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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 SEPTEMBER 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 Incorporation or Organization) (I.R.S. Employer Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of Principal Executive Offices) (Zip Code)
(713) 497-3000
(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 November 8, 2002, Reliant Resources, Inc. (Reliant Resources) had
290,441,403 shares of common stock outstanding excluding 9,362,597 shares held
as treasury stock.
RELIANT RESOURCES, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Consolidated Income (unaudited)
Three and Nine Months Ended September 30, 2001 (as restated) and 2002.......................1
Consolidated Balance Sheets (unaudited)
December 31, 2001 and September 30, 2002....................................................2
Statements of Consolidated Cash Flows (unaudited)
Nine Months Ended September 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......47
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................73
Item 4. Controls and Procedures....................................................................75
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................................................76
Item 5. Other Information..........................................................................76
Item 6. Exhibits and Reports on Form 8-K...........................................................77
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2001 2002 2001 2002
------------- ----------- ------------- -----------
(AS RESTATED) (AS RESTATED)
Revenues ........................................... $ 2,399,819 $ 5,236,855 $ 5,355,007 $ 9,220,825
Trading margins (See Note 3) ....................... 61,869 118,375 311,478 291,031
----------- ----------- ----------- -----------
Total ............................................ 2,461,688 5,355,230 5,666,485 9,511,856
----------- ----------- ----------- -----------
EXPENSES:
Fuel and cost of gas sold ........................ 476,532 495,711 1,744,606 1,083,043
Purchased power .................................. 1,308,183 3,863,918 2,190,671 6,062,458
Accrual for payment to CenterPoint Energy, Inc. .. -- 89,000 -- 89,000
Operation and maintenance ........................ 138,922 259,139 385,610 673,622
General, administrative and development .......... 114,099 223,869 406,846 503,805
Depreciation ..................................... 36,094 134,962 96,675 303,865
Amortization ..................................... 35,774 6,561 82,669 14,962
----------- ----------- ----------- -----------
Total ........................................ 2,109,604 5,073,160 4,907,077 8,730,755
----------- ----------- ----------- -----------
OPERATING INCOME ................................... 352,084 282,070 759,408 781,101
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Gain (loss) from investments, net ................ 3,700 (2,338) 15,015 2,493
Income from equity investments in unconsolidated
subsidiaries ................................... 2,132 955 66,482 10,263
Other, net ....................................... 250 10,487 7,152 14,081
Interest expense ................................. (8,355) (103,130) (52,220) (208,974)
Interest income .................................. 3,010 11,183 18,360 19,493
Interest income - affiliated companies, net ...... 11,319 570 7,888 4,754
----------- ----------- ----------- -----------
Total other income (expense) ................... 12,056 (82,273) 62,677 (157,890)
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE ................................ 364,140 199,797 822,085 623,211
INCOME TAX EXPENSE ................................. 150,279 142,063 300,976 290,146
----------- ----------- ----------- -----------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 213,861 57,734 521,109 333,065
Cumulative effect of accounting change, net of tax -- -- 3,062 (233,600)
----------- ----------- ----------- -----------
NET INCOME ......................................... $ 213,861 $ 57,734 $ 524,171 $ 99,465
=========== =========== =========== ===========
BASIC EARNINGS PER SHARE:
Income before cumulative effect of accounting
change ......................................... $ 0.71 $ 0.20 $ 1.92 $ 1.15
Cumulative effect of accounting change, net of tax -- -- 0.01 (0.81)
----------- ----------- ----------- -----------
Net Income .................................. $ 0.71 $ 0.20 $ 1.93 $ 0.34
=========== =========== =========== ===========
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of accounting
change ......................................... $ 0.71 $ 0.20 $ 1.91 $ 1.14
Cumulative effect of accounting change, net of tax -- -- 0.01 (0.80)
----------- ----------- ----------- -----------
Net Income .................................. $ 0.71 $ 0.20 $ 1.92 $ 0.34
=========== =========== =========== ===========
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, SEPTEMBER 30,
2001 2002
------------ -------------
CURRENT ASSETS:
Cash and cash equivalents .............................................. $ 118,453 $ 1,443,605
Restricted cash ....................................................... 167,421 447,087
Accounts and notes receivable, principally customer, net ............... 1,167,870 1,270,346
Accrued unbilled revenues ............................................. 14,270 418,585
Note receivable related to receivable facility ......................... -- 253,928
Accounts and notes receivable - affiliated companies, net .............. 415,081 --
Fuel stock and petroleum products ...................................... 109,036 218,782
Materials and supplies ................................................. 64,999 117,787
Stranded costs settlement receivable .................................. 201,503 --
Trading and marketing assets ........................................... 1,611,393 1,376,817
Non-trading derivative assets .......................................... 392,900 370,464
Margin deposits on energy trading and hedging activities ............... 213,727 284,086
Collateral for electric generating equipment ........................... 141,701 --
Prepayments and other current assets ................................... 126,936 179,851
------------ ------------
Total current assets ................................................. 4,745,290 6,381,338
------------ ------------
Property, plant and equipment ............................................ 4,834,122 9,494,171
Less accumulated depreciation ............................................ (275,729) (525,810)
------------ ------------
Property, plant and equipment, net ................................... 4,558,393 8,968,361
------------ ------------
OTHER ASSETS:
Goodwill, net .......................................................... 891,061 2,157,244
Air emissions regulatory allowances and other intangibles, net ......... 315,438 402,704
Notes receivable - affiliated companies, net ........................... 30,278 --
Trading and marketing assets ........................................... 446,610 551,308
Non-trading derivative assets .......................................... 254,168 271,375
Equity investments in unconsolidated subsidiaries ...................... 386,841 288,297
Stranded costs indemnification receivable .............................. 203,693 225,931
Accumulated deferred income taxes ...................................... 46,322 --
Prepaid lease .......................................................... 121,699 214,809
Restricted funds for stranded costs .................................... -- 1,514
Collateral for electric generating equipment ........................... 88,268 --
Other .................................................................. 203,645 216,541
------------ ------------
Total other assets ................................................... 2,988,023 4,329,723
------------ ------------
TOTAL ASSETS ....................................................... $ 12,291,706 $ 19,679,422
============ ============
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, SEPTEMBER 30,
2001 2002
------------ -------------
CURRENT LIABILITIES:
Current portion of long-term debt ........................................... $ 23,769 $ 31,768
Short-term borrowings ....................................................... 296,769 5,284,717
Accounts payable, principally trade ......................................... 1,002,326 1,315,417
Trading and marketing liabilities ........................................... 1,478,336 1,265,655
Non-trading derivative liabilities .......................................... 399,277 376,801
Accumulated deferred income taxes ........................................... 37,034 115,891
Margin deposits from customers on energy trading and hedging activities ..... 144,700 66,602
Other ....................................................................... 253,800 468,577
------------ ------------
Total current liabilities ............................................. 3,636,011 8,925,428
------------ ------------
OTHER LIABILITIES:
Accumulated deferred income taxes ........................................... -- 344,553
Trading and marketing liabilities ........................................... 361,786 437,966
Non-trading derivative liabilities .......................................... 639,211 433,274
Major maintenance reserve ................................................... 16,784 20,882
Accrual for payment to CenterPoint Energy, Inc. ............................. -- 89,000
Non-derivative stranded costs liability ..................................... 203,693 225,931
Benefit obligations ......................................................... 127,012 148,748
Other ....................................................................... 455,865 386,904
------------ ------------
Total other liabilities ............................................... 1,804,351 2,087,258
------------ ------------
LONG-TERM DEBT ................................................................ 867,712 2,425,140
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 12)
STOCKHOLDERS' EQUITY:
Preferred stock (125,000,000 shares authorized; none outstanding) ........... -- --
Common stock (2,000,000,000 shares authorized; 299,804,000 issued and
outstanding, respectively) ................................................ 61 61
Additional paid-in capital .................................................. 5,777,169 5,797,057
Treasury stock at cost, 11,000,000 shares and 9,364,221 shares .............. (189,460) (161,333)
Retained earnings ........................................................... 557,451 656,916
Accumulated other comprehensive loss ........................................ (161,589) (51,105)
------------ ------------
Stockholders' equity .................................................. 5,983,632 6,241,596
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ........................... $ 12,291,706 $ 19,679,422
============ ============
See Notes to the Company's Interim Financial Statements
3
RELIANT RESOURCES, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2001 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ......................................................................... $ 524,171 $ 99,465
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization .................................................... 179,344 318,826
Deferred income taxes ............................................................ (8,071) 299,982
Net trading and marketing assets and liabilities ................................. (43,122) (13,994)
Net non-trading derivative assets and liabilities ................................ (1,759) (52,886)
Amortization of contractual rights and obligations ............................... -- (50,128)
Curtailment and related benefit enhancement ...................................... 99,523 --
Accounting settlement for certain benefit plans .................................. -- 47,356
Accrual for payment to CenterPoint Energy, Inc. .................................. -- 89,000
Undistributed earnings of unconsolidated subsidiaries ............................ (31,884) (7,612)
Gain on settlement of stranded costs contracts ................................... -- (109,000)
Cumulative effect of accounting change ........................................... (3,062) 233,600
Changes in other assets and liabilities, net of effects of acquisitions:
Restricted cash ................................................................ 50,000 56,650
Accounts and notes receivable and unbilled revenue, net ........................ 332,181 (354,577)
Accounts receivable/payable - affiliated companies, net ........................ 111,472 26,603
Inventory ...................................................................... (52,779) (103,552)
Collateral for electric generating equipment, net .............................. (62,366) 136,013
Margin deposits on energy trading activities, net .............................. 123,995 (147,267)
Net non-trading derivative assets and liabilities .............................. (74,879) (147,204)
Prepaid lease obligation ....................................................... (195,239) (93,309)
Other current assets ........................................................... 56,954 (5,019)
Other assets ................................................................... (31,563) (32,059)
Accounts payable ............................................................... (979,614) 162,385
Taxes accrued .................................................................. 185,073 41,667
Other current liabilities ...................................................... 63,424 21,268
Other liabilities .............................................................. 27,435 (74,999)
Other, net ...................................................................... (7,489) (21,865)
----------- -----------
Net cash provided by operating activities .................................... 261,745 319,344
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ............................................................... (719,577) (474,974)
Business acquisitions, net of cash acquired ........................................ -- (2,963,801)
Distribution from equity investment in unconsolidated subsidiary ................... -- 137,475
Other, net ......................................................................... 10,675 27
----------- -----------
Net cash used in investing activities ........................................ (708,902) (3,301,273)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt ....................................................... -- 22,324
Proceeds from issuance of stock, net ............................................... 1,697,848 --
Purchase of treasury stock ......................................................... (20,420) --
Payments of long-term debt ......................................................... (2,286) (229,785)
Increase in short-term borrowings, net ............................................. 184,779 4,109,925
Change in notes with affiliated companies, net ..................................... (1,234,444) 385,652
Contributions from owner ........................................................... 9,441 --
Other, net ......................................................................... (3) 13,120
----------- -----------
Net cash provided by financing activities .................................... 634,915 4,301,236
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS ......................... (5,865) 5,845
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS ............................................ 181,893 1,325,152
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ..................................... 89,755 118,453
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ........................................... $ 271,648 $ 1,443,605
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) .............................................. $ 63,692 $ 198,279
Income taxes ....................................................................... 116,716 6,743
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 (Amendment No. 2)
of Reliant Resources (Reliant Resources Form 10-K/A) for the year ended December
31, 2001 filed on November 12, 2002, the Quarterly Report on Form 10-Q of
Reliant Resources for the quarter ended March 31, 2002 (First Quarter 10-Q) and
the Quarterly Report on Form 10-Q of Reliant Resources for the quarter ended
June 30, 2002 (Second 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), Reliant Resources determined on May 9, 2002 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. 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 (Audit Committees) of each of the Board of Directors of
Reliant Resources and Reliant Energy, Incorporated (Reliant Energy) 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.
Prior to the third quarter of 2002, the Company reported 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 61 MWh of power for the three and nine months ended September 30, 2001,
respectively, and 46 Billion cubic feet (Bcf) of natural gas for the nine months
ended September 30, 2001.
These round trip trades collectively had the effect of increasing each
of revenues and purchased power expense by $847 million for the three months
ended September 30, 2001 and increasing revenues, fuel and cost of gas sold
expense and purchased power expense by $3.5 billion, $180 million and $3.3
billion, respectively, for the nine months ended September 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 $13 million and
$30 million for the three and nine months ended September 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 nine months ended
September 30, 2001 were previously recorded on a gross basis with such
transactions being reported in revenues and expenses which resulted
5
in $700 million of revenues, $206 million in fuel and cost of gas sold and $494
million of purchased power expense, and $1.0 billion of revenues, $367 million
in fuel and cost of gas sold and $656 million of purchased power expense being
recognized in each period, respectively. These transactions should have been
accounted for on a net basis.
The consolidated financial statements for the three and nine months
ended September 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 nine months ended September 30, 2001: (Note - Those line items for
which no change in amounts are shown were not affected by the restatement.)
THREE MONTHS ENDED SEPTEMBER 30, 2001
-------------------------------------
AS PREVIOUSLY
AS RESTATED REPORTED (1)(2)
-------------- ---------------
(IN MILLIONS)
Total Revenues ......................... $ 2,462 $ 4,070
Expenses:
Fuel and cost of gas sold ............ 476 737
Purchased power ...................... 1,308 2,655
Other expenses ....................... 326 326
------- -------
Total .............................. 2,110 3,718
------- -------
Operating Income ....................... 352 352
Other Income, net ...................... 12 12
Income Tax Expense ..................... (150) (150)
------- -------
Net Income ............................. $ 214 $ 214
======= =======
NINE MONTHS ENDED SEPTEMBER 30, 2001
------------------------------------
AS PREVIOUSLY
AS RESTATED REPORTED (1)(2)
------------ -----------------
(IN MILLIONS)
Total Revenues .................................................. $ 5,666 $ 10,230
Expenses:
Fuel and cost of gas sold ..................................... 1,744 2,313
Purchased power ............................................... 2,190 6,185
Other expenses ................................................ 973 973
------- --------
Total ....................................................... 4,907 9,471
------- --------
Operating Income ................................................ 759 759
Other Income, net ............................................... 63 63
Income Tax Expense .............................................. (301) (301)
------- --------
Income Before Cumulative Effect of Accounting Change ............ 521 521
Cumulative Effect of Accounting Change, net of tax .............. 3 3
------- --------
Net Income ...................................................... $ 524 $ 524
======= ========
- ------------
(1) Beginning with the quarter ended September 30, 2002, the Company now
reports all energy trading and marketing activities on a net basis as
allowed by Emerging Issues Task Force (EITF) Issue No. 98-10,
"Accounting for Contracts involved in Energy Trading and Risk
Management Activities" (EITF No. 98-10). Comparative financial
statements for prior periods have been reclassified to conform to this
presentation. For information regarding the presentation of trading and
marketing activities on a net basis, see Note 3. Revenues, fuel and
cost of gas sold expense and purchased power expense have been
reclassified to conform to this presentation.
(2) 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 $1 million and
$5 million for the three and nine months ended September 30, 2001,
respectively, have been reclassified to conform to this presentation.
6
The restatement did not impact earnings per share for 2001 or the
Statement of Consolidated Cash Flows for 2001.
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 10-K/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 nine months ended September 30, 2001 from amounts
previously reported, to effect this transaction as described above. The
restatement increased comprehensive income by $14 million from a total
comprehensive income of $40 million, as previously reported, to $54 million, as
restated, for the three months ended September 30, 2001 and decreased
comprehensive income by $132 million (including the $170 million transition
adjustment discussed above) from a total comprehensive income of $608 million,
as previously reported, to $476 million, as restated, for the nine months ended
September 30, 2001. The restatement had no impact on the Company's reported
consolidated cash flows, operating income or net income.
Furthermore, in September 2002, during the Company's review of certain
trading transactions in connection with various pending investigations, the
Company identified four natural gas financial swap transactions that should not
have been recorded in the Company's records. The Company has concluded, based on
the offsetting nature of the transactions and manner in which the transactions
were documented, that none of the transactions should have been given accounting
recognition. The Company accounted for the transactions in its financial
statements as a reduction in revenues in December 2000 and an increase in
revenues in January 2001, with the effect of decreasing net income in the fourth
quarter of 2000 and increasing net income in the first quarter of 2001, in each
case by $20.0 million pre-tax ($12.7 million after-tax), and the effect of
increasing basic and diluted earnings per share by $0.05 in the first quarter of
2001. There were no cash flows associated with the transactions. The Company has
further concluded, after considering both qualitative and quantitative factors,
that a restatement of its financial statements for this item is not required.
However, on November 12, 2002, the Company amended its annual report on Form
10-K/A for the year ended December 31, 2001 to disclose this transaction in its
unaudited quarterly information footnote to the consolidated financial
statements (see Note 15 to the Reliant Resources 10-K/A Notes).
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.
This basis of accounting in the Interim Financial Statements
contemplates the recovery of the Company's assets and the satisfaction of its
liabilities in the normal course of conducting business, which in turn is
dependent upon the Company's ability to successfully execute its refinancing
plans, as described in Note 2. The Company expects to successfully execute its
refinancing plans; accordingly, management believes it will be able to meet its
obligations in a manner consistent with this accounting treatment. However,
there can be no assurance that the Company will be successful in executing its
refinancing plans. If the Company is unable to complete the necessary future
refinancings on acceptable terms and conditions, given the magnitude of the
refinancings the Company may be
7
forced to consider a reorganization under the protection of bankruptcy laws. For
discussion of the Company's refinancing plans, see Note 2.
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. 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. Energy sales
and services related to its electric power generation facilities and to retail
customers not billed by month-end are accrued based upon estimated energy and
services delivered.
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
fair 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 sale of
natural gas, electric power and other energy related commodities are recorded on
a net basis. For information regarding the Company's adoption of 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 3. 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.
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 Company's effective tax rate for the three and nine months ended
September 30, 2002 varied from the historical customary statutory rate as a
result of an additional United States federal tax provision for future cash
distributions from an European equity investment, adjustments to state income
taxes primarily due to Texas franchise tax associated with the Company's retail
energy operations, and valuation allowances that increased due to losses
incurred by the Company's European Energy segment trading and origination
operations.
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, (d) acquisitions and dispositions of
businesses, assets and other interests and (e) changes in interest expense. 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. See applicable note in the Reliant Resources 10-K/A Notes.
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).
For information regarding certain legal, regulatory proceedings and
environmental matters, see Note 12.
Reliant Energy 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 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
8
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) to the Reliant Resources
10-K/A Notes.
CenterPoint Energy, Inc. (CenterPoint Energy) was formed on August 31,
2002 as the new holding company of Reliant Energy. CenterPoint Energy is a
diversified international energy services and energy delivery company that owned
the majority of Reliant Resources outstanding common stock prior to September
30, 2002. On September 30, 2002, CenterPoint Energy distributed all of the 240
million shares of Reliant Resources common stock it owned to its common
shareholders of record as of the close of business on September 20, 2002
(Distribution). The Distribution completed the separation of Reliant Resources
and CenterPoint Energy into two separate publicly held companies.
(2) REFINANCING AND LIQUIDITY ISSUES
During the first nine months of 2002, many factors negatively impacted
the Company. These factors include weaker pricing for capacity, ancillary
services and power, coupled with a narrowing of the spread between power prices
and natural gas fuel costs (spark spread) in the United States; market
contraction, reduced volatility and reduced liquidity in the power trading
markets in the United States and Northwest Europe; downgrades in the Company's
credit ratings to below investment grade by each of the major rating agencies;
various legal and regulatory investigations and proceedings (see Notes 1 and
12); reduced market confidence in the Company's financial reporting in light of
previous restatements and amendments; reduced access to capital and increased
demands for collateral in connection with the Company's trading, hedging and
commercial obligations; the decline in market prices of the Company's common
stock; and continued weakness in the United States economy generally. Many of
these factors are discussed in more detail below.
Refinancing Issues. As of September 30, 2002, the Company had
approximately $6.6 billion of credit facilities that will mature prior to
September 30, 2003, including $5.2 billion prior to March 31, 2003. In October
2002, $1.6 billion of these credit facilities was refinanced as further
discussed below and Note 16(b). The Company expects to extend or replace the
remaining facilities. However, in light of the negative factors summarized above
and the current credit environment, the Company believes that any extended or
replacement facilities are likely to, as compared to the current facilities:
include higher interest rates; more significantly restrict the use of the
Company's cash; require collateral or additional collateral, as the case may be,
as security; and otherwise contain more restrictive terms associated with loans
to non-investment grade borrowers. If the Company is unable to extend or replace
these facilities on acceptable terms and conditions, given the magnitude of the
refinancings, the Company may be forced to consider other alternatives,
including a reorganization under the protection of bankruptcy laws.
9
The following table provides a summary of the amounts owed and amounts
available as of September 30, 2002 under the Company's various credit
facilities.
EXPIRING
TOTAL BY
COMMITTED DRAWN LETTERS OF UNUSED SEPTEMBER
CREDIT AMOUNT CREDIT AMOUNT 30, 2003 EXPIRATION DATE
--------- ------ ---------- ------ --------- ----------------
(IN MILLIONS)
RELIANT RESOURCES:
Orion acquisition
term loan ......................................$2,908 $2,908 $ -- $ -- $2,908 February 2003
364-day revolver/
term loan ...................................... 800 800 -- -- 800 August 2003
Three-year revolver .............................. 800 569 218 13 -- August 2004
WHOLESALE ENERGY:
Orion Power and
Subsidiaries:
Orion Power .................................... 62 51 11 -- 62(1) December 2002
Orion MidWest .................................. 1,063 1,048 15 -- 1,063(1) October 2002
Orion NY ....................................... 442 412 10 20 442(1) December 2002
October 2002 -
Liberty Project ................................ 292 270 17 5 8 April 2026
Reliant Energy
Channelview LP:
Equity bridge .................................. 92 92 -- -- 92 November 2002
Construction term
loan and working capital October 2002 -
facility ..................................... 383 348 -- 35 3(2) July 2024
REMA letter of credit
facility ....................................... 51 -- 38 13 51 August 2003
EUROPEAN ENERGY:
Reliant Energy Capital
Europe, Inc .................................... 592 592 -- -- 592(3) March 2003
REPGB 364-day revolver ........................... 182 35 17 130 182(3) July 2003
REPGB letter of
credit facility ................................ 420 -- 271 149 420(3) July 2003
------ ------ ---- ---- ------
Total ..............................................$8,087 $7,125 $597 $365 $6,623
====== ====== ==== ==== ======
- ------------
(1) As discussed in Note 16(b), these Orion Power and subsidiaries credit
facilities were restructured in October 2002.
(2) Excludes $369 million of facilities expiring in November 2002 as
borrowings under such facilities are convertible into a long-term loan.
(3) The results of the Company's European Energy segment are consolidated
on a one-month lag basis.
During October 2002, the Company restructured (a) the Orion Power
Holdings, Inc. (Orion Power) revolving senior credit facility that matured in
December 2002, (b) the Orion Power MidWest, LP (Orion MidWest) credit facility
that matured in October 2002 and (c) the Orion Power New York, LP (Orion NY)
credit facility that matured in December 2002. As part of this restructuring,
the Orion Power revolving credit facility was terminated, and the Orion MidWest
and Orion NY credit facilities were extended until October 2005. For further
information regarding this restructuring, please read Note 16(b).
It is Reliant Resources' current expectation to invest equity or
subordinated debt in Reliant Energy Channelview LP totaling $92 million using
cash on hand during November 2002. Reliant Energy Channelview LP must use the
funds from this debt or equity investment to repay its equity bridge loan
totaling $92 million during November 2002.
The Company's $2.9 billion term loan to finance the purchase of Orion
Power was funded on February 19, 2002. This term loan must be repaid within one
year from the date on which it was funded, or February 19, 2003. The Company is
currently negotiating with the lead banks regarding the appropriate terms and
conditions for an extension of the maturity of this loan. The Company expects to
complete this extension on or before the maturity. The Company anticipates that
the banks will require that the loan be collateralized, contain additional and
more restrictive covenants, have higher interest rates or fees or contain other
provisions that may be dilutive to stockholders.
10
In August 2002, the Company exercised its option to convert its $800
million 364-day revolving facility to a one-year term loan with a maturity of
August 22, 2003. The Company expects to extend and/or refinance this facility,
as well as the $800 million three-year revolver that expires in August 2004, in
conjunction with any extension of the $2.9 billion Orion acquisition term loan
on terms and conditions substantially similar to any extended $2.9 billion Orion
acquisition loan.
The Company is considering the possibility of requesting equity and
debt participants under the credit agreement related to its construction agency
agreements to restructure and extend the maturity of the existing commitments in
connection with the proposed extensions/refinancings described above. For
further discussion of the construction agency agreements, see Note 12(f). To the
extent that the Company is successful in such effort, it expects that such
equity and debt participants under the credit agreements to the construction
agency agreement may require additional collateral, additional and more
restrictive covenants, and higher interest rates and fees.
The Euro 600 million (approximately $592 million) term loan facility at
Reliant Energy Capital Europe, Inc. (RECE) matures on March 1, 2003. Preliminary
work has commenced on the refinancing of this term loan facility. The Company
anticipates the completion of such refinancing during the first quarter of 2003.
In addition, the Company has various other facilities that mature over
the next twelve months. The Company anticipates refinancing or replacing the
Reliant Energy Mid-Atlantic (REMA) letter of credit facility totaling $51
million maturing in August 2003, the Reliant Energy Power Generation Benelux
(REPGB) 364-day revolver totaling Euro 184 million maturing in July 2003 and the
REPGB letter of credit facility totaling $420 million maturing in July 2003
prior to their maturity, to the extent it continues to need access to this
amount of committed credit. The Company anticipates that the lenders may require
that these facilities be secured, contain additional and more restrictive
covenants and have higher interest rates and fees.
Credit Ratings. During the third quarter of 2002, each of the major
rating agencies downgraded the Company's credit ratings to sub-investment grade.
Credit ratings impact the Company's ability to obtain short- and long-term
financing, the execution of its commercial strategies and the cost of financing
because many of the Company's credit facilities have fees and interest rate
margins based on the Company's credit rating. As of November 8, 2002, the
Company's credit ratings for its senior unsecured debt were as follows:
DATE ASSIGNED RATING AGENCY RATING RATING DESCRIPTION
- ------------------ ----------------- ------ ---------------------------------------
July 31, 2002 Moody's Ba3 Review for potential downgrade
September 13, 2002 Standard & Poor's BB+ Credit watch with negative implications
September 18, 2002 Fitch BB Rating watch negative
The credit ratings of the Company's subsidiaries have been affected as
well. As of November 8, 2002, the REMA lease certificates were rated BB+ by
Standard & Poor's and Baa3 by Moody's. The ratings remain on credit watch with
negative implications and review for possible downgrade, respectively. As of
November 8, 2002, the RECE senior unsecured bank credit facility was rated Ba3
by Moody's. The rating remains on review for possible downgrade. The Standard &
Poor's issuer rating was BB+ and remains on credit watch with negative
implications. As of November 8, 2002, the long-term issuer rating assigned by
Moody's to REPGB was Baa2 and remains on review for possible downgrade. The
senior unsecured bank loan rating assigned by Standard & Poor's was BBB- and
remains on credit watch with negative implications. As of November 8, 2002, the
Moody's senior unsecured debt rating for Orion Power was Ba3. The rating remains
on review for possible downgrade. Standard & Poor's senior unsecured debt and
issuer ratings for Orion Power were BB- and BB+, respectively. These ratings
remain on credit watch with negative implications.
The Company cannot assure that these ratings will remain in effect for
any given period of time or that one or more of these ratings will not be
lowered again. As discussed above, the Company expects to provide additional
collateral as security to obtain future financings and refinancings which may
adversely affect the Company's current credit ratings thereby increasing the
cost of future financings or refinancings. The Company notes that these credit
ratings are not recommendations to buy, sell or hold its securities and may be
revised or withdrawn at any time by such rating agency. Each rating should be
evaluated independently of any other rating. Any future incremental reduction or
withdrawal of one or more of the Company's credit ratings could have a material
adverse impact on its ability to access capital on acceptable terms, including
its ability to refinance debt obligations as they mature. The Company's
financial and operational flexibility is likely to be reduced as a result of
more restrictive covenants, the
11
requirement for security and other terms that are typically imposed on
sub-investment grade borrowers as further discussed above.
The Company could be adversely impacted by its downgrade to
sub-investment grade in connection with certain commercial agreements. These
commercial arrangements primarily include: (a) commercial contracts and/or
guarantees related to the Company's wholesale and retail trading, marketing,
risk management and hedging activities and (b) surety bonds and contractual
obligations related to the development and construction or refurbishment of
power plants and related facilities.
In most cases, the consequences of ratings downgrades are limited to
the requirement by the Company's counterparties that the Company provide credit
support to the counterparties in the form of a pledge of cash collateral, a
letter of credit or other similar credit support. In addition, certain of the
Company's retail electricity contracts with large commercial, industrial and
institutional customers of the Retail Energy segment permit the customers to
terminate their contracts if the Company's unsecured debt ratings fall below
investment grade or if its ratings are withdrawn entirely by a rating agency. As
of November 8, 2002, no retail contracts have been terminated pursuant to these
terms. In light of the credit rating downgrades, the Company is working with its
various commercial counterparties to minimize the disruption to its normal
commercial activities and to reduce the magnitude of the collateral the Company
must post in support of its obligations to such counterparties.
In addition, the Company has been involved in certain commercial
activities (including term sales of electric energy or capacity from its
generating facilities) that prospectively may not be feasible due to the
Company's current credit and liquidity situation, among other factors. The
credit downgrades have resulted also in more limited access to credit worthy
counterparties to transact with and the need to make commercial concessions with
counterparties as an inducement to do business with the Company. Given these
factors, the Company has reduced the level of its trading, marketing and hedging
activities, which could result in greater volatility in future earnings.
On October 1, 2002, the Company's Retail Energy segment, through its
subsidiary, entered into a master power contract with Texas Genco, LP (Texas
Genco), a subsidiary of CenterPoint Energy, covering, among other things, the
Company's purchases of capacity and/or energy from Texas Genco's generating
units, under an unsecured line of credit. This contract contains covenants that
restrict the activities of several of the Retail Energy segment's subsidiaries
transacting business in Texas. These restrictions include limitations on the
ability of these subsidiaries to (a) sell assets (including customers),
consolidate or merge with other companies, including affiliated companies
outside the Retail Energy segment; (b) grant liens on their properties; (c)
borrow money in excess of agreed upon levels; (d) enter into or guaranty certain
trading arrangements; and (e) incur liabilities outside the ordinary course of
the Retail Energy segment's business. In addition, there are restrictions
involving transactions with affiliates. Under some circumstances, the Company
would be required to post collateral in favor of Texas Genco. The primary term
of this contract ends on December 31, 2003.
Other Liquidity Issues and Concerns. Currently, the Company is
satisfying its capital requirements and other commitments primarily with cash
from operations, cash on hand and borrowings available under its credit
facilities. The following table summarizes the Company's credit capacity and
liquidity position at September 30, 2002.
12
RELIANT ORION EUROPEAN
TOTAL RESOURCES POWER (2) ENERGY (3) OTHER
------ --------- --------- ---------- -----
(IN MILLIONS)
Total Committed Credit ............. $8,087 $4,508 $1,859 $1,194 $526
Outstanding Borrowings ............. 7,125 4,277 1,781 627 440
Outstanding Letters of Credit ...... 597 218 53 288 38
------ ------ ------ ------ ----
Unused Borrowing Capacity .......... 365 13 25 279 48
Cash and Cash Equivalents .......... 1,444 1,169 -- 79 196
Restricted Cash(1) ................. 447 7 380 60 --
------ ------ ------ ------ ----
Total Available Liquidity .......... $2,256 $1,189 $ 405 $ 418 $244
====== ====== ====== ====== ====
- ----------
(1) Restricted cash includes cash at certain subsidiaries that is
restricted by financing agreements, but is available to the applicable
subsidiary to use to satisfy certain of its obligations.
(2) On October 30, 2002, Orion Power and its subsidiaries repaid
approximately $144 million in borrowings with cash and restricted cash.
(3) The results of the Company's European Energy segment are consolidated
on a one-month lag basis.
Based on current commodity prices, the Company estimates that as of
November 8, 2002, it could be required to post collateral of up to $478 million.
This estimate could increase based on commodity prices and a reduction in the
current credit rating of REPGB. As of November 8, 2002, the Company had posted
cash collateral and letters of credit in the amount of $363 million and $629
million, respectively. Factors which could lead to an increase in the Company's
actual posting of collateral include additional downgrades, adverse changes in
the Company's industry or in reaction to the possible secured nature of any
extension or refinancing of the Company's debt facilities. As of November 8,
2002, the Company had $1.2 billion in unrestricted available cash and cash
equivalents and $5 million available under committed corporate credit facilities
of the Company to support domestic requirements and $82 million in unrestricted
available cash and cash equivalents and $165 million available under committed
European facilities to support European operations. These amounts are currently
available to meet working capital needs and possible future requirements for
credit support related to the Company's credit ratings.
Assuming successful extension or replacement of its credit facilities
as they mature, the Company believes that its current level of cash and
borrowing capability, along with its future anticipated cash flows from
operations, will be sufficient to meet the liquidity needs of its business for
the next twelve months. Under certain unfavorable commodity price scenarios,
however, it is possible that the Company could experience inadequate liquidity.
In order to enhance the Company's liquidity position, the Company may
sell some of its assets. The Company has identified certain non-strategic
generating assets for potential sale to enhance the Company's liquidity
position. To date, the Company has not reached an agreement to dispose of assets
nor has it contemplated any proceeds from asset sales in its current liquidity
plan. Due to unfavorable market conditions in the wholesale power markets, there
can be no assurance that the Company will be successful in disposing of
generating assets at reasonable prices or on a timely basis.
All of the Company's operations are conducted by its subsidiaries. The
Company's cash flow and its ability to service certain of its indebtedness when
due is dependent upon its receipt of cash dividends, distributions or other cash
transfers. The terms of some of the Company's subsidiaries' indebtedness
restrict their ability to pay dividends or make other restricted payments to the
Company, and future financings at the Company's subsidiaries may contain, to
avoid an event of default under these notes similar or even more stringent
restrictions. Further, Reliant Resources may elect to make the interest payments
on Orion Power's 12% senior notes to avoid an event of default under these
notes, if, at the time of such payments are due, dividends are restricted under
the Orion NY and Orion MidWest credit facilities, and funds generated by Orion
Power's other subsidiaries or from other sources are insufficient to make such
payments.
As further discussed in Note 13(d) to the Reliant Resources Form
10-K/A, during the period from 1994 through 1997, under cross border lease
transactions, REPGB leased several of its power plants and related equipment and
turbines to non-Netherlands based investors. Pursuant to these transactions,
REPGB is required, in specified situations, to post letters of credit. In the
case of early termination of these contracts, REPGB would be contingently liable
for some payments to the sublessors. Letters of credit have been posted as of
September 30, 2002 in the total amount of $307 million. In the event that REPGB
credit ratings fall one notch below their current levels, REPGB will be required
to post an
13
additional $45 million under the cross border leases. As of November 8, 2002,
under its $420 million letter of credit facility, REPGB has unused letter of
credit capacity of $113 million available for this purpose.
As of September 30, 2002, the Company had forward-starting interest
rate swaps having an aggregate notional amount of $500 million to hedge the
interest rate on a portion of future offerings of long-term fixed-rate notes.
The Company liquidated the swaps in November 2002 for $52 million. For
additional information regarding the accounting related to these swaps, see
Notes 4 and 16(d).
In early 2004, the Company expects to pay to CenterPoint Energy
approximately $155 million to $185 million, with a most probable estimate of
$170 million, pursuant to the Texas electric restructuring law. For additional
information, see Note 12(e).
For additional information regarding Reliant Energy Desert Basin
generating facility and the potential requirement of additional letters of
credit, see Note 12(h).
For additional information regarding Liberty Electric Power, LLC and
Liberty Electric PA, LLC credit facility and related issues and concerns, see
Notes 9 and 12(i).
For discussion of a covenant violation under the Receivables Facility,
see Note 16(a).
The Company estimates its consolidated forecasted capital commitments
for the fourth quarter of 2002 and the year ended December 31, 2003 to be
approximately $130 million and $533 million, respectively. We expect these
capital commitments to be met with cash flows from operations, project
financings, securitization of assets and other borrowings. Additional capital
expenditures, some of which may be substantial, depend to a large extent upon
the nature and extent of future project commitments which are discretionary. In
addition to the above, the Company currently estimates the capital expenditures
by off-balance sheet special purpose entities to be $207 million and $304
million in the fourth quarter of 2002 and the year ended December 31, 2003,
respectively. For additional information regarding these off-balance sheet
transactions, see Note 12(f).
Also, in connection with the Company's separation from CenterPoint
Energy, CenterPoint Energy granted the Company an option to purchase all of the
shares of capital stock owned by CenterPoint Energy in January 2004 of Texas
Genco that owns the Texas generating assets of Reliant Energy's former electric
utility division. This option may be exercised between January 10, 2004 and
January 24, 2004. If the Company exercises its purchase option, the Company
expects to fund the purchase obligation with proceeds from asset sales, cash
flows from operations, proceeds from debt and equity offerings, and/or other
borrowings. The Company's liquidity position and restrictive covenants of future
financings, may limit its ability to exercise the option. If the Company does
not exercise the option, the Company will need to contract with Texas Genco or
others to meet its retail supply obligations. For additional information
regarding this option to purchase CenterPoint Energy's interest in Texas Genco,
please read Note 4(b) to the Reliant Resources Form 10-K/A.
(3) 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
14
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
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.
SFAS No. 145 also requires sale-leaseback accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. 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 4 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 7 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 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. In October 2002, the EITF issued a
consensus that superceded the June 2002 consensus. The October 2002 consensus
required, among other things, that energy derivatives held for trading purposes
be shown net in the income statement. This new consensus is effective for fiscal
periods beginning after December 15, 2002. However, consistent with the new
consensus and as allowed under EITF No. 98-10, beginning with the quarter ended
September 30, 2002, the Company now reports all energy trading and marketing
activities on a net basis in the Statements of Consolidated Income. Comparative
financial statements for prior periods have been reclassified to conform to this
presentation.
15
The adoption of net reporting resulted in a reduction of revenues, fuel
and cost of gas sold, purchase power expense during the three and nine months
ended September 30, 2001, and six months ended June 30, 2002 as follows (in
millions):
FOR THE THREE FOR THE NINE FOR THE SIX
MONTHS ENDED MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001 JUNE 30, 2002
------------------ ------------------ -------------
Revenues .......................... $ 6,278 $ 19,687 $ 11,434
Fuel and cost of gas sold ......... 2,471 11,011 6,142
Purchased power ................... 3,807 8,676 5,292
-------- --------- ---------
Net impact on margins ........ $ -- $ -- $ --
======== ========= =========
Furthermore, in October 2002, under EITF No. 02-03, "Accounting for
Contracts Involved in Energy Trading and Risk Management Activities" (EITF No.
02-03) the EITF reached a consensus to rescind EITF No. 98-10. All new contracts
that would have been accounted for under EITF No. 98-10, and that do not fall
within the scope of SFAS No. 133, should no longer be marked-to-market through
earnings beginning October 25, 2002. In addition, inventories used in the
trading and marketing operations should no longer be marked-to-market through
earnings. This transition is effective for the Company for the first quarter
of 2003. A cumulative effect of a change in accounting principle should be
recorded effective January 1, 2003 related to all contracts and inventories that
will no longer be recorded at fair value that were entered into or held, as
applicable, prior to October 25, 2002. The Company is in process of determining
the effect of adoption on its consolidated financial statements.
Finally, the EITF has not reached 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. In the June 2002 EITF meeting and
again in the October 2002 EITF meeting, 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
three and nine months ended September 30, 2002, the Company recorded $8 million
and $54 million, respectively, of fair value at the contract inception related
to trading and marketing activities. The Company believes that any material
inception gains recorded subsequent to the FASB staff comment regarding this
issue were evidenced by quoted market prices and other current market
transactions for energy trading contracts with similar terms and
counterparties.
(4) 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 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
materially impact the Company's consolidated financial statements.
16
Cash Flow Hedges. During the three and nine months ended September 30,
2002, the amount of hedge ineffectiveness recognized in earnings from
derivatives that are designated and qualify as cash flow hedges, including
interest rate swaps, was a $15 million and a $5 million loss, respectively.
During the nine months ended September 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 nine months ended September 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 September 30, 2002, the Company
expects $22 million in accumulated other comprehensive income to be reclassified
into net income during the next twelve months.
Interest Rate Swaps. As of September 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 Company pays floating interest at LIBOR for a fixed interest
rate of 6.92%. 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 future
offerings of long-term fixed-rate notes. With respect to the $500 million of
forward-starting interest rate swaps that are outstanding, the Company pays
fixed interest at a rate of 5.2% for floating interest at LIBOR. 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 7 years. In November 2002, the Company
liquidated $500 million of the forward-starting interest rate swaps at a cost of
$52 million. For further discussion of the liquidation of these swaps, see Note
16(d).
Hedge of Net Investment in Foreign Subsidiaries. The Company has hedged
its entire net investment in its European subsidiaries against a material
decline of the Euro through a combination of Euro-denominated borrowings and
foreign currency option contracts. During the nine months ended September 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 $163
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 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 has a recorded liability of $369
million for the REPGB stranded cost gas and electric commitments in non-trading
derivative liabilities. As of September 30, 2002, the Company has a recorded
liability of $141 million for the REPGB stranded cost gas supply contract in
non-trading derivative liabilities. Pursuant to SFAS No. 133, during nine months
ended September 30, 2002, the Company recognized a net $16 million gain, net of
derivative transactions entered into to economically hedge the stranded cost gas
contracts, recorded in fuel expense related to changes in the valuation of these
non-trading derivative liabilities, excluding the effects of the gain related to
amending the two power contracts as discussed in Note 12(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 13(f) to the Reliant Resources
10-K/A Notes and Note 12(d).
17
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 nine
months ended September 30, 2002, $46 million and $96 million, respectively, of
net non-trading derivative assets were settled related to these transactions,
and a $1 million and $3 million pre-tax unrealized gain, respectively, was
recognized. As of September 30, 2002, the Company has recognized $33 million of
non-trading derivative assets and $8 million of non-trading derivative
liabilities related to these transactions.
(5) HISTORICAL RELATED PARTY TRANSACTIONS
The Interim Financial Statements include significant transactions
between the Company and CenterPoint Energy and its subsidiaries 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 $1
million and $5 million for the three months ended September 30, 2001 and 2002,
respectively. Amounts charged and allocated to the Company for these services
were $6 million and $15 million for the nine months ended September 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 nine months ended September 30, 2001, the Company incurred costs primarily
related to corporate support services which were billed to CenterPoint Energy
and its affiliates of $8 million and $29 million, respectively. Some
subsidiaries of the Company have entered into office rental agreements with
CenterPoint Energy. During the three months ended September 30, 2001 and 2002,
the Company incurred $5 million and $8 million, respectively, of rent expense to
CenterPoint Energy. The Company incurred $13 million and $24 million of rent
expense to CenterPoint Energy during the nine months ended September 30, 2001
and 2002, respectively.
The Company purchases natural gas, electric generation energy and
capacity, electric transmission services and natural gas transportation services
from, supplies natural gas to, and provides marketing and risk management
services to affiliates of CenterPoint Energy. Purchases of electric generation
energy and capacity, electric transmission services, natural gas transportation
services and natural gas from CenterPoint Energy and its subsidiaries were $634
million for the three months ended September 30, 2002 and $1.5 billion for the
nine months ended September 30, 2002. During the three months ended September
30, 2001 and 2002, the sales and services to CenterPoint Energy and its
subsidiaries totaled $87 million and $18 million, respectively, and $416 million
and $176 million for the nine months ended September 30, 2001 and 2002,
respectively.
During the fourth quarter of 2001 and the first and third quarters of
2002, the Company purchased entitlements to some of the generation capacity of
electric generation assets of 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 September 30, 2002, the Company has purchased
entitlements to capacity of Texas Genco averaging 5,967 MW per month for the
remainder of 2002 and 775 MW per
18
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 $46 million in 2002
and $58 million in 2003. During the fourth quarter of 2002, through November 8,
2002, the Company purchased additional entitlements to some of the generation
capacity of electric generation assets of Texas Genco averaging 4,173 MW per
month in 2003. The Company's anticipated capacity payments related to these
additional capacity entitlements are $246 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 nine months ended September 30, 2001, CenterPoint Energy or
its subsidiaries made equity contributions to the Company of $1.8 billion. The
contributions in the nine months ended September 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. During the nine months ended September 30, 2002,
CenterPoint Energy made contributions to the Company of $21 million, which
primarily related to benefit obligations pursuant to the Master Separation
Agreement.
(6) ACQUISITIONS
Orion Power Holdings, Inc. In February 2002, the Company acquired all
of the outstanding shares of common stock of 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 9) 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 September 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 primarily included adjustments in property,
plant and 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 September 30, 2001 and nine months ended September 30, 2001 and
2002, as if the acquisition had occurred on January 1, 2001 and 2002, as
applicable.
THREE MONTHS ENDED
SEPTEMBER 30, 2001
-----------------------------
ACTUAL PRO FORMA
-------- ---------
(IN MILLIONS)
Revenues ............................................. $ 2,462 $ 2,844
Net income ........................................... 214 267
Basic and diluted earnings per share ................. $ 0.71 $ 0.89
19
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2002
----------------------------- -----------------------------
ACTUAL PRO FORMA ACTUAL PRO FORMA
--------- ---------- --------- ----------
(IN MILLIONS)
Revenues .............................................. $ 5,666 $ 6,630 $ 9,512 $ 9,634
Income before cumulative effect of accounting
change .............................................. 521 586 333 274
Net income ............................................ 524 589 99 41
Basic earnings per share before cumulative effect
of accounting change ................................ $ 1.92 $ 2.15 $ 1.15 $ 0.95
Basic earnings per share .............................. 1.93 2.16 0.34 0.14
Diluted earnings per share before cumulative
effect of accounting change ......................... 1.91 2.15 1.14 0.94
Diluted earnings per share ............................ 1.92 2.16 0.34 0.14
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 3 and 7.
Each of Orion Power New York, LP, Orion Power New York GP, Inc.,
Astoria Generating Company, L.P., Carr Street Generating Station, LP, Erie
Boulevard Hydropower, LP, Orion Power MidWest, LP, Orion Power Midwest GP, Inc.,
Twelvepole Creek, LLC and Orion Power Capital, LLC is a separate legal entity
and has its own assets.
(7) 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:
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2001 2002
-------- --------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Reported net income ......................... $ 214 $ 58
Add: Goodwill amortization, net of tax ...... 27 --
-------- --------
Adjusted net income ......................... $ 241 $ 58
======== ========
Basic and Diluted Earnings Per Share:
Reported net income ......................... $ 0.71 $ 0.20
Add: Goodwill amortization, net of tax ...... 0.09 --
-------- --------
Adjusted basic and diluted earnings ......... $ 0.80 $ 0.20
======== ========
20
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2001 2002
-------- --------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Reported net income ......................... $ 524 $ 99
Add: Goodwill amortization, net of tax ...... 44 --
-------- --------
Adjusted net income ......................... $ 568 $ 99
======== ========
Basic Earnings Per Share:
Reported net income ......................... $ 1.93 $ 0.34
Add: Goodwill amortization, net of tax ...... 0.16 --
-------- --------
Adjusted basic earnings ..................... $ 2.09 $ 0.34
======== ========
Diluted Earnings Per Share:
Reported net income ......................... $ 1.92 $ 0.34
Add: Goodwill amortization, net of tax ...... 0.16 --
-------- --------
Adjusted diluted earnings ................... $ 2.08 $ 0.34
======== ========
The components of the Company's other intangible assets consist of the
following:
DECEMBER 31, 2001 SEPTEMBER 30, 2002
-------------------------- ---------------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
(IN MILLIONS)
Air Emission Regulatory Allowances .................... $ 255 $ (78) $ 271 $ (88)
Water Rights .......................................... 68 (4) 68 (6)
Other Power Generation Site Permits ................... 77 (3) 77 (5)
Contractual rights .................................... -- -- 92 (9)
Other ................................................. -- -- 3 --
------ ------ ------ -------
Total ................................................. $ 400 $ (85) $ 511 $ (108)
====== ====== ====== =======
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 September 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 with positive fair value at the date of
acquisition (Contractual Rights) were recorded to intangible assets and those
contracts with negative fair 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 estimated realization of the
fair value established on the acquisition date over the contractual lives.
Additionally, the time value portion of the contract's value is amortized to
interest expense over the contractual lives. There may be times during the life
of the contract when accumulated amortization exceeds the carrying value of the
recorded assets or liabilities due to the timing of realizing the fair value
established on the acquisition date.
Amortization expense for other intangibles, excluding Contractual
Rights, for the three months ended September 30, 2001 and 2002 was $9 million
and $7 million, respectively. Amortization expense for other intangibles,
excluding Contractual Rights, for the nine months ended September 30, 2001 and
2002 was $39 million and $15 million, respectively. Estimated amortization
expense for the remainder of 2002 and the five succeeding fiscal years is as
follows (in millions):
21
2002 ......................... $ 7
2003 ......................... 23
2004 ......................... 13
2005 ......................... 13
2006 ......................... 12
2007 ......................... 12
-----
Total ...................... $ 80
=====
The Company amortized $2 million and $9 million of Contractual Rights
during the three and nine months ended September 30, 2002, respectively. The
Company amortized $49 million and $59 million of Contractual Obligations during