UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
NO. 1
(Mark One)
[ X ] AMENDMENT NO. 1 TO QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
______________________________
Commission file number 1-16455
RELIANT RESOURCES, INC.
(Exact name of registrant as specified in its charter)
Delaware 76-0655566
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
______________________________
Indicate by check mark whether the 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, 2001, Reliant Resources, Inc. (Reliant Resources) had
291,175,800 shares of common stock outstanding including 240,000,000 shares
which were held by Reliant Energy, Incorporated and excluding 8,628,200 shares
held as treasury stock. As of November 8, 2001, 51,161,450 shares of common
stock are held by non-affiliates of Reliant Resources, using the definition of
beneficial ownership contained in Rule 13d-3 promulgated pursuant to the
Securities Exchange Act of 1934.
RELIANT RESOURCES, INC.
QUARTERLY REPORT ON FORM 10-Q/A
FOR THE QUARTER ENDED SEPTEMBER 30, 2001
Reliant Resources, Inc. (Reliant Resources) hereby amends Items 1 and 2 of
Part 1 of its Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2001 as originally filed on November 13, 2001.
RESTATEMENT
On February 5, 2002, Reliant Resources announced that it was restating its
earnings for the second and third quarters of 2001. As more fully described in
Note 1, the restatement relates to a correction in accounting treatment for a
series of four structured transactions that were inappropriately accounted for
as cash flow hedges for the period of May 2001 through September 2001.
Although these transactions were undertaken and accounted for as cash flow
hedges, having further reviewed the transactions, Reliant Resources now believes
they did not meet the requirements of a cash flow hedge under Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended (SFAS No. 133). Consequently, these
contracts should have been accounted for as derivatives with changes in fair
value recognized through the income statement.
As a result, Reliant Resource's unaudited consolidated condensed financial
statements (Original Interim Financial Statements) and related disclosures as of
September 30, 2001 and for the three and nine months ended September 30, 2001
have been restated from amounts previously reported. The principal effects of
the restatement on the accompanying financial statements are set forth in Note 1
of the Notes to Interim Financial Statements.
For purposes of this Form 10-Q/A, and in accordance with Rule 12b-15 under
the Securities Exchange Act of 1934, as amended, each item of the September 30,
2001 Form 10-Q as originally filed on November 13, 2001 that was affected by the
restatement has been amended and restated in its entirety. No attempt has been
made in this Form 10-Q/A to modify or update other disclosures as presented in
the original Form 10-Q except as required to reflect the effects of the
restatement.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.................................................................. 1
Statements of Consolidated Income
Three and Nine Months Ended September 30, 2000 and 2001 (unaudited)................... 1
Consolidated Balance Sheets
December 31, 2000 and September 30, 2001 (unaudited).................................. 2
Statements of Consolidated Cash Flows
Nine Months Ended September 30, 2000 and 2001 (unaudited)............................. 4
Notes to Unaudited Consolidated Financial Statements.................................. 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company ............................................................. 22
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,
------------------------------ ---------------------------------
2000 2001 2000 2001
------------ ------------ ------------ ------------
(AS RESTATED) (AS RESTATED)
REVENUES ............................................ $ 6,885,794 $ 10,347,179 $ 12,819,656 $ 29,911,410
EXPENSES:
Fuel and cost of gas sold ......................... 2,758,948 3,207,769 6,248,794 13,323,166
Purchased power ................................... 3,582,278 6,460,674 5,517,600 14,859,310
Operation and maintenance ......................... 98,843 134,262 280,025 393,876
General, administrative and development ........... 80,244 121,524 166,974 401,346
Depreciation and amortization ..................... 64,552 71,868 130,351 179,344
------------ ------------ ------------ ------------
Total ......................................... 6,584,865 9,996,097 12,343,744 29,157,042
------------ ------------ ------------ ------------
OPERATING INCOME .................................... 300,929 351,082 475,912 754,368
------------ ------------ ------------ ------------
OTHER (EXPENSE) INCOME:
Interest income ................................... 4,299 4,144 10,503 22,678
Interest expense .................................. (10,351) (8,355) (29,498) (52,220)
Interest (expense) income - affiliated companies,
net ................................................. (57,503) 11,319 (129,240) 7,888
(Losses) gains from investments, net .............. (2,148) 3,700 (16,586) 15,015
Income from equity investments in unconsolidated
subsidiaries .................................... 27,142 2,132 33,108 66,482
Gain on sale of development project ............... -- -- 18,011 --
Other, net ........................................ 118 118 2,332 7,874
------------ ------------ ------------ ------------
Total other (expense) income .................... (38,443) 13,058 (111,370) 67,717
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES, CUMULATIVE EFFECT OF
ACCOUNTING CHANGE AND EXTRAORDINARY ITEM .......... 262,486 364,140 364,542 822,085
INCOME TAX EXPENSE .................................. 99,412 150,279 120,158 300,976
------------ ------------ ------------ ------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
AND EXTRAORDINARY ITEM ............................ 163,074 213,861 244,384 521,109
Cumulative effect of accounting change, net of tax -- -- -- 3,062
Extraordinary item ................................ -- -- 7,445 --
------------ ------------ ------------ ------------
NET INCOME .......................................... $ 163,074 $ 213,861 $ 251,829 $ 524,171
============ ============ ============ ============
BASIC EARNINGS PER SHARE:
Income before cumulative effect of accounting $ 0.71 $ 1.92
change...........................................
Cumulative effect of accounting change, net of tax. -- 0.01
------------ ------------
Net Income....................................... $ 0.71 $ 1.93
============ ============
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of accounting $ 0.71 $ 1.91
change...........................................
Cumulative effect of accounting change, net of tax. -- 0.01
------------ ------------
Net Income....................................... $ 0.71 $ 1.92
============ ============
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,
2000 2001
------------ ------------
(AS RESTATED)
CURRENT ASSETS:
Cash and cash equivalents .................................... $ 89,755 $ 271,648
Accounts and notes receivable, principally customer, net ..... 1,811,355 1,477,406
Accounts and notes receivable - affiliated companies, net .... -- 899,942
Fuel stock and petroleum products ............................ 54,954 103,709
Materials and supplies ....................................... 44,491 48,912
Price risk management assets ................................. 4,290,803 2,128,025
Non-trading derivative assets ................................ -- 1,329,842
Margin deposits on energy contracts .......................... 521,004 351,756
Prepayments and other current assets ......................... 180,334 143,141
------------ ------------
Total current assets ....................................... 6,992,696 6,754,381
------------ ------------
Property, plant and equipment .................................. 4,200,139 4,804,466
Less accumulated depreciation .................................. (150,644) (243,455)
------------ ------------
Property, plant and equipment - net ........................ 4,049,495 4,561,011
------------ ------------
OTHER ASSETS:
Goodwill, net ................................................ 1,006,782 934,489
Air emissions regulatory allowances and other intangibles, net 283,952 318,177
Price risk management assets ................................. 544,909 689,983
Non-trading derivative assets ................................ -- 540,199
Notes receivable - affiliated companies, net ................. -- 30,190
Equity investments in unconsolidated subsidiaries ............ 108,727 141,633
Stranded costs indemnification receivable .................... -- 353,000
Other ........................................................ 227,831 476,320
------------ ------------
Total other assets ......................................... 2,172,201 3,483,991
------------ ------------
TOTAL ASSETS ............................................. $ 13,214,392 $ 14,799,383
============ ============
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,
2000 2001
------------ ------------
(AS RESTATED)
CURRENT LIABILITIES:
Short-term borrowings ........................................... $ 126,175 $ 190,917
Current portion of long-term debt ............................... 591 22,070
Accounts payable, principally trade ............................. 2,083,556 1,117,265
Accounts and notes payable - affiliated companies, net .......... 1,321,120 --
Price risk management liabilities ............................... 4,272,771 2,089,274
Non-trading derivative liabilities .............................. -- 1,119,532
Accumulated deferred income taxes ............................... -- 143,630
Margin deposits from customers on energy trading activities ..... 284,603 239,350
Other ........................................................... 315,592 561,492
------------ ------------
Total current liabilities ................................. 8,404,408 5,483,530
------------ ------------
OTHER LIABILITIES:
Accumulated deferred income taxes ............................... 31,181 71,841
Notes payable - affiliated companies, net ....................... 647,499 --
Price risk management liabilities ............................... 530,263 652,992
Non-trading derivative liabilities .............................. -- 563,691
Major maintenance reserve ....................................... 19,899 29,422
Other ........................................................... 356,956 631,785
------------ ------------
Total other liabilities ................................... 1,585,798 1,949,731
------------ ------------
LONG-TERM DEBT .................................................... 891,736 961,951
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 11)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.001 per share (125,000,000 shares
authorized; none outstanding) ................................. -- --
Common stock, par value $0.001 per share (2,000,000,000 shares
authorized; 240,000,000 and 299,804,000 issued and outstanding,
respectively) ................................................. 1 61
Additional paid-in capital ...................................... 2,336,993 5,820,542
Treasury stock .................................................. -- (20,420)
Retained earnings ............................................... -- 524,171
Accumulated other comprehensive (loss) income ................... (4,544) 79,817
------------ ------------
Stockholders' equity ...................................... 2,332,450 6,404,171
------------ ------------
Total Liabilities and Stockholders' Equity
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............... $ 13,214,392 $ 14,799,383
============ ============
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,
-----------------------------------
2000 2001
----------- -----------
(AS RESTATED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .......................................................... $ 251,829 $ 524,171
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization ..................................... 130,351 179,344
Deferred income taxes ............................................. 10,097 (8,071)
Extraordinary gain .............................................. (7,445) --
Cumulative effect of accounting change ............................ -- (3,062)
Undistributed earnings of unconsolidated subsidiaries ............. (33,108) (31,884)
Impairment of marketable equity securities ........................ 26,504 --
Proceeds from sale of debt securities ............................. 123,428 --
Changes in other assets and liabilities:
Accounts and notes receivable, net .............................. (563,872) 332,181
Accounts receivable/payable - affiliated companies, net ......... (48,668) 111,472
Inventory ....................................................... (7,147) (52,779)
Accounts payable ................................................ 410,455 (979,614)
Net price risk management assets and liabilities ................ (24,436) (43,122)
Margin deposits on energy trading activities, net ............... (62,755) 123,995
Net non-trading derivative assets and liabilities ............... -- (76,638)
Restricted deposits ............................................. (76,084) (12,355)
Prepaid lease obligation ........................................ -- (195,239)
Taxes accrued ................................................... 45,345 181,947
Other assets .................................................... (174,877) 70,280
Other current liabilities ....................................... 278,351 66,550
Other liabilities ............................................... (42,786) 82,058
Other, net ........................................................ (1,150) (7,489)
----------- -----------
Net cash provided by operating activities ..................... 234,032 261,745
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ................................................ (676,890) (719,577)
Payment of business purchase obligation ............................. (981,789) --
Business acquisitions, net of cash acquired ......................... (2,127,503) --
Proceeds from sale-leaseback transactions .......................... 1,000,000 --
Investments in unconsolidated subsidiaries .......................... (5,196) --
Other, net .......................................................... 11,349 10,675
----------- -----------
Net cash used in investing activities ...................... (2,780,029) (708,902)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt ........................................ 137,025 --
Proceeds from issuance of stock, net ................................ -- 1,697,848
Purchase of treasury stock .......................................... -- (20,420)
Payments of long-term debt .......................................... (299,375) (2,286)
Increase in short-term borrowings, net .............................. 638,168 184,779
Increase (decrease) in notes payable/receivable with affiliated
companies, net .................................................... 1,221,300 (1,234,444)
Contributions from owner ............................................ 1,067,903 9,441
Other, net .......................................................... (24,108) (3)
----------- -----------
Net cash provided by financing activities ..................... 2,740,913 634,915
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS .......... 9,681 (5,865)
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS ............................. 204,597 181,893
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ...................... 49,271 89,755
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............................ $ 253,868 $ 271,648
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) ............................... $ 158,397 $ 63,692
Income taxes ........................................................ 62,459 116,716
See Notes to the Company's Interim Financial Statements
4
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
Included in this Quarterly Report on Form 10-Q/A (Form 10-Q/A) for Reliant
Resources, Inc. (Reliant Resources), together with its subsidiaries
(collectively, the Company), are the Company's consolidated interim financial
statements and notes (Interim Financial Statements). The Interim Financial
Statements are unaudited, omit certain financial statement disclosures and
should be read with the financial statements included in Reliant Resources'
Prospectus dated April 30, 2001 (Reliant Resources Prospectus) as filed with the
SEC on May 1, 2001 pursuant to Rule 424(b) under the Securities Act of 1933,
relating to Reliant Resources' registration statement on Form S-1 (Registration
No. 333-48038) and the Quarterly Report on Form 10-Q of Reliant Resources for
the quarter ended March 31, 2001 (First Quarter 10-Q) and the Quarterly Report
on Form 10-Q/A for the quarter ended June 30, 2001 (Second Quarter 10-Q/A).
RESTATEMENT
On February 5, 2002, the Company announced that it was restating its
earnings for the second and third quarters of 2001. As more fully described
below, the restatement relates to a correction in accounting treatment for a
series of four structured transactions that were inappropriately accounted for
as cash flow hedges for the period of May 2001 through September 2001.
During the May 2001 through September 2001 time frame, the Company entered
into a series of four structured transactions that were intended to increase
future cash flow and earnings and to increase certainty associated with future
cash flow and earnings, albeit at the expense of 2001 cash flow and earnings. It
was contemplated that the structured transactions would qualify for hedge
accounting under Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended (SFAS
No. 133). The transactions were recorded in the Company's cash flow hedge
accounting records and were, in effect, overlaid on existing contracts entered
into as hedges. In general, each structured transaction involved a series of
forward contracts to buy and sell an energy commodity in 2001 and to buy and
sell an energy commodity in 2002 or 2003. Each series of contracts in a
structure were executed contemporaneously with the same counterparty and were
for the same commodities, quantities and locations. The contracts in each
structure were offsetting in terms of physical attributes. In two of the four
structured transactions, a series of contracts were entered into with the same
counterparty to mitigate credit exposure (the credit mitigation contracts).
These credit mitigation contracts mirrored the cash flows and terms from the
other contracts in the structure, except for an upfront demand payment made to
the counterparty in these two transactions. In addition, in contemplation of one
of the structured transactions, in August 2001, the Company entered into forward
contracts with a different counterparty to buy and sell natural gas, a portion
of which was inappropriately recorded in the fourth quarter of 2001. The
counterparties to all of the structured transactions were independent third
parties that are regularly engaged in the energy trading business.
While each contract in each structure was not at market at inception, the
contracts were intended to be at market in total, so the structure had little or
no fair value at inception. Under the original accounting treatment, however,
the Company recorded each applicable contract in its hedge accounting records on
an individual basis, resulting in the recognition of a non-trading derivative
asset or liability on the balance sheet with an offsetting entry in accumulated
other comprehensive income at inception for each contract. Such accounting
treatment resulted in a net loss being recorded in 2001 and ultimately would
result in income being recorded for 2002 and 2003 related to these four
structured transactions. In this situation, the recognition of other
comprehensive income was in error, because the fair value of each contract in
each structure resulted not from changes in the fair value of any anticipated
transaction, but rather from the fact that the individual contracts were not at
market at inception.
Having further reviewed the transactions, the Company now believes the
contracts should have been accounted for as a unit within each structured
transaction rather than separately and that, viewed as such, they did not
qualify as cash flow hedges under SFAS No. 133. Consequently, these contracts
should have been accounted for as derivatives with changes in fair value
recognized through the income statement.
5
As a result, the Company's unaudited consolidated condensed financial
statements and related disclosures as of September 30, 2001 and for the three
and nine months ended September 30, 2001 have been restated from amounts
previously reported. A summary of the principal effects of the restatement is as
follows: (Note - Those line items for which no change in amounts are shown were
not affected by the restatement.)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------------------ -----------------------------
AS PREVIOUSLY AS PREVIOUSLY
AS RESTATED REPORTED AS RESTATED REPORTED
----------- ------------- ----------- -------------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Revenues ............................................. $ 10,347 $ 10,304 $ 29,911 $ 29,856
Expenses:
Fuel and cost of gas sold ....................... 3,208 3,298 13,323 13,488
Purchased power ................................. 6,461 6,461 14,859 14,859
Other expenses .................................. 327 327 975 975
-------- -------- -------- --------
Total ......................................... 9,996 10,086 29,157 29,322
-------- -------- -------- --------
Operating Income ..................................... 351 218 754 534
Other Income, net .................................... 13 13 68 68
Income Tax Expense ................................... (150) (98) (301) (215)
-------- -------- -------- --------
Income Before Cumulative Effect of Accounting Change . 214 133 521 387
Cumulative effect of accounting change, net of tax ... -- -- 3 3
-------- -------- -------- --------
Net Income ........................................... $ 214 $ 133 $ 524 $ 390
======== ======== ======== ========
BASIC EARNINGS PER SHARE:
Income before cumulative effect of accounting change . $ 0.71 $ 0.44 $ 1.92 $ 1.42
Cumulative effect of accounting change, net of tax ... -- -- 0.01 0.01
-------- -------- -------- --------
Net Income ........................................... $ 0.71 $ 0.44 $ 1.93 $ 1.43
======== ======== ======== ========
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of accounting change . $ 0.71 $ 0.44 $ 1.91 $ 1.42
Cumulative effect of accounting change, net of tax ... -- -- 0.01 0.01
-------- -------- -------- --------
Net Income ........................................... $ 0.71 $ 0.44 $ 1.92 $ 1.43
======== ======== ======== ========
6
SEPTEMBER 30, 2001
-----------------------------------
AS PREVIOUSLY
AS RESTATED REPORTED
---------------------------------
(IN MILLIONS)
ASSETS
CURRENT ASSETS:
Price risk management assets .................................... $ 2,128 $ 2,128
Non-trading derivative assets ................................... 1,330 1,416
Other ........................................................... 3,297 3,297
-------- --------
Total current assets ..................................... 6,755 6,841
PROPERTY, PLANT AND EQUIPMENT, NET ................................ 4,561 4,561
OTHER ASSETS:
Price risk management assets .................................... 690 690
Non-trading derivative assets ................................... 540 628
Other ........................................................... 2,253 2,253
-------- --------
Total other assets ....................................... 3,483 3,571
-------- --------
TOTAL ASSETS ............................................ $ 14,799 $ 14,973
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Price risk management liabilities ............................... $ 2,089 $ 2,157
Non-trading derivative liabilities .............................. 1,119 1,299
Accumulated deferred income taxes ............................... 144 82
Other ........................................................... 2,131 2,131
-------- --------
Total current liabilities ................................ 5,483 5,669
OTHER LIABILITIES:
Accumulated deferred income taxes ............................... 72 72
Price risk management liabilities ............................... 653 731
Non-trading derivative liabilities .............................. 564 564
Other ........................................................... 661 661
-------- --------
Total other liabilities .................................. 1,950 2,028
-------- --------
LONG-TERM DEBT .................................................... 962 962
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.001 per share (125,000,000 shares
authorized; none outstanding) ................................. -- --
Common Stock, par value $0.001 per share (2,000,000,000 shares
authorized; 240,000,000 and 299,804,000 issued and outstanding,
respectively) ................................................. -- --
Additional paid-in capital ...................................... 5,820 5,820
Treasury stock .................................................. (20) (20)
Retained earnings ............................................... 524 390
Accumulated other comprehensive income .......................... 80 124
-------- --------
Stockholders' equity ...................................... 6,404 6,314
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................ $ 14,799 $ 14,973
======== ========
BASIS OF PRESENTATION
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The Interim Financial Statements reflect all normal recurring adjustments
that are, in the opinion of management, necessary to present fairly the
financial position and results of operations for the respective periods. Amounts
reported in the statements of consolidated income are not necessarily indicative
of amounts expected for a full year period due to
7
the effects of, among other things, (a) seasonal fluctuation in demand for
energy and energy services, (b) changes in energy commodity prices, (c) timing
of maintenance and other expenditures, and (d) acquisitions and dispositions of
businesses, assets and other interests. In addition, certain amounts from the
prior period have been reclassified to conform to the Company's presentation of
financial statements in the current period. These reclassifications do not
affect the earnings of the Company.
The following notes to the consolidated financial statements included in
the Reliant Resources Prospectus relate to certain contingencies. These notes,
as updated herein, are incorporated herein by reference:
Notes to Consolidated Financial Statements included in the Reliant
Resources Prospectus (Reliant Resources Prospectus Notes): Note 4
(Agreements Between Reliant Energy and the Company), Note 5 (Business
Acquisitions), Note 6 (Derivative Financial Instruments), Note 11
(Commitments and Contingencies) and Note 15 (Subsequent Events).
For information regarding certain legal, regulatory proceedings and
environmental matters, see Note 11.
On July 27, 2000, Reliant Energy, Incorporated (Reliant Energy) announced
its intention to form a company, Reliant Resources, to own and operate a
substantial portion of its unregulated operations and to offer no more than 20%
of the common stock of Reliant Resources in an initial public offering
(Offering). The Offering closed in May 2001. Reliant Energy has publicly
disclosed that it expects the Offering to be followed by a distribution of the
remaining common stock of Reliant Resources owned by Reliant Energy to Reliant
Energy's or its successor's shareholders (Distribution) within 12 months of the
Offering (Distribution Date). The Distribution is subject to further corporate
approvals, market and other conditions, and government actions, including
receipt of a favorable Internal Revenue Service ruling that the Distribution
would be tax-free to Reliant Energy or its successor and its shareholders for
U.S. federal income tax purposes, as applicable. There can be no assurances that
the Distribution will be completed as described or within the periods outlined
above. Reliant Energy, together with its subsidiaries, is a diversified
international energy services company consisting of regulated and unregulated
energy operations. For information regarding the basis of presentation of the
Interim Financial Statements, see Note 1 to the Reliant Resources Prospectus
Notes. For information regarding the Offering, see Note 9(a).
In September 2001, the Company announced that it is evaluating strategic
alternatives for its European Energy segment, including the possible sale, in
order to pursue business opportunities that are more in line with its domestic
wholesale energy strategies.
(2) NEW ACCOUNTING PRONOUNCEMENTS
In July 2001 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 141 "Business
Combinations" (SFAS No. 141) and SFAS No. 142 "Goodwill and Other Intangible
Assets" (SFAS No. 142). SFAS No. 141 requires business combinations initiated
after June 30, 2001 to be accounted for using the purchase method of accounting,
and broadens the criteria for recording intangible assets separate from
goodwill. Recorded goodwill and intangibles will be evaluated against these new
criteria and may result in certain intangibles being transferred to goodwill, or
alternatively, amounts initially recorded as goodwill may be separately
identified and recognized apart from goodwill. SFAS No. 142 provides for a
nonamortization approach, whereby 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 provisions of each statement which apply to goodwill and intangible
assets acquired prior to June 30, 2001 will be adopted by the Company on January
1, 2002. The Company is in the process of determining the effect of adoption of
SFAS No. 141 and SFAS No. 142 on its consolidated financial statements.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair value of
a liability for an asset retirement legal obligation to be recognized in the
period in which it is incurred. When the liability is initially recorded,
associated costs are capitalized by increasing the carrying amount of the
related long-lived asset. Over time, the liability is accreted to its present
value each period, and the capitalized cost is depreciated over the useful life
of the related asset. SFAS No. 143 is effective for fiscal years beginning after
June 15, 2002, with earlier application encouraged. SFAS No. 143 requires
entities to record a cumulative effect of change in accounting principle in the
income statement in the period of adoption. The Company plans to adopt SFAS No.
143 on January 1, 2003 and is in the process of determining the effect of
adoption on its consolidated financial statements.
8
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, 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 is effective for fiscal years beginning after December 15, 2001,
with early adoption encouraged. SFAS No. 144 is not expected to 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 than is currently permitted. The Company
plans to adopt SFAS No. 144 on January 1, 2002.
(3) DERIVATIVE FINANCIAL INSTRUMENTS
Adoption of SFAS No. 133 on January 1, 2001 resulted in an after-tax
increase in net income of $3 million and a cumulative after-tax increase in
accumulated other comprehensive loss of $290 million. The adoption also
increased current assets, long-term assets, current liabilities and long-term
liabilities by approximately $615 million, $248 million, $811 million, and $339
million, respectively, in the Company's Consolidated Balance Sheet. During the
nine months ended September 30, 2001, losses of $175 million of the initial
transition adjustment recognized in other comprehensive income were realized in
net income. For additional information regarding the adoption of SFAS No. 133
and the Company's accounting policies for derivative financial instruments, see
Note 2 of the First Quarter 10-Q, which is incorporated by reference herein.
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. One criteria of this previously
approved guidance was revised in October 2001 and will become effective on
January 1, 2002. The Company is currently in the process of determining the
effect of adoption of the revised guidance.
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 is April 1, 2002, and the Company is currently assessing the impact of
this recently cleared issue and does not believe it will have a material impact
on the Company's consolidated financial statements.
Cash Flow Hedges. 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 the assessment of
effectiveness. During the nine months ended September 30, 2001, there were no
deferred gains or losses recognized in earnings as a result of the
discontinuance of cash flow hedges because it was no longer probable that the
forecasted transaction would occur. As of September 30, 2001, current
non-trading derivative assets and liabilities and corresponding amounts in
accumulated other comprehensive income are expected to be reclassified into net
income during the next twelve months.
Hedge of Net Investment in Foreign Subsidiaries. The Company has
substantially hedged its net investment in its European Energy segment through a
combination of Euro-denominated borrowings, foreign currency swaps and foreign
currency forward contracts. These are designed to reduce the Company's exposure
to changes in foreign currency rates. During the nine months ended September 30,
2001, the derivative and non-derivative instruments designated as hedging the
net investment in the Company's European Energy segment resulted in a loss of $3
million, which is included in the balance of the cumulative translation
adjustment.
Other Derivatives. In December 2000, the Dutch parliament adopted
legislation allocating to the Dutch generation sector, including a wholly owned
Dutch generating subsidiary of the Company, Reliant Energy Power Generation
Benelux N.V. (REPGB), previously named N.V. UNA (UNA), financial responsibility
for various stranded costs contracts and other liabilities. The legislation
became effective in all material respects on January 1, 2001. In particular, the
legislation allocated to the Dutch generation sector, including REPGB, financial
responsibility to purchase
9
electricity and gas under a gas supply contract and three electricity contracts.
These contracts are derivatives pursuant to SFAS No. 133. As of September 30,
2001, the Company has recognized $138 million in short-term and long-term
non-trading derivative liabilities for REPGB's portion of these stranded costs
contracts. For additional information regarding REPGB's stranded costs and the
related indemnification by the former shareholders of these stranded costs, see
Note 11(e).
During the second and third quarters of 2001, the Company entered into two
structured transactions which were recorded on the balance sheet in non-trading
derivative assets and liabilities. For further discussion of these transactions,
see Note 1. The change in fair value of these derivative assets and liabilities
must be recorded in the statement of income for each reporting period. During
the three and nine months ended September 30, 2001, $62 million and $75 million,
respectively, of net non-trading derivative liabilities were settled related to
these transactions. As of September 30, 2001, the Company has recognized $618
million of non-trading derivative assets and $543 million of non-trading
derivative liabilities related to these transactions.
(4) RELATED PARTY TRANSACTIONS
The Interim Financial Statements include significant transactions between
the Company and Reliant Energy involving services, including various corporate
support services (including accounting, finance, investor relations, planning,
legal, communications, governmental and regulatory affairs and human resources),
information technology services and other shared services such as corporate
security, facilities management, accounts receivable, accounts payable and
payroll, office support services and purchasing and logistics. The costs of
these services have been directly charged or allocated to the Company using
methods that management believes are reasonable. These methods include
negotiated usage rates, dedicated asset assignment, and proportionate corporate
formulas based on assets, operating expenses and employees. These charges and
allocations are not necessarily indicative of what would have been incurred had
the Company been a separate entity. Amounts charged and allocated to the Company
for these services were $19 million and $1 million for the three months ended
September 30, 2000 and 2001, respectively. For the nine months ended September
30, 2000 and 2001, amounts charged and allocated to the Company for these
services were $28 million and $6 million, 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 Reliant Energy and its affiliates of $8 million and $29
million, respectively.
Below is a detail of accounts and notes receivable and payable to affiliated
companies that are not part of the Company:
DECEMBER 31, 2000 SEPTEMBER 30, 2001
----------------- ------------------
(IN MILLIONS)
Net accounts receivable -- affiliated companies ............................ $ 94 $ 8
Net short-term notes (payable) receivable -- affiliated companies .......... (1,415) 892
Net long-term notes (payable) receivable -- affiliated companies ........... (648) 30
------- -------
Total net accounts and notes (payable) receivable -- affiliated companies $(1,969) $ 930
======= =======
Net accounts payable/receivable to/from affiliated companies, representing
primarily current month balances of transactions between the Company and Reliant
Energy or its subsidiaries, relate primarily to natural gas purchases and sales,
interest, charges for services and office space rental. Net short-term notes
payable/receivable to/from affiliated companies represent the accumulation of a
variety of cash transfers and operating transactions and specific negotiated
financing transactions with Reliant Energy or its subsidiaries and generally
bear interest at market-based rates. The notes are payable on demand and will be
repaid prior to Distribution. Net long-term notes payable/receivable to/from
affiliated companies primarily relate to specific negotiated financing
transactions with Reliant Energy or its subsidiaries that bear interest at
market-based rates. Net interest expense related to these net
borrowings/receivables was $57 million and $129 million during the quarter and
nine months ended September 30, 2000, respectively. Net interest income related
to these net borrowings/receivables was $11 million and $8 million during the
quarter and nine months ended September 30, 2001, respectively.
On January 9, 2001, the Company entered into a subordinated note agreement
with Reliant Energy for $1.5 billion. The proceeds of the subordinated note were
used to pay off existing notes payable between the Company and Reliant Energy
and its subsidiaries.
In March 2001, the Company paid $236 million of the debt owed to Reliant
Energy, along with the accrued interest. The repayment was made with general
corporate funds of the Company, including amounts borrowed under the Company's
credit facilities.
10
In May 2001, Reliant Energy converted or contributed an aggregate of $1.7
billion of the indebtedness owed by the Company to Reliant Energy and its
subsidiaries including the subordinated note discussed above, to equity without
the issuance of any additional shares of Reliant Resources common stock,
pursuant to the master separation agreement by recording an increase to
additional paid-in capital of the Company.
The Company purchases natural gas and transportation services from, supplies
natural gas to, and provides marketing and risk management services to
affiliates of Reliant Energy that are not part of the Company. Purchases of
transportation services and natural gas from Reliant Energy and its subsidiaries
were $58 million, $14 million, $129 million and $144 million in the quarters
ended September 30, 2000 and 2001, and the nine months ended September 30, 2000
and 2001, respectively. During the quarters ended September 30, 2000 and 2001,
and the nine months ended September 30, 2000 and 2001, the sales and services to
Reliant Energy and its subsidiaries totaled $117 million, $101 million, $369
million and $560 million, respectively.
During the nine months ended September 30, 2000 and 2001, Reliant Energy or
its subsidiaries made equity contributions to the Company of $1.1 billion and
$1.8 billion, respectively. The contributions in the nine months ended September
30, 2000 primarily related to the conversion of a portion of the borrowings from
Reliant Energy used to fund the acquisition of Reliant Energy Mid-Atlantic Power
Holdings, LLC (REMA) (see Note 5(a)) and general operating costs. The
contributions in the nine months ended September 30, 2001, primarily related to
the conversion into equity of debt and related interest expense totaling $1.7
billion as discussed above and the contribution of net employee benefit assets
and liabilities, net of deferred income taxes.
(5) ACQUISITIONS
(a) Reliant Energy Mid-Atlantic Power Holdings, LLC.
On May 12, 2000, a subsidiary of the Company purchased entities owning
electric power generating assets and development sites located in Pennsylvania,
New Jersey and Maryland having an aggregate net generating capacity of
approximately 4,262 megawatts (MW). With the exception of development entities
that were sold to another subsidiary of the Company in July 2000, the assets of
the entities acquired are held by REMA. The purchase price for the May 2000
transaction was $2.1 billion, subject to post-closing adjustments which
management does not believe will be material. The Company accounted for the
acquisition as a purchase with assets and liabilities of REMA reflected at their
estimated fair values. The Company's fair value adjustments related to the
acquisition primarily included adjustments in property, plant and equipment, air
emissions regulatory allowances, materials and supplies inventory, environmental
reserves and related deferred taxes. The Company finalized these fair value
adjustments in May 2001. There were no additional material modifications to the
preliminary adjustments from December 31, 2000. For additional information
regarding the acquisition of REMA, see Note 5(a) to the Reliant Resources
Prospectus Notes.
The Company's results of operations include the results of REMA only for the
period beginning May 12, 2000. The following table presents selected actual
financial information and pro forma information for the three and nine months
ended September 30, 2000, as if the acquisition had occurred on January 1, 2000.
Pro forma amounts also give effect to the sale and leaseback of interests in
three of the REMA generating plants, consummated in August 2000. For additional
information regarding sale and leaseback transactions, see Note 11(c) to the
Reliant Resources Prospectus Notes.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2000 SEPTEMBER 30, 2000
------------------ ------------------
ACTUAL PRO FORMA ACTUAL PRO FORMA
------ --------- ------ ---------
(IN MILLIONS)
Revenues ........................... $ 6,886 $ 6,886 $12,820 $12,986
Net income before extraordinary item 163 167 245 224
Net income ......................... 163 167 252 231
These pro forma results, based on assumptions deemed appropriate by the
Company's management, have been prepared for informational purposes only and are
not necessarily indicative of the amounts that would have resulted if the
acquisition of the REMA entities had occurred on January 1, 2000.
Purchase-related adjustments to the results of operations include the effects on
depreciation and amortization, interest expense and income taxes.
(b) Orion Power Holdings, Inc.
11
In September 2001, Reliant Resources and Orion Power Holdings, Inc. (Orion
Power) entered into a definitive merger agreement, under which Reliant Resources
agreed to acquire all of the outstanding shares of Orion Power for $26.80 per
share in cash in a transaction valued at approximately $2.9 billion. In the
merger, Reliant Resources will also assume approximately $1.8 billion of Orion
Power's net debt obligations. Orion Power is an independent electric power
generating company formed in March 1998 to acquire, develop, own and operate
power-generating facilities in the newly deregulated wholesale markets
throughout North America. Orion Power has 81 power plants currently in operation
with a total capacity of 5,644 MW and an additional 2,855 MW in construction and
various stages of development. The merger is conditioned upon approval by Orion
Power's shareholders and the receipt of certain regulatory approvals including
the Federal Trade Commission, New York Public Service Commission and Federal
Energy Regulatory Commission (FERC).
(6) DEPRECIATION AND AMORTIZATION EXPENSE
The Company's depreciation expense for the quarter and nine months ended
September 30, 2000 was $37 million and $82 million, respectively, compared to
$37 million and $97 million for the same periods in 2001. Goodwill amortization
related to acquisitions was $5 million and $26 million for the quarter and nine
months ended September 30, 2000, respectively, compared to $27 million and $44
million for the same periods in 2001. Other amortization expense, including
amortization of air emissions regulatory allowances and other intangibles, was
$22 million for both the quarter and nine months ended September 30, 2000,
respectively, compared to $8 million and $38 million for the same periods in
2001.
(7) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2000 2001 2000 2001
----- ----- ----- -----
(IN MILLIONS)
Net income ...................................... $ 163 $ 214 $ 252 $ 524
Other comprehensive income (loss):
Foreign currency translation adjustments ...... (5) (79) (11) (74)
Changes in minimum benefit liability .......... -- -- -- (6)
Cumulative effect of adoption of SFAS No. 133 . -- -- -- (290)
Deferred (loss) gain from cash flow hedges .... -- 13 -- 451
Reclassification of net deferred gain from cash
flow hedges realized in net income .......... -- (105) -- (7)
Unrealized (loss) gain on available-for-sale
securities .................................. (2) (3) -- 10
Reclassification adjustment for impairment loss
on available-for-sale securities realized in
net income .................................. 3 -- 17 --
----- ----- ----- -----
Comprehensive income ............................ $ 159 $ 40 $ 258 $ 608
===== ===== ===== =====
(8) SHORT-TERM BORROWINGS FROM THIRD PARTIES
As of September 30, 2001, the Company had $3.3 billion in committed credit
facilities, including facilities of subsidiaries of Reliant Energy Power
Generation, Inc. (REPG) and REPGB, of which $1.6 billion remained unused. Credit
facilities aggregating $2.4 billion were unsecured. As of September 30, 2001,
letters of credit outstanding under these facilities aggregated $641 million. As
of September 30, 2001, borrowings of $1.1 billion were outstanding under these
facilities of which $918 million were classified as long-term debt, based upon
the availability of committed credit facilities and management's intention to
maintain these borrowings in excess of one year.
During the first half of 2001, the Company entered into facilities
aggregating $2.1 billion in committed credit. These facilities, due to expire on
October 2, 2001, were terminated during the third quarter of 2001 and replaced
with two facilities aggregating $1.5 billion in committed credit. These new
facilities will expire in the years 2002 and 2004. As of September 30, 2001,
letters of credit under these two facilities aggregated $296 million. At
September 30, 2001, there were no outstanding borrowings under these facilities.
Interest rates on the borrowings are based on London interbank offered rate
(LIBOR) plus a margin, a base rate or a rate determined through a bidding
process. These
12
facilities contain various business and financial covenants requiring the
Company to, among other things, maintain a ratio of net debt to the sum of net
debt, stockholders' equity and subordinated affiliate debt not to exceed 0.60 to
1.00. These covenants are not anticipated to materially restrict the Company
from borrowing funds or obtaining letters of credit under these facilities. The
credit facilities are subject to facility and usage fees that are calculated
based on the amount of the facility commitments and on the amounts outstanding
under the facilities, respectively. In October 2001, these facilities were
amended to increase committed credit to $1.6 billion.
(9) STOCKHOLDERS' EQUITY
(a) Initial Public Offering.
On July 27, 2000, Reliant Energy announced its intention to form Reliant
Resources, to own and operate a substantial portion of Reliant Energy's
unregulated operations, and to offer no more than 20% of the common stock of
Reliant Resources in an initial public offering. In May 2001, the Company
offered 59.8 million shares of its common stock to the public at an initial
public offering price of $30 per share and received net proceeds from the
Offering of $1.7 billion. Pursuant to the terms of the master separation
agreement between Reliant Energy and Reliant Resources, Reliant Resources used
$147 million of the net proceeds to repay certain indebtedness owed to Reliant
Energy. Reliant Resources used the remainder of the net proceeds of the Offering
for repayment of third party borrowings, capital expenditures, repurchase of
common stock and increase the Company's working capital. For additional
information, see note 4(c) to the Reliant Resources Prospectus Notes.
(b) Treasury Stock Purchases.
During the third quarter of 2001, Reliant Resources purchased 1,000,000
shares of its common stock at an average price of $20.42 per share, or an
aggregate purchase price of $20.4 million. These shares were purchased in
anticipation of funding benefit plan obligations of the Company expected to be
funded prior to the Distribution. The master separation agreement between
Reliant Resources and Reliant Energy restricts the ability of Reliant Resources
to issue shares of its common stock prior to the separation of the two companies
without the prior consent of Reliant Energy.
On September 18, 2001, Reliant Resources' Board of Directors authorized the
Company to purchase up to 10 million additional shares of its common stock
through February 2003. Purchases will be made on a discretionary basis in the
open market or otherwise at times and in amounts as determined by management
subject to market conditions, legal requirements and other factors.
13
(10) EARNINGS PER SHARE
The following table presents Reliant Resources' basic and diluted earnings
per share (EPS) calculation:
FOR THE THREE FOR THE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2001
-------- --------
(AS RESTATED)
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Basic EPS Calculation:
Income before cumulative effect of accounting change ... $213,861 $521,109
Cumulative effect of accounting change, net of tax ..... -- 3,062
-------- --------
Net income ............................................. $213,861 $524,171
======== ========
Weighted average shares outstanding ...................... 299,164 272,253
======== ========
Basic EPS:
Net income before cumulative effect of accounting change $ 0.71 $ 1.92
Cumulative effect of accounting change, net of tax ..... -- 0.01
-------- --------
Net income ............................................. $ 0.71 $ 1.93
======== ========
Diluted EPS Calculation:
Weighted average shares outstanding ...................... 299,164 272,253
Plus: Incremental shares from assumed conversions:
Stock options ........................................ -- 2
Restricted stock ..................................... 186 186
Employee stock purchase plan ......................... 60 60
-------- --------
Weighted average shares assuming dilution .............. 299,410 272,501
======== ========
Diluted EPS:
Income before cumulative effect of accounting change ... $ 0.71 $ 1.91
Cumulative effect of accounting change, net of tax ..... -- 0.01
-------- --------
Net income ............................................. $ 0.71 $ 1.92
======== ========
Prior to August 9, 2000, Reliant Resources, Inc. was not a separate legal
entity and therefore had no historical capital structure. Accordingly, earnings
per share have not been presented for the three or nine months ended September
30, 2000.
Reliant Resources' Certificate of Incorporation was amended to effect a
240,000 to 1 stock split of Reliant Resources' common stock on January 5, 2001.
For the three months ended September 30, 2001, the computation of diluted
EPS excludes purchase options for 8,671,268 shares of common stock that have an
exercise price (ranging from $23.20 - $34.03 per share) greater than the per
share average market price ($21.08) for the period and would thus be
anti-dilutive if exercised.
For the nine months ended September 30, 2001, the computation of diluted
EPS excludes purchase options for 8,505,100 shares of common stock that have an
exercise price (ranging from $30.00 - $34.03 per share) greater than the average
per share market price ($25.48) for the period and would thus be anti-dilutive
if exercised.
(11) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
California Wholesale Market. Reliant Energy, Reliant Energy Services, Inc.
(a wholly owned subsidiary of Reliant Resources), REPG and several other
subsidiaries of Reliant Resources, as well as three officers of some of these
companies, have been named as defendants in class action lawsuits and other
lawsuits filed against a number of companies that own generation plants in
California and other sellers of electricity in California markets. Pursuant to
the terms of the master separation agreement between Reliant Energy and Reliant
Resources (see Note 4(d) to the Reliant Resources Prospectus Notes), Reliant
Resources has agreed to indemnify Reliant Energy for any damages arising under
14
these lawsuits and may elect to defend these lawsuits at the Company's own
expense. Three of these lawsuits were filed in the Superior Court of the State
of California, San Diego County; two were filed in the Superior Court in San
Francisco County; and one was filed in the Superior Court of Los Angeles County.
While the plaintiffs allege various violations by the defendants of state
antitrust laws and state laws against unfair and unlawful business practices,
each of the lawsuits is grounded on the central allegation that defendants
conspired to drive up the wholesale price of electricity. In addition to
injunctive relief, the plaintiffs in these lawsuits seek treble the amount of
damages alleged, restitution of alleged overpayments, disgorgement of alleged
unlawful profits for sales of electricity, costs of suit and attorneys' fees. In
one of the cases, the plaintiffs allege aggregate damages of over $4 billion.
Although defendants removed all of these cases to federal court, five of the six
cases were remanded back to state court and the parties stipulated to remanding
the sixth case.
In August 2001, plaintiffs and defendants filed petitions to coordinate the
remanded state court cases with plaintiffs seeking coordination in San Francisco
Superior Court and defendants seeking coordination in San Diego Superior Court.
On September 21, 2001, pursuant to a stipulated briefing schedule, defendants
served plaintiffs with their joint demurrer, motion to stay and motion to
strike, which are premised in part on federal preemption and the filed rate
doctrine (the filed rate doctrine bars all claims, both state and federal, that
attempt to challenge a rate that a federal agency has reviewed and approved). On
October 12, 2001, San Diego Superior Court Judge Janis Sammartino, the judge
assigned to hear the coordination petitions, stayed all the actions pending a
decision on coordination. Plaintiffs have voluntarily dismissed Reliant Energy
from two of the three class actions in which it was named as a defendant. The
ultimate outcome of the lawsuits cannot be predicted with any degree of
certainty at this time. However, the Company believes, based on its analysis to
date of the claims asserted in these lawsuits and the underlying facts, that
resolution of these lawsuits will not have a material adverse effect on the
Company's financial condition, results of operations or cash flows.
(b) Environmental Matters.
REMA Ash Disposal Site Closures and Site Contaminations. Under the
agreement to acquire REMA (see Note 5(a) to the Reliant Resources Prospectus
Notes), the Company became responsible for liabilities associated with ash
disposal site closures and site contamination at the acquired facilities in
Pennsylvania and New Jersey prior to a plant closing, except for the first $6
million of remediation costs at the Seward Generating Station. A prior owner
retained liabilities associated with the disposal of hazardous substances to
off-site locations prior to November 24, 1999. As of September 30, 2001, REMA
has liabilities associated with six ash disposal site closures and six site
investigations and environmental remediations. The Company has recorded its
estimate of these environmental liabilities in the amount of $36 million as of
September 30, 2001. The Company expects approximately $13 million will be paid
over the next five years.
REPGB Asbestos Abatement and Soil Remediation. Prior to the Company's
acquisition of REPGB (see Note 5(b) to the Reliant Resources Prospectus Notes),
REPGB had a $23 million obligation primarily related to asbestos abatement, as
required by Dutch law, and soil remediation at six sites. During 2000, the
Company initiated a review of potential environmental matters associated with
REPGB's properties. REPGB began remediation in 2000 of the properties identified
to have exposed asbestos and soil contamination, as required by Dutch law and
the terms of some leasehold agreements with municipalities in which the
contaminated properties are located. All remediation efforts are expected to be
fully completed by 2005. As of September 30, 2001, the estimated undiscounted
liability for this asbestos abatement and soil remediation was $20 million.
(c) Other Legal and Environmental Matters.
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management believes that the disposition of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
(d) California Wholesale Market Uncertainty.
Receivables. During the summer and fall of 2000, and continuing into early
2001, prices for wholesale electricity in California increased dramatically as a
result of a combination of factors, including higher natural gas prices and
emission allowance costs, reduction in available hydroelectric generation
resources, increased demand, decreased net
15
electric imports, structural market flaws including over-reliance on the
electric spot market, and limitations on supply as a result of maintenance and
other outages. Although wholesale prices increased, California's deregulation
legislation kept retail rates frozen below 1996 levels until rates were raised
by the California Public Utilities Commission (CPUC) early in 2001.
Due to the disparity between wholesale and retail rates, the credit ratings
of two of California's public utilities, Pacific Gas and Electric (PG&E) and
Southern California Edison Company (SCE), have fallen below investment grade.
Additionally, PG&E filed for protection under the bankruptcy laws on April 6,
2001. As a result, PG&E and SCE are no longer considered creditworthy and
therefore cannot directly purchase power from third-party suppliers through the
California Independent System Operator (Cal ISO) to serve their short load.
Pursuant to emergency legislation enacted by the California Legislature, the
California Department of Water Resources (CDWR) has negotiated and purchased
power through short- and long-term contracts on behalf of PG&E and SCE to meet
their net short loads. However, the CDWR disputes its direct liability for some
of the power obtained from third-party suppliers, including the Company, to
serve the utilities' net short load. Also, the CDWR has not been billed by, nor
made payments to, the Cal ISO for real-time transactions. The issue of CDWR's
liability for amounts supplied to cover the utilities' short load, as well as
the issue of the Cal ISO's compliance with certain FERC orders are currently
before the FERC. Pursuant to the April 26, 2001 FERC order described below,
generators in California are required to offer all their available capacity for
sale in the real-time market. These types of sales have thus far been nominal
and have not materially increased the Company's receivables balances. However,
these sales to the Cal ISO are being made without adequate assurance of a
creditworthy counterparty despite numerous FERC orders requiring such. The
Company and other parties have filed with the FERC seeking to compel enforcement
of these orders and the Cal ISO tariff. On November 7, 2001, the FERC issued a
finding that the Cal ISO is in violation of its tariff and the creditworthiness
orders previously issued by the FERC. The FERC ordered the Cal ISO to enforce
the creditworthiness requirements in its tariffs and to invoice the CDWR for the
purchases made to meet the net short position of PG&E and SCE. If the Cal ISO
does not comply with this order, the FERC stated it would seek an injunction to
enforce its creditworthiness orders.
In addition, certain contracts intended to serve as collateral for sales to
the California Power Exchange (Cal PX) were seized by California Governor Gray
Davis on February 2 and 5, 2001. The Ninth Circuit Court of Appeals subsequently
ruled that Governor Davis' seizure of these contracts was wrongful. The Company
has filed a lawsuit, currently pending in California, to require the State of
California to compensate it for the seizure of these contracts. If successful in
this action, the Company (either directly or through the Cal PX) would realize
money from these contracts that could reduce, or perhaps eliminate, the level of
receivables due to the Company from the Cal PX. However, the timing and ultimate
resolution of these claims is uncertain at this time.
On September 20, 2001, PG&E filed a Plan of Reorganization and an
accompanying disclosure statement with the bankruptcy court. Under this plan,
PG&E purports to pay all allowed creditor claims in full, through a combination
of cash and long-term notes. Components of the plan will require the approval of
the FERC, the SEC and the Nuclear Energy Regulatory Commission, in addition to
the bankruptcy court. PG&E has stated it seeks to have this plan confirmed by
December 31, 2002.
On October 5, 2001, a federal district court in California entered a
stipulated judgment approving a settlement between SCE and the CPUC in an action
brought by SCE regarding the recovery of its wholesale power costs under the
filed rate doctrine. Under the stipulated judgment, a rate increase approved
earlier this year will remain in place until the earlier of SCE recovering $3.3
billion or December 31, 2002. After that date, the CPUC will review the
sufficiency of retail rates through December 31, 2005. The stipulated judgment
includes no provision relating to payments to SCE's creditors, although SCE has
stated its intention to use the settlement to fund the repayment of its
creditors.
As of December 31, 2000, the Company was owed a total of $282 million by
the Cal PX and the Cal ISO. As of September 30, 2001, the Company was owed a
total of $338 million by the Cal ISO, the Cal PX, the CDWR, and California
Energy Resources Scheduling for energy sales in the California wholesale market
during the fourth quarter of 2000 through September 30, 2001. As of September
30, 2001, the Company had a pre-tax provision of $75 million against receivable
balances related to energy sales in the California market, including $36 million
recorded in the first nine months of 2001. Management will continue to assess
the collectability of these receivables based on further developments affecting
the California electricity market and the market participants described herein.
FERC Market Mitigation. In response to the filing of a number of complaints
challenging the level of wholesale prices, the FERC initiated a staff
investigation and issued a number of orders from December 15, 2000, through
April 26, 2001 implementing a series of wholesale market reforms. Under these
orders, for the period January 1, 2001 through June 19, 2001, approximately $20
million of the $149 million charged by the Company for sales in California
16
to the Cal ISO and the Cal PX were identified as being subject to possible
refunds. This amount is subject to review and adjustment based on the pending
refund proceeding described below. During the second quarter of 2001, the
Company accrued refunds of $15 million, $3 million of which had been previously
reserved in the first quarter of 2001. See " -- FERC Refunds" below.
On April 26, 2001, the FERC issued an order replacing the previous price
review procedures and establishing a market monitoring and mitigation plan,
effective on May 29, 2001, for the California markets. The plan retains a
"breakpoint" approach to price mitigation, for bids in the real-time market
during periods when power reserves fall below 7.5% (i.e., Stages 1, 2 and 3
emergencies in the Cal ISO). The Cal ISO is instructed to use data submitted
confidentially by gas-fired generators in California and daily indices of
natural gas and emissions allowance costs to establish the market-clearing price
in real-time based on the marginal cost of the highest-cost generator called to
run. The plan also requires generators in California to offer all their
available capacity for sale in the real-time market, and conditions sellers'
market-based rate authority such that sellers violating certain conditions on
their bids will be subject to increased scrutiny by the FERC, potential refunds
and even revocation of their market-based rate authority.
On June 19, 2001, the FERC issued an order modifying the market monitoring
and mitigation plan adopted in its April 26 order, to apply price controls to
all hours, instead of just hours of low operating reserve, and to extend the
mitigation measures to other Western states (Arizona, Colorado, Idaho, Montana,
Nevada, New Mexico, Oregon, Utah, Washington and Wyoming) in addition to
California. The proxy market clearing price calculated by the Cal ISO will apply
during reserve deficiencies to all sales in the Cal ISO and Western spot
markets. In non-emergency hours in California, the maximum price in California
and the other Western states will be capped at 85% of the highest Cal ISO hourly
market clearing price established during the hours when the last Stage 1
emergency was in effect. Sellers other than marketers will be allowed to bid
higher than the maximum prices, but such bids are subject to justification and
potential refund. Justification of higher prices is limited to establishing
higher actual gas costs than the proxy calculation averages if conditions or
natural gas markets change significantly.
The modified monitoring and mitigation plan went into effect June 20, 2001,
and will terminate on September 30, 2002, covering two summer peak seasons, or
approximately 16 months. The Company believes that while the mitigation plan
will reduce volatility in the market, assuming the credit issues described above
are addressed, the Company will nevertheless be able to profitably operate its
facilities in the West because the proxy market clearing price is based on the
heat rate of the least efficient unit on-line during each hour. Additionally, as
noted above, the mitigation plan allows sellers, such as the Company, to justify
prices above the proxy price. Finally, any adverse impacts of the mitigation
plan on the Company's operations would be mitigated, in part, by the Company's
forward hedging activities. The FERC set July 2, 2001 as the refund effective
date for sales subject to the price mitigation plan throughout the West. This
means that transactions after that date may be subject to refund if found to be
unjust or unreasonable.
FERC Refunds. The FERC issued an order on July 25, 2001 adopting a refund
methodology and initiating an expedited hearing schedule to determine (1)
retroactive mitigated prices for each hour from October 2, 2000 through June 20,
2001; (2) the amount owed in refunds by each supplier according to the
methodology (these amounts may be in addition to or in place of the refund
amounts previously determined under the March 9, 2001 order); and (3) the amount
currently owed to each supplier. The amounts of any refunds will be determined
by the end of the expedited hearing process, which is scheduled to result in a
recommendation to the FERC commissioners by the Administrative Law Judge
assigned to the case by March 8, 2002. The Company has not reserved any amounts
for potential future refunds under the July 25, 2001 order, nor can it currently
predict the amount of these potential refunds, if any, because the methodology
used to calculate these refunds is dependent on information that is currently
unknown and still subject to review and challenge in the hearing process. Any
refunds that are determined in the FERC proceeding will be offset against unpaid
amounts owed to the Company for its prior sales.
Other Investigations. In addition to the FERC investigation discussed
above, several state and other federal regulatory investigations and complaints
have commenced in connection with the wholesale electricity prices in California
and other neighboring Western states to determine the causes of the high prices
and potentially to recommend remedial action. In California, the California
State Senate and the California Office of the Attorney General have separate
ongoing investigations into the high prices and their causes. Neither of these
investigations has been completed and no findings have been made in connection
with either of them. However, adverse findings or rulings could result in
punitive legislation, sanctions, fines or even criminal charges against the
Company or its employees. The Company is cooperating with both investigations
and has produced a substantial amount of information requested in subpoenas
issued by each body. The Washington and Oregon attorneys general have also begun
similar investigations.
17
Legislative Efforts. Since the inception of the California energy crisis,
various pieces of legislation, including tax proposals, have been introduced in
the U.S. Congress and the California Legislature addressing several issues
related to the increase in wholesale power prices in 2000 and 2001. For example,
a bill was introduced in the California legislature that would have created a
"windfall profits" tax on wholesale electricity sales. To date, only a few
energy-related bills have passed and the Company does not believe that the
legislation that has been enacted to date on these issues will have a material
adverse effect on the Company. However, it is possible that legislation could be
enacted on either the state or federal level that could have a material adverse
effect on the Company's financial condition, results of operations and cash
flows.
(e) Indemnification of Dutch Stranded Costs.
In January 2001, the Dutch Electricity Production Sector Transitional
Arrangements Act (Transition Act) became effective. The Transition Act, among
other things, allocated to REPGB and the three other Dutch generation companies,
a share of the assets, liabilities and stranded cost commitments of BV
Nederlands Elektriciteit Administratiekantoor (formerly, N.V. Samenwerkende
elecktriciteits-produktiebedrijven (SEP)). Prior to the enactment of the
Transition Act, SEP acted as the national electricity pooling and coordinating
body for the generation output of REPGB and the three other national Dutch
generation companies. REPGB and the three other Dutch generation companies are
shareholders of SEP.
The Transition Act and related agreements specify that REPGB has a 22.5%
share of SEP's assets, liabilities and stranded cost commitments. SEP's stranded
cost commitments consisted primarily of various uneconomical or stranded costs
investments and long-term gas supply and power contracts entered into prior to
the liberalization of the Dutch wholesale electricity market. SEP's primary
asset is its ownership interest in the Dutch national grid company, which was
sold to the Dutch government on October 25, 2001 for approximately NLG 2.6
billion (approximately $1.1 billion based on an exchange rate of 2.42 NLG per
U.S. dollar as of September 30, 2001). Under the Transition Act, REPGB can
either assume its 22.5% allocated interest in the contracts or, subject to the
terms of the contracts, sell its interests to third parties.
The Transition Act, as enacted, provided that, subject to the approval of
the European Commission, the Dutch government will provide financial
compensation to the Dutch generation companies, including REPGB, for certain
liabilities associated with long-term district heating contracts entered into by
the generation companies with various municipalities. In July 2001, the European
Commission ruled that under certain conditions the Dutch government can provide
financial compensation to the generation companies for the district heating
contracts. However, at this point, it is unclear what the timing of this
compensation will be or what form it will take. To the extent that this
compensation is not ultimately provided to the generation companies by the Dutch
government, REPGB will collect its compensation directly from the former
shareholders as further discussed below.
The former shareholders have agreed pursuant to a share purchase agreement
to indemnify REPGB for up to NLG 1.9 billion in stranded cost liabilities
(approximately $785 million based on an exchange rate of 2.42 NLG per U.S.
dollar as of September 30, 2001). The indemnity obligation of the former
shareholders and various provincial and municipal entities (including the city
of Amsterdam), is secured by a NLG 900 million escrow account (approximately
$372 million based on an exchange rate of 2.42 NLG per U.S. dollar as of
September 30, 2001). Pursuant to SFAS No. 133, the gas and electric contracts
are marked to market. As of September 30, 2001, the Company has recorded a
liability of $362 million for its stranded cost gas and electric and district
heating commitments. In addition, the Company recorded a corresponding asset of
equal amount for the indemnification of this obligation from REPGB's former
shareholders and the Dutch government. The estimate of stranded cost liability
is based on a number of assumptions, many of which are contingent upon the
outcome of future events, such as fuel and energy prices, that are not known at
this time. The actual amount of the ultimate stranded cost liability may be
greater or smaller depending on the outcome of these assumptions.
To date, the Company has filed indemnity claims totaling of NLG 95 million
(approximately $39 million at an exchange rate of 2.42 NLG per U.S. dollar as of
September 30, 2001) for stranded cost liabilities associated with the district
heating and gas and electricity contract losses incurred during the first and
second quarters of 2001. The former shareholders have so far rejected REPGB's
indemnity claims and in response the Company has initiated arbitration
proceedings against the former shareholders. The Company believes that the
rejection of its indemnity claims is without merit and intends to vigorously
pursue its claims against the former shareholders.
18
During the second quarter of 2001, the Company recorded a $51 million
pre-tax gain (NLG 125 million) recorded as equity income for the preacquisition
gain contingency related to the acquisition of REPGB for the value of its equity
investment in SEP. This gain was based on the Company's evaluation of SEP's
financial position and fair value. Pursuant to the purchase agreement of REPGB,
as amended, REPGB is entitled to a NLG 125 million (approximately $51 million)
dividend from SEP with any remainder owing to the former shareholders.
(f) Payment to Reliant Energy in 2004.
To the extent the Company's price for providing retail electric service to
residential and small commercial customers in Reliant Energy's Houston service
territory during 2002 and 2003, which price is mandated by the Texas electric
restructuring law, exceeds the market price of electricity, the Company may be
required to make a payment to Reliant Energy in early 2004. This payment will be
required unless the Public Utility Commission of Texas (Texas Utility
Commission) determines that, on or prior to January 1, 2004, 40% or more of the
amount of electric power that was consumed in 2000 by residential or small
commercial customers, as applicable, within Reliant Energy's Houston service
territory is committed to be served by retail electric providers other than the
Company. If the 40% test is not met and a payment is required, the amount of
this payment will be equal to (1) the amount that the price to beat, less
non-bypassable delivery charges, is in excess of the market price of electricity
per customer, but not to exceed $150 per customer, multiplied by (2) the number
of residential or small commercial customers, as the case may be, that the
Company serves on January 1, 2004 in Reliant Energy's Houston service territory,
less the number of new retail electric customers the Company serves in other
areas of Texas. As of September 30, 2001, Reliant Energy had approximately 1.7
million residential and small commercial customers. In the master separation
agreement between the Company and Reliant Energy, the Company has agreed to make
this payment, if any, to Reliant Energy.
(g) Construction Agency Agreement.
In April 2001, the Company, through several of its subsidiaries, entered
into operative documents with special purpose entities to facilitate the
development, construction, financing and leasing of several power generation
projects. The special purpose entities have an aggregate financing commitment
from equity and debt participants (Investors) of $2.5 billion. The availability
of the commitment is subject to satisfaction of various conditions. The Company,
through several of its subsidiaries, acts as construction agent for the special
purpose entities and is responsible for completing construction of these
projects by August 31, 2004, but has generally limited its risk related to
construction completion to 89.9% of costs incurred to date, except in certain
events. Upon completion of an individual project and exercise of the lease
option, the Company's subsidiaries will be required to make lease payments in an
amount sufficient to provide a return to the Investors. If the Company does not
exercise its option to lease any project upon its completion, the Company must
purchase the project or remarket the project on behalf of the special purpose
entities. The Company must guarantee that the Investors will receive at least
89.9% of their investment in the case of a remarketing sale at the end of
construction. At the end of an individual project's initial operating lease term
(approximately five years from construction completion), the Company's
subsidiary lessees have the option to extend the lease with the approval of
Investors, purchase the project at a fixed amount equal to the original
construction cost, or act as a remarketing agent and sell the project to an
independent third party. If the lessees elect the remarketing option, they may
be required to make a payment of up to 85% of the project cost, if the proceeds
from remarketing are not sufficient to repay the Investors. The Company has
guaranteed the performance and payment of its subsidiaries' obligations during
the construction periods and, if the lease option is exercised, each lessee's
obligations during the lease period.
(h) REMA Sale/Leaseback Transactions.
In August 2000, the Company entered into separate sale/leaseback
transactions with each of the three owner-lessors for the Company's respective
16.45%, 16.67% and 100% interests in the Conemaugh, Keystone and Shawville
generating stations, respectively, acquired in the REMA acquisition. The lease
documents contain some restrictive covenants that restrict REMA's ability to,
among other things, make dividend distributions unless REMA satisfies various
conditions. As of September 30, 2001, REMA had $143 million of restricted funds
that are available for REMA's working capital needs and to make future lease
payments, including a lease payment of $55 million in January 2002. For
additional discussion of these lease transactions, please read Notes 5(a) and
11(c) to the Reliant Resources Prospectus Notes.
19
(12) BENEFIT CURTAILMENT AND ENHANCEMENT CHARGE
During the nine months ended September 30, 2001, the Company recognized a
pre-tax, non-cash charge of $100 million relating to the redesign of some of
Reliant Energy's benefit plans in anticipation of Reliant Resources' separation
from Reliant Energy.
Effective March 1, 2001, the Company no longer accrues benefits under a
noncontributory pension plan for its domestic non-union employees (Resources
Participants). Effective March 1, 2001, each non-union Resources Participant's
unvested pension account balance became fully vested and a one-time benefit
enhancement was provided to some qualifying participants. During the first
quarter of 2001, the Company incurred a charge to earnings of $83 million
(pre-tax) for a one-time benefit enhancement and a gain of $23 million (pre-tax)
related to the curtailment of Reliant Energy's pension plan. In connection with
the Distribution, the Company expects to incur a loss of $48 million (pre-tax)
related to the settlement of Reliant Energy's pension plan.
Effective March 1, 2001, the Company discontinued providing subsidized
postretirement benefits to its domestic non-union employees. The Company
incurred a pre-tax charge of $40 million during the first quarter of 2001
related to the curtailment of the Company's postretirement obligation. In
connection with the Distribution, the Company expects to incur a pre-tax gain of
$18 million related to the settlement of post retirement benefit obligations.
For additional information regarding these benefit plans, see Notes 9(b) and
9(d) to the Reliant Resources Prospectus Notes.
(13) RELIANT ENERGY COMMUNICATIONS
During the third quarter of 2001, management decided to exit the Company's
Communications business which serves as a facility-based competitive local
exchange carrier and Internet services provider and owns network operations
centers and managed data centers in Houston and Austin. Consequently, the
Company determined the goodwill associated with the Communications business was
impaired. The Company recorded $33 million of pre-tax disposal charges in the
third quarter of 2001. These charges included the write-off of goodwill of $19
million, and fixed asset write-downs, severance reserves and other incremental
costs associated with exiting the Communications business, totaling $14 million.
(14) REPORTABLE SEGMENTS
The Company's determination of reportable segments considers the strategic
operating units under which the Company manages sales, allocates resources and
assesses performance of various products and services to wholesale or retail
customers. The Company has identified the following reportable segments:
Wholesale Energy, European Energy, Retail Energy and Other Operations. For
descriptions of these financial reporting segments, see Note 1 to the Reliant
Resources Prospectus Notes. There were no material inter-segment revenues during
the quarter and the nine months ended September 30, 2000.
Financial data for business segments are as follows:
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
---------------------------------------------
INCOME FROM
EQUITY AS OF DECEMBER
INVESTMENTS IN 31, 2000
REVENUES FROM OPERATING UNCONSOLIDATED --------------
NON-AFFILIATES INCOME (LOSS) SUBSIDIARIES TOTAL ASSETS
-------------- ------------- ------------ ------------
(IN MILLIONS)
Wholesale Energy .................. $ 6,734 $ 320 $ 27 $10,504
European Energy ................... 129 8 -- 2,473
Retail Energy .. .................. 21 (18) -- 131
Other Operations .................. 2 (9) -- 106
------- ------- ------- -------
Consolidated ... .................. $ 6,886 $ 301 $ 27 13,214
======= ======= ======= =======
20
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
--------------------------------------------
INCOME FROM
EQUITY
INVESTMENTS IN
REVENUES FROM OPERATING UNCONSOLIDATED
NON-AFFILIATES INCOME (LOSS) SUBSIDIARIES
-------------- ------------- ------------
(IN MILLIONS)
Wholesale Energy................................... $ 12,342 $ 470 $ 33
European Energy.................................... 415 69 --
Retail Energy...................................... 59 (39) --
Other Operations................................... 4 (24) --
-------- -------- --------
Consolidated....................................... $ 12,820 $ 476 $ 33
======== ======== ========
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------
INCOME FROM
EQUITY AS OF
INVESTMENTS SEPTEMBER 30,
NET IN 2001
REVENUES FROM INTERSEGMENT OPERATING UNCONSOLIDATED --------------
NON-AFFILIATES REVENUES INCOME (LOSS) SUBSIDIARIES TOTAL ASSETS
-------------- -------- ------------- -------------- --------------
(IN MILLIONS)
Wholesale Energy ...... $ 10,022 $ 8 $ 399 $ 2 $ 10,312
European Energy ....... 275 -- (5) -- 3,451
Retail Energy ......... 48 4 (7) -- 256
Other Operations ...... 2 -- (36) -- 1,084
Reconciling Elimination -- (12) -- -- (304)
-------- -------- -------- -------- --------
Consolidated .......... $ 10,347 $ -- $ 351 $ 2 $ 14,799
======== ======== ======== ======== ========
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------
INCOME FROM
EQUITY
INVESTMENTS
NET IN
REVENUES FROM INTERSEGMENT OPERATING UNCONSOLIDATED
NON-AFFILIATES REVENUES INCOME (LOSS) SUBSIDIARIES
-------------- -------- ------------- --------------
(IN MILLIONS)
Wholesale Energy ...... $28,992 $ 8 $ 907 $ 15
European Energy ....... 799 -- 23 51
Retail Energy ......... 112 3 (13) --
Other Operations ...... 8 -- (163) --
Reconciling Elimination -- (11) -- --
------- ------- ------- -------
Consolidated .......... $29,911 $ -- $ 754 $ 66
======= ======= ======= =======
Reconciliation of Operating Income to Net Income:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -------------------------
2000 2001 2000 2001
----- ----- ----- -----
(IN MILLIONS)
Operating income ..................... $ 301 $ 351 $ 476 $ 754
Other (expense) income ............... (38) 13 (111) 68
Income tax expense ................... (100) (150) (120) (301)
Cumulative effect of accounting change -- -- -- 3
Extraordinary item ................... -- -- 7 --
----- ----- ----- -----
Net income ........................... $ 163 $ 214 $ 252 $ 524
===== ===== ===== =====
(15) SUBSEQUENT EVENTS
Treasury Stock Purchases. From October 1, 2001 through November 8, 2001,
Reliant Resources purchased 7,628,200 shares of its common stock at an average
price of $16.69 per share, or an aggregate purchase price of $127 million. These
shares were purchased pursuant to Reliant Resources' Board of Directors
authorization, as described in Note 9(b).
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY
The following discussion and analysis should be read in combination with
our Interim Financial Statements contained in this Form 10-Q/A.
RESTATEMENT OF THE INTERIM FINANCIAL STATEMENTS
On February 5, 2002, the Company announced that it was restating its
earnings for the second and third quarters of 2001. As more fully described in
Note 1, the restatement relates to a correction in accounting treatment for a
series of four structured transactions that were inappropriately accounted for
as cash flow hedges for the period of May 2001 through September 2001.
Although these transactions were undertaken and accounted for as cash flow
hedges, having further reviewed the transactions, the Company now believes they
did not meet the requirements of a cash flow hedge under Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended (SFAS No. 133). Consequently, these contracts should
have been accounted for as derivatives with changes in fair value recognized
through the income statement.
As a result, the Original Interim Financial Statements and related
disclosures as of September 30, 2001 and for the three and nine months ended
September 30, 2001 have been restated from amounts previously reported. The
principal effects of the restatement on the accompanying financial statements
are set forth in Note 1 of the Notes to Interim Financial Statements.
OVERVIEW
We are a rapidly growing provider of electricity and energy services with a
focus on the deregulating competitive wholesale and retail segments of the
electric power industry in the United States and Europe.
In this section we discuss our results of operations on a consolidated
basis and individually for each of our business segments. We also discuss our
liquidity and capital resources. Our financial reporting segments include
Wholesale Energy, European Energy, Retail Energy and Other Operations. For
segment reporting information, please read Note 14 to our Interim Financial
Statements.
On May 12, 2000, one of our subsidiaries purchased entities owning electric
power generating assets and development sites located in Pennsylvania, New
Jersey and Maryland having an aggregate net generating capacity of approximately
4,262 MW. For additional information about this acquisition, including our
accounting treatment of the acquisition, please read Note 5(a) to Reliant
Resources Prospectus Notes and Note 5(a) to our Interim Financial Statements.
OUR SEPARATION FROM RELIANT ENERGY
In connection with our separation from Reliant Energy, Reliant Energy has
contributed to us effective December 31, 2000, by conveyance or merger, our
wholesale, retail and other operations described in Note 1 to Reliant Resources
Prospectus Notes. Through December 31, 2000, these operations were conducted by
Reliant Energy and its direct and indirect subsidiaries. These operations
consist of the following:
- non-rate regulated power generation assets and related energy trading,
marketing, power origination and risk management operations in North
America and Europe,
- retail electric operations, and
- other operations, including our eBusiness, Communications, and venture
capital businesses.
The financial information for the three and nine months ended September 30,
2000, discussed in this section is derived from the consolidated historical
financial statements of Reliant Energy, which include the results of operations
for all of Reliant Energy's businesses, including those businesses which we did
not own. In order to prepare our financial statements for the three and nine
months ended September 30, 2000, contained in this Form 10-Q/A and discussed in
this section, we carved-out the results of operations of the businesses that we
own from Reliant Energy's
22
consolidated historical financial statements. Accordingly, the results of
operations discussed in this section include only revenues and costs directly
attributable to the businesses we own and operate. Some of these costs are for
facilities and services provided by Reliant Energy and for which our operations
have historically been charged based on usage or other allocation factors. We
believe these allocations are reasonable but they are not necessarily indicative
of the expenses that would have resulted if we had actually operated
independently of Reliant Energy. We may experience changes in our cost
structure, funding and operations as a result of our separation from Reliant
Energy, including increased costs associated with reduced economies of scale,
and increased costs associated with being a publicly traded, independent
company. We cannot currently predict, with any certainty, the actual amount of
increased costs we may incur, if any.
In May 2001, we offered 59.8 million shares of our common stock to the
public at an initial public offering (Offering) price of $30 per share and
received net proceeds from the Offering of $1.7 billion. Pursuant to the master
separation agreement, we used $147 million of the net proceeds to repay certain
indebtedness owed to Reliant Energy. Reliant Energy has publicly disclosed that
it expects to distribute the remaining common stock of Reliant Resources that it
owns to Reliant Energy's or its successor's shareholders within 12 months of the
closing of our initial public offering. For additional information regarding our
business separation plan, please read Notes 1 and 4 to Reliant Resources
Prospectus Notes.
In September 2001, we announced that we are evaluating strategic
alternatives for our European Energy Segment, including the possible sale, in
order to pursue business opportunities that are more in line with our domestic
wholesale energy strategies.
During the third quarter of 2001, management decided to exit our
Communications business which serves as a facility-based competitive local
exchange carrier and Internet services provider and owns network operations
centers and managed data centers in Houston and Austin. For additional
information about our Communications business, please read Note 13 to our
Interim Financial Statements.
The following table provides summary data regarding our consolidated
results of operations for the three and nine months ended September 30, 2000 and
2001.
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
-------- -------- -------- --------
(IN MILLIONS)
Operating Revenues ......................... $ 6,886 $ 10,347 $ 12,820 $ 29,911
Operating Expenses ......................... 6,585 9,996 12,344 29,157
-------- -------- -------- --------
Operating Income ........................... 301 351 476 754
Other (Expense) Income, net ................ (38) 13 (111) 68
Income Tax Expense ......................... (100) (150) (120) (301)
-------- -------- -------- --------
Income Before Cumulative Effect of
Accounting Change and Extraordinary Item 163 214 245 521
Cumulative Effect of Accounting Change,
net of tax ............................. -- -- -- 3
Extraordinary item, net of tax ............. -- -- 7 --
-------- -------- -------- --------
Net Income ................................. $ 163 $ 214 $ 252 $ 524
======== ======== ======== ========
Three months ended September 30, 2000 compared to three months ended September
30, 2001
Net Income. We reported consolidated net income of $163 million for the
three months ended September 30, 2000 compared to $214 million for the three
months ended September 30, 2001. The $51 million increase was primarily due to
increased earnings from our Wholesale Energy segment and decreased net interest
expense on notes to affiliated companies, partially offset by decreased earnings
from our European Energy segment, and $33 million in restructuring charges and
impairment of goodwill related to the exiting our Communications business in the
third quarter of 2001 (please read Note 13 to our Interim Financial Statements).
Operating Income. For an explanation of changes in operating income,
please read the discussion below of operating income (loss) by segment.
23
Other (Expense) Income. Other expense was $38 million for the third
quarter of 2000 compared to other income of $13 million for the third quarter of
2001. This increase in other income was primarily due to decreased interest
expense on notes to affiliated companies of $69 million. Net intercompany
interest related to affiliated debt decreased from the three months ended
September 30, 2000 compared to the same period in 2001 primarily due to the
following:
- the conversion into equity of $1.7 billion of debt owed to Reliant Energy
and its subsidiaries upon the completion of the Offering in May 2001 (see
Note 4 to our Interim Financial Statements),
- the repayment in August 2000 of $1.0 billion of debt owed to Reliant
Energy related to the REMA acquisition from proceeds received from the
sale-leaseback transactions (see Note 5(a) to Reliant Resources Prospectus
Notes), and
- the investing of excess cash primarily resulting from the Offering with a
subsidiary of Reliant Energy during the third quarter of 2001.
In addition, other income increased from the third quarter of 2000
compared to the same period in 2001 due to an additional impairment loss of $4
million (pre-tax) on marketable equity securities classified as
"available-for-sale" recorded during the three months ended September 30, 2000.
These items were partially offset by decreased earnings from
unconsolidated subsidiaries of Wholesale Energy for the third quarter of 2001 of
$25 million compared to the same period in 2000.
Income Tax Expense. During the three months ended September 30, 2000 and
2001, our effective tax rate was 37.9% and 41.3%, respectively. Our reconciling
items from the federal statutory rate of 35% to the effective tax rate totaled
$23 million for the three months ended September 30, 2001. These items primarily
related to nondeductible goodwill, state income taxes and valuation allowances.
Our reconciling items from the federal statutory rate of 35% to the effective
tax rate totaled $8 million for the three months ended September 30, 2000. These
items primarily related to nondeductible goodwill, state income taxes and
valuation allowances and were partially offset by income earned by REPGB. In
2001 and prior years, the earnings of REPGB were subject to a zero percent Dutch
corporate income tax rate as a result of the Dutch tax holiday related to the
Dutch electricity industry. In 2002, all of European Energy's earnings in the
Netherlands will be subject to the standard Dutch corporate income tax rate,
which is currently 35%.
Nine months ended September 30, 2000 compared to nine months ended September 30,
2001
Net Income. We reported consolidated net income of $252 million for the
nine months ended September 30, 2000 compared to $524 million for the nine
months ended September 30, 2001. The increase of $272 million was primarily due
to the following:
- increased operating income from Wholesale Energy,
- lower operating losses from the Retail Energy segment,
- a $51 million pre-tax gain recorded in equity income related to a
preacquisition contingency for the value of SEP, the coordinating body for
the Dutch electricity generating sector,
- a decrease in net interest expense, and
- a $27 million pre-tax impairment loss on marketable equity securities
classified as "available-for-sale" recorded during the nine months ended
September 30, 2000.
The above items were partially offset by:
- a $100 million pre-tax, non-cash charge relating to the redesign of some
of Reliant Energy's benefit plans in anticipation of our separation from
Reliant Energy,
- a $36 million provision against receivable balances related to our energy
sales during the first nine months of 2001 in the California market,
24
- a net $12 million write-off in receivable balances related to our energy
sales in the California market recorded in the three months ended June 30,
2001, resulting from refunds,
- $33 million in disposal charges, including a $19 million goodwill
write-off, related to the exiting of our Communications business in the
third quarter of 2001,
- an $18 million pre-tax gain on the sale of a development-stage project
recognized in the nine months ended September 30, 2000, and
- a decrease in operating income from European Energy as the Dutch wholesale
electric market was completely opened to competition on January 1, 2001.
A cumulative effect of accounting change of $3 million was recognized in
the first quarter of 2001, related to the adoption of SFAS No. 133, which is
discussed in Note 3 to our Interim Financial Statements. During the second
quarter of 2000, we recognized a $7 million extraordinary gain related to the
early extinguishment of long-term debt.
Operating Income. For an explanation of changes in our operating income,
please read the discussion below of operating income (loss) by segment.
Other Income (Expense). Other income increased by $179 million during the
nine months ended September 30, 2001 compared to the same period in 2000,
primarily due to the following:
- decreased interest expense of $137 million on debt to affiliated
companies, as discussed above in the quarterly results of operations,
- a $51 million pre-tax preacquisition contingency gain recorded as equity
income, as discussed above and in Note 11(e) of our Interim Financial
Statements,
- an impairment loss of $27 million on marketable equity securities
classified as "available-for-sale" recorded during the nine months ended
September 30, 2000,
- net increased unrealized and realized gains on marketable equity
securities and other investments of $5 million, and
- increased interest income of $12 million primarily related to increased
deposits from Wholesale Energy.
The above items were partially offset by increased interest expense to
third parties of $23 million, primarily as a result of higher levels of
borrowings associated, in part, with the funding of a portion of the acquisition
of REPGB in March 2000 and capital expenditures, as well as a $18 million
decrease in earnings from unconsolidated subsidiaries of Wholesale Energy for
the nine months ended September 30, 2001 compared to the same period in 2000,
primarily due to a plant outage at one of our equity investments and decreased
power prices. In addition, we recognized an $18 million pre-tax gain on the sale
of a development-stage project recognized in the nine months ended September 30,
2000.
For additional information regarding our investment in the marketable
equity securities noted above, see Note 2(l) to Reliant Resources Prospectus
Notes.
During the nine months ended September 30, 2001, the Company recognized
$16 million of interest expense to affiliates that was subsequently converted or
contributed to our equity in May 2001 by Reliant Energy.
Income Tax Expense. During the nine months ended September 30, 2000 and
2001, our effective tax rate was 33.0% and 36.6%, respectively. Our reconciling
items from the federal statutory tax rate of 35% to the effective tax rate
totaled $13 million for the nine months ended September 30, 2001. These items
primarily related to nondeductible goodwill, state income taxes and valuation
allowances and were partially offset by income earned by REPGB. Our reconciling
items from the federal statutory tax rate to the effective tax rate totaled $7
million for the nine months ended September 30, 2000. These items primarily
related to income earned by REPGB and were partially offset by nondeductible
goodwill and state income taxes.
25
As discussed in Note 11(e) to our Interim Financial Statements, the
Transition Act allocated to the Dutch generation sector, including REPGB,
financial responsibility for SEP's obligations to purchase electricity and gas
under a gas supply contract and three electricity contracts. As a result of the
above, we recorded an out-of-market, net stranded cost liability of $138 million
and a related deferred tax asset of $48 million at September 30, 2001 for our
statutorily allocated share of these gas supply and electricity contracts. We
believe that the costs incurred by REPGB subsequent to the tax holiday ending in
2001 related to these contracts will be deductible for Dutch tax purposes.
However, due to the uncertainties related to the deductibility of these costs,
we have recorded a reserve in other liabilities in our Interim Financial
Statements of $48 million as of September 30, 2001.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income (loss) for each of our
business segments for the three and nine months ended September 30, 2000 and
2001.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
----- ----- ----- -----
(IN MILLIONS)
Wholesale Energy ................. $ 320 $ 399 $ 470 $ 907
European Energy .................. 8 (5) 69 23
Retail Energy .................... (18) (7) (39) (13)
Other Operations ................. (9) (36) (24) (163)
----- ----- ----- -----
Total Consolidated ......... $ 301 $ 351 $ 476 $ 754
===== ===== ===== =====
WHOLESALE ENERGY
Wholesale Energy includes our non-rate regulated power generation
operations in the United States and our wholesale energy trading, marketing,
power origination and risk management operations in North America. Trading and
marketing purchases fuel to supply existing generation assets, sells the
electricity produced by these assets, and manages the day-to-day trading and
dispatch associated with these portfolios. As a result, we have made, and expect
to continue to make, significant investments in developing the trading and
marketing infrastructure including software, trading and risk control resources.
The following table provides summary data regarding the results of
operations of Wholesale Energy for the three and nine months ended September 30,
2000 and 2001.
WHOLESALE ENERGY
---------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
------- ------- ------- -------
(IN MILLIONS)
Operating Revenues ...................... $ 6,734 $10,030 $12,342 $29,000
Operating Expenses:
Fuel and Cost of Gas Sold ............. 2,699 3,117 6,062 13,030
Purchased Power ....................... 3,575 6,326 5,506 14,527
Operation and Maintenance ............. 48 91 122 255
General, Administrative and Development 47 69 112 191
Depreciation and Amortization ......... 45 28 70 90
------- ------- ------- -------
Total Operating Expenses ............ 6,414 9,631 11,872 28,093
------- ------- ------- -------
Operating Income ........................ $ 320 $ 399 $ 470 $ 907
======= ======= ======= =======
Operations Data:
Electricity Wholesale Power Sales
(in MMWH (1)) ....................... 68 108 132 270
Natural Gas Sales (in Bcf (2)) ........ 625 1,097 1,707 2,723
--------------
(1) Million megawatt hours.
(2) Billion cubic feet.
Wholesale Energy's operating income increased $79 million for the third
quarter of 2001 compared to the same period in 2000. The increase was primarily
due to increased gross margins (revenues less fuel and cost of gas sold and
purchased power), partially offset by increased operation and maintenance
expenses from facilities in the West and
26
Mid-Atlantic regions, higher legal and regulatory expenses related to Western
markets and higher general and administrative expenses to support expanded
commercial activities and operations. These costs were partially offset by
decreased amortization expense related to air emissions regulatory allowances.
Wholesale Energy's operating revenues increased $3.3 billion for the third
quarter of 2001 compared to the same period in 2000. The increased revenues
during the third quarter of 2001 compared to the same period in 2000 were
primarily due to increased volumes for natural gas and power sales partially
offset by decreased prices for natural gas sales. Wholesale Energy's fuel and
gas costs and purchased power increased $3.2 billion in the third quarter of
2001 compared to the same period in 2000 primarily due to the same reasons as
the increase in revenues. Operation and maintenance expenses for Wholesale
Energy increased $43 million in the third quarter of 2001 compared to the same
period in 2000, primarily due to costs associated with the operation and
maintenance of generating plants in the West region and higher lease expense
associated with the Mid-Atlantic generating facilities' sale/leaseback
transactions that were entered into in August 2000. The higher lease expense
associated with the Mid-Atlantic generating facilities was offset by lower
interest expense in the consolidated results of operations in the third quarter
of 2001 compared to the same period in 2000. General, administrative and
development expenses increased $22 million in the third quarter of 2001 compared
to the same period in 2000, primarily due to higher administrative costs to
support growing wholesale commercial activities and operations and higher legal
and regulatory expenses related to Western markets, partially offset by
decreased development expenses. Depreciation and amortization expense for the
third quarter of 2001 compared to the same period in 2000 decreased by $17
million primarily due to changes in expense related to the amortization of our
air emissions regulatory allowances, primarily in California.
Wholesale Energy's operating income increased $437 million for the first
nine months of 2001 compared to the same period in 2000. The increase was
primarily due to increased gross margins. Gross margins for Wholesale Energy
increased by $669 million primarily due to increased revenues from energy and
ancillary services, increased volumes and higher margins from its trading and
marketing activities and the addition of our Mid-Atlantic assets and strong
commercial and operational performance in other regions. These results were
partially offset by higher operation and maintenance expenses from facilities in
the West and Mid-Atlantic regions, higher general and administrative expenses,
increased depreciation and amortization expense, and a $36 million provision and
a $12 million net write-off against receivable balances related to energy sales
in the West region.
Wholesale Energy's operating revenues increased $16.7 billion for the first
nine months of 2001 compared to the same period in 2000. The increased revenues
were primarily due to increased volumes for natural gas and power sales and to a
lesser extent increased prices for natural gas and power sales. Wholesale
Energy's fuel and gas costs and purchased power increased $16.0 billion in the
first nine months of 2001 compared to the same period in 2000. Increased fuel
and gas costs and purchased power were primarily due to increased purchased
volumes for natural gas and power sales and to a lesser extent increases in
plant output and increased prices for natural gas and power purchases. Operation
and maintenance expenses for Wholesale Energy increased $133 million in the
first nine months of 2001 compared to the same period in 2000, primarily due to
costs associated with the operation and maintenance of generating plants from
facilities in the West and Mid-Atlantic regions and higher lease expense
associated with the Mid-Atlantic generating facilities' sale/leaseback
transactions. The higher lease expense associated with the Mid-Atlantic
generating facilities was offset by lower interest expense in the consolidated
results of operations in the first nine months of 2001 compared to the same
period in 2000. General, administrative and development expenses increased $79
million in the first nine months of 2001 compared to the same period in 2000,
primarily due to the same reasons as the increase in the third quarter of 2001,
as discussed above. Depreciation and amortization expense during the first nine
months of 2001 compared to the same period in 2000 increased by $20 million as a
result of higher expense related to the depreciation of our Mid-Atlantic plants,
which were acquired in May 2000 and increased amortization of air emissions
regulatory allowances.
On June 19, 2001, the FERC issued an order modifying the market monitoring
and mitigation plan it had previously adopted on April 26, 2001. This
modification to the mitigation plan extends the hours to which the price
controls are applied, as well as the states in which the price controls will be
in effect. Additionally, the FERC issued an order on July 25, 2001, which
ordered among other items, a methodology for calculating possible refunds by
sellers of electricity in the West region. We, however, believe that while the
mitigation plan will reduce volatility in the market, we will nevertheless be
able to profitably operate our facilities in the West because the proxy market
clearing price is based on the heat rate of the least efficient unit on-line
during each hour. Additionally, as noted above, the mitigation plan allows
sellers, such as us, to justify prices above the proxy price. Finally, any
adverse impacts of the mitigation plan on our operations would be mitigated, in
part, by our forward hedging activities. The amounts of any refunds will be
determined by the end of an expedited hearing process which is scheduled to
conclude March 8, 2002. We have not reserved any amounts for potential future
refunds, nor can we currently predict the amount of these potential refunds, if
27
any, because the methodology used to calculate these refunds is dependent on
information that is currently unknown to us and still subject to review and
challenge in the hearing process.
For information regarding the reserve against receivables and uncertainties
in the California wholesale energy market, please read Notes 11(a) and 11(d) to
our Interim Financial Statements.
EUROPEAN ENERGY
Our European Energy segment includes the operations of REPGB and its
subsidiaries and our European trading, marketing and risk management operations.
European Energy generates and sells power from its generation facilities in the
Netherlands and participates in the emerging wholesale energy trading and
marketing industry in Europe.
In September 2001, we announced that we are evaluating strategic
alternatives for our European Energy segment, including its possible sale, in
order to pursue business opportunities that are more in line with our domestic
wholesale energy strategies.
Beginning January 1, 2001, the Dutch wholesale electric market was
completely opened to competition. Consistent with our expectations at the time
that we made the acquisition, REPGB has experienced a significant decline in
electric margins in 2001 attributable to the deregulation of the market. For
additional information regarding these and other factors that may affect the
future results of operations of European Energy, please read "Risk Factors -
Risks Related to our Wholesale Business - We will experience a significant
decline in our European Energy business segment's gross margin in 2001" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Factors Affecting Our Future Earnings - Our European
Operations" in the Reliant Resources Prospectus, which information is
incorporated herein by reference.
The following table provides summary data regarding the results of
operations of European Energy for the three and nine months ended September 30,
2000 and 2001.
EUROPEAN ENERGY
----------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
----- ----- ----- -----
(IN MILLIONS)
Operating Revenues ............ $ 129 $ 275 $ 415 $ 799
Operating Expenses:
Fuel ........................ 61 91 188 294
Purchased Power ............. 7 138 11 335
Operation and Maintenance ... 22 18 73 57
General and Administrative .. 14 13 19 33
Depreciation and Amortization 17 20 55 57
----- ----- ----- -----
Total Operating Expenses . 121 280 346 776
----- ----- ----- -----
Operating Income (Loss) ....... $ 8 $ (5) $ 69 $ 23
===== ===== ===== =====
Electricity (in MMWH):
Wholesale Sales ............. 2.8 4.6 8.7 11.9
Trading Sales ............... 0.2 5.7 0.3 14.6
European Energy's operating income decreased $13 million and $46 million
for the third quarter and the first nine months of 2001 compared to the same
periods in 2000. These decreases were primarily due to a decrease in margins
(revenues less fuel and purchased power), as the Dutch electric market was
completely opened to wholesale competition on January 1, 2001. Increased margins
from ancillary services and trading activities partially offset this decline. In
the first half of 2001, efficiency and energy payments from SEP totaling $30
million and increased district heating sales partially offset the decline for
the nine months ended September 30, 2001 compared to the same period in 2000.
European Energy's operating revenues increased $146 million and $384
million for the third quarter and the first nine months of 2001 compared to the
same periods in 2000. The increases were primarily due to increased trading
revenues associated with our participation in the Dutch and German power
markets. Fuel and purchased power costs increased $161 million and $430 million
in the third quarter and the first nine months of 2001 compared to the same
28
periods in 2000 primarily due to increased purchased power for trading
activities, and to a lesser extent increased cost of natural gas and other fuels
due to increased output from our generating facilities.
RETAIL ENERGY
Retail Energy provides energy products and services to end-use customers,
ranging from residential and small commercial customers to large commercial,
institutional and industrial customers. In addition, Retail Energy includes
billing and remittance services provided to Reliant Energy's regulated electric
utility and two of its natural gas distribution divisions. Retail Energy charges
the regulated electric and gas utilities for these services at cost. We expect
to succeed to a significant electric retail customer base in the Houston
metropolitan area when the Texas market opens to competition in January 2002.
The Texas electric restructuring law calls for the commencement of retail
competition beginning on January 1, 2002. This law authorizes the Texas Utility
Commission to delay the date which the retail electric market is opened to
competition in any power region in Texas if it is determined that the region is
unable to offer fair competition and reliable service to all retail customer
classes on that date. We anticipate retail competition will commence on January
1, 2002. If retail competition is delayed, Retail Energy's results of operations
and cash flows could be materially affected depending on the length of the
delay.
The following table provides summary data regarding the results of
operations of Retail Energy for the three and nine months ended September 30,
2000 and 2001.
RETAIL ENERGY
----------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
----- ----- ----- -----
(IN MILLIONS)
Operating Revenues ...................... $ 21 $ 52 $ 59 $ 115
Operating Expenses:
Natural Gas .......................... -- 8 -- 8
Operation and Maintenance ............. 28 20 81 67
General, Administrative and Development 11 28 15 46
Depreciation and Amortization ......... -- 3 2 7
----- ----- ----- -----
Total Operating Expenses ........... 39 59 98 128
----- ----- ----- -----
Operating Loss .......................... $ (18) $ (7) $ (39) $ (13)
===== ===== ===== =====
Our Retail Energy segment operating loss decreased $11 million and $26
million, respectively, in the third quarter and the first nine months of 2001
compared to the same periods in 2000. The operating loss reduction was primarily
due to increased sales of energy and energy services to commercial and
industrial customers from our Reliant Energy Solutions unit and energy sales and
services for certain Texas governmental agencies under a program mandated by the
Texas electric deregulation legislation. Operating revenues increased $31
million and $56 million, respectively, in the third quarter and the first nine
months of 2001 compared to the same periods in 2000, due to revenues from sales
of energy and energy services to commercial and industrial customers, energy
sales and services for certain Texas governmental agencies, as well as increased
revenues for the billing and remittance services provided to Reliant Energy.
Operations and maintenance and general, administrative and development expenses
increased $9 million and $17 million in the third quarter and the first nine
months of 2001 compared to the same periods in 2000, primarily due to increased
personnel and employee related costs, costs related to building an
infrastructure necessary to prepare for competition in the retail electric
market in Texas and advertising costs.
OTHER OPERATIONS
Our Other Operations segment includes the operations of our eBusiness,
Communications, and venture capital businesses, along with unallocated corporate
costs. Historically, our Other Operations segment has included the operations of
our Communications business. For additional information about our exiting of our
Communication business, please read Note 13 to our Interim Financial Statements.
The following table provides summary data regarding the results of
operations of Other Operations for the three and nine months ended September 30,
2000 and 2001.
29
OTHER OPERATIONS
----------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
----- ----- ----- -----
(IN MILLIONS)
Operating Revenues ...................... $ 2 $ 2 $ 4 $ 8
Operating Expenses:
Operation and Maintenance ............. 2 5 4 15
General, Administrative and Development 8 12 21 131
Depreciation and Amortization ......... 1 21 3 25
----- ----- ----- -----
Total Operating Expenses ........... 11 38 28 171
----- ----- ----- -----
Operating Loss .......................... $ (9) $ (36) $ (24) $(163)
===== ===== ===== =====
Other Operation's operating loss increased $27 million and $139 million in
the third quarter and first nine months of 2001 compared to the same periods in
2000. During the third quarter of 2001, we recognized $14 million of
restructuring charges and $19 million of goodwill impairment related to the
exiting of our Communications business. The goodwill impairment is included in
amortization expense. During the first quarter of 2001, we incurred a pre-tax
non-cash charge of $100 million relating to the redesign of some of Reliant
Energy's benefit plans in anticipation of our separation from Reliant Energy. In
addition, our Communications business operating loss increased $7 million for
the nine months ended September 30, 2001 compared to the same period in 2000.
For additional information about the benefit charge noted above, please read
Note 12 to our Interim Financial Statements.
CERTAIN FACTORS AFFECTING OUR FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Risk Factors" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Certain Factors Affecting Our Future Earnings" in the Reliant Resources
Prospectus, which is incorporated herein by reference. For additional
information regarding the California wholesale market and related litigation,
please read Notes 11(a) and 11(d) to our Interim Financial Statements.
FINANCIAL CONDITION
The following table summarizes the net cash provided by (used in)
operating, investing and financing activities for the nine months ended
September 30, 2000 and 2001.
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2000 2001
---- ----
(IN MILLIONS)
Cash provided by (used in):
Operating activities..................................................... $ 234 $ 262
Investing activities..................................................... (2,780) (709)
Financing activities..................................................... 2,741 635
Net cash provided by operating activities during the nine months ended
September 30, 2001 increased $28 million compared to the same period in 2000,
primarily due to improved operating cash flows from Wholesale Energy and a
decrease in margin deposits on energy trading activities partially offset by a
prepayment of a lease obligation related to the REMA sale/leaseback transactions
and other changes in working capital.
Net cash used in investing activities during the nine months ended
September 30, 2001 decreased $2.1 billion compared to the same period in 2000,
primarily due to the funding of the remaining purchase obligation for REPGB for
$982 million on March 1, 2000, and the acquisition of REMA for $2.1 billion on
May 12, 2000, partially offset by proceeds from REMA sale/leaseback transactions
of $1 billion, as well as an increase in capital expenditures related to the
construction of domestic power generation projects during the nine months ended
September 30, 2001.
Cash flows provided by financing activities during the nine months ended
September 30, 2001 decreased $2.1 billion compared to the same period in 2000,
primarily due to investing excess cash in an affiliate of Reliant Energy,
reduced contributions from Reliant Energy and a decrease in short-term
borrowings, partially offset by $1.7 billion in net proceeds from the Offering.
30
FUTURE SOURCES AND USES OF CASH FLOWS
Credit Facilities. In August 2001, we entered into two new credit
facilities with financial institutions, which provide for $750 million each or
an aggregate of $1.5 billion in committed credit to replace $2.1 billion of
credit facilities which were to expire on October 2, 2001. One of these
facilities expires on August 22, 2002, with any outstanding loans on such date
being converted at our option to term loans with a maturity of one year from the
date of conversion, provided we meet certain conditions. The other facility has
a maturity date of August 22, 2004. Interest rates on the borrowings are based
on LIBOR plus a margin, a base rate or a rate determined through a bidding
process. These facilities contain various business and financial covenants
requiring us to, among other things, maintain a ratio of net debt to the sum of
net debt, subordinated affiliate debt and stockholders' equity not to exceed
0.60 to 1.00. These covenants are not anticipated to materially restrict us from
borrowing funds or obtaining letters of credit under these facilities. The
credit facilities are subject to facility and usage fees that are calculated
based on the amount of the facility commitments (used or unused) and on the
amounts outstanding under the facilities, respectively. In addition, our
subsidiaries have credit facilities of $1.8 billion. Of the aggregated credit
facilities of $3.3 billion, $1.6 billion remains unused as of September 30,
2001.
Of the $3.3 billion of committed credit facilities described above, $978
million will expire by September 30, 2002, including the $750 million facility
expiring on August 22, 2002. To the extent that we still need these facilities,
we expect to be able to renew or replace them on normal commercial terms prior
to their expiration.
Initial Public Offering of Reliant Resources. In May 2001, we offered 59.8
million shares of our common stock to the public at an initial public offering
price of $30 per share and received net proceeds from the Offering of $1.7
billion. Pursuant to the terms of the master separation agreement between
Reliant Energy and us, we used $147 million of the net proceeds to repay certain
indebtedness owed to Reliant Energy. We used the remainder of the net proceeds
of the Offering for repayment of third party borrowings, capital expenditures
repurchase of our common stock and increase working capital. Reliant Energy has
publicly disclosed that it expects the Offering to be followed by a distribution
of the remaining shares of our common stock owned by Reliant Energy to Reliant
Energy's or its successor's shareholders within 12 months of the Offering. For
additional information, please read Notes 1 and 4 to Reliant Resources
Prospectus Notes.
Acquisition of Mid-Atlantic Assets. On May 12, 2000, we completed the
acquisition of our Mid-Atlantic assets from Sithe Energies, Inc. for an
aggregate purchase price of $2.1 billion. The acquisition was originally
financed through bridge loans from Reliant Energy and $1.0 billion was converted
to equity. In August 2000, we entered into separate sale/leaseback transactions
with each of the three owner-lessors for our respective 16.45%, 16.67% and 100%
interests in the Conemaugh, Keystone and Shawville generating stations,
respectively, which we acquired as part of the Mid-Atlantic acquisition. For
additional discussion of these lease transactions, please read Notes 5(a) and
11(c) to Reliant Resources Prospectus Notes. As consideration for the sale of
our interest in the facilities, we received a total of $1.0 billion in cash that
was used to repay indebtedness owed to Reliant Energy. We will continue to make
lease payments through 2029. The lease terms expire in 2034.
Acquisition of Orion Power Holdings, Inc. In September 2001, we entered
into a definitive merger agreement with Orion Power Holdings, Inc. (Orion
Power), under which we agreed to acquire all of the outstanding shares of Orion
Power for $26.80 per share in cash in a transaction valued at approximately $2.9
billion. In the merger, we will also assume approximately $1.8 billion of Orion
Power's net debt obligations. Orion Power is an independent electric power
generating company formed in March 1998 to acquire, develop, own and operate
power-generating facilities in the newly deregulated wholesale markets
throughout North America. Orion Power has 81 power plants currently in operation
with a total capacity of 5,644 MW and an additional 2,855 MW in construction and
various stages of development. The merger is conditioned upon approval by Orion
Power's shareholders and receipt of certain regulatory approvals including the
Federal Trade Commission, New York Public Service Commission and the FERC. We
expect to finance the purchase price with existing cash balances, existing
credit facilities and new financing, which will be in place at or prior to
closing.
Generating Projects. As of September 30, 2001, we had four generating
facilities under construction. Total estimated costs of constructing these
facilities are $1.4 billion, including $365 million in commitments for the
purchase of combustion turbines. As of September 30, 2001, we had incurred $917
million of the total projected costs of these projects, which were funded
primarily from borrowings and equity. We believe that our level of cash, our
borrowing capability and proceeds from the Offering as discussed above will be
sufficient to fund these commitments. In addition, we have options to purchase
additional combustion turbines for a total estimated cost of $112 million for
future
31
generation projects, which we are actively trying to remarket. We believe that
our current level of cash, our borrowing capability and proceeds from the
Offering will be sufficient to fund these options should we choose to exercise
them.
Construction Agency Agreement. In April 2001, we, through several of our
subsidiaries, entered into operative documents with special purpose entities to
facilitate the development, construction, financing and leasing of several power
generation projects. The special purpose entities have an aggregate financing
commitment from equity and debt participants (Investors) of $2.5 billion. The
availability of the commitment is subject to satisfaction of various conditions.
We, through several of our subsidiaries, act as construction agent for the
special purpose entities and are responsible for completing construction of
these projects by August 31, 2004, but have generally limited our risk related
to construction completion to 89.9% of costs incurred to date, except in certain
events. Upon completion of an individual project and exercise of the lease
option, our subsidiaries will be required to make lease payments in an amount
sufficient to provide a return to the Investors. If we do not exercise our
option to lease any project upon its completion, we must purchase the project or
remarket the project on behalf of the special purpose entities. We must
guarantee that the Investors will receive at least 89.9% of their investment in
the case of a remarketing sale at the end of construction. At the end of an
individual project's initial operating lease term (approximately five years from
construction completion), our subsidiary lessees have the option to extend the
lease with the approval of the Investors, purchase the project at a fixed amount
equal to the original construction cost, or act as a remarketing agent and sell
the project to an independent third party. If the lessees elect the remarketing
option, they may be required to make a payment of up to 85% of the project cost
if the proceeds from remarketing are not sufficient to repay the Investors. We
have guaranteed the performance and payment of our subsidiaries' obligations
during the construction periods and, if the lease option is exercised, each
lessee's obligations during the lease period.
California Trade Receivables. During the summer and fall of 2000, and
continuing into early 2001, prices for wholesale electricity in California
increased dramatically as a result of a combination of factors, including higher
natural gas prices and emissions allowance costs, reduction in available
hydroelectric generation resources, increased demand, decreases in net electric
imports, structural market flaws including over-reliance on the spot market, and
limitations on supply as a result of maintenance and other outages. Although
wholesale prices increased, California's deregulation legislation kept retail
rates frozen below 1996 levels until rates were raised by the CPUC earlier this
year. This caused two of California's public utilities, which are our customers
based on our deliveries to the Cal PX and the Cal ISO, to accrue billions of
dollars of unrecovered wholesale power costs and ultimately default in January
and February 2001 on payments owed for wholesale power purchased through the Cal
PX and from the Cal ISO, and in the case of PG&E, to file a voluntary petition
for bankruptcy. As of September 30, 2001, we were owed $338 million by the Cal
ISO, the Cal PX, the CDWR and California Energy Resource Scheduling for energy
sales in the California wholesale market, during the fourth quarter of 2000
through September 30, 2001 and have recorded an allowance against such
receivables of $75 million. From October 1, 2001 through November 8, 2001, we
have collected $3.2 million of these receivable balances. For additional
information regarding uncertainties in the California wholesale market, please
read Notes 11(a) and 11(d) to our Interim Financial Statements and Notes 11(e)
and 11(h) to Reliant Resources Prospectus Notes.
Payment to Reliant Energy. To the extent that our price for providing
retail electric service to residential and small commercial customers in Reliant
Energy's Houston service territory during 2002 and 2003, which price is mandated
by the Texas electric restructuring law, exceeds the market price of
electricity, we may be required to make a payment to Reliant Energy in early
2004. This payment will be required unless the Texas Utility Commission
determines that, on or prior to January 1, 2004, 40% or more of the amount of
electric power that was consumed in 2000 by residential or small commercial
customers, as applicable, within Reliant Energy's Houston service territory is
committed to be served by retail electric providers other than us. If the 40%
test is not met and a payment is required, the amount of this payment will be
equal to (1) the amount that the price to beat, less non-bypassable delivery
charges, is in excess of the market price of electricity per customer, but not
to exceed $150 customer, multiplied by (2) the number of residential or small
commercial customers, as the case may be, that we serve on January 1, 2004 in
Reliant Energy's Houston service territory, less the number of new retail
electric customers we serve in other areas of Texas. As of September 30, 2001,
Reliant Energy had approximately 1.7 million residential and small commercial
customers. In the master separation agreement with Reliant Energy, we have
agreed to make this payment, if any, to Reliant Energy.
Treasury Stock Purchase. In July 2001, our Board of Directors authorized us
to purchase up to one million shares of our common stock in anticipation of
funding of our benefit plan obligations expected to be funded prior to
Distribution. During the third quarter of 2001, we purchased 1,000,000 shares of
our common stock at an average price of $20.42 per share, or an aggregate
purchase price of $20.4 million.
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In addition, on September 18, 2001, our Board of Directors authorized us to
purchase up to 10 million additional shares of our common stock through February
2003. Purchases will be made on a discretionary basis in the open market or
otherwise at times and in amounts as determined by management subject to market
conditions, legal requirements and other factors. From October 1, 2001 through
November 8, 2001, we had purchased 7,628,200 shares of our common stock at an
average price of $16.69 per share.
Other Sources/Uses of Cash. Our liquidity and capital requirements are
affected primarily by acquisitions, capital expenditures, debt service
requirements and varied working capital needs. We expect to continue to bid in
future acquisitions of independent power projects and privatizations of
generation facilities. We expect any resulting capital requirements to be met
with excess cash flows from operations, as well as proceeds from debt and equity
offerings, project financings and other borrowings. We also expect to establish
a commercial paper program in late 2001 or the first half of 2002. Additional
capital expenditures depend upon the nature and extent of future project
commitments, some of which may be substantial. We believe that our current level
of cash (including proceeds from our Offering) and borrowing capability, along
with future cash flows from operations, will be sufficient to meet the existing
operational needs of our business for the next 12 months.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standard Board (FASB) issued
Statement of Financial Accounting Standards No. 141 "Business Combinations"
(SFAS No. 141) and "Goodwill and Other Intangible Assets" (SFAS No. 142). SFAS
No. 141 requires business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting, and broadens the criteria
for recording intangible assets separate from goodwill. Recorded goodwill and
intangibles will be evaluated against these new criteria and may result in
certain intangibles being transferred to goodwill, or alternatively, amounts
initially recorded as goodwill may be separately identified and recognized apart
from goodwill. SFAS No. 142 provides for a nonamortization approach, whereby
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 provisions of each statement
which apply to goodwill and intangible assets acquired prior to June 30, 2001
will be adopted by us on January 1, 2002. We are in the process of determining
the effect of adoption of SFAS No. 141 and SFAS No. 142 on our consolidated
financial statements.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair value of
a liability for an asset retirement legal obligation to be recognized in the
period in which it is incurred. When the liability is initially recorded,
associated costs are capitalized by increasing the carrying amount of the
related long-lived asset. Over time, the liability is accreted to its present
value each period, and the capitalized cost is depreciated over the useful life
of the related asset. SFAS No. 143 is effective for fiscal years beginning after
June 15, 2002, with earlier application encouraged. SFAS No. 143 requires
entities to record a cumulative effect of change in accounting principle in the
income statement in the period of adoption. We plan to adopt SFAS No. 143 on
January 1, 2003 and are in the process of determining the effect of adoption on
our 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, 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 is effective for fiscal years beginning after December 15, 2001,
with early adoption encouraged. SFAS No. 144 is not expected to materially
change the methods used by us to measure impairment losses on long-lived assets,
but may result in additional future dispositions being reported as discontinued
operations than is currently permitted. We plan to adopt SFAS No. 144 on January
1, 2002.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Form 10-Q/A to be signed on its behalf by the
undersigned thereunto duly authorized.
RELIANT RESOURCES, INC.
(Registrant)
By: /s/ Mary P. Ricciardello
-------------------------------------
Mary P. Ricciardello
Senior Vice President
and Chief Accounting Officer
Date: March 25, 2002
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