UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
NO. 1
(Mark One)
[X] AMENDMENT NO. 1 TO QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001
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 Identification No.)
incorporation or organization)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
-----------------------------
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 twelve months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
As of August 3, 2001, Reliant Energy, Incorporated had 297,799,335 shares of
common stock outstanding, including 7,528,889 ESOP shares not deemed outstanding
for financial statement purposes and excluding 4,511,691 shares held as treasury
stock.
RELIANT ENERGY, INCORPORATED
QUARTERLY REPORT ON FORM 10-Q/A
FOR THE QUARTER ENDED JUNE 30, 2001
Reliant Energy, Incorporated (Reliant Energy) hereby amends Items 1 and 2
of Part 1 of its Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 2001 as originally filed on August 10, 2001.
RESTATEMENT
On February 5, 2002, Reliant Energy announced that it was restating its
earnings for the second and third quarters of 2001. As more fully described in
Note 1, the restatement relates to a correction in accounting treatment for a
series of four structured transactions that were inappropriately accounted for
as cash flow hedges for the period of May 2001 through September 2001.
Although these transactions were undertaken and accounted for as cash flow
hedges, having further reviewed the transactions, Reliant Energy now believes
that they did not meet the requirements of a cash flow hedge under Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended (SFAS No. 133). Consequently, these
contracts should have been accounted for as derivatives with changes in fair
value recognized through the income statement.
As a result, Reliant Energy's unaudited consolidated condensed financial
statements (Original Interim Financial Statements) and related disclosures as of
June 30, 2001 and for the three and six months ended June 30, 2001 have been
restated from amounts previously reported. The principal effects of the
restatement on the accompanying financial statements are set forth in Note 1 of
the Notes to Interim Financial Statements.
For purposes of this Form 10-Q/A, and in accordance with Rule 12b-15 under
the Securities Exchange Act of 1934, as amended, each item of the June 30, 2001
Form 10-Q as originally filed on August 10, 2001 that was affected by the
restatement has been amended and restated in its entirety. No attempt has been
made in this Form 10-Q/A to modify or update other disclosures as presented in
the original Form 10-Q except as required to reflect the effects of the
restatement.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements...........................................1
Statements of Consolidated Income
Three and Six Months Ended June 30, 2000 and 2001 (unaudited).....1
Consolidated Balance Sheets
December 31, 2000 and June 30, 2001 (unaudited)...................2
Statements of Consolidated Cash Flows
Six Months Ended June 30, 2000 and 2001 (unaudited)...............4
Notes to Unaudited Consolidated Financial Statements..............5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations of Reliant
Energy and Subsidiaries..........................................25
PART I. FINANCIAL INFORMATION
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2000 2001 2000 2001
------------ ------------ ---------- ------------
(AS RESTATED) (AS RESTATED)
REVENUES ................................................................. $ 5,755,169 $ 11,986,483 $9,968,175 $ 25,270,804
EXPENSES:
Fuel and cost of gas sold ............................................. 2,921,920 5,313,470 5,254,509 12,980,609
Purchased power ....................................................... 1,405,945 5,076,669 2,190,879 9,184,292
Operation and maintenance ............................................. 564,194 619,582 1,029,142 1,334,596
Taxes other than income taxes ......................................... 115,045 142,126 225,610 281,814
Depreciation and amortization ......................................... 234,119 224,711 412,735 419,765
------------ ------------ ---------- ------------
Total ............................................................. 5,241,223 11,376,558 9,112,875 24,201,076
------------ ------------ ---------- ------------
OPERATING INCOME ......................................................... 513,946 609,925 855,300 1,069,728
------------ ------------ ---------- ------------
OTHER (EXPENSE) INCOME:
Unrealized (loss) gain on AOL Time Warner investment .................. (1,320,755) 330,901 202,928 467,983
Unrealized gain (loss) on indexed debt securities ..................... 1,320,755 (329,185) (202,870) (464,232)
Income from equity investments in unconsolidated subsidiaries ......... 5,481 51,572 5,966 64,350
Interest expense ...................................................... (186,709) (150,293) (346,763) (328,245)
Distribution on trust preferred securities ............................ (12,812) (13,899) (26,704) (27,799)
Minority interest ..................................................... 208 (34,103) 515 (33,812)
Other, net ............................................................ 26,439 34,503 46,533 69,820
------------ ------------ ---------- ------------
Total ............................................................. (167,393) (110,504) (320,395) (251,935)
------------ ------------ ---------- ------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, EXTRAORDINARY
ITEM, CUMULATIVE EFFECT OF ACCOUNTING CHANGE AND PREFERRED DIVIDENDS .. 346,553 499,421 534,905 817,793
Income Tax Expense .................................................... 110,620 183,060 165,156 293,210
------------ ------------ ---------- ------------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEM,
CUMULATIVE EFFECT OF ACCOUNTING CHANGE AND PREFERRED DIVIDENDS ........ 235,933 316,361 369,749 524,583
Loss from Discontinued Operations, net of tax of $3,213 and $1,813 .... (19,447) -- (20,110) --
Loss on Disposal of Discontinued Operations, net of tax of $(1,640) ... -- -- -- (7,294)
------------ ------------ ---------- ------------
INCOME BEFORE EXTRAORDINARY ITEM, CUMULATIVE EFFECT OF ACCOUNTING
CHANGE AND PREFERRED DIVIDENDS ........................................ 216,486 316,361 349,639 517,289
Extraordinary Item .................................................... 7,445 -- 7,445 --
------------ ------------ ---------- ------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE AND PREFERRED
DIVIDENDS ............................................................. 223,931 316,361 357,084 517,289
Cumulative Effect of Accounting Change, net of tax of zero
and $33,205 ......................................................... -- (47) -- 61,619
------------ ------------ ---------- ------------
INCOME BEFORE PREFERRED DIVIDENDS ........................................ 223,931 316,314 357,084 578,908
Preferred Dividends ................................................... 98 98 195 195
------------ ------------ ---------- ------------
NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS ........................... $ 223,833 $ 316,216 $ 356,889 $ 578,713
============ ============ ========== ============
BASIC EARNINGS PER SHARE:
Income from Continuing Operations ..................................... $ 0.83 $ 1.09 $ 1.30 $ 1.82
Loss from Discontinued Operations, net of tax ......................... (0.07) -- (0.07) --
Loss on Disposal of Discontinued Operations, net of tax ............... -- -- -- (0.03)
Extraordinary Item .................................................... 0.03 -- 0.03 --
Cumulative Effect of Accounting Change, net of tax .................... -- -- -- 0.22
------------ ------------ ---------- ------------
Net Income Attributable to Common Stockholders ........................ $ 0.79 $ 1.09 $ 1.26 $ 2.01
============ ============ ========== ============
DILUTED EARNINGS PER SHARE:
Income from Continuing Operations ..................................... $ 0.82 $ 1.08 $ 1.29 $ 1.81
Loss from Discontinued Operations, net of tax ......................... (0.07) -- (0.07) --
Loss on Disposal of Discontinued Operations, net of tax ............... -- -- -- (0.03)
Extraordinary Item .................................................... 0.03 -- 0.03 --
Cumulative Effect of Accounting Change, net of tax .................... -- -- -- 0.21
------------ ------------ ---------- ------------
Net Income Attributable to Common Stockholders ........................ $ 0.78 $ 1.08 $ 1.25 $ 1.99
============ ============ ========== ============
See Notes to the Company's Interim Financial Statements
1
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, 2000 JUNE 30, 2001
----------------- -------------
CURRENT ASSETS: (AS RESTATED)
Cash and cash equivalents ............................... $ 175,972 $ 107,705
Investment in AOL Time Warner common stock .............. 896,824 1,364,807
Accounts receivable, net ................................ 2,623,492 2,622,813
Accrued unbilled revenues ............................... 592,618 274,117
Fuel stock and petroleum products ....................... 213,484 315,097
Materials and supplies .................................. 269,729 274,118
Price risk management assets ............................ 4,290,803 2,513,734
Non-trading derivative assets ........................... -- 2,032,273
Margin deposits on energy trading activities ........... 521,004 186,582
Other ................................................... 253,335 281,125
----------------- -------------
Total current assets ................................. 9,837,261 9,972,371
----------------- -------------
Property, plant and equipment .............................. 22,391,874 23,136,189
Less accumulated depreciation and amortization ............. (7,128,316) (7,309,770)
----------------- -------------
Property, plant and equipment, net ...................... 15,263,558 15,826,419
----------------- -------------
OTHER ASSETS:
Goodwill and other intangibles, net ..................... 3,077,304 2,997,523
Regulatory assets ....................................... 1,926,103 1,688,517
Price risk management assets ........................... 544,909 542,954
Non-trading derivative assets ........................... -- 618,674
Equity investments in unconsolidated subsidiaries ...... 108,727 139,523
Stranded costs indemnification receivable ............... -- 367,000
Net assets of discontinued operations .................. 194,858 120,455
Other .................................................. 746,709 858,333
----------------- -------------
Total other assets ................................... 6,598,610 7,332,979
----------------- -------------
TOTAL ASSETS ....................................... $ 31,699,429 $ 33,131,769
================= =============
See Notes to the Company's Interim Financial Statements
2
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, 2000 JUNE 30, 2001
----------------- -------------
CURRENT LIABILITIES: (AS RESTATED)
Short-term borrowings ......................................................... $ 5,004,494 $ 3,036,770
Current portion of long-term debt ............................................. 1,623,202 479,977
Indexed debt securities derivative ............................................ -- 1,252,490
Accounts payable .............................................................. 3,057,948 2,366,241
Taxes accrued ................................................................. 172,449 329,798
Interest accrued .............................................................. 103,489 123,879
Dividends declared ............................................................ 110,893 111,949
Price risk management liabilities ............................................. 4,272,771 2,419,718
Non-trading derivative liabilities ............................................ -- 1,799,425
Margin deposits from customers on energy trading activities ................... 284,603 380,400
Accumulated deferred income taxes ............................................. 309,008 409,086
Other ......................................................................... 630,357 527,359
----------------- -------------
Total current liabilities .................................................. 15,569,214 13,237,092
----------------- -------------
OTHER LIABILITIES:
Accumulated deferred income taxes ............................................. 2,548,891 2,691,236
Unamortized investment tax credits ............................................ 265,737 256,572
Price risk management liabilities ............................................. 530,263 488,361
Non-trading derivative liabilities ............................................ -- 677,712
Benefit obligations ........................................................... 491,964 538,049
Other ......................................................................... 1,100,505 1,149,193
----------------- -------------
Total other liabilities .................................................... 4,937,360 5,801,123
----------------- -------------
LONG-TERM DEBT ................................................................... 4,996,095 5,448,676
----------------- -------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 12)
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES ................................... 9,345 1,231,843
----------------- -------------
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS
HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF THE COMPANY .................. 705,355 705,569
----------------- -------------
STOCKHOLDERS' EQUITY:
Cumulative preferred stock .................................................... 9,740 9,740
Common stock .................................................................. 3,257,190 3,869,251
Treasury stock ................................................................ (120,856) (113,336)
Unearned ESOP stock ........................................................... (161,158) (143,499)
Retained earnings ............................................................. 2,520,350 2,881,523
Accumulated other comprehensive (loss) income ................................. (23,206) 203,787
----------------- -------------
Total stockholders' equity ................................................. 5,482,060 6,707,466
----------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................... $ 31,699,429 $ 33,131,769
================= =============
See Notes to the Company's Interim Financial Statements
3
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
--------------------------
2000 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES: (AS RESTATED)
Net income attributable to common stockholders ........................................ $ 356,889 $ 578,713
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ....................................................... 412,735 419,765
Deferred income taxes ............................................................... (12,697) 89,852
Investment tax credits .............................................................. (9,142) (9,165)
Cumulative effect of accounting change .............................................. -- (61,619)
Unrealized gain on AOL Time Warner investment ....................................... (202,928) (467,983)
Unrealized loss on indexed debt securities .......................................... 202,870 464,232
Undistributed earnings of unconsolidated subsidiaries ............................... (5,966) (30,822)
Proceeds from sale of debt securities ............................................... 123,428 --
Impairment of marketable equity securities .......................................... 22,185 --
Extraordinary item .................................................................. (7,445) --
Net cash provided by discontinued operations ........................................ 19,266 80,189
Minority interest ................................................................... (515) 33,812
Changes in other assets and liabilities:
Accounts receivable, net .......................................................... (509,885) 372,364
Inventory ......................................................................... (8,669) (99,554)
Accounts payable .................................................................. 539,982 (689,852)
Federal tax refund ................................................................ 52,817 --
Fuel cost under-recovery .......................................................... (261,094) (267,754)
Net price risk management assets and liabilities................................... (26,650) (116,103)
Margin deposits on energy trading activities, net ................................. (128,884) 430,219
Prepaid lease obligation .......................................................... -- (101,542)
Interest and taxes accrued ........................................................ 82,707 179,826
Other current assets .............................................................. 366 64,653
Other current liabilities ......................................................... 47,401 (101,113)
Other assets ...................................................................... (59,861) 167,307
Other liabilities ................................................................. (23,668) 47,231
Other, net .......................................................................... 82,732 102,945
----------- -----------
Net cash provided by operating activities ....................................... 685,974 1,085,601
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .................................................................. (817,265) (1,037,259)
Business acquisitions, net of cash acquired ........................................... (2,120,312) --
Payment of business purchase obligation ............................................... (981,789) --
Investments in unconsolidated subsidiaries ............................................ (3,204) 26
Net cash used in discontinued operations .............................................. (36,553) (5,806)
Other, net ............................................................................ 24,214 (12,541)
----------- -----------
Net cash used in investing activities ........................................... (3,934,909) (1,055,580)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt, net ..................................................... 92,098 544,632
Increase (decrease) in short-term borrowing, net ...................................... 3,795,000 (1,814,158)
Payments of long-term debt ............................................................ (448,194) (377,951)
Payment of common stock dividends ..................................................... (212,423) (216,170)
Proceeds from issuance of stock ....................................................... 18,389 82,223
Proceeds from subsidiary issuance of stock ............................................ -- 1,697,848
Purchase of treasury stock ............................................................ (27,306) --
Net cash provided by discontinued operations .......................................... 41,514 --
Other, net ............................................................................ 782 (9,867)
----------- -----------
Net cash provided by (used in) financing activities ............................... 3,259,860 (93,443)
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH .................................................. 6,693 (4,845)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..................................... 17,618 (68,267)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ......................................... 80,767 175,972
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............................................... $ 98,385 $ 107,705
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) ................................................. $ 374,015 $ 314,135
Income taxes .......................................................................... 72,195 111,869
See Notes to the Company's Interim Financial Statements
4
RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Included in this Quarterly Report on Form 10-Q/A (Form 10-Q/A) for Reliant
Energy, Incorporated (Reliant Energy), together with its subsidiaries (the
Company) are Reliant Energy's consolidated interim financial statements and
notes (Interim Financial Statements) including the Company's wholly owned and
majority owned subsidiaries. The Interim Financial Statements are unaudited,
omit certain financial statement disclosures and should be read with the
combined Annual Report on Form 10-K of Reliant Energy (Reliant Energy Form 10-K)
and Reliant Energy Resources Corp. (RERC Corp.) (RERC Corp. Form 10-K) for the
year ended December 31, 2000 and the Quarterly Report on Form 10-Q of Reliant
Energy (Reliant Energy First Quarter 10-Q) and RERC Corp (RERC Corp. First
Quarter 10-Q) for the quarter ended March 31, 2001.
RESTATEMENT
On February 5, 2002, the Company announced that it was restating its
earnings for the second and third quarters of 2001. As more fully described
below, the restatement relates to a correction in accounting treatment for a
series of four structured transactions that were inappropriately accounted for
as cash flow hedges for the period of May 2001 through September 2001.
During the May 2001 through September 2001 time frame, the Company entered
into a series of four structured transactions that were intended to increase
future cash flow and earnings and to increase certainty associated with future
cash flow and earnings, albeit at the expense of 2001 cash flow and earnings. It
was contemplated that the structured transactions would qualify for hedge
accounting under Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended (SFAS
No. 133). The transactions were recorded in the Company's cash flow hedge
accounting records and were, in effect, overlaid on existing contracts entered
into as hedges. In general, each structured transaction involved a series of
forward contracts to buy and sell an energy commodity in 2001 and to buy and
sell an energy commodity in 2002 or 2003. Each series of contracts in a
structure were executed contemporaneously with the same counterparty and were
for the same commodities, quantities and locations. The contracts in each
structure were offsetting in terms of physical attributes. In two of the four
structured transactions, a series of contracts were entered into with the same
counterparty to mitigate credit exposure (the credit mitigation contracts).
These credit mitigation contracts mirrored the cash flows and terms from the
other contracts in the structure, except for an upfront demand payment made to
the counterparty in these two transactions. In addition, in contemplation of one
of the structured transactions, in August 2001, the Company entered into forward
contracts with a different counterparty to buy and sell natural gas, a portion
of which was inappropriately recorded in the fourth quarter of 2001. The
counterparties to all of the structured transactions were independent third
parties that are regularly engaged in the energy trading business.
While each contract in each structure was not at market at inception, the
contracts were intended to be at market in total, so the structure had little or
no fair value at inception. Under the original accounting treatment, however,
the Company recorded each applicable contract in its hedge accounting records on
an individual basis, resulting in the recognition of a non-trading derivative
asset or liability on the balance sheet with an offsetting entry in accumulated
other comprehensive income at inception for each contract. Such accounting
treatment resulted in a net loss being recorded in 2001 and ultimately would
result in income being recorded for 2002 and 2003 related to these four
structured transactions. In this situation, the recognition of other
comprehensive income was in error, because the fair value of each contract in
each structure resulted not from changes in the fair value of any anticipated
transaction, but rather from the fact that the individual contracts were not at
market at inception.
Having further reviewed the transactions, the Company now believes the
contracts should have been accounted for as a unit within each structured
transaction rather than separately and that, viewed as such, they did not
qualify as cash flow hedges under SFAS No. 133. Consequently, these contracts
should have been accounted for as derivatives with changes in fair value
recognized through the income statement.
As a result, the unaudited consolidated condensed financial statements and
related disclosures as of June 30, 2001 and for the three and six months ended
June 30, 2001 have been restated from amounts previously reported. A
5
summary of the principal effects of the restatement is as follows: (Note - Those
line items for which no change in amounts are shown were not affected by the
restatement.)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2001 JUNE 30, 2001
------------------------------- -------------------------------
AS PREVIOUSLY AS PREVIOUSLY
AS RESTATED REPORTED AS RESTATED REPORTED
------------- ------------- ------------- -------------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Revenues ................................................... $ 11,986 $ 11,974 $ 25,271 $ 25,259
Expenses:
Fuel and cost of gas sold ............................. 5,314 5,389 12,981 13,056
Purchased power ....................................... 5,077 5,077 9,184 9,184
Other expenses ........................................ 986 986 2,037 2,037
------------- ------------- ------------- -------------
Total ............................................... 11,377 11,452 24,202 24,277
------------- ------------- ------------- -------------
Operating Income ........................................... 609 522 1,069 982
Other Expense, net ......................................... (77) (77) (218) (218)
Minority Interest .......................................... (34) (23) (34) (23)
Income Tax Expense ......................................... (182) (148) (294) (260)
------------- ------------- ------------- -------------
Income from Continuing Operations Before Cumulative Effect
of Accounting Change and Preferred Dividends ............ 316 274 523 481
Loss on Disposal of Discontinued Operations, net of tax .... -- -- (7) (7)
Cumulative effect of accounting change, net of tax ......... -- -- 62 62
Preferred Dividends ........................................ -- -- -- --
------------- ------------- ------------- -------------
Net Income Attributable to Common Shareholders ............. $ 316 $ 274 $ 578 $ 536
============= ============= ============= =============
BASIC EARNINGS PER SHARE:
Income from Continuing Operations .......................... $ 1.09 $ 0.94 $ 1.82 $ 1.67
Loss on Disposal of Discontinued Operations, net of tax .... -- -- (0.03) (0.03)
Cumulative effect of accounting change, net of tax ......... -- -- 0.22 0.22
------------- ------------- ------------- -------------
Net Income Attributable to Common Shareholders ............. $ 1.09 $ 0.94 $ 2.01 $ 1.86
============= ============= ============= =============
DILUTED EARNINGS PER SHARE:
Income from Continuing Operations .......................... $ 1.08 $ 0.93 $ 1.81 $ 1.66
Loss on Disposal of Discontinued Operations, net of tax -- -- (0.03) (0.03)
Cumulative effect of accounting change, net of tax ......... -- -- 0.21 0.21
------------- ------------- ------------- -------------
Net Income Attributable to Common Shareholders ............. $ 1.08 $ 0.93 $ 1.99 $ 1.84
============= ============= ============= =============
6
JUNE 30, 2001
------------------------------
AS PREVIOUSLY
AS RESTATED REPORTED
------------------------------
ASSETS (IN MILLIONS)
CURRENT ASSETS:
Price risk management assets.......................................................... $ 2,514 $ 2,514
Non-trading derivative assets......................................................... 2,033 2,047
Other ................................................................................ 5,426 5,426
----------- -------------
Total current assets........................................................... 9,973 9,987
----------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET....................................................... 15,826 15,826
----------- -------------
OTHER ASSETS:
Price risk management assets.......................................................... 543 543
Non-trading derivative assets......................................................... 619 711
Other ................................................................................ 6,171 6,171
----------- -------------
Total other assets............................................................. 7,333 7,425
----------- -------------
TOTAL ASSETS................................................................... $ 33,132 $ 33,238
=========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Price risk management liabilities..................................................... $ 2,420 $ 2,420
Non-trading derivative liabilities.................................................... 1,800 1,809
Accumulated deferred income taxes..................................................... 409 412
Other................................................................................. 8,608 8,608
----------- -------------
Total current liabilities...................................................... 13,237 13,249
----------- -------------
OTHER LIABILITIES:
Accumulated deferred income taxes..................................................... 2,691 2,694
Price risk management liabilities..................................................... 489 564
Non-trading derivative liabilities.................................................... 678 677
Other................................................................................. 1,944 1,944
----------- -------------
Total other liabilities........................................................ 5,802 5,879
----------- -------------
LONG-TERM DEBT........................................................................... 5,449 5,449
----------- -------------
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES........................................... 1,232 1,221
----------- -------------
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS....... 705 705
----------- -------------
STOCKHOLDERS' EQUITY:
Cumulative preferred stock............................................................ 10 10
Common stock.......................................................................... 3,869 3,869
Treasury stock........................................................................ (113) (113)
Unearned ESOP......................................................................... (144) (144)
Retained earnings..................................................................... 2,881 2,839
Accumulated other comprehensive income................................................ 204 274
----------- -------------
Stockholders' equity........................................................... 6,707 6,735
----------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..................................... $ 33,132 $ 33,238
=========== =============
BASIS OF PRESENTATION
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The Interim Financial Statements reflect all normal recurring adjustments
that are, in the opinion of management, necessary to present fairly the
financial position and results of operations for the respective periods. Amounts
reported in the Company's Statements of Consolidated Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (a) seasonal fluctuations in demand for energy and energy
services, (b) changes in energy commodity prices, (c) timing of maintenance and
other
7
expenditures and (d) acquisitions and dispositions of businesses, assets and
other interests. In addition, certain amounts from the prior year have been
reclassified to conform to the Company's presentation of financial statements in
the current year. These reclassifications do not affect the earnings of the
Company.
The following notes to the consolidated financial statements in the
Reliant Energy Form 10-K relate to certain contingencies. These notes, as
updated herein, are incorporated herein by reference:
Notes to Consolidated Financial Statements of Reliant Energy (Reliant
Energy 10-K Notes): Note 2(f) (Summary of Significant Accounting Policies
-- Regulatory Assets), Note 3 (Business Acquisitions), Note 4 (Regulatory
Matters), Note 5 (Derivative Financial Instruments), Note 8 (Indexed Debt
Securities (ACES and ZENS) and AOL Time Warner Securities), Note 14
(Commitments and Contingencies) and Note 20 (Subsequent Events).
For information regarding certain legal, tax and regulatory proceedings
and environmental matters, see Note 12.
(2) NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141 "Business Combinations"
(SFAS No. 141) and SFAS No. 142 "Goodwill and Other Intangible Assets" (SFAS No.
142). SFAS No. 141 requires business combinations initiated after June 30, 2001
to be accounted for using the purchase method of accounting, and broadens the
criteria for recording intangible assets separate from goodwill. Recorded
goodwill and intangibles will be evaluated against these new criteria and may
result in certain intangibles being transferred to goodwill, or alternatively,
amounts initially recorded as goodwill may be separately identified and
recognized apart from goodwill. Under SFAS No. 142, a nonamortization approach,
goodwill and certain intangibles with indefinite lives will not be amortized
into results of operations, but instead would be reviewed periodically for
impairment and written down and charged to results of operations only in the
periods in which the recorded value of goodwill and certain intangibles with
indefinite lives is more than its fair value. The provisions of each statement
which apply to goodwill and intangible assets acquired prior to June 30, 2001
will be adopted by the Company on January 1, 2002. The Company is in the process
of determining the effect of adoption of SFAS No. 141 and SFAS No. 142 on its
consolidated financial statements.
(3) DERIVATIVE FINANCIAL INSTRUMENTS
Adoption of SFAS No. 133 on January 1, 2001 resulted in an after-tax
increase in net income of $61 million and a cumulative after-tax increase in
accumulated other comprehensive loss of $252 million. The adoption also
increased current assets, long-term assets, current liabilities and long-term
liabilities by $703 million, $252 million, $805 million and $340 million,
respectively, in the Company's Consolidated Balance Sheet. The Company also
reclassified $788 million related to the Company's Zero-Premium Exchangeable
Subordinated Notes (ZENS) due to the adoption from the current portion of
long-term debt to indexed debt securities derivative. During the six months
ended June 30, 2001, losses of $35 million of the initial transition adjustment
recognized in other comprehensive income were realized in net income. For
additional information regarding the adoption of SFAS No. 133 and the Company's
accounting policies for derivative financial instruments, see Note 2 of Reliant
Energy First Quarter 10-Q.
The application of SFAS No. 133 is still evolving as the FASB clears
issues submitted to the Derivatives Implementation Group for consideration. The
FASB approved a number of issues regarding the normal purchases and normal sales
exception in the second quarter. One issue concludes forward contracts with
volumetric optionality do not qualify for the normal purchases and normal sales
exception, while another issue applies exclusively to the electric industry and
allows the normal purchases and normal sales exception for option-type contracts
if certain criteria are met. The effective date for implementation of these
decisions is July 1, 2001. The Company is currently assessing the impact of the
recently cleared issues and does not believe they will have a material impact on
the Company's Consolidated Financial Statements.
Cash Flow Hedges. During the six months ended June 30, 2001, the Company
entered into interest-rate swaps in order to adjust the interest rate on $1.6
billion of its floating rate debt. In addition, as of June 30, 2001, the
Company's European Energy segment had entered into transactions to purchase
approximately $103 million at fixed exchange rates in order to hedge future fuel
purchases payable in U.S. dollars.
8
During the six months ended June 30, 2001, the amount of hedge
ineffectiveness recognized in earnings from derivatives that are designated and
qualify as cash flow hedges was immaterial. No component of the derivative
instruments' gain or loss was excluded from the assessment of effectiveness.
During the six months ended June 30, 2001, there were no deferred gains or
losses recognized in earnings as a result of the discontinuance of cash flow
hedges because it was no longer probable that the forecasted transaction would
occur. As of June 30, 2001, current non-trading derivative assets and
liabilities and corresponding amounts in accumulated other comprehensive income
are expected to be reclassified into net income during the next twelve months.
The maximum length of time the Company is hedging its exposure to the
variability in future cash flows for forecasted transactions is five years.
Hedge of Net Investment in Foreign Subsidiaries. The Company has
substantially hedged its net investment in its European Energy segment through a
combination of Euro-denominated borrowings, foreign currency swaps and foreign
currency forward contracts. These are designed to reduce the Company's exposure
to changes in foreign currency rates. During the six months ended June 30, 2001,
the derivative and non-derivative instruments designated as hedging the net
investment in the Company's European Energy segment resulted in a gain of $227
million, which is included in the balance of the cumulative translation
adjustment.
Other Derivatives. Upon adoption of SFAS No. 133 effective January 1,
2001, the Company's indexed debt securities obligations related to its ZENS
obligation was bifurcated into a debt component valued at $122 million and an
embedded derivative component valued at $788 million. Changes in the fair value
of the derivative component are recorded in the Company's Statements of
Consolidated Income. During the six months ended June 30, 2001, the Company
recorded a $464 million loss associated with the fair value of the derivative
component of the indexed debt securities obligations. During the six months
ended June 30, 2001, the Company recorded a $468 million gain on the Company's
investment in AOL Time Warner Inc. common stock. Changes in the fair value of
the Company's Investment in AOL Time Warner Inc. common stock should
substantially offset changes in the fair value of the derivative component of
the ZENS.
In December 2000, the Dutch parliament adopted legislation allocating to
the Dutch generation sector, including an indirect Dutch generating subsidiary
of the Company, Reliant Energy Power Generation Benelux N.V. (REPGB), previously
named N.V. UNA (UNA), financial responsibility for various stranded costs
contracts and other liabilities. The legislation became effective in all
material respects on January 1, 2001. In particular, the legislation allocated
to the Dutch generation sector, including REPGB, financial responsibility to
purchase electricity and gas under a gas supply contract and three electricity
contracts. These contracts are derivatives pursuant to SFAS No. 133 due to the
pricing indices. As of June 30, 2001, the Company has recognized $169 million in
short-term and long-term non-trading derivative liabilities for REPGB's portion
of these stranded costs contracts. For additional information regarding REPGB's
stranded costs and the related indemnification by former shareholders of these
stranded costs, see Note 12(e).
During the second quarter of 2001, the Company entered into a structured
transaction which was recorded on the balance sheet in non-trading derivative
assets and liabilities. For further discussion of this transaction, see Note 1.
The change in fair value of these derivative assets and liabilities must be
recorded in the statement of income for each reporting period. During the second
quarter of 2001, $13 million of net non-trading derivative liabilities were
settled related to this transaction. As of June 30, 2001, the Company has
recognized $815 million of non-trading derivative assets and $803 million of
non-trading derivative liabilities related to this transaction.
(4) ACQUISITION OF RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
On May 12, 2000, an indirect subsidiary of the Company purchased entities
owning electric power generating assets and development sites located in
Pennsylvania, New Jersey and Maryland having an aggregate net generating
capacity of approximately 4,262 megawatts (MW). With the exception of
development entities that were sold to another subsidiary of the Company in July
2000, the assets of the entities acquired are held by Reliant Energy
Mid-Atlantic Power Holdings, LLC (REMA). The purchase price for the May 2000
transaction was $2.1 billion, subject to post-closing adjustments which
management does not believe will be material. The Company accounted for the
acquisition as a purchase with assets and liabilities of REMA reflected at their
estimated fair values. The Company's fair value adjustments related to the
acquisition primarily included adjustments in property, plant and equipment, air
emissions regulatory allowances, materials and supplies inventory, environmental
reserves and related deferred taxes. The Company finalized these fair value
adjustments in May 2001. There were no additional material modifications to the
preliminary adjustments from December 31, 2000. For additional information
regarding the acquisition of REMA, see Note 3(a) to Reliant Energy 10-K Notes.
9
The Company's results of operations include the results of REMA only for
the period beginning May 12, 2000. The following table presents selected actual
financial information and pro forma information for the six months ended June
30, 2000, as if the acquisition had occurred on January 1, 2000. Pro forma
amounts also give effect to the sale and leaseback of interests in three of the
REMA generating plants, consummated in August 2000. For additional information
regarding sale and leaseback transactions, see Note 14(c) to Reliant Energy 10-K
Notes.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 2000
---------------------- ----------------------
ACTUAL PRO FORMA ACTUAL PRO FORMA
-------- ----------- -------- -----------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Revenues......................................... $ 5,755 $ 5,814 $ 9,968 $ 10,134
Income from continuing operations................ 236 227 370 345
Net income attributable to common stockholders... 224 215 357 332
Basic earnings per share......................... 0.79 0.76 1.26 1.17
Diluted earnings per share....................... 0.78 0.75 1.25 1.16
These pro forma results, based on assumptions deemed appropriate by the
Company's management, have been prepared for informational purposes only and are
not necessarily indicative of the amounts that would have resulted if the
acquisition of the REMA entities had occurred on January 1, 2000.
Purchase-related adjustments to the results of operations include the effects on
depreciation and amortization, interest expense and income taxes.
(5) DISCONTINUED OPERATIONS
Effective December 1, 2000, Reliant Energy's Board of Directors approved a
plan to dispose of the Company's Latin American segment through sales of its
assets. Accordingly, the Company is reporting the results of its Latin American
segment as discontinued operations for all periods presented in the Interim
Financial Statements in accordance with Accounting Principles Board Opinion No.
30. During the three months ended March 31, 2001, the Company recorded an
additional loss on disposal of $7 million (after-tax) related to its Latin
American segment. No additional loss was recorded during the three months ended
June 30, 2001.
(6) DEPRECIATION AND AMORTIZATION
The Company's depreciation expense for the quarter and six months ended
June 30, 2000 was $97 million and $186 million, respectively, compared to $99
million and $200 million for the same periods in 2001. Goodwill amortization
related to acquisitions was $20 million and $42 million for the quarter and six
months ended June 30, 2000, respectively, compared to $19 million and $42
million for the same periods in 2001. Other amortization expense, including
amortization of regulatory assets, was $117 million and $185 million for the
quarter and six months ended June 30, 2000, respectively, compared to $107
million and $178 million for the same periods in 2001.
In June 1998, the Public Utility Commission of Texas (Texas Utility
Commission) issued an order approving a transition to competition plan
(Transition Plan) filed by Reliant Energy HL&P in December 1997. For information
regarding the additional depreciation of electric utility generating assets and
the redirection of transmission and distribution (T&D) depreciation to
generation assets under the Transition Plan, see Note 2(g) to Reliant Energy
10-K Notes. In June 1999, the Texas legislature adopted the Texas Electric
Choice Plan (Legislation), which substantially amended the regulatory structure
governing electric utilities in Texas in order to allow retail electric
competition beginning on January 1, 2002. The Legislation provides that
depreciation expense for T&D related assets may be redirected to generation
assets from 1999 through 2001 for regulatory purposes. Because the electric
generation operations portion of Reliant Energy HL&P discontinued application of
SFAS No. 71 effective June 30, 1999, such operations can no longer record
additional or redirected depreciation for financial reporting purposes. However,
for regulatory purposes, the Company continues to redirect T&D depreciation to
generation assets. As of December 31, 2000 and June 30, 2001, the cumulative
amount of redirected depreciation for regulatory purposes was $611 million and
$725 million, respectively.
In 1999, the Company determined that approximately $800 million of Reliant
Energy HL&P's electric generation assets were impaired. The Legislation provides
for recovery of this impairment through regulated cash flows. Therefore, a
regulatory asset was recorded for an amount equal to the impairment in the
Company's Consolidated Balance Sheets. The Company amortizes this regulatory
asset as it is recovered from regulated cash flows. Amortization expense related
to the recoverable impaired plant costs and other deferred debits created from
10
discontinuing SFAS No. 71 was $95 million and $147 million for the quarter and
six months ended June 30, 2000, respectively, compared to $87 million and $123
million for the same periods in 2001.
(7) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ------------------------
2000 2001 2000 2001
------ ------ ------ ------
(IN MILLIONS)
Net income attributable to common stockholders ............ $ 224 $ 316 $ 357 $ 578
Other comprehensive income (loss):
Foreign currency translation adjustments from continuing
operations ........................................... 5 6 (5) 5
Foreign currency translation adjustments from
discontinued operations .............................. (23) -- (23) --
Additional minimum non-qualified pension liability
adjustment ........................................... -- 3 -- 1
Cumulative effect of adoption of SFAS No. 133 .......... -- -- -- (252)
Net deferred gains from cash flow hedges ............... -- 194 -- 377
Reclassification of deferred loss from cash flow hedges
realized in net income ............................... -- 83 -- 83
Unrealized gain on available-for-sale securities ....... 1 6 2 13
Reclassification adjustment for impairment loss on
available-for-sale securities realized in net income . -- -- 14 --
------ ------ ------ ------
Comprehensive income ...................................... $ 207 $ 608 $ 345 $ 805
====== ====== ====== ======
(8) LONG-TERM DEBT AND SHORT-TERM BORROWINGS
(a) Short-term Borrowings.
As of June 30, 2001, the Company had credit facilities, which included the
facilities of various financing subsidiaries, Reliant Resources, Inc. (Reliant
Resources), REPGB and RERC Corp., with financial institutions which provide for
an aggregate of $7.4 billion in committed credit, of which $3.0 billion was
unused. As of June 30, 2001, borrowings of $3.8 billion were outstanding or
supported under these credit facilities of which $852 million were classified as
long-term debt, based on availability of committed credit with expiration dates
exceeding one year and management's intention to maintain these borrowings in
excess of one year. Various credit facilities aggregating $2.7 billion may be
used for letters of credit of which $0.6 billion were outstanding as of June 30,
2001. Interest rates on borrowings are based on the London interbank offered
rate (LIBOR) plus a margin, Euro interbank deposits plus a margin, a base rate
or a rate determined through a bidding process. Credit facilities aggregating
$3.7 billion are unsecured. The credit facilities contain covenants and
requirements that must be met to borrow funds and obtain letters of credit, as
applicable. Such covenants are not anticipated to materially restrict the
borrowers from borrowing funds or obtaining letters of credit, as applicable,
under such facilities. As of June 30, 2001, the borrowers are in compliance with
the covenants under all of these credit agreements.
(b) Long-term Debt.
In February 2001, RERC Corp. issued $550 million aggregate principal
amount of unsecured unsubordinated notes that bear interest at 7.75% per year
and mature in February 2011. Net proceeds to RERC Corp. were $545 million. RERC
Corp. used the net proceeds from the sale of the notes to pay a $400 million
dividend to Reliant Energy, and for general corporate purposes. Reliant Energy
used the $400 million proceeds from the dividend for general corporate purposes,
including the repayment of short-term debt.
11
(9) EARNINGS PER SHARE
The following table presents Reliant Energy's basic and diluted earnings
per share (EPS) calculation:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ -------------------------------
2000 2001 2000 2001
------------- ------------ ------------- -------------
(IN MILLIONS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Basic EPS Calculation:
Income from continuing operations ......................... $ 236 $ 316 $ 370 $ 523
Loss from discontinued operations, net of tax ............. (19) -- (20) --
Loss on disposal of discontinued operations, net of tax ... -- -- -- (7)
Extraordinary item ........................................ 7 -- 7 --
Cumulative effect of accounting change, net of tax ........ -- -- -- 62
------------- ------------ ------------- -------------
Net income attributable to common stockholders ............ $ 224 $ 316 $ 357 $ 578
============= ============ ============= =============
Weighted average shares outstanding .......................... 284,238,000 289,743,000 283,658,000 288,546,000
============= ============ ============= =============
Basic EPS:
Income from continuing operations ......................... $ 0.83 $ 1.09 $ 1.30 $ 1.82
Loss from discontinued operations, net of tax ............. (0.07) -- (0.07) --
Loss on disposal of discontinued operations, net of tax ... -- -- -- (0.03)
Extraordinary item ........................................ 0.03 -- 0.03 --
Cumulative effect of accounting change, net of tax ........ -- -- -- 0.22
------------- ------------ ------------- -------------
Net income attributable to common stockholders ............ $ 0.79 $ 1.09 $ 1.26 $ 2.01
============= ============ ============= =============
Diluted EPS Calculation:
Net income attributable to common stockholders ............ $ 224 $ 316 $ 357 $ 578
Plus: Income impact of assumed conversions:
Interest on 6 -1/4% convertible trust preferred
securities .............................................. -- -- -- --
------------- ------------ ------------- -------------
Total earnings effect assuming dilution ................... $ 224 $ 316 $ 357 $ 578
============= ============ ============= =============
Weighted average shares outstanding .......................... 284,238,000 289,743,000 283,658,000 288,546,000
Plus: Incremental shares from assumed conversions (1):
Stock options ........................................... 1,562,000 2,373,000 979,000 2,233,000
Restricted stock ........................................ 753,000 607,000 753,000 607,000
6 -1/4% convertible trust preferred securities .......... 15,000 14,000 15,000 14,000
------------- ------------ ------------- -------------
Weighted average shares assuming dilution ................. 286,568,000 292,737,000 285,405,000 291,400,000
============= ============ ============= =============
Diluted EPS:
Income from continuing operations ......................... $ 0.82 $ 1.08 $ 1.29 $ 1.81
Loss from discontinued operations, net of tax ............. (0.07) -- (0.07) --
Loss on disposal of discontinued operations, net of tax ... -- -- -- (0.03)
Extraordinary item ........................................ 0.03 -- 0.03 --
Cumulative effect of accounting change, net of tax ........ -- -- -- 0.21
------------- ------------ ------------- -------------
Net income attributable to common stockholders ............ $ 0.78 $ 1.08 $ 1.25 $ 1.99
============= ============ ============= =============
- ------------------
(1) For the three months ended June 30, 2000 and 2001, the computation of
diluted EPS excludes 52,307 and 1,860,256 purchase options, respectively,
for shares of common stock that have exercise prices (ranging from $28.72
to $32.22 per share and $45.57 to $50.00 per share for the second quarter
2000 and 2001, respectively) greater than the per share average market
price for the period and would thus be anti-dilutive if exercised.
For the six months ended June 30, 2000 and 2001, the computation of
diluted EPS excludes 452,327 and 1,978,698 purchase options, respectively,
for shares of common stock that have exercise prices (ranging from $25.81
to $32.22 per share and $41.69 to $50.00 per share for the first six
months of 2000 and 2001, respectively) greater than the per share average
market price for the period and would thus be anti-dilutive if exercised.
(10) CAPITAL STOCK
Common Stock. Reliant Energy has 700,000,000 authorized shares of common
stock. At December 31, 2000, 299,914,791 shares of Reliant Energy common stock
were issued and 286,464,709 shares of Reliant Energy
12
common stock were outstanding. At June 30, 2001, 302,263,474 shares of Reliant
Energy common stock were issued and 290,222,894 shares of Reliant Energy common
stock were outstanding. Outstanding common shares exclude (a) shares pledged to
secure a loan to Reliant Energy's Employee Stock Ownership Plan (8,638,889 and
7,528,889 at December 31, 2000 and June 30, 2001, respectively) and (b) treasury
shares (4,811,193 and 4,511,691 at December 31, 2000 and June 30, 2001,
respectively). Reliant Energy declared dividends of $0.375 per share in the
second quarter of 2000 and 2001 and $0.75 per share in the first six months of
2000 and 2001.
During the six months ended June 30, 2001, Reliant Energy issued 300,000
shares of Reliant Energy common stock out of its treasury stock. As of June 30,
2001, Reliant Energy was authorized to purchase up to $271 million of Reliant
Energy common stock under its stock repurchase program.
(11) TRUST PREFERRED SECURITIES
(a) Reliant Energy.
Statutory business trusts created by Reliant Energy have issued trust
preferred securities, the terms of which, and the related series of junior
subordinated debentures, are described below (in millions):
AGGREGATE LIQUIDATION
AMOUNT MANDATORY
----------------------------
DECEMBER 31, JUNE 30, DISTRIBUTION RATE/ REDEMPTION DATE/ JUNIOR SUBORDINATED
TRUST 2000 2001 INTEREST RATE MATURITY DATE DEBENTURES
- --------------------- ------------ -------- ------------------ ---------------- ---------------------------
REI Trust I $ 375 $ 375 7.20% March 2048 7.20% Junior Subordinated
Debentures due 2048
HL&P Capital Trust I $ 250 $ 250 8.125% March 2048 8.125% Junior Subordinated
Deferrable Interest
Debentures Series A
HL&P Capital Trust II $ 100 $ 100 8.257% February 2037 8.257% Junior Subordinated
Deferrable Interest
Debentures Series B
For additional information regarding the $625 million of preferred
securities and the $100 million of capital securities, see Note 11 to Reliant
Energy 10-K Notes. The sole asset of each trust consists of junior subordinated
debentures of Reliant Energy 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 that trust.
(b) RERC Corp.
A statutory business trust created by RERC Corp. has issued convertible
trust preferred securities, the terms of which, and the related series of
convertible junior subordinated debentures, are described below (in millions):
AGGREGATE LIQUIDATION
AMOUNT MANDATORY
----------------------------
DECEMBER 31, JUNE 30, DISTRIBUTION RATE/ REDEMPTION DATE/ JUNIOR SUBORDINATED
TRUST 2000 2001 INTEREST RATE MATURITY DATE DEBENTURES
- ------------------- ------------ -------- ------------------ ---------------- ---------------------------
Resources Trust $ 1 $ 1 6.25% June 2026 6.25% Convertible Junior
Subordinated Debentures due 2026
For additional information regarding the convertible preferred securities,
see Note 11 to Reliant Energy 10-K Notes and Note 6 to RERC Corp. 10-K Notes.
The sole asset of the trust consists of convertible junior subordinated
debentures of RERC Corp. having an interest rate and maturity date corresponding
to the convertible preferred securities, and the principal amount corresponding
to the common and convertible preferred securities issued by the trust.
13
(12) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
Reliant Energy HL&P Municipal Franchise Fee Lawsuits. In February 1996,
the cities of Wharton, Galveston and Pasadena filed suit, for themselves and a
proposed class of all similarly situated cities in Reliant Energy HL&P's service
area, against Reliant Energy and Houston Industries Finance, Inc. (formerly a
wholly owned subsidiary of Reliant Energy) alleging underpayment of municipal
franchise fees. Plaintiffs claim that they are entitled to 4% of all receipts of
any kind for business conducted within these cities over the previous four
decades. Because the franchise ordinances at issue affecting Reliant Energy HL&P
expressly impose fees only on its own receipts and only from sales of
electricity for consumption within a city, the Company regards all of
plaintiffs' allegations as spurious and is vigorously contesting the case. The
plaintiffs' pleadings asserted that their damages exceeded $250 million. The
269th Judicial District Court for Harris County granted partial summary judgment
in favor of Reliant Energy dismissing all claims for franchise fees based on
sales tax collections. Other motions for partial summary judgment were denied. A
six-week jury trial of the original claimant cities (but not the class of
cities) ended on April 4, 2000 (Three Cities case). Although the jury found for
Reliant Energy on many issues, they found in favor of the original claimant
cities on three issues, and assessed a total of $4 million in actual and $30
million in punitive damages. However, the jury also found in favor of Reliant
Energy on the affirmative defense of laches, a defense similar to a statute of
limitations defense, due to the original claimant cities having unreasonably
delayed bringing their claims during the 43 years since the alleged wrongs
began.
The trial court in the Three Cities case granted most of Reliant Energy's
motions to disregard the jury's findings. The trial court's rulings reduced the
judgment to $1.7 million, including interest, plus an award of $13.7 million in
legal fees. In addition, the trial court granted Reliant Energy's motion to
decertify the class and vacated its prior orders certifying a class. Following
this ruling, 45 cities filed individual suits against Reliant Energy in the
District Court of Harris County.
The extent to which issues in the Three Cities case may affect the claims
of the other cities served by Reliant Energy HL&P cannot be assessed until
judgments are final and no longer subject to appeal. However, the trial court's
rulings disregarding most of the jury's findings are consistent with Texas
Supreme Court opinions over the past decade. The Company estimates the range of
possible outcomes for the plaintiffs to be between zero and $17 million
inclusive of interest and attorneys' fees.
The Three Cities case has been appealed. The Company believes that the
$1.7 million damage award resulted from serious errors of law and that it will
be set aside by the Texas appellate courts. In addition, the Company believes
that because of an agreement between the parties limiting fees to a percentage
of the damages, reversal of the award of $13.7 million in attorneys' fees in the
Three Cities case is probable.
California Wholesale Market. Reliant Energy, Reliant Energy Services, Inc.
(a wholly owned subsidiary of Reliant Resources), Reliant Energy Power
Generation, Inc. (a wholly owned subsidiary of Reliant Resources) and several
other subsidiaries of Reliant Resources, as well as several officers of some of
these companies, have been named as defendants in class action lawsuits and
other lawsuits filed against a number of companies that own generation plants in
California and other sellers of electricity in California markets. Pursuant to
the terms of the master separation agreement between Reliant Energy and Reliant
Resources (see Note 4(b) to Reliant Energy 10-K Notes), Reliant Resources has
agreed to indemnify Reliant Energy for any damages arising under these lawsuits
and may elect to defend these lawsuits at Reliant Resources' own expense. Three
of these lawsuits were filed in the Superior Court of the State of California,
San Diego County; two were filed in the Superior Court of San Francisco County;
and one was filed in the Superior Court of Los Angeles County. While the
plaintiffs allege various violations by the defendants of state antitrust laws
and state laws against unfair and unlawful business practices, each of the
lawsuits is grounded on the central allegation that defendants conspired to
drive up the wholesale price of electricity. In addition to injunctive relief,
the plaintiffs in these lawsuits seek treble the amount of damages alleged,
restitution of alleged overpayments, disgorgement of alleged unlawful profits
for sales of electricity, costs of suit and attorneys' fees. In one of the cases
the plaintiffs allege aggregate damages of over $4 billion. Defendants sought to
remove all of these cases to federal court. The Judicial Panel on Multidistrict
Litigation issued an order consolidating and transferring them to the Honorable
Robert H. Whaley, a U.S. District Court Judge from the Eastern District of
Washington, sitting by designation in San Diego, California. On June 27, 2001,
Judge Whaley heard argument on plaintiffs' motions to remand five of the six
cases back to state court. A motion to remand the sixth case has not been filed
at this time. Judge Whaley issued a ruling on July 30, 2001, remanding the five
cases back to state court. On August 1, 2001, a motion to consolidate the
remanded state court cases was filed. The
14
ultimate outcome of the lawsuits cannot be predicted with any degree of
certainty at this time. However, the Company believes, based on its analysis to
date of the claims asserted in these lawsuits and the underlying facts, that
resolution of these lawsuits will not have a material adverse effect on the
Company's financial condition, results of operations or cash flows.
(b) Environmental Matters.
Clean Air Standards. The Company has participated in a lawsuit against the
Texas Natural Resource Conservation Commission (TNRCC) regarding the limitation
of the emission of oxides of nitrogen (NOx) in the Houston area. A settlement of
the lawsuit was reached with the TNRCC in the second quarter of 2001. The
settlement provides for an increase in allowable NOx emissions, compared to the
original TNRCC requirements, through 2004. Further emission reduction
requirements may or may not be required through 2007, depending upon the outcome
of further investigations of regional air quality issues. Under the settlement,
the Company will expend substantial funds to achieve significant reductions of
NOx emissions. The Company anticipates investing up to $720 million in capital
and other special project expenditures by 2004, and an additional $140 million
between 2004 and 2007 to comply with this settlement.
Manufactured Gas Plant Sites. RERC Corp. and its subsidiaries
(collectively, RERC) and its predecessors operated a manufactured gas plant
(MGP) adjacent to the Mississippi River in Minnesota, formerly known as
Minneapolis Gas Works (MGW) until 1960. RERC has substantially completed
remediation of the main site other than ongoing water monitoring and treatment.
The manufactured gas was stored in separate holders. RERC is negotiating
clean-up of one such holder. There are six other former MGP sites in the
Minnesota service territory. Remediation has been completed on one site. Of the
remaining five sites, RERC believes that two were neither owned nor operated by
RERC. RERC believes it has no liability with respect to the sites it neither
owned nor operated.
At June 30, 2001, RERC had accrued $19 million for remediation of the
Minnesota sites. At June 30, 2001, the estimated range of possible remediation
costs was $8 million to $36 million. The cost estimates of the MGW 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.
Issues relating to the identification and remediation of MGPs are common
in the natural gas distribution industry. RERC has received notices from the
United States Environmental Protection Agency and others regarding its status as
a potentially responsible party (PRP) for other sites. Based on current
information, RERC has not been able to quantify a range of environmental
expenditures for potential remediation expenditures with respect to other MGP
sites.
Other Minnesota Matters. At June 30, 2001, RERC had recorded accruals of
$4 million (with a maximum estimated exposure of approximately $17 million at
June 30, 2001) for other environmental matters in Minnesota for which
remediation may be required.
Mercury Contamination. The Company's pipeline and distribution operations
have in the past employed elemental mercury in measuring and regulating
equipment. It is possible that small amounts of mercury may have been spilled in
the course of normal maintenance and replacement operations and that these
spills may have contaminated the immediate area with elemental mercury. The
Company has found this type of contamination at some sites in the past, and the
Company has conducted remediation at these sites. It is possible that other
contaminated sites may exist and that remediation costs may be incurred for
these sites. Although the total amount of these costs cannot be known at this
time, based on experience of the Company and that of others in the natural gas
industry to date and on the current regulations regarding remediation of these
sites, the Company believes that the costs of any remediation of these sites
will not be material to the Company's financial condition, results of operations
or cash flows.
REMA Ash Disposal Site Closures and Site Contaminations. Under the
agreement to acquire REMA (see Note 3(a) to Reliant Energy 10-K Notes), the
Company became responsible for liabilities associated with ash disposal site
closures and site contamination at the acquired facilities in Pennsylvania and
New Jersey prior to a plant closing, except for the first $6 million of
remediation costs at the Seward generating station. A prior owner retained
liabilities associated with the disposal of hazardous substances to off-site
locations prior to November 24, 1999. As of June 30, 2001, REMA has liabilities
associated with six ash disposal site closures and six site investigations and
15
environmental remediations. The Company has recorded its estimate of these
environmental liabilities in the amount of $36 million as of June 30, 2001. The
Company expects approximately $13 million will be paid over the next five years.
REPGB Asbestos Abatement and Soil Remediation. Prior to the Company's
acquisition of REPGB (see Note 3(b) to Reliant Energy 10-K Notes), REPGB had a
$25 million obligation primarily related to asbestos abatement, as required by
Dutch law, and soil remediation at six sites. During 2000, the Company initiated
a review of potential environmental matters associated with REPGB's properties.
REPGB began remediation in 2000 of the properties identified to have exposed
asbestos and soil contamination, as required by Dutch law and the terms of some
leasehold agreements with municipalities in which the contaminated properties
are located. All remediation efforts are expected to be fully completed by 2005.
As of June 30, 2001, the estimated undiscounted liability for this asbestos
abatement and soil remediation was $21 million.
Other. From time to time the Company has received notices from regulatory
authorities or others regarding its status as a PRP in connection with sites
found to require remediation due to the presence of environmental contaminants.
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 vigorously contesting claims that 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 condition, results of operations or
cash flows.
(c) Other Legal and Environmental Matters.
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings 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 disposition of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
(d) California Wholesale Market Uncertainty.
During the summer and fall of 2000, and continuing into early 2001, prices
for wholesale electricity in California increased dramatically as a result of a
combination of factors, including higher natural gas prices and emission
allowance costs, reduction in available hydroelectric generation resources,
increased demand, decreases in net electric imports, structural market flaws
including over-reliance on the electric spot market, and limitations on supply
as a result of maintenance and other outages. Although wholesale prices
increased, California's deregulation legislation kept retail rates frozen below
1996 levels until rates were raised by the California Public Utilities
Commission (CPUC) early this year.
As of December 31, 2000, the Company was owed a total of $282 million by
the California Power Exchange (Cal PX) and the California Independent System
Operator (Cal ISO). In the fourth quarter of 2000, the Company recorded a
pre-tax provision of $39 million against receivable balances related to energy
sales in the California market. As of June 30, 2001, the Company was owed a
total of $318 million by the Cal ISO, the Cal PX, the California Department of
Water Resources (CDWR) and California Energy Resource Scheduling for energy
sales in the California wholesale market during the fourth quarter of 2000
through June 30, 2001. In the first six months of 2001, the Company recorded a
pre-tax provision of $37 million against receivable balances related to energy
sales from January 1, 2001 through June 30, 2001 in the California market.
Management will continue to assess the collectibility of these receivables based
on further developments affecting the California electricity market and the
market participants described herein. Additional provisions to the allowance may
be warranted in the future.
In response to the filing of a number of complaints challenging the level
of wholesale prices, the Federal Energy Regulatory Commission (FERC) initiated a
staff investigation and issued an order on December 15, 2000 implementing a
series of wholesale market reforms, including an interim price review procedure
for prices above a $150/MWh "breakpoint" on sales to the Cal ISO and through the
Cal PX. The order did not prohibit sales above the
16
"breakpoint," but the seller was subject to weekly reporting and monitoring
requirements. For each reported transaction, potential refund liability extends
for a period of 60 days following the date any such transaction is reported to
the FERC.
On March 9, 2001, the FERC issued an order outlining criteria for
determining amounts subject to possible refund based on a monthly proxy market
clearing price for transactions in the Cal ISO and Cal PX markets from January
1, 2001 through May 28, 2001. According to those criteria, approximately $12
million of the $125 million charged by the Company in January 2001 for sales in
California to the Cal ISO and the Cal PX and approximately $7 million of the $47
million charged by the Company in February 2001 for sales in California to the
Cal ISO are subject to possible refunds. In addition, approximately $370,000 of
the $6.6 million charged by the Company from May 1 through May 28, 2001, for
sales in California to the Cal ISO are subject to possible refund. The FERC
found that the Company did not have any potential refund obligations associated
with its sales in March or April 2001. In the March 9 order, the FERC set forth
procedures for challenging possible refund obligations. On April 11 and 13 and
May 11, the Company submitted cost or other justification for most of the
January and February transactions designated as subject to refund. During the
second quarter of 2001, the Company accrued refunds of $15 million of which $3
million had been previously reserved in the first quarter of 2001. On June 22,
2001, the Company notified the FERC that it agreed to refund amounts in excess
of the proxy prices for May transactions in light of changes in environmental
restrictions on the Company's generators. Any refunds the Company may ultimately
be obligated to pay are to be credited against unpaid amounts owed to the
Company for its sales in the Cal PX or to the Cal ISO. The December 15 order
established that a refund condition would be in place for the period beginning
October 2, 2000 through December 31, 2002. Motions for rehearing have been filed
on a number of issues related to the December 15 order and such motions are
still pending before the FERC.
On April 26, 2001, the FERC issued an order establishing a market
monitoring and mitigation plan for the California markets to replace the
$150/MWh breakpoint plan. This plan became effective on May 29, 2001 and was to
have lasted no more than one year. The plan retains the "breakpoint" approach to
price mitigation, for bids in the real-time market during periods when power
reserves fall below 7.5 percent (i.e., Stages 1, 2 and 3 emergencies in the Cal
ISO). The plan's breakpoint amount is based on variable cost calculations using
data submitted confidentially by each gas-fired generator to the FERC and the
Cal ISO. The Cal ISO is instructed to use this data and daily indices of natural
gas and emissions allowance costs to establish the market-clearing price in
real-time based on the marginal cost of the highest-cost generator called to
run. The plan also increases the Cal ISO's authority to coordinate and control
generating facility outages, subject to periodic reports to and review by the
FERC; requires generators in California to offer all their available capacity
for sale in the real-time market; and conditions sellers' market-based rate
authority such that sellers violating certain conditions on their bids will be
subject to increased scrutiny by the FERC, potential refunds and even revocation
of their market-based rate authority. The FERC conditioned implementation of the
market monitoring and mitigation plan on the Cal ISO and the three California
public utilities filing a regional transmission organization proposal by June 1,
2001. On June 1, 2001, the Cal ISO and the three California public utilities
made a filing purporting to meet this requirement.
On June 19, 2001, the FERC issued an order modifying the market monitoring
and mitigation plan adopted in its April 26 order, to apply price controls to
all hours, instead of just hours of low operating reserve, and to extend the
mitigation measures to other Western states in addition to California. The proxy
market clearing price calculated by the Cal ISO will apply during reserve
deficiencies to all sales in the Cal ISO and Western spot markets. The affected
Western states are Arizona, Colorado, Idaho, Montana, Nevada, New Mexico,
Oregon, Utah, Washington and Wyoming. The proxy market clearing price will
include variable operations and maintenance costs ($6/MWh) and natural gas
costs, while emissions costs and start-up fuel costs incurred in providing
energy will be billed by suppliers directly to the Cal ISO. The Cal ISO will
also add a 10 percent premium to market clearing prices to compensate sellers
for credit uncertainty in California. In non-emergency hours in California, the
maximum price in California and the West will be capped at 85 percent of the
highest Cal ISO hourly market clearing price established during the hours when
the last Stage 1 emergency was in effect. Sellers other than marketers will be
allowed to bid higher than the maximum prices, but such bids are subject to
justification and potential refund. Justification of higher prices is limited to
establishing higher actual gas costs than the proxy calculation averages.
Marketers cannot justify prices above the set maximum, but rather must be price
takers. The plan requires that every non-hydroelectric generator located in
California with available uncommitted capacity must bid into the Cal ISO's
real-time market in every hour, and non-hydroelectric generators in other
Western states that use the interstate transmission grid must likewise make
their uncommitted capacity available to a spot market of their choice. The
modified monitoring and mitigation plan went into effect June 20, 2001, and will
terminate on September 30, 2002, covering two summer peak seasons, or
approximately 16 months. The Company believes that while the mitigation plan
will reduce volatility in the market, the Company will nevertheless be able to
profitably operate its facilities in
17
the West because the proxy market clearing price is based on the heat rate of
the least efficient unit on-line during each hour. Additionally, as noted above,
the mitigation plan allows sellers, such as the Company, to justify prices above
the proxy price. Finally, any adverse impacts of the mitigation plan on the
Company's operations would be mitigated, in part, by the Company's forward
hedging activities. The FERC set July 2, 2001, as the refund effective date for
mitigation of prices throughout the West. This means that transactions after
that date may be subject to refund if found to be unjust or unreasonable.
The order issued June 19 further requires all public utility sellers and
buyers in the Cal ISO's markets to participate in settlement discussions to
address past accounts and creditworthiness issues and to structure more
long-term contracting. This conference convened on June 25, 2001, and continued
through July 9, 2001 The settlement judge made his recommendations to the FERC
regarding a proposed methodology for calculating possible refunds by sellers and
procedures for resolving that and other outstanding issues on July 12, 2001. The
FERC issued an order on July 25, 2001 adopting most of the settlement judge's
recommendations, with modifications, and set an expedited hearing schedule. The
Company cannot currently predict the amount of these potential refunds, if any,
because the methodology used to calculate these refunds is dependent on
information that is only known to the Cal ISO. The amounts of any refunds will
be determined by the end of the expedited hearing process. This proceeding
should be completed by September 24, 2001. The Company has not reserved any
amounts for potential future refunds as a reasonable estimate cannot currently
be made. Any refunds that are determined in the FERC proceeding are to be offset
against unpaid amounts owed to the Company for its prior sales.
In addition to the FERC investigation discussed above, several state and
other federal regulatory investigations and complaints have commenced in
connection with the wholesale electricity prices in California and other
neighboring Western states to determine the causes of the high prices and
potentially to recommend remedial action. In California, the CPUC, the
California Electricity Oversight Board, the California Bureau of State Audits,
the California State Senate and the California Office of the Attorney General
all have separate ongoing investigations into the high prices and their causes.
The Washington and Oregon attorney generals have begun similar investigations.
With the exception of a report by the California Bureau of State Audits, none of
these investigations has been completed and no findings have been made in
connection with any of them. The California state audit report, released earlier
this year, concluded that the foremost cause of the market disruptions in
California was fundamental flaws in the structure of the power market. In
addition, recently promulgated regulations may make the Company subject to
additional reporting requirements to the California Energy Commission.
Pursuant to a resolution by the California Senate Rules Committee, the
California Senate has established a Select Committee on Price Manipulation of
the Wholesale Market (Committee). On June 12, 2001, the Committee served on
Reliant Energy Services, Inc., and Reliant Energy Power Generation, Inc.,
subpoenas for documents. On July 18, 2001, the Committee found that these two
companies had not provided an adequate response to the subpoenas, and it voted
to recommend that the Senate initiate contempt proceedings against those
entities. The ultimate outcome of the Senate proceedings cannot be predicted
with any degree of certainty at this time.
In default on payments for wholesale power purchased through the Cal PX
and from the Cal ISO, the credit ratings of two of California's public
utilities, Pacific Gas and Electric (PG&E) and Southern California Edison
Company (SCE), remain below investment grade. As a result, PG&E and SCE are no
longer able to schedule power transactions through the Cal ISO, which has relied
on its emergency dispatch authority to serve the load of PG&E and SCE that
cannot be served by generation owned or under contract by PG&E or SCE. According
to orders of the FERC, the Cal ISO may not make real-time power purchases or
issue emergency dispatch orders to third-party suppliers to serve the utilities'
net short load in the absence of a creditworthy counterparty to back the
liabilities of PG&E or SCE. The bankruptcy court judge in the PG&E bankruptcy
has also issued an injunction precluding the Cal ISO from making such purchases.
The CDWR has acted as a creditworthy counterparty for certain real-time
transactions on behalf of PG&E and SCE, but disputes its direct liability for
some of the power obtained from third-party suppliers to serve the utilities'
net short load. The issue of CDWR's liability for amounts due from PG&E and SCE
is currently before the FERC. Since January 2000, pursuant to emergency
legislation enacted by the California Legislature, the CDWR has negotiated and
purchased power through short- and long-term contracts on behalf of PG&E and
SCE. On May 10, 2001, the CDWR received authorization under state law to issue
up to $13.4 billion in bonds to cover the costs of power purchased on behalf of
PG&E and SCE. These funds may not, however, be used to pay for any past
under-collections or to service existing debt of the utilities.
18
In addition to creditworthiness and payment disputes regarding
transactions through the Cal ISO, certain issues remain outstanding with regard
to the defaults of PG&E and SCE in the markets operated by the Cal PX, which is
now in Chapter 11 bankruptcy proceedings. The Cal PX initially allocated the
utilities' defaults to other market participants, under a chargeback provision
of the Cal PX tariff, which action was challenged in both federal court and at
the FERC. Although the Cal PX's actions with regard to the chargebacks were
ultimately stayed by the federal court and ordered by the FERC to be rescinded,
the issue of how monies held in escrow by the Cal PX will be distributed among
market participants is still outstanding. In addition, Reliant Energy Services,
Inc. and the Cal PX have filed actions to recover payment from the state of
California for its seizure of block forward contracts purchased by PG&E and SCE
that secured the utilities' activities in the Cal PX markets.
In May 2001, a bill was passed by the California Senate that proposed a
tax on "windfall profits" earned by electric generators in California. The bill
would impose a 100 percent tax on any electricity sold by California generators
that exceeds a "just and reasonable price," such price to be set by the CPUC.
This bill expired when the first extraordinary session ended. During the second
extraordinary session of the California legislature, currently in progress,
similar bills have been introduced in both the California Senate and the
California Assembly. The Senate bill, which was introduced on May 17, would
impose a tax equal to the portion of sales above the "cost based rates," which
include "reasonable" profit margins and maintenance and operating expenses. This
bill passed the Senate on May 17 and is currently in committee in the California
Assembly. It must be voted on and passed by the California Assembly, and signed
by the Governor, before it will become law. On May 15, the California Assembly
also introduced a bill that would tax "excess" gross receipts from electrical
energy distribution. The Assembly bill would impose a tax equal to 50% of all
gross receipts higher than a base price but not more than 150% of the base
price. For receipts between 150% and 200% of the base price, the tax is 70%, and
for receipts over 200% of the base price, the tax is 90% of the gross receipts.
The bill sets the base price at $60 per megawatt hour until the CPUC sets an
appropriate price. This bill has not yet passed the California Assembly. If
either bill is enacted into law in its current form, such a tax could
significantly increase the cost of operating power generation facilities serving
the California market and could have a material adverse effect on the Company's
financial condition, results of operations and cash flows.
(e) Indemnification of Dutch Stranded Costs.
In January 2001, the Dutch Electricity Production Sector Transitional
Arrangements Act (Transition Act) became effective. The Transition Act, among
other things, allocated to REPGB and the three other Dutch generation companies,
a share of the assets, liabilities and stranded cost commitments of BV
Nederlands Elektriciteit Administratiekantoor (formerly, N.V. Samenwerkende
elecktriciteits-produktiebedrijven (SEP)). Prior to the enactment of the
Transition Act, SEP acted as the national electricity pooling and coordinating
body for the generation output of REPGB and the three other national Dutch
generation companies. REPGB and the three other Dutch generation companies are
shareholders of SEP.
The Transition Act and related agreements specify that REPGB has a 22.5%
share of SEP's assets, liabilities and stranded cost commitments. SEP's stranded
cost commitments consisted primarily of various uneconomical or stranded cost
investments and long-term gas supply and power contracts entered into prior to
the liberalization of the Dutch wholesale electricity market. SEP's primary
asset is its ownership interest in the Dutch national grid company, which is
expected to be sold to the Dutch government in the fourth quarter of 2001 for
approximately NLG 2.55 billion (approximately $982 million based on an exchange
rate of 2.59 NLG per U.S. dollar as of June 30, 2001). Under the Transition Act,
REPGB can either assume its 22.5% allocated interest in the contracts or,
subject to the terms of the contracts, sell its interests to third parties.
The Transition Act, as enacted, provided that, subject to the approval of
the European Commission, the Dutch government will provide financial
compensation to the Dutch generation companies, including REPGB, for certain
liabilities associated with long-term district heating contracts entered into by
the generation companies with various municipalities. In July 2001, the European
Commission ruled that under certain conditions the Dutch government can provide
financial compensation to the generation companies for the district heating
contracts. However, at this point, it is unclear what the timing of this
compensation will be or what form it will take. To the extent that this
compensation is not ultimately provided to the generation companies by the Dutch
government, REPGB will collect its compensation directly from the former
shareholders as further discussed below.
The former shareholders have agreed pursuant to a share purchase agreement
to indemnify REPGB for up to NLG 1.9 billion in stranded cost liabilities
(approximately $734 million based on an exchange rate of 2.59 NLG per U.S.
dollar as of June 30, 2001). The indemnity obligation of the former shareholders
and various provincial and
19
municipal entities (including the city of Amsterdam), is secured by a NLG 900
million escrow account (approximately $347 million based on an exchange rate of
2.59 NLG per U.S. dollar as of June 30, 2001). In the first quarter of 2001,
REPGB recorded a $544 million liability representing the estimated net present
value of its statutorily allocated share of SEP's stranded cost gas and electric
and district heating commitments over the life of the respective contracts.
Pursuant to SFAS No. 133, the gas and electric contracts are marked to market.
As of June 30, 2001, the Company has recorded a liability of $376 million for
its stranded cost gas and electric and district heating commitments. In
addition, the Company recorded a corresponding asset of equal amount for the
indemnification of this obligation from REPGB's former shareholders and the
Dutch government. The estimate of stranded cost liability is based on a number
of assumptions, many of which are contingent upon the outcome of future events,
such as fuel and energy prices, that are not known at this time. The actual
amount of the ultimate stranded cost liability may be greater or smaller
depending on the outcome of these assumptions.
During the second quarter of 2001, the Company filed aggregate indemnity
claims of NLG 64 million (approximately $25 million) for stranded cost
liabilities associated with the district heating and gas and electricity
contract losses incurred during the first quarter of 2001. Based on current
market projections, the Company expects to file similar claims on a quarterly
basis for the lifetime of these contracts. On May 31 and July 9, 2001, the
former shareholders rejected REPGB's indemnity claims. The Company believes that
the rejection of its indemnity claims is without merit and intends to vigorously
pursue its claims against the former shareholders.
During the second quarter of 2001, the Company recorded a $51 million
pre-tax gain (NLG 125 million) recorded as equity income for the preacquisition
gain contingency related to the acquisition of REPGB for the value of its equity
investment in SEP. This gain was based on the Company's evaluation of SEP's
financial position and fair value. Pursuant to the purchase agreement of REPGB,
as amended, REPGB is entitled to a NLG 125 million (approximately $51 million)
dividend from SEP under certain conditions.
(f) Reliant Energy HL&P Rate Matters.
The Texas Utility Commission has issued an interim order on June 5, 2001
requiring Reliant Energy HL&P to reverse the amount of redirected depreciation
and accelerated depreciation since it was in the Texas Utility Commission's
estimation that the utility had overmitigated its stranded costs. The Company
disagrees with certain positions prescribed in the interim order by the Texas
Utility Commission and will determine future action based on the final order
anticipated in August 2001. At June 30, 2001, cumulative redirected depreciation
and cumulative accelerated depreciation for regulatory purposes totaled $725
million and approximately $1 billion, respectively. If implemented, the reversal
of redirected depreciation would result in a lower rate for the transmission and
distribution utility, and the accelerated depreciation being returned through
credits over seven years would serve as offsets to the transmission and
distribution utility's non-bypassable charges. The rates derived from the Texas
Utility Commission's June 5, 2001 interim order will be used during the retail
electric pilot project which began on July 31, 2001. The Company does not expect
the final Reliant Energy HL&P transmission and distribution rate to be
established until the end of August 2001 and implemented until January 1, 2002.
The credits related to accelerated depreciation will begin on January 1, 2002.
For information regarding redirected depreciation and accelerated depreciation,
see Note 4(a) to Reliant Energy 10-K Notes.
(g) Construction Agency Agreement.
In April 2001, Reliant Resources, through several of its subsidiaries,
entered into operative documents with special purpose entities to facilitate the
development, construction, financing and leasing of several power generation
projects. The special purpose entities have an aggregate financing commitment
from equity and debt participants (Investors) of $2.5 billion. Reliant
Resources, through several of its subsidiaries, acts as construction agent for
the special purpose entities, and is responsible for completing construction of
these projects by August 31, 2004, but has generally limited its risk related to
construction completion to less than 90% of costs incurred to date, except in
certain events. Upon completion of an individual project and exercise of the
lease option, Reliant Resources' subsidiaries will be required to make lease
payments in an amount sufficient to provide a return to the Investors. If
Reliant Resources does not exercise its option to lease any project upon its
completion, Reliant Resources must purchase the project or remarket the project
on behalf of the special purpose entities. At the end of an individual project's
operating lease term (approximately five years from construction completion),
the lessees have the option to extend the lease at fair market value, purchase
the project at a fixed amount equal to the original construction cost, or act as
a remarketing agent and sell the project to an independent third party. If the
lessees elect the remarketing option, they may be required to make a payment of
up to 85% of the project cost if the proceeds from remarketing are not
sufficient to repay the Investors. Reliant Resources has guaranteed the
performance and
20
payment of its subsidiaries' obligations during the construction periods and, if
the lease option is exercised, the lessee's obligations during the lease period.
(13) BENEFIT CURTAILMENT AND ENHANCEMENT CHARGE
During the first quarter of 2001, the Company recognized a pre-tax,
non-cash charge of $101 million relating to the redesign of some of Reliant
Energy's benefit plans in anticipation of distributing to Reliant Energy's or
its successor's shareholders the remaining common stock of its unregulated
subsidiary, Reliant Resources. For information regarding this anticipated
transaction, see Note 4(b) to Reliant Energy 10-K Notes.
Effective March 1, 2001, the Company will no longer accrue benefits under
a noncontributory pension plan for its domestic non-union employees of Reliant
Resources and Reliant Energy Tegco, Inc. (Resources Participants). Effective
March 1, 2001, each non-union Resources Participant's unvested pension account
balance became fully vested and a one-time benefit enhancement was provided to
some qualifying participants. During the first quarter of 2001, the Company
incurred a charge to earnings of $84 million (pre-tax) for a one-time benefit
enhancement and a gain of $23 million (pre-tax) related to the curtailment of
Reliant Energy's pension plan.
Effective March 1, 2001, the Company discontinued providing subsidized
postretirement benefits to its domestic non-union employees of Reliant Resources
and its participating subsidiaries and Reliant Energy Tegco, Inc. The Company
incurred a pre-tax charge of $40 million during the first quarter of 2001
related to the curtailment of the Company's postretirement obligation. For
additional information regarding these benefit plans, see Notes 12(b) and 12(d)
to Reliant Energy 10-K Notes.
(14) REPORTABLE SEGMENTS
The Company's determination of reportable segments considers the strategic
operating units under which the Company manages sales, allocates resources and
assesses performance of various products and services to wholesale or retail
customers in differing regulatory environments. The Company has identified the
following reportable segments: Electric Operations, Natural Gas Distribution,
Pipelines and Gathering, Wholesale Energy, European Energy and Other Operations.
For descriptions of these reporting segments, see Note 1 to Reliant Energy 10-K
Notes. Financial data for the business segments are as follows:
FOR THE THREE MONTHS ENDED JUNE 30, 2000 AS OF
-------------------------------------------------- DECEMBER 31,
NET 2000
REVENUES FROM INTERSEGMENT OPERATING -------------
NON-AFFILIATES REVENUES INCOME (LOSS) TOTAL ASSETS
-------------- ------------ ------------ ------------
(IN MILLIONS)
Electric Operations........................ $ 1,421 $ -- $ 325 $ 10,691
Natural Gas Distribution................... 785 8 (12) 4,509
Pipelines and Gathering.................... 39 52 33 2,358
Wholesale Energy........................... 3,354 98 173 10,794
European Energy............................ 136 -- 24 2,521
Other Operations........................... 20 8 (29) 2,296
Discontinued Operations (1)................ -- -- -- 195
Reconciling Elimination.................... -- (166) -- (1,665)
Consolidated............................... $ 5,755 $ -- $ 514 $ 31,699
21
FOR THE SIX MONTHS ENDED JUNE 30, 2000
-----------------------------------------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS)
-------------- ------------- ------------
(IN MILLIONS)
Electric Operations.......... $ 2,368 $ -- $ 527
Natural Gas Distribution..... 1,829 15 93
Pipelines and Gathering...... 86 95 65
Wholesale Energy............. 5,368 240 151
European Energy.............. 286 -- 57
Other Operations............. 31 13 (38)
Reconciling Elimination...... -- (363) --
-------------- ------------- ------------
Consolidated................. $ 9,968 $ -- $ 855
============== ============= ============
AS OF
FOR THE THREE MONTHS ENDED JUNE 30, 2001 JUNE 30, 2001
-------------------------------------------------- -------------
NET
REVENUES FROM INTERSEGMENT OPERATING TOTAL
NON-AFFILIATES REVENUES INCOME (LOSS) ASSETS
-------------- ------------ ------------ -------------
(IN MILLIONS)
Electric Operations..................................... $ 1,523 $ -- $ 342 $ 10,908
Natural Gas Distribution................................ 856 32 (49) 3,706
Pipelines and Gathering................................. 50 46 34 2,335
Wholesale Energy........................................ 9,252 126 292 11,744
European Energy......................................... 276 -- 9 3,043
Other Operations........................................ 29 12 (19) 2,157
Discontinued Operations (1)............................. -- -- -- 120
Reconciling Elimination................................. -- (216) -- (881)
-------------- ------------ ------------ -------------
Consolidated............................................ $ 11,986 $ -- $ 609 $ 33,132
============== ============ ============ =============
FOR THE SIX MONTHS ENDED JUNE 30, 2001
----------------------------------------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS)
-------------- ------------- ------------
(IN MILLIONS)
Electric Operations.......... $ 2,913 $ -- $ 528
Natural Gas Distribution..... 3,125 86 86
Pipelines and Gathering...... 125 101 72
Wholesale Energy............. 18,536 435 508
European Energy.............. 524 -- 27
Other Operations............. 48 25 (152)
Reconciling Elimination...... -- (647) --
-------------- ------------- ------------
Consolidated................. $ 25,271 $ -- $ 1,069
============== ============= ============
- ----------------
(1) Effective December 1, 2000, Reliant Energy's Board of Directors approved a
plan to dispose of its Latin American segment, through sales of its
assets. For more information regarding the Company's discontinued
operations, see Note 5.
22
Reconciliation of Operating Income to Net Income Attributable to Common
Stockholders:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------- -------------------------
2000 2001 2000 2001
------- ------- ------- -------
(IN MILLIONS)
Operating Income......................................... $ 514 $ 609 $ 855 $ 1,069
Other Expense............................................ (167) (111) (320) (252)
Income Tax Expense....................................... (111) (182) (165) (294)
Loss from Discontinued Operations, net of tax............ (19) -- (20) --
Loss on Disposal of Discontinued Operations, net of tax.. -- -- -- (7)
Extraordinary Item....................................... 7 -- 7 --
Cumulative Effect of Accounting Change, net of tax....... -- -- -- 62
------- ------- ------- -------
Net Income Attributable to Common Stockholders........... $ 224 $ 316 $ 357 $ 578
======= ======= ======= =======
(15) INITIAL PUBLIC OFFERING OF RELIANT RESOURCES
On July 27, 2000, Reliant Energy announced its intention to form Reliant
Resources to own and operate a substantial portion of Reliant Energy's
unregulated operations, and to offer no more than 20% of the common stock of
Reliant Resources in an initial public offering (Offering) in connection with
the Company's business separation plan. In May 2001, Reliant Resources completed
its initial public offering of 59.8 million shares of its common stock and
received net proceeds of $1.7 billion. Pursuant to the terms of the master
separation agreement, Reliant Resources used $147 million of the net proceeds to
repay certain indebtedness owed to Reliant Energy. Reliant Resources used the
remainder of net proceeds to increase its working capital. Reliant Energy
expects the Offering to be followed by a distribution of the remaining common
stock of Reliant Resources owned by Reliant Energy to Reliant Energy's or its
successor's shareholders within twelve months of the Offering (Distribution). As
a result of the Offering, the Company recorded directly into stockholders'
equity as a component of common stock a $509 million gain on the sale of its
subsidiary's stock. For additional information regarding the Company's business
separation plan, see Note 4(b) to Reliant Energy 10-K Notes. The Reliant
Resources common stock issued in the Offering has been reflected as minority
interest in consolidated subsidiaries in the Company's Consolidated Balance
Sheet as of June 30, 2001.
The Distribution is subject to further corporate approvals, market and
other conditions, and government actions, including receipt of a favorable
Internal Revenue Service ruling that the Distribution would be tax-free to
Reliant Energy or its successor and its shareholders for U.S. federal income tax
purposes, as applicable. There can be no assurance that the Distribution will be
completed as described or within the time periods outlined above.
(16) SUBSEQUENT EVENTS
(a) Debt Refinancing.
In July 2001, financing subsidiaries of Reliant Energy terminated several
bank credit facilities and entered into new bank credit facilities which
increased the aggregate amount of bank facilities at financing subsidiaries to
$4.3 billion. The new bank facilities expire in July 2002 and are expected to
support the issuance of commercial paper. In connection with the termination of
a Euro 560 million bank facility, financing subsidiary bank loans of Euro 560
million were refinanced with U.S. dollar denominated commercial paper issued by
a financing subsidiary.
(b) Reliant Resources Stock Repurchase.
During the third quarter of 2001, Reliant Resources purchased 840,000
shares of Reliant Resources common stock at an average price of $20.58 per
share, or an aggregate purchase price of $17.3 million. These shares were
purchased in anticipation of funding benefit plan obligations of Reliant
Resources expected to be funded prior to the Distribution. The master separation
agreement between Reliant Resources and Reliant Energy restricts the ability of
Reliant Resources to issue shares of its common stock prior to the separation of
the two companies without the prior consent of Reliant Energy. Accordingly,
Reliant Resources may make future purchases of its common stock in anticipation
of funding pre-Distribution employee benefit plan obligations.
23
(c) Hedge of Net Investment in Foreign Subsidiaries.
In July 2001, the Company has entered into foreign currency swaps on Euro
560 million (approximately $475 million based on an exchange rate of 0.8490 Euro
per U.S. dollar as of June 30, 2001) to hedge its net investment in its European
Energy segment, which expire in 2002. The Company has designated these
derivative instruments as hedges. Changes in the fair value of the swaps will be
recorded as foreign currency translation adjustments as a component of
stockholders' equity.
(d) Reliant Energy Communications.
During the third quarter of 2001, the Company decided to evaluate
strategic alternatives, including divestiture, partnerships with other market
participants or other strategic alternatives, for the Company's Communications
business which serves as a facility-based competitive local exchange carrier and
Internet services provider as well as network operations centers and managed
data centers in Houston and Austin. The Company does not believe the disposition
or other strategic alternatives of this business will have a material adverse
effect on its consolidated financial condition, results of operations or cash
flows in 2001 and in future periods.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF RELIANT ENERGY AND SUBSIDIARIES
The following discussion and analysis should be read in combination with
our Interim Financial Statements contained in this Form 10-Q/A.
RESTATEMENT OF THE INTERIM FINANCIAL STATEMENTS
On February 5, 2002, the Company announced that it was restating its
earnings for the second and third quarters of 2001. As more fully described in
Note 1, the restatement relates to a correction in accounting treatment for a
series of four structured transactions that were inappropriately accounted for
as cash flow hedges for the period of May 2001 through September 2001.
Although these transactions were undertaken and accounted for as cash flow
hedges, having further reviewed the transactions, the Company now believes that
they did not meet the requirements of a cash flow hedge under Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended (SFAS No. 133). Consequently, these
contracts should have been accounted for as derivatives with changes in fair
value recognized through the income statement.
As a result, the Original Interim Financial Statements and related
disclosures as of June 30, 2001 and for the three and six months ended June 30,
2001 have been restated from amounts previously reported. The principal effects
of the restatement on the accompanying financial statements are set forth in
Note 1 of the Notes to Interim Financial Statements.
OVERVIEW
We are a diversified international energy services and energy delivery
company that provides energy and energy services in North America and Europe. We
operate one of the nation's largest electric utilities in terms of kilowatt-hour
(KWh) sales, and our three natural gas distribution divisions together form one
of the United States' largest natural gas distribution operations in terms of
customers served. We invest in the acquisition, development and operation of
domestic and international non-rate regulated power generation facilities. We
own two interstate natural gas pipelines that provide gas transportation,
supply, gathering and storage services, and we also engage in wholesale energy
marketing and trading.
In this section we discuss our results of operations on a consolidated
basis and individually for each of our business segments. We also discuss our
liquidity and capital resources. Our financial reporting segments include
Electric Operations, Natural Gas Distribution, Pipelines and Gathering,
Wholesale Energy, European Energy and Other Operations. For segment reporting
information, please read Note 14 to our Interim Financial Statements.
Effective December 1, 2000, our Board of Directors approved a plan to
dispose of our Latin American business segment and sale of its assets.
Accordingly, we are reporting the results of our Latin American business segment
as discontinued operations for all periods presented in our Interim Financial
Statements in accordance with Accounting Principles Board Opinion No. 30. For
additional information regarding the disposal of our Latin American business
segment, please read Note 19 to Reliant Energy 10-K Notes.
In 2000, we submitted a business separation plan to the Texas Utility
Commission that was later amended during the year to restructure our businesses
into two separate publicly traded companies in order to separate our unregulated
businesses from our regulated businesses. In December 2000, the plan was
substantially approved by the Texas Utility Commission in its entirety and a
final order was issued on April 10, 2001. For additional information regarding
our business separation plan, please read Note 4(b) to Reliant Energy 10-K
Notes.
As part of the separation, Reliant Energy will undergo a restructuring of
its corporate organization to achieve a new holding company structure. The new
holding company will hold our regulated businesses. In connection with the
formation of the new holding company, we will seek an exemption from the
registration requirements of the Public Utility Holding Company Act of 1935
(1935 Act) or, if no exemption is available, the new holding company will
register as a public utility holding company under the 1935 Act. The
restructuring will require approval of the Securities and Exchange Commission,
certain of the affected state commissions and the Nuclear Regulatory Commission.
25
In connection with our business separation plan, we formed Reliant
Resources, which owns and operates a substantial portion of our unregulated
operations. In May 2001, Reliant Resources offered 59.8 million shares of its
common stock to the public at an initial public offering (Offering) price of $30
per share and received net proceeds from the Offering of $1.7 billion. Pursuant
to the master separation agreement, Reliant Resources used $147 million of the
net proceeds to repay certain indebtedness owed to Reliant Energy. Reliant
Energy expects to distribute the remaining common stock of Reliant Resources it
owns to Reliant Energy's or its successor's shareholders within twelve months of
the closing of the Reliant Resources initial public offering.
On May 12, 2000, one of our subsidiaries purchased entities owning
electric power generating assets and development sites located in Pennsylvania,
New Jersey, and Maryland having an aggregate net generating capacity of
approximately 4,262 MW. The purchase price for the May 2000 transaction was $2.1
billion. We accounted for the acquisition as a purchase, and accordingly, our
results of operations include the results of operations for REMA only for the
period after the acquisition date. For additional information about this
acquisition, including our accounting treatment of the acquisition, please read
Note 3(a) to Reliant Energy 10-K Notes and Note 4 to our Interim Financial
Statements.
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2000 2001 2000 2001
-------- -------- -------- --------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Revenues .............................................. $ 5,755 $ 11,986 $ 9,968 $ 25,271
Operating Expenses .................................... (5,241) (11,377) (9,113) (24,202)
-------- -------- -------- --------
Operating Income ...................................... 514 609 855 1,069
Income from equity investments in unconsolidated
subsidiaries ....................................... 5 52 6 64
Interest Expense ...................................... (187) (150) (347) (328)
Distribution on Trust Preferred Securities ............ (13) (14) (27) (28)
Minority Interest ..................................... -- (34) 1 (34)
Other Income .......................................... 28 35 47 74
Income Tax Expense .................................... (111) (182) (165) (294)
Loss from Discontinued Operations, net of tax ......... (19) -- (20) --
Loss on Disposal of Discontinued Operations, net of tax -- -- -- (7)
Extraordinary Item .................................... 7 -- 7 --
Cumulative Effect of Accounting Change, net of tax .... -- -- -- 62
-------- -------- -------- --------
Net Income Attributable to Common Stockholders ........ $ 224 $ 316 $ 357 $ 578
======== ======== ======== ========
Basic Earnings Per Share .............................. $ 0.79 $ 1.09 $ 1.26 $ 2.01
Diluted Earnings Per Share ............................ $ 0.78 $ 1.08 $ 1.25 $ 1.99
Three months ended June 30, 2000 compared to three months ended June 30, 2001
We reported consolidated net income of $224 million ($0.78 per diluted
share) for the three months ended June 30, 2000 compared to $316 million ($1.08
per diluted share) for the three months ended June 30, 2001. The 2000 results
include a $19 million loss from discontinued operations in Latin America and a
$7 million extraordinary gain related to the early extinguishment of long-term
debt. The 2001 results include a $33 million after-tax gain recorded in equity
income related to a preacquisition contingency for the value of SEP, the
coordinating body for the Dutch electricity generating sector, offset by related
minority interest of $6 million.
Our consolidated net income, after adjusting for the items described
above, was $236 million ($0.82 per diluted share) for the three months ended
June 30, 2000 compared to $289 million ($0.99 per diluted share) for the three
months ended June 30, 2001. The improvement was primarily due to increased
profitability from our Wholesale Energy and Electric Operations businesses,
partially offset by reduced contributions from our Natural Gas Distribution and
European Energy segments.
For an explanation of changes in operating income for the second quarter
of 2000 versus 2001, see the discussion below of operating income by segment.
26
Equity income from unconsolidated subsidiaries increased by $47 million
during the second quarter of 2001 compared to 2000 primarily due to the pre-tax
gain of $51 million related to a preacquisition contingency recorded by our
European Energy segment (see Note 12(e)), partially offset by decreased earnings
from unconsolidated subsidiaries of our Wholesale Energy segment due to a plant
outage at one of our equity investments. Our Wholesale Energy segment reported
income from equity investments for the three months ended June 30, 2000 of $5.5
million compared to $1 million for the same period in 2001.
We incurred charges for interest expense and distribution on trust
preferred securities of $200 million and $164 million for the second quarters of
2000 and 2001, respectively. The decrease resulted from a combination of lower
levels of both short-term borrowings and long-term debt and lower interest rates
in the second quarter of 2001 compared to the same period in 2000.
Other income increased by $7 million during the second quarter of 2001
compared to 2000, primarily due to increased interest income from our Electric
Operations and Wholesale Energy segments.
During the second quarter of 2001, we recorded minority interest expense
of $34.4 million related to the minority interest in Reliant Resources.
The effective tax rate for the second quarter of 2000 and 2001 was 32% and 37%,
respectively.
Six months ended June 30,2000 compared to six months ended June 30, 2001
We reported consolidated net income of $357 million ($1.25 per diluted
share) for the six months ended June 30, 2000 compared to $578 million ($1.99
per diluted share) for the six months ended June 30, 2001. The 2000 results
include a $20 million loss from discontinued operations in Latin America and an
extraordinary gain of $7 million related to the early extinguishment of
long-term debt. The 2001 results reflect a $7 million after-tax loss on the
disposal of discontinued operations in Latin America, a $62 million after-tax
cumulative effect of an accounting change from the adoption of SFAS No. 133, a
$65 million after-tax non-cash charge relating to the redesign of the company's
benefit plans for employees of our unregulated businesses and a $33 million
after-tax gain recorded in equity income related to a preacquisition contingency
for the value of SEP, offset by related minority interest of $6 million.
Our consolidated net income, after adjusting for the items described
above, was $370 million ($1.29 per diluted share) for the first six months of
2000 compared to $563 million ($1.94 per diluted share) for the first six months
of 2001. The increase in adjusted earnings for this period was largely driven by
strong performance from our Wholesale Energy businesses.
For information regarding the adoption of SFAS No. 133, the discontinuance
of our Latin American segment, the gain related to the preacquisition
contingency and the benefit charge incurred in the first quarter of 2001, see
Notes 3, 5, 12(e) and 13 to our Interim Financial Statements.
For an explanation of changes in operating income for the first six months
of 2000 versus 2001, see the discussion below of operating income (loss) by
segment.
Equity income from unconsolidated subsidiaries increased by $58 million
during the first half of 2001 compared to 2000 primarily due to the pre-tax gain
of $51 million related to a preacquisition contingency recorded by our European
Energy segment, as discussed above, and increased earnings from unconsolidated
subsidiaries of our Wholesale Energy segment. Our Wholesale Energy segment
reported income from equity investments for the six months ended June 30, 2000
of $6 million compared to $14 million in the same period in 2001. The equity
income in 2001 primarily resulted from an investment in an electric generation
plant in Boulder City, Nevada. The plant became operational in May 2000.
We incurred charges for interest expense and distribution on trust
preferred securities of $374 million and $356 million for the first six months
of 2000 and 2001, respectively. The decrease resulted from a combination of
lower levels of both short-term borrowings and long-term debt and lower interest
rates in the first six months of 2001 compared to the same period in 2000.
Other income increased by $27 million during the first six months of 2001
compared to 2000 primarily due to increased interest income from our Electric
Operations and Wholesale Energy segments and a pre-tax impairment
27
loss of $22 million recorded in 2000 related to certain marketable securities,
partially offset by a $15 million gain related to the sale of a
development-stage project in 2000 and a federal tax refund in 2000. For
additional information regarding our investment equity securities noted above,
see Note 2(l) to Reliant Energy 10-K Notes.
During the six months ended June 30, 2001, we recorded minority interest
expense of $34.4 million related to the minority interest in Reliant Resources.
The effective tax rate for the first six months of 2000 and 2001 was 31%
and 36%, respectively.
As discussed in Note 12(e) to our Interim Financial Statements, the
Transition Act allocated to the Dutch generation sector, including REPGB,
financial responsibility for SEP's obligations to purchase electricity and gas
under a gas supply contract and three electricity contracts. As a result of the
above, we recorded an out-of-market, net stranded cost liability of $169 million
and a related deferred tax asset of $61 million at June 30, 2001 for our
statutorily allocated share of these gas supply and electricity contracts. We
believe that the costs incurred by REPGB subsequent to the tax holiday ending in
2001 related to these contracts will be deductible for Dutch tax purposes.
However, due to the uncertainties related to the deductibility of these costs,
we have recorded a reserve in other liabilities in our Interim Financial
Statements of $61 million as of June 30, 2001.
The table below shows operating income (loss) by segment:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2000 2001 2000 2001
------------ ------------ ---------- ----------
(IN MILLIONS)
Electric Operations......................................... $ 325 $ 342 $ 527 $ 528
Natural Gas Distribution.................................... (12) (49) 93 86
Pipelines and Gathering..................................... 33 34 65 72
Wholesale Energy............................................ 173 292 151 508
European Energy............................................. 24 9 57 27
Other Operations............................................ (29) (19) (38) (152)
------------ ------------ ---------- ----------
Total Consolidated.................................... $ 514 $ 609 $ 855 $ 1,069
============ ============ ========== ==========
ELECTRIC OPERATIONS
Our Electric Operations segment conducts operations under the name
"Reliant Energy HL&P," an unincorporated division of Reliant Energy. Our
Electric Operations segment generates, purchases, transmits and distributes
electricity to approximately 1.7 million customers in a 5,000 square mile area
on the Texas Gulf Coast, including Houston, Texas.
28
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
(IN MILLIONS)
Operating Revenues:
Base Revenues............................................ $ 834 $ 816 $ 1,436 $ 1,433
Reconcilable Fuel Revenues............................... 587 707 932 1,480
---------- ---------- ---------- ----------
Total Operating Revenues............................... 1,421 1,523 2,368 2,913
---------- ---------- ---------- ----------
Operating Expenses:
Fuel and Purchased Power................................. 601 721 959 1,507
Operation and Maintenance................................ 256 224 466 472
Depreciation and Amortization............................ 144 129 243 208
Other Operating Expenses................................. 95 107 173 198
---------- ---------- ---------- ----------
Total Operating Expenses............................... 1,096 1,181 1,841 2,385
---------- ---------- ---------- ----------
Operating Income............................................ $ 325 $ 342 $ 527 $ 528
========== ========== ========== ==========
Electric Sales Including Unbilled (in GWh(1)):
Residential.............................................. 5,987 5,784 9,433 9,736
Commercial............................................... 4,497 4,540 8,235 8,509
Industrial............................................... 7,276 7,705 14,285 14,508
Industrial - Interruptible............................... 1,369 803 2,682 1,437
Other 306 381 1,026 677
---------- ---------- ---------- ----------
Total Sales Including Unbilled........................... 19,435 19,213 35,661 34,867
========== ========== ========== ==========
Average Cost of Fuel (in Cents/MMBtu (2))................... 263.5 288.5 231.3 294.3
- --------------
(1) Gigawatt hours
(2) Million British thermal units
Our Electric Operations segment's operating income for the three months
ended June 30, 2001 increased $17 million compared to the three months ended
June 30, 2000. The increase was primarily due to the timing of information
technology and software expenses and transmission cost of service, and decreases
in labor related costs, other operation and maintenance expenses and
amortization expense. These decreases were partially offset by increased tax
expenses, a reduction in revenues due to milder weather and reduced rates for
certain governmental agencies as mandated by Texas deregulation legislation.
Our Electric Operations segment's operating income for the six months
ended June 30, 2001 increased $1 million compared to the six months ended June
30, 2000. The increase was primarily due to increased revenue growth and
decreased amortization expense offset by a reduction in revenues due to milder
weather and reduced rates for certain governmental agencies as mandated by Texas
deregulation legislation and increased tax expenses.
Base revenues decreased $18 million and $3 million for the quarter and six
months ended June 30, 2001, respectively, primarily due to milder weather
compared to prior year and a reduction in revenues due to reduced rates for
certain governmental agencies as mandated by Texas deregulation legislation.
These decreases were partially offset by customer growth.
Reconcilable fuel revenues and fuel and purchased power expenses for the
quarter and six months ended June 30, 2001 increased as a result of an increase
in the price of natural gas ($3.59 and $4.85 per MMBtu in the second quarters of
2000 and 2001, respectively, and $3.25 and $5.64 per MMBtu for the first six
months of 2000 and 2001, respectively).
Operation and maintenance expenses and other operating expenses for the
second quarter of 2001 decreased by $32 million and increased by $12 million,
respectively, when compared to the same period in 2000. The decrease in
operation and maintenance expenses is largely due to the timing of software and
hardware maintenance costs and decreases in labor related costs and other
operations and maintenance expenses. The increase in other operating expenses is
primarily due to an increase in franchise tax requirements resulting from
increased revenues.
Operation and maintenance expenses and other operating expenses for the
first six months of 2001 increased by $6 million and $25 million, respectively,
when compared to the same period in 2000. The increase in operation and
maintenance expense is primarily due to higher benefit costs partially offset by
decreased legal fees. The increase in
29
other operating expenses is primarily due to an increase in franchise tax
requirements resulting from increased revenues.
Depreciation and amortization expense for the quarter and six months ended
June 30, 2001 decreased $15 million and $35 million, respectively, compared to
the same periods in 2000. The decrease was primarily due to a decrease in
amortization of the book impairment regulatory asset recorded in June 1999 and
decreased amortization expense due to regulatory assets related to cancelled
projects being fully amortized in June 2000. For information regarding items
that affect depreciation and amortization expense of Electric Operations
pursuant to the Legislation and the Transition Plan, see Notes 2(g) and 4(a) to
Reliant Energy 10-K Notes.
NATURAL GAS DISTRIBUTION
Our Natural Gas Distribution segment's operations consist of intrastate
natural gas sales to, and natural gas transportation for residential, commercial
and industrial customers in Arkansas, Louisiana, Minnesota, Mississippi,
Oklahoma and Texas and some non-rate regulated retail marketing of natural gas.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
(IN MILLIONS)
Operating Revenues.......................................... $ 793 $ 888 $ 1,844 $ 3,211
Operating Expenses:
Natural Gas.............................................. 622 725 1,380 2,702
Operation and Maintenance................................ 126 150 250 283
Depreciation and Amortization............................ 37 37 73 73
Other Operating Expenses................................. 20 25 48 67
---------- ---------- ---------- ----------
Total Operating Expenses............................... 805 937 1,751 3,125
---------- ---------- ---------- ----------
Operating (Loss) Income..................................... $ (12) $ (49) $ 93 $ 86
========== ========== ========== ==========
Throughput Data (in Bcf (1)):
Residential and Commercial Sales......................... 46 37 160 189
Industrial Sales......................................... 13 12 38 23
Transportation........................................... 11 11 27 26
Retail 141 107 281 239
---------- ---------- ---------- ----------
Total Throughput....................................... 211 167 506 477
========== ========== ========== ==========
- ---------------
(1) Billion cubic feet.
Our Natural Gas Distribution segment's operating loss increased $37
million and operating income decreased $7 million for the quarter and six months
ended June 30, 2001 as compared to the same periods in 2000. The increase in the
loss for the quarter was largely due to increased bad debt expense in addition
to changes in estimates of unbilled revenues and recoverability of deferred gas
accounts and other items. The decrease in income for the first six months in
2001 compared to the same period in 2000 is primarily due to increased bad debt
expense, in addition to changes in estimates of unbilled revenues and
recoverability of deferred gas accounts and other items, partially offset by
improved margins from colder weather and reduced operation and maintenance
expense due to exiting certain retail gas markets during 2000.
30
PIPELINES AND GATHERING
Our Pipelines and Gathering segment operates two interstate natural gas
pipelines and provides gathering and pipeline services.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ------------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
(IN MILLIONS)
Operating Revenues.......................................... $ 91 $ 96 $ 181 $ 226
Operating Expenses:
Natural Gas.............................................. 16 12 31 58
Operation and Maintenance................................ 24 31 49 59
Depreciation and Amortization............................ 14 15 28 29
Other Operating Expenses................................. 4 4 8 8
---------- ---------- ---------- ----------
Total Operating Expenses............................... 58 62 116 154
---------- ---------- ---------- ----------
Operating Income............................................ $ 33 $ 34 $ 65 $ 72
========== ========== ========== ==========
Throughput Data (in MMBtu):
Natural Gas Sales........................................ 3 3 7 9
Transportation........................................... 209 193 470 439
Gathering................................................ 71 77 141 147
Elimination (1).......................................... (3) (1) (6) (2)
---------- ---------- ---------- ----------
Total Throughput............................................ 280 272 612 593
========== ========== ========== ==========
- -------------
(1) Elimination of volumes both transported and sold.
Our Pipelines and Gathering segment's operating income for the quarter and
six months ended June 30, 2001 increased $1 million and $7 million,
respectively, compared to the same periods in 2000. Increased margins for our
gas gathering business were offset by a decrease in margins from our Pipelines
operations and increased operating expenses in the second quarter of 2001.
Improved operating margins (revenues less natural gas costs) from both the
pipelines and gas gathering businesses partially offset by increased operating
expenses contributed to the increase for the first six months of 2001.
WHOLESALE ENERGY
Our Wholesale Energy segment includes our non-rate regulated power
generation operations in the United States and our wholesale energy trading,
marketing, power origination and risk management operations in North America.
Trading and marketing purchases fuel to supply existing generation assets, sells
the electricity produced by these assets, and manages the day-to-day trading and
dispatch associated with these portfolios. As a result, we have made, and expect
to continue to make, significant investments in developing the trading and
marketing infrastructure including software, trading and risk control resources.
31
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
(IN MILLIONS)
Operating Revenues.......................................... $ 3,452 $ 9,378 $ 5,608 $ 18,971
Operating Expenses:
Fuel and Cost of Gas Sold................................ 1,943 4,259 3,363 9,913
Purchased Power.......................................... 1,244 4,654 1,931 8,201
Operation and Maintenance................................ 71 146 133 279
Depreciation and Amortization............................ 18 21 25 62
Other Operating Expenses................................. 3 6 5 8
---------- ---------- ---------- ----------
Total Operating Expenses............................... 3,279 9,086 5,457 18,463
---------- ---------- ---------- ----------
Operating Income............................................ $ 173 $ 292 $ 151 $ 508
========== ========== ========== ==========
Operations Data:
Natural Gas (in Bcf):
Sales.................................................... 533 859 1,082 1,626
========== ========== ========== ==========
Electricity (in MMWh):
Wholesale Power Sales.................................... 35.8 86.1 64.1 162.6
========== ========== ========== ==========
Our Wholesale Energy segment's operating income increased $119 million and
$357 million, respectively, for the quarter and six months ended June 30, 2001
compared to the same periods in 2000. The increases were primarily due to
increased gross margins (revenues less fuel and cost of gas sold and purchased
power. Gross margins for Wholesale Energy rose by $200 million and $543 million
for the quarter and six months ended June 30, 2001 compared to the same periods
in 2000, respectively. Gross margins increased primarily due to increased
revenues from energy and ancillary services, increased volumes and higher
margins from its trading and marketing activities and the addition of our
Mid-Atlantic assets and strong commercial and operational performance in other
regions. These results were partially offset by higher operation and maintenance
expenses, higher general and administrative and development expenses and a $37
million provision and a $12 million net write-off against receivables balances
related to energy sales in the West Region.
On June 19, 2001, the FERC issued an order modifying the market monitoring
and mitigation plan it had previously adopted on April 26, 2001. This mitigation
plan extends the hours to which the price controls are applied, as well as the
states in which the price controls will be in effect. Additionally, the FERC
issued an order on July 25, 2001 adopting certain recommendations made by an
administrative law judge regarding a proposed methodology for calculating
possible refunds by sellers of electricity in the Western Region. We, however,
believe that while the mitigation plan will reduce volatility in the market, we
will nevertheless be able to profitably operate our facilities in the West
because the proxy market clearing price is based on the heat rate of the least
efficient unit on-line during each hour. Additionally, as noted above, the
mitigation plan allows sellers, such as us, to justify prices above the proxy
price. Finally, any adverse impacts of the mitigation plan on our operations
would be mitigated, in part, by our forward hedging activities. We have not
reserved any amounts for potential future refunds as a reasonable estimate
cannot currently be made. For information regarding the reserve against
receivables and uncertainties in the California wholesale energy market, see
Notes 12(a) and 12(d) to our Interim Financial Statements.
Our Wholesale Energy segment's operating revenues increased $6 billion and
$13 billion, respectively, for the quarter and six months ended June 30, 2001
compared to the same periods in 2000. The increases were primarily due to
increases in prices and volumes for gas and power sales. Our fuel and gas costs
increased $2 billion and $7 billion, respectively, in the quarter and six months
ended June 30, 2001 compared to the same periods in 2000, largely due to a
higher average cost of gas and increased volume. Our purchased power expense
increased $3 billion and $6 billion, respectively, in the quarter and six months
ended June 30, 2001, primarily due to higher power sales volumes and higher
average cost of power. Operation and maintenance expenses increased $75 million
and $146 million, respectively, in the quarter and six months ended June 30,
2001 compared to the same periods in 2000, primarily due to costs associated
with the operation and maintenance of generating plants acquired or placed into
service after the first quarter of 2000, lease expense associated with the
Mid-Atlantic generating facilities' sale/leaseback transactions, higher staffing
levels to support increased sales and expanded trading and marketing efforts and
increased corporate allocations to Wholesale Energy. Depreciation and
amortization expense for the quarter and six months ended June 30, 2001 compared
to the same periods in 2000 increased by $3 million and $37
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million, respectively, as a result of higher expense related to the amortization
of air emissions regulatory allowances, primarily in California, and
depreciation of our Mid-Atlantic plants, which were acquired in May 2000.
EUROPEAN ENERGY
Our European Energy segment includes the operations of Reliant Energy
Power Generation Benelux N.V. (REPGB) and its subsidiaries and our European
trading, marketing and risk management operations. Our European Energy segment
generates and sells power from its generation facilities in the Netherlands and
participates in the emerging wholesale energy trading and marketing industry in
Europe.
Beginning January 1, 2001, the Dutch wholesale electric market was
completely opened to competition. Consistent with our expectations at the time
we made the acquisition, REPGB has experienced a significant decline in electric
margins in 2001 attributable to the deregulation of the market. For additional
information on these and other factors that may affect the future results of
operations of European Energy, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Certain Factors Affecting Our
Future Earnings - Competitive, Regulatory and Other Factors Affecting Our
European Energy Operations" in the Reliant Energy Form 10-K, which information
is incorporated herein by reference.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2000 2001 2000 2001
---------- ---------- --------- ---------
(IN MILLIONS)
Operating Revenues.......................................... $ 136 $ 276 $ 286 $ 524
Operating Expenses:
Fuel and Purchased Power................................. 62 218 131 400
Operation and Maintenance and Other...................... 31 30 59 59
Depreciation and Amortization............................ 19 19 39 38
---------- ---------- --------- ---------
Total Operating Expenses............................... 112 267 229 497
---------- ---------- --------- ---------
Operating Income............................................ $ 24 $ 9 $ 57 $ 27
========== ========== ========= =========
Electricity (in MMWh):
Wholesale Sales.......................................... 2.8 3.7 5.9 7.3
Trading Sales............................................ -- 5.9 -- 9.0
Our European Energy segment operating income decreased $15 million and $30
million, respectively, for the quarter and six months ended June 30, 2001
compared to the same periods in 2000. These decreases were primarily due to a
decrease in margins (revenues less fuel and purchased power) as the Dutch
electric market was completely opened to wholesale competition on January 1,
2001. Increased margins from ancillary services, district heating sales and an
efficiency and energy payment from SEP totaling $30 million partially offset
this decline.
Our European Energy segment operating revenues increased $140 million and
$238 million, respectively, for the quarter and six months ended June 30, 2001
compared to the same periods in 2000. These increases were primarily due to
increased trading revenues associated with our participation in the now fully
deregulated Dutch wholesale electric market. Fuel and purchased power costs
increased $156 million and $269 million, respectively, in the quarter and six
months ended June 30, 2001 compared to same periods in 2000, primarily due to
increased purchased power for trading activities and increased cost of natural
gas and other fuels.
OTHER OPERATIONS
Our Other Operations segment includes the operations of our unregulated
retail electric operations, a communications business offering enhanced data,
voice and other services to customers in Texas, an eBusiness group,
non-operating investments, certain real estate holdings and unallocated
corporate costs.
Our Other Operations segment's operating loss decreased $10 million and
increased $114 million, respectively, for the quarter and six months ended June
30, 2001 compared to the same periods in 2000. The decreased loss in the second
quarter was primarily due to increased sales of energy and energy services to
commercial and industrial customers from our Reliant Energy Solutions unit
partially offset by increased staffing and systems costs in preparation for full
retail competition in Texas beginning January 1, 2002. The increased loss for
the six months was primarily due to a $101 million pre-tax, non-cash charge
related to the redesign of certain of our benefit plans in anticipation of the
separation of our regulated businesses and our unregulated businesses. In
addition, the increased
33
operating loss was due to the timing of certain legal expenses, as well as costs
related to our communications operations. For information regarding the benefit
charge incurred in the first quarter of 2001, see Note 13 to our Interim
Financial Statements.
During the third quarter of 2001, we decided to evaluate strategic
alternatives, including divestiture, partnerships with other market participants
or other strategic alternatives, for our Communications business which serves as
a facility-based competitive local exchange carrier and Internet services
provider as well as network operations centers and managed data centers in
Houston and Austin. We do not believe the disposition or other strategic
alternatives of this business will have a material adverse effect on our
consolidated financial condition, results of operations or cash flows in 2001
and in future periods.
CERTAIN FACTORS AFFECTING OUR FUTURE EARNINGS
GENERAL
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Certain Factors Affecting
Our Future Earnings" in the Reliant Energy Form 10-K, which is incorporated
herein by reference. For additional information regarding the California
wholesale market and related litigation, please read Notes 12(a) and 12(d) to
our Interim Financial Statements.
ELECTRIC OPERATIONS
In contemplation of open competition, our Electric Operations segment has
been allowed since 1998 under our Transition Plan approved by the Texas Utility
Commission and the Legislation to earn base revenues which produced earnings in
excess of traditional regulated levels. These excess earnings have been utilized
to mitigate stranded cost of generation plants by accelerating the depreciation
of these assets for regulatory purposes.
This transition to competition period is scheduled to end on December 31,
2001. At that time, and in accordance with the Legislation, we expect our
Electric Operations segment will be unbundled pursuant to our business
separation plan (please read Notes 4(a) and 4(b) to Reliant Energy 10-K Notes)
into three distinct businesses: a transmission and distribution company, a power
generation company and a retail company. New rates based on the allowed invested
capital, or "rate base", of the transmission and distribution business will be
implemented beginning on January 1, 2002. For more information regarding the
interim rulings in the rate case for the transmission and distribution company,
please read Note 12(f) to our Interim Financial Statements. The retail business
will be conducted by a subsidiary of Reliant Resources. The generation business
will sell power via capacity auctions at market rates. However, the Legislation
provides that during the 2004 stranded cost true-up (please read Note 4(a) to
Reliant Energy 10-K Notes), a true-up amount will be calculated which will be
recovered from or returned to customers to adjust the market revenues earned
from the capacity auctions to a level that would approximate a regulated return
on the invested capital of the generation business. Thus, beginning in 2002,
earnings of our Electric Operations segment will be reduced to near traditional
regulated returns independent of any additional positive or negative cash flows
which may result from implementation of competitive transition charges received
from customers or other credits to customers, as applicable. Accordingly, the
results of operations of our Electric Operations segment post-competition will
significantly decline.
FINANCIAL CONDITION
The following table summarizes the net cash provided by (used in)
operating, investing and financing activities for the six months ended June 30,
2000 and 2001.
SIX MONTHS ENDED JUNE 30,
------------------------
2000 2001
-------- --------
(IN MILLIONS)
Cash provided by (used in):
Operating activities................................................... $ 686 $ 1,086
Investing activities................................................... (3,935) (1,056)
Financing activities................................................... 3,260 (93)
34
Net cash provided by operating activities during the six months ended June
30, 2001 increased $400 million compared to the same period in 2000 primarily
due to improved operating cash flows from Wholesale Energy and a decrease in
margin deposits on energy trading activities partially offset by changes in
working capital.
Net cash used in investing activities decreased $2.9 billion during the
six months ended June 30, 2001 compared to the same period in 2000 primarily due
to the funding of the remaining purchase obligation for REPGB for $982 million
on March 1, 2000 and the acquisition of REMA for $2.1 billion on May 12, 2000,
partially offset by an increase in capital expenditures related to the
construction of domestic power generation projects during the six months ended
June 30, 2001.
Cash flows provided by financing activities decreased $3.4 billion during
the six months ended June 30, 2001 compared to the same period in 2000 primarily
due to a decline in short-term borrowings, partially offset by $1.7 billion in
net proceeds from the initial public offering of Reliant Resources.
FUTURE SOURCES AND USES OF CASH FLOWS
Credit Facilities. As of June 30, 2001, we had credit facilities in
effect, including facilities of various financing subsidiaries and operating
subsidiaries, which provided for an aggregate of $7.4 billion in committed
credit, of which $4.0 billion was scheduled to expire in 2001. As of June 30,
2001, $4.4 billion was outstanding under these facilities including other
borrowings of $3.8 billion and letters of credit of $0.6 billion. The remaining
unused credit facilities totaled $3.0 billion. To the extent that we continue to
need access to this amount of committed credit, we expect to extend or replace
these facilities on normal commercial terms on a timely basis.
In May 2001, aggregate bank facilities and aggregate amount of commercial
paper that can be offered were reduced by $1.7 billion, the amount of net
proceeds from the Offering.
Debt Refinancing. In July 2001, various financing subsidiaries terminated
several bank credit facilities and entered into new bank credit facilities which
increased the aggregate amount of bank facilities at financing subsidiaries to
$4.3 billion. The new bank facilities expire in July 2002 and are expected to
support the issuance of commercial paper. In connection with the termination of
a Euro 560 million bank facility, financing subsidiary bank loans of Euro 560
million were refinanced with U.S. dollar denominated commercial paper issued by
a financing subsidiary.
Shelf Registrations. At June 30, 2001, Reliant Energy had shelf
registration statements providing for the issuance of $230 million aggregate
liquidation value of our preferred stock, $580 million aggregate principal
amount of our debt securities and $125 million of trust preferred securities and
related junior subordinated debt securities. In addition, Reliant Energy had a
shelf registration for 15 million shares of its common stock, which would have
been worth $483 million as of June 30, 2001 based on the closing price of its
common stock as of that date. In January 2001, RERC Corp. filed a shelf
registration statement for $600 million of unsecured unsubordinated debt
securities of which $550 million was issued in February 2001.
RERC Corp. Debt Issuance. In February 2001, RERC Corp. issued $550 million
aggregate principal amount of unsecured unsubordinated notes that bear interest
at 7.75% per year and mature in February 2011. Net proceeds to RERC Corp. were
$545 million. RERC Corp. used the net proceeds from the sale of the notes to pay
a $400 million dividend to Reliant Energy, and for general corporate purposes.
Reliant Energy used the $400 million proceeds from the dividend for general
corporate purposes, including the repayment of short-term borrowings.
Securitization. Reliant Energy HL&P filed an application with the Texas
Utility Commission requesting a financing order authorizing the issuance by a
special purpose entity organized by us, of transition bonds relating to Reliant
Energy HL&P's generation related regulatory assets. In May 2000, the Texas
Utility Commission issued a financing order to Reliant Energy authorizing the
issuance of transition bonds for the recovery of costs associated with
generation-related regulatory assets in the amount of $738 million plus issuance
costs of up to $11 million. Payments on the transition bonds will be made out of
funds derived from non-bypassable transition charges assessed to users of
Reliant Energy HL&P's transmission and distribution services. The offering of
the transition bonds is expected to be consummated during the third quarter of
2001.
Fuel Filing. As of June 30, 2001, Reliant Energy HL&P was under-collected
on fuel recovery by approximately $667 million. In two separate filings with the
Texas Utility Commission in 2000, Reliant Energy
35
HL&P received approval to implement fuel surcharges to collect the
under-recovery of fuel expenses, as well as to adjust the fuel factor to
compensate for significant increases in the price of natural gas.
On March 15, 2001, Reliant Energy HL&P filed with the Texas Utility
Commission to revise its fuel factor and address its undercollected fuel costs
of $389 million, which is the accumulated amount since September 2000 through
February 2001, plus estimates for March and April 2001. Reliant Energy
HL&P requested to revise its fixed fuel factor to be implemented with the May
2001 billing cycle and proposed to defer the collection of the $389 million
until the 2004 stranded costs true-up proceeding. On April 16, 2001, the Texas
Utility Commission issued an order approving interim rates effective with the
May 2001 billing cycle.
On June 21, 2001, Reliant Energy HL&P filed with the Texas Utility
Commission to terminate the interim factor and return to the prior fuel factor
due to the forecasted decline in natural gas prices. On July 20, 2001, the Texas
Utility Commission issued an order of dismissal approving Reliant Energy HL&P's
request that the interim rates approved on April 16, 2001, effective with
Reliant Energy HL&P's May billing month, be terminated and Reliant Energy HL&P
prospectively bill its customers using the prior fuel factor established in a
previous order beginning with Reliant Energy HL&P's August billing month. The
Texas Utility Commission also granted Reliant Energy HL&P a good cause exception
in that Reliant Energy HL&P will not be required to refund amounts collected
through the interim rates. Reliant Energy HL&P did not waive its right to
collect any final fuel balance.
Initial Public Offering of Reliant Resources. On July 27, 2000, Reliant
Energy announced its intention to form Reliant Resources to own and operate a
substantial portion of Reliant Energy's unregulated operations, and to offer no
more than 20% of the common stock of Reliant Resources in the Offering in
connection with our business separation plan. In May 2001, Reliant Resources
completed its initial public offering of 59.8 million shares of its common stock
and received net proceeds of $1.7 billion. Pursuant to the terms of the master
separation agreement, Reliant Resources used $147 million of the net proceeds to
repay certain indebtedness owed to Reliant Energy. Reliant Resources used the
remainder of the net proceeds to increase its working capital. Reliant Energy
expects the Offering to be followed by a distribution of the remaining common
stock of Reliant Resources owned by Reliant Energy to Reliant Energy's or its
successor's shareholders within twelve months of the Offering. For additional
information regarding our business separation plan, please read Note 4(b) to
Reliant Energy 10-K Notes.
Reliant Resources Stock Repurchase. During the third quarter of 2001,
Reliant Resources purchased 840,000 shares of Reliant Resources common stock at
an average price of $20.58 per share, or an aggregate purchase price of $17.3
million. These shares were purchased in anticipation of funding benefit plan
obligations expected to be funded prior to the Distribution. The master
separation agreement between Reliant Resources and Reliant Energy restricts the
ability of Reliant Resources to issue shares of common stock prior to the
separation of the two companies without the prior consent of Reliant Energy.
Accordingly, Reliant Resources may make future purchases of its common stock in
anticipation of funding pre-Distribution employee benefit plan obligations.
Acquisition of Mid-Atlantic Assets. On May 12, 2000, we completed the
acquisition of our Mid-Atlantic assets from Sithe Energies, Inc. for an
aggregate purchase price of $2.1 billion. The acquisition was originally
financed through commercial paper borrowings at one of our financing
subsidiaries. In August 2000, we entered into separate sale/leaseback
transactions with each of the three owner-lessors for our respective 16.45%,
16.67% and 100% interests in the Conemaugh, Keystone and Shawville generating
stations, respectively, which we acquired as part of the Mid-Atlantic
acquisition. For additional discussion of these lease transactions, please read
Notes 3(a) and 14(c) to Reliant Energy 10-K Notes. As consideration for the sale
of our interest in the facilities, we received a total of $1.0 billion in cash
that was used to repay commercial paper borrowings at one of our financing
subsidiaries. We will continue to make lease payments through 2029. The lease
terms expire in 2034.
Channelview Project. Our 781 MW gas-fired, combined cycle, cogeneration
plant located in Channelview, Texas, which is currently under construction, is
expected to cost $463 million, including $129 million in commitments for the
purchase of combustion turbines. Of this amount, $348 million had been incurred
as of June 30, 2001. The project continues to be financed through funds received
under the terms of a committed equity bridge facility, which totals $92 million,
a non-recourse debt facility aggregating $369 million and projected construction
revenues of $2 million.
Other Generating Projects. As of June 30, 2001, we had three additional
non-rate regulated generating facilities under construction. Total estimated
costs of constructing these facilities are $1.2 billion, including $349 million
in commitments for the purchase of combustion turbines. As of June 30, 2001, we
had incurred $513 million of the total projected costs of these projects, which
were funded primarily through short-term borrowings from
36
various financing subsidiaries of Reliant Energy. We believe that our level of
cash, our borrowing capability and proceeds from the initial public offering of
Reliant Resources as discussed above will be sufficient to fund these
commitments. In addition, we have options to purchase additional combustion
turbines for a total estimated cost of $296 million for future generation
projects. We believe that our current level of cash, our borrowing capability
and proceeds from the initial public offering will be sufficient to fund these
options should we choose to exercise them.
Construction Agency Agreement. In April 2001, Reliant Resources, through
several of its subsidiaries, entered into operative documents with special
purpose entities to facilitate the development, construction, financing and
leasing of several power generation projects. The special purpose entities have
an aggregate financing commitment from equity and debt participants (Investors)
of $2.5 billion. Reliant Resources, through several of its subsidiaries, acts as
construction agent for the special purpose entities, and is responsible for
completing construction of these projects by August 31, 2004, but has generally
limited Reliant Resources' risk related to construction completion to less than
90% of project costs incurred to date, except in certain events. Upon completion
of an individual project and exercise of the lease option, Reliant Resources'
subsidiaries will be required to make lease payments in an amount sufficient to
provide a return to the Investors. If Reliant Resources does not exercise its
option to lease any project upon its completion, it must purchase the project or
remarket the project on behalf of the special purpose entities. At the end of an
individual project's operating lease term (approximately five years from
construction completion), the lessees have the option to extend the lease at
fair market value, purchase the project at a fixed amount equal to the original
construction cost, or act as remarketing agent and sell the project to an
independent third party. If the lessees elect the remarketing option, they may
be required to make a payment up to 85% of the project cost if the proceeds from
remarketing are deficient to repay the Investors. Reliant Resources has
guaranteed the performance and payment of its subsidiaries' obligations during
the construction periods and, if the lease option is exercised, the lessee's
obligations during the lease period.
California Trade Receivables. During the summer and fall of 2000, and
continuing into early 2001, prices for wholesale electricity in California
increased dramatically as a result of a combination of factors, including higher
natural gas prices and emissions allowance costs, reduction in available
hydroelectric generation resources, increased demand, decreases in net electric
imports, structural market flaws including over-reliance on the spot market, and
limitations on supply as a result of maintenance and other outages. Although
wholesale prices increased, California's deregulation legislation kept retail
rates frozen below 1996 levels until rates were raised by the CPUC early this
year. This caused two of California's public utilities, which are our customers
based on our deliveries to the Cal PX and the Cal ISO, to accrue billions of
dollars of unrecovered wholesale power costs and ultimately default in January
and February 2001 on payments owed for wholesale power purchased through the Cal
PX and from the Cal ISO, and in the case of Pacific Gas and Electric Company, to
file a voluntary petition for bankruptcy. As of June 30, 2001, we were owed $318
million by the Cal ISO, the Cal PX, the CDWR and California Energy Resource
Scheduling for energy sales in the California wholesale market during the fourth
quarter of 2000 through June 30, 2001 and have recorded an allowance against
such receivables of $76 million. From July 1, 2001 through August 6, 2001, we
have collected none of these receivable balances. For additional information
regarding uncertainties in the California wholesale market, please read Notes
12(a) and 12(d) to our Interim Financial Statements and Notes 14(g) and 14(h) to
Reliant Energy 10-K Notes.
Reliant Energy HL&P Rate Matters. The Texas Utility Commission has issued
an interim order on June 5, 2001 requiring Reliant Energy HL&P to reverse the
amount of redirected depreciation and accelerated depreciation since it was in
the Texas Utility Commission's estimation that the utility had overmitigated its
stranded costs. We disagree with certain positions prescribed in the interim
order by the Texas Utility Commission and will determine future action based on
the final order anticipated in August 2001. At June 30, 2001, cumulative
redirected depreciation and cumulative accelerated depreciation for regulatory
purposes totaled $725 million and approximately $1 billion, respectively. If
implemented, the reversal of redirected depreciation would result in a lower
rate for the transmission and distribution utility and the accelerated
depreciation being returned through credits over seven years would serve as
offsets to the transmission and distribution utility's non-bypassable charges.
The rates derived from the Texas Utility Commission's June 5, 2001 interim order
will be used during the retail electric pilot project which began on July 31,
2001. We do not expect the final Reliant Energy HL&P transmission and
distribution rate to be established until the end of August 2001 and implemented
until January 1, 2002. The credits related to accelerated depreciation will
begin on January 1, 2002. For information regarding redirected depreciation and
accelerated depreciation, see Note 4(a) to Reliant Energy 10-K Notes.
Florida Tolling Arrangement. In the first quarter of 2001, our Wholesale
Energy segment entered into tolling arrangements with a third party to purchase
the rights to utilize and dispatch electric generating capacity of approximately
1,100 MW. This electricity is expected to be generated by two gas-fired,
simple-cycle peaking
37
plants, with fuel oil backup, to be constructed by the tolling partner in
Florida, which are anticipated to be completed by the summer of 2002, at which
time we will commence tolling payments.
Other Sources/Uses of Cash. Our liquidity and capital requirements are
affected primarily by capital expenditures, debt service requirements and
various working capital needs. We expect to continue to bid on future
acquisitions of independent power projects and privatizations of generation
facilities. We expect any resulting capital requirements to be met with excess
cash flows from operations, as well as proceeds from debt and equity offerings,
project financings and other borrowings. We also expect Reliant Resources to
establish a commercial paper program in late 2001 or the first half of 2002.
Additional capital expenditures depend upon the nature and extent of future
project commitments, some of which may be substantial. We believe that our
current level of cash, our borrowing capability and proceeds from the Reliant
Resources initial public offering discussed above, along with future cash flows
from operations, will be sufficient to meet the existing operational needs of
our businesses for the next twelve months.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141 and SFAS No. 142. SFAS No. 141
requires business combinations initiated after June 30, 2001 to be accounted for
using the purchase method of accounting, and broadens the criteria for recording
intangible assets separate from goodwill. Recorded goodwill and intangibles will
be evaluated against these new criteria and may result in certain intangibles
being transferred to goodwill, or alternatively, amounts initially recorded as
goodwill may be separately identified and recognized apart from goodwill. Under
SFAS No. 142, a nonamortization approach, goodwill and certain intangibles with
indefinite lives will not be amortized into results of operations, but instead
would be reviewed periodically for impairment and written down and charged to
results of operations only in the periods in which the recorded value of
goodwill and certain intangibles with indefinite lives is more than its fair
value. The provisions of each statement which apply to goodwill and intangible
assets acquired prior to June 30, 2001 will be adopted by us on January 1, 2002.
We are in the process of determining the effect of adoption of SFAS No. 141 and
SFAS No. 142 on our consolidated financial statements.
38
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Form 10-Q/A to be signed on its behalf by the
undersigned thereunto duly authorized.
RELIANT ENERGY, INCORPORATED
(Registrant)
By: /s/ Mary P. Ricciardello
---------------------------------------------------
Mary P. Ricciardello
Senior Vice President and Chief Accounting Officer
Date: March 25, 2002
39
