------------- -------------
COMMITMENTS AND CONTINGENCIES (NOTE 1)
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY........................... $ 6,677,304 $ 6,655,521
============= =============
See Notes to Resources' Consolidated Financial Statements.
29
32
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------------
1999 1998
------------- -------------
Cash Flows from Operating Activities:
Net income............................................................ $ 70,973 $ 61,828
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization....................................... 50,018 44,730
Deferred income taxes............................................... 4,500 14,785
Changes in other assets and liabilities:
Accounts and notes receivable - net................................. (59,641) 88,460
Inventories......................................................... 141,926 29,930
Other current assets................................................ (18,501) 16,238
Accounts payable.................................................... (73,233) (133,074)
Interest and taxes accrued.......................................... 55,116 41,956
Other current liabilities........................................... (47,769) (15,216)
Net price risk management activities................................ (18,262) (6,670)
Other - net......................................................... (24,188) 34,471
------------- -------------
Net cash provided by operating activities....................... 80,939 177,438
------------- -------------
Cash Flows from Investing Activities:
Capital expenditures.................................................. (45,540) (38,639)
Other - net.......................................................... (1,769) 2,371
------------- -------------
Net cash used in investing activities........................... (47,309) (36,268)
============= =============
Cash Flows from Financing Activities:
Retirements and reacquisitions of long-term debt...................... (6,042) (1,000)
Other debt repayments................................................. (417,027)
Proceeds from issuance of debentures.................................. 300,000
Redemption of convertible securities.................................. (7) (3,255)
Other - net........................................................... (3,750) (3,905)
------------- -------------
Net cash used in financing activities............................. (9,799) (125,187)
------------- -------------
Net Increase in Cash and Cash Equivalents............................... 23,831 15,983
Cash and Cash Equivalents at Beginning of the Period.................... 26,576 35,682
------------- -------------
Cash and Cash Equivalents at End of the Period.......................... $ 50,407 $ 51,665
============= =============
Supplemental Disclosure of Cash Flow Information:
Cash Payments:
Interest (net of amounts capitalized)................................. $ 30,939 $ 39,194
Income taxes - net.................................................... (2,549) (13,792)
See Notes to Resources' Consolidated Financial Statements.
30
33
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY AND COMPREHENSIVE INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ACCUMULATED
OTHER TOTAL TOTAL
COMMON STOCK RETAINED COMPRE- STOCK- COMPRE-
--------------------------- PAID IN EARNINGS HENSIVE HOLDER'S HENSIVE
SHARES AMOUNT CAPITAL (DEFICIT) INCOME EQUITY INCOME
----------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 1997.. 1,000 $ 1 $2,463,831 $ 20,847 $ (5,634) $2,479,045
Net Income.................... 61,828 61,828 $ 61,828
Change in Market Value of
Marketable Equity
Securities, net tax of
($781)...................... 1,379 1,379 1,379
----------
Comprehensive Income 63,207
----------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at March 31, 1998..... 1,000 1 2,463,831 82,675 (4,255) 2,542,252
----------- ---------- ---------- ---------- ---------- ----------
Net Income.................... 31,996 31,996 31,996
Change in Market Value of
Marketable Equity
Securities, net tax of
$6,658...................... (11,749) (11,749) (11,749)
----------
Comprehensive Income.......... 20,247
----------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 1998.. 1,000 1 2,463,831 114,671 (16,004) 2,562,499
=========== ========== ========== ========== ========== ==========
Net Income.................... 70,973 70,973 70,973
Change in Market Value of
Marketable Equity
Securities, net tax of
($1,189) 2,098 2,098 2,098
----------
Comprehensive Income.......... $ 73,071
----------- ---------- ---------- ---------- ---------- ---------- ----------
Balance at March 31, 1999..... 1,000 $ 1 $2,463,831 $ 185,644 $ (13,906) $2,635,570
=========== ========== ========== ========== ========== ==========
See Notes to Resources' Consolidated Financial Statements.
31
34
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The Notes to the unaudited consolidated financial statements of Reliant
Energy Resources Corp. are included in the Notes to the unaudited consolidated
financial statements of Reliant Energy, Incorporated (Company) as follows and
are incorporated herein by reference:
(1) BASIS OF PRESENTATION -- see Company Note 1.
(2) DEPRECIATION -- see Company Note 3 (b).
(3) CHANGE IN ACCOUNTING PRINCIPLE -- see Company Note 5.
(4) COMPANY/RESOURCES OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED
SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED
DEBENTURES OF THE COMPANY/RESOURCES -- see Company Note 8(b).
(5) LONG-TERM DEBT AND SHORT-TERM FINANCING -- see Company Note 9(b).
(6) REPORTABLE SEGMENTS
Effective January 1, 1998, Resources adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information" (SFAS No. 131). Because
Resources is a wholly owned subsidiary of the Company, Resources has determined
its reportable segments based in part on the operating units under which its
parent manages sales to wholesale or retail customers in differing regulatory
environments. The segment financial data include information for the Company and
Resources on a combined basis, except for Electric Operations, which has no
Resources operations, and International, which has minimal Resources operations.
Reconciling items included under the caption "Elimination of Non-Resources
Operations" reduce the amounts by those operations not conducted within the
Resources legal entity. Operations not owned or operated by Resources, but
included in segment information before elimination, include primarily the
operations of the Company's non-rate regulated power generation business, and
non-Resources corporate expenses.
In accordance with SFAS No. 131, the Company has identified the
following reportable segments: Electric Operations, Natural Gas Distribution,
Interstate Pipelines, Wholesale Energy, International and Corporate. See Note 12
to the Company's Interim Financial Statements for a description of these
segments.
ELIMINATION OF
NON-
NATURAL GAS INTERSTATE WHOLESALE CORPORATE RECONCILING RESOURCES
DISTRIBUTION PIPELINES ENERGY AND OTHER ELIMINATIONS(1) OPERATIONS CONSOLIDATED
------------ --------- ------ --------- --------------- ---------- ------------
(THOUSANDS OF DOLLARS)
For the Three Months Ended
March 31, 1999:
Revenues from non-affiliates....$ 662,876 $ 26,481 $ 938,882 $ 216,243 $ (16,418) $ 1,828,064
Intersegment revenues........... 288 39,624 69,221 19,142 $ (128,275)
Operating income................ 98,100 27,893 1,178 (3,636) 26,642 150,177
For the Three Months Ended
March 31, 1998:
Revenues from non-affiliates.... 716,575 33,232 828,165 179,542 (2,973) 1,754,541
Intersegment revenues........... 321 37,748 63,209 23,291 (124,569)
Operating income................ 101,604 32,073 513 (4,889) 14,193 143,494
- ----------
(1) Includes data for operations conducted at the parent level. This data is
eliminated for purposes of the consolidated data at the Resources level.
32
35
Reconciliation of Operating Income to Net Income:
THREE MONTHS ENDED MARCH 31,
-------------------------------------
1999 1998
--------------- ---------------
(THOUSANDS OF DOLLARS)
Operating income.......................................................... $ 150,177 $ 143,494
Interest expense.......................................................... (29,662) (26,900)
Distribution on preferred trust securities................................ (99) (268)
Income tax expense........................................................ (52,474) (57,054)
Other income, net......................................................... 3,031 2,556
--------------- ---------------
Net income................................................................ $ 70,973 $ 61,828
=============== ===============
(7) COMPANY/RESOURCES INTERIM PERIOD RESULTS; RECLASSIFICATIONS -- see
Company Note 14.
33
36
MANAGEMENT'S NARRATIVE ANALYSIS OF
THE RESULTS OF OPERATIONS OF RESOURCES
Resources reports its financial information in the following segments:
Natural Gas Distribution, Interstate Pipelines, Wholesale Energy (through which
Resources conducts the energy trading and marketing operations and natural gas
gathering operations, but does not conduct the operations of Reliant Energy
Power Generation, Inc.) and Corporate. Although Resources has international
operations, they are not significant.
Resources meets the conditions specified in General Instruction H to Form
10-Q and is permitted to use the reduced disclosure format for wholly owned
subsidiaries of reporting companies. Accordingly, Resources has omitted from
this report the information called for by Item 3 (quantitative and qualitative
disclosure about market risk) of Part I and the following Part II items of Form
10-Q: Item 2 (changes in securities and use of proceeds), Item 3 (defaults upon
senior securities) and Item 4 (submission of matters to a vote of security
holders). The following discussion explains material changes in the amount of
revenue and expense items of Resources between the first quarter of 1999 and the
first quarter of 1998. Reference is made to Management's Narrative Analysis of
the Results of Operations in Item 7 of Resources' Form 10-K, the Resources 10-K
Notes referred to herein and Resources' Interim Financial Statements contained
in this Form 10-Q.
CONSOLIDATED RESULTS OF OPERATIONS
QUARTER ENDED MARCH 31,
------------------------------------- PERCENT
1999 1998 CHANGE
---------------- ---------------- -------------
(THOUSANDS OF DOLLARS)
Operating Revenues................................... $ 1,828,064 $ 1,754,541 4%
Operating Expenses................................... 1,677,887 1,611,047 4%
Operating Income, Net................................ 150,177 143,494 5%
Interest Expense, Net................................ 29,662 26,900 10%
Distributions on Subsidiary Trust Securities......... 99 268 (63%)
Other Income, Net.................................... 3,031 2,556 19%
Income Tax Expense................................... 52,474 57,054 (8%)
---------------- ----------------
Net Income......................................... $ 70,973 $ 61,828 15%
================ ================
First Quarter of 1999 Compared to First Quarter of 1998. Resources' net
income increased $9 million in the first quarter of 1999 compared to the 1998
period primarily due to increased operating income of $7 million related to
improved trading and marketing results at Wholesale Energy. This increase was
partially offset by a decrease in operating income at Natural Gas Distribution
due to warmer weather and at Interstate Pipelines due to a rate settlement,
which resulted in $5 million of reduced depreciation expense recorded in the
first quarter of 1998.
Resources' revenues increased approximately $74 million due primarily
to increased trading activities at Wholesale Energy offset by decreases at
Natural Gas Distribution due to the effects of warmer weather. Resources'
operating expenses increased $67 million due largely to increases in gas sales
at Wholesale Energy.
The decrease in income taxes in the first quarter of 1999 is
attributable to decreases in non-deductible expenditures and state tax expenses.
To minimize risks associated with fluctuations in the price of natural
gas and transportation, Resources, through its subsidiary, Reliant Energy
Services, Inc., enters into futures transactions, swaps and options relating to
(i) certain commitments to buy, sell and transport natural gas, (ii) existing
natural gas and heating oil inventory, (iii)
34
37
crude oil and refined products and (iv) certain anticipated transactions, some
of which carry off-balance sheet risk. Reliant Energy Services also enters into
commodity derivatives in its trading and price risk management activities. For a
discussion of the accounting treatment of derivative instruments, see Note 2 of
Resources 10-K Notes and Item 7A (Quantitative and Qualitative Disclosure About
Market Risk) in the Company's Form 10-K.
Seasonality and Other Factors. Resources' results of operations are
affected by seasonal fluctuations in the demand for and, to a lesser extent, the
price of natural gas. Resources' 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 Resources and its
subsidiaries, competition in Resources' various business operations, debt
service costs and income tax expense. For a discussion of certain other factors
that may affect Resources' 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 - Competition - Other Operations," "- Fluctuations in Commodity
Prices and Derivative Instruments," "- Environmental Expenditures" and "- Other
Contingencies" in the Company's Form 10-K.
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
the Company's Form 10-Q for a discussion of certain new accounting issues
affecting Resources.
35
38
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Company:
For a description of legal proceedings affecting the Company
and its subsidiaries, please review Item 3 of the Company Form
10-K and Notes 3(b), 12(h) and 12(i) of the Company 10-K
Notes, which are incorporated herein by reference.
Resources:
For a description of legal proceedings affecting Resources,
please review Note 8(g) of the Resources 10-K Notes, which is
incorporated herein by reference.
ITEM 5. OTHER INFORMATION.
Forward-Looking Statements. From time to time, the Company and
Resources 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 Resources 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 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 structures 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 Resources; (iii) the weather and other natural phenomena; (iv) the
timing and extent of changes in commodity prices and interest rates;
(v) changes in environmental and other laws and regulations to which
the Company, Resources and their respective subsidiaries are subject or
other external factors over which the Company and Resources have no
control; (vi) the results of financing efforts; (vii) growth in
opportunities for the Company's and Resources' subsidiaries and
diversified operations; (viii) risks incidental to the Company's
overseas operations (including the effects of fluctuations in foreign
currency exchange rates); (ix) the effect of the Company's and
Resources' accounting policies; (x) the timing of the closing of the
Company's acquisition of an interest in UNA; and (xi) other factors
discussed in this and other filings by the Company and Resources with
the Securities and Exchange Commission.
When used in the Company's or Resources' documents or oral
presentations, the words "anticipate," estimate," "expect,"
"objective," "projection," "forecast," "goal" or similar words are
intended to identify forward-looking statements.
36
39
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Company:
Exhibit 3 Amendment to the Company's Articles of
Incorporation.
Exhibit 10.1 Employment Agreement effective as of June 1, 1999,
between the Company and Don D. Jordan.
Exhibit 10.2 Share Subscription Agreement dated March 29, 1999
among Reliant Energy Wholesale Holdings (Europe)
Inc., Provincie Noord Holland, Gemeente Amsterdam,
N.V. Provinciaal En Gemeenelijk Utrechts
Stroomleveringsbedrijf, Reliant Energy Power
Generation, Inc. and UNA
Exhibit 10.3 Share Purchase Agreement dated March 29, 1999
among Reliant Energy Wholesale Holdings (Europe)
Inc., Provincie Noord Holland, Gemeente Amsterdam,
N.V. Provinciaal En Gemeenelijk Utrechts
Stroomleveringsbedrijf, Reliant Energy Power
Generation, Inc. and UNA.
Exhibit 12 Ratio of Earnings to Fixed Charges and Preferred
Dividends.
Exhibit 27 Financial Data Schedule.
Exhibit 99 Items incorporated by reference from the Company
Form 10-K: Item 3 "Legal Proceedings." Item 7
"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" and "- New
Accounting Issues." and Item 7A "Quantitative and
Qualitative Disclosures About Market Risk." Note
1(c) (Regulatory Assets and Other Long-Lived
Assets), Note 1(n) (Investments in Time Warner
Securities), Note 1(p) (Foreign Currency
Adjustments), Note 1(r) (Change in Accounting
Principle), Note 2 (Derivative Financial
Instruments), Note 3 (Rate Matters), Note 4
(Jointly Owned Electric Utility Plant), Note 5
(Equity Investments and Advances to Unconsolidated
Subsidiaries), Note 8(c) (FinanceCo and FinanceCo
II Credit Facilities), Note 8(d) (Company Credit
Facility), Note 9(a) (Trust Securities - Company),
Note 12 (Commitments and Contingencies) and Note
16(a) (Foreign Currency Devaluation) of the
Company 10-K Notes.
Resources:
Exhibit 12 Ratio of Earnings to Fixed Charges.
Exhibit 27 Financial Data Schedule.
Exhibit 99 Items incorporated by reference from Resources
Form 10-K: Item 3 "Legal Proceedings." Item 7
"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" and "- New
Accounting Issues." Item 7A "Quantitative and
Qualitative Disclosures About Market Risk." Item
7 "Management's Narrative Analysis of the Results
of Operations of Reliant Energy Resources Corp.
and Consolidated Subsidiaries." Note 1(c)
(Regulatory Assets and Regulation), Note 2
(Derivative Financial Instruments), Note 4
(Long-Term and Short-Term Financing), Note 5
(Trust Securities); and Note 8 (Commitments and
Contingencies) of Resources 10-K Notes.
(b) Reports on Form 8-K.
Company:
Form 8-K dated January 26,1999 (filed February 1, 1999) filing press
release regarding currency devaluation in Brazil.
Form 8-K dated February 23, 1999 (filed February 26, 1999) regarding
the issuance and sale of 7.20% Trust Original Preferred Securities,
Series C.
Resources:
None.
37
40
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RELIANT ENERGY, INCORPORATED
(Registrant)
By: /s/ Mary P. Ricciardello
-----------------------------------
Mary P. Ricciardello
Vice President and Comptroller
(Principal Accounting Officer)
Date: May 14, 1999
38
41
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RELIANT ENERGY RESOURCES CORP.
(Registrant)
By: /s/ Mary P. Ricciardello
-----------------------------------
Mary P. Ricciardello
Vice President and Comptroller
(Principal Accounting Officer)
Date: May 14, 1999
39
42
Exhibit Index
EXHIBIT
NUMBER DESCRIPTION
------- -----------
Company
Exhibit 3 Amendment to the Company's Articles of
Incorporation.
Exhibit 10.1 Employment Agreement effective as of June 1, 1999,
between the Company and Don D. Jordan.
Exhibit 10.2 Share Subscription Agreement dated March 29, 1999
among Reliant Energy Wholesale Holdings (Europe)
Inc., Provincie Noord Holland, Gemeente Amsterdam,
N.V. Provinciaal En Gemeenelijk Utrechts
Stroomleveringsbedrijf, Reliant Energy Power
Generation, Inc. and UNA.
Exhibit 10.3 Share Purchase Agreement dated March 29, 1999
among Reliant Energy Wholesale Holdings (Europe)
Inc., Provincie Noord Holland, Gemeente Amsterdam,
N.V. Provinciaal En Gemeenelijk Utrechts
Stroomleveringsbedrijf, Reliant Energy Power
Generation, Inc. and UNA.
Exhibit 12 Ratio of Earnings to Fixed Charges and Preferred
Dividends.
Exhibit 27 Financial Data Schedule.
Exhibit 99 Items incorporated by reference from the Company
Form 10-K: Item 3 "Legal Proceedings." Item 7
"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" and "- New
Accounting Issues." and Item 7A "Quantitative and
Qualitative Disclosures About Market Risk." Note
1(c) (Regulatory Assets and Other Long-Lived
Assets), Note 1(n) (Investments in Time Warner
Securities), Note 1(p) (Foreign Currency
Adjustments), Note 1(r) (Change in Accounting
Principle), Note 2 (Derivative Financial
Instruments), Note 3 (Rate Matters), Note 4
(Jointly Owned Electric Utility Plant), Note 5
(Equity Investments and Advances to Unconsolidated
Subsidiaries), Note 8(c) (FinanceCo and FinanceCo
II Credit Facilities), Note 8(d) (Company Credit
Facility), Note 9(a) (Trust Securities - Company),
Note 12 (Commitments and Contingencies) and Note
16(a) (Foreign Currency Devaluation) of the
Company 10-K Notes.
Resources
Exhibit 12 Ratio of Earnings to Fixed Charges.
Exhibit 27 Financial Data Schedule.
Exhibit 99 Items incorporated by reference from Resources
Form 10-K: Item 3 "Legal Proceedings." Item 7
"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" and "- New
Accounting Issues." Item 7A "Quantitative and
Qualitative Disclosures About Market Risk." Item
7 "Management's Narrative Analysis of the Results
of Operations of Reliant Energy Resources Corp.
and Consolidated Subsidiaries." Note 1(c)
(Regulatory Assets and Regulation), Note 2
(Derivative Financial Instruments), Note 4
(Long-Term and Short-Term Financing), Note 5
(Trust Securities); and Note 8 (Commitments and
Contingencies) of Resources 10-K Notes.
1
EXHIBIT 3
ARTICLES OF AMENDMENT
TO THE
RESTATED ARTICLES OF INCORPORATION
OF
HOUSTON INDUSTRIES INCORPORATED
Pursuant to and in accordance with the provisions of
Article 4.04 of the Texas Business Corporation Act, Houston Industries
Incorporated, a Texas corporation (the "Corporation"), hereby adopts the
following Articles of Amendment (the "Articles of Amendment") to its Restated
Articles of Incorporation (the "Articles of Incorporation"):
ARTICLE I
The name of the Corporation is Houston Industries Incorporated.
ARTICLE II
The following amendment to the Articles of Incorporation (the
"Amendment") was duly adopted by the shareholders of the Corporation on the
fifth day of May,1999:
The Articles of Incorporation are hereby amended by deleting
ARTICLE I thereof in its entirety and replacing in lieu thereof a new ARTICLE
I reading in its entirety as follows:
"ARTICLE I
The name of the Company is "Reliant Energy, Incorporated."
ARTICLE III
The number of shares of the Corporation outstanding at the
time of the adoption of the Amendment was 296,421,672 shares of Common Stock,
without par value ("Common Stock"), 97,397 shares of Preferred Stock, without
par value, and 18,575 shares of Preference Stock, without par value; and the
number of shares entitled to vote on the Amendment was 296,329,501 shares of
Common Stock.
2
ARTICLE VI
The number of shares of Common Stock voted for the
Amendment was 246,013,385; and the number of shares of Common Stock voted
against the Amendment was 3,012,801.
IN WITNESS WHEREOF, the Corporation has caused these
Articles of Amendment to be duly executed as of the 5th day of May, 1999.
HOUSTON INDUSTRIES INCORPORATED
By: /s/ Rufus S. Scott
----------------------------------
Rufus S. Scott
Vice President, Deputy General Counsel
and Assistant Corporate Secretary
-2-
1
EXHIBIT 10.1
AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
THIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (the
"Agreement") is entered into by and between HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED, a Texas corporation (said corporation,
together with its successors and assigns permitted under this Agreement,
hereinafter referred to as the "Company"), and DON D. JORDAN (the
"Executive"), this _____ day of March, 1999.
W I T N E S S E T H:
WHEREAS, on November 7, 1997, the Company and the Executive
entered into an Amended and Restated Employment Agreement (the "Prior
Agreement") under which the Executive would be employed by the Company until
June 1, 1999; and
WHEREAS, the parties to said Prior Agreement desire to
completely amend and restate said Prior Agreement to provide for the extended
employment of the Executive through December 31, 2000; and
WHEREAS, Section 15(A) of the Prior Agreement contemplates
the amendment of the Prior Agreement with the mutual consent of the parties
and the parties desire to amend and restate the Prior Agreement;
NOW, THEREFORE, in consideration of the mutual covenants
and agreements herein contained, the parties hereto agree that the Prior
Agreement shall be amended and restated in its entirety, effective June 1,
1999, to read as follows:
1. CERTAIN DEFINITIONS:
"ACCRUED OBLIGATIONS" shall have the meaning set forth in
Section 5(B)(i)(a).
"AFFILIATED COMPANIES" shall mean and include any company
controlled by, controlling or under common control with the Company within
the meaning of Section 414 of the Code.
"ANNUAL BASE SALARY" shall mean the salary of the Executive
provided for in Section 3(B)(i), as adjusted and in effect from time to time.
"BENEFICIARY" shall mean the person or persons, trustee or
trustees of a trust, partnership, corporation, limited liability partnership,
limited liability company or other entity named, in a writing filed with the
Company, to receive any compensation or benefit payable
-1-
2
hereunder following the Executive's death or, in the event no such person or
entity is named or survives the Executive, his estate. In the event of the
Executive's death or a judicial determination of his incompetence, reference
in this Agreement to the Executive shall be deemed, where appropriate, to
refer to his Beneficiary, estate or other legal representative.
"BOARD" shall mean the Board of Directors of the Company.
"CAUSE" shall mean (i) repeated violations by the Executive
of the Executive's obligations under Section 3(A) (other than as a result of
incapacity due to physical or mental illness) which are demonstrably willful
and deliberate on the Executive's part, which are committed in bad faith or
without reasonable belief that such violations are in the best interests of
the Company and which are not remedied in a reasonable period of time after
receipt of written notice from the Company specifying such violations or (ii)
the conviction of the Executive of a felony involving moral turpitude.
"CODE" shall mean the Internal Revenue Code of 1986, as in
effect on the Effective Date and as thereafter amended.
"DATE OF TERMINATION" shall mean (a) if the Executive's
employment is terminated by the Company for Cause, or by the Executive for
Good Reason, the date of receipt of the Notice of Termination or any later
date specified therein, as the case may be, (b) if the Executive's employment
is terminated by the Company other than for Cause or Disability, the date on
which the Company notifies the Executive of such termination, (c) if the
Executive's employment is terminated by reason of death, Retirement or
Disability, the date of death or Retirement of the Executive or the
Disability Effective Date, as the case may be, and (d) if the Executive's
employment is terminated by reason of the expiration of the Employment
Period, the last day of the Employment Period.
"DEFERRED COMPENSATION PLAN" shall mean each of the
Deferred Compensation Plan (amended and restated effective January 1, 1991),
the Deferred Compensation Plan (amended and restated effective January 1,
1989) and the Deferred Compensation Plan (amended and restated effective
September 1, 1985), each of which is sponsored by the Company, as in effect
from time to time.
"DISABILITY" shall mean the absence of the Executive from
the Executive's duties with the Company on a full-time basis for 180
consecutive business days as a result of incapacity due to mental or physical
illness which is determined to be total and permanent by a physician selected
by the Company or its insurers and acceptable to the Executive or the
Executive's legal representative, such agreement as to acceptability by the
Executive not to be withheld unreasonably.
"DISABILITY EFFECTIVE DATE" shall mean the date so described
in Section 4(A).
"DIVIDEND DEFERRAL ACCOUNT" shall mean the bookkeeping
account maintained by the Company to track the dividends (and associated
accumulated interest) payable with respect to Stock Deferrals.
"EFFECTIVE DATE" shall mean June 1, 1999.
-2-
3
"EICP" shall mean the Company's Executive Incentive
Compensation Plan, as in effect from time to time, or any similar successor
plan adopted by the Company.
"EMPLOYMENT PERIOD" shall mean the period commencing on the
Effective Date and ending on December 31, 2000.
"GOOD REASON" shall mean:
(a) the assignment to the Executive of any duties
inconsistent in any respect with the Executive's position (including
status, offices, titles and reporting requirements), authority,
duties or responsibilities as contemplated by Section 3(A), or any
other action by the Company which results in a diminution in such
position, authority, duties or responsibilities, excluding for this
purpose an isolated, insubstantial and inadvertent action not taken
in bad faith and which is remedied by the Company promptly after
receipt of notice thereof given by the Executive;
(b) any failure by the Company to comply with any of the
provisions of Section 3(B), other than an isolated, insubstantial
and inadvertent failure not occurring in bad faith and which is
remedied by the Company promptly after receipt of notice thereof
given by the Executive;
(c) the Company's requiring the Executive to be based at
any office or location other than that described in Section 3(A)(i)
or the Company's failure to provide the residence required by
Section 3(A)(i);
(d) any purported termination by the Company of the
Executive's employment otherwise than as expressly permitted by this
Agreement; or
(e) any failure by the Company to comply with and satisfy
Section 11(C), provided that the successor described in Section
11(C) has received at least ten days' prior written notice from the
Company or the Executive of the requirements of Section 11(C).
"LICP" shall mean the Company's Long-Term Incentive
Compensation Plan, as in effect from time to time, or any similar successor
plan adopted by the Company.
"NOTICE OF TERMINATION" shall mean a written notice that
(a) indicates the specific termination provision in this Agreement relied
upon, (b) to the extent applicable, sets forth in reasonable detail the facts
and circumstances claimed to provide a basis for termination of the
Executive's employment under the provision so indicated and (c) if the Date
of Termination is other than the date of receipt of such notice, specifies
the termination date (which date shall be not more than 15 days after the
giving of such notice except in the case of a Disability Effective Date).
"OTHER BENEFITS" shall mean the amounts so described in
Section 5(B)(i)(e).
-3-
4
"PRIOR STOCK AWARD" shall mean the award of Stock described
as the 'Stock Award' in Section 3(B)(ii) of the Prior Agreement.
"RETIREMENT" shall mean the retirement of the Executive with
the express consent of the Board.
"SERP" shall mean the Benefit Restoration Plan of the Company.
"SPOUSE" shall mean the person who is legally married to the
Executive.
"STOCK" shall mean the Common Stock, without par value, of
the Company.
"STOCK DEFERRALS" shall mean the shares of Stock
potentially payable pursuant to the Prior Stock Award, the receipt of which
is deferred by Executive pursuant to Section 6.
"SUPPLEMENTAL RETIREMENT BENEFIT" shall mean the benefit so
described in Section 5(B)(i)(c).
"TARGET BONUS" shall mean the Executive's target incentive
opportunity under the EICP in effect for the year with respect to which the
Target Bonus is being determined or, if no such plan is then in effect, for
the last year in which such a plan was in effect, expressed as a dollar
amount based upon the Executive's Annual Base Salary for the year of such
determination.
"WELFARE BENEFIT CONTINUATION" shall mean the continuation
of benefits so described in Section 5(B)(i)(d).
"WITHOUT CAUSE" shall mean without Cause and for reasons
other than death, Disability or Retirement.
"WITHOUT GOOD REASON" shall mean without Good Reason and
for reasons other than death, Disability or Retirement.
2. EMPLOYMENT PERIOD: The Company hereby agrees to continue the
Executive in its employ, and the Executive hereby agrees to remain in the
employ of the Company, in accordance with the terms and provisions of this
Agreement, for the Employment Period.
3. TERMS OF EMPLOYMENT:
A. POSITION AND DUTIES: During the Employment Period:
(i) The Executive shall relinquish the title and office of
Chief Executive Officer of the Company, effective as of the
Effective Date, and shall be employed as the Chairman of the Board
of the Company during the remainder of the Employment Period. The
Executive, in carrying out his duties under this Agreement, shall
report only to the Board and shall perform the duties and functions
set forth on Exhibit A attached hereto and incorporated herein for
all purposes. The Executive's services
-4-
5
shall be performed at the location where the Executive was employed
immediately preceding the Effective Date or any office which is the
headquarters of the Company and is less than 50 miles from such
location. It is hereby agreed and understood that the Executive may
be required by the Company to move his business office (within the
50-mile limit set forth above) but not his principle place of
residence. In the event that the Company requires the Executive to
move his main office outside of Harris County, the Company shall
provide, at no expense to the Executive, an apartment or town home
in the new location which is commensurate with the Executive's
standard of living.
(ii) Excluding any periods of vacation and sick leave to
which the Executive is entitled, the Executive agrees to devote
reasonable attention and time during normal business hours to the
business and affairs of the Company and, to the extent necessary to
discharge the responsibilities assigned to the Executive hereunder,
to use the Executive's reasonable best efforts to perform faithfully
and efficiently such responsibilities. It shall not be a violation
of this Agreement for the Executive to (a) serve on corporate, civic
or charitable boards or committees, (b) deliver lectures, fulfill
speaking engagements or teach at educational institutions and (c)
manage personal investments, so long as such activities do not
significantly interfere with the performance of the Executive's
responsibilities as an employee of the Company in accordance with
this Agreement. It is expressly understood and agreed that to the
extent that any such activities have been conducted by the Executive
prior to the Effective Date, the continued conduct of such
activities (or the conduct of activities similar in nature and scope
thereto) subsequent to the Effective Date shall not thereafter be
deemed to interfere with the performance of the Executive's
responsibilities to the Company.
B. COMPENSATION:
(i) Annual Base Salary: During the Employment Period, the
Executive shall receive an Annual Base Salary, payable on a
semi-monthly basis in accordance with the Company's normal payroll
practices, at an annual rate at least equal to $1,460,000; provided,
however, that the monthly salary payable to the Executive during the
period from the Effective Date to December 31, 1999 shall be
adjusted upward such that the total Annual Base Salary paid to the
Executive between January 1, 1999 and December 31, 1999 equals
$1,460,000. Annual Base Salary shall not be reduced.
(ii) Benefit and Bonus Plans: During the Employment Period,
except as otherwise set forth in this paragraph (ii), the Executive
shall be entitled to participate in all incentive, savings and
retirement plans, practices, policies and programs applicable
generally to other peer executives of the Company and its Affiliated
Companies. The Executive and/or the Executive's family, as the case
may be, shall be eligible for participation in and shall receive all
benefits under welfare benefit plans, practices, policies and
programs provided by the Company and its Affiliated Companies
(including, without limitation, medical, prescription, dental,
disability,
-5-
6
the Executive salary continuance, employee life, group life,
accidental death and travel accident insurance plans and programs)
to the extent applicable generally to other peer executives of the
Company and its Affiliated Companies.
Notwithstanding the foregoing:
(a) The Executive shall not be granted awards
under the Company's Long-Term Incentive Compensation Plan
for performance cycles commencing in 1999 and 2000;
(b) The Executive shall be entitled to receive a
separate monthly supplemental retirement benefit from the
Company equal to the excess, if any, of (1) the benefit
payable under the Retirement Plan and the SERP based on the
benefit accrual formulas and actuarial assumptions in
effect at the Effective Date over (2) the Executive's
actual benefit (paid or payable) under the Retirement Plan
and the SERP. Any such benefit shall commence at the same
time and be payable in the same form as the amounts paid
under the Retirement Plan and the SERP.
(iii) Expenses: During the Employment Period, the Executive
shall be entitled to receive prompt reimbursement for all reasonable
expenses incurred by the Executive in accordance with the policies,
practices and procedures of the Company and its Affiliated Companies
to the extent applicable generally to other peer executives of the
Company and its Affiliated Companies.
(iv) Vacation and Fringe Benefits: During the Employment
Period, the Executive shall be entitled to paid vacation and fringe
benefits in accordance with the plans, practices, programs and
policies of the Company and its Affiliated Companies to the extent
applicable generally to other peer executives of the Company and its
Affiliated Companies.
(v) Other Perquisites: During the Employment Period, the
Executive shall continue to be provided with such perquisites as
were provided to the Executive on the Effective Date of this
Agreement. Such perquisites shall be reviewed annually by the
Compensation Committee of the Board.
(vi) Termination Bonus: The Company hereby agrees that
within 60 days after the expiration of the Employment Period, it
shall review the performance of Executive hereunder and the extent
to which his efforts have contributed to any increase in shareholder
value of the Company and determine if a cash bonus or other
compensation in addition to that otherwise provided herein is
appropriate. The payment of any such additional compensation shall
be made at the Board's sole discretion.
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4. TERMINATION OF EMPLOYMENT:
A. DEATH OR DISABILITY: The Executive's employment shall terminate
automatically upon the Executive's death during the Employment Period. If the
Company determines in good faith that the Disability of the Executive has
occurred during the Employment Period, it may give to the Executive written
notice in accordance with Section 15(B) of its intention to terminate the
Executive's employment. In such event, the Executive's employment with the
Company shall terminate effective on the 30th day after receipt of such
notice by the Executive (the "Disability Effective Date"), provided that,
within the 30 days after such receipt, the Executive shall not have returned
to full-time performance of the Executive's duties.
B. CAUSE: The Company may terminate the Executive's employment
during the Employment Period for Cause.
C. GOOD REASON: The Executive's employment may be terminated during
the Employment Period by the Executive for Good Reason. For purposes of this
Section 4(C), any good faith determination of Good Reason made by the
Executive shall be conclusive.
D. NOTICE OF TERMINATION: Any termination by the Company for Cause,
or by the Executive for Good Reason, shall be communicated by Notice of
Termination to the other party hereto given in accordance with Section 15(B).
The failure by the Executive or the Company to set forth in the Notice of
Termination any fact or circumstance which contributes to a showing of Good
Reason or Cause shall not waive any right of the Executive or the Company
hereunder or preclude the Executive or the Company from asserting such fact
or circumstance in enforcing the Executive's or the Company's rights
hereunder.
E. EXPIRATION OF EMPLOYMENT PERIOD: The Executive's employment shall
terminate automatically upon the expiration of the Employment Period.
5. OBLIGATIONS OF THE COMPANY UPON TERMINATION OF EMPLOYMENT:
A. FOR CAUSE OR WITHOUT GOOD REASON: If, at any time during the
Employment Period, the Company terminates the Executive's employment for
Cause or the Executive terminates his employment Without Good Reason, this
Agreement shall terminate without further obligations to the Executive other
than (i) the obligation to pay to the Executive the Annual Base Salary
through the Date of Termination plus the amount of any compensation
previously deferred by the Executive, in each case to the extent theretofore
unpaid, (ii) the timely provision of Other Benefits, and (iii) fulfillment of
the requirements of Section 3(B)(ii)(b), Sections 5(C) and (D) (to the extent
applicable), Section 6 and Section 16. Any unpaid but due Annual Base Salary
shall be paid to the Executive in a lump sum in cash within 30 days of the
Date of Termination under this paragraph.
B. WITHOUT CAUSE, FOR GOOD REASON, DEATH, DISABILITY OR RETIREMENT:
If, during the Employment Period, the employment of the Executive terminates
(except for Cause or Without Good Reason, which are addressed in Section
5(A)), the obligations of the Company shall be as set forth below:
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(i) For Good Reason or Without Cause: If, at a time
described in this Section 5(B), the Executive terminates his
employment for Good Reason or the Company terminates the Executive's
employment Without Cause, then:
(a) the Company shall pay to the Executive in a
lump sum in cash (or common stock of the Company with
respect to certain payments under the LICP), within 30 days
after the Date of Termination, determined without any
reduction for the present value of such lump-sum payment,
the aggregate of:
(I) the Annual Base Salary payable to the
Executive for the remainder of the Employment
Period, as if there had been no termination of
employment;
(II) all bonuses payable to the Executive
for the remainder of the Employment Period, as if
there had been no termination of employment
(including, but not by way of limitation, all
bonuses awarded to the Executive under the EICP
and the LICP and all bonuses that would have been
awarded to the Executive under the EICP and LICP
during the remainder of the Employment Period),
assuming, for purposes of determining the amount
of any bonus, (x) that bonus awards continued to
be granted at the levels most recently granted to
the Executive prior to the Date of Termination
(unless a reduction in the level of any bonus
award was the basis for a termination for Good
Reason, in which case reference shall be made to
the level in effect prior to such reduction) and
(y) that any applicable performance objectives
were met at the "target" level; and
(III) any accrued vacation pay;
in each case to the extent not theretofore paid (the sum of
the amounts described in clauses (I) - (III) above shall be
referred to herein as the "Accrued Obligations");
(b) the benefits accrued up to the Date of
Termination under the Retirement Plan and the SERP or any
successor plan thereto shall commence thereunder in such
form and at such time as elected by the Executive in
accordance with the terms of said Plans, subject to the
requirements of Section 16;
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(c) the Company shall pay a separate monthly
supplemental retirement benefit equal to the excess, if
any, of (I) the benefit payable under the Retirement Plan
and the SERP or any other successor supplemental and/or
excess retirement plan of the Company and its Affiliated
Companies providing benefits for the Executive which the
Executive would receive if the Executive's employment
continued at the compensation level provided for in Section
3(B) for the remainder of the Employment Period, assuming
for this purpose that (x) all accrued benefits are fully
vested and (y) benefit accrual formulas and actuarial
assumptions are no less advantageous to the Executive than
those in effect at the Effective Date, over (II) the
Executive's actual benefit (paid or payable), if any, under
the Retirement Plan and the SERP (the amount of such
benefit calculated under this Section 5(B)(i)(c), which
shall commence at the same time and be payable in the same
form as the amounts described in Section 5(B)(i)(b), shall
be referred to herein as the "Supplemental Retirement
Benefit");
(d) for the remainder of the Employment Period, or
such longer period as any plan, program, practice or policy
may provide, the Company shall continue benefits to the
Executive and/or the Executive's family at least equal to
those which would have been provided to them in accordance
with the welfare benefit plans, programs, practices and
policies described in Section 3(B)(ii) if the Executive's
employment had not been terminated; provided, however, that
if the Executive becomes reemployed with another employer
and is eligible to receive medical or other welfare
benefits under another employer provided plan, the medical
and other welfare benefits described herein shall be
secondary to those provided under such other plan during
such applicable period of eligibility (such continuation of
such benefits for the applicable period herein set forth
shall be referred to herein as "Welfare Benefit
Continuation");
(e) to the extent not theretofore paid or
provided, the Company shall timely pay or provide to the
Executive and/or the Executive's family any other amounts
or benefits required to be paid or provided or which the
Executive and/or the Executive's family is eligible to
receive pursuant to this Agreement and under any plan,
program, policy or practice or contract or agreement of the
Company and its Affiliated Companies as in effect and
applicable generally to other peer executives and their
families (such other amounts and benefits, payable as
described in this paragraph, shall be referred to herein as
the "Other Benefits"); and
(f) the Company shall pay to the Executive in a
lump sum in cash, within 30 days after the Date of
Termination, the amount it
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would have contributed as an employer contribution to the
tax-qualified Savings Plan of the Company for the remainder
of the Employment Period, had the Executive contributed at
the maximum rate during said period and had the terms of
said Savings Plan as in effect on the Effective Date
remained unchanged during said remainder of the Employment
Period; and
(g) the Company shall fulfill the requirements of
Section 5(C) and (D), Section 6 and Section 16.
(ii) By Reason of Death or Disability: If, at a time
described in this Section 5(B), the Executive's employment is
terminated by reason of the Executive's death or Disability, this
Agreement shall terminate without further obligations to or in
respect of the Executive under this Agreement, other than for (a)
payment of Accrued Obligations (which shall be paid to the Executive
or the Executive's Beneficiary in a lump sum in cash (or common
stock of the Company with respect to certain payments under the
LICP) within 30 days of the Date of Termination), (b) the timely
payment or provision of the Welfare Benefit Continuation and Other
Benefits in accordance with Section 5(B)(i), and (c) fulfillment of
the requirements of Section 3(B)(ii)(b), Section 5(C) and (D) (to
the extent applicable), Section 6 and Section 16.
(iii) Retirement: If, at a time described in this Section
5(B), the Executive terminates his employment with the Company by
reason of Retirement, he shall be entitled to receive under this
Agreement, in addition to all other benefits otherwise due from the
Company upon Retirement, the prompt payment of all benefits due
under Section 5(B)(i) had the Executive terminated employment for
Good Reason as described therein. The Company shall also fulfill its
obligations under Section 6. Furthermore, the Executive shall be
entitled, for the remainder of the Employment Period, to the prompt
reimbursement of all expenses incurred for civic or industry
activities undertaken on behalf of the Company which are of a
similar nature and scope to those expenses reimbursable by the
Company to the Executive on the Effective Date. In this connection,
the Executive shall also be afforded reasonable use of any Company
aircraft.
C. EXECUTIVE BENEFITS PLAN/DEFERRED COMPENSATION: Upon a termination
of employment during or at the end of the Employment Period for any reason,
the Company hereby agrees that the Executive shall be fully vested in the
benefit provided under the Executive Benefits Plan, as in effect on the
Effective Date, and that the benefit payable thereunder shall be based on his
Annual Base Salary as provided in Section 3(B)(i). The Company and the Board
hereby agree to cause the Deferred Compensation Plan to be administered or
amended so that any and all amounts of salary and/or bonus theretofore
deferred by the Executive and held under the Deferred Compensation Plan with
instructions from the Executive to pay in 15 annual installments shall be
paid in said 15 installments commencing on June 1, 2002, notwithstanding any
provision of the Deferred Compensation Plan to the contrary.
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D. OFFICE: Upon a termination of employment during or at the end of
the Employment Period for any reason other than death or for Cause, the
Company shall provide the Executive with suitable executive office space and
secretarial help at an acceptable location outside the premises of any
Company location. Such office and secretary shall be provided the Executive
until such time as mutually agreed by the parties to be no longer necessary.
6. DEFERRAL OF PRIOR STOCK AWARD:
A. DEFERRAL: By executing this Agreement, the Executive hereby
irrevocably elects to defer the receipt of any amounts which may be payable,
or shares of Stock which may be deliverable, to him on account of the Prior
Stock Award. The deferred delivery of the shares of Stock deliverable on
account of the Prior Stock Award (the "Stock Deferrals") shall be implemented
by a credit to a bookkeeping account maintained by the Company evidencing the
Executive's unfunded right to receive shares of Stock of the Company on the
Executive's Termination Date.
B. DIVIDENDS AND INTEREST: The Company shall maintain a separate
bookkeeping account (the "Dividend Deferral Account") to reflect the
dividends accumulated on shares of Stock credited to the Deferral Account.
The beginning balance of the Dividend Deferral Account shall be the amount of
any cash payment to which the Executive would be entitled pursuant to Section
3(B)(ii)(e) of the Prior Agreement on account of accumulated dividends. From
the date the Prior Stock Award would otherwise be payable until the
Executive's Termination Date, the Dividend Deferral Account shall be
credited, as of the date any dividend is payable, with the amount of the
dividend payable with respect to the shares of Stock represented in the
Deferral Account. Until paid to the Executive, amounts credited to the
Dividend Deferral Account shall be credited, on a quarterly basis, with
interest calculated at an annual rate equal to the composite yield on Moody's
Long-Term Corporate Bond Index for the applicable calendar quarter as
determined from Moody's Bond Record published by Moody's Investors' Service,
Inc. (or any successor thereto), or, if such yield is no longer published, a
substantially similar average selected by the Compensation Committee, plus
2%.
C. PAYMENT: Within 30 days after the Termination Date, shares of
Stock representing the Stock Deferrals shall be registered in the name of the
Executive and certificates representing such shares of Stock shall be
delivered to the Executive. Unless the Company determines otherwise, shares
of Stock delivered to the Executive shall consist of shares of Stock
theretofore held by the Company in its treasury or by a subsidiary of the
Company. In addition, within 30 days after the Termination Date, the Company
shall deliver to the Executive a lump sum cash payment equal to the amount of
the Dividend Deferral Account.
7. NON-EXCLUSIVITY OF RIGHTS: Except as provided in Section 5,
nothing in this Agreement shall prevent or limit the Executive's continuing
or further participation in any plan, program, policy or practice provided by
the Company or any of its Affiliated Companies and for which the Executive
may qualify, nor shall anything herein limit or otherwise affect such rights
as the Executive may have under any contract or agreement with the Company or
any of its Affiliated Companies. Amounts which are vested benefits or which
the Executive is otherwise entitled to receive under any plan, policy,
practice or program of or any contract or agreement with the Company or any
of its Affiliated Companies at or subsequent to the Date of Termination shall
be
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payable in accordance with such plan, policy, practice or program or contract
or agreement except as explicitly modified by this Agreement.
8. SET-OFF; MITIGATION; LEGAL FEES; EXPENSES; OBLIGATIONS
PENDING DISPUTE
RESOLUTION:
A. SET-OFF AND MITIGATION: The Company's obligation to make the
payments provided for in this Agreement and otherwise to perform its
obligations hereunder shall not be affected by any set-off, counterclaim,
recoupment, defense or other claim, right or action which the Company may
have against the Executive or others. In no event shall the Executive be
obligated to seek other employment or take any other action by way of
mitigation of the amounts payable to the Executive under any of the
provisions of this Agreement and, except as provided in Section 5(B)(i)(d),
such amounts shall not be reduced whether or not the Executive obtains other
employment.
B. LEGAL FEES AND EXPENSES: It is the intent of the Company that the
Executive not be required to incur legal fees and the related expenses
associated with the interpretation, enforcement or defense of the Executive's
rights under this Agreement by litigation or otherwise because the cost and
expense thereof would detract from the benefits intended to be extended to
the Executive hereunder. Accordingly, if it should appear to the Executive
that the Company has failed to comply with any of its obligations under this
Agreement or in the event that the Company or any other person takes or
threatens to take any action to declare this Agreement void or unenforceable,
or institutes any litigation or other action or proceeding designed to deny,
or to recover from, the Executive the benefits provided or intended to be
provided to the Executive hereunder, the Company irrevocably authorizes the
Executive from time to time to retain counsel of the Executive's choice, at
the expense of the Company as hereafter provided, to advise and represent the
Executive in connection with any such interpretation, enforcement or defense,
including without limitation the initiation or defense of any litigation or
other legal action, whether by or against the Company or any director,
officer, stockholder or other person affiliated with the Company, in any
jurisdiction. Notwithstanding any existing or prior attorney-client
relationship between the Company and such counsel, the Company irrevocably
consents to the Executive entering into an attorney-client relationship with
such counsel, and in that connection the Company and the Executive agree that
a confidential relationship will exist between the Executive and such
counsel. Without respect to whether the Executive prevails, in whole or in
part, in connection with any of the foregoing, the Company will pay and be
solely financially responsible for any and all attorneys' fees and related
expenses incurred by the Executive in connection with any of the foregoing
except to the extent that a final judgment no longer subject to appeal finds
that a claim or defense asserted by the Executive was frivolous. (In such a
case, the portion of such fees and expenses incurred by the Executive as a
result of such frivolous claim or defense shall become the Executive's sole
responsibility and any funds advanced by the Company or by a Trust created to
secure such payment shall be repaid.) The Company agrees to pay promptly as
incurred, to the full extent permitted by law, all legal fees and expenses
which the Executive incurs as described above, plus in each case interest on
any delayed payment at the applicable Federal rate provided for in Section
7872(f)(2)(A) of the Code.
In addition and to the extent not already provided by the
terms of any insurance policy owned by the Company, the Company hereby agrees
to pay promptly as incurred, to the full extent permitted by law, all legal
fees and expenses which the Executive may reasonably incur as a result
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of any litigation or other legal action filed against the Executive or his
estate arising out of, or in any way connected with or resulting from,
actions taken or omitted to be taken by the Executive during his employment
with the Company.
In the event a "Change in Control" (as defined in the Prior
Agreement and hereinafter referred to "CIC") occurs, the performance of the
Company's obligations under this Section 8 will be funded by amounts
deposited or to be deposited in trust pursuant to certain trust agreements to
which the Company will be a party providing that the fees and expenses of
counsel selected from time to time by the Executive pursuant to this Section
8 will be paid, or reimbursed to the Executive if paid by the Executive,
either in accordance with the terms of such trust agreements, or, if not so
provided, on a regular, periodic basis upon presentation by the Executive to
the trustee of a statement or statements prepared by such counsel in
accordance with its customary practices. In order to be eligible for payment
of expenses directly from the Company, Executive must first exhaust all
rights to payment under the trust agreements contemplated immediately above.
The pendency of a claim by the Company that a claim or defense of the
Executive is frivolous or otherwise lacking merit shall not excuse the
Company (or the trustee of a Trust contemplated by this Section 8) from
making periodic payments of legal fees and expenses until a final judgment is
rendered as hereinabove provided. Any failure by the Company to satisfy any
of its obligations under this Section 8 will not limit the rights of the
Executive hereunder. Subject to the foregoing, the Executive will have the
status of a general unsecured creditor of the Company and will have no right
to, or security interest in, any assets of the Company or any Affiliate.
C. OBLIGATIONS PENDING DISPUTE RESOLUTION: If there shall be any
dispute between the Company and the Executive regarding (i) in the event of
any termination of the Executive's employment by the Company, whether such
termination was for Cause, or (ii) in the event of any termination of
employment by the Executive, whether Good Reason existed, then, unless and
until there is a final, nonappealable judgment by a court of competent
jurisdiction declaring that such termination was for Cause or that the
determination by the Executive of the existence of Good Reason was not made
in good faith, the Company shall pay all amounts, and provide all benefits,
to the Executive and/or the Executive's family or other beneficiaries, as the
case may be, that the Company would be required to pay or provide pursuant to
this Agreement as though such termination were by the Company without Cause
or by the Executive with Good Reason; provided, however, that the Company
shall not be required to pay any disputed amounts pursuant to this paragraph
except upon receipt of an undertaking by or on behalf of the Executive to
repay all such amounts to which the Executive is ultimately adjudged by such
court not to be entitled.
9. CERTAIN ADDITIONAL PAYMENTS BY THE COMPANY: Anything in this
Agreement to the contrary notwithstanding, in the event it shall be
determined that any payment or distribution by the Company to or for the
benefit of the Executive (whether paid or payable or distributed or
distributable pursuant to the terms of this Agreement or otherwise, but
determined without regard to any additional payments required under this
Section 9 (a "Payment")) would be subject to the excise tax imposed by
Section 4999 of the Code or any interest or penalties incurred by the
Executive with respect to such excise tax (such excise tax, together with any
such interest and penalties, are hereinafter collectively referred to as the
"Excise Tax"), then Executive shall be entitled to receive an additional
payment (a "Gross-Up Payment") in an amount such that after payment (whether
through withholding at the source or otherwise) by the Executive of all taxes
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(including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and
penalties imposed with respect thereto), employment taxes and Excise Tax
imposed upon the Gross-Up Payment, the Executive retains an amount of the
Gross-Up Payment equal to the Excise Tax imposed upon the Payments.
Subject to the provisions of this Section 9, all
determinations required to be made under this Section 9, including whether
and when a Gross-Up Payment is required and the amount of such Gross-Up
Payment and the assumptions to be utilized in arriving at such determination,
shall be made by Deloitte & Touche (the "Accounting Firm") which shall
provide detailed supporting calculations both to the Company and the
Executive within 15 business days of the receipt of notice from the Executive
that there has been a Payment, or such earlier time as is requested by the
Company. In the event that the Accounting Firm is serving as accountant or
auditor for the individual, entity or group effecting the CIC, the Executive
shall appoint another nationally recognized accounting firm to make the
determinations required hereunder (which accounting firm shall then be
referred to as the Accounting Firm hereunder). All fees and expenses of the
Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment,
as determined pursuant to this Section 9, shall be paid by the Company to the
Executive within five days of the receipt of the Accounting Firm's
determination. If the Accounting Firm determines that no Excise Tax is
payable by the Executive, it shall furnish the Executive with a written
opinion that failure to report the Excise Tax on the Executive's applicable
federal income tax return would not result in the imposition of negligence or
similar penalty. Any determination by the Accounting Firm shall be binding
upon the Company and the Executive. As a result of the uncertainty in the
application of Section 4999 of the Code at the time of the initial
determination by the Accounting Firm hereunder, it is possible that Gross-Up
Payments which will not have been made by the Company should have been made
("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that the Company exhausts its remedies pursuant to
the following provisions of this Section 9 and the Executive thereafter is
required to make a payment of any Excise Tax, the Accounting Firm shall
determine the amount of the Underpayment that has occurred and any such
Underpayment shall be promptly paid by the Company to or for the benefit of
the Executive.
The Executive shall notify the Company in writing of any
claim by the Internal Revenue Service that, if successful, would require the
payment by the Company of the Gross-Up Payment. Such notification shall be
given as soon as practicable but no later than ten business days after the
Executive is informed in writing of such claim and shall apprise the Company
of the nature of such claim and the date on which such claim is requested to
be paid. The Executive shall not pay such claim prior to the expiration of
the 30-day period following the date on which it gives such notice to the
Company (or such shorter period ending on the date that any payment of taxes
with respect to such claim is due). If the Company notifies the Executive in
writing prior to the expiration of such period that it desires to contest
such claim, the Executive shall:
(a) give the Company any information reasonably
requested by the Company relating to such claim;
(b) take such action in connection with contesting such
claim as the Company shall reasonably request in writing from time
to time, including, without
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limitation, accepting legal representation with respect to such claim
by an attorney reasonably selected by the Company;
(c) cooperate with the Company in good faith in order to
effectively contest such claim; and
(d) permit the Company to participate in any proceedings
relating to such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and hold the Executive harmless, on an
after-tax basis, for any Excise Tax, employment tax or income tax (including
interest and penalties with respect thereto) imposed as a result of such
representation and payment of costs and expenses. Without limitation of the
foregoing provisions of this Section 9, the Company shall control all
proceedings taken in connection with such contest and, at its sole option,
may pursue or forgo any and all administrative appeals, proceedings, hearings
and conferences with the taxing authority in respect of such claim and may,
at its sole option, either direct the Executive to pay the tax claimed and
sue for a refund or contest the claim in any permissible manner, and the
Executive agrees to prosecute such contest to a determination before any
administrative tribunal, in a court of initial jurisdiction and in one or
more appellate courts, as the Company shall determine; provided, however,
that if the Company directs the Executive to pay such claim and sue for a
refund, the Company shall advance the amount of such payment to the
Executive, on an interest-free basis and shall indemnify and hold the
Executive harmless, on an after-tax basis, from any Excise Tax, employment
tax or income tax (including interest or penalties with respect thereto)
imposed with respect to such advance or with respect to any imputed income
with respect to such advance; and further provided that any extension of the
statute of limitations relating to payment of taxes for the taxable year of
the Executive with respect to which such contested amount is claimed to be
due is limited solely to such contested amount. Furthermore, the Company's
control of the contest shall be limited to issues with respect to which a
Gross-Up Payment would be payable hereunder and the Executive shall be
entitled to settle or contest, as the case may be, any other issue raised by
the Internal Revenue Service or any other taxing authority.
If, after the receipt by the Executive of an amount
advanced by the Company pursuant to the foregoing provisions of this Section
9, the Executive becomes entitled to receive any refund with respect to such
claim, the Executive shall (subject to the Company complying with the
requirements of this Section 9) promptly pay to the Company the amount of
such refund (together with any interest paid or credited thereon after taxes
applicable thereto). If, after the receipt by the Executive of an amount
advanced by the Company pursuant to the foregoing provisions of this Section
9, a determination is made that the Executive shall not be entitled to any
refund with respect to such claim and the Company does not notify the
Executive in writing of its intent to contest such denial of refund prior to
the expiration of 30 days after such determination, then such advance shall
be forgiven and shall not be required to be repaid and the amount of such
advance shall offset, to the extent thereof, the amount of Gross-Up Payment
required to be paid.
If the Company is obligated to provide the Executive with
Welfare Benefit Continuation and the amount of such benefits or the value of
such benefit coverage (including
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without limitation any insurance premiums paid by the Company to provide such
benefits) is subject to any income, employment or similar tax imposed by
federal, state or local law, or any interest or penalties with respect to such
tax (such tax or taxes, together with any such interest and penalties, being
hereafter collectively referred to as the "Income Tax") because such benefits
cannot be provided under a nondiscriminatory health plan described in Section
105 of the Code or for any other reason, the Company will pay to the Executive
an additional payment or payments (collectively, an "Income Tax Payment"). The
Income Tax Payment will be in an amount such that, after payment by the
Executive of all taxes (including any interest or penalties imposed with
respect to such taxes), the Executive retains an amount of the Income Tax
Payment equal to the Income Tax imposed with respect to such Welfare Benefits
Continuation.
10. CONFIDENTIAL INFORMATION: The Executive shall hold in a
fiduciary capacity for the benefit of the Company all secret or confidential
information, knowledge or data relating to the Company or any of its
Affiliated Companies, and their respective businesses, which shall have been
obtained by the Executive during the Executive's employment by the Company or
any of its Affiliated Companies and which shall not be or become public
knowledge (other than by acts by the Executive or representatives of the
Executive in violation of this Agreement). After termination of the
Executive's employment with the Company, the Executive shall not, without the
prior written consent of the Company or as may otherwise be required by law
or legal process, communicate or divulge any such information, knowledge or
data to anyone other than the Company and those designated by it. In no event
shall an asserted violation of the provisions of this Section 10 constitute a
basis for deferring or withholding any amounts otherwise payable to the
Executive under this Agreement.
11. SUCCESSORS:
A. This Agreement is personal to the Executive and without the prior
written consent of the Company shall not be assignable by the Executive
otherwise than by will or the laws of descent and distribution. This
Agreement shall inure to the benefit of and be enforceable by the Executive's
legal representatives.
B. This Agreement shall inure to the benefit of and be binding upon
the Company and its successors and assigns.
C. The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Company to assume
expressly and agree to perform this Agreement in the same manner and to the
same extent that the Company would be required to perform it if no such
succession had taken place. As used in this Agreement, "Company" shall mean
the Company as hereinbefore defined and any successor to its business and/or
assets as aforesaid which assumes and agrees to perform this Agreement by
operation of law, or otherwise.
12. SOURCE OF PAYMENTS: All payments provided in this Agreement shall, unless
the plan or program pursuant to which they are made provide otherwise, be paid
in cash from the general funds of the Company, and no special or separate funds
shall be established and no other segregation of assets shall be made to assure
payment. The Executive shall have no right, title or interest
-16-
17
whatever in or to any investments which the Company may make to aid the Company
in meeting its obligations hereunder. Nothing contained in this Agreement, and
no action taken pursuant to this provision, shall create or be construed to
create a trust of any kind, or a fiduciary relationship, between the Company
and the Executive or any other person. To the extent that any person acquires a
right to receive payments from the Company hereunder, such right shall be no
greater than the right of an unsecured creditor of the Company.
13. EFFECT OF PRIOR AGREEMENTS: This Agreement contains the entire
understanding between the parties hereto and supersedes any prior employment
agreement between the Company or any predecessor of the Company and the
Executive, except that this Agreement shall not affect or operate to reduce
(a) any benefit or compensation inuring to the Executive of a kind elsewhere
provided and not expressly provided or modified in this Agreement or (b) the
agreements of the Company set forth in those three separate letters to the
Executive from John T. Cater, Robert J. Cruikshank and R. Steve Letbetter,
dated November 28, 1995, September 2, 1998 and March 9, 1999, respectively,
regarding various matters directly or indirectly related to or arising out of
Executive's employment with the Company. Specifically, but not by way of
limitation, this Agreement supersedes and replaces that certain amended and
restated Employment Agreement between the parties, dated November 7, 1997,
except to the extent necessary to determine the amounts deferred and payable
pursuant to Section 6.
14. CONSOLIDATION, MERGER OR SALE OF ASSETS: Nothing in this
Agreement shall preclude the Company from consolidating or merging into or
with, or transferring all or substantially all of its assets to, another
corporation which assumes this Agreement and all obligations and undertakings
of the Company hereunder; provided that no such action shall diminish the
Executive's rights hereunder, including, without limitation, rights under
Section 4(C). Upon such a consolidation, merger or transfer of assets and
assumption, the term "Company" as used herein shall mean such other
corporation.
15. MISCELLANEOUS:
A. This Agreement shall be governed by and construed in accordance
with the laws of the State of Texas, without reference to principles of
conflict of laws. The captions of this Agreement are not part of the
provisions hereof and shall have no force or effect. This Agreement may not
be amended or modified otherwise than by a written agreement executed by the
parties hereto or their respective successors and legal representatives.
B. All notices and other communications hereunder shall be in
writing and shall be given by hand delivery to the other party or by
registered or certified-mail, return receipt requested, postage prepaid,
addressed as follows:
If to the Executive: Don D. Jordan
5 Stayton Circle
Houston, Texas 77024
-17-
18
If to the Company: Houston Industries Incorporated
d/b/a Reliant Energy, Incorporated
P.O. Box 4567
Houston, Texas 77210
ATTENTION: Mr. Hugh Rice Kelly
Vice President, General
Counsel and Secretary
or to such other address as either party shall have furnished to the other in
writing in accordance herewith. Notice and communications shall be effective
when actually received by the addressee.
C. The invalidity or unenforceability of any provision of this
Agreement shall not affect the validity or enforceability of any other
provision of this Agreement.
D. The Company may withhold from any amounts payable under this
Agreement such Federal, state or local taxes as shall be required to be
withheld pursuant to any applicable law or regulation.
E. The Executive's or the Company's failure to insist upon strict
compliance with any provision hereof or any other provision of this Agreement
or the failure to assert any right the Executive or the Company may have
hereunder, including, without limitation, the right of the Executive to
terminate employment for Good Reason pursuant to Section 4(C), shall not be
deemed to be a waiver of such provision or right or any other provision or
right of this Agreement.
F. The headings of paragraphs herein are included solely for
convenience and reference and shall not control the meaning or interpretation
of any of the provisions of this Agreement.
16. DEFERRED COMPENSATION PLAN AND SERP PAYMENTS: Notwithstanding
any provision herein or any provision of the Deferred Compensation Plan of
the Company to the contrary, the Company and the Board hereby agree to cause
the Deferred Compensation Plan to be administered so that any and all amounts
of salary and/or bonus theretofore deferred by the Executive and held under
the Deferred Compensation Plan with instructions from the Executive to pay in
15 annual installments (a) shall be paid in said 15 installments, (b) shall
remain in said Plan earning interest at the rate prescribed therein until
installment distributions commence, (c) shall commence at the time provided
herein (or, if not provided for herein, at the time provided in said Plan)
and (d) shall not be commuted and paid in a lump sum. Notwithstanding any
provision of this Agreement or any provision of the SERP to the contrary, the
Company and the Board hereby agree to cause the SERP to be administered so
that no benefit payable to or on behalf of the Executive under the SERP may
be commuted and paid in a lump sum.
-18-
19
IN WITNESS WHEREOF, the Executive has hereunto set the
Executive's hand and, pursuant to the authorization from its Board of
Directors, the Company has caused these presents to be executed in its name
and on its behalf, all on the day and year first above written, but effective
as of the Effective Date.
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED
By /s/ Robert J. Cruikshank
---------------------------------
Robert J. Cruikshank, Chairman of
the Compensation Committee of the
Board of Directors
EXECUTIVE
/s/ Don D. Jordan
---------------------------------
Don D. Jordan
-19-
20
EXHIBIT A
DUTIES OF
THE CHAIRMAN OF THE BOARD
Duties with respect to Board of Directors:
Chair meetings of the Board of Directors ("Board")
Establish Board agenda (in consultation with Board and CEO); provide
materials for Board preparation
Keep the Board apprised of merger and acquisition opportunities and
the status of any deals in progress
Specific executive duties:
Represent the company on Boards of venture capital fund investments
(Utech Climate Challenge Fund, Utility Competitive Advantage Fund,
Micro-Generation Technology Fund)
Represent company in specific external settings:
o President, World Energy Council
o Executive Committee, Edison Electric Institute
o Others (T.B.D.)
Provide principal interface to Federal legislative officials
Advise and assist CEO with respect to:
Interface with Board
Major corporate development initiatives (acquisitions and divestitures)
International development (acquisitions, divestitures and alliances)
Utilize Chairman's existing network of associations and affiliations
to expand community
and business contacts of CEO and other top officers
Other projects/issues as the CEO may request
(i)
1
EXHIBIT 10.2
SHARE SUBSCRIPTION AGREEMENT
This Share Subscription Agreement, hereinafter referred to as the "Share
Subscription Agreement", is entered into on this 29th day of March 1999
by and between
1 RELIANT ENERGY WHOLESALE HOLDINGS (EUROPE) INC., a company
incorporated under the laws of the State of Delaware, USA, having
its principal offices at 1111 Louisiana, Houston, Texas, United
States of America, herein represented by R. Steve Letbetter,
hereinafter referred to, together with any successors and permitted
assignees, as the "New Partner";
and
2 PROVINCIE NOORD HOLLAND
having its seat at Haarlem, the Netherlands,
herein represented by J.P.J. Lagrand,
hereinafter referred to as the "Province of North Holland";
and
3 GEMEENTE AMSTERDAM
having its seat at Amsterdam, the Netherlands,
herein represented by G. ter Horst,
hereinafter referred to as the "City of Amsterdam";
and
4 N.V. PROVINCIAAL EN GEMEENTELIJK UTRECHTS
STROOMLEVERINGSBEDRIJF
having its registered office at Utrecht, the Netherlands,
herein represented by M. ten Klooster,
hereinafter referred to as "Pegus";
and
5 RELIANT ENERGY POWER GENERATION, INC., a company incorporated
under the laws of the State of Delaware, United States of America,
with its principal offices at 1111 Louisiana, Houston, Texas,
United States of America,
herein represented by R. Steve Letbetter,
2
hereinafter referred to as the "Ultimate Parent 2"
and
6 N.V. ENERSIEPRODUKTIEBEDRIJF UNA
having its registered office at Utrecht, the Netherlands,
herein represented by P. Koppen de Neve,
hereinafter referred to as the "Company";
(The New Partner, Province of North Holland, City of Amsterdam, Pegus, the
Ultimate Parent 2 and the Company hereinafter collectively referred to as the
"Parties" and each individually as a "Party").
WHEREAS:
A. Pursuant to the Partnership Documentation concluded between Parties
on the Signing Date (i) the Existing Partners will sell and transfer
their Shares to the New Partner and the New Partner will purchase
and accept such Shares on the terms and conditions set forth in the
Share Purchase Agreement and (ii) the New Partner wishes to
subscribe for the Subscription Shares and in respect of such
subscription contribute the Subscription Price on the terms and
conditions set out in this Share Subscription Agreement.
IT IS HEREBY AGREED AS FOLLOWS:
ARTICLE 1 DEFINITIONS
1.1. Capitalized terms used in this Share Subscription Agreement and not
otherwise defined shall have the meanings ascribed to them in
schedule 1.1 to the Partnership Agreement, which schedule is
attached hereto as SCHEDULE 1.1, except as the context may otherwise
require.
1.2. All Schedules and Annexes to this Share Subscription Agreement shall
form an integral part hereof.
1.3. References to Articles, Schedules or Annexes shall be references to
Articles of and Schedules and Annexes to this Share Subscription
Agreement.
1.4. Headings are inserted for convenience only and shall not affect the
interpretation of this Share Subscription Agreement.
1.5. Nouns, pronouns and verbs of the singular number shall be deemed to
include the plural, and vice versa, and pronouns of the masculine
gender shall be deemed to include the feminine and neuter, and vice
versa, all as the context may require.
1.6. The words "include", "includes" and "including" shall be deemed to
be followed by the phrase "without limitation".
3
1.7. Whenever used in this Share Subscription Agreement the words
"hereof", "herein" and similar words shall be construed as
references to this Share Subscription Agreement as a whole and not
limited to the particular Article or subsection in which the
reference appears.
1.8. The words "best knowledge" shall mean such knowledge as the relevant
entities, officials, directors or members of the management board,
municipal executive board or provincial executive body, as the case
may be, have or may reasonably be expected to have.
ARTICLE 2SUBSCRIPTION AND SUBSCRIPTION PRICE
2.1. Subject to the terms and conditions of this Share Subscription
Agreement, the Company agrees to issue to the New Partner and the
New Partner agrees to subscribe for 850 (in words: eight hundred
and fifty) Shares (the "Subscription Shares") free from any and all
liens, charges, claims, third party rights, pledges and
encumbrances and together with all rights attaching to them.
2.2. The subscription price for the Subscription Shares (the "Subscription
Price") shall be NLG 897,667,150 (in words: eight hundred ninety
seven million six hundred sixty seven thousand one hundred and
fifty Dutch Guilders), and shall be payable as set forth in Article
6.3.
ARTICLE 3 SIGNING
3.1. The Signing Actions shall take place on the Signing Date and shall be
deemed to take place simultaneously, with each such action being
conditional upon all such actions being effected.
ARTICLE 4CONDITIONS TO COMPLETION
4.1. The obligations of the Parties under this Share Subscription
Agreement shall be subject to and conditional upon each of the
First Completion Conditions being satisfied or waived by the Party
to whose benefit the First Completion Conditions inure.
4.2. Each of the Parties hereto agrees to make all reasonable efforts to
ensure that each of the First Completion Conditions is satisfied as
soon as possible after the Signing Date. If at any time a Party
becomes aware of anything that may prevent any First Completion
Conditions being satisfied, it shall immediately inform the other
Parties and they shall cooperate to make all reasonable efforts to
ensure that the First Completion Conditions are satisfied.
4
ARTICLE 5 COVENANTS PRIOR TO COMPLETION
5.1. The Company shall ensure, from the Signing Date to the First
Completion Date, that no action contrary to the Pre-Completion
Covenants shall be taken without the prior written approval of the
New Partner.
ARTICLE 6 COMPLETION AND PAYMENT
6.1. The Completion of the Subscription Shares shall take place at the
Amsterdam offices of Loeff Claeys Verbeke at the First Completion
Date.
6.2. The issuance of the Subscription Shares shall be carried out by
means of execution of a notarial deed, in accordance with the form
attached hereto as SCHEDULE 6.2,to be executed by the Notary. The
Notary is a civil law notary of Loeff Claeys Verbeke, the firm of
the external legal advisors of the Company. The other Parties
hereby acknowledge that they are aware of the provisions of
articles 8, 9, l0 and 14.2 of the "Guidelines" concerning
associations between civil law notaries ("notarissen") and
associations between civil law notaries (notarissen) and
barristers/solicitors ("advocaten") as established by the Board of
the Royal Regulatory Body of Civil Law Notaries ("Koninklijke
Notariele Beroepsorganisatie"). The other Parties hereby explicitly
agree that Loeff Claeys Verbeke shall advise and act on behalf of
the Company with respect to this Share Subscription Agreement, any
agreements resulting from this Share Subscription Agreement and/or
any disputes resulting therefrom. To this end the other Parties
hereby approve the exchange of essential information, relating to
the issuance of the Subscription Shares, between the
barristers/solicitors ("advocaten "), tax advisors ("fiscalisten")
and civil law notaries ("notarissen") of Loeff Claeys Verbeke.
6.3. The New Partner shall pay the Subscription Price to the Company at
the First Completion Date in accordance with the First Completion
Actions as follows:
(i) an amount of NLG 21,250,000 (in words: twenty one million two
hundred fifty thousand Dutch Guilders) in cash, which is
equal to 25% (in words: twenty five percent) of the nominal
value of the Subscription Shares;
(ii) the remainder of the Subscription Price by way of assignment
to the Company of a promissory note issued to New Partner by
Ultimate Parent 2, the form of which note is attached as
SCHEDULE 6.3.
6.4. The Company hereby waives any right under Chapter III, article 8 of
its Articles of Association to call up that portion of the nominal
amount of the Subscription Shares in excess of the cash portion
thereof other than as provided in the Promissory Note, all Parties
acknowledging that the promissory note delivered under Article 6.3
constitutes, together with said cash portion, complete payment for
the Subscription Shares.
5
ARTICLE 7 COMPLETION
7.1. At the Completion of the Subscription Shares, the First Completion
Actions shall take place, which actions shall be deemed to take
place as described in schedule 18.2 to the Partnership Agreement,
with each such action being conditional upon all such actions being
effected.
7.2. Each Party shall at the reasonable request of the other Party
execute all documents and do all other acts and things as may
reasonably be deemed necessary to give full effect to this Share
Subscription Agreement and all agreements pursuant hereto.
ARTICLE 8 WAIVER
8.1. The Existing Partners unconditionally and irrevocably waive all of
their respective rights under the Articles of Association in respect
of the issuance of the Subscription Shares.
ARTICLE 9 DUE DILIGENCE INVESTIGATION
9.1. The New Partner and the Ultimate Parent 2 acknowledge and agree that
they have performed, with the assistance of professional legal,
accountancy, financial, technical and tax advisors, a due diligence
investigation (the "Due Diligence Investigation") and furthermore:
9.1.1. that for the purposes of the Due Diligence Investigation
they have had (and that their advisors have had)
opportunity to review the information, including the data
room information set out in SCHEDULE 9.1.1., made
available to them and their advisors;
9.1.2. that they have obtained (and their advisors have obtained)
other information that they (and their advisors) deemed
proper, and necessary for the purposes of entering into
this Share Subscription Agreement, through management
interviews, management presentations, site visits and
questions submitted to the Existing Partners and the
Companies and their advisors;
9.1.3. that they have raised with the Existing Partners and the
Companies any and all specific issues which they
considered relevant in connection with the transactions
contemplated hereby.
9.2. The New Partner and the Ultimate Parent 2 acknowledge that the
representations and warranties contained in this Share Subscription
Agreement are the only representations, warranties or other
assurances of any kind given by or on behalf of the Company on which
the New Partner and the Ultimate Parent 2 may rely (and have relied
on) in entering into this Share Subscription Agreement.
6
9.3. The New Partner and the Ultimate Parent 2 hereby declare that they
are not aware as of the Signing Date of any matter or anything which
is inconsistent with the representations and warranties of the
Company contained in this Share Subscription Agreement.
ARTICLE 10 REPRESENTATIONS AND WARRANTIES OF THE COMPANY
- ---------- ----------------------------------------------
10.1. Subject to the provisions of Article 9 and Article 12, the Company
represents and warrants to the New Partner that as of First
Completion Date the following statements (the "Warranties") shall be
true and correct:
10.1.1. the Companies have been duly incorporated and
are validly existing under the laws of the
Netherlands;
10.1.2. the Company is registered with the Trade
Register of the Chamber of Commerce of "Utrecht
en omstreken" under file number 30084656 in
conformity with the extract attached as annex
1.4 to the Share Purchase Agreement and the
information contained in the extract is correct;
10.1.3. the Company has the power and authority to enter into this
Share Subscription Agreement and to carry out its
obligations thereunder;
10.1.4. the Company has legally resolved to enter into
this Share Subscription Agreement subject to the
provisions hereof, the signing hereof has been
duly authorized and upon signature hereof this
Share Subscription Agreement will constitute the
legally valid and binding obligations of the
Company enforceable against the Company in
accordance with its terms and conditions;
10.1.5. execution, delivery and performance of this Share
Subscription Agreement by the Company and its compliance
with the terms andconditions hereof do not violate,
conflict with or constitute a breach of any of the terms
or provisions of, or a default under (or an event
that with notice or lapse of time, or both,
would constitute a default), or require consent
under, or result in the creation or imposition
of a lien, charge, pledge or encumbrance on any
property or assets of the Companies or an
acceleration of any indebtedness of any of the
Companies pursuant to (i) any statute, rule or
regulation under applicable laws or any order of
any governmental agency or of any court or any
agreement to which the Company is a party or
subject or (ii) any bond, debenture, note,
indenture, mortgage, deed of pledge or trust,
loan or credit agreement, reimbursement
agreement relating to any letter of credit,
7
license, permit, authorization, leases,
subleases or other agreement or instrument to
which any of the Companies is a party or is
subject, except as it would not have a material
adverse effect on the Company or the Companies;
10.1.6. the entire issued and paid-up share capital of the Company
consists of 2,550 (in words: two thousand five hundred
and fifty) Shares before the Completion of the
Subscription Shares;
10.1.7. the authorized share capital of the Company amounts to Euro
204,210,000 (in words: two hundred four million two
hundred one thousand Euro), divided into 4,500 Shares;
10.1.8. the New Partner shall have full right and title to the
Subscription Shares free of any pledge, usufruct,
attachment or any other charge;
10.1.9. no person other than the New Partner has any right,
contingent or otherwise, to acquire or to be offered the
Subscription Shares or any other Shares;
10.1.10. the Companies are legally and validly registered in
accordance with the laws of the Netherlands;
10.1.11. the most recent versions of the articles of
association of the Companies have been submitted
to the New Partner prior to the signing date. No
action has since been taken to amend any of the
articles of association, except as provided for
in the Partnership Agreement. The Company is
subject to the provisions of the statutory
regime with respect to large companies
(structuurregime);
10.1.12. none of the Companies has been dissolved or liquidated
and no resolution has been adopted with respect to the
dissolution or liquidation of the Companies and there are
no circumstances known to the Company that may cause the
dissolution or liquidation of any of the Companies;
10.1.13. none of the Companies has been declared bankrupt
and no suspension of payments has been granted
to any of the Companies; no resolution has been
adopted to the aforesaid effect and no
circumstances exist that could require one or
more of the Companies being declared bankrupt or
granted a suspension of payments;
10.1.14. no resolution has been adopted with respect to any of the
Companies to issue shares additional to the issued and
outstanding share capital of each of such Companies;
8
10.1.15. no rights - including options, warrants and convertible
debentures - have been granted with respect to unissued
shares in the capital of the Companies;
10.1.16. the Companies' investments in the Participations and the
results of operations of the Participations are not
material to the financial condition, results of operations
or prospects of the Companies.
ARTICLE 11 REPRESENTATIONS AND WARRANTIES OF THE NEW PARTNER AND
ULTIMATE PARENT 2
11.1. The New Partner and the Ultimate Parent 2 represent and warrant to
the Company that each and every statement made by them under article
19 of the Partnership Agreement shall be true and correct at the
First Completion Date.
ARTICLE 12 BREACH OF WARRANTIES, NON-FULFILMENT, DAMAGES
12.1. In the event of a breach of any of the Warranties by the Company,
the New Partner or the Ultimate Parent 2 ("Breach") or
non-fulfilment by the Company, the New Partner or the Ultimate
Parent 2 of any other obligation contemplated by this Share
Subscription Agreement ("Non-Fulfilment"), the Company, the New
Partner or the Ultimate Parent 2 (the "Notifying Party"), as the
case may be, shall upon obtaining knowledge thereof notify the
other Party (the "Notified Party") of such Breach or Non-Fulfilment
promptly and in writing, and under no circumstances later than 30
(in words: thirty) days after obtaining knowledge of the Breach or
Non-Fulfilment, setting out in reasonable detail the events or
facts giving rise to the Breach or Non Fulfilment, and specifying
the amount of Damages claimed as a result of any Breach of
Warranties.
12.2. If the Notified Party fails to take appropriate measures to remedy
the Breach or Non-Fulfilment within 30 (thirty) days of such
notification and a dispute arises, the Notifying Party shall be
entitled to institute arbitration proceedings with a view to
resolving the dispute pursuant to article 40 of the Partnership
Agreement.
12.3. Subject to the other provisions of this Article 12, the Company
shall indemnify the New Partner for all Damages incurred by the New
Partner, resulting from any Breach or any Non-Fulfilment, as the
case may be.
12.4. The Company shall not owe Damages to the New Partner by virtue of
this Article 12 or otherwise have obligations towards the New
Partner if and to the extent that the Damage ensuing from a Breach
or Non-Fulfilment:
12.4.1. has been paid to the New Partner by virtue of any
insurance policy;
9
12.4.2. has been paid to the New Partner by a third party other
than an insurance company;
12.4.3. has not been reported in writing with a statement of the
nature, cause and scope of the loss or damage to the
Company within 60 (in words: sixty) days after the day the
New Partner has become aware of a Breach or Non-Fulfilment;
12.4.4. is specifically, fairly and fully disclosed in writing to
the New Partner before the Signing Date;
12.4.5. is covered by means of a reserve in the 1998
Annual Accounts, on the understanding that, for
the application of this Article 12.4.5, reserves
which are (or should be) released after the
First Completion Date shall be added to reserves
which at that instance are found to be
insufficient for the underlying Damage if there
is not definitive insight concerning the
sufficiency of the other reserves;
12.4.6. are solely due to changes in legislation, regulations or
case law after the First Completion Date;
12.4.7. is a consequence of a change after the Completion Date of
the corporate tax structure or the accounting policies of
the Companies;
12.4.8. would not have occurred without an action or
omission after the Completion Date by the New
Partner, the Companies or any person whose
action or omission is attributable to the New
Partner and/or the Companies which bear a
material connection to the Damage;
12.4.9. except as otherwise specifically provided in this Share
Subscription Agreement, if and to the extent it reduces
the tax obligations of the New Partner relating to its
investment in the Company or of the Companies after the
First Completion Date; and
12.4.10. furthermore, if and to the extent that the
alleged Breach or Non Fulfilment is not
submitted by the New Partner to the arbitral
body referred to in article 40 of the
Partnership Agreement within a period of three
months after the written notification by the New
Partner to Existing Partners of the Breach or
Non-Fulfilment.
12.5. The Existing Partners and the Company shall ensure that reasonable
steps are taken to prevent or mitigate Damages which could give
rise to a claim by virtue of this Article 12. If the Damages
concerned are a consequence of or bear connection to a claim from
or liability towards a third party, neither the Existing Partners
10
nor the Company shall in the matter of such claim or liability
agree to any terms with the third party without prior written
permission from the New Partner. In addition, the Company shall not
agree to any such terms without prior permission from the Existing
Partners. The Company shall keep the New Partner and the Existing
Partners fully informed of such Damages and of the defense to be
conducted by the Company.
12.6. A Damage claim against the Company in connection with a Breach or
Non-Fulfilment shall not be permitted for any individual claims for
an amount below NLG 1,000,000 (in words: one million Dutch
Guilders) and in any event the aggregate amount of all claims (as
finally determined or agreed) in excess of NLG 1,000,000 (in words:
one million Dutch Guilders) must total more than NLG 50,000,000 (in
words: fifty million Dutch Guilders) before a claim may be lodged
in which case the excess over NLG 50,000,000 (in words: fifty
million Dutch Guilders) shall be payable.
12.7. Under no circumstances shall the aggregate amount of all awards or
Damages awarded or agreed against the Company exceed an amount equal
to 20% (in words: twenty percent) of the Subscription Price.
12.8. The New Partner shall not be entitled to make any claim against the
Company for any Breach or Non-Fulfilment unless notice in writing of
such claim is given prior to 1 May immediately following the first
full Fiscal Year of the Company after the First Completion Date.
12.9. The amount of any award or Damages owed by the Company to the New
Partner shall, at the option of the New Partner, be either paid
directly to the New Partner or subtracted from the unpaid amount of
the Promissory Note referred to in Article 6.3.
12.10. The New Partner irrevocably and unconditionally waives its right to
claim Damages against the Company with respect to Stranded Costs
and/or Legal Action Stranded Costs.
ARTICLE 13 TERMINATION
13.1. If the Partnership Agreement is terminated in accordance with
article 22 of the Partnership Agreement, this Share Purchase
Agreement shall terminate in accordance with its terms.
ARTICLE 14 MISCELLANEOUS
14.1. Articles 19 and 22 through 40 of the Partnership Agreement shall
govern this Share Purchase Agreement.
11
IN WITNESS WHEREOF this Share Subscription Agreement has been executed by the
Parties hereto in sixfold on the date set out on page one
SIGNED by
for and on behalf of Provincie Noord Holland
By: J.P.J. Lagrand
SIGNED by
for and on behalf of Gemeente Amsterdam
By: G. ter Horst
SIGNED by
for and on behalf of N.V. Provinciaal en Gemeentelijk Utrechts
Stroomleveringsbedrijf
By: M. ten Klooster
SIGNED by
for and on behalf of Reliant Energy Wholesale Holdings (Europe) Inc.
By: R. Steve Letbetter
12
SIGNED by
Reliant Energy Power Generation, Inc.
By: R. Steve Letbetter
SIGNED by
for and on behalf of N.V. Energieproduktiebedrijf UNA
By: P. Koppen de Neve
13
Schedules to the Share Subscription Agreement
Schedule 1.1 : Definitions
Schedule 6.2 : Draft Deed of issuance
Schedule 6.3 : Principal Terms of Promissory Note
1
EXHIBIT 10.3
SHARE PURCHASE AGREEMENT
This Share Purchase Agreement, hereinafter referred to as the "Share Purchase
Agreement", is entered into on this 29th day of March 1999
by and between
1. RELIANT ENERGY WHOLESALE HOLDING (EUROPE) INC.
having its principal offices at 1111 Louisiana, Houston, Texas,
United States of America herein represented by R. Steve Letbetter,
hereinafter referred to, together with any successors and permitted
assignors, as the "New Partner";
and
2. PROVINCIE NOORD HOLLAND
having its seat at Haarlem, the Netherlands, herein represented by
J.P.J. Lagrand, hereinafter referred to as the "Province of North
Holland";
and
3. GEMEENTE AMSTERDAM
having its seat at Amsterdam, the Netherlands, herein represented
by G. ter Horst, hereinafter referred to as the "Municipality of
Amsterdam";
and
4. PROVINCIE UTRECHT
having its seat in Utrecht, the Netherlands, herein represented
by D.H. Kok, hereinafter referred to as the "Province of Utrecht";
and
5. GEMEENTE UTRECHT
having its seat in Utrecht, the Netherlands, herein represented
by H.H.W. Kernkamp, hereinafter referred to as the "Municipality
of Utrecht";
and
6. N.V. PROVINCIAAL EN GEMEENTELIJK UTRECHTS
STROOMLEVERINGSBEDRIJF
having its registered office at Utrecht, the Netherlands,
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herein represented by M. ten Klooster,
hereinafter referred to as "Pegus";
and
7. RELIANT ENERGY POWER GENERATION, INC., a company
incorporated under the laws of the State of Delaware, United States
of America, with its principal offices at 1111 Louisiana, Houston,
Texas United States of America
herein represented by R. Steve Letbetter,
hereinafter referred to as the "Ultimate Parent 2";
and
8. N.V. ENERGIEPRODUKTIEBEDRIJIF UNA
having its registered office at Utrecht, the Netherlands,
herein represented by P. Koppen cle Neve,
hereinafter referred to as the "Company".
(The New Partner, Province of North Holland, Municipality of Amsterdam, Pegus,
the Ultimate Parent 2 and the Company hereinafter collectively referred to as
the "Parties" and each individually as a "Party").
WHEREAS:
A. The Existing Partners are the legal and beneficial owners of the
entire issued and outstanding share capital of the Company whereby:
(i) the Province of North Holland is the legal and beneficial owner of
850 (in words: eight hundred and fifty) Shares;
(ii) the Municipality of Amsterdam is the legal and beneficial owner of
850 (in words: eight hundred and fifty) Shares;
(iii) Pegus is the legal and beneficial owner of 850 (in words: eight
hundred and fifty) Shares;
B. Pursuant to the Partnership Documentation concluded between Parties
on the Signing Date, (i) the New Partner will subscribe for the
Subscription Shares and, in respect of such subscription, contribute
the Subscription Price on the terms and conditions set out in the
Share Subscription Agreement and (ii) the Existing Partners wish to
sell and transfer their Shares to the New Partner and the New
Partner wishes to purchase and accept such Shares on the terms and
conditions set out in this Share Purchase Agreement.
3
IT IS HEREBY AGREED AS FOLLOWS:
ARTICLE 1 DEFINITIONS AND INTERPRETATION
1.1. Capitalized terms used in this Share Purchase Agreement shall have
the meanings ascribed to them in schedule 1.1 to the Partnership
Agreement, which Schedule is attached hereto as SCHEDULE 1.1, except
as the context may otherwise require.
1.2. All Schedules and Annexes to this Share Purchase Agreement shall form
an integral part hereof.
1.3. References to Articles, Schedules or Annexes shall be references to
Articles of and Schedules and Annexes to this Share Purchase
Agreement.
1.4. Headings are inserted for convenience only and shall not affect the
interpretation of this Share Purchase Agreement.
1.5. Nouns, pronouns and verbs of the singular number shall be deemed to
include the plural, and vice versa, and pronouns of the masculine
gender shall be deemed to include the feminine and neuter, and vice
versa, all as the context may require.
1.6. The words "include", "includes" and "including" shall be deemed to be
followed by the phrase "without limitation".
1.7. Whenever used in this Share Purchase Agreement the words "hereof",
"herein" and similar words shall be construed as references to this
Share Purchase Agreement as a whole and not limited to the particular
Article or subsection in which the reference appears.
1.8. The words "best knowledge" shall mean such knowledge as the relevant
entities, officials, directors or members of the management board,
municipal executive board or provincial executive body, as the case
may be, have or may reasonably be expected to have.
ARTICLE 2 SALE, PURCHASE AND PURCHASE PRICE
2.1. Subject to the terms and conditions of this Share Purchase Agreement:
2.1.1. Each of the Existing Partners hereby sells to the New
Partner and the New Partner hereby purchases from
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each of the Existing Partners such number of its
Shares as set forth in SCHEDULE 2.1.1 (the "First
Tranche Shares");
2.1.2. Subject to the Second Completion Conditions, the
Existing Partners hereby sell to the New Partner and
the New Partner hereby purchases from the Existing
Partners such number of Shares as is required to
provide the New Partner with a majority interest of
52% (in words: fifty two percent), in the issued and
outstanding share capital of the Company, whereby
each Existing Partner sells to the New Partner at
least one third of such number of Shares provided,
however that the New Partner shall, if requested by
an Existing Partner, purchase and accept such
additional number of Shares as shall be determined
by each of the Existing Partners at its sole
discretion and notified to the New Partner in the
Request (the "Second Tranche Shares");
2.1.3. Subject to the Third Completion Conditions, each of
the Existing Partners hereby sells to the New Partner
and the New Partner hereby purchases from each of the
Existing Partners all the Shares, if any, which such
Existing Partner shall hold after Completion of the
Second Tranche Shares (the "Third Tranche Shares").
2.2. The aggregate purchase price (the "Purchase Price") to be paid by the
New Partner to the Existing Partners shall be:
2.2.1. for the First Tranche Shares, the First Purchase
Price which shall be determined and allocated to the
respective Existing Partners in the amounts set
forth in Schedule 2.1.1;
2.2.2. for the Second Tranche Shares the price (the "Second
Purchase Price") shall be calculated, determined and
allocated amongst the Existing Partners in accordance
with the formula set forth in SCHEDULE 2.2.2;
2.2.3. for the Third Tranche Shares the price (the "Third
Purchase Price") shall be calculated, determined and
allocated amongst the Existing Partners in accordance
with the formula set forth in Schedule 2.2.2;
5
2.3. As security for due performance by the Ultimate Parent 2 of its
obligation to guarantee payment of the Second Purchase Price and the
Third Purchase Price to the Existing Partners, the Ultimate Parent 2
shall pledge on the First Completion Date 65% of its ownership
interest in Reliant Energy Wholesale Holdings (Europe) Inc. to the
Existing Partners by means of a pledge agreement, in accordance with
the form attached hereto as SCHEDULE 2.3.
ARTICLE 3 SIGNING
3.1. The Signing Actions shall take place on the Signing Date and shall be
deemed to take place simultaneously, with each such action being
conditional upon all such actions being effected.
ARTICLE 4 CONDITIONS TO COMPLETION
4.1. The obligations of the Parties under this Share Purchase Agreement
shall be:
4.1.1. with respect to the transfer of the First Tranche
Shares subject to and conditional upon the First
Completion Conditions being satisfied or waived by
the Party to whose benefit these conditions inure;
4.1.2. with respect to the sale and transfer of the
Second Tranche Shares subject to and
conditional upon the completion conditions
attached hereto as SCHEDULE 4.1.2. (the
---------------
"Second Completion Conditions") being satisfied
or waived by the Party to whose benefit these
conditions inure;
4.1.3. with respect to the sale and transfer of the Third
Tranche Shares subject to and conditional upon the
completion conditions attached hereto as SCHEDULE
4.1.3. (the "Third Completion Conditions") being
satisfied or waived by the Party to whose benefit
these conditions inure.
4.2. Each of the Parties shall make all reasonable efforts to ensure that
each of the Completion Conditions is satisfied as early as possible
before the related Completion Date. If at any time a Party becomes
aware of anything that may prevent any Completion Condition being
satisfied, it
6
shall immediately inform the other Parties and the Parties shall
cooperate to make all reasonable efforts to ensure the Completion
Conditions are satisfied.
ARTICLE 5 COVENANTS PRIOR TO THE FIRST COMPLETION DATE
5.1. The Existing Partners and the Company shall procure that, from the
Signing Date until the First Completion Date, the Pre-Completion
Covenants shall be complied with.
ARTICLE 6 COMPLETION AND PAYMENT REGARDING THE SOLD SHARES
6.1. The Completion of the Sold Shares shall take place at the Amsterdam
offices of Loeff Claeys Verbeke whereby:
6.1.1. the Completion of the First Tranche Shares shall
take place on a Business Day within 15 (in
words: fifteen) Business Days, as mutually
agreed between the New Partner and Existing
Partners after the date on which any and all First
Completion Conditions shall have been fulfilled
or waived by the Party to whose benefit these
First Completion Conditions inure (the "First
Completion Date");
6.1.2. the Completion of the Second Tranche Shares
shall take place pursuant to a Request subject to
Article 6.1.4 by one of the Existing Partners to
the New Partner on a Business Day (the
"Second Completion Date") within 60 (in words:
sixty) Business Days after such Request, as
mutually agreed between the New Partner and
the Existing Partners, but in no event later than
31 December 2002;
6.1.3. the Completion of the Third Tranche Shares, if
any, shall take place pursuant to a Request
subject to Article 6.1.4 by each respective
Existing Partner within 60 (in words: sixty)
Business Days, after such Request as mutually
agreed between the New Partner and the
Existing Partners, but in no event later than 31
December 2006 (the "Third Completion Date");
7
6.1.4. the Requests referred to in Articles 6.1.2. and
Articles 6.1.3, respectively, shall set forth the
number of Shares to be transferred to the New
Partner on the respective Completion Date, and
be submitted to the New Partner at least 120 (in
words: hundred twenty) days prior to such
Completion Date or 60 (in words: sixty) days
after the respective Completion Conditions have
been fulfilled or waived by the Party to whose
benefit these Completion Conditions inure which
ever date is later;
6.2. Notwithstanding any provision in the Partnership Documentation to the
contrary, the Existing Partners will remain obligated under this
Share Purchase Agreement to sell, and the New Partner will remain
obligated to purchase, Second Tranche Shares and Third Tranche Shares
even if, for any reason whatsoever, the Second Tranche Shares and
Third Tranche Shares are not sold to New Partner by the Second
Completion Date and the Third Completion Date, respectively.
6.3. The respective transfers of the Sold Shares shall be carried out
through execution of a notarial deed, in form attached hereto as
SCHEDULE 6.3 before the Notary. The Notary shall be a civil law
notary of Loeff Claeys Verbeke, the firm of the external legal
advisors of the Company. The other Parties hereby acknowledge that
they are aware of the provisions of articles 8, 9, 10 and 14.2 of
the "Guidelines" concerning associations between civil law notaries
(notarissen) and associations between civil law notaries (notarissen)
and barristers/solicitors ("advocaten")" as established by the
Board of the Royal Regulatory Body of Civil Law Notaries
("Koninklijke Notariele Beroepsorganisatie"). The other Parties
hereby explicitly agree that Loeff Claeys Verbeke shall advise and
act on behalf of the Company with respect to this Share Purchase
Agreement, any agreements resulting from this Share Purchase
Agreement or any disputes resulting therefrom. To this end the other
Parties hereby approve the exchange of essential information,
relating to the transfer of the Sold Shares, between the barristers/
solicitors ("advocaten"), tax advisors ("fiscalisten") and civil
law notaries ("notarissen") of Loeff Claeys Verbeke.
6.4. The New Partner shall pay the First Purchase Price, which shall be
estimated and allocated in accordance with Schedule 2.2.1, the Second
Purchase Price and the Third Purchase Price on the respective
Completion Dates in accordance with the respective Completion
Actions.
8
ARTICLE 7 COMPLETION
7.1. At the Completion of the First Tranche Shares, the First Completion
Actions shall take place, which actions shall be deemed to take place
as described in Schedule 18.2 to the Partnership Agreement, with each
such action being conditional upon all such actions being effected;
7.2. At the Completion of the Second Tranche Shares and Third Tranche
Shares, respectively, the actions referred to in SCHEDULE 7.2A (the
"Second Completion Actions") and the actions referred to in SCHEDULE
7.2B (the "Third Completion Actions"), respectively, shall take
place, which actions shall be deemed to take place simultaneously,
with each such action being conditional upon all such actions being
effected.
7.3. Each Party shall at the reasonable request of another Party execute
all documents and do all other acts and things as may reasonably be
deemed necessary to give full effect to this Share Purchase Agreement
and all agreements pursuant hereto.
7.4. After the First Completion Date, the New Partner and the Existing
Partners shall determine, allocate and settle the actual First
Purchase Price in accordance with Schedule 2.2.1.
ARTICLE 8 WAIVER
8.1. The New Partner and each of the Existing Partners unconditionally and
irrevocably waive all of their respective rights under the Articles
of Association in respect of the sale and transfer of the Sold
Shares.
ARTICLE 9 STRANDED COSTS
9.1. For the purpose of determination of the Purchase Price, the Parties
have estimated that the Stranded Costs for the account of the Company
shall be NLG 500,000,000 (in words: five hundred million Dutch
Guilders) (the "Estimated Stranded Costs"), which estimate is based
on the expected allocation of the Stranded Costs between each of the
Dutch electricity generators and the Ministry of Economic Affairs as
set forth in SCHEDULE 9.1 (the "Expected Allocation").
9.2. In the event that either (i) the Company and the other Dutch energy
generating companies in the Netherlands (EPON, EPZ and EZH and the
naamloze vennootschap Samenwerkendle Electriciteits Produktie
Bedrijven (SEP)) shall enter into a definitive settlement agreement,
which shall have become final and binding, with respect to the
allocation of the Stranded Costs, or (ii) the Ministry of Economic
Affairs or a competent court or arbitral tribunal shall issue a
ruling with respect to the allocation
9
of the Stranded Costs that is subsequently approved, in as far as
required by all governmental authorities, including those of the
European Union, which shall be final and binding on the Company, the
Company shall as soon as possible after such definitive settlement
agreement or final ruling submit a statement (the "Statement") to the
Shareholders providing for the calculation of the Stranded Costs by
adjusting the Estimated Stranded Costs and the Expected Allocation as
set forth in Schedule 9.1 in accordance with the following principles
(the "Adjustment Principles"):
9.2.1. the allocation of the Stranded Costs reflected in
the Expected Allocation between the Dutch
electricity generators and the Ministry of
Economic Affairs shall be adjusted if necessary
so as to conform to the contributions of the
Ministry of Economic Affairs at the 7ct/KWh
basic load price level in either the settlement
agreement or the ruling referred to in this Article
9.2 under (i) and (ii), as the case may be;
9.2.2. the allocation of the Stranded Costs reflected in
the Expected Allocation between the Dutch
electricity generators shall be adjusted if
necessary so as to conform to the allocation
determined in either the settlement agreement or
the ruling referred to in this Article 9.2 under (i)
and (ii), as the case may be;
9.2.3. the amounts mentioned in Schedule 9.1 under
the column "Total" shall remain unchanged.
9.3. The Existing Partners and the New Partner shall review the Statement
and shall consult with each other and with the Company with a view to
agreeing in good faith on the definitive amount of the Stranded Costs
calculated in accordance with the Adjustment Principles (the
"Definitive Stranded Costs"). The provisions made in Article 9.6 and
Article 9.8 shall apply if the Existing Partners, the New Partner and
the Company reach agreement on the Definitive Stranded Costs.
9.4. If the Existing Partners, the New Partner and the Company shall fail
to agree on the application of the Adjustment Principles and the
corresponding Definitive Stranded Costs within 60 (in words: sixty)
days of the date on which the Company sent out the Statement, each of
the Existing Partners, the Company or the New Partner may serve
written notice on the others and may refer the dispute for resolution
to an
10
independent chartered accountant acting as an expert (bindend
adviseur) and not as an arbitrator to be appointed by agreement
between the Existing Partners, the Company and the New Partner or,
failing agreement as to nomination within 10 (in words: ten) Business
Days of such written notice, to be nominated by the president for the
time being of the "Nederlands Instituut Van Register Accountants".
The independent chartered accountant shall be instructed to use
reasonable efforts to deliver his opinion within 20 (in words:
twenty) Business Days of the referral to him or so soon thereafter as
is practicable and his decision on the application of the Adjustment
Principles and the corresponding Definitive Stranded Costs shall, in
the absence of manifest error, be final and binding on the Parties.
The costs of an independent chartered accountant shall be borne in
the way that he sees fit.
9.5. The Parties shall procure that the New Partner's Accountants, the
Existing Partners' Accountants and any independent chartered
accountant shall have reasonable access during business hours to all
relevant books, records, accounts, personnel and other information of
the Companies for the purpose of reviewing the Statement. The costs
of the New Partner's Accountants and the Existing Partners'
Accountants shall be borne by the New Partner and by the Existing
Partner respectively.
9.6. The Purchase Price shall be increased, if the sum of (i) the amount
of the Definitive Stranded Costs (as agreed or determined under the
provisions of this Article 9) and (ii) the aggregate amount of Legal
Action Stranded Costs is less than the amount of the Estimated
Stranded Costs. The Purchase Price shall be reduced if the sum of
(i) the amount of the Definitive Stranded Costs (as agreed or
determined under the provisions of this Article 9 and (ii) the
aggregate amount of Legal Action Stranded Costs exceeds the
Estimated Stranded Costs. The increase or reduction of the Purchase
Price as the case may be, shall be calculated, determined and
applied in the manner set forth in Schedule 9.
9.7. The Existing Partners shall repay to the New Partner the amount of
any reduction in the Purchase Price and the New Partner shall repay
to the Existing Partners the amount of any increase in the Purchase
Price, calculated and determined under the provisions of this
Article 9 on the later of the Second Completion Date or the 30th day
(or if that day is not a Business Day, the next succeeding Business
Day) following the date on which the Definitive Stranded Costs are
agreed or determined under the provisions of this Article 9 (the
"Date of Payment") by wire transfer to such account or accounts as
the New Partner or the Existing Partners, as the case may be, may
specify in writing, or by such other method as the Existing Partners
and the New Partner may agree.
11
9.8. The Company shall keep the New Partner and the Existing Partners
fully informed of the Stranded Costs and actions taken by the Company
and the Existing Partners with respect to such Stranded Costs.
9.9. The obligation of the Existing Partners and the New Partner to pay in
accordance with Article 9.6 the difference between the Definitive
Stranded Costs over the amount of Estimated Stranded Costs shall
expire at the later of 31 December 2004 or the last Third Completion
Date unless (i) there has been a settlement agreement or ruling
referred to in Article 9.2 under (i) and(ii) for which no Purchase
Price adjustment has yet been made under Article 9.6 or (ii) there
is outstanding on such date an action that could result in Legal
Action Stranded Costs.
9.10. At the option of the New Partner, New Partner may reduce the Second
Purchase Price and Third Purchase Price with respect to any amounts
it is entitled to receive (and has not received) from the Existing
Partners under this Article 9.
ARTICLE 10 DUE DILIGENCE INVESTIGATION
10.1. The New Partner and the Ultimate Parent 2 acknowledge and agree that
they have performed, with the assistance of professional legal,
accountancy, financial technical and tax advisors, a due diligence
investigation (the "Due Diligence Investigation") and furthermore;
10.1.1. that for the purposes of the Due Diligence
Investigation they have had (and that their advisors
have had), opportunity to review the information
including the data room information set out in
SCHEDULE 10.1.1 made available to them and their
advisors;
10.1.2. that they have obtained (and their advisors have
obtained) other information that they (and their
advisors) deemed proper and necessary for the
purposes of entering into this Share Purchase
Agreement, through management interviews,
management presentations, site visits and
questions submitted to the Existing Partners and
the Companies and their advisors; and
10.1.3. that they have raised with the Existing Partners and
the Companies any and all specific issues which they
considered relevant in connection with the
transactions contemplated hereby.
12
10.2. The New Partner and the Ultimate Parent 2 acknowledge that the
representations and warranties contained in this Share Purchase
Agreement are the only representations, warranties or other
assurances of any kind given by or on behalf of the Existing Partners
and the Companies on which the New Partner and the Ultimate Parent 2
may rely (and have relied upon) in entering into this Share Purchase
Agreement.
10.3. The New Partner and the Ultimate Parent 2 hereby declare that they
are not aware as of the Signing Date of any matter or anything which
is inconsistent with the representations and warranties of the
Existing Partners contained in this Share Purchase Agreement.
ARTICLE 11 REPRESENTATIONS AND WARRANTIES OF EXISTING PARTNERS
11.1. Subject to the provisions of Article 10 and Article 13, the Existing
Partners jointly ("niet-hoofdelijk") represent and warrant to the New
Partner that at the Signing Date each and every statement (the
"Warranties") set out in SCHEDULE 11.1 is, and that at the First
Completion Date each and every Warranty shall be, true and correct.
The Existing Partners also represent and warrant to the New Partner
that at the Second Completion Date and Third Completion Date, the
Warranties set out in articles 2.1 and 2.2 with respect to the
Second Tranche Shares and the Third Tranch Shares, respectively,
shall be true and correct.
ARTICLE 12 REPRESENTATIONS AND WARRANTIES OF THE NEW PARTNER
AND ULTIMATE PARENT
12.1. The New Partner and the Ultimate Parent 2 represent and warrant to
the Existing Partners that each and every statement made by them in
article 19 of the Partnership Agreement is, and at the First
Completion Date shall be true and correct.
ARTICLE 13 BREACH OF WARRANTIES, NON-FULFILLMENT, DAMAGES
13.1. In the event of a breach of any of the Warranties by the Existing
Partners or the New Partner or the Ultimate Parent 2 ("Breach") or
Non-Fulfillment by the Existing Partners, the New Partner or the
Ultimate Parent 2 of any other obligation contemplated by this Share
Purchase Agreement ("Nonfulfillment"), the Existing Partners, the
New Partner or the Ultimate Parent 2, (the "Notifying Party"), as
the case may be, shall upon obtaining knowledge thereof notify the
other Party (the "Notified Party") of such Breach or Nonfulfillment
promptly and in writing, and under no circumstances later than 30
(in words: thirty) days after obtaining knowledge of the Breach or
Nonfulfillment, setting out in reasonable detail the events or facts
giving rise to the Breach or Non-Fulfillment, and
13
specifying the amount of Damages claimed as a result of any Breach or
Non-Fulfillment.
13.2. If the Notified Party fails to take appropriate measures to remedy
the Breach or Non-Fulfillment within 30 (thirty) days of such
notification and a dispute arises, the Notifying Party shall be
entitled to institute arbitration proceedings with a view of
resolving the dispute pursuant to article 40 of the Partnership
Agreement.
13.3. Subject to the other provisions of this Article 13, the Existing
Partners shall indemnify the New Partner for all Damages incurred by
the New Partner, resulting from any Breach or any Non-Fulfillment, as
the case may be.
13.4. The Existing Partners shall not owe Damages to the New Partner by
virtue of this Article 13 or otherwise have obligations towards the
New Partner if and to the extent that the Damage ensuing from a
Breach or Non-Fulfillment:
13.4.1. has been paid to the New Partner or to the
Company or Companies by virtue of any
insurance policy;
13.4.2. has been paid to the New Partner or to the
Company or Companies by a third party other
than an insurance company;
13.4.3. has not been reported in writing with a statement of
nature, cause and scope of the loss or damage to the
Existing Partners within 60 (in words: sixty) days
after the day the New Partner has become aware of the
Breach or Non- Fulfillment arose;
13.4.4. is specifically, fairly and fully disclosed in
writing to the New Partner before the Signing Date;
13.4.5. is covered by means of a reserve in the 1998 Annual
Accounts, on the understanding that, for the
application of this Article 13.4.5, reserves which
are (or should be) released after the First
Completion Date shall be added to reserves which at
that instance are found to be insufficient for the
underlying Damage; or if there is not definitive
insight concerning the sufficiency of the other
reserves, shall be included in a new general reserve
that
14
shall be created for the purpose of supplementing
reserves found at a later instance to be insufficient
to cover the underlying Damage, whereby cases of
Damage for which reserves are nonexistent or
insufficient at the instance of liability and which
occurred prior to release within the meaning of this
Article 13.4.5, shall be set-off retroactive against
a released reserve;
13.4.6. are solely due to changes in legislation, regulations
or case law that had taken effect after the First
Completion Date and except as specifically provided
for in this Share Purchase Agreement;
13.4.7. is a consequence of a change after the First
Completion Date of the corporate or tax structure
or the accounting policies of the Companies;
13.4.8. would not have occurred without an action or omission
after the First Completion Date by the New Partner,
the Companies or any person whose action or omission
is attributable to the New Partner and/or the
Companies which bear a material connection to the
Damage;
13.4.9. if and to the extent it reduces the tax obligations
of the New Partner relating to its investment in the
Company or of the Companies after the First
Completion Date and except as specifically provided
for in this Share Purchase Agreement;
13.4.10. and furthermore, if and to the extent that the
alleged Breach or Nonfulfillment is not submitted by
the New Partner to the arbitral body referred to in
article 40 of the Partnership Agreement within a
period of three months after the written notification
by the New Partner to Existing Partners of the Breach
or Non-Fulfillment.
13.5. The Existing Partners and the Company shall ensure that reasonable
steps are taken to prevent or mitigate Damages, which could give rise
to a claim by virtue of this Article 13. If the Damages concerned
are a consequence of or bears connection to a claim from or
liability towards a third party neither the Existing Partner nor
the Company shall in the matter of such claim or liability agree
to any term with the third party without prior written permission
from the New Partner. In addition, the Company shall not agree to
any such terms without prior permission from the Existing Partners.
The Company shall keep the New Partner and the
15
Existing Partners fully informed of such Damages and of the defense
to be conducted by the Company.
13.6. A Damage claim against the Existing Partners in connection with a
Breach or Non-Fulfillment shall not be permitted for any individual
claims for an amount below NLG 1,000,000 (in words: one million Dutch
Guilders), and in any event the aggregate amount of all claims (as
finally determined or agreed) in excess of NLG 1,000,000 (in words:
one million Dutch Guilders) must total more than NLG 150,000,000
(in words: one hundred and fifty million Dutch Guilders) before a
claim may be lodged, in which case the excess over NLG 150,000,000
(in words: one hundred and fifty million Dutch Guilders) shall be
payable.
13.7. Under no circumstances shall the aggregate amount of (i) all awards
or Damages awarded or agreed against the Existing Partners, (ii) a
reduction of the Purchase Price pursuant to Article 9.6, if any, and
(iii) any other payment obligation of the Existing Partners under
this Share Purchase Agreement other than (x) any payments to adjust
the estimated First Purchase Price to the actual First Purchase Price
to reflect changes in net debt and dividend payments as provided in
Schedule 2.1.1, (y) any requirements of an Existing Partner to pay
expenses under the provisions of the Partnership Documentation
including, but not limited to, articles 33.1 and 40.7 of the
Partnership Agreement and articles 9.4 and 9.8 and (z) any
obligation to pay interest in respect of an adjustment of the
Purchase Price as contemplated by Schedule 9.6, exceed an amount
equal to 40% (in words: forty percent) of the Purchase Price.
13.8. The New Partner shall not be entitled to make any claim against the
Existing Partners for any Breach or Non-Fulfillment unless notice in
writing of such claim is given prior to 1 May immediately following
the first full Fiscal Year of the Company after the First Completion
Date except for (i) a claim for a Breach of article 4.5 of Schedule
11.1 for which the New Partner shall not be entitled to make any
claim against the Existing Partners unless written notice of such
claim is given prior to the day 30 (in words: thirty) months after
the First Completion Date and (ii) a claim for a Breach relating to
tax, for which the New Partner shall not be entitled to make any
claim against the Existing Partners unless written notice of such
claim is given prior to the end of the period during which the
relevant Dutch tax authorities are competent, according to the laws
of the Netherlands, to impose an additional tax assessment
("navorderingsaanslag" or "naheffingsaanslag") concerning events,
omissions, acts or behaviors that have taken place prior to the First
Completion Date increased by a period of six months.
16
13.9. Any Damages and any other amount payable by each respective Existing
Partner under Article 13 shall only be payable at 1/3 (in words: one
third) of the amount otherwise due under the subsections of this
Article 13.
13.10. Without prejudice to the provisions of Article 9, the Existing
Partners shall not owe Damages to the New Partner by virtue of this
Article 13 or otherwise have obligations towards the New Partner if
and to the extent that the Damages ensue from or are related to
Stranded Costs.
13.11. The amount of any award or Damages owed by the Existing Partners to
the New Partner shall at the option of the Existing Partners be
either paid directly to the New Partner or subtracted from the
amount, if any, of the Second Purchase Price and the Third Purchase
Price if necessary, owed by the New Partner to the Existing Partners.
Any such obligation to make payment by the Existing Partners or
subtraction from the Purchase Price shall be allocated among the
Existing Partners in proportion to the numbers of First Tranche
Shares sold by the Existing Partners being 1/3 (in words: one third).
At the option of the New Partner, the New Partner may reduce the
Second Purchase Price and Third Purchase Price with respect to any
amounts it is entitled to receive (and has not received) from the
Existing Partners under this Article 13.
13.12. The Province of Utrecht and the Municipality of Utrecht jointly
("niet hoofdelijk"), irrevocably and unconditionally guarantee to the
New Partner as guarantor for Pegus prompt performance by Pegus of all
its obligations under or in connection with the Share Purchase
Agreement.
ARTICLE 14 TERMINATION
14.1. If the Partnership Agreement is terminated in accordance with Article
22 of the Partnership Agreement, this Share Purchase Agreement shall
terminate in accordance with its terms.
ARTICLE 15 MISCELLANEOUS
15.1. Articles 19 and 22 through 40 of the Partnership Agreement shall
govern this Share Purchase Agreement.
17
IN WITNESS WHEREOF this Share Purchase Agreement has been executed by the
Parties hereof in eightfold on the date set out on page one.
SIGNED by
- --------------------------------------------
for and on behalf of Provincie Noord Holland
By: J.P.J. Lagrand
SIGNED by
- --------------------------------------------
for and on behalf of Gemeente Utrecht
By: H.H.W. Kernkamp
SIGNED by
- --------------------------------------------
for and on behalf of Gemeente Amsterdam
By: G. ter Horst
SIGNED by
- --------------------------------------------
for and on behalf of Provincie Utrecht
By: D.H. Kok
SIGNED by
- --------------------------------------------
for and on behalf of N.V. Provinciaal en
Gemeentelijk Utrechts Stroomleveringsbedrijf
By: M. ten Klooster
18
SIGNED by
- --------------------------------------------
Reliant Energy Wholesale Holdings (Europe) Inc.
By: R. Steve Letbetter
SIGNED by
- --------------------------------------------
for and on behalf of Reliant Energy Power Generation, Inc.
By: R. Steve Letbetter
SIGNED by
- --------------------------------------------
for and on behalf of N.V. Energieproduktiebedrijf UNA
By: P. Koppen de Neve
19
Schedules to the Share Purchase Agreement
Schedule 1.1 : Definitions
Schedule 2.1.1 : First Tranche Shares
Schedule 2.2.2 : Second Tranche Shares and Third Tranche Shares
Schedule 2.3 : Principal Terms of Pledge Agreement
Schedule 4.1.2 : Second Completion Conditions
Schedule 4.1.3 : Third Completion Conditions
Schedule 6.3 : Draft Deed of Transfer
Schedule 7.2a : Second Completion Actions
Schedule 7.2b : Third Completion Actions
Schedule 9.1 : Expected Allocation
Schedule 9.6 : Adjustment Purchase Price
Schedule 10.1.1 : Data room Information
Schedule 11.1 : Warranties
1
EXHIBIT 12
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
THREE
MONTHS ENDED TWELVE MONTHS
MARCH 31, ENDED MARCH 31,
--------------- ---------------
1999 1999
--------------- ---------------
Fixed Charges as Defined:
(1) Interest on Long-Term Debt........................................ $ 103,854 $ 413,963
(2) Other Interest.................................................... 23,339 96,747
(3) Capitalized Interest.............................................. 779 8,170
(4) Distribution on Trust Securities.................................. 9,791 31,582
(5) Interest Component of Rentals Charged to Operating Expense........ 2,600 11,085
--------------- ---------------
(6) Total Fixed Charges............................................... $ 140,363 $ 561,547
=============== ===============
Earnings as Defined:
(7) Income (loss) from Continuing Operations.......................... $ (209,789) $ (321,156)
(8) Income Taxes for Continuing Operations............................ (56,543) (91,251)
(9) Fixed Charges (line 6)............................................ 140,363 561,547
(10) Capitalized Interest.............................................. (779) (8,170)
--------------- ---------------
(11) Income from Continuing Operations Before Income Taxes and Fixed
Charges......................................................... (126,748) 140,970
=============== ===============
Ratio of Earnings to Fixed Charges (line 11 divided by line 6)............. 0.25
Preferred Dividends Requirements:
(12) Preferred Stock Dividends......................................... $ 97 $ 390
(13) Less Tax Deduction for Preferred Dividends........................ $ 27 $ 54
--------------- ---------------
(14) Total............................................................. $ 70 $ 336
(15) Ratio of Pre-Tax Income from Continuing Operations to Net Income
(line 7 plus line 8 divided by line 7).......................... 1.27 1.28
--------------- ---------------
(16) Line 14 times line 15............................................. 89 430
(17) Add Back Tax Deduction (line 13).................................. 27 54
--------------- ---------------
(18) Preferred Dividends Factor........................................ 116 484
=============== ===============
(19) Total Fixed Charges (line 6)...................................... $ 140,363 $ 561,547
(20) Preferred Dividends Factor (line 18)............................. 116 484
--------------- ---------------
(21) Total............................................................. 140,479 562,031
=============== ===============
Ratios of Earnings to Fixed Charges and Preferred Dividends (line 11
divided by line 21)...................................................... 0.25
=============== ===============
Earnings for the three months ended March 31, 1999 are inadequate to cover
fixed charges; the coverage deficiency is approximately $267 million for the
three-month period ended March 31, 1999 and $421 million for the twelve-month
period ended March 31, 1999. The deficiency results from the non-cash,
unrealized accounting loss recorded for the ACES of $331 million for the three
months ended March 31, 1999 and $1,318 million for the twelve months ended March
31, 1999. Excluding ACES, earnings from continuing operations to fixed charges
would have been 1.46 and 2.60 for the three months and twelve months ended March
31, 1999.
OPUR1
0000048732
RELIANT ENERGY INC
1,000
3-MOS
DEC-31-1999
MAR-31-1999
PER-BOOK
9,639,082
3,806,571
1,558,610
3,882,262
0
18,886,525
2,931,138
0
1,029,892
3,961,030
0
9,740
7,677,463
0
302,300
1,435,703
375,497
0
13,502
0
5,111,290
18,886,525
2,642,904
(56,543)
2,452,789
2,452,789
190,115
(320,296)
(130,181)
136,054
(209,692)
97
(209,789)
106,905
85,437
202,226
(0.74)
(0.74)
Total annual interest charges on all bonds is as of year-to-date 03/31/99.
1
EXHIBIT 99A
[ITEMS INCORPORATED BY REFERENCE FROM THE COMPANY 10-K.]
ITEM 3. LEGAL PROCEEDINGS.
(a) Company.
For a description of certain legal and regulatory proceedings affecting the
Company, see Notes 3(b), 12(h) and 12(i) to the Company's Consolidated Financial
Statements, which notes are incorporated herein by reference.
ITEM. 7 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
Earnings for the past three years are not necessarily indicative of future
earnings and results. The level of future earnings depends on numerous factors
including (i) the future growth in the Company's and its subsidiaries' energy
sales; (ii) weather; (iii) the success of the Company's and its subsidiaries'
entry into non-rate regulated businesses such as energy marketing and
international and domestic power projects; (iv) the Company's and its
subsidiaries' ability to respond to rapid changes in a competitive environment
and in the legislative and regulatory framework under which they have
traditionally operated; (v) rates of economic growth in the Company's and its
subsidiaries' service areas; (vi) the ability of the Company and its
subsidiaries to control costs and to maintain pricing structures that are both
attractive to customers and profitable; (vii) the outcome of future rate
proceedings; (viii) the effect that foreign exchange rate changes may have on
the Company's investments in international operations; and (ix) future
legislative initiatives.
In order to adapt to the increasingly competitive environment in which the
Company operates, the Company continues to evaluate a wide array of potential
business strategies, including business combinations or acquisitions involving
other utility or non-utility businesses or properties, internal restructuring,
reorganizations or dispositions of currently owned properties or currently
operating business units and new products, services and customer strategies. In
addition, the Company continues to engage in new business ventures, such as
electric power trading and marketing, which arise from competitive and
regulatory changes in the utility industry.
COMPETITION AND RESTRUCTURING OF THE ELECTRIC UTILITY INDUSTRY
The electric utility industry is becoming increasingly competitive due to
changing government regulations, technological developments and the availability
of alternative energy sources.
Long-Term Trends in Electric Utility Industry. The electric utility
industry historically has been composed of vertically integrated companies
providing electric service on an exclusive basis within governmentally-defined
geographic areas. Prices for electric service have typically been set by
governmental authorities under principles designed to provide the utility with
an opportunity to recover its cost of providing electric service plus a
reasonable return on its invested capital. Federal legislation and regulation as
well as legislative and regulatory initiatives in various states have encouraged
competition among electric utility and non-utility owned power generators. These
developments, combined with increased demand for lower-priced electricity and
technological advances in electric generation, have continued to move the
electric utility industry in the direction of more competition.
Based on a strategic review of the Company's business and of ongoing
developments in the electric utility and related industries regarding
competition, regulation and consolidation, the Company's management believes
that the electric utility industry will continue its path toward competition,
albeit on a state-by-state basis. The Company's management also believes the
business of electricity and natural gas are converging and consolidating and
these trends will alter the structure and business practices of companies
serving these markets in the future.
Competition in Wholesale Market. The Federal Energy Policy Act of 1992, the
Public Utility Regulatory Act of 1995 (now the Texas Utilities Code) and
regulations promulgated by the Federal Energy Regulatory Commission (FERC)
contain provisions intended to facilitate the development of a wholesale energy
market. Although Reliant Energy HL&P's wholesale sales traditionally have
accounted for less than 1% of its total revenues, the expansion of competition
in the wholesale electric market is significant in that it has increased the
range of non-utility competitors, such as exempt wholesale generators (EWGs) and
power marketers, in the Texas electric market as well as resulted in fundamental
changes in the operation of the state transmission grid.
In February 1996, the Texas Utility Commission adopted rules granting
third-party users of transmission systems open access to such systems at rates,
terms and conditions comparable to those available to utilities owning such
transmission assets. Under the Texas Utility Commission order implementing the
rule, Reliant Energy HL&P was required to separate, on an operational basis, its
wholesale power marketing operations from the operations of the transmission
grid and, for purposes of transmission pricing, to disclose each of its separate
costs of generation, transmission and distribution.
Within ERCOT, an independent system operator (ISO) manages the state's
electric grid, ensuring system reliability and providing non-discriminatory
transmission access to all power producers and traders. The ERCOT ISO, the first
in the nation, is a key component for implementing the Texas Utility
Commission's overall strategy to create a
2
competitive wholesale market. ERCOT formed an ad hoc committee in early 1998 to
investigate the potential impacts of a competitive retail market on the ISO. The
ERCOT committee report was released in December 1998 and concluded that the
ISO's role and function would necessarily expand in a competitive retail
environment, but the changes required of the ISO to support retail choice should
not impede introduction of retail choice.
Competition in Retail Market. The Company estimates that, since 1978,
cogeneration projects representing approximately one-third of current total peak
generating capability have been built in the Houston area and that, as a result,
Reliant Energy HL&P has seen a reduction of approximately 2,500 MW in customer
load to self-generation. Reliant Energy HL&P has utilized flexible pricing to
respond to situations where large industrial customers have an alternative to
buying power from it, primarily by constructing their own generating facilities.
Under a tariff option approved by the Texas Utility Commission in 1995, Reliant
Energy HL&P was permitted to implement contracts based upon flexible pricing for
up to 700 MW. Currently, this rate is fully subscribed.
Texas law currently does not permit retail sales by unregulated entities
such as cogenerators. The Company anticipates that cogenerators and other
interests will continue to exert pressure to obtain access to the electric
transmission and distribution systems of regulated utilities for the purpose of
making retail sales to customers of regulated utilities.
Legislative Proposals. A number of proposals to restructure the electric
utility industry have been introduced in the 1999 session of the Texas
legislature. If adopted, legislation may permit and encourage alternative
suppliers to compete to serve Reliant Energy HL&P's current rate-regulated
retail customers. The various legislative proposals include provisions governing
recovery of stranded costs and permitting securitization of those costs;
freezing rates until 2002; requiring firm sales of energy to competing retail
electric providers; requiring disaggregation of generation, transmission and
distribution, and retail sales into separate companies and limiting the ability
of existing utilities' affiliates competing for retail electric customers on the
basis of price until they have lost a substantial percentage of their
residential and small commercial load to alternative retail providers. In
addition to the Texas legislative proposals, a number of federal legislative
proposals to promote retail electric competition or restructure the U.S.
electric utility industry have been introduced during the current congressional
session.
At this time, the Company is unable to make any prediction as to whether
any legislation to restructure electric operations or provide retail competition
will be enacted or as to the content or impact on the Company of any legislation
which may be enacted. However, because the proposed legislation is intended to
fundamentally restructure electric utility operations, it is likely that enacted
legislation would have a material impact on the Company.
Stranded Costs. As the U.S. electric utility industry continues its
transition to a more competitive environment, a substantial amount of fixed
costs previously approved for recovery under traditional utility regulatory
practices (including regulatory assets and liabilities) may become "stranded,"
i.e., unrecoverable at competitive market prices. The issue of stranded costs
could be particularly significant with respect to fixed costs incurred in
connection with the past construction of generation plants, such as nuclear
power plants, which, because of their high fixed costs, would not command the
same price for their output as they have in a regulated environment.
In January 1997, the Texas Utility Commission delivered a report to the
Texas legislature on stranded investments in the electric utility industry in
Texas (referred to by the Texas Utility Commission as "Excess Cost Over Market")
(ECOM). In April 1998, the Texas Utility Commission submitted to the Texas
Senate Interim Committee on Electric Utility Restructuring an updated study of
ECOM estimates. Assuming that retail competition is adopted at the beginning of
2002, the updated study estimated that the total amount of stranded costs for
all Texas electric utilities could be $4.5 billion. If instead, retail
competition is adopted one year later, the study estimates statewide ECOM to be
$3.3 billion. Estimates of ECOM vary widely and there is inherent uncertainty in
calculating these costs.
Transition Plan. In June 1998, the Texas Utility Commission approved the
Transition Plan filed by Reliant Energy HL&P in December 1997. The Transition
Plan included base rate credits to residential and certain commercial
2
3
customers in 1998 and 1999, an overall rate of return cap formula for 1998 and
1999 and approval of accounting procedures designed to accelerate recovery of
stranded costs which may arise under restructuring legislation. The Transition
Plan permits the redirection of depreciation expense to generation assets that
Electric Operations otherwise would apply to transmission, distribution and
general plant assets. In addition, the Transition Plan provides that all
earnings above a 9.844% overall annual rate of return on invested capital be
used to recover Electric Operations' investment in generation assets. In
1998, Reliant Energy HL&P recorded an additional $194 million in depreciation
under the Transition Plan. Certain parties have appealed the order approving the
Transition Plan. For additional information, see Notes 1(f) and 3(b) to the
Company's Consolidated Financial Statements.
COMPETITION -- OTHER OPERATIONs
Natural Gas Distribution competes primarily with alternate energy sources
such as electricity and other fuel sources as well as with providers of energy
conservation products. In addition, as a result of federal regulatory changes
affecting interstate pipelines, it has become possible for other natural gas
suppliers and distributors to bypass Natural Gas Distribution's facilities and
market, sell and/or transport natural gas directly to small commercial and/or
large volume customers.
The Interstate Pipeline segment competes with other interstate and
intrastate pipelines in the transportation and storage of natural gas. The
principal elements of competition among pipelines are rates, terms of service,
and flexibility and reliability of service. Interstate Pipeline competes
indirectly with other forms of energy available to its customers, including
electricity, coal and fuel oils. The primary competitive factor is price.
Changes in the availability of energy and pipeline capacity, the level of
business activity, conservation and governmental regulations, the capability to
convert to alternative fuels, and other factors, including weather, affect the
demand for natural gas in areas served by Interstate Pipeline and the level of
competition for transport and storage services.
Reliant Energy Services competes for sales in its gas and power trading and
marketing business with other natural gas and power merchants, producers and
pipelines based on its ability to aggregate supplies at competitive prices from
different sources and locations and to efficiently utilize transportation from
third-party pipelines and transmission from electric utilities. Reliant Energy
Services also competes against other energy marketers on the basis of its
relative financial position and access to credit sources. This competitive
factor reflects the tendency of energy customers, natural gas suppliers and
natural gas transporters to seek financial guarantees and other assurances that
their energy contracts will be satisfied. As pricing information becomes
increasingly available in the energy trading and marketing business and as
deregulation in the electricity markets continues to accelerate, the Company
anticipates that Reliant Energy Services will experience greater competition and
downward pressure on per-unit profit margins in the energy marketing industry.
Competition for acquisition of international and domestic non-rate
regulated power projects is intense. International and Power Generation compete
against a number of other participants in the non-utility power generation
industry, some of which have greater financial resources and have been engaged
in non-utility power projects for periods longer than the Company and have
accumulated greater portfolios of projects. Competitive factors relevant to the
non-utility power industry include financial resources, access to non-recourse
funding and regulatory factors.
FLUCTUATIONS IN COMMODITY PRICES AND DERIVATIVE INSTRUMENTS
For information regarding the Company's exposure to risk as a result of
fluctuations in commodity prices and derivative instruments, see "Quantitative
and Qualitative Disclosures About Market Risk" in Item 7A of this Report.
ACCOUNTING TREATMENT OF ACES
The Company accounts for its investment in Time Warner Convertible
Preferred Stock (TW Preferred) under the cost method. As a result of the
Company's issuance of the ACES, a portion of the increase in the market value
above $27.7922 per share of Time Warner common stock (the security into which
the TW Preferred is convertible) (TW
3
4
Common) results in unrealized accounting losses to the Company, pending the
conversion of the Company's TW Preferred into TW Common. For consistency
purposes, the TW Common and related per share prices retroactively reflect a 2
for 1 stock split effective December 15, 1998.
Prior to the conversion of the TW Preferred into TW Common, when the market
price of TW Common increases above $27.7922, the Company records in Other Income
(Expense) an unrealized, non-cash accounting loss for the ACES equal to the
aggregate amount of such increase as applicable to all ACES multiplied by
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 TW Common that underlies
the TW Preferred. Upon conversion of the TW Preferred (which is anticipated to
occur in June 1999 when the preferential dividend on the TW Preferred expires),
the Company will begin recording future unrealized net changes in the market
prices of the TW Common and the ACES as a component of common stock equity and
other comprehensive income.
As of December 31, 1998, the market price of TW Common was $62.062 per
share. Accordingly, the Company recognized an increase of $1.2 billion in 1998
in the unrealized liability relating to its ACES indebtedness (which resulted in
an after-tax earnings reduction of $764 million or $2.69 basic earnings per
share in 1998). The Company believes that the cumulative unrealized loss for the
ACES of approximately $1.3 billion is more than economically offset by the
approximately $1.8 billion unrecorded unrealized gain at December 31, 1998
relating to the increase in the fair value of the TW Common underlying the
investment in TW Preferred since the date of its acquisition. Any gain related
to the increase in fair value of TW Common would be recognized as a component of
net income upon the sale of the TW Preferred or the shares of TW Common into
which such TW Preferred is converted. As of March 11, 1999, the price of TW
Common was $70.75 per share, which would have resulted in the Company
recognizing an additional increase of $329 million in the unrealized liability
represented by its indebtedness under the ACES. The related unrecorded
unrealized gain as of March 11, 1999 would have been computed as an additional
$398 million.
Excluding the unrealized, non-cash accounting loss for ACES, the Company's
retained earnings and total common stock equity would have been $2.3 billion and
$5.2 billion, respectively.
IMPACT OF THE YEAR 2000 ISSUE AND OTHER SYSTEM IMPLEMENTATION 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 Resources' and
other Company subsidiaries' mainframe applications, infrastructures, embedded
systems and client-developed applications that will not be migrated into
existing or planned Company or Resources systems prior to the year 2000. The
evaluation of Year 2000 issues included those related to significant customers,
key vendors, service suppliers and other parties material to the Company's and
its subsidiaries' 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.
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 (Priority 1); activities that would impact back
office activities such as billing (Priority 2); activities that would cause
inconvenience or productivity loss in normal business operations (e.g. air
conditioning systems and elevators) (Priority 3). 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
4
5
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. The following table illustrates the Company's completion
percentages for the Year 2000 activities as of February 28, 1999:
PRIORITY 1 PRIORITY 2 PRIORITY 3
-------------- -------------- ---------------
Assessment.............................................. 95% 86% 96%
Conversion.............................................. 86% 70% 91%
Testing................................................. 80% 61% 87%
Implementation.......................................... 76% 54% 75%
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 with respect to the Company and its subsidiaries will be between $35
and $40 million. This estimate includes approximately $7 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 $12 million during 1998. The remaining 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 customer care, finance and 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 Resources and the Company's expansion into the 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. Portions of the SAP system were implemented in
December 1998 and March 1999, and it is expected that the final portion of the
SAP system will be fully implemented by July 2000. The estimated costs of
implementing the SAP system is approximately $182 million, inclusive of internal
costs. In 1998, the Company and its subsidiaries spent $108 million of such
costs. In 1999, the Company and its subsidiaries expect to spend $59 million
with the remaining amounts to be spent in 2000.
The estimated Year 2000 project costs do not give effect to any future
corporate acquisitions or divestitures made by the Company or its subsidiaries.
Risks and Contingency Plans. The major systems which pose the greatest Year
2000 risks for the Company and its subsidiaries if implementation of the Year
2000 compliance program is not successful are the process control systems for
energy delivery systems; the time in use, demand and recorder metering system
for commercial and industrial customers; the outage analysis system; and the
power billing systems. The potential problems related to these systems are
temporary electric service interruptions to customers, temporary interruptions
in revenue data gathering and temporary poor customer relations resulting from
delayed billing. Although the Company does not believe that this scenario will
occur, the Company has considerable experience responding to emergency
situations, including computer failure. Existing emergency operations, disaster
recovery and business continuation plans are being enhanced to ensure
preparedness and to mitigate the long-term effect of such a scenario.
The North American Electric Reliability Council (NERC) is coordinating
electric utility industry contingency planning on a national level. Additional
contingency planning is being done at the regional electric reliability council
level. Reliant Energy HL&P filed a draft Year 2000 Contingency Plan with NERC
and with the Texas Utility Commission in December 1998. The draft plan addresses
restoration of electric service and related business processes, and is designed
to work in conjunction with the Emergency Operating Plan and with the plans of
NERC and ERCOT.
5
6
A final contingency plan is scheduled to be complete by June 30, 1999. In
addition, Reliant Energy HL&P will participate in industry preparedness drills,
such as the two NERC drills scheduled to be held on April 9, 1999 and September
9, 1999.
The existing business continuity disaster recovery and emergency operations
plans are being reviewed and enhanced, and where necessary, additional plans
will be developed to include mitigation strategies and action plans specifically
addressing potential Year 2000 scenarios. The expected completion date for these
plans is June 30, 1999.
In order to assist in preparing for and mitigating the foregoing scenarios,
the Company intends to complete all mission critical Year 2000 remediation and
testing activity by the end of the second quarter of 1999. In addition, 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' Year
2000 projects. The Company expects to meet with mission-critical third parties,
including suppliers, in order to ascertain and assess the relative risks of
Year-2000-related issues, and to mitigate such risks. Notwithstanding the
foregoing, the Company cautions that (i) the nature of testing is such that it
cannot comprehensively address all future combinations of dates and events and
(ii) it is impossible for the Company to assess with precision or certainty the
compliance of third parties with Year 2000 remediation efforts. Due to the
speculative and uncertain nature of contingency planning, there can be no
assurance that such plans actually will be sufficient to reduce the risk of
material impacts on the Company's and its subsidiaries' operations.
RISKS OF INTERNATIONAL OPERATIONS
The Company's international operations are subject to various risks
incidental to investing or operating in emerging market countries. These risks
include political risks, such as governmental instability, and economic risks,
such as fluctuations in currency exchange rates, restrictions on the
repatriation of foreign earnings and/or restrictions on the conversion of local
currency earnings into U.S. dollars. The Company's international operations are
also highly capital intensive and, thus, dependent to a significant extent on
the continued availability of bank financing and other sources of capital on
commercially acceptable terms.
Impact of Currency Fluctuations on Company Earnings. The Company, through
Reliant Energy International's subsidiaries, owns 11.69% of the stock of Light
and, through its investment in Light, an 8.753% interest in the stock of
Metropolitana Electricidade de Sao Paulo S.A. (Metropolitana). The Company
accounts for its investment in Light under the equity method of accounting and
records its proportionate share, based on stock ownership, in the net income of
Light and its affiliates (including Metropolitana) as part of the Company's
consolidated net income.
At December 31, 1998, Light and Metropolitana had total borrowings of
approximately $3.2 billion denominated in non-local currencies. Because of the
devaluation of the Brazilian real subsequent to December 31, 1998, Light and
Metropolitana are expected to record a charge to March 31, 1999 earnings that
reflects the increase in the liability represented by their non-local currency
denominated bank borrowings relative to the Brazilian real. Because the Company
uses the Brazilian real as the functional currency in which it reports Light's
equity earnings, the resulting decrease in Light's earnings will also be
reflected in the Company's consolidated earnings to the extent of the Company's
11.69% ownership interest in Light. At December 31, 1998, one U. S. dollar could
be exchanged for 1.21 Brazilian reais. Using the exchange rate of 2.06 Brazilian
reais in effect at the end of February, and the average exchange rate in effect
since the end of the year, the Company estimates that its share of the after-tax
charge to be recorded by Light would be approximately $125 million. This
estimate does not reflect the possibility of additional fluctuations in the
exchange rate and does not include other non-debt-related impacts of Brazil's
currency devaluation on Light's and Metropolitana's future earnings.
6
7
None of Light's or Metropolitana's tariff adjustment mechanisms are
directly indexed to the U.S. dollar or other non-local currencies. Each company
currently is evaluating various options including regulatory rate relief to
mitigate the impact of the devaluation of the Brazilian real. For example, the
long-term concession contracts under which Light and Metropolitana operate
contain mechanisms for adjusting electricity tariffs to reflect changes in
operating costs resulting from inflation. If the devaluation of the Brazilian
real results in an increase in the local rate of inflation and if an adjustment
to tariff rates is made promptly to reflect such increase, the Company believes
that the financial results of Light and Metropolitana should be protected, at
least in part, from the effects of devaluation. However, there can be no
assurance the implementation of such tariff adjustments will be timely or that
the economic impact of the devaluation will be completely reflected in increased
inflation rates.
Certain of Reliant Energy International's other foreign electric
distribution companies have incurred U.S. dollar and other non-local currency
indebtedness (approximately $71 million at December 31, 1998). For further
analysis of foreign currency fluctuations in the Company's earnings and cash
flows, see "Quantitative and Qualitative Disclosures About Market Risk --
Foreign Currency Exchange Rate Risk" in Item 7A of this Form 10-K.
Impact of Foreign Currency Devaluation on Project Capital Resources. In the
first quarter of 1999, approximately $117 million of Metropolitana's U.S. dollar
denominated debt will mature. In the second quarter of 1999, approximately $980
million of Light's and approximately $696 million of Metropolitana's U.S. and
non-local currency denominated bank debt will mature. In March 1999, Light
refinanced approximately $130 million of its U.S. dollar denominated debt
through a local - currency denominated loan. The ability of Light and
Metropolitana to repay or refinance their debt obligations at maturity is
dependent on many factors, including local and international economic conditions
prevailing at the time such debt matures.
If economic conditions in the international markets continue to be
unsettled or deteriorate, it is possible that Light, Metropolitana and the other
foreign electric distribution companies in which the Company holds investments
might encounter difficulties in refinancing their debt (both local currency and
non-local currency borrowings) on terms and conditions that are commercially
acceptable to them and their shareholders. In such circumstances, in lieu of
declaring a default or extending the maturity, it is possible that lenders might
seek to require, among other things, higher borrowing rates, and additional
equity contributions and/or increased levels of credit support from the
shareholders of such entities. The availability or terms of refinancing such
debt cannot be assured.
Currency fluctuation and instability affecting Latin America may also
adversely affect Reliant Energy International's ability to refinance its equity
investments with debt. In 1998, Reliant Energy International invested $411
million in Colombia and El Salvador. As of January 1999, $100 million of these
investments were refinanced with debt. Reliant Energy International intends to
refinance approximately $75 million more of such initial investments with debt.
ENVIRONMENTAL EXPENDITURES
The Company and its subsidiaries, including Resources, are subject to
numerous environmental laws and regulations, which require them to incur
substantial costs to operate existing facilities, construct and operate new
facilities, and mitigate or remove the effect of past operations on the
environment.
Clean Air Act Expenditures. The Company expects the majority of capital
expenditures associated with environmental matters to be incurred by Electric
Operations in connection with new emission limitations under the Federal Clean
Air Act (Clean Air Act) for oxides of nitrogen (NOx). The standards applicable
to Electric Operations' generating units in the Houston, Texas area will become
effective in November 1999. NOx reduction costs incurred by Electric Operations
totaled approximately $7 million in 1998. The Company estimates that Electric
Operations will incur approximately $8 million in 1999 and $10 million in 2000
for such expenditures. The Texas Natural Resources Conservation Commission
(TNRCC) has indicated that additional NOx reduction will be required after 2000;
however, since the magnitude and timing of these reductions have not yet been
established, it is impossible for the Company to estimate a reasonable range of
such expenditures at this time.
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8
In 1998, the Wholesale Energy spent approximately $100,000 in order to
comply with NOx reduction with respect to Southern California generating
facilities acquired by Power Generation from Southern California Edison (SCE) in
1998. In 1999, based on existing requirements, the Company projects that it will
spend an additional $100,000 on NOx reduction standards with respect to such
plants and approximately $1 million on continuous emission monitoring system
upgrades for such plants.
Site Remediation Expenditures. From time to time the Company and its
subsidiaries have received notices from regulatory authorities or others
regarding their status as potentially responsible parties in connection with
sites found to require remediation due to the presence of environmental
contaminants.
The Company's identified sites with respect to which it may be claimed to
have a remediation liability include several sites for which there is a lack of
current available information, including the nature and magnitude of
contamination, and the extent, if any, to which the Company may be held
responsible for contributing to any costs incurred for remediating these sites.
Thus, no reasonable estimate of cleanup costs can now be made for these sites.
Based on currently available information, the Company believes that such costs
ultimately will not materially affect its financial position, results of
operations or cash flows. There can be no assurance, however, that future
developments, including additional information about existing sites or the
identification of new sites, will not require material revisions to such
estimates. For information about specific sites that are the subject of
remediation claims, see Note 12(h) to the Company's Consolidated Financial
Statements and Note 8(g) to Resources' Consolidated Financial Statements, each
of which is incorporated herein by reference.
Mercury Contamination. Like other natural gas pipelines, Resources'
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 Resources at some sites
in the past, and Resources has conducted remediation at sites found to be
contaminated. Although Resources 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 of Resources and others in the natural
gas industry to date and on the current regulations regarding remediation of
such sites, the Company and Resources believe that the cost of any remediation
of such sites will not be material to the Company's or Resources' financial
position, results of operations or cash flows.
Other. In addition, the Company has been named as a defendant in litigation
related to such sites and in recent years has been named, along with numerous
others, as a defendant in several lawsuits filed by a large number of
individuals who claim injury due to exposure to asbestos while working at sites
along the Texas Gulf Coast. Most of these claimants have been workers who
participated in construction of various industrial facilities, including power
plants, and some of the claimants have worked at locations owned by the Company.
The Company anticipates that additional claims like those received may be
asserted in the future and intends to continue its practice of vigorously
contesting claims which it does not consider to have merit. Although their
ultimate outcome cannot be predicted at this time, the Company does not believe,
based on its experience to date, that these matters, either individually or in
the aggregate, will have a material adverse effect on the Company's financial
position, results of operations or cash flows.
OTHER CONTINGENCIES
For a description of certain other legal and regulatory proceedings
affecting the Company and its subsidiaries, see Notes 3, 4, 5 and 12 to the
Company's Consolidated Financial Statements and Note 8 to Resources'
Consolidated Financial Statements, which notes are incorporated herein by
reference.
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9
NEW ACCOUNTING ISSUES
In 1998, the Company and Resources adopted SFAS No. 130, "Reporting
Comprehensive Income" (SFAS No. 130), 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). For further discussion of these accounting statements, see Note 15 to
the Company's Consolidated Financial Statements and Note 9 to Resources'
Consolidated Financial Statements.
In 2000, the Company and Resources expect to adopt SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133),
which 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. The
Company is in the process of determining the effect of adoption of SFAS No. 133
on its consolidated financial statements.
In December 1998, The Emerging Issues Task Force of the Financial
Accounting Standards Board reached consensus on Issue 98-10, "Accounting for
Contracts Involved in Energy Trading and Risk Management Activities" (EITF Issue
98-10). EITF Issue 98-10 requires energy trading contracts to be recorded at
fair value on the balance sheet, with the changes in fair value included in
earnings. EITF Issue 98-10 is effective for fiscal years beginning after
December 15, 1998. The Company expects to adopt EITF Issue 98-10 in the first
quarter of 1999. The Company does not expect the implementation of EITF Issue
98-10 to be material to its consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company and its subsidiaries have long-term debt, Company/ Resources
obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debentures of the Company/Resources (Trust
Securities), securities held in the Company's nuclear decommissioning trust,
bank facilities, certain lease obligations and interest rate swaps which subject
the Company, Resources and certain of their subsidiaries to the risk of loss
associated with movements in market interest rates.
At December 31, 1998, the Company and certain of its subsidiaries had
issued fixed-rate long-term debt (excluding ACES) and Trust Securities
aggregating $5.0 billion in principal amount and having a fair value of $5.2
billion. These instruments are fixed-rate and, therefore, do not expose the
Company and its subsidiaries to the risk of earnings loss due to changes in
market interest rates (see Notes 8 and 9 to the Company's Consolidated Financial
Statements). However, the fair value of these instruments would increase by
approximately $260.6 million if interest rates were to decline by 10% from their
levels at December 31, 1998. In general, such an increase in fair value would
impact earnings and cash flows only if the Company and its subsidiaries were to
reacquire all or a portion of these instruments in the open market prior to
their maturity.
The Company and certain of its subsidiaries' floating-rate obligations
aggregated $1.8 billion at December 31, 1998 (see Note 8 to the Company's
Consolidated Financial Statements), inclusive of (i) amounts borrowed under
short-term and long-term credit facilities of the Company and its subsidiaries
(including the issuance of commercial paper supported by such facilities), (ii)
borrowings underlying Resources' receivables facility and (iii) amounts subject
to a master leasing agreement of Resources under which lease payments vary
depending on short-term interest rates. These floating-rate obligations expose
the Company, Resources and their subsidiaries to the risk of increased interest
and lease expense in the event of increases in short-term interest rates. If the
floating rates were to increase by 10% from December 31, 1998 levels, the
Company's consolidated interest expense and expense under operating leases would
increase by a total of approximately $0.9 million each month in which such
increase continued.
As discussed in Notes 1(o), 4(c) and 13 to the Company's Consolidated
Financial Statements, the Company contributes $14.8 million per year to a trust
established to fund the Company's share of the decommissioning costs for the
South Texas Project. The securities held by the trust for decommissioning costs
had an estimated fair value of $119.1 million as of December 31, 1998, of which
approximately 44% were fixed-rate debt securities that subject the Company to
risk of loss of fair value with movements in market interest rates. If interest
rates were to increase by 10% from their levels at December 31, 1998, the
decrease in fair value of the fixed-rate debt securities would not be material
to the Company. In addition, the risk of an economic loss is mitigated at this
time as a result of the Company's regulated status. Any unrealized gains or
losses are accounted for in accordance with SFAS No. 71 as a regulatory
asset/liability because the Company believes that its future contributions which
are currently recovered through the rate-making process will be adjusted for
these gains and losses.
Certain subsidiaries of the Company have entered into interest rate swaps
for the purpose of decreasing the amount of debt subject to interest rate
fluctuations. At December 31, 1998, these interest rate swaps had an aggregate
notional amount of $75.4 million, which the Company could terminate at a cost of
$3.2 million (see Notes 2 and 13 to the Company's Consolidated Financial
Statements). An increase of 10% in the December 31, 1998 level of interest rates
would not increase the cost of termination of the swaps by a material amount to
the Company. Swap termination costs would impact the Company's and its
subsidiaries' earnings and cash flows only if all or a portion of the swap
instruments were terminated prior to their expiration.
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10
As discussed in Note 8(h) to the Company's Consolidated Financial
Statements, Resources sold $500 million aggregate principal amount of its 6 3/8%
TERM Notes which included an embedded option to remarket the securities. The
option is expected to be exercised in the event that the ten-year Treasury rate
in 2003 is below 5.66%. At December 31, 1998, the Company could terminate the
option at a cost of $30.7 million. A decrease of 10% in the December 31, 1998
level of interest rates would not increase the cost of termination of the option
by a material amount to the Company.
The change in exposure to loss in earnings and cash flows related to
interest rate risk from December 31, 1997 to December 31, 1998 is not material
to the Company.
EQUITY MARKET RISK
The Company holds an investment in TW Preferred which is convertible into
Time Warner common stock (TW Common) as described in "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 --
Accounting Treatment of ACES" in Item 7 of this Form 10-K. As a result, the
Company is exposed to losses in the fair value of this security. For purposes of
analyzing market risk in this Item 7A, the Company assumed that the TW Preferred
was converted into TW Common. In addition, Resources' investment in the common
stock of Itron, Inc. (Itron) exposes the Company and Resources to losses in the
fair value of Itron common stock. A 10% decline in the market value per share of
TW Common and Itron common stock from the December 31, 1998 levels would result
in a loss in fair value of approximately $284.4 million and $1.1 million,
respectively.
The Company's and its subsidiaries' ability to realize gains and losses
related to the TW Preferred and the Itron common stock is limited by the
following: (i) the TW Preferred is not publicly traded and its sale is subject
to certain limitations and (ii) the market for the common stock of Itron is
fairly illiquid.
The ACES expose the Company to accounting losses as the Company is required
to record in Other Income (Expense) an unrealized accounting loss equal to (i)
the aggregate amount of the increase in the market price of TW Common above
$27.7922 as applicable to all ACES multiplied by (ii) 0.8264. Prior to the
conversion of the TW Preferred into TW Common, such loss would affect earnings.
After conversion, such loss would be recognized as an adjustment to common stock
equity through a reduction of other comprehensive income. However, there would
be an offsetting increase in common stock equity through an increase in
accumulated other comprehensive income on the Company's Statements of
Consolidated Retained Earnings and Comprehensive Income for the fair value
increase in the investment in TW Common. For additional information on the
accounting treatment of the ACES and related accounting losses recorded in 1998,
see Note 1(n) to the Company's Consolidated Financial Statements. An increase of
15% in the price of the TW Common above its December 31, 1998 market value of
$62.062 per share would result in the recognition of an additional unrealized
accounting loss (net of tax) of approximately $229.1 million. The Company
believes that this additional unrealized loss for the ACES would be more than
economically hedged by the unrecorded unrealized gain relating to the increase
in the fair value of the TW Common underlying the investment in TW Preferred
since the date of its acquisition.
For a discussion of the non-cash, unrealized accounting loss recorded in
1998 and 1997 related to the ACES, see "-- Certain Factors Affecting Future
Earnings of the Company and its Subsidiaries -- Accounting Treatment of ACES" in
Item 7 of this Form 10-K.
As discussed above under "-- Interest Rate Risk," the Company contributes
to a trust established to fund the Company's share of the decommissioning costs
for the South Texas Project which held debt and equity securities as of December
31, 1998. The equity securities expose the Company to losses in fair value. If
the market prices of the individual equity securities were to decrease by 10%
from their levels at December 31, 1998, the resulting loss in fair value of
these securities would not be material to the Company. Currently, the risk of an
economic loss is mitigated as a result of the Company's regulated status as
discussed above under "--Interest Rate Risk."
FOREIGN CURRENCY EXCHANGE RATE RISK
As further described in "Certain Factors Affecting Future Earnings of the
Company and Its Subsidiaries -- Risks of International Operations" in Item 7 of
this Form 10-K, the Company, through Reliant Energy International invests in
certain foreign operations which to date have been primarily in South America.
As of December 31, 1998, the Company's Consolidated Balance Sheets reflected
$1.1 billion of foreign investments, a substantial portion of which represent
investments accounted for under the equity method. These foreign investments
expose the Company to risk of loss in earnings and cash flows due to the
fluctuation in foreign currencies relative to the Company's consolidated
reporting currency, the U.S. dollar. The Company accounts for adjustments
resulting from translation of its investments with functional currencies other
than the U.S. dollar as a charge or credit directly to a separate component of
stockholders' equity. For further discussion of the accounting for foreign
currency adjustments, see Note 1(p) in the Notes to the Company's Consolidated
Financial Statements. The cumulative translation loss of $34 million, recorded
as of December 31, 1998, will be realized as a loss in earnings and cash flows
only upon the disposition of the related investment. The foreign currency loss
in earnings and cash flows related to debt obligations held by foreign
operations in currencies other than their own functional currencies was not
material to the Company as of December 31, 1997.
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11
In addition, certain of Reliant Energy International's foreign operations
have entered into obligations in currencies other than their own functional
currencies which expose the Company to a loss in earnings. In such cases, as the
respective investment's functional currency devalues relative to the non-local
currencies, the Company will record its proportionate share of its investments'
foreign currency transaction losses related to the non-local currency
denominated debt. At December 31, 1998, Light and Metropolitana had borrowings
of approximately $3.2 billion denominated in non-local currencies. Because of
the devaluation of the Brazilian real subsequent to December 31, 1998, Light and
Metropolitana are expected to record a charge to earnings for the quarter ended
March 31, 1999, primarily related to foreign currency transaction losses on
their non-local currency denominated debt. For further discussion and analysis
of the possible effect on the Company's Consolidated Financial Statements, see
"Certain Factors Affecting Future Earnings of the Company and Its Subsidiaries
- -- Risks of International Operations" in Item 7 of this Form 10-K.
The company attempts to manage and mitigate this foreign risk by properly
balancing the higher cost of financing with local denominated debt against the
risk of devaluation of that local currency and including a measure of the risk
of devaluation in all its financial plans. In addition, where possible, Reliant
Energy International attempts to structure its tariffs and revenue contracts to
ensure some measure of adjustment due to changes in inflation and currency
exchange rates; however, there can be no assurance that such efforts will
compensate for the full effect of currency devaluation, if any.
ENERGY COMMODITY PRICE RISK
As further described in Note 2 to the Company's Consolidated Financial
Statements, certain of the Company's subsidiaries utilize a variety of
derivative financial instruments (Derivatives), including swaps and
exchange-traded futures and options, as part of the Company's overall hedging
strategies and for trading purposes. To reduce the risk from the adverse effect
of market fluctuations in the price of electric power, natural gas, crude oil
and refined products and related transportation, Resources and certain
subsidiaries of the Company and Resources enter into futures transactions,
forward contracts, swaps and options (Energy Derivatives) in order to hedge
certain commodities in storage, as well as certain expected purchases, sales and
transportation of energy commodities (a portion of which are firm commitments at
the inception of the hedge). The Company's policies prohibit the use of
leveraged financial instruments. In addition, Reliant Energy Services, a
subsidiary of Resources, maintains a portfolio of Energy Derivatives to provide
price risk management services and for trading purposes (Trading Derivatives).
The Company uses value-at-risk and a sensitivity analysis method for
assessing the market risk of its derivatives.
With respect to the Energy Derivatives (other than Trading Derivatives)
held by subsidiaries of the Company and Resources as of December 31, 1998, a
decrease of 10% in the market prices of natural gas and electric power from
year-end levels would decrease the fair value of these instruments by
approximately $3 million. As of December 31, 1997, a decrease of 10% in the
prices of natural gas would have resulted in a loss of $7 million in fair values
of the Energy Derivatives (other than for trading purposes).
The above analysis of the Energy Derivatives utilized for hedging purposes
does not include the favorable impact that the same hypothetical price movement
would have on the Company's and its subsidiaries' physical purchases and sales
of natural gas and electric power to which the hedges relate. The portfolio of
Energy Derivatives held for hedging purposes is no greater than the notional
quantity of the expected or committed transaction volume of physical commodities
with equal and opposite commodity price risk for the same time periods.
Furthermore, the Energy Derivative portfolio is managed to complement the
physical transaction portfolio, reducing overall risks within limits. Therefore,
the adverse impact to the fair value of the portfolio of Energy Derivatives held
for hedging purposes associated with the hypothetical changes in commodity
prices referenced above would be offset by a favorable impact on the underlying
hedged physical transactions, assuming (i) the Energy Derivatives are not closed
out in advance of their expected term, (ii) the Energy Derivatives continue to
function effectively as hedges of the underlying risk and (iii) as applicable,
anticipated transactions occur as expected.
The disclosure with respect to the Energy Derivatives relies on the
assumption that the contracts will exist parallel to the underlying physical
transactions. If the underlying transactions or positions are liquidated prior
to the maturity of the Energy Derivatives, a loss on the financial instruments
may occur, or the options might be worthless as determined by the prevailing
market value on their termination or maturity date, whichever comes first.
With respect to the Trading Derivatives held by Reliant Energy Services,
consisting of natural gas, electric power, crude oil and refined products,
physical forwards, swaps, options and exchange-traded futures, this subsidiary
is exposed to losses in fair value due to changes in the price and volatility of
the underlying derivatives. During the year ended December 31, 1998 and 1997,
the highest, lowest and average monthly value-at-risk in the Trading Derivative
portfolio was less than $5 million at a 95% confidence level and for a holding
period of one business day. The Company uses the variance/covariance method for
calculating the value-at-risk and includes the delta approximation for options
positions.
The Company has established a Corporate Risk Oversight Committee comprised
of corporate and business segment officers that oversees all corporate price and
credit risk activities, including derivative trading activities discussed above.
The committee's duties are to establish the Company's policies and to monitor
and ensure compliance with risk management policies and procedures and the
trading limits established by the Company's board of directors.
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COMPANY 10-K NOTES
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(c) Regulatory Assets and Other Long-Lived Assets.
The Company and certain subsidiaries of Resources apply the accounting
policies established in SFAS No. 71, "Accounting for the Effects of Certain
Types of Regulation" (SFAS No. 71), to the accounts of Electric Operations,
Natural Gas Distribution and the Interstate Pipeline operations of a subsidiary
of Resources. In general, SFAS No. 71 permits a company with cost-based rates to
defer certain costs that would otherwise be expensed to the extent that the rate
regulated company is recovering or expects to recover such costs in rates
charged to its customers.
The following is a list of regulatory assets/liabilities reflected on the
Company's Consolidated Balance Sheet as of December 31, 1998, detailed by
Electric Operations and other segments.
ELECTRIC TOTAL
OPERATIONS OTHER COMPANY
---------- ----- -------
(MILLIONS OF DOLLARS)
Deferred plant costs-- net............................................ $ 536 $ $ 536
Recoverable project costs-- net....................................... 55 55
Regulatory tax asset-- net............................................ 418 418
Unamortized loss on reacquired debt................................... 140 140
Fuel-related debits/credits-- net..................................... (15) (15)
Other deferred debits................................................. 54 12 66
--------- -------- --------
Total....................................................... $ 1,188 $ 12 $ 1,200
--------- -------- --------
If, as a result of changes in regulation or competition, the Company's and
Resources' ability to recover these assets and liabilities would not be assured,
then pursuant to SFAS No. 101, "Accounting for the Discontinuation of
Application of SFAS No. 71" (SFAS No. 101) and SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
(SFAS No. 121), the Company and Resources would be required to write off or
write down such regulatory assets and liabilities, unless some form of
transition cost recovery continues through rates established and collected for
their remaining regulated operations. In addition, the Company and Resources
would be required to determine any impairment to the carrying costs of
deregulated plant and inventory assets. In order to reduce exposure to
potentially stranded costs related to generation assets, Electric Operations
redirected $195 million of depreciation in 1998 from transmission, distribution
and general plant assets to generation assets. Such redirection is in accordance
with the Company's transition to competition plan (Transition Plan) described in
Note 1(f). If Electric Operations was required to apply SFAS No. 101 to the
generation portion of its business only, the cumulative amount of redirected
depreciation of $195 million would become a regulatory asset of the transmission
and distribution portion of its business.
Effective January 1, 1996, the Company and Resources adopted SFAS No. 121.
SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles to be held and used or disposed of by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Adoption of the standard did
not result in a write-down of the carrying amount of any asset on the books of
the Company or Resources.
In July 1997, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board reached a consensus on Issue No. 97-4, "Deregulation
of the Pricing of Electricity -- Issues Related to the Application of FASB
Statements No. 71, Accounting for the Effects of Certain Types of Regulation,
and No. 101, Regulated Enterprises -- Accounting for the Discontinuation of
Application of FASB Statement No. 71" (EITF 97-4). EITF 97-4 concluded that the
application of SFAS No. 71 to a segment which is subject to a deregulation plan
should cease when the legislation and enabling rate order contain sufficient
detail for the utility to reasonably determine how the plan will affect the
segment to be deregulated. In addition, EITF 97-4 requires the regulatory assets
and liabilities to be allocated to the applicable portion of the electric
utility from which the source of the regulated cash flows will be derived. As a
part of the Transition Plan, the Company has agreed to support future
legislation providing for retail customer choice and other provisions consistent
with those in the 1997 proposed Texas legislation. At this time, the Company is
unable to make any predictions as to the details of legislation being considered
by the Texas legislature or the likelihood that such legislation will ultimately
be enacted. Although the Company has determined that no impairment loss or
write-offs of regulatory assets or carrying costs of plant and inventory assets
need to be recognized for applicable assets of Electric Operations as of
December 31, 1998, this conclusion may change in the future (i) as competition
influences wholesale and retail pricing in the electric utility industry, (ii)
depending on regulatory action, if any and (iii) depending on legislation, if
any, that is passed.
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(n) Investments 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 redeemable after
July 6, 2000, has an aggregate liquidation preference of $100 per share (plus
accrued and unpaid dividends), is entitled to annual dividends of $3.75 per
share until July 6, 1999, is currently convertible by the Company and after July
6, 1999 is exchangeable by Time Warner into approximately 45.8 million shares of
Time Warner common stock (TW Common). Each share of TW Preferred is entitled to
two votes (voting together with the holders of the TW Common as a single class).
The Company has accounted for its investment in TW Preferred under the cost
method at a value of $990 million on the Company's Consolidated Balance Sheets.
Dividends on these securities are recognized as income at the time they are
earned. The Company recorded pre-tax dividend income with respect to the Time
Warner securities of $41.3 million in 1998 and 1997 and $41.6 million in 1996.
To monetize its investment in the TW Preferred, the Company sold in July
1997, 22.9 million of ACES. At maturity in July 2000, the principal amount of
the ACES will be mandatorily exchangeable by the Company into either (i) a
number of shares of TW Common based on an exchange rate or (ii) cash having an
equal value. Subject to adjustments that may result from certain dilution
events, the exchange rate for each ACES is determined as follows: (i) 1.6528
shares of TW Common if the price of TW Common at maturity (Maturity Price) is at
least $27.7922 per share, (ii) a fractional share of TW Common such that the
fractional share will have a value equal to $22.96875 if the Maturity Price is
less than $27.7922 but greater than $22.96875 and (iii) one share of TW Common
if the Maturity Price is not more than $22.96875. The closing price of TW Common
was $62.062 per share on December 31, 1998.
Prior to maturity, the Company has the option of redeeming the ACES if (i)
changes in federal tax regulations require recognition of a taxable gain on the
Company's TW Preferred and (ii) the Company could defer such gain by redeeming
the ACES. The redemption price is 105% of the closing sales price of the ACES as
determined over a period prior to the redemption notice. The redemption price
may be paid in cash or in shares of TW Common or a combination of the two.
As a result of the issuance of the ACES, a portion of the increase in the
market value above $27.7922 per share of TW Common results in non-cash,
unrealized accounting losses to the Company for the ACES, pending the conversion
of the Company's TW Preferred into TW Common. For example, prior to the
conversion, when the market price of TW Common increases above $27.7922, the
Company records in Other Income (Expense) an unrealized, non-cash 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 TW Common that underlies the TW Preferred. Upon conversion of the TW
Preferred (anticipated to occur in July 1999), the Company will begin recording
future unrealized net changes in the market prices of the TW Common and the ACES
as a component of common stock equity and other comprehensive income.
As of December 31, 1998 and 1997, the market price of TW Common was $62.062
and $31.00 per share, respectively. Accordingly, the Company recognized an
increase of $1.2 billion in 1998 and $121 million in 1997 in the unrealized
liability relating to its ACES indebtedness (which resulted in an after-tax
earnings reduction of $764 million or $2.69 basic earnings per share and $79
million or $.31 basic earnings per share, respectively). The Company believes
that the cumulative unrealized loss for the ACES of approximately $1.3 billion
is more than economically hedged by the approximately $1.8 billion unrecorded
unrealized gain at December 31, 1998 relating to the increase in the fair value
of the TW Common underlying the investment in TW Preferred since the date of its
acquisition. Any gain related to the increase in fair value of TW Common would
be recognized as a component of net income upon the sale of the TW Preferred or
the shares of TW Common into which such TW Preferred is converted. As of March
11, 1999, the price of TW Common was $70.75 per share which would have resulted
in the Company recognizing an additional increase of $329 million in the
unrealized liability relating to its ACES indebtedness. The related unrecorded
unrealized gain as of March 11, 1999 would have been computed as an additional
$398 million.
(p) Foreign Currency Adjustments
International assets and liabilities where the local currency is the
functional currency, have been translated into U.S. dollars using the exchange
rate at the balance sheet date. Revenues, expenses, gains, and losses have been
translated using the weighted average exchange rate for each month prevailing
during the periods reported. Cumulative adjustments resulting from translation
have been recorded in stockholders' equity and other comprehensive income. When
the U.S. dollar is the functional currency, the financial statements of
International are remeasured in U.S. dollars using historical exchange rates for
non-monetary accounts and the current rate at the respective balance sheet date
and the weighted average exchange rate for all other balance sheet and income
statement accounts, respectively. All exchange gains and losses from
remeasurement and foreign currency transactions are included in consolidated net
income. However, fluctuations in foreign currency exchange rates relative to the
U.S. dollar can have an impact on the reported equity earnings of the Company's
foreign investments. For additional information about the Company's investments
in unconsolidated affiliates, see Note 5. For additional information about the
Company's investments in Brazil and the devaluation of the Brazilian real in
January 1999, see Note 16(a).
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14
(r) Change in Accounting Principle.
In the fourth quarter of 1998, the Company adopted mark-to-market
accounting for all of the energy price risk management and trading activities of
Reliant Energy Services. Under mark-to-market accounting, the Company records
the fair value of energy-related derivative financial instruments, including
physical forward contracts, swaps, options and exchange-traded futures contracts
at each balance sheet date. Such amounts are recorded in the Company's
Consolidated Balance Sheet as price risk management assets, price risk
management liabilities, deferred debits and deferred liabilities. The realized
and unrealized gains (losses) are recorded as a component of operating revenues
in the Company's Consolidated Statements of Income. The Company has applied
mark-to-market accounting retroactively to January 1, 1998. This change was made
in order to adopt a generally accepted accounting methodology that provided
consistency between financial reporting and the methodology used in all reported
periods by the Company in managing its trading activities. There was no material
cumulative effect resulting from the accounting change.
The Company will adopt Emerging Issues Task Force Issue 98-10, "Accounting
for Contracts Involved in Energy Trading and Risk Management Activities" in the
first quarter of 1999 for Reliant Energy Services' trading activities. The
Company does not expect the implementation of EITF Issue 98-10 to be material
to its consolidated financial statements.
(2) DERIVATIVE FINANCIAL INSTRUMENTS
(a) Price Risk Management and Trading Activities.
The Company, through Reliant Energy Services, offers energy price risk
management services primarily in the natural gas, electric and crude oil and
refined product industries. Reliant Energy Services provides these services by
utilizing, a variety of derivative financial instruments, including fixed and
variable-priced physical forward contracts, fixed-price swap agreements,
variable-price swap agreements, exchange-traded energy futures and option
contracts, and swaps and options traded in the over-the-counter financial
markets (Trading Derivatives). Fixed-price swap agreements require payments to,
or receipts of payments from, counterparties based on the differential between
a fixed and variable price for the commodity. Variable-price swap agreements
require payments to, or receipts of payments from, counterparties based on the
differential between industry pricing publications or exchange quotations.
Prior to 1998, Reliant Energy Services applied hedge accounting to certain
physical commodity activities that qualified for hedge accounting. In 1998,
Reliant Energy Services adopted mark-to-market accounting for all of its price
risk management and trading activities. Accordingly, as of such date such
Trading Derivatives are recorded at fair value with realized and unrealized
gains (losses) recorded as a component of operating revenues in the Company's
Consolidated Statements of Income. The recognized, unrealized balance is
recorded as price risk management assets/liabilities and deferred
debits/credits on the Company's Consolidated Balance Sheets (See Note 1(r)).
The notional quantities, maximum terms and the estimated fair value of
Trading Derivatives at December 31, 1998 are presented below (volumes in
billions of British thermal units equivalent (BBtue) and dollars in millions):
VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
1998 PRICE PAYOR RECEIVER TERM (YEARS)
---- ----------- -------- ------------
Natural gas.................................................. 937,264 977,293 9
Electricity.................................................. 122,950 124,878 3
Crude oil and products....................................... 205,499 204,223 3
AVERAGE FAIR
FAIR VALUE VALUE (a)
---------------------- ----------------------
1998 ASSETS LIABILITIES ASSETS LIABILITIES
---- ------ ----------- ------ -----------
Natural gas.............................................. $ 224 $ 213 $ 124 $ 108
Electricity.............................................. 34 33 186 186
Crude oil and products................................... 29 23 21 17
------ ----------- ------ -----------
$ 287 $ 269 $ 331 $ 311
====== =========== ====== ===========
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The notional quantities, maximum terms and the estimated fair value of
derivative financial instruments at December 31, 1997 are presented below
(volumes in BBtue and dollars in millions):
VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
1997 PRICE PAYOR RECEIVER TERM (YEARS)
---- ----------- -------- ------------
Natural gas.................................................. 85,701 64,890 4
Electricity.................................................. 40,511 42,976 1
AVERAGE FAIR
FAIR VALUE VALUE (a)
---------------------- ----------------------
1997 ASSETS LIABILITIES ASSETS LIABILITIES
---- ------ ----------- ------ -----------
Natural gas.............................................. $ 46 $ 39 $ 56 $ 48
Electricity.............................................. 6 6 3 2
------ ----------- ------ -----------
$ 52 $ 45 $ 59 $ 50
====== =========== ====== ===========
- ---------
(a) Computed using the ending balance of each month.
In addition to the fixed-price notional volumes above, Reliant Energy
Services also has variable-priced agreements, as discussed above, totaling
1,702,977 and 101,465 BBtue as of December 31, 1998 and 1997, respectively.
Notional amounts reflect the volume of transactions but do not represent the
amounts exchanged by the parties to the financial instruments. Accordingly,
notional amounts do not accurately measure the Company's exposure to market or
credit risks.
All of the fair value shown in the table above at December 31, 1998 and
substantially all of the fair value at December 31, 1997 have been recognized in
income. The fair value as of December 31, 1998 and 1997 was estimated using
quoted prices where available and considering the liquidity of the market for
the Trading Derivatives. The prices are subject to significant changes based on
changing market conditions.
At December 31, 1998, $22 million of the fair value of the assets and $41
million of the fair value of the liabilities are recorded as long-term on
deferred debits and deferred credits, respectively on the Company's Consolidated
Balance Sheets.
The weighted-average term of the trading portfolio, based on volumes, is
less than one year. The maximum and average terms disclosed herein are not
indicative of likely future cash flows, as these positions may be changed by new
transactions in the trading portfolio at any time in response to changing market
conditions, market liquidity and the Company's risk management portfolio needs
and strategies. Terms regarding cash settlements of these contracts vary with
respect to the actual timing of cash receipts and payments.
In addition to the risk associated with price movements, credit risk is
also inherent in the Company and its subsidiaries' risk management activities.
Credit risk relates to the risk of loss resulting from non-performance of
contractual obligations by a counterparty. The following table shows the
composition of the total price risk management assets of Reliant Energy Services
as of December 31, 1998.
INVESTMENT
GRADE (1) TOTAL
---------------------------------
(Thousands of Dollars)
------------ ------------
Energy marketers....................................... $ 102,458 $ 123,779
Financial institutions................................. 61,572 61,572
Gas and electric utilities............................. 46,880 48,015
Oil and gas producers.................................. 7,197 8,323
Industrials............................................ 1,807 3,233
Independent power producers............................ 1,452 1,463
Others................................................. 45,421 46,696
------------ ------------
Total............................................. $ 266,787 $ 293,081
============
Credit and other reserves.............................. (6,464)
------------
Energy price risk management assets (2)................ $ 286,617
============
- ---------
(1) "Investment Grade" is primarily determined using publicly available credit
ratings along with the consideration of credit support (e.g., parent
company guarantees) and collateral, which encompass cash and standby
letters of credit.
(2) The Company has credit risk exposure with respect to two investment grade
customers, each of which represents an amount greater than 5% but less than
10% of Price Risk Management Assets.
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16
(b) Non-Trading Activities.
To reduce the risk from market fluctuations in the price of electric power,
natural gas and related transportation, the Company, Resources and certain of
its subsidiaries enter into futures transactions, swaps and options (Energy
Derivatives) in order to hedge certain natural gas in storage, as well as
certain expected purchases, sales and transportation of natural gas and electric
power (a portion of which are firm commitments at the inception of the hedge).
Energy Derivatives are also utilized to fix the price of compressor fuel or
other future operational gas requirements, although usage to date for this
purpose has not been material. The Company applies hedge accounting with respect
to its derivative financial instruments.
Certain subsidiaries of the Company also utilize interest-rate derivatives
(principally interest-rate swaps) in order to adjust the portion of its overall
borrowings which are subject to interest rate risk and also utilize such
derivatives to effectively fix the interest rate on debt expected to be issued
for refunding purposes.
For transactions involving either Energy Derivatives or interest-rate
derivatives, hedge accounting is applied only if the derivative (i) reduces the
price risk of the underlying hedged item and (ii) is designated as a hedge at
its inception. Additionally, the derivatives must be expected to result in
financial impacts which are inversely correlated to those of the item(s) to be
hedged. This correlation (a measure of hedge effectiveness) is measured both at
the inception of the hedge and on an ongoing basis, with an acceptable level of
correlation of at least 80% for hedge designation. If and when correlation
ceases to exist at an acceptable level, hedge accounting ceases and
mark-to-market accounting is applied.
In the case of interest-rate swaps associated with existing obligations,
cash flows and expenses associated with the interest-rate derivative
transactions are matched with the cash flows and interest expense of the
obligation being hedged, resulting in an adjustment to the effective interest
rate. When interest rate swaps are utilized to effectively fix the interest rate
for an anticipated debt issuance, changes in the market value of the
interest-rate derivatives are deferred and recognized as an adjustment to the
effective interest rate on the newly issued debt.
Unrealized changes in the market value of Energy Derivatives utilized as
hedges are not generally recognized in the Company's Consolidated Statements of
Income until the underlying hedged transaction occurs. Once it becomes probable
that an anticipated transaction will not occur, deferred gains and losses are
recognized. In general, the financial impact of transactions involving these
Energy Derivatives is included in the Company's Statements of Consolidated
Income under the captions (i) fuel expenses, in the case of natural gas
transactions and (ii) purchased power, in the case of electric power
transactions. Cash flows resulting from these transactions in Energy Derivatives
are included in the Company's Statements of Consolidated Cash Flows in the same
category as the item being hedged.
At December 31, 1998, subsidiaries of Resources were fixed-price payors and
fixed-price receivers in Energy Derivatives covering 42,498 billion British
thermal units (Bbtu) and 3,930 BBtu of natural gas, respectively. At December
31, 1997, subsidiaries of Resources were fixed-price payors and fixed-price
receivers in Energy Derivatives covering 38,754 BBtu and 7,647 BBtu of natural
gas, respectively. Also, at December 31, 1998 and 1997, subsidiaries of
Resources were parties to variable-priced Energy Derivatives totaling 21,437
Bbtu and 3,630 BBtu of natural gas, respectively. The weighted average maturity
of these instruments is less than one year.
The notional amount is intended to be indicative of the Company's and its
subsidiaries' level of activity in such derivatives, although the amounts at
risk are significantly smaller because, in view of the price movement
correlation required for hedge accounting, changes in the market value of these
derivatives generally are offset by changes in the value associated with the
underlying physical transactions or in other derivatives. When Energy
Derivatives are closed out in advance of the underlying commitment or
anticipated transaction, however, the market value changes may not offset due to
the fact that price movement correlation ceases to exist when the positions are
closed, as further discussed below. Under such circumstances, gains (losses) are
deferred and recognized as a component of income when the underlying hedged item
is recognized in income.
The average maturity discussed above and the fair value discussed in Note
13 are not necessarily indicative of likely future cash flows as these positions
may be changed by new transactions in the trading portfolio at any time in
response to changing market conditions, market liquidity and the Company's risk
management portfolio needs and strategies. Terms regarding cash settlements of
these contracts vary with respect to the actual timing of cash receipts and
payments.
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17
(c) Trading and Non-trading -- General Policy.
In addition to the risk associated with price movements, credit risk is
also inherent in the Company's and its subsidiaries' risk management activities.
Credit risk relates to the risk of loss resulting from non-performance of
contractual obligations by a counterparty. While as yet the Company and its
subsidiaries have experienced only minor losses due to the credit risk
associated with these arrangements, the Company has off-balance sheet risk to
the extent that the counterparties to these transactions may fail to perform as
required by the terms of each such contract. In order to minimize this risk, the
Company and/or its subsidiaries, as the case may be, enter into such contracts
primarily with those counterparties with a minimum Standard & Poor's or Moody's
rating of BBB- or Baa3, respectively. For long-term arrangements, the Company
and its subsidiaries periodically review the financial condition of such firms
in addition to monitoring the effectiveness of these financial contracts in
achieving the Company's objectives. Should the counterparties to these
arrangements fail to perform, the Company would seek to compel performance at
law or otherwise or obtain compensatory damages in lieu thereof. The Company
might be forced to acquire alternative hedging arrangements or be required to
honor the underlying commitment at then- current market prices. In such event,
the Company might incur additional loss to the extent of amounts, if any,
already paid to the counterparties. In view of its criteria for selecting
counterparties, its process for monitoring the financial strength of these
counterparties and its experience to date in successfully completing these
transactions, the Company believes that the risk of incurring a significant
financial statement loss due to the non-performance of counterparties to these
transactions is minimal.
The Company's policies prohibit the use of leveraged financial instruments.
The Company has established a Corporate Risk Oversight Committee, comprised
of corporate and business segment officers, to oversee all corporate price and
credit risks, including Reliant Energy Services' trading, marketing and risk
management activities. The Corporate Risk Oversight Committee's responsibilities
include reviewing the Company's and its subsidiaries' hedging, trading and price
risk management strategies, activities and limits and monitoring to ensure
compliance with the Company's risk management policies and procedures and
trading limits established by the Company's board of directors.
(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 Plan.
In June 1998, the Texas Utility Commission issued an order in Docket No.
18465 approving the Company's Transition Plan filed by Electric Operations in
December 1997. The Transition Plan included base rate credits to residential
customers of 4% in 1998 and an additional 2% in 1999. Commercial customers whose
monthly billing is 1,000 kva or less are entitled to receive base rate credits
of 2% in each of 1998 and 1999. The Company implemented the Transition Plan
effective January 1, 1998.
For information about additional depreciation of generation assets and
redirecting depreciation pursuant to the Transition Plan, see Note 1(f).
Review of the Texas Utility Commission's order in Docket No. 18465 is
currently pending before the Travis County District Court. In August 1998, the
Office of the Attorney General for the State of Texas and a Texas municipality
filed an appeal seeking, among other things, to reverse the portion of the Texas
Utility Commission's order relating to the redirection of depreciation expenses
under the Transition Plan. Because of the number of variables that can affect
the ultimate resolution of an appeal of Commission orders, the Company is not in
a position at this time to predict the outcome of this matter or the ultimate
effect that adverse action by the courts could have on the Company.
(4) JOINTLY OWNED ELECTRIC UTILITY PLANT
(a) Investment in South Texas Project.
The Company has a 30.8% interest in the South Texas Project, which consists
of two 1,250 megawatt (MW) nuclear generating units and bears a corresponding
30.8% share of capital and operating costs associated with the project. As of
December 31, 1998, the Company's investment in the South Texas Project
(including AFUDC) was $1.4 billion (net of $1.1 billion accumulated
depreciation). The Company's investment in nuclear fuel (including AFUDC) was
$41 million (net of $230 million amortization) as of such date.
6
18
The South Texas Project is owned as a tenancy in common among its four
co-owners, with each owner retaining its undivided ownership interest in the two
nuclear-fueled generating units and the electrical output from those units. The
four co-owners have delegated management and operation responsibility for the
South Texas Project to the South Texas Nuclear Operating Company (STPNOC).
STPNOC is managed by a board of directors comprised of one director from each of
the four owners, along with the chief executive officer of STPNOC. The four
owners provide oversight through an owners' committee comprised of
representatives of each of the owners and through the board of directors of
STPNOC. Prior to November 1997, the Company was the operator of the South Texas
Project.
(b) Nuclear Insurance.
The Company and the other owners of the South Texas Project maintain
nuclear property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
This coverage consists of $500 million in primary property damage insurance and
excess property insurance in the amount of $2.25 billion. With respect to excess
property insurance, the Company and the other owners of the South Texas Project
are subject to assessments, the maximum aggregate assessment under current
policies being $16.5 million during any one policy year. The application of the
proceeds of such property insurance is subject to the priorities established by
the Nuclear Regulatory Commission (NRC) regulations relating to the safety of
licensed reactors and decontamination operations.
Pursuant to the Price Anderson Act, the maximum liability to the public of
owners of nuclear power plants, such as the South Texas Project, was $9.145
billion as of December 31, 1998. Owners are required under the Price Anderson
Act to insure their liability for nuclear incidents and protective evacuations
by maintaining the maximum amount of financial protection available from private
sources and by maintaining secondary financial protection through an industry
retrospective rating plan. The assessment of deferred premiums provided by the
plan for each nuclear incident is up to $83.9 million per reactor, subject to
indexing for inflation, a possible 5% surcharge (but no more than $10 million
per reactor per incident in any one year) and a 3% state premium tax. The
Company and the other owners of the South Texas Project currently maintain the
required nuclear liability insurance and participate in the industry
retrospective rating plan.
There can be no assurance that all potential losses or liabilities will be
insurable, or that the amount of insurance will be sufficient to cover them. Any
substantial losses not covered by insurance would have a material effect on the
Company's financial condition, results of operations and cash flows.
(c) Nuclear Decommissioning.
The Company contributes $14.8 million per year to a trust established to
fund its share of the decommissioning costs for the South Texas Project. For a
discussion of the accounting treatment for the securities held in the Company's
nuclear decommissioning trust, see Note 1(o). In May 1994, an outside consultant
estimated the Company's portion of decommissioning costs to be approximately
$318 million (1994 dollars). The consultant's calculation of decommissioning
costs for financial planning purposes used the DECON methodology (prompt
removal/dismantling), one of the three alternatives acceptable to the NRC and
assumed deactivation of Units Nos. 1 and 2 upon the expiration of their 40-year
operating licenses. While the current and projected funding levels currently
exceed minimum NRC requirements, no assurance can be given that the amounts held
in trust will be adequate to cover the actual decommissioning costs of the South
Texas Project. Such costs may vary because of changes in the assumed date of
decommissioning, changes in regulatory and accounting requirements, changes in
technology and changes in costs of labor, materials and equipment. An update of
the 1994 study is in the process of being completed.
(d) Assessment Fees for Spent Fuel Disposal and Enrichment and Decommissioning.
By contract, the United States Department of Energy (DOE) has committed
itself ultimately to take possession of all spent fuel generated by the South
Texas Project. The DOE contract currently requires payment of a spent fuel
disposal fee on nuclear plant-generated electricity of one mill (one-tenth of a
cent) per net KWH sold. This fee is subject to adjustment to ensure full cost
recovery by the DOE. The Energy Policy Act also includes a provision that
assesses a fee upon domestic utilities that purchased nuclear fuel enrichment
services from the DOE before October 24, 1992. The South Texas Project's
assessment is approximately $2 million per year (subject to escalation for
inflation). The Company has a remaining estimated liability of $5 million for
such assessments.
7
19
(e) 1996 Settlement of South Texas Project Litigation.
In 1996, the Company recorded an aggregate $95 million ($62 million net of
tax) charge in connection with various settlements of lawsuits filed by
co-owners of the South Texas Project. For information about the execution of an
operations agreement with the City of San Antonio in connection with one of
these settlements, see Note 12(c).
(5) EQUITY INVESTMENTS AND ADVANCES TO UNCONSOLIDATED SUBSIDIARIES
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 and its subsidiaries' equity investments and advances in
unconsolidated subsidiaries at December 31, 1998 and 1997 were $1 billion and
$704 million, respectively. The Company's and its subsidiaries' equity income
from these investments, included in International revenues and other net income,
was $71 million, $49 million and $17 million in 1998, 1997 and 1996,
respectively. Dividends received from the investments amounted to $44 million
and $46 million in 1998 and 1997, respectively. No dividends were received from
these investments in 1996.
(a) International.
In April 1998, Light ServiHos de Eletricidade S.A. (Light), a
Brazilian corporation in which Reliant Energy International, Inc. (Reliant
Energy International) indirectly owns an 11.69% common stock interest, purchased
74.88% of the common stock of Metropolitana Eletricidade de Sao Paulo S.A.
(Metropolitana), an electric distribution company that serves the metropolitan
area of Sao Paulo, Brazil. The purchase price for the shares was approximately
$1.8 billion and was financed with proceeds from bank borrowings. As of December
31, 1998, Light and Metropolitana had approximately $3.2 billion in non-local
currency denominated borrowings. For information regarding foreign currency
adjustments, see Note 1(p). For information about the devaluation of the
Brazilian real in January 1999, see Note 16(a).
In May 1997, Reliant Energy International increased its indirect ownership
interest in an Argentine electric utility from 48% to 63%. The purchase price
of the additional interest was $28 million.
On June 30, 1998, Reliant Energy International sold its 63% ownership
interest in an Argentine affiliate and certain related assets for approximately
$243 million. Reliant Energy International acquired its initial ownership
interests in the electric utility in 1992. The Company recorded an $80 million
after-tax gain from this sale in the second quarter of 1998.
In 1998, a subsidiary of Reliant Energy International acquired for
approximately $150 million, equity interests (currently ranging from
approximately 36% to 45%) in three electric distribution systems located in El
Salvador. Corporacion EDC S.A.C.A. (CEDC), Reliant Energy International's
partner in this venture, acquired majority interests in the systems when they
were privatized in early 1998. On June 30, 1998, CEDC closed on the sale of
approximately half of its interests in the systems to a subsidiary of Reliant
Energy International.
In August 1998, Reliant Energy International and CEDC jointly acquired,
through subsidiaries, 65% of the stock of two Colombian electric distribution
companies, Electricaribe and Electrocosta. The shares of these companies are
indirectly held by an offshore holding company jointly owned by special purpose
subsidiaries of CEDC and Reliant Energy International.
The purchase price for the joint investment in Electricaribe and
Electrocosta was approximately $522 million, excluding transaction costs. The
purchase price was funded with capital contributions from Reliant Energy
International and CEDC and a U.S. $200 million loan obtained by the holding
company from a United States bank. A $100 million advance on the loan was
obtained in October 1998 with subsequent advances of $25 million and $75 million
obtained in December 1998 and January 1999, respectively. The loan will mature
on October 31, 2003. Reliant Energy International funded its capital
contributions with a portion of the proceeds from the sale of the Argentine
affiliate discussed above and capital contributions from the Company. Under the
terms of a support agreement, Reliant Energy International and CEDC have agreed,
among other things, to repurchase up to U.S. $50 million of the loan from the
bank to the extent that the bank is unable to syndicate that portion of the loan
to other banks on or prior to June 15, 1999.
In June 1997, a consortium of investors which included a subsidiary of
Reliant Energy International, 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 province of Colombia,
including the area surrounding the city of Cali. Reliant Energy International
contributed $152 million of the purchase price for a 28.35% ownership interest
in EPSA. In addition to its distribution facilities, EPSA owns 850 MW of
electric generation capacity.
8
20
Reliant Energy International has accounted for these transactions under
purchase accounting and has recorded its investments and its interest in the
affiliates' earnings after the acquisition dates using the equity method. The
purchase prices were allocated, on a preliminary basis, using the estimated fair
market values of the assets acquired and the liabilities assumed as of the dates
of acquisition. The differences between the amounts paid and the underlying fair
values of the net assets acquired are being amortized as a component of earnings
attributable to unconsolidated affiliates over the estimated lives of the
projects ranging from 30 to 40 years. Purchase price adjustments to fixed assets
are being amortized over the underlying assets' estimated useful lives.
(b) Combined Financial Statement Data of Equity Investments and Advances to
Unconsolidated Subsidiaries.
The following table sets forth certain summarized financial information of
the Company's unconsolidated affiliates as of December 31, 1998 and 1997 and for
the years then ended or periods from the respective affiliates' acquisition date
through December 31, 1998, 1997 and 1996, if shorter:
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997 1996
---------------- ---------------- ----------------
($ IN THOUSANDS)
Income Statement:
Revenues....................... $ 2,449,335 $ 2,011,927 $ 994,743
Operating Expenses............. 1,762,166 1,460,248 768,993
Net Income..................... 514,005 403,323 149,038
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997
---------------- ----------------
($ IN THOUSANDS)
Balance Sheet:
Current Assets................... $ 1,841,857 $ 726,997
Noncurrent Assets................ 13,643,747 5,791,858
Current Liabilities.............. 4,074,603 566,596
Noncurrent Liabilities........... 6,284,821 1,398,385
Owner's Equity................... 5,126,180 4,553,874
(8) LONG-TERM DEBT AND SHORT-TERM BORROWINGS
(c) FinanceCo and FinanceCo II Credit Facilities.
In August 1997, a limited partnership special purpose subsidiary of the
Company (FinanceCo) established a five-year, $1.644 billion revolving credit
facility (FinanceCo Facility). The FinanceCo Facility supported $1.360 billion
in commercial paper borrowings by FinanceCo at December 31, 1998 recorded as
notes payable on the Company's Consolidated Balance Sheet. The weighted average
interest rate of these borrowings was 5.88% at December 31, 1998, and 6.15%
at December 31, 1997.
Borrowings under the FinanceCo Facility bear interest at a rate based upon
the London interbank offered rate (LIBOR) plus a margin, a base rate or at a
rate determined through a bidding process. The FinanceCo Facility may be used
(i) to support the issuance of commercial paper or other short-term indebtedness
of FinanceCo, (ii) subject to certain limitations, to finance purchases of
Company common stock and (iii) subject to certain limitations, to provide funds
for general purposes of FinanceCo, including the making of intercompany loans
to, or securing letters of credit for the benefit of, FinanceCo's affiliates.
The FinanceCo Facility requires the Company to maintain a ratio of
consolidated indebtedness for borrowed money to consolidated capitalization (as
defined) that does not exceed 0.65:1.00. The FinanceCo Facility also contains
restrictions applicable to the Company and certain of its subsidiaries with
respect to, among other things, (i) liens, (ii) consolidations, mergers and
dispositions of assets, (iii) dividends and purchases of common stock, (iv)
certain types of investments and (v) certain changes in its business. The
FinanceCo Facility contains customary covenants and default provisions
applicable to FinanceCo and its subsidiaries, including limitations on, among
other things, additional indebtedness (other than certain permitted
indebtedness), liens and certain investments or loans.
Subject to certain conditions and limitations, the Company is required to
make cash payments from time to time to FinanceCo from excess cash flow (as
defined in the FinanceCo Facility) to the extent necessary to enable FinanceCo
to meet its financial obligations. At December 31, 1998, commercial paper
supported by the FinanceCo Facility was secured by pledges of (i) all of the
limited and general partner interests of FinanceCo, (ii) the Series B Preference
Stock and (iii) certain intercompany notes held by FinanceCo. The obligations
under the FinanceCo Facility are not secured by the utility assets of the
Company or Resources or by the Company's investment in Time Warner securities.
In March 1998, a limited partnership special purpose subsidiary of the
Company (FinanceCo II) executed a $150 million credit agreement (FinanceCo II
Facility) which terminated March 2, 1999. Proceeds from $150 million of
borrowings under the FinanceCo II Facility were used to fund a portion of the
April 1998 purchase by Reliant Energy Power Generation, Inc. (Power Generation)
of four electric generation plants. Borrowings under the FinanceCo II Facility
bore interest at LIBOR-based and negotiated rates. At December 31, 1998,
FinanceCo II had $150 million of borrowings under this facility at an interest
rate of 5.75%. In March 1999, the $150 million of borrowings under the FinanceCo
II facility were paid at maturity with borrowings under the FinanceCo facility.
9
21
(d) Company Credit Facility.
The Company meets its short-term financing needs primarily through sales of
commercial paper supported by a $200 million revolving credit facility.
Borrowings under the facility are unsecured and a facility fee is paid. At
December 31, 1998, there was no outstanding commercial paper and there were no
outstanding borrowings under the bank facility.
(9) TRUST SECURITIES
(a) Company.
In February 1997, two Delaware statutory business trusts (Reliant Trusts)
established by the Company issued (i) $250 million of preferred securities and
(ii) $100 million of capital securities, respectively. The preferred securities
have a distribution rate of 8.125% payable quarterly in arrears, a stated
liquidation amount of $25 per preferred security and must be redeemed by March
2046. The capital securities have a distribution rate of 8.257% payable
quarterly in arrears, a stated liquidation amount of $1,000 per capital security
and must be redeemed by February 2037.
The Reliant Trusts sold the preferred and capital securities to the public
and used the proceeds to purchase $350 million aggregate principal amount of
subordinated debentures (Debentures) from the Company having interest rates
corresponding to the distribution rates of the securities and maturity dates
corresponding to the mandatory redemption dates of the securities. The Reliant
Trusts are accounted for as wholly owned consolidated subsidiaries of the
Company. The Debentures represent the Reliant Trusts' sole assets and its entire
operations. The Company has fully and unconditionally guaranteed, on a
subordinated basis, each Trust's obligations, including the payment of
distributions and all other payments due with respect to the respective
preferred and capital securities. The preferred and capital securities are
mandatorily redeemable upon the repayment of the related Debentures at their
stated maturity or earlier redemption.
Subject to certain limitations, the Company has the option of deferring
payments of interest on the Debentures held by the Reliant Trusts. If and for as
long as interest payments on the Debentures have been deferred, or an event of
default under the indenture relating thereto has occurred and is continuing, the
Company may not pay dividends on its capital stock. As of December 31, 1998, no
interest payments on the Debentures had been deferred.
(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
$210 million in 1999, $187 million in 2000 and $188 million in 2001.
Additionally, minimum payment obligations for lignite mining and lease
agreements are approximately $9 million for 1999, $10 million for 2000 and $10
million for 2001. Minimum payment obligations for both natural gas purchase and
storage contracts associated with Electric Operations are approximately $10
million in 1999, $9 million in 2000 and $9 million in 2001.
The Company also has commitments to purchase firm capacity from two
cogenerators totaling approximately $22 million in both 1999 and 2000. 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, these two firm capacity contracts contain
provisions allowing the Company to suspend or reduce payments and seek repayment
for amounts disallowed. Both of these firm capacity contracts have initial terms
ending March 31, 2005.
10
22
(c) Operations Agreement with City of San Antonio.
As part of the 1996 settlement of certain litigation claims asserted by the
City of San Antonio with respect to the South Texas Project, 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 and 1998, savings generated for CPS'
account for a full year of operation were approximately $22 million and $14
million, respectively.
(d) Transportation Agreement.
Resources had an agreement (ANR Agreement) with ANR Pipeline Company (ANR)
which contemplated that Resources would transfer to ANR an interest in certain
of Resources' pipeline and related assets. The interest represented capacity of
250 Mmcf/day. Under the ANR Agreement, an ANR affiliate advanced $125 million to
Resources. Subsequently, the parties restructured the ANR Agreement and
Resources refunded in 1995 and 1993, respectively, $50 million and $34 million
to ANR or an affiliate. Resources recorded $41 million as a liability reflecting
ANR's or its affiliates' use of 130 Mmcf/day of capacity in certain of
Resources' transportation facilities. The level of transportation will decline
to 100 Mmcf/day in the year 2003 with a refund of $5 million to an ANR
affiliate. 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 the Company's
obligations under non-cancelable long-term operating leases:
Minimum Lease Commitments at December 31, 1998 (1)
(Millions of Dollars)
1999.................................................... $ 20
2000.................................................... 16
2001.................................................... 15
2002.................................................... 11
2003.................................................... 10
2004 and beyond......................................... 66
---------
Total......................................... $ 138
---------
- ----------
(1) Principally consisting of rental agreements for building space and data
processing equipment and vehicles (including major work equipment).
Resources 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. Resources does not expect to lease additional property under
this lease agreement.
Total rental expense for all Resources' leases was approximately $25
million in 1998. Total rental expense for all leases in 1997 since the
Acquisition Date was approximately $15 million.
(f) Letters of Credit.
At December 31, 1998, the Company and Resources had letters of credit
incidental with their ordinary business operations totaling approximately $34
million under which they are obligated to reimburse drawings, if any.
(g) Indemnity Provisions.
At December 31, 1998, Resources had a $5.8 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 Resources'
former subsidiaries or divisions, including the sale of (i) Louisiana Intrastate
Gas Corporation, a former Resources subsidiary engaged in the intrastate
pipeline and liquids extraction business; (ii) Arkla Exploration Company, a
former Resources subsidiary engaged in oil and gas exploration and production
activities; and (iii) Dyco Petroleum Company, a former Resources subsidiary
engaged in oil and gas exploration and production.
(h) Environmental Matters.
The Company is a defendant in litigation arising out of the environmental
remediation of a site in Corpus Christi, Texas. The litigation was instituted in
1985 by adjacent landowners. The litigation is pending before the United States
District Court for the Southern District of Texas, Corpus Christi Division. The
site was operated by third parties as a metals reclaiming operation. Although
the Company neither operated nor owned the site, certain transformers and other
equipment originally sold by the Company may have been delivered to the site by
third parties. The Company and others have remediated the site pursuant to a
plan approved by appropriate state agencies and a federal court. To date, the
Company has recovered or has commitments to recover from other responsible
parties $2.2 million of the more than $3 million it has spent on remediation.
11
23
In 1992, the United States Environmental Protection Agency (EPA) (i)
identified the Company, along with several other parties, as "potentially
responsible parties" (PRP) under the Comprehensive Environmental Response,
Compensation and Liability Act (CERCLA) for the costs of cleaning up a site
located adjacent to one of the Company's transmission lines in La Marque, Texas
and (ii) issued an administrative order for the remediation of the site. The
Company believes that the EPA took this action solely on the basis of
information indicating that the Company in the 1950s acquired record title to a
portion of the land on which the site is located. The Company does not believe
that it now or previously has held any ownership interest in the property
covered by the order and has obtained a judgement to that effect from a court in
Galveston County, Texas. Based on this judgement and other defenses that the
Company believes to be meritorious, the Company has elected not to adhere to the
EPA's administrative order, even though the Company understands that other PRPs
are proceeding with site remediation. To date, neither the EPA nor any other PRP
has instituted an action against the Company for any share of the remediation
costs for the site. However, if the Company was determined to be a responsible
party, the Company could be jointly and severally liable along with the other
PRPs for the aggregate remediation costs of the site (which the Company
currently estimates to be approximately $80 million in the aggregate) and could
be assessed substantial fines and damage claims. Although the ultimate outcome
of this matter cannot currently be predicted at this time, the Company does not
believe that this case will have a material adverse effect on the Company's
financial condition, liquidity or results of operations.
From time to time the Company and its subsidiaries have received notices
from regulatory authorities or others regarding their status as potential PRPs
in connection with sites found to require remediation due to the presence of
environmental contaminants. In addition, the Company has been named as defendant
in litigation related to such sites and in recent years has been named, along
with numerous others, as a defendant in several lawsuits filed by a large number
of individuals who claim injury due to exposure to asbestos while working at
sites along the Texas Gulf Coast. Most of these claimants have been workers who
participated in construction of various industrial facilities, including power
plants, and some of the claimants have worked at locations owned by the Company.
The Company anticipates that additional claims like those received may be
asserted in the future and intends to continue its practice of vigorously
contesting claims which it does not consider to have merit. Although their
ultimate outcome cannot be predicted at this time, the Company does not believe,
based on its experience to date, that these matters, either individually or in
the aggregate, will have a material adverse effect on the Company's financial
position, results of operation or cash flows.
(i) 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 Resources 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 Resources' 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 Electric Operations on receipts from sales to other
utilities and on receipts from services as well as sales of electricity.
Plaintiffs advance their claims notwithstanding their failure to notice such
claims over the previous four decades. Because all of the franchise ordinances
affecting Electric Operations expressly impose fees only on receipts from sales
of electricity for consumption within a city, the Company regards plaintiffs'
allegations as spurious and is vigorously contesting the matter. The plaintiffs'
pleadings assert that their damages exceed $250 million. The District Court for
Harris County has granted a partial summary judgment in favor of the Company
dismissing all claims for franchise fees based on sales tax collections. Other
motions for partial summary judgment remain pending. 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.
(16) SUBSEQUENT EVENTS
(a) Foreign Currency Devaluation.
In January 1999, the Brazilian real was devalued and allowed to float
against other major currencies. The Company expects to take a charge against
first quarter earnings as a result of the Brazilian devaluation. The charge will
reflect the Company's proportionate share of the impact of the devaluation on
foreign denominated debt of Brazilian corporations in which the Company holds an
equity interest. The amount of the charge will not be known until the end of the
first quarter.
At December 31, 1998, one U.S. dollar could be exchanged for 1.21 Brazilian
reais. Using the exchange rate of 2.06 reais/dollar in effect at the end of
February, and the average exchange rate in effect since the end of the year, the
Company estimates that its share of the after-tax charge that would be recorded
by the Brazilian companies in which it owns an interest would be approximately
$125 million.
12
1
EXHIBIT 12
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
THREE MONTHS
ENDED TWELVE MONTHS
MARCH 31, ENDED MARCH 31,
--------------- ---------------
1999 1999
--------------- ---------------
Income from Continuing Operations.......................................... $ 70,973 102,969
Income Taxes from Continuing Operations.................................... 52,474 107,250
Non-Utility Interest Capitalized........................................... -- --
--------------- ---------------
Income from Continuing Operations Before Income Taxes...................... 123,447 210,219
=============== ===============
Fixed Charges Interest..................................................... 29,270 113,908
Amortization of debt discount and expense.................................. 491 654
Portion of Rents Considered to Represent an Interest Factor................ 2,143 9,519
--------------- ---------------
Total Fixed Charges........................................................ 31,904 124,081
=============== ===============
Income from Continuing Operations Before Income Taxes and Fixed Charges.... $ 155,351 $ 334,300
Ratio of Earnings to Fixed Charges......................................... 4.87 2.69
=============== ===============
OPUR1
0001042773
RELIANT ENERGY RESOURCES CORP
1,000
3-MOS
DEC-31-1999
MAR-31-1999
PER-BOOK
1,346,267
1,496,149
1,493,481
2,341,407
0
6,667,304
1
2,449,925
185,644
2,635,570
0
0
1,506,121
0
300,000
0
201,965
0
0
0
2,033,648
6,677,304
1,828,064
52,474
1,677,887
1,677,887
150,177
3,031
153,208
29,761
70,973
0
70,973
0
29,662
80,939
0
0
1
EXHIBIT 99B
[ITEMS INCORPORATED
FROM THE RESOURCES 10-K]
ITEM 3. LEGAL PROCEEDINGS.
(b) Resources.
For a description of certain legal and regulatory proceedings affecting
Resources, see Note 8(g) to Resources' Consolidated Financial Statements, which
note is incorporated herein by reference.
ITEM. 7 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
Earnings for the past three years are not necessarily indicative of future
earnings and results. The level of future earnings depends on numerous factors
including (i) the future growth in the Company's and its subsidiaries' energy
sales; (ii) weather; (iii) the success of the Company's and its subsidiaries'
entry into non-rate regulated businesses such as energy marketing and
international and domestic power projects; (iv) the Company's and its
subsidiaries' ability to respond to rapid changes in a competitive environment
and in the legislative and regulatory framework under which they have
traditionally operated; (v) rates of economic growth in the Company's and its
subsidiaries' service areas; (vi) the ability of the Company and its
subsidiaries to control costs and to maintain pricing structures that are both
attractive to customers and profitable; (vii) the outcome of future rate
proceedings; (viii) the effect that foreign exchange rate changes may have on
the Company's investments in international operations; and (ix) future
legislative initiatives.
In order to adapt to the increasingly competitive environment in which the
Company operates, the Company continues to evaluate a wide array of potential
business strategies, including business combinations or acquisitions involving
other utility or non-utility businesses or properties, internal restructuring,
reorganizations or dispositions of currently owned properties or currently
operating business units and new products, services and customer strategies. In
addition, the Company continues to engage in new business ventures, such as
electric power trading and marketing, which arise from competitive and
regulatory changes in the utility industry.
COMPETITION AND RESTRUCTURING OF THE ELECTRIC UTILITY INDUSTRY
The electric utility industry is becoming increasingly competitive due to
changing government regulations, technological developments and the availability
of alternative energy sources.
Long-Term Trends in Electric Utility Industry. The electric utility
industry historically has been composed of vertically integrated companies
providing electric service on an exclusive basis within governmentally-defined
geographic areas. Prices for electric service have typically been set by
governmental authorities under principles designed to provide the utility with
an opportunity to recover its cost of providing electric service plus a
reasonable return on its invested capital. Federal legislation and regulation as
well as legislative and regulatory initiatives in various states have encouraged
competition among electric utility and non-utility owned power generators. These
developments, combined with increased demand for lower-priced electricity and
technological advances in electric generation, have continued to move the
electric utility industry in the direction of more competition.
Based on a strategic review of the Company's business and of ongoing
developments in the electric utility and related industries regarding
competition, regulation and consolidation, the Company's management believes
that the electric utility industry will continue its path toward competition,
albeit on a state-by-state basis. The Company's management also believes the
business of electricity and natural gas are converging and consolidating and
these trends will alter the structure and business practices of companies
serving these markets in the future.
Competition in Wholesale Market. The Federal Energy Policy Act of 1992, the
Public Utility Regulatory Act of 1995 (now the Texas Utilities Code) and
regulations promulgated by the Federal Energy Regulatory Commission (FERC)
contain provisions intended to facilitate the development of a wholesale energy
market. Although Reliant Energy HL&P's wholesale sales traditionally have
accounted for less than 1% of its total revenues, the expansion of competition
in the wholesale electric market is significant in that it has increased the
range of non-utility competitors, such as exempt wholesale generators (EWGs) and
power marketers, in the Texas electric market as well as resulted in fundamental
changes in the operation of the state transmission grid.
In February 1996, the Texas Utility Commission adopted rules granting
third-party users of transmission systems open access to such systems at rates,
terms and conditions comparable to those available to utilities owning such
transmission assets. Under the Texas Utility Commission order implementing the
rule, Reliant Energy HL&P was required to separate, on an operational basis, its
wholesale power marketing operations from the operations of the transmission
grid and, for purposes of transmission pricing, to disclose each of its separate
costs of generation, transmission and distribution.
Within ERCOT, an independent system operator (ISO) manages the state's
electric grid, ensuring system reliability and providing non-discriminatory
transmission access to all power producers and traders. The ERCOT ISO, the first
in the nation, is a key component for implementing the Texas Utility
Commission's overall strategy to create a
2
competitive wholesale market. ERCOT formed an ad hoc committee in early 1998 to
investigate the potential impacts of a competitive retail market on the ISO. The
ERCOT committee report was released in December 1998 and concluded that the
ISO's role and function would necessarily expand in a competitive retail
environment, but the changes required of the ISO to support retail choice should
not impede introduction of retail choice.
Competition in Retail Market. The Company estimates that, since 1978,
cogeneration projects representing approximately one-third of current total peak
generating capability have been built in the Houston area and that, as a result,
Reliant Energy HL&P has seen a reduction of approximately 2,500 MW in customer
load to self-generation. Reliant Energy HL&P has utilized flexible pricing to
respond to situations where large industrial customers have an alternative to
buying power from it, primarily by constructing their own generating facilities.
Under a tariff option approved by the Texas Utility Commission in 1995, Reliant
Energy HL&P was permitted to implement contracts based upon flexible pricing for
up to 700 MW. Currently, this rate is fully subscribed.
Texas law currently does not permit retail sales by unregulated entities
such as cogenerators. The Company anticipates that cogenerators and other
interests will continue to exert pressure to obtain access to the electric
transmission and distribution systems of regulated utilities for the purpose of
making retail sales to customers of regulated utilities.
Legislative Proposals. A number of proposals to restructure the electric
utility industry have been introduced in the 1999 session of the Texas
legislature. If adopted, legislation may permit and encourage alternative
suppliers to compete to serve Reliant Energy HL&P's current rate-regulated
retail customers. The various legislative proposals include provisions governing
recovery of stranded costs and permitting securitization of those costs;
freezing rates until 2002; requiring firm sales of energy to competing retail
electric providers; requiring disaggregation of generation, transmission and
distribution, and retail sales into separate companies and limiting the ability
of existing utilities' affiliates competing for retail electric customers on the
basis of price until they have lost a substantial percentage of their
residential and small commercial load to alternative retail providers. In
addition to the Texas legislative proposals, a number of federal legislative
proposals to promote retail electric competition or restructure the U.S.
electric utility industry have been introduced during the current congressional
session.
At this time, the Company is unable to make any prediction as to whether
any legislation to restructure electric operations or provide retail competition
will be enacted or as to the content or impact on the Company of any legislation
which may be enacted. However, because the proposed legislation is intended to
fundamentally restructure electric utility operations, it is likely that enacted
legislation would have a material impact on the Company.
Stranded Costs. As the U.S. electric utility industry continues its
transition to a more competitive environment, a substantial amount of fixed
costs previously approved for recovery under traditional utility regulatory
practices (including regulatory assets and liabilities) may become "stranded,"
i.e., unrecoverable at competitive market prices. The issue of stranded costs
could be particularly significant with respect to fixed costs incurred in
connection with the past construction of generation plants, such as nuclear
power plants, which, because of their high fixed costs, would not command the
same price for their output as they have in a regulated environment.
In January 1997, the Texas Utility Commission delivered a report to the
Texas legislature on stranded investments in the electric utility industry in
Texas (referred to by the Texas Utility Commission as "Excess Cost Over Market")
(ECOM). In April 1998, the Texas Utility Commission submitted to the Texas
Senate Interim Committee on Electric Utility Restructuring an updated study of
ECOM estimates. Assuming that retail competition is adopted at the beginning of
2002, the updated study estimated that the total amount of stranded costs for
all Texas electric utilities could be $4.5 billion. If instead, retail
competition is adopted one year later, the study estimates statewide ECOM to be
$3.3 billion. Estimates of ECOM vary widely and there is inherent uncertainty in
calculating these costs.
Transition Plan. In June 1998, the Texas Utility Commission approved the
Transition Plan filed by Reliant Energy HL&P in December 1997. The Transition
Plan included base rate credits to residential and certain commercial
2
3
customers in 1998 and 1999, an overall rate of return cap formula for 1998 and
1999 and approval of accounting procedures designed to accelerate recovery of
stranded costs which may arise under restructuring legislation. The Transition
Plan permits the redirection of depreciation expense to generation assets that
Electric Operations otherwise would apply to transmission, distribution and
general plant assets. In addition, the Transition Plan provides that all
earnings above a 9.844% overall annual rate of return on invested capital be
used to recover Electric Operations' investment in generation assets. In
1998, Reliant Energy HL&P recorded an additional $194 million in depreciation
under the Transition Plan. Certain parties have appealed the order approving the
Transition Plan. For additional information, see Notes 1(f) and 3(b) to the
Company's Consolidated Financial Statements.
COMPETITION -- OTHER OPERATIONs
Natural Gas Distribution competes primarily with alternate energy sources
such as electricity and other fuel sources as well as with providers of energy
conservation products. In addition, as a result of federal regulatory changes
affecting interstate pipelines, it has become possible for other natural gas
suppliers and distributors to bypass Natural Gas Distribution's facilities and
market, sell and/or transport natural gas directly to small commercial and/or
large volume customers.
The Interstate Pipeline segment competes with other interstate and
intrastate pipelines in the transportation and storage of natural gas. The
principal elements of competition among pipelines are rates, terms of service,
and flexibility and reliability of service. Interstate Pipeline competes
indirectly with other forms of energy available to its customers, including
electricity, coal and fuel oils. The primary competitive factor is price.
Changes in the availability of energy and pipeline capacity, the level of
business activity, conservation and governmental regulations, the capability to
convert to alternative fuels, and other factors, including weather, affect the
demand for natural gas in areas served by Interstate Pipeline and the level of
competition for transport and storage services.
Reliant Energy Services competes for sales in its gas and power trading and
marketing business with other natural gas and power merchants, producers and
pipelines based on its ability to aggregate supplies at competitive prices from
different sources and locations and to efficiently utilize transportation from
third-party pipelines and transmission from electric utilities. Reliant Energy
Services also competes against other energy marketers on the basis of its
relative financial position and access to credit sources. This competitive
factor reflects the tendency of energy customers, natural gas suppliers and
natural gas transporters to seek financial guarantees and other assurances that
their energy contracts will be satisfied. As pricing information becomes
increasingly available in the energy trading and marketing business and as
deregulation in the electricity markets continues to accelerate, the Company
anticipates that Reliant Energy Services will experience greater competition and
downward pressure on per-unit profit margins in the energy marketing industry.
Competition for acquisition of international and domestic non-rate
regulated power projects is intense. International and Power Generation compete
against a number of other participants in the non-utility power generation
industry, some of which have greater financial resources and have been engaged
in non-utility power projects for periods longer than the Company and have
accumulated greater portfolios of projects. Competitive factors relevant to the
non-utility power industry include financial resources, access to non-recourse
funding and regulatory factors.
FLUCTUATIONS IN COMMODITY PRICES AND DERIVATIVE INSTRUMENTS
For information regarding the Company's exposure to risk as a result of
fluctuations in commodity prices and derivative instruments, see "Quantitative
and Qualitative Disclosures About Market Risk" in Item 7A of this Report.
ACCOUNTING TREATMENT OF ACES
The Company accounts for its investment in Time Warner Convertible
Preferred Stock (TW Preferred) under the cost method. As a result of the
Company's issuance of the ACES, a portion of the increase in the market value
above $27.7922 per share of Time Warner common stock (the security into which
the TW Preferred is convertible) (TW
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Common) results in unrealized accounting losses to the Company, pending the
conversion of the Company's TW Preferred into TW Common. For consistency
purposes, the TW Common and related per share prices retroactively reflect a 2
for 1 stock split effective December 15, 1998.
Prior to the conversion of the TW Preferred into TW Common, when the market
price of TW Common increases above $27.7922, the Company records in Other Income
(Expense) an unrealized, non-cash accounting loss for the ACES equal to the
aggregate amount of such increase as applicable to all ACES multiplied by
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 TW Common that underlies
the TW Preferred. Upon conversion of the TW Preferred (which is anticipated to
occur in June 1999 when the preferential dividend on the TW Preferred expires),
the Company will begin recording future unrealized net changes in the market
prices of the TW Common and the ACES as a component of common stock equity and
other comprehensive income.
As of December 31, 1998, the market price of TW Common was $62.062 per
share. Accordingly, the Company recognized an increase of $1.2 billion in 1998
in the unrealized liability relating to its ACES indebtedness (which resulted in
an after-tax earnings reduction of $764 million or $2.69 basic earnings per
share in 1998). The Company believes that the cumulative unrealized loss for the
ACES of approximately $1.3 billion is more than economically offset by the
approximately $1.8 billion unrecorded unrealized gain at December 31, 1998
relating to the increase in the fair value of the TW Common underlying the
investment in TW Preferred since the date of its acquisition. Any gain related
to the increase in fair value of TW Common would be recognized as a component of
net income upon the sale of the TW Preferred or the shares of TW Common into
which such TW Preferred is converted. As of March 11, 1999, the price of TW
Common was $70.75 per share, which would have resulted in the Company
recognizing an additional increase of $329 million in the unrealized liability
represented by its indebtedness under the ACES. The related unrecorded
unrealized gain as of March 11, 1999 would have been computed as an additional
$398 million.
Excluding the unrealized, non-cash accounting loss for ACES, the Company's
retained earnings and total common stock equity would have been $2.3 billion and
$5.2 billion, respectively.
IMPACT OF THE YEAR 2000 ISSUE AND OTHER SYSTEM IMPLEMENTATION 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 Resources' and
other Company subsidiaries' mainframe applications, infrastructures, embedded
systems and client-developed applications that will not be migrated into
existing or planned Company or Resources systems prior to the year 2000. The
evaluation of Year 2000 issues included those related to significant customers,
key vendors, service suppliers and other parties material to the Company's and
its subsidiaries' 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.
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 (Priority 1); activities that would impact back
office activities such as billing (Priority 2); activities that would cause
inconvenience or productivity loss in normal business operations (e.g. air
conditioning systems and elevators) (Priority 3). 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
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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. The following table illustrates the Company's completion
percentages for the Year 2000 activities as of February 28, 1999:
PRIORITY 1 PRIORITY 2 PRIORITY 3
-------------- -------------- ---------------
Assessment.............................................. 95% 86% 96%
Conversion.............................................. 86% 70% 91%
Testing................................................. 80% 61% 87%
Implementation.......................................... 76% 54% 75%
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 with respect to the Company and its subsidiaries will be between $35
and $40 million. This estimate includes approximately $7 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 $12 million during 1998. The remaining 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 customer care, finance and 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 Resources and the Company's expansion into the 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. Portions of the SAP system were implemented in
December 1998 and March 1999, and it is expected that the final portion of the
SAP system will be fully implemented by July 2000. The estimated costs of
implementing the SAP system is approximately $182 million, inclusive of internal
costs. In 1998, the Company and its subsidiaries spent $108 million of such
costs. In 1999, the Company and its subsidiaries expect to spend $59 million
with the remaining amounts to be spent in 2000.
The estimated Year 2000 project costs do not give effect to any future
corporate acquisitions or divestitures made by the Company or its subsidiaries.
Risks and Contingency Plans. The major systems which pose the greatest Year
2000 risks for the Company and its subsidiaries if implementation of the Year
2000 compliance program is not successful are the process control systems for
energy delivery systems; the time in use, demand and recorder metering system
for commercial and industrial customers; the outage analysis system; and the
power billing systems. The potential problems related to these systems are
temporary electric service interruptions to customers, temporary interruptions
in revenue data gathering and temporary poor customer relations resulting from
delayed billing. Although the Company does not believe that this scenario will
occur, the Company has considerable experience responding to emergency
situations, including computer failure. Existing emergency operations, disaster
recovery and business continuation plans are being enhanced to ensure
preparedness and to mitigate the long-term effect of such a scenario.
The North American Electric Reliability Council (NERC) is coordinating
electric utility industry contingency planning on a national level. Additional
contingency planning is being done at the regional electric reliability council
level. Reliant Energy HL&P filed a draft Year 2000 Contingency Plan with NERC
and with the Texas Utility Commission in December 1998. The draft plan addresses
restoration of electric service and related business processes, and is designed
to work in conjunction with the Emergency Operating Plan and with the plans of
NERC and ERCOT.
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A final contingency plan is scheduled to be complete by June 30, 1999. In
addition, Reliant Energy HL&P will participate in industry preparedness drills,
such as the two NERC drills scheduled to be held on April 9, 1999 and September
9, 1999.
The existing business continuity disaster recovery and emergency operations
plans are being reviewed and enhanced, and where necessary, additional plans
will be developed to include mitigation strategies and action plans specifically
addressing potential Year 2000 scenarios. The expected completion date for these
plans is June 30, 1999.
In order to assist in preparing for and mitigating the foregoing scenarios,
the Company intends to complete all mission critical Year 2000 remediation and
testing activity by the end of the second quarter of 1999. In addition, 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' Year
2000 projects. The Company expects to meet with mission-critical third parties,
including suppliers, in order to ascertain and assess the relative risks of
Year-2000-related issues, and to mitigate such risks. Notwithstanding the
foregoing, the Company cautions that (i) the nature of testing is such that it
cannot comprehensively address all future combinations of dates and events and
(ii) it is impossible for the Company to assess with precision or certainty the
compliance of third parties with Year 2000 remediation efforts. Due to the
speculative and uncertain nature of contingency planning, there can be no
assurance that such plans actually will be sufficient to reduce the risk of
material impacts on the Company's and its subsidiaries' operations.
RISKS OF INTERNATIONAL OPERATIONS
The Company's international operations are subject to various risks
incidental to investing or operating in emerging market countries. These risks
include political risks, such as governmental instability, and economic risks,
such as fluctuations in currency exchange rates, restrictions on the
repatriation of foreign earnings and/or restrictions on the conversion of local
currency earnings into U.S. dollars. The Company's international operations are
also highly capital intensive and, thus, dependent to a significant extent on
the continued availability of bank financing and other sources of capital on
commercially acceptable terms.
Impact of Currency Fluctuations on Company Earnings. The Company, through
Reliant Energy International's subsidiaries, owns 11.69% of the stock of Light
and, through its investment in Light, an 8.753% interest in the stock of
Metropolitana Electricidade de Sao Paulo S.A. (Metropolitana). The Company
accounts for its investment in Light under the equity method of accounting and
records its proportionate share, based on stock ownership, in the net income of
Light and its affiliates (including Metropolitana) as part of the Company's
consolidated net income.
At December 31, 1998, Light and Metropolitana had total borrowings of
approximately $3.2 billion denominated in non-local currencies. Because of the
devaluation of the Brazilian real subsequent to December 31, 1998, Light and
Metropolitana are expected to record a charge to March 31, 1999 earnings that
reflects the increase in the liability represented by their non-local currency
denominated bank borrowings relative to the Brazilian real. Because the Company
uses the Brazilian real as the functional currency in which it reports Light's
equity earnings, the resulting decrease in Light's earnings will also be
reflected in the Company's consolidated earnings to the extent of the Company's
11.69% ownership interest in Light. At December 31, 1998, one U. S. dollar could
be exchanged for 1.21 Brazilian reais. Using the exchange rate of 2.06 Brazilian
reais in effect at the end of February, and the average exchange rate in effect
since the end of the year, the Company estimates that its share of the after-tax
charge to be recorded by Light would be approximately $125 million. This
estimate does not reflect the possibility of additional fluctuations in the
exchange rate and does not include other non-debt-related impacts of Brazil's
currency devaluation on Light's and Metropolitana's future earnings.
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None of Light's or Metropolitana's tariff adjustment mechanisms are
directly indexed to the U.S. dollar or other non-local currencies. Each company
currently is evaluating various options including regulatory rate relief to
mitigate the impact of the devaluation of the Brazilian real. For example, the
long-term concession contracts under which Light and Metropolitana operate
contain mechanisms for adjusting electricity tariffs to reflect changes in
operating costs resulting from inflation. If the devaluation of the Brazilian
real results in an increase in the local rate of inflation and if an adjustment
to tariff rates is made promptly to reflect such increase, the Company believes
that the financial results of Light and Metropolitana should be protected, at
least in part, from the effects of devaluation. However, there can be no
assurance the implementation of such tariff adjustments will be timely or that
the economic impact of the devaluation will be completely reflected in increased
inflation rates.
Certain of Reliant Energy International's other foreign electric
distribution companies have incurred U.S. dollar and other non-local currency
indebtedness (approximately $71 million at December 31, 1998). For further
analysis of foreign currency fluctuations in the Company's earnings and cash
flows, see "Quantitative and Qualitative Disclosures About Market Risk --
Foreign Currency Exchange Rate Risk" in Item 7A of this Form 10-K.
Impact of Foreign Currency Devaluation on Project Capital Resources. In the
first quarter of 1999, approximately $117 million of Metropolitana's U.S. dollar
denominated debt will mature. In the second quarter of 1999, approximately $980
million of Light's and approximately $696 million of Metropolitana's U.S. and
non-local currency denominated bank debt will mature. In March 1999, Light
refinanced approximately $130 million of its U.S. dollar denominated debt
through a local - currency denominated loan. The ability of Light and
Metropolitana to repay or refinance their debt obligations at maturity is
dependent on many factors, including local and international economic conditions
prevailing at the time such debt matures.
If economic conditions in the international markets continue to be
unsettled or deteriorate, it is possible that Light, Metropolitana and the other
foreign electric distribution companies in which the Company holds investments
might encounter difficulties in refinancing their debt (both local currency and
non-local currency borrowings) on terms and conditions that are commercially
acceptable to them and their shareholders. In such circumstances, in lieu of
declaring a default or extending the maturity, it is possible that lenders might
seek to require, among other things, higher borrowing rates, and additional
equity contributions and/or increased levels of credit support from the
shareholders of such entities. The availability or terms of refinancing such
debt cannot be assured.
Currency fluctuation and instability affecting Latin America may also
adversely affect Reliant Energy International's ability to refinance its equity
investments with debt. In 1998, Reliant Energy International invested $411
million in Colombia and El Salvador. As of January 1999, $100 million of these
investments were refinanced with debt. Reliant Energy International intends to
refinance approximately $75 million more of such initial investments with debt.
ENVIRONMENTAL EXPENDITURES
The Company and its subsidiaries, including Resources, are subject to
numerous environmental laws and regulations, which require them to incur
substantial costs to operate existing facilities, construct and operate new
facilities, and mitigate or remove the effect of past operations on the
environment.
Clean Air Act Expenditures. The Company expects the majority of capital
expenditures associated with environmental matters to be incurred by Electric
Operations in connection with new emission limitations under the Federal Clean
Air Act (Clean Air Act) for oxides of nitrogen (NOx). The standards applicable
to Electric Operations' generating units in the Houston, Texas area will become
effective in November 1999. NOx reduction costs incurred by Electric Operations
totaled approximately $7 million in 1998. The Company estimates that Electric
Operations will incur approximately $8 million in 1999 and $10 million in 2000
for such expenditures. The Texas Natural Resources Conservation Commission
(TNRCC) has indicated that additional NOx reduction will be required after 2000;
however, since the magnitude and timing of these reductions have not yet been
established, it is impossible for the Company to estimate a reasonable range of
such expenditures at this time.
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In 1998, the Wholesale Energy spent approximately $100,000 in order to
comply with NOx reduction with respect to Southern California generating
facilities acquired by Power Generation from Southern California Edison (SCE) in
1998. In 1999, based on existing requirements, the Company projects that it will
spend an additional $100,000 on NOx reduction standards with respect to such
plants and approximately $1 million on continuous emission monitoring system
upgrades for such plants.
Site Remediation Expenditures. From time to time the Company and its
subsidiaries have received notices from regulatory authorities or others
regarding their status as potentially responsible parties in connection with
sites found to require remediation due to the presence of environmental
contaminants.
The Company's identified sites with respect to which it may be claimed to
have a remediation liability include several sites for which there is a lack of
current available information, including the nature and magnitude of
contamination, and the extent, if any, to which the Company may be held
responsible for contributing to any costs incurred for remediating these sites.
Thus, no reasonable estimate of cleanup costs can now be made for these sites.
Based on currently available information, the Company believes that such costs
ultimately will not materially affect its financial position, results of
operations or cash flows. There can be no assurance, however, that future
developments, including additional information about existing sites or the
identification of new sites, will not require material revisions to such
estimates. For information about specific sites that are the subject of
remediation claims, see Note 12(h) to the Company's Consolidated Financial
Statements and Note 8(g) to Resources' Consolidated Financial Statements, each
of which is incorporated herein by reference.
Mercury Contamination. Like other natural gas pipelines, Resources'
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 Resources at some sites
in the past, and Resources has conducted remediation at sites found to be
contaminated. Although Resources 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 of Resources and others in the natural
gas industry to date and on the current regulations regarding remediation of
such sites, the Company and Resources believe that the cost of any remediation
of such sites will not be material to the Company's or Resources' financial
position, results of operations or cash flows.
Other. In addition, the Company has been named as a defendant in litigation
related to such sites and in recent years has been named, along with numerous
others, as a defendant in several lawsuits filed by a large number of
individuals who claim injury due to exposure to asbestos while working at sites
along the Texas Gulf Coast. Most of these claimants have been workers who
participated in construction of various industrial facilities, including power
plants, and some of the claimants have worked at locations owned by the Company.
The Company anticipates that additional claims like those received may be
asserted in the future and intends to continue its practice of vigorously
contesting claims which it does not consider to have merit. Although their
ultimate outcome cannot be predicted at this time, the Company does not believe,
based on its experience to date, that these matters, either individually or in
the aggregate, will have a material adverse effect on the Company's financial
position, results of operations or cash flows.
OTHER CONTINGENCIES
For a description of certain other legal and regulatory proceedings
affecting the Company and its subsidiaries, see Notes 3, 4, 5 and 12 to the
Company's Consolidated Financial Statements and Note 8 to Resources'
Consolidated Financial Statements, which notes are incorporated herein by
reference.
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NEW ACCOUNTING ISSUES
In 1998, the Company and Resources adopted SFAS No. 130, "Reporting
Comprehensive Income" (SFAS No. 130), 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). For further discussion of these accounting statements, see Note 15 to
the Company's Consolidated Financial Statements and Note 9 to Resources'
Consolidated Financial Statements.
In 2000, the Company and Resources expect to adopt SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133),
which 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. The
Company is in the process of determining the effect of adoption of SFAS No. 133
on its consolidated financial statements.
In December 1998, The Emerging Issues Task Force of the Financial
Accounting Standards Board reached consensus on Issue 98-10, "Accounting for
Contracts Involved in Energy Trading and Risk Management Activities" (EITF Issue
98-10). EITF Issue 98-10 requires energy trading contracts to be recorded at
fair value on the balance sheet, with the changes in fair value included in
earnings. EITF Issue 98-10 is effective for fiscal years beginning after
December 15, 1998. The Company expects to adopt EITF Issue 98-10 in the first
quarter of 1999. The Company does not expect the implementation of EITF Issue
98-10 to be material to its consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company and its subsidiaries have long-term debt, Company/ Resources
obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debentures of the Company/Resources (Trust
Securities), securities held in the Company's nuclear decommissioning trust,
bank facilities, certain lease obligations and interest rate swaps which subject
the Company, Resources and certain of their subsidiaries to the risk of loss
associated with movements in market interest rates.
At December 31, 1998, the Company and certain of its subsidiaries had
issued fixed-rate long-term debt (excluding ACES) and Trust Securities
aggregating $5.0 billion in principal amount and having a fair value of $5.2
billion. These instruments are fixed-rate and, therefore, do not expose the
Company and its subsidiaries to the risk of earnings loss due to changes in
market interest rates (see Notes 8 and 9 to the Company's Consolidated Financial
Statements). However, the fair value of these instruments would increase by
approximately $260.6 million if interest rates were to decline by 10% from their
levels at December 31, 1998. In general, such an increase in fair value would
impact earnings and cash flows only if the Company and its subsidiaries were to
reacquire all or a portion of these instruments in the open market prior to
their maturity.
The Company and certain of its subsidiaries' floating-rate obligations
aggregated $1.8 billion at December 31, 1998 (see Note 8 to the Company's
Consolidated Financial Statements), inclusive of (i) amounts borrowed under
short-term and long-term credit facilities of the Company and its subsidiaries
(including the issuance of commercial paper supported by such facilities), (ii)
borrowings underlying Resources' receivables facility and (iii) amounts subject
to a master leasing agreement of Resources under which lease payments vary
depending on short-term interest rates. These floating-rate obligations expose
the Company, Resources and their subsidiaries to the risk of increased interest
and lease expense in the event of increases in short-term interest rates. If the
floating rates were to increase by 10% from December 31, 1998 levels, the
Company's consolidated interest expense and expense under operating leases would
increase by a total of approximately $0.9 million each month in which such
increase continued.
As discussed in Notes 1(o), 4(c) and 13 to the Company's Consolidated
Financial Statements, the Company contributes $14.8 million per year to a trust
established to fund the Company's share of the decommissioning costs for the
South Texas Project. The securities held by the trust for decommissioning costs
had an estimated fair value of $119.1 million as of December 31, 1998, of which
approximately 44% were fixed-rate debt securities that subject the Company to
risk of loss of fair value with movements in market interest rates. If interest
rates were to increase by 10% from their levels at December 31, 1998, the
decrease in fair value of the fixed-rate debt securities would not be material
to the Company. In addition, the risk of an economic loss is mitigated at this
time as a result of the Company's regulated status. Any unrealized gains or
losses are accounted for in accordance with SFAS No. 71 as a regulatory
asset/liability because the Company believes that its future contributions which
are currently recovered through the rate-making process will be adjusted for
these gains and losses.
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Certain subsidiaries of the Company have entered into interest rate swaps
for the purpose of decreasing the amount of debt subject to interest rate
fluctuations. At December 31, 1998, these interest rate swaps had an aggregate
notional amount of $75.4 million, which the Company could terminate at a cost of
$3.2 million (see Notes 2 and 13 to the Company's Consolidated Financial
Statements). An increase of 10% in the December 31, 1998 level of interest rates
would not increase the cost of termination of the swaps by a material amount to
the Company. Swap termination costs would impact the Company's and its
subsidiaries' earnings and cash flows only if all or a portion of the swap
instruments were terminated prior to their expiration.
As discussed in Note 8(h) to the Company's Consolidated Financial
Statements, Resources sold $500 million aggregate principal amount of its 6 3/8%
TERM Notes which included an embedded option to remarket the securities. The
option is expected to be exercised in the event that the ten-year Treasury rate
in 2003 is below 5.66%. At December 31, 1998, the Company could terminate the
option at a cost of $30.7 million. A decrease of 10% in the December 31, 1998
level of interest rates would not increase the cost of termination of the option
by a material amount to the Company.
The change in exposure to loss in earnings and cash flows related to
interest rate risk from December 31, 1997 to December 31, 1998 is not material
to the Company.
EQUITY MARKET RISK
The Company holds an investment in TW Preferred which is convertible into
Time Warner common stock (TW Common) as described in "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 --
Accounting Treatment of ACES" in Item 7 of this Form 10-K. As a result, the
Company is exposed to losses in the fair value of this security. For purposes of
analyzing market risk in this Item 7A, the Company assumed that the TW Preferred
was converted into TW Common. In addition, Resources' investment in the common
stock of Itron, Inc. (Itron) exposes the Company and Resources to losses in the
fair value of Itron common stock. A 10% decline in the market value per share of
TW Common and Itron common stock from the December 31, 1998 levels would result
in a loss in fair value of approximately $284.4 million and $1.1 million,
respectively.
The Company's and its subsidiaries' ability to realize gains and losses
related to the TW Preferred and the Itron common stock is limited by the
following: (i) the TW Preferred is not publicly traded and its sale is subject
to certain limitations and (ii) the market for the common stock of Itron is
fairly illiquid.
The ACES expose the Company to accounting losses as the Company is required
to record in Other Income (Expense) an unrealized accounting loss equal to (i)
the aggregate amount of the increase in the market price of TW Common above
$27.7922 as applicable to all ACES multiplied by (ii) 0.8264. Prior to the
conversion of the TW Preferred into TW Common, such loss would affect earnings.
After conversion, such loss would be recognized as an adjustment to common stock
equity through a reduction of other comprehensive income. However, there would
be an offsetting increase in common stock equity through an increase in
accumulated other comprehensive income on the Company's Statements of
Consolidated Retained Earnings and Comprehensive Income for the fair value
increase in the investment in TW Common. For additional information on the
accounting treatment of the ACES and related accounting losses recorded in 1998,
see Note 1(n) to the Company's Consolidated Financial Statements. An increase of
15% in the price of the TW Common above its December 31, 1998 market value of
$62.062 per share would result in the recognition of an additional unrealized
accounting loss (net of tax) of approximately $229.1 million. The Company
believes that this additional unrealized loss for the ACES would be more than
economically hedged by the unrecorded unrealized gain relating to the increase
in the fair value of the TW Common underlying the investment in TW Preferred
since the date of its acquisition.
For a discussion of the non-cash, unrealized accounting loss recorded in
1998 and 1997 related to the ACES, see "-- Certain Factors Affecting Future
Earnings of the Company and its Subsidiaries -- Accounting Treatment of ACES" in
Item 7 of this Form 10-K.
As discussed above under "-- Interest Rate Risk," the Company contributes
to a trust established to fund the Company's share of the decommissioning costs
for the South Texas Project which held debt and equity securities as of December
31, 1998. The equity securities expose the Company to losses in fair value. If
the market prices of the individual equity securities were to decrease by 10%
from their levels at December 31, 1998, the resulting loss in fair value of
these securities would not be material to the Company. Currently, the risk of an
economic loss is mitigated as a result of the Company's regulated status as
discussed above under "--Interest Rate Risk."
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FOREIGN CURRENCY EXCHANGE RATE RISK
As further described in "Certain Factors Affecting Future Earnings of the
Company and Its Subsidiaries -- Risks of International Operations" in Item 7 of
this Form 10-K, the Company, through Reliant Energy International invests in
certain foreign operations which to date have been primarily in South America.
As of December 31, 1998, the Company's Consolidated Balance Sheets reflected
$1.1 billion of foreign investments, a substantial portion of which represent
investments accounted for under the equity method. These foreign investments
expose the Company to risk of loss in earnings and cash flows due to the
fluctuation in foreign currencies relative to the Company's consolidated
reporting currency, the U.S. dollar. The Company accounts for adjustments
resulting from translation of its investments with functional currencies other
than the U.S. dollar as a charge or credit directly to a separate component of
stockholders' equity. For further discussion of the accounting for foreign
currency adjustments, see Note 1(p) in the Notes to the Company's Consolidated
Financial Statements. The cumulative translation loss of $34 million, recorded
as of December 31, 1998, will be realized as a loss in earnings and cash flows
only upon the disposition of the related investment. The foreign currency loss
in earnings and cash flows related to debt obligations held by foreign
operations in currencies other than their own functional currencies was not
material to the Company as of December 31, 1997.
In addition, certain of Reliant Energy International's foreign operations
have entered into obligations in currencies other than their own functional
currencies which expose the Company to a loss in earnings. In such cases, as the
respective investment's functional currency devalues relative to the non-local
currencies, the Company will record its proportionate share of its investments'
foreign currency transaction losses related to the non-local currency
denominated debt. At December 31, 1998, Light and Metropolitana had borrowings
of approximately $3.2 billion denominated in non-local currencies. Because of
the devaluation of the Brazilian real subsequent to December 31, 1998, Light and
Metropolitana are expected to record a charge to earnings for the quarter ended
March 31, 1999, primarily related to foreign currency transaction losses on
their non-local currency denominated debt. For further discussion and analysis
of the possible effect on the Company's Consolidated Financial Statements, see
"Certain Factors Affecting Future Earnings of the Company and Its Subsidiaries
- -- Risks of International Operations" in Item 7 of this Form 10-K.
The company attempts to manage and mitigate this foreign risk by properly
balancing the higher cost of financing with local denominated debt against the
risk of devaluation of that local currency and including a measure of the risk
of devaluation in all its financial plans. In addition, where possible, Reliant
Energy International attempts to structure its tariffs and revenue contracts to
ensure some measure of adjustment due to changes in inflation and currency
exchange rates; however, there can be no assurance that such efforts will
compensate for the full effect of currency devaluation, if any.
ENERGY COMMODITY PRICE RISK
As further described in Note 2 to the Company's Consolidated Financial
Statements, certain of the Company's subsidiaries utilize a variety of
derivative financial instruments (Derivatives), including swaps and
exchange-traded futures and options, as part of the Company's overall hedging
strategies and for trading purposes. To reduce the risk from the adverse effect
of market fluctuations in the price of electric power, natural gas, crude oil
and refined products and related transportation, Resources and certain
subsidiaries of the Company and Resources enter into futures transactions,
forward contracts, swaps and options (Energy Derivatives) in order to hedge
certain commodities in storage, as well as certain expected purchases, sales and
transportation of energy commodities (a portion of which are firm commitments at
the inception of the hedge). The Company's policies prohibit the use of
leveraged financial instruments. In addition, Reliant Energy Services, a
subsidiary of Resources, maintains a portfolio of Energy Derivatives to provide
price risk management services and for trading purposes (Trading Derivatives).
The Company uses value-at-risk and a sensitivity analysis method for
assessing the market risk of its derivatives.
11
12
With respect to the Energy Derivatives (other than Trading Derivatives)
held by subsidiaries of the Company and Resources as of December 31, 1998, a
decrease of 10% in the market prices of natural gas and electric power from
year-end levels would decrease the fair value of these instruments by
approximately $3 million. As of December 31, 1997, a decrease of 10% in the
prices of natural gas would have resulted in a loss of $7 million in fair values
of the Energy Derivatives (other than for trading purposes).
The above analysis of the Energy Derivatives utilized for hedging purposes
does not include the favorable impact that the same hypothetical price movement
would have on the Company's and its subsidiaries' physical purchases and sales
of natural gas and electric power to which the hedges relate. The portfolio of
Energy Derivatives held for hedging purposes is no greater than the notional
quantity of the expected or committed transaction volume of physical commodities
with equal and opposite commodity price risk for the same time periods.
Furthermore, the Energy Derivative portfolio is managed to complement the
physical transaction portfolio, reducing overall risks within limits. Therefore,
the adverse impact to the fair value of the portfolio of Energy Derivatives held
for hedging purposes associated with the hypothetical changes in commodity
prices referenced above would be offset by a favorable impact on the underlying
hedged physical transactions, assuming (i) the Energy Derivatives are not closed
out in advance of their expected term, (ii) the Energy Derivatives continue to
function effectively as hedges of the underlying risk and (iii) as applicable,
anticipated transactions occur as expected.
The disclosure with respect to the Energy Derivatives relies on the
assumption that the contracts will exist parallel to the underlying physical
transactions. If the underlying transactions or positions are liquidated prior
to the maturity of the Energy Derivatives, a loss on the financial instruments
may occur, or the options might be worthless as determined by the prevailing
market value on their termination or maturity date, whichever comes first.
With respect to the Trading Derivatives held by Reliant Energy Services,
consisting of natural gas, electric power, crude oil and refined products,
physical forwards, swaps, options and exchange-traded futures, this subsidiary
is exposed to losses in fair value due to changes in the price and volatility of
the underlying derivatives. During the year ended December 31, 1998 and 1997,
the highest, lowest and average monthly value-at-risk in the Trading Derivative
portfolio was less than $5 million at a 95% confidence level and for a holding
period of one business day. The Company uses the variance/covariance method for
calculating the value-at-risk and includes the delta approximation for options
positions.
The Company has established a Corporate Risk Oversight Committee comprised
of corporate and business segment officers that oversees all corporate price and
credit risk activities, including derivative trading activities discussed above.
The committee's duties are to establish the Company's policies and to monitor
and ensure compliance with risk management policies and procedures and the
trading limits established by the Company's board of directors.
12
13
ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS OF RELIANT
ENERGY RESOURCES CORP. AND CONSOLIDATED SUBSIDIARIES.
The following narrative and analysis should be read in combination with the
consolidated financial statements and notes (Resources' Consolidated Financial
Statements) of Reliant Energy Resources Corp. (formerly NorAm Energy Corp.)
(Resources) contained in Item 8 of the Form 10-K of Resources.
RELIANT ENERGY RESOURCES CORP.
On August 6, 1997 (Acquisition Date), the former parent corporation (Former
Parent) of Houston Industries Incorporated d/b/a Reliant Energy, Incorporated
(Reliant Energy) merged with and into Reliant Energy, and NorAm Energy Corp.
(Former Resources) merged with and into Resources. Effective upon the mergers
(collectively, the Merger), each outstanding share of common stock of Former
Parent was converted into one share of common stock (including associated
preference stock purchase rights) of Reliant Energy, and each outstanding share
of common stock of Former Resources was converted into the right to receive
$16.3051 cash or 0.74963 shares of common stock of Reliant Energy. The aggregate
consideration paid to Former Resources stockholders in connection with the
Merger consisted of $1.4 billion in cash and 47.8 million shares of Reliant
Energy's common stock valued at approximately $1.0 billion. The overall
transaction was valued at $4.0 billion consisting of $2.4 billion for Former
Resources' common stock and common stock equivalents and $1.6 billion of Former
Resources 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 Resources reflected at their estimated fair values as of the
Acquisition Date, resulting in a "new basis" of accounting. In Resources'
Consolidated Financial Statements, periods which reflect the new basis of
accounting are labeled as "Current Resources" and periods which do not reflect
the new basis of accounting are labeled as "Former Resources." Former Resources'
Statement of Consolidated Income for the seven months ended July 31, 1997
included certain adjustments from August 1, 1997 to the Acquisition Date for
pre-merger transactions.
Effective January 1, 1998, Resources adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information" (SFAS No. 131). Because
Resources is a wholly owned subsidiary of Reliant Energy, Resources'
determination of reportable segments considers the strategic operating units
under which Reliant Energy manages sales of various products and services to
wholesale or retail customers in differing regulatory environments. In
accordance with SFAS No. 131, Reliant Energy has identified the following
reportable segments: Electric Operations, Natural Gas Distribution, Interstate
Pipelines, Wholesale Energy Marketing and Generation (Wholesale Energy),
International and Corporate. Of these segments, the following operations are
conducted by Resources: Natural Gas Distribution, Interstate Pipelines,
Wholesale Energy (which includes the energy trading and marketing operations and
natural gas gathering operations of the Wholesale Energy segment but excludes
the operations of Reliant Energy Power Generation, Inc.) and Corporate
(excluding the impact of ACES).
Resources meets the conditions specified in General Instruction I to Form
10-K and is thereby permitted to use the reduced disclosure format for wholly
owned subsidiaries of reporting companies specified therein. Accordingly,
Resources has omitted from this Combined Annual Report the information called
for by Item 4 (submission of matters to a vote of security holders), Item 10
(directors and executive officers), Item 11 (executive compensation), Item 12
(security ownership of certain beneficial owners and management) and Item 13
(certain relationships and related transactions) of Form 10-K. In lieu of the
information called for by Item 6 (selected financial data) and Item 7
(management's discussion and analysis of financial condition and results of
operations) of Form 10-K, Resources has included the following Management's
Narrative Analysis of the Results of Operations to explain material changes in
the amount of revenue and expense items of Resources between 1998 and 1997.
Reference is hereby made to Item 1 (business), Item 2 (properties), Item 3
(legal proceedings), Item 5 (market for common equity and related stockholder
matters), Item 7A (quantitative and qualitative disclosures about market risk)
and Item 9 (changes in and disagreements with accountants on accounting and
financial disclosure) of this Combined Annual Report for additional information
regarding Resources required by the reduced disclosure format of General
Instruction I to Form 10-K.
CONSOLIDATED RESULTS OF OPERATIONS
Seasonality and Other Factors. Resources' results of operations are
affected by seasonal fluctuations in the demand for and, to a lesser
extent, the price of natural gas. Resources' results of operations are also
affected by,
14
among other things, the actions of various federal and state governmental
authorities having jurisdiction over rates charged by Resources and its
subsidiaries, competition in Resources' various business operations, debt
service costs and income tax expense. For a discussion of certain other factors
that may affect Resources' 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
- -- Competition -- Other Operations"; "-- Impact of the Year 2000 Issue and Other
System Implementation Issues" and "-- Environmental Expenditures -- Mercury
Contamination" in Item 7 of Reliant Energy's Form 10-K.
Accounting Impact of the Merger. The Merger created a new basis of
accounting for Resources, resulting in new carrying values for certain of
Resources' assets, liabilities and equity commencing upon the Acquisition Date.
Resources' financial statements for periods subsequent to the Acquisition Date
are not comparable to prior periods because of the following purchase
accounting adjustments:
1. The impact of the amortization of newly-recognized goodwill ($39.4
million);
2. The amortization (to interest expense) of the revaluation of
long-term debt ($9.8 million);
3. The removal of the amortization (to operating expense) previously
associated with the pension and postretirement obligations ($2.1
million); and
4. The deferred income tax expense associated with these adjustments
($4.9 million).
Interest expense and related debt incurred by Reliant Energy to fund the cash
portion of the purchase consideration has not been pushed down to Resources and
its subsidiaries.
Because results of operations and other financial information for periods
before and after the Acquisition Date are not comparable, Resources is
presenting certain financial data on: (i) an actual basis for Resources for
1998 and 1997 and (ii) a pro forma basis for 1997 as if the Merger had taken
place at the beginning of the period. 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 and pro forma basis for the years ended December 31, 1998 and 1997,
followed by a discussion of significant variances in period-to-period results:
SELECTED FINANCIAL RESULTS:
UNAUDITED
ACTUAL PRO FORMA (1)
--------------------------------------------- --------------
YEAR FIVE MONTHS SEVEN MONTHS YEAR ACTUAL TO
ENDED ENDED ENDED ENDED PRO FORMA
DECEMBER 31, DECEMBER 31, JULY 31, DECEMBER 31, PERCENTAGE
----------- ----------- ----------- ----------- CHANGE
1998 1997 1997 1997
----------- ----------- ----------- -----------
(THOUSANDS OF DOLLARS)
Operating Revenues .................. $ 6,758,412 $ 2,526,182 $ 3,313,591 $ 5,839,773 16%
Operating Expenses .................. 6,448,107 2,434,282 3,141,295 5,597,716 15%
Operating Income .................... 310,305 91,900 172,296 242,057 28%
Merger Transaction Costs (2) ........ 1,144 17,256
Consolidated ........................ 310,305 90,756 155,040 242,057 28%
Interest Expense, Net ............... 111,337 47,490 78,660 112,996 (1%)
Distributions on Subsidiary Trust
Securities .......................... 632 279 6,317 1,479 (57%)
Other (Income) and Deductions ....... (7,318) (2,243) (7,210) (9,453) (23%)
Income Tax Expense .................. 111,830 24,383 31,398 71,093 57%
Extraordinary (Gain), Less Taxes .... (237)
----------- ----------- ----------- -----------
Net Income ........................ $ 93,824 $ 20,847 $ 46,112 $ 65,942 42%
=========== =========== =========== ===========
2
15
- ----------
(1) Pro forma results reflect purchase accounting adjustments as if the Merger
had occurred on January 1, 1997.
(2) For expenses associated with the completion of the business combination
with Reliant Energy, see Note 1(o) to Resources' Consolidated Financial
Statements.
1998 Compared to 1997 (Actual). Resources' consolidated net income for 1998 was
$94 million compared to consolidated net income of $67 million in 1997. The
increase in net income for 1998 as compared to 1997 was due to increased
operating income from several business segments as discussed below, partially
offset by a decrease in operating income from Resources' Natural Gas
Distribution segment due to the effects of warm weather. Also contributing to
the increase in net income was a reduction in interest expense due to the
refinancing of debt and reduced interest expense due to debt fair value
devaluation at the time of the Merger.
Resources operating revenues for 1998 were $6.8 billion as compared to
$5.8 billion in 1997. The $900 million, or 16% increase was primarily
attributable to a $1.4 billion increase in wholesale trading revenue. Wholesale
trading revenue increased due to increased power and natural gas trading
volumes. The increase in trading revenues was offset by reduced revenues at
Resources' Natural Gas Distribution unit of approximately $400 million,
principally due to warmer weather.
Resources operating expenses for 1998 were $6.4 billion compared to $5.6
billion in 1997. The $800 million, or 16% increase was primarily due to
increased natural gas and purchased power expenses associated with increased
wholesale trading activities. The increase in operating expenses was offset by
decreased natural gas purchases at Resources' Natural Gas Distribution unit
because of lower volumes resulting from the warmer weather.
Operating income increased in 1998 by $65 million over 1997 due to improved
operating results at Interstate Pipelines, Corporate retail operations and
Wholesale Energy, partially offset by the unfavorable effects of warm weather on
the operations of Natural Gas Distribution. Operating income for 1997 included
approximately $18 million of merger-related costs that did not recur in 1998.
Improved results at Interstate Pipelines were due to continued cost control
initiatives and reduced benefits expenses, as well as the effects of a rate case
settlement and a dispute settlement which contributed to the increase in
operating income. In addition, margins at Wholesale Energy improved over margins
in 1997; however, this effect was partially offset by increased staffing
expenses to support increased sales and marketing efforts and an increase in
credit reserves. Improved results at Wholesale Energy were also due to the fact
that operating income in 1997 for Wholesale Energy was negatively impacted by
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
totaling $17 million.
1998 (Actual) Compared to 1997 (Pro Forma). Resources' consolidated net income
for 1998 was $94 million compared to pro forma net income of $66 million in
1997. The increase in earnings for 1998 as compared to pro forma 1997 was due
to increased operating income from several business segments, as discussed
below, offset by the effects of unfavorable weather at Resources' Natural Gas
Distribution unit. Also contributing to the increase in earnings is a
reduction in interest expense due to the refinancing of debt.
Resources operating revenues for 1998 were $6.8 billion compared to pro
forma operating revenues of $5.8 billion in 1997. The $919 million, or 16%
increase was primarily attributable to an $1.4 billion increase in wholesale
trading revenue. Wholesale trading revenue increased due to increased electric
and natural gas trading volumes. The increase in trading revenues was offset by
reduced revenues at Resources' Natural Gas Distribution unit of approximately
$400 million, principally due to warmer weather.
Resources operating expenses for 1998 were $6.4 billion compared to pro
forma operating expense of $5.6 billion in 1997. The $800 million, or 16%
increase was primarily due to increased natural gas and purchased power
expenses associated with increased wholesale trading activities. The increase
in operating expense was offset by decreased natural gas purchases at
Resources' Natural Gas Distribution unit because of lower volumes resulting
from warmer weather.
3
16
Operating income increased in 1998 by $68 million over pro forma 1997 due
to improved operating results at Interstate Pipelines, Corporate retail
operations and Wholesale Energy, partially offset by the unfavorable effects of
Warm weather on the operations of Natural Gas Distribution. Improved results at
Interstate Pipelines are due to continued cost control initiatives and reduced
benefits expenses as well as the effects of a rate case settlement and a dispute
settlement. In addition, margins at Wholesale Energy improved over margins in
1997, however, this effect was partially offset by increased staffing expenses
to support increased sales and marketing efforts and an increase in credit
reserves at Wholesale Energy also contributed to the increase in operating
income. Operating income in 1997 for Wholesale Energy was negatively impacted by
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
totaling $17 million.
Resources estimates that its total direct cost of resolving the Year 2000
issues will be between $5 and $6 million. This estimate includes approximately
$3.4 million spent through year-end 1998. For additional information regarding
Year 2000 issues, 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
Issue and Other System Implementation Issues" in Item 7 of the Form 10-K of
Reliant Energy, which has been jointly filed with the Resources Form 10-K.
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 7 of the Form 10-K of Reliant Energy, which has been jointly filed with
the Resources Form 10-K, for discussion of certain new accounting issues.
RESOURCES 10-K NOTES
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(c) Regulatory Assets and Regulation.
In general, Resources' Interstate Pipelines operations are subject to
regulation by the Federal Energy Regulatory Commission, while its Natural Gas
Distribution operations are subject to regulation at the state or municipal
level. Historically, all of Resources' rate-regulated businesses have followed
the accounting guidance contained in Statement of Financial Accounting Standards
No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS No.
71). Resources discontinued application of SFAS No. 71 to REGT in 1992. As a
result of the continued application of SFAS No. 71 to MRT and the Natural Gas
Distribution operations, Resources' financial statements contain assets and
liabilities which would not be recognized by unregulated entities.
At December 31, 1998 Resources' Consolidated Balance Sheet included
approximately $12 million in regulatory assets recorded as deferred debits.
These assets represent probable future revenue to Resources associated with
certain incurred costs as these costs are recovered through the rate making
process. These costs are being recovered through rates over varying periods up
to 40 years.
(2) DERIVATIVE FINANCIAL INSTRUMENTS
(a) Price Risk Management and Trading Activities.
Resources, through its subsidiary, Reliant Energy Services, offers energy
price risk management services primarily in the natural gas, electric and crude
oil and refined product industries. Reliant Energy Services provides these
services by utilizing a variety of derivative financial instruments, including
fixed and variable-priced physical forward contracts, fixed-price swap
agreements, variable-price swap agreements, exchange-traded energy futures and
option contracts, and swaps and options traded in the over-the-counter financial
markets (Trading Derivatives). Fixed-price swap agreements require payments to,
or receipts of payments from, counterparties based on the differential between a
fixed and variable price for the commodity. Variable-price swap agreements
require payments to, or receipts of payments from, counterparties based on the
differential between industry pricing publications or exchange quotations.
Prior to 1998 Reliant Energy Services applied hedge accounting to certain
physical commodity activities that qualified for hedge accounting. In 1998,
Reliant Energy Services adopted mark-to-market accounting for all of its price
risk management and trading activities. Accordingly, as of such date, such
Trading Derivatives are recorded at fair value with realized and unrealized
gains (losses) recorded as a component of operating revenues in Resources'
Consolidated Statements of Income. The recognized, unrealized balance is
recorded as price risk management assets/liabilities and deferred debits/credits
on Resources' Consolidated Balance Sheets (See Note 1(r)).
The notional quantities, maximum terms and the estimated fair value of
Trading Derivatives at December 31, 1998 are presented below (volumes in
billions of British thermal units equivalent (BBtue) and dollars in millions):
VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
1998 PRICE PAYOR RECEIVER TERM (YEARS)
---- ----------- -------- ------------
Natural gas.................................................. 937,264 977,293 9
Electricity.................................................. 122,950 124,878 3
Crude oil and products....................................... 205,499 204,223 3
4
17
AVERAGE FAIR
FAIR VALUE VALUE (a)
--------------------------- ---------------------------
1998 ASSETS LIABILITIES ASSETS LIABILITIES
---- ------ ----------- ------ -----------
Natural gas.............................................. $ 224 $ 213 $ 124 $ 108
Electricity.............................................. 34 33 186 186
Crude oil and products................................... 29 23 21 17
--------- --------- --------- ---------
$ 287 $ 269 $ 331 $ 311
The notional quantities, maximum terms and the estimated fair value of
derivative financial instruments at December 31, 1997 are presented below
(volumes in BBtue and dollars in millions):
VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
1997 PRICE PAYOR RECEIVER TERM (YEARS)
----
Natural gas.................................................. 85,701 64,890 4
Electricity.................................................. 40,511 42,976 1
AVERAGE FAIR
FAIR VALUE VALUE (A)
--------------------------- ---------------------------
1997 ASSETS LIABILITIES ASSETS LIABILITIES
---- ------ ----------- ------ -----------
Natural gas.............................................. $ 46 $ 39 $ 56 $ 48
Electricity.............................................. 6 6 3 2
------- ------- ------- -------
$ 52 $ 45 $ 59 $ 50
- ---------
(a) Computed using the ending balance of each month.
In addition to the fixed-price notional volumes above, Reliant Energy
Services also has variable-priced agreements, as discussed above, totaling
1,702,977 and 101,465 BBtue as of December 31, 1998 and 1997, respectively.
Notional amounts reflect the volume of transactions but do not represent the
amounts exchanged by the parties to the financial instruments. Accordingly,
notional amounts do not accurately measure Resources' exposure to market or
credit risks.
All of the fair values shown in the table above at December 31, 1998 and
substantially all at December 31, 1997 have been recognized in income. The fair
value as of December 31, 1998 and 1997 was estimated using quoted prices where
available and considering the liquidity of the market for the Trading
Derivatives. The prices are subject to significant changes based on changing
market conditions.
At December 31, 1998, $22 million of the fair value of the assets and $41
million of the fair value of the liabilities are recorded as long-term in
deferred debits and deferred credits, respectively, on Resources' Consolidated
Balance Sheets.
The weighted-average term of the trading portfolio, based on volumes, is
less than one year. The maximum and average terms disclosed herein are not
indicative of likely future cash flows, as these positions may be changed by
new transactions in the trading portfolio at any time in response to changing
market conditions, market liquidity and Resources' risk management portfolio
needs and strategies. Terms regarding cash settlements of these contracts vary
with respect to the actual timing of cash receipts and payments.
In addition to the risk associated with price movements, credit risk is
also inherent in Resources', and its subsidiaries' risk management activities.
Credit risk relates to the risk of loss resulting from non-performance of
contractual obligations by a counterparty. The following table shows the
composition of the total price risk management assets of Reliant Energy
Services as of December 31, 1998.
5
18
INVESTMENT
GRADE (1) TOTAL
----------------- -----------------
(THOUSANDS OF DOLLARS)
Energy marketers.......................................................... $ 102,458 $ 123,779
Financial institutions.................................................... 61,572 61,572
Gas and electric utilities................................................ 46,880 48,015
Oil and gas producers..................................................... 7,197 8,323
Industrials............................................................... 1,807 3,233
Independent power producers............................................... 1,452 1,463
Others.................................................................... 45,421 46,696
------------- -------------
Total................................................................ $ 266,787 293,081
=============
Credit and other reserves................................................. (6,464)
-------------
Energy price risk management assets(2).................................... $ 286,617
=============
- ---------
(1) "Investment Grade" is primarily determined using publicly available credit
ratings along with the consideration of credit support (e.g., parent
company guarantees) and collateral, which encompass cash and standby
letters of credit.
(2) Resources has credit risk exposure with respect to two investment grade
customers, each of which represents an amount greater than 5% but less than
10% of Price Risk Management Assets.
(b) Non-Trading Activities.
To reduce the risk from market fluctuations in the price of electric
power, natural gas and related transportation, Resources and certain of its
subsidiaries enter into futures transactions, swaps and options (Energy
Derivatives) in order to hedge certain natural gas in storage, as well as
certain expected purchases, sales and transportation of natural gas and
electric power (a portion of which are firm commitments at the inception of the
hedge). Energy Derivatives are also utilized to fix the price of compressor
fuel or other future operational gas requirements, although usage to date for
this purpose has not been material. Resources applies hedge accounting with
respect to its derivative financial instruments.
Certain subsidiaries of Resources also utilize interest rate derivatives
(principally interest rate swaps) in order to adjust the portion of its overall
borrowings which are subject to interest rate risk and also utilize such
derivatives to effectively fix the interest rate on debt expected to be issued
for refunding purposes.
For transactions involving either Energy Derivatives or interest rate
derivatives, hedge accounting is applied only if the derivative (i) reduces the
price risk of the underlying hedged item and (ii) is designated as a hedge at
its inception. Additionally, the derivatives must be expected to result in
financial impacts which are inversely correlated to those of the item(s) to be
hedged. This correlation (a measure of hedge effectiveness) is measured both at
the inception of the hedge and on an ongoing basis, with an acceptable level of
correlation of at least 80% for hedge designation. If and when correlation
ceases to exist at an acceptable level, hedge accounting ceases and
mark-to-market accounting is applied.
In the case of interest rate swaps associated with existing obligations,
cash flows and expenses associated with the interest rate derivative
transactions are matched with the cash flows and interest expense of the
obligation being hedged, resulting in an adjustment to the effective interest
rate. When interest rate swaps are utilized to effectively fix the interest
rate for an anticipated debt issuance, changes in the market value of the
interest rate derivatives are deferred and recognized as an adjustment to the
effective interest rate on the newly issued debt.
Unrealized changes in the market value of Energy Derivatives utilized as
hedges are not generally recognized in Resources' Consolidated Statements of
Income until the underlying hedged transaction occurs. Once it becomes
6
19
probable that an anticipated transaction will not occur, deferred gains and
losses are recognized. In general, the financial impact of transactions
involving these Energy Derivatives is included in Resources' Statements of
Consolidated Income under the captions (i) fuel expenses, in the case of
natural gas transactions and (ii) purchased power, in the case of electric
power transactions. Cash flows resulting from these transactions in Energy
Derivatives are included in Resources' Statements of Consolidated Cash Flows in
the same category as the item being hedged.
At December 31, 1998, subsidiaries of Resources were fixed-price payors
and fixed-price receivers in Energy Derivatives covering 42,498 billion British
thermal units (BBtu) and 3,930 BBtu of natural gas, respectively. At December
31, 1997, subsidiaries of Resources were fixed-price payors and fixed-price
receivers in Energy Derivatives covering 38,754 BBtu and 7,647 BBtu of natural
gas, respectively. Also, at December 31, 1998 and 1997, subsidiaries of
Resources were parties to variable-priced Energy Derivatives totaling 21,437
BBtu and 3,630 BBtu of natural gas, respectively. The weighted average maturity
of these instruments is less than one year.
The notional amount is intended to be indicative of Resources' and its
subsidiaries' level of activity in such derivatives, although the amounts at
risk are significantly smaller because, in view of the price movement
correlation required for hedge accounting, changes in the market value of these
derivatives generally are offset by changes in the value associated with the
underlying physical transactions or in other derivatives. When Energy
Derivatives are closed out in advance of the underlying commitment or
anticipated transaction, however, the market value changes may not offset due
to the fact that price movement correlation ceases to exist when the positions
are closed, as further discussed below. Under such circumstances, gains
(losses) are deferred and recognized as a component of income when the
underlying hedged item is recognized in income.
The average maturity discussed above and the fair value discussed in Note
10 are not necessarily indicative of likely future cash flows as these
positions may be changed by new transactions in the trading portfolio at any
time in response to changing market conditions, market liquidity and Resources'
risk management portfolio needs and strategies. Terms regarding cash
settlements of these contracts vary with respect to the actual timing of cash
receipts and payments.
(c) Trading and Non-trading -- General Policy.
In addition to the risk associated with price movements, credit risk is
also inherent in Resources' and its subsidiaries' risk management activities.
Credit risk relates to the risk of loss resulting from non-performance of
contractual obligations by a counterparty. While as yet Resources and its
subsidiaries have experienced only minor losses due to the credit risk
associated with these arrangements, Resources has off-balance sheet risk to the
extent that the counterparties to these transactions may fail to perform as
required by the terms of each such contract. In order to minimize this risk,
Resources and/or its subsidiaries, as the case may be, enter into such
contracts primarily with those counterparties with a minimum Standard & Poor's
or Moody's rating of BBB- or Baa3, respectively. For long-term arrangements,
Resources and its subsidiaries periodically review the financial condition of
such firms in addition to monitoring the effectiveness of these financial
contracts in achieving Resources' objectives. Should the counterparties to
these arrangements fail to perform, Resources would seek to compel performance
at law or otherwise or obtain compensatory damages in lieu thereof. Resources
might be forced to acquire alternative hedging arrangements or be required to
honor the underlying commitment at then-current market prices. In such event,
Resources might incur additional loss to the extent of amounts, if any, already
paid to the counterparties. In view of its criteria for selecting
counterparties, its process for monitoring the financial strength of these
counterparties and its experience to date in successfully completing these
transactions, Resources believes that the risk of incurring a significant
financial statement loss due to the non-performance of counterparties to these
transactions is minimal.
Resources' policies prohibit the use of leveraged financial instruments.
(4) LONG-TERM AND SHORT-TERM FINANCING
(a) Short-term Financing.
In 1998, Resources met its short-term financing needs primarily through a
bank facility, bank lines of credit, a receivables facility and the issuance of
commercial paper. In March 1998, Resources replaced its $400 million revolving
credit facility with a five-year $350 million revolving credit facility
(Resources Credit Facility). Borrowings under the Resources Credit Facility are
unsecured and bear interest at a rate based upon either the London interbank
offered rate (LIBOR) plus a margin, a base rate or a rate determined through a
bidding process. The Resources Credit Facility is used to support Resources'
issuance of up to $350 million of commercial paper. There were no commercial
paper borrowings and no loans outstanding under the Resources Credit Facility
at December 31, 1998. Borrowings under Resources' prior credit facility at
December 31, 1997 were $340 million. In addition, Resources had $50 million of
outstanding loans under uncommitted lines of credit at December 31, 1997 having
a weighted average interest rate of 6.82%.
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A $65 million committed bank facility under which Resources obtained
letters of credit and all of Resources' uncommitted lines of credit were
terminated in 1998. Subsequent to the December 1998 termination, Resources
obtained letters of credit under an uncommitted line. Resources expects to amend
the Resources Credit Facility in March 1999 to add a $65 million letter of
credit subfacility.
Under a trade receivables facility (Receivables Facility) which expires in
August 1999, Resources sells, with limited recourse, an undivided interest
(limited to a maximum of $300 million) in a designated pool of accounts
receivable. The amount of receivables sold and uncollected was $300 million at
December 31, 1998 and at December 31, 1997. The weighted average interest rate
was approximately 5.54% at December 31, 1998 and 5.65% at December 31, 1997.
Certain of Resources' remaining receivables serve as collateral for receivables
sold and represent the maximum exposure to Resources should all receivables sold
prove ultimately uncollectible. Resources has retained servicing responsibility
under the Receivables Facility for which it is paid a servicing fee. Pursuant to
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities", Resources accounts for amounts transferred
pursuant to the Receivables Facility as collateralized borrowings. As a result,
these receivables are recorded as assets on Resources' Consolidated Balance
Sheet and amounts received by Resources pursuant to this facility are recorded
as a current liability under the caption "Receivables Facility."
(b) Long-term Debt.
Resources' consolidated long-term debt outstanding, which is summarized in
the following table, is noncallable and without sinking fund requirements
except as noted. Carrying amounts and amounts due in one year reflect $33.2
million and $3.4 million, respectively, for fair value adjustments recorded in
connection with the Merger.
DECEMBER 31, 1998
--------------------------------------------------------
CARRYING AMOUNTS
----------------------------
EFFECTIVE PRINCIPAL NON-CURRENT CURRENT
RATE AMOUNT PORTION PORTION
---- ------ ------- -------
(MILLIONS OF DOLLARS)
Medium-term notes, Series A and B due through
2001, weighted average rate of 8.96% at
December 31, 1998................................... 6.4% $ 165.6 $ 177.6
8.875% Series due 1999................................. 6.3% 200.0 $ 202.7
7.5% Series due 2000................................... 6.4% 200.0 203.1
8.9% Series due 2006................................... 6.8% 145.1 163.4
6% Convertible Subordinated Debentures due 2012........ 6.5% 109.6 104.6
10% Series due 2019(1)................................. 8.8% 42.8 47.6
6 1/2% Series due 2008................................. 6.5% 300.0 300.0
6 %% Series due 2003................................... 6.4% 517.0 517.0
Other.................................................. 0.7
---------- ---------- ----------
$ 1,680.1 $ 1,513.3 $ 203.4
========== ========== ==========
DECEMBER 31, 1997
--------------------------------------------------------
CARRYING AMOUNTS
----------------------------
EFFECTIVE PRINCIPAL NON-CURRENT CURRENT
RATE AMOUNT PORTION PORTION
---- ------ ------- -------
(MILLIONS OF DOLLARS)
Medium-term notes, Series A and B due through
2001, weighted average rate of 8.90% at
December 31, 1997............................ 6.4% $ 241.6 $ 183.8 $ 78.8
Bank Term Loan due 1998................................ 6.2% 150.0 153.3
8.875% Series due 1999................................. 6.3% 200.0 207.2
7.5% Series due 2000................................... 6.4% 200.0 205.0
8.9% Series due 2006................................... 6.8% 145.1 165.1
6% Convertible Subordinated Debentures due 2012........ 6.5% 116.3 107.2
10% Series due 2019(1)................................. 8.8% 42.8 47.8
Other.................................................. 4.1% 0.6 0.6
---------- ---------- -----------
$ 1,096.4 $ 916.7 $ 232.1
========== ========== ===========
- ----------
(1) In the fourth quarter of 1997 Resources purchased $101.4 million aggregate
principal amount of its 10% Debentures due 2019 at an average price of
111.98% plus accrued interest. Because Resources' debt was stated at fair
market value as of the Acquisition Date, the loss on the reacquisition of
these debentures was not material.
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Consolidated maturities of long-term debt and sinking fund requirements
for Resources are approximately $207 million for 1999, $228 million in 2000,
$151 million in 2001, $7 million in 2002 and $7 million in 2003.
Resources' retirements and reacquisitions of long-term debt are summarized
in the following table. In cases where premiums were paid or discounts were
realized in association with these reacquisitions and retirements, such amounts
are reported in Resources' Statements of Consolidated Income as "Extraordinary
gain (loss) on early retirement of debt, less taxes" and are net of taxes of
$0.1 million and ($2.5) million in 1997 and 1996, respectively. For retirements
and reacquisitions after the Acquisition Date, gains or losses on early
retirement are immaterial since the carrying amounts reflect the fair value
adjustments described above.
YEAR ENDED DECEMBER 31,
------------------------------------
1998(1) 1997(1)
------- -------
Reacquisition of 10% Debentures due 2019................................. $ 101.4
Reacquisition of 6% Convertible Subordinated Debentures due 2012(2)...... $ 6.7 5.8
Retirement, at maturity, of Medium Term Notes(3)......................... 76.0 52.0
Retirement of Bank Term Loan due 2000.................................... 150.0
Retirement of 9.875% Notes due 1997...................................... 225.0
Net (gain) loss on reacquisition of debt, less taxes..................... (0.2)
-------------- --------------
$ 232.7 $ 384.0
============== ==============
- ----------
(1) Excludes the conversion of 6% Convertible Subordinated Debentures due 2012
in the amount of approximately $0 and $.7 million at December 31, 1998 and
December 31, 1997, respectively.
(2) These reacquired debentures may be credited against sinking fund
requirements.
(3) Weighted average interest rate of 8.75% and 9.25% in 1998 and 1997,
respectively.
In June 1996, Resources exercised its right to exchange the $130 million
principal amount of its $3.00 Convertible Exchangeable Preferred Stock, Series
A for its 6% Convertible Subordinated Debentures due 2012 (Subordinated
Debentures). The holders of the Subordinated Debentures receive interest
quarterly and have the right at any time on or before the maturity date thereof
to convert each Subordinated Debenture into 0.65 shares of common stock of
Reliant Energy and $14.24 in cash. The Subordinated Debentures are callable
beginning in 1999 at redemption prices beginning at 105.0% and declining to par
in November 2009. Resources is required to make annual sinking fund payments of
$6.5 million on the Subordinated Debentures which began on March 15, 1997 and
will continue on each succeeding March 15 up to and including March 15, 2011.
Resources (i) may credit against the sinking fund requirements any Subordinated
Debentures redeemed by Resources and Subordinated Debentures which have been
converted at the option of the holder and (ii) may deliver purchased
Subordinated Debentures in satisfaction of the sinking fund requirements.
Resources satisfied its 1998 sinking fund requirement of $6.5 million by
delivering Subordinated Debentures purchased in 1996 and 1997.
In February 1998, Resources 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 Resources, including the
indebtedness incurred in connection with the 1997 purchase of $101 million
aggregate principal amount of its 10% debentures and the repayment of $53
million aggregate principal amount of Resources debt that matured in December
1997 and January 1998. In connection with the issuance of the 6.5% debentures,
Resources received approximately $1 million upon unwinding a $300 million
treasury rate lock agreement, which was tied to the interest rate on 10-year
treasury bonds. The rate lock agreement was executed in January 1998, and
proceeds from the unwind will be amortized over the 10 year life of Resources'
6.5% debentures.
In November 1998, Resources sold $500 million aggregate principal amount
of its 6 3/8% Term Enhanced ReMarketable Securities (TERM Notes). Included
within the TERM Notes is an embedded option sold to an investment bank which
gives the investment bank the right to remarket the TERM Notes in 2003 if it
chooses to exercise the option. The net proceeds of $514 million from the
offering of the TERM Notes were used for general corporate purposes, including
the repayment of (i) $178.5 million of Resources' outstanding commercial paper
and (ii) a $150 million term loan of Resources that matured on November 13,
1998. The TERM Notes are unsecured obligations of Resources which bear interest
at an annual rate of 6 3/8% through November 1, 2003. On November 1, 2003, the
holders of the TERM Notes are required to tender their notes at 100% of their
principal amount. The portion of the proceeds attributable to the option
premium will be amortized over the stated term of the securities. If the option
is not exercised, Resources will repurchase the TERM Notes at 100% of their
principal amount on November 1, 2003. If the option is exercised, the TERM
Notes will be remarketed on a date, selected by Resources, within the 52-week
period beginning November 1, 2003. During such period and prior to remarketing,
the TERM Notes will bear interest at rates, adjusted weekly, based on an index
selected by Resources. If the TERM Notes are
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remarketed, the final maturity date of the TERM Notes will be November 1, 2013,
subject to adjustment, and the effective interest rate on the remarketed TERM
Notes will be 5.66% plus Resources' applicable credit spread at the time of
such remarketing.
(b) Restrictions on Debt.
Under the provisions of the Resources Credit Facility, Resources' total
debt is limited to 55% of its total capitalization. This provision did not
significantly restrict Resources' ability to issue debt or to pay dividends in
1998. At December 31, 1998, Resources' total debt to total capitalization
equaled 40%.
(5) TRUST SECURITIES
In June 1996, a Delaware statutory business trust (Resources Trust)
established by Resources issued in a public offering $172.5 million of
convertible preferred securities and sold approximately $5.3 million of
Resources Trust common stock (106,720 shares, representing 100% of the
Resources Trust's common equity) to Resources. The convertible preferred
securities have a distribution rate of 6.25% payable quarterly in arrears, a
stated liquidation amount of $50 per convertible preferred security and must be
redeemed by 2026. The proceeds from the sale of the preferred and common
securities were used by Resources Trust to purchase $177.8 million of 6.25%
Convertible Junior Subordinated Debentures from Resources having an interest
rate corresponding to the distribution rate of the convertible preferred
securities and a maturity date corresponding to the mandatory redemption date
of the convertible preferred securities. Under existing law, interest payments
made by Resources for the junior subordinated debentures are deductible for
federal income tax purposes. Resources has the right at any time and from time
to time to defer interest payments on the junior subordinated debentures for
successive periods not to exceed 20 consecutive quarters for each such
extension period. In such case, (1) quarterly distributions on the junior
subordinated debentures would also be deferred and (2) Resources has agreed to
not declare or pay any dividend on any common or preferred stock, except in
certain instances.
The Resources Trust is accounted for as a wholly owned consolidated
subsidiary of Resources. The junior subordinated debentures are the sole assets
of the Resources Trust. Resources has fully and unconditionally guaranteed, on
a subordinated basis, the Resources Trust's obligations, including the payment
of distributions and all other payments, with respect to the convertible
preferred securities. The convertible preferred securities are mandatorily
redeemable upon the repayment of the related junior subordinated debentures at
their stated maturity or earlier redemption. Each convertible preferred security
is convertible at the option of the holder into $33.62 of cash and 1.55 shares
of Reliant Energy common stock. During 1998, convertible preferred securities
aggregating $15.5 million were converted, leaving $0.9 million liquidation
amount of convertible preferred securities outstanding at December 31, 1998.
(8) COMMITMENTS AND CONTINGENCIES
(a) Lease Commitments.
The following table sets forth certain information concerning Resources'
obligations under operating leases:
Minimum Lease Commitments at December 31, 1998(1)
(millions of dollars)
1999........................................................................ $ 19
2000........................................................................ 15
2001........................................................................ 14
2002........................................................................ 10
2003........................................................................ 9
2004 and beyond............................................................. 61
----------
Total......................................................................... $ 128
==========
- ----------
(1) Principally consisting of rental agreements for building space and data
processing equipment and vehicles (including major work equipment);
approximately $16 million represents rental agreements with Reliant
Energy.
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Resources 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, 1998, the unamortized value of equipment
covered by the master leasing agreement was $26.9 million. Resources does not
expect to lease additional property under this lease agreement.
Total rental expense for all leases was $25.0 million, $24.0 million and
$33.4 million in 1998, 1997 and 1996, respectively.
(b) Letters of Credit.
At December 31, 1998, Resources had letters of credit incidental to its
ordinary business operations totaling approximately $30 million under which
Resources is obligated to reimburse drawings, if any.
(c) Indemnity Provisions.
At December 31, 1998, Resources had a $5.8 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 Resources' receivables are collateral for receivables which
have been sold pursuant to the terms of the Receivables Facility. For
information regarding these receivables, see Note 4(a).
(e) Gas Purchase Claims.
In conjunction with settlements of "take-or-pay" claims, Resources has
prepaid for certain volumes of gas, which prepayments have been recorded at
their net realizable value and, to the extent that Resources is unable to
realize at least the carrying amount as the gas is delivered and sold,
Resources' earnings will be reduced, although such reduction is not expected to
be material. In addition to these prepayments, Resources 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 Resources expects that these commitments will
result in losses over the contract term, Resources has established reserves
equal to such expected losses. As of December 31, 1998, these reserves were not
material.
(f) Transportation Agreement.
Resources had an agreement (ANR Agreement) with ANR Pipeline Company (ANR)
which contemplated that Resources would transfer to ANR an interest in certain
of Resources' pipeline and related assets. The interest represented capacity of
250 Mmcf/day. Under the ANR Agreement, an ANR affiliate advanced $125 million
to Resources. Subsequently, the parties restructured the ANR Agreement and
Resources refunded in 1995 and 1993, respectively, $50 million and $34 million
to ANR or an affiliate. Resources recorded $41 million as a liability
reflecting ANR's or its affiliates' use of 130 Mmcf/ day of capacity in certain
of Resources' transportation facilities. The level of transportation will
decline to 100 Mmcf/day in the year 2003 with a refund of $5 million to an ANR
affiliate. 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, Resources 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
Resources' business subject to SFAS No. 71, corresponding regulatory assets are
recorded in anticipation of recovery through the rate making process.
Manufactured Gas Plant Sites. Resources 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. Resources has
substantially 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, Resources believes that two were neither owned nor operated by
Resources; two were owned by Resources at one time but were operated by others
and are currently owned by others; and one site was previously owned and
operated by Resources but is currently owned by others. Resources believes it
has no liability with respect to the sites it neither owned nor operated.
At December 31, 1998, Resources had estimated a range of $12 million to
$70 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 Resources, assuming use of Resources' proposed remediation
methods. The upper end of the range was determined based on the sites once
owned by Resources, whether or not operated by Resources. The cost estimates of
the FMGW site are based on studies of that site. The remediation costs for the
other sites are based on industry average costs for remediation of sites of
similar size. The actual remediation costs will be dependent upon the number of
sites remediated, the participation of other potentially responsible parties,
if any, and the remediation methods used.
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At December 31, 1998 and 1997, Resources had recorded accruals of $5.4
million and $3.3 million, respectively (with a maximum estimated exposure of
approximately $8 million and $18 million at December 31, 1998 and 1997,
respectively) and an offsetting regulatory asset for environmental matters in
connection with a former fire training facility, a landfill and an underground
gas storage facility for which future remediation may be required. This accrual
is in addition to the accrual for MGP sites as previously discussed.
In its 1995 rate case, Reliant Energy Minnegasco was allowed to recover
approximately $7 million annually for remediation costs. In 1998, Reliant
Energy Minnegasco received approval to reduce its annual recovery rate to zero.
Remediation 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 or refund in the next rate case. At December 31,
1998 and 1997, Reliant Energy Minnegasco had over recovered $13 million and
$1.8 million, respectively. At December 31, 1998 and 1997, Minnegasco had
recorded a liability of $20.7 million and $21.7 million, respectively, to cover
the cost of future remediation. In addition, at December 31, 1998, Minnegasco
had receivables from insurance settlements of $.6 million. These insurance
settlements will be collected in 1999. Minnegasco expects that approximately
43% of its accrual as of December 31, 1998 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 Resources'
overall cash requirements, results of operations or cash flows.
Issues relating to the identification and remediation of MGPs are common
in the natural gas distribution industry. Resources has received notices from
the United States Environmental Protection Agency (EPA) and others regarding
its status as a potentially responsible party (PRP) for other sites. Based on
current information, Resources 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, Resources'
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 Resources at some sites
in the past, and Resources has conducted remediation at sites found to be
contaminated. Although Resources 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 Resources and others in the natural
gas industry to date and on the current regulations regarding remediation of
such sites, Resources believes that the cost of any remediation of such sites
will not be material to Resources' financial position, results of operation or
cash flows.
Potentially Responsible Party Notifications. From time to time Resources
and its subsidiaries have been notified that they are PRP's with respect to
properties which environmental authorities have determined warrant remediation
under state or federal environmental laws and regulations. In October 1994 the
EPA issued such a notice with respect to the South 8th Street landfill site in
West Memphis, Arkansas, and in December 1995, the Louisiana Department of
Environmental Quality advised that one of Resources' subsidiaries had been
identified as a PRP with respect to a hazardous waste site in Shreveport,
Louisiana.
In 1998, MRT received a notice of potential liability from the EPA
regarding MRT's PRP status with respect to the Gurley Pit Superfund Site. The
notice stated that MRT is a PRP for the response costs at this site because MRT
allegedly generated materials that were disposed of at the site. MRT
subsequently notified the EPA that it does not believe that it has liability
because it did not have operations in the state from which the material was
allegedly hauled. In December 1998, MRT learned that the South 8th Street
Superfund Site Group and the EPA reached a tentative settlement regarding the
South 8th Street and Gurley Pit Superfund Sites.
Considering the information currently known about such sites and the
involvement of Resources or its subsidiaries in activities at these sites,
Resources does not believe that these matters will have a material adverse
effect on Resources' financial position, results of operation or cash flows.
Resources 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 Resources' Consolidated Financial Statements, if any, from
the disposition of these matters will not be material.
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