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 1-16455
--------------------
RELIANT RESOURCES, INC.
(Exact name of registrant as specified in its charter)
Delaware 76-0655566
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1111 Louisiana 77002
Houston, Texas (Zip Code)
(Address of principal executive offices)
(713) 207-3000
(Registrant's telephone number, including area code)
--------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of August 7, 2001, Reliant Resources, Inc. (Reliant Resources) had
298,964,000 shares of common stock outstanding including 240,000,000 shares
which were held by Reliant Energy, Incorporated and excluding 840,000 shares
held as treasury stock. As of August 7, 2001, 58,952,250 shares of common stock
are held by non-affiliates of Reliant Resources, using the definition of
beneficial ownership contained in Rule 13d-3 promulgated pursuant to the
Securities Exchange Act of 1934.
RELIANT RESOURCES, INC.
QUARTERLY REPORT ON FORM 10-Q/A
FOR THE QUARTER ENDED JUNE 30, 2001
Reliant Resources, Inc. (Reliant Resources) 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 Resources 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 Resources now believes
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 Resource'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 the Company .....................................................21
i
PART I. FINANCIAL INFORMATION
RELIANT RESOURCES, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- -----------------------------
2000 2001 2000 2001
------------- ------------- ------------- --------------
(AS RESTATED) (AS RESTATED)
REVENUES............................................. $ 3,613,128 $ 9,693,304 $ 5,933,862 $19,564,231
EXPENSES:
Fuel and cost of gas sold.......................... 2,000,582 4,360,005 3,489,846 10,115,397
Purchased power.................................... 1,247,529 4,771,444 1,935,322 8,398,636
Operation and maintenance.......................... 107,188 132,354 180,717 242,689
General, administrative and development............ 45,993 97,265 86,730 296,747
Depreciation and amortization...................... 38,223 43,346 65,799 107,476
--------- --------- --------- ----------
Total.......................................... 3,439,515 9,404,414 5,758,414 19,160,945
--------- --------- --------- ----------
OPERATING INCOME..................................... 173,613 288,890 175,448 403,286
--------- --------- --------- ----------
OTHER INCOME (EXPENSE):
Interest income.................................... 2,341 6,240 6,204 18,534
Interest expense................................... (8,662) (19,627) (19,147) (43,865)
Interest (expense) income - affiliated companies,
net (50,376) 11,155 (71,737) (3,431)
(Loss) gain from investments, net.................. (58) 4,592 (14,903) 11,315
Income from equity investments in unconsolidated
subsidiaries.................................... 5,481 51,572 5,966 64,350
Gain on sale of development project................ 18,011 -- 18,011 --
Other, net......................................... 1,523 5,698 2,214 7,756
--------- --------- --------- ----------
Total other (expense) income..................... (31,740) 59,630 (73,392) 54,659
--------- --------- --------- ----------
INCOME BEFORE INCOME TAXES, CUMULATIVE EFFECT OF
ACCOUNTING CHANGE AND EXTRAORDINARY ITEM........... 141,873 348,520 102,056 457,945
INCOME TAX EXPENSE................................... 37,973 119,785 20,746 150,697
--------- --------- --------- ----------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
AND EXTRAORDINARY ITEM............................. 103,900 228,735 81,310 307,248
Cumulative effect of accounting change, net of tax. -- (47) -- 3,062
Extraordinary item................................. 7,445 -- 7,445 --
--------- --------- --------- ----------
NET INCOME........................................... $ 111,345 $ 228,688 $ 88,755 $ 310,310
========= ========= ========= =========
BASIC EARNINGS PER SHARE:
Income before cumulative effect of accounting
change........................................... $ 0.83 $ 1.19
Cumulative effect of accounting change, net of tax. -- 0.01
--------- ----------
Net Income....................................... $ 0.83 $ 1.20
========= ==========
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of accounting
change........................................... $ 0.82 $ 1.19
Cumulative effect of accounting change, net of tax. -- 0.01
--------- ----------
Net Income....................................... $ 0.82 $ 1.20
========= ==========
See Notes to the Company's Interim Financial Statements
1
RELIANT RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, 2000 JUNE 30, 2001
----------------- --------------
(AS RESTATED)
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 89,755 $ 85,149
Accounts and notes receivable, principally customer, net.................. 1,811,355 2,071,981
Accounts and notes receivable - affiliated companies, net................. -- 1,362,026
Fuel stock and petroleum products......................................... 54,954 117,755
Materials and supplies.................................................... 44,491 47,582
Price risk management assets.............................................. 4,290,803 2,513,734
Non-trading derivative assets............................................. -- 2,020,609
Margin deposits on energy contracts....................................... 521,004 186,582
Prepayments and other current assets...................................... 180,334 261,232
--------- ---------
Total current assets.................................................... 6,992,696 8,666,650
--------- ---------
Property, plant and equipment............................................... 4,200,139 4,474,665
Less accumulated depreciation............................................... (150,666) (201,922)
--------- ---------
Property, plant and equipment, net....................................... 4,049,473 4,272,743
--------- ---------
OTHER ASSETS:
Goodwill, net............................................................. 1,006,782 915,528
Air emissions regulatory allowances and other intangibles, net............ 283,974 316,765
Price risk management assets.............................................. 544,909 542,954
Non-trading derivative assets............................................. -- 614,690
Notes receivable - affiliated companies, net.............................. -- 29,598
Equity investments in unconsolidated subsidiaries......................... 108,727 139,523
Stranded costs indemnification receivable................................. -- 367,000
Other 227,831 385,287
--------- ---------
Total other assets...................................................... 2,172,223 3,311,345
--------- ---------
TOTAL ASSETS.......................................................... $ 13,214,392 $ 16,250,738
========== =========
See Notes to the Company's Interim Financial Statements
2
RELIANT RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, 2000 JUNE 30, 2001
----------------- ---------------
(AS RESTATED)
CURRENT LIABILITIES:
Short-term borrowings..................................................... $ 126,175 $ 173,366
Current portion of long-term debt......................................... 591 2,451
Accounts payable, principally trade....................................... 2,103,536 1,922,348
Accounts and notes payable - affiliated companies, net.................... 1,321,120 --
Price risk management liabilities......................................... 4,272,771 2,419,718
Non-trading derivative liabilities........................................ -- 1,733,320
Accumulated deferred income taxes......................................... -- 102,258
Margin deposits from customers on energy trading activities............... 284,603 380,400
Other 296,009 281,123
--------- ---------
Total current liabilities........................................... 8,404,805 7,014,984
--------- ---------
OTHER LIABILITIES:
Accumulated deferred income taxes......................................... 30,784 160,866
Notes payable - affiliated companies, net................................. 647,499 --
Price risk management liabilities......................................... 530,263 488,361
Non-trading derivative liabilities........................................ -- 667,077
Major maintenance reserve................................................. 19,899 15,367
Other 356,956 613,141
--------- ---------
Total other liabilities............................................. 1,585,401 1,944,812
--------- ---------
LONG-TERM DEBT.............................................................. 891,736 908,180
--------- ---------
COMMITMENTS AND CONTINGENCIES (NOTE 11)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.001 per share (125,000,000 shares
authorized; none outstanding) -- --
Common stock, par value $0.001 per share (2,000,000,000 shares
authorized; 240,000,000 and 299,804,000 issued and outstanding,
respectively)........................................................... 1 61
Additional paid-in capital................................................ 2,336,993 5,820,308
Retained earnings......................................................... -- 310,310
Accumulated other comprehensive (loss) income............................. (4,544) 252,083
--------- ---------
Stockholders' equity................................................ 2,332,450 6,382,762
--------- ---------
Total Liabilities and Stockholders' Equity ........................ $ 13,214,392 $ 16,250,738
========= =========
See Notes to the Company's Interim Financial Statements
3
RELIANT RESOURCES, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
---------------------------------
2000 2001
-------------- --------------
(AS RESTATED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................ $ 88,755 $ 310,310
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation and amortization........................................... 65,799 107,476
Deferred income taxes................................................... 605 61,443
Extraordinary gain.................................................... (7,445) --
Cumulative effect of accounting change.................................. -- (3,062)
Undistributed earnings of unconsolidated subsidiaries................... (5,966) (30,822)
Impairment of marketable equity securities.............................. 22,185 --
Proceeds from sale of debt securities................................... 123,428 --
Changes in other assets and liabilities:
Accounts and notes receivable, net.................................... (583,650) (263,991)
Accounts receivable/payable - affiliated companies, net............... (39,910) 115,357
Inventory............................................................. 8,991 (65,764)
Accounts payable...................................................... 399,654 (179,333)
Net price risk management assets and liabilities...................... (26,650) (116,103)
Margin deposits on energy trading activities, net..................... (128,884) 430,219
Net non-trading derivative assets and liabilities..................... -- (15,987)
Restricted deposits................................................... -- (16,726)
Prepaid lease obligation.............................................. -- (101,542)
Other assets.......................................................... (20,512) 34,504
Other current liabilities............................................. 39,445 8,713
Other liabilities..................................................... 50,129 59,758
Other, net.............................................................. (20,216) (6,843)
------------- -------------
Net cash (used in) provided by operating activities................. (34,242) 327,607
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................................... (428,745) (499,578)
Payment of business purchase obligation................................... (981,789) --
Business acquisitions, net of cash acquired............................... (2,120,312) --
Investments in unconsolidated subsidiaries................................ (3,204) 26
Other, net................................................................ (3,826) 10,572
------------- -------------
Net cash used in investing activities............................... (3,537,876) (488,980)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt.............................................. 92,098 --
Proceeds from issuance of stock, net...................................... -- 1,697,848
Payments of long-term debt................................................ (298,194) (1,795)
Increase in short-term borrowings, net.................................... 664,202 148,677
Increase (decrease) in notes payable/receivable with affiliated
companies, net.......................................................... 2,040,754 (1,692,552)
Contributions from owner.................................................. 1,069,744 9,441
Other, net................................................................ 627 (7)
------------- -------------
Net cash provided by financing activities........................... 3,569,231 161,612
------------- -------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS................ 6,693 (4,845)
------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........................ 3,806 (4,606)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............................ 49,271 89,755
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................................. $ 53,077 $ 85,149
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized)..................................... $ 92,207 $ 101,176
Income taxes.............................................................. -- 112,801
See Notes to the Company's Interim Financial Statements
4
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
Included in this Quarterly Report on Form 10-Q/A (Form 10-Q/A) for Reliant
Resources, Inc. (Reliant Resources), together with its subsidiaries
(collectively, the Company), are the Company's consolidated interim financial
statements and notes (Interim Financial Statements). The Interim Financial
Statements are unaudited, omit certain financial statement disclosures and
should be read with the financial statements included in Reliant Resources'
Prospectus dated April 30, 2001 (Reliant Resources Prospectus) as filed with the
SEC on May 1, 2001 pursuant to Rule 424(b) under the Securities Act of 1933,
relating to Reliant Resources' registration statement on Form S-1 (Registration
No. 333-48038) and the Quarterly Report on Form 10-Q of Reliant Resources for
the quarter ended March 31, 2001 (First Quarter 10-Q).
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 Company's 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
5
reported. A 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 .............................................. $ 9,693 $ 9,681 $ 19,564 $ 19,552
Expenses:
Fuel and cost of gas sold ........................ 4,361 4,436 10,116 10,191
Purchased power .................................. 4,771 4,771 8,399 8,399
Other expenses ................................... 273 273 646 646
-------- -------- -------- --------
Total .......................................... 9,405 9,480 19,161 19,236
-------- -------- -------- --------
Operating Income ...................................... 288 201 403 316
Other Income, net ..................................... 60 60 55 55
Income Tax Expense .................................... (120) (86) (151) (117)
-------- -------- -------- --------
Income Before Cumulative Effect of Accounting Change .. 228 175 307 254
Cumulative effect of accounting change, net of tax .... -- -- 3 3
-------- -------- -------- --------
Net Income ............................................ $ 228 $ 175 $ 310 $ 257
======== ======== ======== ========
BASIC EARNINGS PER SHARE:
Income before cumulative effect of accounting change .. $ 0.83 $ 0.63 $ 1.19 $ 0.98
Cumulative effect of accounting change, net of tax .... -- -- 0.01 0.01
-------- -------- -------- --------
Net Income ............................................ $ 0.83 $ 0.63 $ 1.20 $ 0.99
-------- -------- -------- --------
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of accounting change .. $ 0.82 $ 0.63 $ 1.19 $ 0.98
Cumulative effect of accounting change, net of tax .... -- -- 0.01 0.01
-------- -------- -------- --------
Net Income ............................................ $ 0.82 $ 0.63 $ 1.20 $ 0.99
======== ======== ======== ========
JUNE 30, 2001
-------------------------------
AS PREVIOUSLY
AS RESTATED REPORTED
----------- -------------
(IN MILLIONS)
ASSETS
CURRENT ASSETS:
Price risk management assets.................... $ 2,514 $ 2,514
Non-trading derivative assets................... 2,021 2,035
Other........................................... 4,132 4,132
------------ ------------
Total current assets..................... 8,667 8,681
PROPERTY, PLANT AND EQUIPMENT, NET................ 4,273 4,273
OTHER ASSETS:
Price risk management assets.................... 543 543
Non-trading derivative assets................... 615 707
Other........................................... 2,153 2,153
------------ ------------
Total other assets....................... 3,311 3,403
------------ ------------
TOTAL ASSETS............................. $ 16,251 $ 16,357
============ ============
6
JUNE 30, 2001
-------------------------------
AS PREVIOUSLY
AS RESTATED REPORTED
----------- -------------
(IN MILLIONS)
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Price risk management liabilities......................................... $ 2,420 $ 2,420
Non-trading derivative liabilities........................................ 1,733 1,742
Accumulated deferred income taxes......................................... 102 105
Other..................................................................... 2,760 2,760
------------ ------------
Total current liabilities.......................................... 7,015 7,027
OTHER LIABILITIES:
Accumulated deferred income taxes......................................... 161 164
Price risk management liabilities......................................... 489 564
Non-trading derivative liabilities........................................ 667 666
Other..................................................................... 628 628
------------ ------------
Total other liabilities............................................ 1,945 2,022
------------ ------------
LONG-TERM DEBT.............................................................. 908 908
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock; par value $0.001 per share (125,000,000 shares
authorized; none outstanding)........................................... -- --
Common Stock, par value $0.001 per share (2,000,000,000 shares
authorized; 240,000,000 and 299,804,000 issued and outstanding;
respectively)........................................................... -- --
Additional paid-in capital................................................ 5,820 5,820
Retained earnings......................................................... 310 257
Accumulated other comprehensive income.................................... 253 323
------------ ------------
Stockholders' equity............................................... 6,383 6,400
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......................... $ 16,251 $ 16,357
============ ============
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 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 fluctuation in demand for energy and energy services, (b)
changes in energy commodity prices, (c) timing of maintenance and other
expenditures and (d) acquisitions and dispositions of businesses, assets and
other interests. In addition, certain amounts from the prior period have been
reclassified to conform to the Company's presentation of financial statements in
the current period. These reclassifications do not affect the earnings of the
Company.
The following notes to the consolidated financial statements included in
Reliant Resources Prospectus relate to certain contingencies. These notes, as
updated herein, are incorporated herein by reference:
Notes to Consolidated Financial Statements included in Reliant Resources
Prospectus (Reliant Resources Prospectus Notes): Note 4 (Agreements Between
Reliant Energy and the Company), Note 5 (Business Acquisitions), Note 6
(Derivative Financial Instruments), Note 11 (Commitments and Contingencies)
and Note 15 (Subsequent Events).
For information regarding certain legal, regulatory proceedings and
environmental matters, see Note 11.
On July 27, 2000, Reliant Energy, Incorporated (Reliant Energy) announced
its intention to form a company, Reliant Resources, to own and operate a
substantial portion of its unregulated operations and to offer no more than 20%
of the common stock of Reliant Resources in an initial public offering
(Offering). The Offering closed in May 2001. Reliant Energy has publicly
disclosed that it 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
7
(Distribution) within 12 months of the Offering (Distribution Date). 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 assurances that the Distribution will be completed
as described or within the periods outlined above. Reliant Energy, together with
its subsidiaries, is a diversified international energy services company
consisting of regulated and unregulated energy operations. For information
regarding the basis of presentation of the Interim Financial Statements, see
Note 1 to Reliant Resources Prospectus Notes. For information regarding the
Offering, see Note 9.
(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 $3 million and a cumulative after-tax increase in
accumulated other comprehensive loss of $290 million. The adoption also
increased current assets, long-term assets, current liabilities and long-term
liabilities by approximately $615 million, $248 million, $811 million, and $339
million, respectively, in the Company's Consolidated Balance Sheet. During the
three and six months ended June 30, 2001, losses of $42 million and $62 million,
respectively, 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 the 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 concluded 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 fix the interest rate on $150
million of its floating rate debt. In addition, as of June 30, 2001, European
Energy 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.
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.
8
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. In December 2000, the Dutch parliament adopted
legislation allocating to the Dutch generation sector, including a wholly owned
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 the former shareholders of these stranded costs, see Note
11(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) RELATED PARTY TRANSACTIONS
The Interim Financial Statements include significant transactions between
the Company and Reliant Energy involving services, including various corporate
support services (including accounting, finance, investor relations, planning,
legal, communications, governmental and regulatory affairs and human resources),
information technology services and other shared services such as corporate
security, facilities management, accounts receivable, accounts payable and
payroll, office support services and purchasing and logistics. The costs of
these services have been directly charged or allocated to the Company using
methods that management believes are reasonable. These methods include
negotiated usage rates, dedicated asset assignment, and proportionate corporate
formulas based on assets, operating expenses and employees. These charges and
allocations are not necessarily indicative of what would have been incurred had
the Company been a separate entity. Amounts charged and allocated to the Company
for these services were $5 million and $2 million for the three months ended
June 30, 2000 and 2001, respectively. For the six months ended June 30, 2000 and
2001, amounts charged and allocated to the Company for these services were $9
million and $4 million, respectively, and are included primarily in operation
and maintenance expenses and general and administrative expenses. In addition,
during the three and six months ended June 30, 2001, the Company incurred costs
primarily related to corporate support services which were billed to Reliant
Energy and its affiliates of $13 million and $20 million, respectively.
Below is a detail of accounts and notes receivable and payable to affiliated
companies that are not part of the Company:
DECEMBER 31, 2000 JUNE 30, 2001
------------------- ---------------
(IN MILLIONS)
Net accounts receivable (payable) -- affiliated companies................... $ 94 $ (3)
Net short-term notes (payable) receivable -- affiliated companies........... (1,415) 1,365
Net long-term notes (payable) receivable -- affiliated companies............ (648) 30
------- -------
Total net accounts and notes (payable) receivable -- affiliated companies. $(1,969) $ 1,392
======= =======
Net accounts payable/receivable to/from affiliated companies, representing
primarily current month balances of transactions between the Company and Reliant
Energy or its subsidiaries, relate primarily to natural gas purchases and sales,
interest, charges for services and office space rental. Net short-term notes
payable/receivable to/from affiliated companies represent the accumulation of a
variety of cash transfers and operating transactions and specific negotiated
9
financing transactions with Reliant Energy or its subsidiaries and generally
bear interest at market-based rates. Net long-term notes payable/receivable
to/from affiliated companies primarily relate to specific negotiated financing
transactions with Reliant Energy or its subsidiaries that bear interest at
market-based rates. Net interest expense related to these net
borrowings/receivables was $50 million, $72 million and $3 million during the
quarter ended June 30, 2000 and the six months ended June 30, 2000 and 2001,
respectively. Net interest income related to these net borrowings/receivables
was $11 million during the quarter ended June 30, 2001.
On January 9, 2001, the Company entered into a subordinated note agreement
with Reliant Energy for $1.5 billion. The proceeds of the subordinated note were
used to pay off existing notes payable between the Company and Reliant Energy
and its subsidiaries.
In March 2001, the Company paid $236 million of the debt owed to Reliant
Energy, along with the accrued interest on the amount. The repayment was made
with general corporate funds of the Company, including amounts borrowed under
the Company's credit facilities.
In May 2001, Reliant Energy converted or contributed an aggregate of $1.7
billion of the indebtedness owed by the Company to Reliant Energy and its
subsidiaries including the subordinated note discussed above, to equity without
the issuance of any additional shares of Reliant Resources common stock,
pursuant to the master separation agreement by recording an increase to
additional paid-in capital of the Company.
The Company purchases natural gas and transportation services from, supplies
natural gas to, and provides marketing and risk management services to
affiliates of Reliant Energy that are not part of the Company. Purchases of
transportation services and natural gas from Reliant Energy and its subsidiaries
were $25 million, $44 million, $71 million and $130 million in the quarter ended
June 30, 2000 and 2001, and the six months ended June 30, 2000 and 2001,
respectively. During the quarter ended June 30, 2000 and 2001, and the six
months ended June 30, 2000 and 2001, the sales and services to Reliant Energy
and its subsidiaries totaled $104 million, $137 million, $252 million and $459
million, respectively.
During the quarter ended June 30, 2000 and 2001, and the six months ended
June 30, 2000 and 2001, Reliant Energy or its subsidiaries made equity
contributions to the Company of $1.1 billion, $1.7 billion, $1.1 billion and
$1.8 billion, respectively. The contributions in the three months and six months
ended June 30, 2000 primarily related to the conversion of a portion of the
borrowings from Reliant Energy used to fund the acquisition of Reliant Energy
Mid-Atlantic Power Holdings, LLC (REMA) (see Note 5) and general operating
costs. The contributions in the three months ended June 30, 2001, primarily
related to the conversion into equity of debt owed to Reliant Energy and its
subsidiaries and some related interest expense totaling $1.7 billion. The
contributions in the six months ended June 30, 2001, primarily related to the
conversion into equity of debt and related interest expense as discussed above
and the contribution of net benefit assets and liabilities, net of deferred
income taxes.
(5) ACQUISITION OF RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
On May 12, 2000, a 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 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 5(a) to Reliant Resources Prospectus
Notes.
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 11(c) to Reliant Resources
Prospectus Notes.
10
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 2000
-------------------------- ------------------------
ACTUAL PRO FORMA ACTUAL PRO FORMA
---------- ----------- --------- ----------
(IN MILLIONS)
Revenues........................................... $ 3,613 $ 3,672 $ 5,934 $ 6,100
Net income before cumulative effect of accounting
change and extraordinary item.................... 104 95 81 56
Net income......................................... 111 102 89 64
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.
(6) DEPRECIATION AND AMORTIZATION EXPENSE
The Company's depreciation expense for the quarter and six months ended
June 30, 2000 was $26 million and $45 million, respectively, compared to $29
million and $60 million for the same periods in 2001. Goodwill amortization
related to acquisitions was $12 million and $21 million for the quarter and six
months ended June 30, 2000, respectively, compared to $8 million and $17 million
for the same periods in 2001. Other amortization expense, including amortization
of air emissions regulatory allowances and other intangibles, was zero for the
quarter and six months ended June 30, 2000, respectively, compared to $6 million
and $30 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 $ 111 $ 228 $ 89 $ 310
Other comprehensive income (loss):
Foreign currency translation adjustments 5 5 (6) 5
Changes in minimum benefit liability -- -- -- (6)
Cumulative effect of adoption of SFAS No. 133 -- -- -- (290)
Deferred gain from cash flow hedges -- 251 -- 437
Reclassification of deferred loss from cash flow
hedges realized in net income -- 78 -- 98
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 $ 117 $ 568 $ 99 $ 567
========== ========== ========== ===========-
(8) SHORT-TERM BORROWINGS FROM THIRD PARTIES
As of June 30, 2001, the Company had $3.9 billion in committed credit
facilities, including facilities of subsidiaries of Reliant Energy Power
Generation, Inc. (REPG) and REPGB, of which $2.3 billion remained unused. Credit
facilities aggregating $3.0 billion were unsecured. As of June 30, 2001, letters
of credit outstanding under these facilities aggregated $544 million. As of June
30, 2001, borrowings of $979 million were outstanding under these facilities of
which $852 million were classified as long-term debt, based upon the
availability of committed credit facilities and management's intention to
maintain these borrowings in excess of one year.
Of the credit facilities described above, facilities aggregating $2.1
billion in committed credit, were entered into during 2001. At June 30, 2001,
there were no outstanding borrowings under these facilities. As of June 30,
2001, letters of credit under these facilities aggregated $150 million. These
facilities became effective in 2001 and expire on October 2, 2001. Interest
rates on the borrowings are based on London interbank offered rate (LIBOR) plus
a margin, a base rate or a rate determined through a bidding process. These
facilities contain various business and financial covenants requiring the
Company to, among other things, maintain a ratio of net debt to the sum of net
debt,
11
stockholders' equity and subordinated affiliate debt not to exceed 0.60 to 1.00.
These covenants are not anticipated to materially restrict the Company from
borrowing funds or obtaining letters of credit under these facilities. The
credit facilities are subject to commitment and usage fees that are calculated
based on the amount of the facility commitments and on the amounts outstanding
under the facilities, respectively.
(9) STOCKHOLDERS' EQUITY
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. In May 2001, the Company
offered 59.8 million shares of its common stock to the public at an initial
public offering price of $30 per share and received net proceeds from the
Offering of $1.7 billion. Pursuant to the terms of the master separation
agreement between Reliant Energy and Reliant Resources, 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 of the Offering
to increase the Company's working capital. For additional information, see note
4(c) to Reliant Resources Prospectus Notes.
(10) EARNINGS PER SHARE
The following table presents Reliant Resources' basic and diluted earnings
per share (EPS) calculation:
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, 2001 JUNE 30, 2001
---------------- ---------------
(IN MILLIONS, EXCEPT SHARE AND
PER SHARE AMOUNTS)
Basic EPS Calculation:
Income before cumulative effect of accounting change...................... $ 228 $ 307
Cumulative effect of accounting change, net of tax........................ -- 3
---------------- ---------------
Net income................................................................ $ 228 $ 310
================ ===============
Weighted average shares outstanding......................................... 276,944,000 258,574,000
================ ===============
Basic EPS:
Net income before cumulative effect of accounting change.................. $ 0.83 $ 1.19
Cumulative effect of accounting change, net of tax........................ -- 0.01
---------------- ---------------
Net income................................................................ $ 0.83 $ 1.20
================ ===============
Diluted EPS Calculation:
Weighted average shares outstanding......................................... 276,944,000 258,574,000
Plus: Incremental shares from assumed conversions:
Stock options........................................................... 172,000 86,000
Restricted stock........................................................ 116,000 116,000
Employee stock purchase plan............................................ 14,000 14,000
---------------- ---------------
Weighted average shares assuming dilution................................. 277,246,000 258,790,000
================ ===============
Diluted EPS:
Income before cumulative effect of accounting change...................... $ 0.82 $ 1.19
Cumulative effect of accounting change, net of tax........................ -- 0.01
---------------- ---------------
Net income................................................................ $ 0.82 $ 1.20
================ ===============
12
Prior to August 9, 2000, Reliant Resources, Inc. was not a separate legal
entity and therefore had no historical capital structure. Accordingly, earnings
per share have not been presented for the three or six months ended June 30,
2000.
Reliant Resources' Certificate of Incorporation was amended to effect a
240,000 to 1 stock split of Reliant Resources' common stock on January 5, 2001.
For the three and six months ended June 30, 2001, the computation of
diluted EPS excludes purchase options for 9,517 shares of common stock that have
an exercise price ($34.03) greater than the per share average market price
($31.45) for the period and would thus be anti-dilutive if exercised.
(11) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
California Wholesale Market. Reliant Energy, Reliant Energy Services, Inc.
(a wholly owned subsidiary), Reliant Energy Power Generation, Inc. (a wholly
owned subsidiary) 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(d) to Reliant Resources
Prospectus Notes), Reliant Resources has agreed to indemnify Reliant Energy for
any damages arising under these lawsuits and may elect to defend these lawsuits
at the Company's 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 in 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 these
cases 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 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.
REMA Ash Disposal Site Closures and Site Contaminations. Under the
agreement to acquire REMA (see Note 5(a) of the Reliant Resources Prospectus
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 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 5(b) of the Reliant Resources Prospectus 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.
13
(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 by the California Power
Exchange (Cal PX) and the California Independent System Operator (Cal ISO) a
total of $282 million. 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 "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
14
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 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
15
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 on 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.
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.
16
(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 costs
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 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.
17
(f) Payment to Reliant Energy in 2004.
To the extent the Company's price for providing retail electric service to
residential and small commercial customers in Reliant Energy's Houston service
territory during 2002 and 2003, which price is mandated by the Texas electric
restructuring law, exceeds the market price of electricity, the Company may be
required to make a payment to Reliant Energy in early 2004. This payment would
be required unless the Public Utility Commission of Texas (Texas Utility
Commission) determines that, on or prior to January 1, 2004, 40% or more of the
amount of electric power that was consumed in 2000 by residential or small
commercial customers, as applicable, within Reliant Energy's Houston service
territory as of January 1, 2002 is committed to be served by retail electric
providers other than the Company. If the 40% test is not met and a payment is
required, the amount of this payment will not exceed, but could be up to $150
per customer multiplied by the number of residential or small commercial
customers, as the case may be, that the Company serves on January 1, 2004 in
Reliant Energy's Houston service territory, less the number of new retail
electric customers the Company serves in other areas of Texas. As of June 30,
2001, Reliant Energy had approximately 1.5 million residential and small
commercial customers. In the master separation agreement between the Company and
Reliant Energy, the Company has agreed to make this payment, if any, to Reliant
Energy.
(g) Construction Agency Agreement.
In April 2001, the Company, 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. The Company,
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 project costs incurred to date,
except in certain events. Upon completion of an individual project and exercise
of the lease option, the Company's subsidiaries will be required to make lease
payments in an amount sufficient to provide a return to the Investors. If the
Company does not exercise its option to lease any project upon its completion,
the Company 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 of up to 85% of
the project cost, if the proceeds from remarketing are not sufficient to repay
the Investors. The Company 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.
(12) BENEFIT CURTAILMENT AND ENHANCEMENT CHARGE
During the six months ended June 30, 2001, the Company recognized a
pre-tax, non-cash charge of $100 million relating to the redesign of some of
Reliant Energy's benefit plans in anticipation of Reliant Resources' separation
from Reliant Energy.
Effective March 1, 2001, the Company no longer accrues benefits under a
noncontributory pension plan for its domestic non-union employees (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 $83 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. In connection with
the Distribution, the Company expects to incur a loss of $48 million (pre-tax)
related to the settlement of Reliant Energy's pension plan.
Effective March 1, 2001, the Company discontinued providing subsidized
postretirement benefits to its domestic non-union employees. 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. In
connection with the Distribution, the Company expects to incur a pre-tax gain of
$18 million related to the settlement of post retirement benefit obligations.
For additional information regarding these benefit plans, see Notes 9(b) and
9(d) to Reliant Resources Prospectus Notes.
18
(13) 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. The Company has identified these following reportable segments:
Wholesale Energy, European Energy, Retail Energy and Other Operations. For
descriptions of these financial reporting segments, see Note 1 of the Reliant
Resources Prospectus Notes. There were no material inter-segment revenues during
the quarters ended June 30, 2000 and June 30, 2001.
Financial data for business segments are as follows:
FOR THE THREE MONTHS ENDED JUNE 30, 2000
--------------------------------------------------
INCOME FROM
EQUITY
INVESTMENTS AS OF
IN DECEMBER 31,
REVENUES FROM OPERATING UNCONSOLIDATED 2000
NON-AFFILIATES INCOME (LOSS) SUBSIDIARIES TOTAL ASSETS
-------------- -------------- -------------- -----------------
(IN MILLIONS)
Wholesale Energy................................... $ 3,452 $ 172 $ 5 $ 10,504
European Energy.................................... 136 26 -- 2,473
Retail Energy...................................... 23 (12) -- 131
Other Operations................................... 2 (12) -- 106
--------------- --------------- --------------- ---------------
Consolidated....................................... $ 3,613 $ 174 $ 5 13,214
=============== =============== =============== ===============
FOR THE SIX MONTHS ENDED JUNE 30, 2000
--------------------------------------------
INCOME FROM
EQUITY
INVESTMENTS
IN
REVENUES FROM OPERATING UNCONSOLIDATED
NON-AFFILIATES INCOME (LOSS) SUBSIDIARIES
-------------- ------------- --------------
(IN MILLIONS)
Wholesale Energy................................... $ 5,608 $ 150 $ 6
European Energy.................................... 286 61 --
Retail Energy...................................... 38 (21) --
Other Operations................................... 2 (15) --
--------- --------- --------
Consolidated....................................... $ 5,934 $ 175 $ 6
========= ========= ========
FOR THE THREE MONTHS ENDED JUNE 30, 2001
------------------------------------------------
INCOME FROM
EQUITY
INVESTMENTS IN AS OF
REVENUES FROM OPERATING UNCONSOLIDATED JUNE 30, 2001
NON-AFFILIATES INCOME (LOSS) SUSUBSIDIARIES TOTAL ASSETS
-------------- ------------- -------------- ----------------
(IN MILLIONS)
Wholesale Energy................................... $ 9,378 $ 292 $ 1 $ 11,744
European Energy.................................... 276 9 51 3,043
Retail Energy...................................... 36 (3) -- 193
Other Operations................................... 3 (10) -- 1,562
Reconciling Elimination............................ -- -- -- (291)
-------------- ------------- -------------- ----------------
Consolidated....................................... $ 9,693 $ 288 $ 52 $ 16,251
============== ============= ============== ================
FOR THE SIX MONTHS ENDED JUNE 30, 2001
-------------------------------------------------
INCOME FROM
EQUITY
INVESTMENTS IN
REVENUES FROM OPERATING UNCONSOLIDATED
NON-AFFILIATES INCOME (LOSS) SUSUBSIDIARIES
-------------- ------------- --------------
(IN MILLIONS)
Wholesale Energy................................... $ 18,971 $ 508 $ 14
European Energy.................................... 524 27 51
Retail Energy...................................... 63 (6) --
Other Operations................................... 6 (126) --
-------------- ------------- --------------
Consolidated....................................... $ 19,564 $ 403 $ 65
============== ============= ==============
19
Reconciliation of Operating Income to Net Income:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ----------------------------
2000 2001 2000 2001
------------ -------- ------------- ----------
(IN MILLIONS)
Operating income................................. $ 174 $ 288 $ 175 $ 403
Other (expense) income........................... (32) 60 (73) 55
Income tax expense............................... (38) (120) (20) (151)
Cumulative effect of accounting change........... -- -- -- 3
Extraordinary item............................... 7 -- 7 --
--------- --------- --------- ---------
Net income....................................... $ 111 $ 228 $ 89 $ 310
========= ========= ========= =========
(14) SUBSEQUENT EVENTS
(a) 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 included as a component of
stockholders' equity.
(b) Treasury Stock Purchases.
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 the Company
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.
(c) 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.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY
The following discussion and analysis should be read in combination with
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 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 rapidly growing provider of electricity and energy services with a
focus on the deregulating competitive wholesale and retail segments of the
electric power industry in the United States and Europe.
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
Wholesale Energy, European Energy, Retail Energy and Other Operations. For
segment reporting information, please read Note 13 to our Interim Financial
Statements.
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. For additional information about this acquisition, including our
accounting treatment of the acquisition, please read Note 5(a) to Reliant
Resources Prospectus Notes and Note 5 to our Interim Financial Statements.
OUR SEPARATION FROM RELIANT ENERGY
In connection with our separation from Reliant Energy, Reliant Energy has
contributed to us effective December 31, 2000, by conveyance or merger, our
wholesale, retail and other operations described in Note 1 to Reliant Resources
Prospectus Notes. Through December 31, 2000, these operations were conducted by
Reliant Energy and its direct and indirect subsidiaries. These operations
consist of the following:
- non-rate regulated power generation assets and related energy trading,
marketing, power origination and risk management operations in North
America and Europe,
- retail electric operations, and
- other operations, including our eBusiness, communications, and venture
capital businesses which we refer to as "New Ventures businesses."
The financial information for the three and six months ended June 30, 2000,
discussed in this section is derived from the consolidated historical financial
statements of Reliant Energy, which include the results of operations for all of
Reliant Energy's businesses, including those businesses which we did not own. In
order to prepare our financial statements for the three and six months ended
June 30, 2000, contained in this Form 10-Q/A and discussed in this
21
section, we carved-out the results of operations of the businesses that we own
from Reliant Energy's consolidated historical financial statements. Accordingly,
the results of operations discussed in this section include only revenues and
costs directly attributable to the businesses we own and operate. Some of these
costs are for facilities and services provided by Reliant Energy and for which
our operations have historically been charged based on usage or other allocation
factors. We believe these allocations are reasonable but they are not
necessarily indicative of the expenses that would have resulted if we had
actually operated independently of Reliant Energy. We may experience changes in
our cost structure, funding and operations as a result of our separation from
Reliant Energy, including increased costs associated with reduced economies of
scale, and increased costs associated with being a publicly traded, independent
company. We cannot currently predict, with any certainty, the actual amount of
increased costs we may incur, if any.
In May 2001, we offered 59.8 million shares of our 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, we used $147 million of the net proceeds to repay certain
indebtedness owed to Reliant Energy. Reliant Energy has publicly disclosed that
it expects to distribute the remaining common stock of Reliant Resources that it
owns to Reliant Energy's or its successor's shareholders within 12 months of the
closing of our initial public offering. For additional information regarding our
business separation plan, please read Notes 1 and 4 to Reliant Resources
Prospectus Notes.
The following table provides summary data regarding our consolidated
results of operations for the three and six months ended June 30, 2000 and 2001.
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ----------------------------
2000 2001 2000 2001
------------ -------- ------------- ----------
(IN MILLIONS)
Operating Revenues................................. $ 3,613 $ 9,693 $ 5,934 $ 19,564
Operating Expenses................................. 3,439 9,405 5,759 19,161
--------- --------- --------- ---------
Operating Income................................... 174 288 175 403
Other (Expense) Income, net ....................... (32) 60 (73) 55
Income Tax Expense................................. (38) (120) (20) (151)
--------- --------- --------- ---------
Income Before Cumulative Effect of
Accounting Change and Extraordinary Item...... 104 228 82 307
Cumulative Effect of Accounting Change,
net of tax................................... -- -- -- 3
Extraordinary item, net of tax..................... 7 -- 7 --
--------- --------- --------- ---------
Net Income......................................... $ 111 $ 228 $ 89 $ 310
========= ========= ========= =========
Three months ended June 30, 2000 compared to three months ended June 30, 2001
Net Income. We reported consolidated net income of $111 million for the
three months ended June 30, 2000 compared to $228 million for the three months
ended June 30, 2001. During the second quarter of 2000, we recognized a $7
million extraordinary gain related to the early extinguishment of long-term
debt. The $117 million increase was primarily due to a $51 million pre-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,
increased earnings from Wholesale Energy and a decrease in net interest expense
partially offset by the following:
- an $18 million pre-tax gain on the sale of a development-stage project
recognized in the three months ended June 30, 2000,
- a net $12 million write-off in receivable balances related to our
energy sales in the California market recorded in the three months
ended June 30, 2001, resulting from refunds, and
- a decrease in margins realized by European Energy as the Dutch
wholesale electric market was completely opened to competition on
January 1, 2001.
Operating Income. For an explanation of changes in operating income, please
read the discussion below of operating income (loss) by segment.
22
Other Income (Expense). Other expense was $32 million for the second
quarter of 2000 compared to other income of $60 million for the second quarter
of 2001. This increase in other income was primarily due to decreased interest
expense on notes to affiliated companies of $62 million and the $51 million
pre-tax gain recorded in equity income as described above. Net intercompany
interest related to affiliated debt decreased from the three months ended June
30, 2000 compared to the same period in 2001 primarily due to the following:
- the conversion into equity of debt owed to Reliant Energy and its
subsidiaries of $1.7 billion upon the completion of the offering (see
Note 4 to our Interim Financial Statements),
- the repayment in August 2000 of $1.0 billion of debt owed to Reliant
Energy related to the REMA acquisition from proceeds received from the
sale-leaseback transactions (see Note 5(a) to Reliant Resources
Prospectus Notes), and
- the investing of excess cash primarily resulting from the Offering
with a subsidiary of Reliant Energy during the second quarter of 2001.
For additional information regarding the $51 million gain recognized in the
second quarter of 2001 related to European Energy's value of its equity
investment in SEP, see Note 11(e) to our Interim Financial Statements. These
items were partially offset by the following:
- an increase in interest expense to third parties of $11 million
primarily as a result of higher levels of short-term and long-term
borrowings associated, in part, with capital expenditures.
- decreased earnings from unconsolidated subsidiaries of Wholesale
Energy for the second quarter of 2001 of $5 million compared to the
same period in 2000, and
- an $18 million pre-tax gain on the sale of a development-stage project
recognized in the second quarter of 2000.
Income Tax Expense. During the three months ended June 30, 2000 and 2001,
our effective tax rate was 26.8% and 34.4%, respectively. Our reconciling items
from the federal statutory rate of 35% to the effective tax rate totaled $2.2
million for the three months ended June 30, 2001. These items primarily related
to income earned by REPGB and were partially offset by nondeductible goodwill,
state income taxes and valuation allowances. Our reconciling items from the
federal statutory rate of 35% to the effective tax rate totaled $11.7 million
for the three months ended June 30, 2000. These items primarily related to
income earned by REPGB and were partially offset by nondeductible goodwill,
state income taxes and valuation allowances. In 2001 and prior years, the
earnings of REPGB were subject to a zero percent Dutch corporate income tax rate
as a result of the Dutch tax holiday related to the Dutch electricity industry.
In 2002, all of European Energy's earnings in the Netherlands will be subject to
the standard Dutch corporate income tax rate, which is currently 35%.
Six months ended June 30, 2000 compared to six months ended June 30, 2001
Net Income. We reported consolidated net income of $89 million for the six
months ended June 30, 2000 compared to $310 million for the six months ended
June 30, 2001. The increase of $221 million was primarily due to increased
earnings from Wholesale Energy, equity income related to a preacquisition
contingency for the value of SEP as discussed above and Wholesale Energy, a
decrease in net interest expense, and a pre-tax impairment loss of $22 million
on marketable equity securities classified as "available-for-sale" recorded in
the first quarter of 2000, partially offset by the following:
- a pre-tax, non-cash charge of $100 million relating to the redesign of
some of Reliant Energy's benefit plans in anticipation of our
separation from Reliant Energy,
- a $37 million provision against receivable balances related to our
energy sales during the first six months of 2001 in the California
market,
- an $18 million pre-tax gain on the sale of a development-stage project
recognized in the six months ended June 30, 2000,
23
- a net $12 million write-off in receivable balances related to our
energy sales in the California market recorded in the three months
ended June 30, 2001, resulting from refunds, and
- a decrease in margins realized by European Energy as the Dutch
wholesale electric market was completely opened to competition on
January 1, 2001.
A cumulative effect of accounting change of $3 million was recognized in
the first quarter of 2001, related to the adoption of SFAS No. 133, which is
discussed in Note 3 to our Interim Financial Statements. During the second
quarter of 2000, we recognized a $7 million extraordinary gain related to the
early extinguishment of long-term debt.
Operating Income. For an explanation of changes in our operating income,
please read the discussion below of operating income (loss) by segment.
Other Income (Expense). Other expense decreased by $128 million during the
six months ended June 30, 2000 compared to the same period in 2001, primarily
due to the following:
- decreased interest expense of $68 million on debt to affiliated
companies, as discussed above in the quarterly results of operations,
- a $51 million pre-tax preacquisition contingency gain recorded as
equity income, as discussed in Note 11(e) of our Interim Financial
Statements,
- an $8 million increase in earnings compared to the same period in 2000
from unconsolidated subsidiaries of Wholesale Energy for the six
months ended June 30, 2001,
- an impairment loss of $22 million on marketable equity securities
classified as "available-for-sale" recorded in the first quarter of
2000,
- increased unrealized and realized gains on marketable equity
securities of $4 million, and
- increased interest income of $12 million primarily related to
increased deposits from Wholesale Energy.
The above items were partially offset by increased interest expense to
third parties of $25 million, primarily as a result of higher levels of
short-term and long-term borrowings associated, in part, with the funding of a
portion of the acquisition of REPGB in March 2000 and capital expenditures. In
addition, we recognized an $18 million pre-tax gain on the sale of a
development-stage project recognized in the six months ended June 30, 2000.
For additional information regarding our investment in the marketable
equity securities noted above, see Note 2(l) to Reliant Resources Prospectus
Notes.
During the six months ended June 30, 2001, the Company recognized $16
million of interest expense to affiliates that was subsequently converted or
contributed to our equity in May 2001 by Reliant Energy.
Income Tax Expense. During the six months ended June 30, 2000 and 2001, our
effective tax rate was 20.3% and 32.9%, respectively. Our reconciling items from
the federal statutory tax rate of 35% to the effective tax rate totaled $9.6
million for the six months ended June 30, 2001. These items primarily related to
income earned by REPGB and were partially offset by nondeductible goodwill,
state income taxes and valuation allowances. Our reconciling items from the
federal statutory tax rate to the effective tax rate totaled $15.0 million for
the six months ended June 30, 2000. These items primarily related to income
earned by REPGB and were partially offset by nondeductible goodwill and state
income taxes.
As discussed in Note 11(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.
24
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income (loss) for each of our
business segments for the three and six months ended June 30, 2000 and 2001.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
2000 2001 2000 2001
------------- ---------- ------------ ---------
(IN MILLIONS)
Wholesale Energy................................... $ 172 $ 292 $ 150 $ 508
European Energy.................................... 26 9 61 27
Retail Energy...................................... (12) (3) (21) (6)
Other Operations................................... (12) (10) (15) (126)
--------- --------- --------- ---------
Total Consolidated........................... $ 174 $ 288 $ 175 $ 403
========= ========= ========= =========
WHOLESALE ENERGY
Wholesale Energy 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.
The following table provides summary data regarding the results of
operations of Wholesale Energy for the three and six months ended June 30, 2000
and 2001.
WHOLESALE ENERGY
------------------------------------------------------------
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........................ 42 83 74 148
General, Administrative and Development.......... 33 69 65 139
Depreciation and Amortization.................... 18 21 25 62
--------- --------- --------- ---------
Total Operating Expenses....................... 3,280 9,086 5,458 18,463
--------- --------- --------- ---------
Operating Income................................... $ 172 $ 292 $ 150 $ 508
========= ========= ========= =========
Operations Data:
Electricity Wholesale Power Sales
(in MMWH (1)).................................. 36 86 64 163
Natural Gas Sales (in Bcf (2))................... 533 859 1,082 1,626
(1) Million megawatt hours.
(2) Billion cubic feet.
Wholesale Energy's operating income increased $120 million and $358 million
for the second quarter and first six months of 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 second quarter and the
first six months of 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,
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.
25
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. The company has
not reserved any amounts for potential future refunds as a reasonable estimate
cannot be made.
For information regarding the reserve against receivables and uncertainties
in the California wholesale energy market, please read Notes 11(a) and 11(d) to
our Interim Financial Statements.
Wholesale Energy's operating revenues increased $5.9 billion and $13.4
billion for the second quarter and the first six months of 2001 compared to the
same periods in 2000. The increases were primarily due to increases in prices
and volumes for gas and power sales. Wholesale Energy's fuel and gas costs
increased $2.3 billion and $6.6 billion in the second quarter and the first six
months of 2001 compared to the same periods in 2000, largely due to a higher
average cost of gas and increased volume. Wholesale Energy's purchased power
expense increased $3.4 billion and $6.3 billion for the second quarter and the
first six months of 2001 compared to the same periods in 2000, primarily due to
higher power sales volumes and higher average cost of power. Operation and
maintenance expenses for Wholesale Energy increased $41 million and $74 million
in the second quarter and the first six months of 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 and lease expense associated with the Mid-Atlantic generating
facilities' sale/leaseback transactions. General, administrative and development
expenses increased $36 million and $74 million in the second quarter and first
six months of 2001 compared to the same periods in 2000, primarily due to higher
staffing levels to support increased sales and expanded trading and marketing
efforts. Depreciation and amortization expense for the second quarter and the
first six months of 2001 compared to the same periods in 2000 increased by $3
million and $37 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 REPGB and its
subsidiaries and our European trading, marketing and risk management operations.
European Energy 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
that 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 regarding these and other factors that may affect the
future results of operations of European Energy, please read "Risk Factors -
Risks Related to our Wholesale Business - We will experience a significant
decline in our European Energy business segment's gross margin in 2001" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Factors Affecting Our Future Earnings - Our European
Operations" in the Reliant Resources Prospectus, which information is
incorporated herein by reference.
The following table provides summary data regarding the results of
operations of European Energy for the three and six months ended June 30, 2000
and 2001.
26
EUROPEAN ENERGY
------------------------------------------------------------
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............................................. 58 101 127 203
Purchased Power.................................. 4 117 4 197
Operation and Maintenance........................ 29 19 51 39
General and Administrative....................... 1 11 5 20
Depreciation and Amortization.................... 18 19 38 38
--------- --------- --------- ---------
Total Operating Expenses...................... 110 267 225 497
--------- --------- --------- ---------
Operating Income................................... $ 26 $ 9 $ 61 $ 27
========= ========= ========= =========
Electricity (in MMWH):
Wholesale Sales.................................. 2.8 3.7 5.9 7.3
Trading Sales.................................... -- 5.9 -- 9.0
European Energy's operating income decreased $17 million and $34 million
for the second quarter and the first six months of 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.
European Energy's operating revenues increased $140 million and $238
million for the second quarter and the first six months of 2001 compared to the
same periods in 2000. The 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 in the second quarter and the first six months of 2001 compared
to the same periods in 2000 primarily due to increased purchased power for
trading activities, and increased cost of natural gas and other fuels.
RETAIL ENERGY
Retail Energy provides energy products and services to end-use customers,
ranging from residential and small commercial customers to large commercial,
institutional and industrial customers. In addition, Retail Energy includes
billing and remittance services provided to Reliant Energy's regulated electric
utility and two of its natural gas distribution divisions. Retail Energy charges
the regulated electric and gas utilities for these services at cost. We expect
to succeed to a significant electric retail customer base in the Houston
metropolitan area when the Texas market opens to competition in January 2002.
The following table provides summary data regarding the results of
operations of Retail Energy for the three and six months ended June 30, 2000 and
2001.
RETAIL ENERGY
------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
2000 2001 2000 2001
------------ ----------- ----------- ----------
(IN MILLIONS)
Operating Revenues................................. $ 23 $ 36 $ 38 $ 63
Operating Expenses:
Operation and Maintenance........................ 32 26 53 47
General, Administrative and Development.......... 2 11 4 18
Depreciation and Amortization.................... 1 2 2 4
--------- --------- --------- --------
Total Operating Expenses...................... 35 39 59 69
--------- --------- --------- --------
Operating Loss..................................... $ (12) $ (3) $ (21) $ (6)
========= ========= ========= ========
Our Retail Energy segment operating loss decreased $9 million and $15
million, respectively, in the second quarter and the first six months of 2001
compared to the same periods in 2000. The operating loss reduction was primarily
due to increased sales of energy and energy services to commercial and
industrial customers from our Reliant Energy Solutions unit. Operating revenues
increased $13 million and $25 million, respectively, in the second quarter and
the first six months of 2001 compared to the same periods in 2000, due to
revenues from sales of energy and energy
27
services to commercial and industrial customers as well as increased revenues
for the billing and remittance services provided to Reliant Energy. Operations
and maintenance and general, administrative and development expenses increased
$3 million and $8 million in the second quarter and the first six months of 2001
compared to the same periods in 2000, primarily due to increased personnel and
employee related costs and costs related to building an infrastructure necessary
to prepare for competition in the retail electric market in Texas.
OTHER OPERATIONS
Our Other Operations segment includes the operations of our New Ventures
businesses, along with unallocated corporate costs.
The following table provides summary data regarding the results of
operations of Other Operations for the three and six months ended June 30, 2000
and 2001.
OTHER OPERATIONS
------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------- ----------------------------
2000 2001 2000 2001
------------- ------------ -------------- -----------
(IN MILLIONS)
Operating Revenues................................. $ 2 $ 3 $ 2 $ 6
Operating Expenses:
Operation and Maintenance........................ 2 5 2 9
General, Administrative and Development.......... 10 6 13 119
Depreciation and Amortization.................... 2 2 2 4
----------- --------- ----------- ---------
Total Operating Expenses...................... 14 13 17 132
----------- --------- ----------- ---------
Operating Loss..................................... $ (12) $ (10) $ (15) $ (126)
=========== ========= =========== =========
Other Operation's operating revenues increased $1 million and $4 million in
the second quarter and the first six months of 2001 compared to the same periods
in 2000, primarily due to our communications business. Operation and maintenance
and general, administrative and development expenses increased $113 million in
the first six months of 2001 compared to the same period in 2000, primarily due
to a pre-tax non-cash charge of $100 million relating to the redesign of some of
Reliant Energy's benefit plans in anticipation of our separation from Reliant
Energy, and due to the timing of legal expenses and increased communications
business and information technology expenses. The $2 million increase in
depreciation and amortization expense in the first six months of 2001 is
primarily related to capital expenditures subsequent to the first quarter of
2000. For additional information about the benefit charge noted above, please
read Note 12 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
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Risk Factors" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Certain Factors Affecting Our Future Earnings" in the Reliant Resources
Prospectus, which is incorporated herein by reference. For additional
information regarding the California wholesale market and related litigation,
please read Notes 11(a) and 11(d) to our Interim Financial Statements.
28
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...................................................... $ (34) $ 328
Investing activities...................................................... (3,538) (489)
Financing activities...................................................... 3,569 162
Net cash provided by operating activities during the six months ended June
30, 2001 increased $362 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 a prepayment of
a lease obligation related to the REMA sale/leaseback transactions and other
changes in working capital.
Net cash used in investing activities during the six months ended June 30,
2001 decreased $3.0 billion 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, 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 during the six months ended
June 30, 2001 decreased $3.4 billion compared to the same period in 2000,
primarily due to investing excess cash in an affiliate of Reliant Energy and a
decrease in short-term borrowings, partially offset by $1.7 billion in net
proceeds from our initial public offering.
FUTURE SOURCES AND USES OF CASH FLOWS
Credit Facilities. We have bilateral credit facilities with financial
institutions, which provide for an aggregate of $2.1 billion in committed
credit. Of this amount, $350 million was added during the second quarter of
2001. These facilities expire on October 2, 2001. Interest rates on the
borrowings are based on LIBOR plus a margin, a base rate or a rate determined
through a bidding process. These facilities contain various business and
financial covenants requiring us to, among other things, maintain a ratio of net
debt to the sum of net debt, subordinated affiliate debt and stockholders'
equity not to exceed 0.60 to 1.00. These covenants are not anticipated to
materially restrict us from borrowing funds or obtaining letters of credit under
these facilities. The credit facilities are subject to commitment and usage fees
that are calculated based on the amount of the facility commitments and on the
amounts outstanding under the facilities, respectively. In addition, we have
credit facilities of $1.8 billion. Of the aggregated credit facilities of $3.9
billion, $2.3 billion remain unused as of June 30, 2001.
Of the $3.9 billion of committed credit facilities described above, $2.1
billion will expire in 2001. 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.
Initial Public Offering of Reliant Resources. In May 2001, we offered 59.8
million shares of our common stock to the public at an initial public offering
price of $30 per share and received net proceeds from the Offering of $1.7
billion. Pursuant to the terms of the master separation agreement between
Reliant Energy and us, we used $147 million of the net proceeds to repay certain
indebtedness owed to Reliant Energy. We used the remainder of the net proceeds
of the Offering to increase our working capital. Reliant Energy has publicly
disclosed that it expects the Offering to be followed by a distribution of the
remaining shares of our common stock owned by Reliant Energy to Reliant Energy's
or its successor's shareholders within 12 months of the Offering. For additional
information, please read Notes 1 and 4 to Reliant Resources Prospectus Notes.
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 bridge loans from Reliant Energy and $1.0 billion was converted
to equity. 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 5(a) and
11(c) to
29
Reliant Resources Prospectus 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 indebtedness owed by us to Reliant Energy. 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 loan 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
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 from equity. We believe that our level of cash, our borrowing
capability and proceeds from our Offering 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 our Offering will be sufficient to fund these
options should we choose to exercise them.
Construction Agency Agreement. In April 2001, we, through several of our
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. We,
through several of our subsidiaries, act as construction agent for the special
purpose entities, and are responsible for completing construction of these
projects by August 31, 2004, but have generally limited our 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, our subsidiaries will be required to make lease payments in
an amount sufficient to provide a return to the Investors. If we do not exercise
our option to lease any project at our completion, we 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 not sufficient to repay the Investors. We have guaranteed
the performance and payment of our subsidiaries' obligations during the
construction periods and, if the lease option is exercised, each 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 earlier 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 11(a) and 11(d) to our Interim Financial Statements and Notes 11(e)
and 11(h) to Reliant Resources Prospectus Notes.
Payment to Reliant Energy. To the extent that our price for providing
retail electric service to residential and small commercial customers in Reliant
Energy's Houston service territory during 2002 and 2003, which price is mandated
by the Texas electric restructuring law, exceeds the market price of
electricity, we will be required to make a payment to Reliant Energy in early
2004 unless the Texas Utility Commission determines that, on or prior to January
1, 2004, 40% or more of the amount of electric power that was consumed in 2000
by residential or small commercial customers, as applicable, within Reliant
Energy's Houston service territory as of January 1, 2002 is committed to be
served by retail
30
electric providers other than us. If the 40% test is not met and a payment is
required, the amount of this payment will not exceed, but could be up to, $150
per customer multiplied by the number of residential or small commercial
customers, as the case may be, that we serve on January 1, 2004 in Reliant
Energy's Houston service territory, less the number of new retail electric
customers we serve in other areas of Texas. As of June 30, 2001, Reliant Energy
had approximately 1.5 million residential and small commercial customers. In the
master separation agreement with Reliant Energy, we have agreed to make this
payment, if any, to Reliant Energy.
Treasury Stock Purchase. 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 of our benefit
plan obligations expected to be funded prior to the Distribution. The master
separation agreement between us and Reliant Energy restricts our ability to
issue shares of common stock prior to the separation of the two companies
without prior consent of Reliant Energy. Accordingly, we may make future
purchases of our common stock in anticipation of funding pre-Distribution
employee benefit plan obligations.
Florida Tolling Arrangement. In the first quarter of 2001, we 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
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 varied
working capital needs. We expect to continue to bid in 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 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 (including
proceeds from our Offering) and borrowing capability, along with future cash
flows from operations, will be sufficient to meet the existing operational needs
of our business for the next 12 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.
31
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 RESOURCES, INC.
(Registrant)
By: /s/ Mary P. Ricciardello
-------------------------------
Mary P. Ricciardello
Senior Vice President
and Chief Accounting Officer
Date: March 25, 2002
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