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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
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 of (I.R.S. Employer
incorporation or organization) Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
----------
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 9, 2002, Reliant Resources, Inc. (Reliant Resources) had
290,439,779 shares of common stock outstanding including 240,000,000 shares
which were held by Reliant Energy, Incorporated and excluding 9,364,221 shares
held as treasury stock. As of August 9, 2002, 50,402,716 shares of common
stock were 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
FOR THE QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Consolidated Income (unaudited)
Three and Six Months Ended June 30, 2001 (as restated) and
2002 ......................................................................1
Consolidated Balance Sheets (unaudited)
December 31, 2001 and June 30, 2002 .......................................2
Statements of Consolidated Cash Flows (unaudited)
Six Months Ended June 30, 2001 and 2002 ...................................4
Notes to Unaudited Consolidated Financial Statements...................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................38
Item 3. Quantitative and Qualitative Disclosures About Market Risk................59
PART II OTHER INFORMATION
Item 1. Legal Proceedings.........................................................61
Item 2. Changes in Securities and Use of Proceeds.................................61
Item 5. Other Information.........................................................61
Item 6. Exhibits and Reports on Form 8-K..........................................63
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,
------------------------------- -------------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
(AS RESTATED) (AS RESTATED)
REVENUES .................................... $ 7,975,148 $ 8,560,903 $ 16,613,160 $ 15,590,885
EXPENSES:
Fuel and cost of gas sold ................. 4,053,830 4,096,400 9,808,369 6,729,816
Purchased power ........................... 3,355,424 3,622,800 5,750,556 7,490,315
Operation and maintenance ................. 131,855 235,714 246,688 414,483
General, administrative and development ... 97,765 166,912 292,747 279,936
Depreciation .............................. 29,315 101,649 60,581 168,903
Amortization .............................. 14,031 4,733 46,895 8,401
------------ ------------ ------------ ------------
Total .................................. 7,682,220 8,228,208 16,205,836 15,091,854
------------ ------------ ------------ ------------
OPERATING INCOME ............................ 292,928 332,695 407,324 499,031
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Gain from investments, net ................ 4,592 2,286 11,315 4,831
Income from equity investments in
unconsolidated subsidiaries .............. 51,572 5,524 64,350 9,308
Other, net ................................ 3,481 4,082 6,902 3,594
Interest expense .......................... (19,627) (66,918) (43,865) (105,844)
Interest income ........................... 4,419 4,484 15,350 8,310
Interest income (expense) -- affiliated
companies, net .......................... 11,155 1,526 (3,431) 4,184
------------ ------------ ------------ ------------
Total other income (expense) ............. 55,592 (49,016) 50,621 (75,617)
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE ............... 348,520 283,679 457,945 423,414
INCOME TAX EXPENSE .......................... 119,785 105,224 150,697 148,083
------------ ------------ ------------ ------------
INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE ......................... 228,735 178,455 307,248 275,331
Cumulative effect of accounting change,
net of tax ............................... (47) -- 3,062 --
------------ ------------ ------------ ------------
NET INCOME .................................. $ 228,688 $ 178,455 $ 310,310 $ 275,331
============ ============ ============ ============
BASIC EARNINGS PER SHARE:
Income before cumulative effect of
accounting change ........................ $ 0.83 $ 0.62 $ 1.19 $ 0.95
Cumulative effect of accounting change,
net of tax ............................... -- -- 0.01 --
------------ ------------ ------------ ------------
Net Income ........................... $ 0.83 $ 0.62 $ 1.20 $ 0.95
============ ============ ============ ============
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of
accounting change ........................ $ 0.82 $ 0.61 $ 1.19 $ 0.95
Cumulative effect of accounting change,
net of tax ............................... -- -- 0.01 --
------------ ------------ ------------ ------------
Net income ............................. $ 0.82 $ 0.61 $ 1.20 $ 0.95
============ ============ ============ ============
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, JUNE 30,
2001 2002
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 118,453 $ 459,561
Restricted cash .................................................. 167,421 375,773
Accounts and notes receivable, principally customer, net ......... 1,167,870 2,020,678
Accrued unbilled revenues ........................................ 14,270 498,322
Accounts and notes receivable - affiliated companies, net ........ 415,081 --
Fuel stock and petroleum products ................................ 109,036 197,289
Materials and supplies ........................................... 64,999 114,907
Stranded costs settlement receivable ............................. 201,503 --
Trading and marketing assets ..................................... 1,611,393 1,367,261
Non-trading derivative assets .................................... 392,900 467,946
Margin deposits on energy trading and hedging activities ......... 213,727 27,909
Collateral for electric generating equipment ..................... 141,701 --
Prepayments and other current assets ............................. 126,936 382,366
------------ ------------
Total current assets ............................................ 4,745,290 5,912,012
------------ ------------
Property, plant and equipment ...................................... 4,834,122 9,304,087
Less accumulated depreciation ...................................... (275,729) (434,433)
------------ ------------
Property, plant and equipment, net .............................. 4,558,393 8,869,654
------------ ------------
OTHER ASSETS:
Goodwill, net .................................................... 891,061 2,383,956
Air emissions regulatory allowances and other intangibles, net ... 315,438 405,697
Notes receivable - affiliated companies, net ..................... 30,278 31,898
Trading and marketing assets ..................................... 446,610 656,440
Non-trading derivative assets .................................... 254,168 348,795
Equity investments in unconsolidated subsidiaries ................ 386,841 289,978
Stranded costs indemnification receivable ........................ 203,693 227,031
Accumulated deferred income taxes ................................ 46,322 --
Prepaid rent ..................................................... 121,699 147,823
Restricted funds for stranded costs .............................. -- 63,008
Collateral for electric generating equipment ..................... 88,268 91,645
Other ............................................................ 203,645 203,220
------------ ------------
Total other assets .............................................. 2,988,023 4,849,491
------------ ------------
TOTAL ASSETS .................................................. $ 12,291,706 $ 19,631,157
============ ============
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, JUNE 30,
2001 2002
------------ ------------
CURRENT LIABILITIES:
Current portion of long-term debt ........................... $ 23,769 $ 16,031
Short-term borrowings ....................................... 296,769 5,831,613
Accounts payable, principally trade ......................... 1,002,326 1,604,485
Accounts and notes payable -- affiliated companies, net ..... -- 149,771
Trading and marketing liabilities ........................... 1,478,336 1,204,274
Non-trading derivative liabilities .......................... 399,277 370,728
Accumulated deferred income taxes ........................... 37,034 48,592
Margin deposits from customers on energy trading and
hedging activities ......................................... 144,700 162,240
Other ....................................................... 253,800 439,297
------------ ------------
Total current liabilities ............................... 3,636,011 9,827,031
------------ ------------
OTHER LIABILITIES:
Accumulated deferred income taxes ........................... -- 294,981
Trading and marketing liabilities ........................... 361,786 591,698
Non-trading derivative liabilities .......................... 639,211 395,720
Major maintenance reserve ................................... 16,784 21,173
Non-derivative stranded costs liability ..................... 203,693 227,031
Benefit obligations ......................................... 127,012 173,974
Other ....................................................... 455,865 431,611
------------ ------------
Total other liabilities ................................. 1,804,351 2,136,188
------------ ------------
LONG-TERM DEBT ................................................ 867,712 1,130,530
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 11)
STOCKHOLDERS' EQUITY:
Preferred stock (125,000,000 shares authorized; none
outstanding) ............................................... -- --
Common stock (2,000,000,000 shares authorized; 240,000,000
and 299,804,000 issued and outstanding, respectively) ...... 61 61
Additional paid-in capital .................................. 5,777,169 5,777,611
Treasury stock at cost, 11,000,000 shares and 10,140,283
shares ..................................................... (189,460) (174,676)
Retained earnings ........................................... 557,451 832,780
Accumulated other comprehensive (loss) income ............... (161,589) 101,632
------------ ------------
Stockholders' equity .................................... 5,983,632 6,537,408
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............ $ 12,291,706 $ 19,631,157
============ ============
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,
-----------------------------
2001 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................................... $ 310,310 $ 275,331
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................ 107,476 177,304
Deferred income taxes ........................................ 61,443 94,645
Net trading and marketing assets and liabilities ............. (116,103) 20,422
Net non-trading derivative assets and liabilities ............ (15,987) (13,719)
Curtailment and related benefit enhancement .................. 99,523 --
Undistributed earnings of unconsolidated subsidiaries ........ (30,822) (7,941)
Gain on settlement of stranded costs ......................... -- (109,000)
Cumulative effect of accounting contracts..................... (3,062) --
Changes in other assets and liabilities, net of effects of
acquisitions:
Restricted cash ............................................ 50,000 67,804
Accounts and notes receivable and unbilled revenue, net .... (263,991) (929,355)
Accounts receivable/payable -- affiliated companies, net ... 115,357 176,598
Inventory .................................................. (65,764) (79,505)
Collateral for electric generating equipment, net .......... (66,726) 138,324
Margin deposits on energy trading activities, net .......... 430,219 203,358
Prepaid lease obligation ................................... (101,542) (26,324)
Settlement payment on stranded cost contracts .............. -- (100,280)
Settlement of hedges of net investment in foreign
subsidiaries ............................................ -- (143,982)
Other current assets ....................................... 11,631 (48,956)
Other assets ............................................... (22,026) (17,505)
Accounts payable ........................................... (179,333) 466,771
Taxes accrued .............................................. (23,080) 104,216
Other current liabilities .................................. 12,566 (54,896)
Other liabilities .......................................... 24,361 (83,803)
Other, net ................................................. (6,843) 4,038
----------- -----------
Net cash provided by operating activities ................. 327,607 113,545
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .......................................... (499,578) (329,946)
Business acquisitions, net of cash acquired ................... -- (2,948,821)
Investments in unconsolidated subsidiaries .................... 26 --
Other, net .................................................... 10,572 (2,299)
----------- -----------
Net cash used in investing activities ..................... (488,980) (3,281,066)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt .................................. -- 22,356
Proceeds from issuance of stock, net .......................... 1,697,848 --
Payments of long-term debt .................................... (1,795) (227,958)
Increase in short-term borrowings, net ........................ 148,677 3,317,929
Change in notes with affiliated companies, net ................ (1,692,552) 386,603
Contributions from owner ...................................... 9,441 --
Other, net .................................................... (7) 7,920
----------- -----------
Net cash provided by financing activities ................. 161,612 3,506,850
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS .... (4,845) 1,779
----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ............ (4,606) 341,108
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ................ 89,755 118,453
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................... $ 85,149 $ 459,561
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) ......................... $ 101,176 $ 122,999
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 (Form 10-Q) 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 amended annual report on Form 10-K/A of Reliant
Resources (Reliant Resources Form 10-K/A) for the year ended December 31, 2001
and the Quarterly Report on Form 10-Q of Reliant Resources for the quarter ended
March 31, 2002 (First Quarter 10-Q).
RESTATEMENT
Also as more fully described in Note 1 to the Consolidated Financial
Statements included in the Reliant Resources Form 10-K/A (Reliant Resources
10-K/A Notes), which is incorporated by reference herein, on May 9, 2002,
Reliant Resources determined that it had engaged in same-day commodity trading
transactions involving purchases and sales with the same counterparty for the
same volume at substantially the same price, which the personnel who effected
these transactions apparently did so with the sole objective of increasing
volumes. Reliant Resources commenced a review to quantify the amount and assess
the impact of these trades (round trip trades). The Audit Committees of each of
the Board of Directors of Reliant Resources and Reliant Energy, Incorporated
(Reliant Energy), a diversified international energy services and energy
delivery company that owns approximately 83% of Reliant Resources outstanding
common stock, (Audit Committees) also directed an internal investigation by
outside legal counsel, with assistance by outside accountants, of the facts and
circumstances relating to the round trip trades and related matters.
The Company reports all trading, marketing and risk management services
transactions on a gross basis with such transactions being reported in revenues
and expenses except primarily for financial gas transactions such as swaps.
Therefore, the round trip trades were reflected in both the Company's revenues
and expenses. The round trip trades should not have been recognized in revenues
or expenses (i.e., they should have been reflected on a net basis). However,
since the round trip trades were done at the same volume and substantially the
same price, they had no impact on the Company's reported cash flows, operating
income or net income.
Based on the Company's review, the Company determined that it engaged in
such round trip trades in 1999, 2000 and 2001. The results of the Audit
Committees' investigation were consistent with the results of the Company's
review. The round trip trades were for 20 million megawatt hours (MWh) of power
and 41 MWh of power and 46 billion cubic feet (Bcf) of natural gas and 46 Bcf of
natural gas for the three and six months ended June 30, 2001, respectively.
These transactions, referred to above, collectively had the effect of
increasing revenues, fuel and cost of gas sold expense and purchased power
expense by $1.4 billion, $131 million and $1.3 billion, respectively, for the
three months ended June 30, 2001 and by $2.6 billion, $131 million and $2.5
billion, respectively, for the six months ended June 30, 2001.
In the course of the Company's review, the Company also identified and
determined that it should record on a net basis several transactions for energy
related services (not involving round trip trades) that totaled $17 million and
$19 million for the three and six months ended June 30, 2001, respectively.
These transactions were originally recorded on a gross basis.
In addition, during the May 2001 through September 2001 time frame, the
Company entered into four structured transactions involving a series of forward
or swap contracts to buy and sell an energy commodity in 2001 and to buy and
sell an energy commodity in 2002 or 2003 (four structured transactions). The
four structured transactions 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. Each series of
contracts in a structure were executed with the same counterparty. The contracts
in each structure were offsetting in the aggregate in terms of physical
attributes. The transactions that settled during the three and six months ended
June 30, 2001 were previously recorded on a gross basis with such transactions
being reported in revenues and expenses which resulted in $323 million of
revenues, $161 million in fuel and cost of gas sold and $162 million of
purchased power expense
5
being recognized in each period. Having further reviewed the transactions, the
Company now believes these transactions should have been accounted for on a net
basis.
The consolidated financial statements for the three and six months ended
June 30, 2001 have been restated from amounts previously reported to reflect the
transactions discussed above on a net basis. The restatement had no impact on
previously reported consolidated cash flows, operating income or net income. A
summary of the principal effects of the restatement are as follows for the three
and six months ended June 30, 2001: (Note -- Those line items for which no
change in amounts are shown were not affected by the restatement.)
THREE MONTHS ENDED
JUNE 30, 2001
-------------------------------
AS PREVIOUSLY
AS RESTATED REPORTED(1)
----------- -------------
(IN MILLIONS)
Revenues ......................................... $ 7,975 $ 9,697
Expenses:
Fuel and cost of gas sold ...................... 4,054 4,360
Purchased power ................................ 3,355 4,771
Other expenses ................................. 273 273
------- -------
Total ......................................... 7,682 9,404
------- -------
Operating Income ................................. 293 293
Other Income, net ................................ 56 56
Income Tax Expense ............................... (120) (120)
------- -------
Net Income ....................................... $ 229 $ 229
======= =======
SIX MONTHS ENDED
JUNE 30, 2001
----------------------------
AS PREVIOUSLY
AS RESTATED REPORTED(1)
----------- -------------
(IN MILLIONS)
Revenues .............................................. $ 16,613 $ 19,568
Expenses:
Fuel and cost of gas sold ........................... 9,808 10,115
Purchased power ..................................... 5,751 8,399
Other expenses ...................................... 647 647
-------- --------
Total .............................................. 16,206 19,161
-------- --------
Operating Income ...................................... 407 407
Other Income, net ..................................... 51 51
Income Tax Expense .................................... (151) (151)
-------- --------
Income Before Cumulative Effect of Accounting Change .. 307 307
Cumulative effect of accounting change, net of tax .... 3 3
-------- --------
Net Income ............................................ $ 310 $ 310
======== ========
(1) In the fourth quarter 2001, the Company changed the classification of
receipts of business interruption insurance claims from other non-operating
income to operating revenues. Receipts of $4 million for both the three and
six months ended June 30, 2001 have been reclassified to conform to this
presentation.
The restatement did not impact earnings per share for 2001 or the Statements
of Consolidated Cash Flows for 2001.
6
In addition to the round trip trades described above, Reliant Resources'
review and the Audit Committees' investigation also considered other
transactions executed on the same day at the same volume, price and delivery
terms and with the same counterparty. These transactions were executed in the
normal course of the Company's trading and marketing activities, and were
historically reported on a gross basis, and were not material.
Also as more fully described in Note 1 to the Reliant Resources 10K/A Notes,
during the fourth quarter of 2000, two power generation swap contracts with a
fair value of $261 million were terminated and replaced with a substantially
similar contract providing for physical delivery and designated to hedge
electric generation. The termination of the original contracts and execution of
the replacement contract represented a substantive modification to the original
contract. As a result, upon termination of the original contracts, a contractual
liability representing the fair value of the original contracts and a deferred
asset of equal amount should have been recorded. As of January 1, 2001, in
connection with the adoption of SFAS No. 133, the deferred asset should have
been recorded as a transition adjustment to other comprehensive loss totaling
$170 million. The liability and transition adjustment should have been amortized
on a straight-line basis over the term of the power generation contract
replacing the terminated power generation contracts (through May 2004). The
Company previously did not give accounting recognition to these transactions. As
a result, the Company restated its Consolidated Balance Sheets as of December
31, 2000 and 2001 and the Statement of Consolidated Stockholder's Equity and
Comprehensive Income for the year ended December 31, 2001 in the Reliant
Resources Form 10-K/A. The Company has restated its comprehensive income
disclosure for the three and six months ended June 30, 2001 from amounts
previously reported, to effect this transaction as described above. The
restatement increased comprehensive income by $12 million from a total
comprehensive income of $569 million, as previously reported, to $581 million,
as restated, for the three months ended June 30, 2001 and decreased
comprehensive income by $146 million (including the $170 million transition
adjustment discussed above) from a total comprehensive income of $567 million,
as previously reported, to $421 million, as restated, for the six months ended
June 30, 2001. The restatement had no impact on the Company's reported
consolidated cash flows, operating income or net income.
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 Company records gross revenue for energy sales and services related to
its electric power generation facilities under the accrual method and these
revenues generally are recognized upon delivery. Energy sales and services
related to its electric power generation facilities not billed by month-end are
accrued based upon estimated energy and services delivered. Electric power and
other energy services are sold at market-based prices through existing power
exchanges or through third-party contracts. The Company records gross revenue
for energy sales and services to retail customers under the accrual method and
these revenues generally are recognized upon delivery, except for sales to large
commercial, industrial and institutional customers under contract.
The Company's energy trading, marketing, power origination and risk
management services activities and sales of electricity to large commercial,
industrial and institutional customers under contract are accounted for under
the mark-to-market method of accounting. Under the mark-to-market method of
accounting, derivative instruments and contractual commitments are recorded at
market value in revenues upon contract execution. The net changes in their fair
values are recognized in the Statements of Consolidated Income as revenues in
the period of change. Trading and marketing revenues related to the physical
sale of natural gas, electric power and other energy related commodities are
recorded on a gross basis in the delivery period. For additional discussion
regarding trading and marketing revenue recognition and the related estimates
and assumptions that can affect reported amounts of such revenues, see Note 6 to
the Reliant Resources 10-K/A Notes. For information regarding the Company's
adoption of Emerging Issues Task Force (EITF) Issue No. 02-03 "Accounting for
Contracts involved in Energy Trading and Risk Management Activities" (EITF No.
02-03) and the presentation of trading and marketing activities on a net basis
beginning in the quarter ending September 30, 2002, see Note 2.
The gains and losses related to financial instruments and contractual
commitments qualifying and designated as hedges related to the purchase and sale
of electric power and purchase of fuel are deferred in accumulated other
comprehensive income to the extent the contracts are effective, and then are
recognized in the same period as the settlement of the underlying physical
transaction. Realized gains and losses on financial contracts designated as
hedges are included in operating revenues in the Statements of Consolidated
Income. Revenues, fuel and cost of gas sold, and purchased power related to
physical sale and purchase contracts designated as hedges are generally recorded
on a gross basis in the delivery period. For additional discussion, see Note 6
to the Reliant Resources 10-K/A Notes.
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 of the Company 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 Reliant Resources 10-K/A Notes relate to certain
contingencies. These notes, as updated herein, are incorporated herein by
reference:
Notes to Consolidated Financial Statements included in the Reliant Resources
Form 10-K/A: Note 4 (Related Party Agreements -- Agreements Between Reliant
Energy and the Company), Note 5 (Business Acquisitions), Note 6 (Derivative
Instruments), Note 13 (Commitments and Contingencies), Note 17 (Bankruptcy
of Enron Corp. and its Affiliates) and Note 19 (Subsequent Events).
7
For information regarding certain legal, regulatory proceedings and
environmental matters, see Note 11.
Reliant Energy has adopted a business separation plan in response to the
Texas Electric Choice Plan (Texas electric restructuring law) adopted by the
Texas legislature in June 1999. The Texas electric restructuring law
substantially amended the regulatory structure governing electric utilities in
Texas in order to allow retail electric competition with respect to all customer
classes beginning in January 2002. Under its business separation plan filed with
the Public Utility Commission of Texas (Texas Utility Commission), Reliant
Energy has transferred substantially all of its unregulated businesses to the
Company in order to separate its regulated and unregulated operations. In
accordance with the plan, the Company completed its initial public offering
(IPO) of nearly 20% of its common stock in May 2001 and received net proceeds
from the IPO of $1.7 billion. For additional information regarding the IPO, see
Note 1 and Note 9(a), which is incorporated by reference herein, to the Reliant
Resources 10-K/A Notes.
As part of its business separation plan, Reliant Energy has publicly
disclosed that it intends to restructure its corporate organization into a
public utility holding company structure (Reorganization) by August 31, 2002 and
to distribute, subject to further corporate approvals, market and other
conditions, all of the shares of Reliant Resources common stock that it owns to
its shareholders (Distribution) early in the fall of 2002. In December 2001,
Reliant Energy's shareholders voted to approve the merger required for the
holding company reorganization. Reliant Energy has publicly disclosed its goal
to complete the Reorganization and subsequent Distribution as quickly as
possible after all the necessary conditions are fulfilled. In July 2002, Reliant
Energy received an order from the Securities and Exchange Commission (SEC)
granting the required approvals under the Public Utility Holding Company Act of
1935 (1935 Act) to adopt a new holding company structure and allow it to compete
the Distribution. Also in July 2002, Reliant Energy received a supplemental
ruling from the IRS which confirms that the Distribution will be tax-free to
Reliant Energy and its shareholders. There can be no assurances that the
Distribution will be completed as described or within the time period outlined
above.
(2) NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141 "Business Combinations" (SFAS No. 141). 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. The
Company adopted the provisions of the statement which apply to goodwill and
intangible assets acquired prior to June 30, 2001 on January 1, 2002. The
adoption of SFAS No. 141 did not have a material impact on the Company's
historical results of operations or financial position.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair value of
a liability for an asset retirement legal obligation to be recognized in the
period in which it is incurred. When the liability is initially recorded,
associated costs are capitalized by increasing the carrying amount of the
related long-lived asset. Over time, the liability is accreted to its present
value each period, and the capitalized cost is depreciated over the useful life
of the related asset. SFAS No. 143 is effective for fiscal years beginning after
June 15, 2002, with earlier application encouraged. SFAS No. 143 requires
entities to record a cumulative effect of change in accounting principle in the
income statement in the period of adoption. The Company plans to adopt SFAS No.
143 on January 1, 2003, and is in the process of determining the effect of
adoption on its consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. SFAS No. 144 supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," while retaining many of the requirements of these two statements.
Under SFAS No. 144, assets held for sale that are a component of an entity will
be included in discontinued operations if the operations and cash flows will be
or have been eliminated from the ongoing operations of the entity and the entity
will not have any significant continuing involvement in the operations
prospectively. SFAS No. 144 did not materially change the methods used by the
Company to measure impairment losses on long-lived assets, but may
8
result in additional future dispositions being reported as discontinued
operations. The Company adopted SFAS No. 144 on January 1, 2002.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent. The
changes related to debt extinguishment will be effective for fiscal years
beginning after May 15, 2002, and the changes related to lease accounting will
be effective for transactions occurring after May 15, 2002. The Company will
apply this guidance prospectively.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146 nullifies EITF
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)" (EITF No. 94-3). The principal difference between SFAS No. 146
and EITF No. 94-3 relates to the requirements for recognition of a liability for
cost associated with an exit or disposal activity. SFAS No. 146 requires that a
liability be recognized for a cost associated with an exit or disposal activity
when it is incurred. A liability is incurred when a transaction or event occurs
that leaves an entity little or no discretion to avoid the future transfer or
use of assets to settle the liability. Under EITF No. 94-3, a liability for an
exit cost was recognized at the date of an entity's commitment to an exit plan.
In addition, SFAS No. 146 also requires that a liability for a cost associated
with an exit or disposal activity be recognized at its fair value when it is
incurred. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002 with early application encouraged. The Company
will apply the provisions of SFAS No. 146 to all exit or disposal activities
initiated after December 31, 2002.
See Note 3 for a discussion regarding the Company's adoption of SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
(SFAS No. 133) on January 1, 2001 and adoption of subsequent cleared guidance.
See Note 6 for a discussion regarding the Company's adoption of SFAS No. 142
"Goodwill and Other Intangible Assets" (SFAS No. 142) on January 1, 2002.
In June 2002, the EITF reached a consensus on EITF No. 02-03 that all
mark-to-market gains and losses on energy trading contracts should be shown net
in the income statement whether or not settled physically. An entity should
disclose the gross transaction volumes for those energy trading contracts that
are physically settled. The EITF did not reach a consensus on whether
recognition of dealer profit, or unrealized gains and losses at inception of an
energy trading contract is appropriate in the absence of quoted market prices or
current market transactions for contracts with similar terms. The FASB staff
indicated that until such time as a consensus is reached, the FASB staff will
continue to hold the view that previous EITF consensus do not allow for
recognition of dealer profit, unless evidenced by quoted market prices or other
current market transactions for energy trading contracts with similar terms and
counterparties. During the six months ended June 30, 2002, the Company recorded
$46 million of fair value of the contract inception related to trading and
marketing activities. The consensus on presenting gains and losses on energy
trading contracts net is effective for financial statements issued for periods
ending after July 15, 2002. Upon application of the consensus, comparative
financial statements for prior periods should be reclassified to conform to the
consensus. The Company currently reports all trading, marketing and risk
management services transactions on a gross basis with such transactions being
reported in revenues and expenses except primarily for financial gas
transactions such as swaps. Beginning with the quarter ended September 30, 2002,
the Company will report all energy trading and marketing activities on a net
basis in the Statements of Consolidated Income pursuant to EITF No. 02-03.
Although the Company is in the process of determining the effect of adoption of
EITF No. 02-03 on its Statements of Consolidated Income, the Company expects the
adoption will result in a substantial reduction in operating revenues, fuel and
cost of gas sold, and purchased power.
(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 $460 million. The adoption also
increased current assets, long-term assets, current liabilities and long-term
liabilities by $566 million, $127 million, $811 million and $339 million,
respectively, in the Company's Consolidated Balance Sheet. For additional
information regarding the adoption of SFAS No. 133 and the Company's accounting
policies for derivative financial instruments, see Note 6 to the Reliant
Resources 10-K/A Notes.
The application of SFAS No. 133 is still evolving as the FASB clears
issues submitted to the Derivatives Implementation Group for consideration.
During the second quarter of 2001, an issue that applies exclusively to the
electric industry and allows the normal purchases and normal sales exception for
option-type contracts if certain
9
criteria are met was approved by the FASB with an effective date of July 1,
2001. The adoption of this cleared guidance had no impact on the Company's
results of operations. Certain criteria of this previously approved guidance
were revised in October and December 2001 and became effective on April 1, 2002.
The effect of adoption of the revised guidance did not impact the Company's
consolidated financial statements.
During the third quarter of 2001, the FASB cleared an issue related to
application of the normal purchases and normal sales exception to contracts that
combine forward and purchased option contracts. The effective date of this
guidance was April 1, 2002, and the effect of adoption of this guidance did not
impact the Company's consolidated financial statements.
Cash Flow Hedges. During the six months ended June 30, 2002, the amount of
hedge ineffectiveness recognized in earnings from derivatives that are
designated and qualify as cash flow hedges was a $12 million gain. 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 this assessment of effectiveness. During the six months ended June
30, 2002, there was a loss of approximately $0.2 million 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, 2002, the
Company expects $27 million in accumulated other comprehensive income to be
reclassified into net income during the next twelve months.
Interest Rate Swaps. As of June 30, 2002, the Company holds interest rate
swaps with an aggregate notional amount of $1.2 billion to fix the interest rate
applicable to floating rate short-term debt and floating rate long-term debt.
The swaps relating to both short-term and long-term debt qualify for hedge
accounting under SFAS No. 133 and the periodic settlements are recognized as an
adjustment to interest expense in the Statements of Consolidated Income over the
term of the swap agreements. During January 2002, the Company entered into
forward-starting interest rate swaps having an aggregate notional amount of $1.0
billion, of which $500 million has been liquidated as discussed below, to hedge
the interest rate on a portion of a future offering of long-term fixed-rate
notes. These swaps qualify as cash flow hedges under SFAS No. 133. On May 9,
2002, the Company liquidated $500 million of the forward starting interest rate
swaps that were entered into in January 2002. The liquidation of these swaps
resulted in a loss of $3 million, which was recorded in other comprehensive
income and will be amortized into interest expense in the same period during
which the forecasted interest payment affects earnings. Should the forecasted
interest payments no longer be probable, any remaining deferred amount will be
recognized immediately as an expense. The maximum length of time the Company is
hedging its exposure to the payment of variable interest rates is 8 years.
Hedge of Net Investment in Foreign Subsidiaries. The Company has
substantially hedged its net investment in its European subsidiaries to reduce
the Company's exposure to changes in foreign exchange rates through a
combination of Euro-denominated borrowings, foreign currency swaps and foreign
currency option contracts. During the six months ended June 30, 2002, the
derivative and non-derivative instruments designated as hedging the net
investment in the Company's European subsidiaries resulted in a loss of $16
million, which is included in the balance of the cumulative translation
adjustment in accumulated other comprehensive income.
Other Derivatives. In December 2000, the Dutch parliament adopted
legislation allocating to the Dutch generation sector, including Reliant Energy
Power Generation Benelux N.V. (REPGB), financial responsibility for various
out-of-market 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 imported electricity and gas under certain long-term
power contracts and a gas contract entered into by NEA B.V. (NEA), the regulated
entity which formerly purchased and sold energy in the Netherlands.
The Company accounts for the gas supply contract at fair value as a
non-trading derivative pursuant to SFAS No. 133. Prior to amending the
electricity import contracts in May 2002, the Company also accounted for the
electricity import contracts at fair value as non-trading derivatives pursuant
to SFAS No. 133. However, subsequent to amending the electricity import
contracts, the Company began to account for the electricity contracts as a part
of the Company's energy trading activities.
As of December 31, 2001, the Company recorded a liability of $369 million
for the REPGB stranded cost gas and electric commitments in non-trading
derivative liabilities. As of June 30, 2002, the Company recorded a liability of
$155 million for the REPGB stranded cost gas supply contract in non-trading
derivative liabilities. Pursuant to SFAS No. 133, during the three and six
months ended June 30, 2002, the Company recognized a $3 million loss and net $16
million gain, respectively, recorded in fuel expense related to changes in the
valuation of these non-trading
10
derivative liabilities, excluding the effects of the gain related to amending
the two power contracts as discussed in Note 11(d).
For additional information regarding REPGB's obligations under these
out-of-market contracts and the related indemnification by former shareholders
of these stranded costs during 2001, see Note 11(d) and Note 13(f) to the
Reliant Resources 10-K/A Notes.
During the May 2001 through September 2001 time frame, the Company entered
into two structured transactions which were recorded on the balance sheet in
non-trading derivative assets and liabilities involving 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. The change in fair value of these derivative
assets and liabilities must be recorded in the statement of income for each
reporting period. As of December 31, 2001, the Company has recognized $221
million of non-trading derivative assets and $103 million of non-trading
derivative liabilities related to these transactions. During the three and six
months ended June 30, 2002, $26 million and $50 million, respectively, of net
non-trading derivative assets were settled related to these transactions, and a
$1 million and $2 million, respectively, pre-tax unrealized gain was recognized.
As of June 30, 2002, the Company has recognized $163 million of non-trading
derivative assets and $93 million of non-trading derivative liabilities related
to these transactions.
(4) HISTORICAL 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 an unaffiliated entity. Amounts charged and allocated to the
Company for these services were $2 million and $5 million for the three months
ended June 30, 2001 and 2002, respectively. Amounts charged and allocated to the
Company for these services were $4 million and $10 million for the six months
ended June 30, 2001 and 2002, 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. Some subsidiaries of the Company have entered into office rental
agreements with Reliant Energy. During the three months ended June 30, 2001 and
2002, the Company incurred $5 million and $8 million, respectively, of rent
expense to Reliant Energy. The Company incurred $8 million and $16 million of
rent expense to Reliant Energy during the six months ended June 30, 2001 and
2002, respectively.
Below is a detail of accounts and notes receivable to affiliated
companies that are not part of the Company:
DECEMBER 31, JUNE 30,
2001 2002
----------- --------
(IN MILLIONS)
Net accounts receivable (payable) -- affiliated companies .... $ 27 $(148)
Net short-term notes receivable (payable) -- affiliated
companies .................................................. 388 (2)
Net long-term notes receivable -- affiliated companies ....... 30 32
----- -----
Total net accounts and notes receivable (payable) --
affiliated companies ..................................... $ 445 $(118)
===== =====
Net accounts receivable/(payable) 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,
electric generation capacity purchases, electric transmission services, charges
for services and office space rental. Net short-term notes receivable/(payable)
from affiliated companies represent the accumulation of a variety of cash
transfers and operating transactions and generally bear interest at market-based
rates. Net long-term notes receivable 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 income
related to these net borrowings/receivables was $11 million and $2 million
during the three months ended June 30, 2001 and 2002, respectively. Net interest
expense related to these net receivables was $3 million during the six months
ended June 30, 2001. Net interest income related to these receivables was $4
million during the six months ended June 30, 2002.
11
During 2001 and 2002, proceeds not initially utilized from the IPO were
advanced to a subsidiary of Reliant Energy (the Reliant Energy money fund) on a
short-term basis. The Company has reduced its advance to the Reliant Energy
money fund following the IPO to fund capital expenditures and to meet its
working capital needs. As of December 31, 2001, the Company had outstanding
advances to the Reliant Energy money fund of $390 million which is included in
accounts and notes receivable in the Company's Consolidated Balance Sheet.
During the six months ended June 30, 2002, these advances were returned to the
Company.
The Company purchases natural gas, electric generation capacity, electric
transmission services and natural gas 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
electric generation capacity, electric transmission services, natural gas
transportation services and natural gas from Reliant Energy and its subsidiaries
were $44 million and $516 million for the three months ended June 30, 2001 and
2002, respectively, and $130 million and $881 million for the six months ended
June 30, 2001 and 2002, respectively. During the three months ended June 30,
2001 and 2002, the sales and services to Reliant Energy and its subsidiaries
totaled $137 million and $70 million, respectively, and $459 million and $185
million for the six months ended June 30, 2001 and 2002, respectively.
During the fourth quarter of 2001 and the first quarter of 2002, the Company
purchased entitlements to some of the generation capacity of Reliant Energy's
Texas electric utility generation assets (Texas Genco). The Company purchased
these entitlements under the terms of a master separation agreement between
Reliant Resources and Reliant Energy (Master Separation Agreement) and in
capacity auctions conducted by Texas Genco. Under the Texas electric
restructuring law, Texas Genco is required to sell at auction entitlements to at
least 15% of its installed generating capacity (State Mandated Auctions). Under
the law, the Company is not permitted to participate in the State Mandated
Auctions. However, the Company is entitled to purchase capacity and energy in
the auction entitlements required by the Texas electric restructuring law
of the power generation companies affiliated with the other Texas electric
utilities. Under the Master Separation Agreement, Texas Genco is obligated to
auction entitlements to all of its capacity and related ancillary services
available after the State Mandated Auctions subject to certain permitted
reductions, for a specified period of time, subject to certain agreements
(Contractually Mandated Auctions). Under the Master Separation Agreement, the
Company is entitled to elect to purchase 50% of the capacity to be auctioned by
Texas Genco in the Contractually Mandated Auctions at the prices established in
such auctions. In addition to this right, the Company may participate in the
Contractually Mandated Auctions. As of June 30, 2002, the Company has purchased
entitlements to capacity of Texas Genco averaging 6,917 MW per month for the
remainder of 2002 and 775 MW per month in 2003. The Company has no minimum
obligations for energy or ancillary services under the Master Separation
Agreement. The Company's anticipated capacity payments related to these capacity
entitlements are $149 million in 2002 and $58 million in 2003. For additional
information regarding agreements relating to Texas Genco, see Note 4(b) to the
Reliant Resources 10-K/A Notes.
During the three and six months ended June 30, 2001, Reliant Energy or its
subsidiaries made equity contributions to the Company of $1.7 billion and $1.8
billion, respectively. There were no contributions for the six months ended June
30, 2002. 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) ACQUISITIONS
Orion Power Holdings, Inc. In February 2002, the Company acquired all of the
outstanding shares of common stock of Orion Power Holdings, Inc. (Orion Power)
for $26.80 per share in cash for an aggregate purchase price of $2.9 billion.
The Company funded the Orion Power acquisition with a $2.9 billion credit
facility (see Note 8) and $41 million of cash on hand. As a result of the
acquisition, the Company's consolidated net debt obligations also increased by
the amount of Orion Power's net debt obligations. As of February 19, 2002, Orion
Power's debt obligations were $2.4 billion ($2.1 billion net of restricted cash
pursuant to debt covenants). Orion Power is an electric power generating company
formed in March 1998 to acquire, develop, own and operate power-generating
facilities in certain deregulated wholesale markets throughout North America. As
of February 19, 2002, Orion Power had 81 power plants with a total generating
capacity of 5,644 MW and two development projects with an additional 804 MW of
capacity under construction. As of June 30, 2002, both projects under
construction had reached commercial operation.
The Company accounted for the acquisition as a purchase with assets and
liabilities of Orion Power reflected at their estimated fair values. The
Company's fair value adjustments included adjustments in property, plant and
12
equipment, contracts, severance liabilities, debt, unrecognized pension and
postretirement benefits liabilities and related deferred taxes. The Company
expects to finalize these fair value adjustments no later than February 2003,
based on valuations of property, plant and equipment, intangible assets and
other assets and obligations.
The Company's results of operations include the results of Orion Power only
for the period beginning February 19, 2002. The following table presents
selected financial information and unaudited pro forma information for the three
months ended June 30, 2001 and six months ended June 30, 2001 and 2002, as if
the acquisition had occurred on January 1, 2001 and 2002, as applicable.
THREE MONTHS ENDED
JUNE 30, 2001
-------------------------
ACTUAL PRO FORMA
------ ---------
(IN MILLIONS)
Revenues ........................................... $7,975 $8,281
Net income ......................................... 229 238
Basic earnings per share ........................... $ 0.83 $ 0.86
Diluted earnings per share ......................... 0.82 0.86
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2001 JUNE 30, 2002
---------------------- ----------------------
ACTUAL PRO FORMA ACTUAL PRO FORMA
-------- ---------- ------- ---------
(IN MILLIONS)
Revenues ............................... $16,613 $17,195 $15,591 $15,713
Income before cumulative effect of
accounting change .................... 307 320 275 217
Net income ............................. 310 323 275 217
Basic and diluted earnings per share
before cumulative effect of accounting
change................................. $ 1.19 $ 1.24 $ 0.95 $ 0.75
Basic and diluted earnings per share..... 1.20 1.25 0.95 0.75
These unaudited 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 Orion Power had occurred on January 1, 2001 and 2002, as
applicable. Purchase-related adjustments to the results of operations include
the effects on depreciation and amortization, interest expense, interest income
and income taxes. The unaudited pro forma condensed consolidated financial
statements reflect the acquisition of Orion Power in accordance with SFAS No.
141 and SFAS No. 142. For additional information regarding the Company's
adoption of SFAS No. 141 and SFAS No. 142, see Notes 2 and 6.
(6) GOODWILL AND INTANGIBLES
In July 2001, the FASB issued SFAS No. 142, which provides that goodwill and
certain intangibles with indefinite lives will not be amortized into results of
operations, but instead will 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 Company adopted the provisions of the statement which
apply to goodwill and intangible assets acquired prior to June 30, 2001 on
January 1, 2002.
On January 1, 2002, the Company discontinued amortizing goodwill into its
results of operations pursuant to SFAS No. 142. A reconciliation of previously
reported net income and earnings per share to the amounts adjusted for the
exclusion of goodwill amortization:
13
THREE MONTHS ENDED JUNE 30,
---------------------------
2001 2002
------- -------
(IN MILLIONS, EXCEPT PER
SHARE AMOUNTS)
Reported net income ................................ $ 229 $ 178
Add: Goodwill amortization, net of tax ............. 8 --
------- -------
Adjusted net income ................................ $ 237 $ 178
======= =======
Basic Earnings Per Share:
Reported net income ................................ $ 0.83 $ 0.62
Add: Goodwill amortization, net of tax ............. 0.03 --
------- -------
Adjusted basic earnings ............................ $ 0.86 $ 0.62
======= =======
Diluted Earnings Per Share:
Reported net income ................................ $ 0.82 $ 0.61
Add: Goodwill amortization, net of tax ............. 0.03 --
------- -------
Adjusted diluted earnings .......................... $ 0.85 $ 0.61
======= =======
SIX MONTHS ENDED JUNE 30,
-------------------------
2001 2002
------- -------
(IN MILLIONS, EXCEPT PER
SHARE AMOUNTS)
Reported net income ................................ $ 310 $ 275
Add: Goodwill amortization, net of tax ............. 17 --
------- -------
Adjusted net income ................................ $ 327 $ 275
======= =======
Basic and Diluted Earnings Per Share:
Reported net income ................................ $ 1.20 $ 0.95
Add: Goodwill amortization, net of tax ............. 0.07 --
------- -------
Adjusted basic and diluted earnings ................ $ 1.27 $ 0.95
======= =======
The components of the Company's other intangible assets consist of the
following:
DECEMBER 31, 2001 JUNE 30, 2002
----------------------- -------------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
(IN MILLIONS)
Air Emission Regulatory Allowances ..... $255 $(78) $268 $ (82)
Water Rights ........................... 68 (4) 68 (5)
Other Power Generation Site Permits .... 77 (3) 77 (5)
Contractual rights ..................... -- -- 91 (8)
Other .................................. -- -- 2 (1)
---- ---- ---- -----
Total .................................. $400 $(85) $506 $(100)
==== ==== ==== =====
The Company recognizes specifically identifiable intangibles, including air
emissions regulatory allowances, water rights and permits, when specific rights
and contracts are acquired. The Company has no intangible assets with indefinite
lives recorded as of June 30, 2002. The Company amortizes air emissions
regulatory allowances primarily on a units-of-production basis as utilized. The
Company amortizes other acquired intangibles, excluding contractual rights, on a
straight-line basis over the lesser of their contractual or estimated useful
lives with a weighted average amortization period of 35 years.
In connection with the acquisition of Orion Power, the Company recorded
the fair value of certain fuel and power contracts acquired. The Company
estimated the fair value of the contracts using forward pricing curves over the
life of each contract. Those contracts that net fair value exceeded book value
at the date of acquisition were recorded to intangible assets (Contractual
Rights) and those contracts that net fair value were below book value at the
date of acquisition (Contractual Obligations) were recorded to other current and
long-term liabilities in the Consolidated Balance Sheet.
Contractual Rights and Contractual Obligations are amortized to fuel expense
and revenues, as applicable, based on the pattern in which the economic effects
are estimated to be realized over the contractual lives. Amortization in future
periods will be disclosed as the purchase price allocation is finalized.
14
Amortization expense for other intangibles, excluding Contractual Rights,
for the three months ended June 30, 2001 and 2002 was $7 million and $4 million,
respectively. Amortization expense for other intangibles, excluding Contractual
Rights, for the six months ended June 30, 2001 and 2002 was $30 million and $8
million, respectively. The Company amortized $7 million of Contractual Rights
and $10 million of Contractual Obligations during both the three and six months
ended June 30, 2002. Estimated amortization expense, excluding Contractual
Rights, for the remainder of 2002 and the five succeeding fiscal years is as
follows (in millions):
2002 ......................... $ 7
2003 ......................... 13
2004 ......................... 13
2005 ......................... 13
2006 ......................... 13
2007 ......................... 13
---
Total ...................... $72
===
Changes in the carrying amount of goodwill for the six months ended June 30,
2002, by reportable segment, are as follows:
GOODWILL FOREIGN
AS OF ACQUIRED CURRENCY AS OF
JANUARY 1, DURING THE EXCHANGE JUNE 30,
2002 PERIOD IMPACT OTHER 2002
---------- ---------- --------- ----- -------
(IN MILLIONS)
Wholesale Energy ....... $184 $1,411 $-- $1 $1,596
European Energy ........ 675 -- 81 - 756
Retail Energy .......... 32 -- -- - 32
---- ------ --- -- ------
Total ................ $891 $1,411 $81 $1 $2,384
==== ====== === == ======
The Company is in the process of determining further effects of adoption
of SFAS No. 142 on its Consolidated Financial Statements, including the review
of goodwill for impairment. The Company has not completed its review pursuant to
SFAS No. 142. The Company has completed the first step of the goodwill
impairment test, used to identify potential impairments, which compares the fair
value of a reporting unit with its carrying amount, including goodwill. Based on
the first step of the goodwill impairment test, the Company's European Energy
segment's goodwill is impaired by approximately $250 million. The Company
believes that its final impairment loss will approximate the impairment loss
indicated in the first step of the goodwill impairment. The Company has retained
an outside valuation firm to assist in the Company's review and will finalize
its review of goodwill of the European Energy segment during 2002. The
impairment loss resulting from the transitional impairment test will be recorded
retroactively as a cumulative effect of a change in accounting principle for the
quarter ended March 31, 2002. Based on the first step of the goodwill impairment
test, no other reporting units' goodwill was impaired. As of March 31, 2002, the
Company completed its assessment of intangible assets and no indefinite lived
intangible assets were identified. No related impairment losses were recorded in
the first quarter of 2002 and no changes were made to the expected useful lives
of its intangible assets as a result of this assessment.
15
(7) COMPREHENSIVE INCOME
The following table summarized the component of total comprehensive income:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -------------------
2001 2002 2001 2002
----- ----- ----- -----
(IN MILLIONS)
Net income ....................................... $ 229 $ 178 $ 310 $ 275
Other comprehensive income (loss):
Foreign currency translation adjustments ....... 5 115 5 105
Changes in minimum benefit liability ........... -- -- (6) --
Cumulative effect of adoption of SFAS
No. 133 ....................................... -- -- (460) --
Deferred gain from cash flow hedges ............ 251 33 437 186
Reclassification of deferred loss (gain) from
cash flow hedges realized in net income ....... 90 (8) 122 (27)
Unrealized gain on available-for-sale
securities ................................... 7 1 15 1
Reclassification adjustments for gains
on sales of available-for-sale securities
realized in net income ....................... (1) (1) (2) (2)
----- ----- ----- -----
Comprehensive income ............................. $ 581 $ 318 $ 421 $ 538
===== ===== ===== =====
Included in "Reclassification of deferred loss (gain) from cash flow hedges
realized in net income" above for the six months ended June 30, 2001 and 2002 is
$12 million of amortization for both the three months ended March 31, 2001 and
2002 related to the amortization of the transition adjustment arising from the
termination and replacement of two power generation swap contracts referred to
in Note 1. Included in "Cumulative effect of adoption of SFAS No. 133" above for
the six months ended June 30, 2001 is a $170 million transition adjustment
referred to in Note 1. Such amounts have not been previously reported in the
Company's comprehensive income disclosure for the three months ended March 31,
2001 and 2002.
(8) BORROWINGS FROM THIRD PARTIES
Credit Facilities. As of June 30, 2002, the Company had $8.3 billion in
committed credit facilities of which $1.2 billion remained unused. Credit
facilities aggregating $5.4 billion were unsecured. As of June 30, 2002, letters
of credit outstanding under these facilities aggregated $803 million. As of
June 30, 2002, borrowings of $6.3 billion were outstanding under these
facilities of which $602 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.
16
The following table provides a summary of the amounts owed and amounts
available as of June 30, 2002 under the Company's various credit facilities.
TOTAL EXPIRING BY
COMMITTED DRAWN LETTERS UNUSED JUNE 30, EXPIRATION
CREDIT AMOUNT OF CREDIT AMOUNT 2003 DATE
--------- ------- --------- ------- ----------- -----------
(IN MILLIONS)
RELIANT RESOURCES:
Orion acquisition term
loan.................... $ 2,908 $ 2,908 $ -- $ -- $ 2,908 February 2003
364-day revolver.......... 800 -- -- 800 800 August 2002(1)
Three-year revolver....... 800 400 386 14 -- August 2004
WHOLESALE ENERGY:
Orion Power and
Subsidiaries:
Orion Power.............. 75 43 24 8 75 December 2002
Orion MidWest............ 1,063 1,028 15 20 1,063 October 2002
Orion NY................. 532 502 10 20 532 December 2002
October 2002 -
Liberty Project.......... 292 270 17 5 6 April 2026
Reliant Energy Channelview LP:
Equity bridge............ 92 92 -- -- 92 November 2002
Construction term loan
and working capital October 2002 -
facility............... 383 340 -- 43 2(2) July 2024
REMA letter of credit
facility................. 81 -- 81 -- -- August 2003
EUROPEAN ENERGY:
Reliant Energy Capital
Europe, Inc.............. 595 595 -- -- 595 March 2003
REPGB 364-day revolver.... 248 124 -- 124 248 July 2002
REPGB letter of credit
facility................. 420 -- 270 150 -- July 2003
------- ------- ------- ------- -------
Total ...................... $ 8,289 $ 6,302 $ 803 $ 1,184 $ 6,321
======= ======= ======= ======= =======
- ------------
(1) The Company has given notice that it intends to exercise its option to
convert this facility to a one-year loan with a maturity of August 22, 2003.
(2) Excludes $369 million of facilities expiring in November 2002
as borrowings under such facilities are convertible into a long-term loan.
These facilities include a term loan facility entered into during the fourth
quarter of 2001 and amended in January 2002 that provided for $2.9 billion in
funding to finance the purchase of Orion Power. Interest rates on the borrowings
under this facility are based on London inter-bank offered rate (LIBOR) plus a
margin or a base rate. This facility was funded on February 19, 2002 for $2.9
billion. As of June 30, 2002, the weighted average interest rate on outstanding
borrowings was 2.79%. This term loan must be repaid within one year from the
date on which it was funded. For a discussion of the acquisition of Orion Power,
see Note 5.
In addition to credit facilities, the Company had long-term debt totaling
$529 million of which $411 million related to bonds issued by Orion Power.
Refinancing Issues. As a result of several recent events, including the
United States economic recession, the general common stock price decline of
participants in the Company's industry sector, the general credit rating
downgrades of the participants in the Company's industry sector, the Company's
credit rating downgrades and its placement on review for future downgrades, the
availability and cost of capital for the Company's business has been adversely
affected. The credit environment may require the Company's future facilities to
include terms that are more restrictive or burdensome or at higher borrowing
rates than those of the Company's current facilities and that may require us to
provide collateral as security. In addition, certain financial institutions may
limit the amount of additional financings or discontinue providing financings to
the Company. The terms of any new credit facilities may also be adversely
affected by any delay in the date of the Distribution. In addition, any future
reduction or withdrawal of one or more of the Company's credit ratings could
have a material adverse impact on the Company's ability to access capital on
acceptable terms, including the ability to refinance debt obligations as they
mature.
As of June 30, 2002, the Company had $6.3 billion of committed credit
facilities which will expire by June 30, 2003 of which $2.8 billion will expire
by December 31, 2002. The Company expects to extend or replace these facilities.
In order to meet the Company's future needs the Company may obtain financings
that are secured by certain of the Company's assets or the operations of the
Company's subsidiaries. In addition to giving security, other terms, conditions,
covenants or restrictions may be imposed as part of these financings that may
adversely affect the Company. Providing collateral to obtain future financings
or refinancings may adversely affect the Company's credit ratings thereby
increasing the cost of the Company's debt.
17
Although the Company expects to obtain future financings, there can be no
assurance that the Company will be successful.
The Company's $800 million unsecured 364-day revolving credit facility
expires on August 22, 2002. The facility agreement allows the Company the option
to borrow the entire amount and convert it, provided that there is no default on
the conversion date, to a one-year term loan with a maturity of August 22,
2003. The Company has given notice that the Company intends to exercise
this option.
The Company is currently negotiating with the banks regarding the
appropriate terms and conditions for an extension of the maturity of its $2.9
billion Orion acquisition term loan, which is scheduled to mature on February
19, 2003. The Company expects to complete this extension in the second half of
2002.
The Company is also in negotiations with the lead arrangers for a
refinancing of the facilities at Orion Power, Orion Power MidWest, LP (Orion
MidWest) and Orion Power New York, LP (Orion NY), which are discussed below. The
Company anticipates that the new financings will total approximately $1.3
billion and will be completed in September 2002. Similar to the existing Orion
MidWest and Orion NY credit agreements. The refinancings for Orion MidWest
and Orion NY will likely be secured by the assets of both Orion MidWest
and Orion NY.
The Company's refinancing plan contemplates the simultaneous refinancing of
the $2.9 billion term loan, the $800 million 364-day revolving credit facility,
the $800 million three-year revolving credit facility, and the Orion NY and
MidWest credit agreements.
The Euro 600 million (approximately $595 million) term loan facility at
Reliant Energy Capital Europe, Inc. matures on March 1, 2003. Preliminary work
has commenced on the refinancing of this term loan facility. The Company plans
to execute such refinancing during the fourth quarter of 2002 or first quarter
of 2003.
In May 2002, the Company established a $300 million commercial paper program
which is supported by its existing credit facilities. Due to market conditions
and the Company's current credit ratings, the Company has not yet attempted to
issue commercial paper. It is unlikely that the Company will be able to issue
commercial paper in the near future.
During July 2002, the Company, through a subsidiary, established a
receivables facility to finance certain of its Retail Energy segment's
receivables up to $250 million. For further discussion, see Note 15(a).
During July 2002, REPGB renewed its 364-day revolving credit facility
through July 2003. The amount of the credit facility was reduced from Euro 250
million (approximately $248 million) to Euro 184 million (approximately $182
million). An option was added that permits REPGB to utilize up to Euro 100
million (approximately $99 million) of the facility for letters of credit. For
further discussion, see Note 15(b).
Orion Power's Debt Obligations. As a result of the Company's acquisition of
Orion Power, the Company's consolidated net debt obligations also increased by
the amount of Orion Power's net debt obligations, which are discussed below.
New York Credit Agreement. As of June 30, 2002, Orion NY, a wholly owned
subsidiary of Orion Power, had a secured credit agreement (New York Credit
Agreement), which includes a $502 million acquisition facility and a $30 million
revolving working capital facility. As of June 30, 2002, Orion NY had $502
million of acquisition loans outstanding. As of June 30, 2002, there were no
revolving loans outstanding. A total of $10 million in letters of credit were
also outstanding under the New York Credit Agreement. The loans bear interest at
the borrower's option at (a) a base rate or (b) LIBOR plus a margin. The
weighted average interest rate on outstanding borrowings as of June 30, 2002,
was 3.61%. The credit agreement is secured by substantially all of the assets of
Orion NY. The credit agreement expires in December 2002.
MidWest Credit Agreement. As of June 30, 2002, Orion MidWest, a wholly owned
subsidiary of Orion Power, had a secured credit agreement (Midwest Credit
Agreement), which includes a $988 million acquisition facility and a $75 million
revolving working capital facility. As of June 30, 2002, Orion MidWest had $988
million and $40 million of acquisition loans and revolving loans outstanding,
respectively. A total of $15 million in letters of credit were also outstanding
under the MidWest Credit Agreement. The loans bear interest at the borrower's
option at (a) a base rate or (b) LIBOR plus a margin. The weighted average
interest rate on outstanding borrowings as of June 30, 2002, was 3.88%.
Borrowings under the MidWest Credit Agreement are secured by substantially all
the assets of Orion MidWest. The credit agreement expires in October 2002.
The New York Credit Agreement and the Midwest Credit Agreement
(collectively, the Orion Credit Agreements) contain restrictive covenants that
restrict the ability of Orion NY or Orion MidWest to, among other things, make
dividend distributions unless Orion NY or Orion MidWest satisfy various
conditions. As of June 30, 2002, restricted cash under the Orion Credit
Agreements totaled $346 million.
18
In connection with the Orion Power acquisition, the existing interest rate
swaps for the Orion Credit Agreements were bifurcated into a debt component and
a derivative component. The fair value of the debt component, approximately $31
million for the New York Credit Agreement and $59 million for the MidWest Credit
Agreement, was based on the Company's incremental borrowing rates at the
acquisition date for similar types of borrowing arrangements. The value of the
debt component will be amortized to interest expense over the life of the
interest rate swaps to which they relate. For the period from February 20, 2002
through June 30, 2002, $3 million and $7 million was amortized to interest
expense for the New York Credit Agreement and MidWest Credit Agreement,
respectively. See Note 3 for information regarding the Company's derivative
financial instruments.
The Orion Credit Agreements contain various business and financial covenants
requiring Orion NY or Orion MidWest to, among other things, maintain a debt
service coverage ratio of at least 1.5 to 1.0. Because it was anticipated that
Orion MidWest would not meet this ratio for the quarter ended June 30, 2002, the
MidWest Credit Agreement was amended to provide that Orion MidWest is not
required to meet this ratio until the quarter ending September 30, 2002. Orion
MidWest may not be able to meet this debt service coverage ratio for the quarter
ending September 30, 2002. It is the Company's current intention to arrange for
the repayment, refinancing or amendment of these facilities prior to September
30, 2002. If the MidWest Credit Agreement is not repaid, refinanced or amended
prior to that date, and if a waiver is required under this credit facility, the
Company currently believes that it will be able to obtain such a waiver.
However, the Company currently has no assurance that it will be able to obtain
such a waiver or amendment from the lender group if required under the MidWest
Credit Agreement. If the debt service coverage ratio is not met, and the MidWest
Credit Agreement is not repaid, refinanced or amended or no waiver is obtained,
the MidWest Credit Agreement would be in default and the lenders could demand
payment of all outstanding amounts under the MidWest Credit Agreement.
Liberty Credit Agreement. Liberty Electric Power, LLC (LEP) and Liberty
Electric PA, LLC (Liberty), wholly owned subsidiaries of Orion Power, entered
into a facility that provides for (a) a construction/term loan in an amount of
up to $105 million; (b) an institutional term loan in an amount of up to $165
million; (c) a revolving working capital facility for an amount of up to $5
million; and (d) a debt service reserve letter of credit facility of $17.5
million (Liberty Credit Agreement).
In May 2002, the construction loan was converted to a term loan. As of the
conversion date, the term loan had an outstanding principal balance of $270
million, with $105 million having a final maturity in 2012 and the balance in
2026. On the conversion date, Orion Power made the required cash equity
contribution of $30 million into Liberty, which was used to repay a like amount
of equity bridge loans advanced by the lenders. A related $41 million letter of
credit furnished by Orion Power as credit support was returned for cancellation.
In addition, on the conversion date, a $17.5 million letter of credit was issued
in satisfaction of Liberty's obligation to provide a debt service reserve fund.
The project financing facility also provides for a $5 million working capital
line of credit. The debt service reserve letter of credit facility and the
working capital facility expire in May 2007.
Amounts outstanding under the Liberty Credit Agreement bear interest at a
floating rate for a portion of the facility, which may be either (a) a base rate
or (b) LIBOR plus a margin, except for the institutional term loan which bears
interest at a fixed rate. At June 30, 2002, the weighted average interest rate
on the outstanding borrowings was 3.12% on the floating rate component and 9.02%
on the fixed rate portion. As of June 30, 2002, Liberty had $105 million and
$165 million of the floating rate and fixed rate portions of the facility
outstanding, respectively. A total of $17.5 million in letters of credit were
also outstanding under the Liberty Credit Agreement.
The lenders under the Liberty Credit Agreement have a security interest in
substantially all of the assets of Liberty. The Liberty Credit Agreement
contains restrictive covenants that restrict Liberty's ability to, among other
things, make dividend distributions unless Liberty satisfies various conditions.
As of June 30, 2002, restricted cash under the Liberty Credit Agreement totaled
$20 million.
Senior Notes. Orion Power has outstanding $400 million aggregate principal
amount of 12% senior notes due 2010 (Senior Notes). The Senior Notes are senior
unsecured obligations of Orion Power. Orion Power is not required to make any
mandatory redemption or sinking fund payments with respect to the Senior Notes.
The Senior Notes are not guaranteed by any of Orion Power's subsidiaries. In
connection with the Orion Power acquisition, the Company recorded the Senior
Notes at estimated fair value of $479 million. The $79 million premium will be
amortized against interest expense over the life of the Senior Notes. For the
six months ended June 30, 2002, $2 million was amortized to interest expense for
the Senior Notes. The fair value of the Senior Notes is based on the Company's
current incremental borrowing rates for similar types of borrowing arrangements.
The Senior Notes indenture contains covenants that include among others,
restrictions on the payment of dividends by Orion Power.
19
Pursuant to certain change of control provisions, Orion Power commenced an
offer to repurchase the Senior Notes on March 21, 2002. The offer to repurchase
expired on April 18, 2002. There were no acceptances of the offer to repurchase
and the entire $400 million aggregate principal amount remains outstanding.
Before May 1, 2003, Orion Power may redeem up to 35% of the Senior Notes
issued under the indenture at a redemption price of 112% of the principal amount
of the notes redeemed, plus accrued and unpaid interest and special interest,
with the net cash proceeds of an equity offering provided that certain
provisions under the indenture are met.
Revolving Senior Credit Facility. Orion Power has an unsecured $75 million
revolving senior credit facility that matures in December 2002. Amounts
outstanding under the facility bear interest at a floating rate. As of June 30,
2002, there were $43 million of borrowings outstanding under this facility, and
a total of $24 million in letters of credit were also outstanding. This credit
facility contains various covenants that include, among others, restrictions on
the payment of dividends by Orion Power. As of June 30, 2002, restricted cash
under this revolving senior credit facility totaled $7 million.
The senior credit facility of Orion Power contains various business and
financial covenants that require Orion Power to, among other things, maintain a
debt service coverage ratio of at least 1.4 to 1.0. Orion Power did not meet the
debt service coverage ratio for the three months ended March 31, 2002 and June
30, 2002, as required. While the failure to meet such ratio for two consecutive
fiscal quarters is a default under the senior credit facility, the senior credit
facility was amended to provide that such failure will not be considered to be
an event of default until September 30, 2002. It is the Company's current
intention to arrange for the repayment, refinancing or amendment of this
facility prior to September 30, 2002. If this facility is not repaid, refinanced
or amended prior to that date, and if a waiver is required under this credit
facility, the Company currently believes that it will be able to obtain such a
waiver. However, the Company currently has no assurance that it will be able to
obtain such a waiver or amendment from the lender groups if required under this
credit facility. If the debt service coverage ratio is not met, and the senior
credit facility is not repaid, refinanced or amended or no waiver is obtained,
the senior credit facility would be in default and the lenders could demand
payment of all outstanding amounts under the senior credit facility.
Convertible Senior Notes. Orion Power had outstanding $200 million of
aggregate principal amount of 4.5% convertible senior notes, due on June 1, 2008
(Convertible Senior Notes). Pursuant to certain change of control provisions,
Orion Power commenced an offer to repurchase the Convertible Senior Notes on
March 1, 2002, which expired on April 10, 2002. During the second quarter of
2002, the Company repurchased $189 million in principal amount under the offer
to repurchase and $11 million aggregate principal amount of the Convertible
Senior Notes remains outstanding.
(9) TREASURY STOCK
On December 6, 2001, Reliant Resources' Board of Directors authorized the
Company to purchase up to 10 million shares of its common stock through June
2003. Any purchases will be made on a discretionary basis in the open market or
otherwise at times and in amounts as determined by management subject to market
conditions, legal requirements and other factors. Since the date of
authorization through August 9, 2002, the Company has not purchased any shares
of its common stock under this program.
In January 2002, the Company sold 550,781 treasury shares to employees under
an employee stock purchase plan at a price of $14.07 per share. In April 2002,
the Company made a discretionary annual contribution of 308,936 shares to the
employee savings plan. The Company funded its contribution using treasury
shares.
20
(10) EARNINGS PER SHARE
The following tables presents Reliant Resources' basic and diluted earnings
per share (EPS) calculation. There were no dilutive reconciling items to net
income.
FOR THE THREE MONTHS ENDED
JUNE 30,
--------------------------
2001 2002
------- -------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
Weighted average shares outstanding ..................... 276,944 289,591
======= =======
Diluted EPS Calculation:
Weighted average shares outstanding ..................... 276,944 289,591
Plus: Incremental shares from assumed conversions:
Stock options ........................................ 172 364
Restricted stock ..................................... 116 539
Employee stock purchase plan ......................... 14 139
------- -------
Weighted average shares assuming dilution ............. 277,246 290,633
======= =======
Basic EPS:
Income before cumulative effect of accounting change .. $ 0.83 $ 0.62
Cumulative effect of accounting change, net of tax .... -- --
------- -------
Net income ............................................ $ 0.83 $ 0.62
======= =======
Diluted EPS:
Income before cumulative effect of accounting change .. $ 0.82 $ 0.61
Cumulative effect of accounting change, net of tax .... -- --
------- -------
Net income ............................................ $ 0.82 $ 0.61
======= =======
For the three months ended June 30, 2002, the computation of diluted EPS
excludes purchase options for 7,966,882 shares of common stock that have an
exercise price (ranging from $14.23 -- $34.03 per share) greater than the per
share average market price ($11.97) for the period and would thus be
anti-dilutive if exercised. For the three 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.
FOR THE SIX MONTHS ENDED
JUNE 30,
------------------------
2001 2002
------- -------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
Weighted average shares outstanding ...................... 258,574 289,464
======= =======
Diluted EPS Calculation:
Weighted average shares outstanding ...................... 258,574 289,464
Plus: Incremental shares from assumed conversions:
Stock options ......................................... 86 410
Restricted stock ...................................... 116 539
Employee stock purchase plan .......................... 14 139
------- -------
Weighted average shares assuming dilution .............. 258,790 290,552
======= =======
Basic and Diluted EPS:
Income before cumulative effect of accounting change ... $ 1.19 $ 0.95
Cumulative effect of accounting change, net of tax ..... 0.01 --
------- -------
Net income ............................................. $ 1.20 $ 0.95
======= =======
For the six months ended June 30, 2002, the computation of diluted EPS
excludes purchase options for 7,966,882 shares of common stock that have an
exercise price (ranging from $14.23 -- $34.03 per share) greater than the per
share average market price ($12.82) for the period and would thus be
anti-dilutive if exercised. For the six months ended June 30, 2001, the
computation of diluted EPS excludes purchase options for 9,517 shares of common
21
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.
Southern California Class Actions. Reliant Energy, Reliant Energy Services,
Inc. (Reliant Energy Services), REPG and several other subsidiaries of Reliant
Resources, as well as two former officers and one present officer 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. 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. Plaintiffs have voluntarily
dismissed Reliant Energy from two of the three class actions in which it was
named as a defendant.
The cases were initially removed to federal court and were then assigned to
Judge Robert H. Whaley, United States District Judge, pursuant to the federal
procedures for multi-district litigation. On July 30, 2000, Judge Whaley
remanded the cases to state court. Upon remand to state court, the cases were
assigned to Superior Court Judge Janis L. Sammartino pursuant to the California
state coordination procedures. On March 4, 2002, Judge Sammartino adopted a
schedule proposed by the parties that would result in a trial beginning on March
1, 2004. On March 8, 2002, the plaintiffs filed a single, consolidated complaint
naming numerous defendants, including Reliant Energy Services and other Reliant
Resources' subsidiaries, that restated the allegations described above and
alleged that damages against all defendants could be as much as $1 billion. On
April 22 and 23, 2002, the Company and Duke Energy filed cross complaints in the
coordinated proceedings seeking, in an alternative pleading, relief against
other market participants in California, the surrounding states, Canada and
Mexico including Powerex Corp., the Los Angeles Department of Water and Power
and the Bonneville Power Administration. Powerex Corp. and Bonneville Power
Administration removed the case once again to federal court where it was
re-assigned to Judge Whaley. On July 10, 2002, a motion to dismiss was filed in
coordinated proceedings seeking dismissal of the complaints on the basis of the
filed rate doctrine and federal preemption.
On March 11, 2002, the California Attorney General filed a civil lawsuit in
San Francisco Superior Court naming Reliant Energy, Reliant Resources, Reliant
Energy Services, REPG, and several other subsidiaries of Reliant Resources as
defendants. The Attorney General alleges various violations by the defendants of
state laws against unfair and unlawful business practices arising out of
transactions in the markets for ancillary services run by the California
Independent System Operator (Cal ISO). In addition to injunctive relief, the
Attorney General seeks restitution and disgorgement of alleged unlawful profits
for sales of electricity, and civil penalties. The Company removed this lawsuit
to federal court in April 2002, where it has been assigned to Judge Vaughn
Walker in the Northern District of California.
On March 19, 2002, the California Attorney General filed a complaint with
the Federal Energy Regulatory Commission (FERC) naming Reliant Energy Services
an