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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 2002
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____to_____
MIRANT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 58-2056305
------------------------------------------- ------------------------------------
(State or other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1155 Perimeter Center West, Suite 100, Atlanta, Georgia 30338
-------------------------------------------------------- -----------------------
(Address of Principal Executive Offices) (Zip Code)
(678) 579-5000
--------------------------------------------------------------------------------
(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___
__________
The number of shares outstanding of the Registrant's Common Stock, par value
$0.01 per share, at October 30, 2002 was 402,923,915.
Mirant Corporation and Subsidiaries
INDEX
For the Quarterly Period Ended June 30, 2002
Page
Number
DEFINITIONS 1
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION 3
PART I - FINANCIAL INFORMATION
Item 1. Interim Financial Statements (Unaudited):
Condensed Consolidated Statements of Income 5
Condensed Consolidated Balance Sheets 6
Condensed Consolidated Statement of Stockholders' Equity 8
Condensed Consolidated Statements of Cash Flows 9
Notes to the Condensed Consolidated Financial Statements 10
Independent Accountants' Review Report 47
Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 48
Item 3. Quantitative and Qualitative Disclosures about Market Risk 73
Item 4. Controls and Procedures 76
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 79
Item 2. Changes in Securities and Use of Proceeds Inapplicable
Item 3. Defaults Upon Senior Securities Inapplicable
Item 4. Submission of Matters to a Vote of Security Holders 79
Item 5. Other Information Inapplicable
Item 6. Exhibits and Reports on Form 8-K 79
Signatures
Certifications
i
DEFINITIONS
TERM MEANING
---- -------
APB Accounting Principles Board
Bewag Bewag AG
BP BP p.l.c.
CAISO California Independent System Operator
CEMIG Companhia Energetica de Minas Gerais
Cleco Cleco Midstream Resources, LLC
the Company Mirant Corporation and its subsidiaries
CPUC California Public Utilities Commission
DWR California Department of Water Resources
EITF Emerging Issues Task Force
Enron Enron Corporation and its affiliates
EPA U. S. Environmental Protection Agency
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Fitch Fitch, Inc.
GAAP Generally accepted accounting principles
Hyder Hyder Limited
JPSCo Jamaica Public Service Company Limited
Kogan Creek MAP Australia (BVI) Limited
LIBOR London Interbank Offering Rate
Mirant Americas Energy Marketing Mirant Americas Energy Marketing, L. P.
Mirant Americas Energy Capital Mirant Americas Energy Capital, LP
Mirant Americas Generation Mirant Americas Generation, LLC
Mirant Americas Mirant Americas, Inc.
Mirant Asia-Pacific Mirant Asia-Pacific Ventures, Inc.
Mirant Canada Energy Marketing Mirant Canada Energy Marketing, Ltd.
Mirant Mirant Corporation and its subsidiaries
Mirant Delta Mirant Delta, LLC
Mirant Mid-Atlantic Mirant Mid-Atlantic, LLC and its subsidiaries
Mirant New England Mirant New England, LLC
Mirant New York Mirant New York, Inc., Mirant New York
Investments, Inc., and subsidiaries
Mirant Potrero Mirant Potrero, LLC
Moody's Moody's Investors Service
MW Megawatts
NPC National Power Corporation
OCI Other comprehensive income
OTC Over-the-counter
Pacific Gas and Electric Pacific Gas and Electric Co.
PEPCO Potomac Electric Power Company
Perryville Perryville Energy Partners, LLC
PX California Power Exchange Corporation
RMR Reliability-Must-Run
SCE Southern California Edison
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting Standards
Shajiao C Guangdong Guanghope Power Company Limited
SIPD Shandong International Power Development
Company Limited
Southern Southern Company
1
S&P Standard & Poor's
State Line State Line Energy, L.L.C.
Vastar Vastar Resources Inc.
WPD Western Power Distribution group headed by
WPD 1953 Limited
2
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
The information presented in this quarterly report on Form 10-Q includes
forward-looking statements, in addition to historical information. These
statements involve known and unknown risks and relate to future events, Mirant's
future financial performance or projected business results. In some cases,
forward-looking statements by terminology may be identified by statements such
as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "targets," "potential" or "continue" or the negative of
these terms or other comparable terminology.
Forward-looking statements are only predictions. Actual events or results
may differ materially from any forward-looking statement as a result of various
factors, which include:
o legislative and regulatory initiatives regarding deregulation, regulation
or restructuring of the electric utility industry;
o the extent and timing of the entry of additional competition in the markets
of our subsidiaries and affiliates;
o our pursuit of potential business strategies, including
acquisitions or dispositions of assets or internal restructuring;
o political, legal and economic conditions and developments and state,
federal and other rate regulations in the United States and in foreign
countries in which our subsidiaries and affiliates operate;
o changes in or application of environmental and other laws and regulations
to which we and our subsidiaries and affiliates are subject;
o financial market conditions and the results of our financing or refinancing
efforts;
o changes in market conditions, including developments in energy and
commodity supply, volume and pricing and interest rates;
o weather and other natural phenomena;
o developments in the California power markets, including, but not limited
to, governmental intervention, deterioration in the financial condition of
our counterparties, default on receivables due and adverse results in
current or future litigation;
o the direct or indirect effects on our business, including the availability
of insurance, resulting from the terrorist actions on September 11, 2001 or
any other terrorist actions or responses to such actions, including, but
not limited to, acts of war;
o the direct or indirect effects on our business resulting from the financial
difficulties of competitors of Mirant, including, but not limited to, their
effects on liquidity in the trading and power industry, and their effects
on the capital markets views of the energy or trading industry and our
ability to access the capital markets on the same favorable terms as in the
past;
o the direct or indirect effects on our business of a further lowering of our
credit rating (or actions we may take in response to changing credit
ratings criteria), including, increased collateral requirements to execute
our business plan, demands for increased collateral by our current
counterparties, refusal by our current or potential counterparties to enter
into transactions with us and our inability to obtain credit or capital in
amounts or on terms favorable to us;
o the disposition of the pending litigation described in our Form 10-K/A
filed on March 11, 2002, our Form 10-Q filed on May 13, 2002, as amended on
November 7, 2002, our Form 8-K filed on June 27, 2002 and this Form 10-Q;
o the direct or indirect effects of the accounting issues discussed in Notes
A and L in the notes to the unaudited condensed consolidated financial
statements included in this Form 10-Q and the additional issues arising
from the weaknesses identified by the internal control and procedures
review discussed in Item 4 of this Form 10-Q;
o the direct or indirect ramifications of the results of the reaudit of our
2000 and 2001 financial statements and the restatements that will be
required as a result of these reaudits including potential effects on our
financing arrangements and refinancing efforts;
o the direct or indirect effects of informal inquiries by the U.S. Securities
& Exchange Commission and the U.S. Department of Justice and the
Commodities Futures Trading Commission regarding, among other things, the
accounting issues described in the Company's July 30 and August 14, 2002
press releases and energy trading issues;
3
o the direct or indirect effects on our business of our or our subsidiaries'
failure to timely file our or their Form 10-Q for the quarter ended June
30, 2002; and
o other factors discussed in this Form 10-Q and in our reports filed from
time to time with the SEC (including our Form 10-K filed on March 11, 2002,
as amended by Form 10-K/A, filed on March 11, 2002 and our Form 10-Q filed
on May 13, 2002, as amended by Form 10-Q/A, filed on November 7, 2002).
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, events, levels of
activity, performance or achievements. We expressly disclaim a duty to update
any of the forward-looking statements contained herein.
4
MIRANT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
----------- ------------ ------------- ------------
(in millions, except per share data)
Operating Revenues: $6,134 $7,915 $13,042 $16,083
----------- ------------ ------------- ------------
Operating Expenses:
Cost of fuel, electricity and other products 5,554 7,127 11,852 14,508
----------- ------------ ------------- ------------
Gross Margin 580 788 1,190 1,575
----------- ------------ ------------- ------------
Other Operating Expenses:
Depreciation and amortization 79 94 156 179
Maintenance 29 41 61 68
Selling, general and administrative 168 187 316 483
Impairment loss (Note D) - 89 - 93
Restructuring charge (Note H) 28 - 590 -
Gain on sales of assets, net (Note H) (27) - (27) -
Other 119 129 226 228
----------- ------------ ------------- ------------
Total operating expenses 396 540 1,322 1,051
----------- ------------ ------------- ------------
Operating Income (Loss) 184 248 (132) 524
----------- ------------ ------------- ------------
Other Expense, net:
Interest income 15 36 32 88
Interest expense (107) (143) (226) (286)
Gain/(loss) on sales of assets, net (Note H) (9) 2 282 2
Equity in income of affiliates 42 47 120 126
Impairment loss on minority owned affiliates (Note D) (317) - (317) -
Receivables recovery (Note A) - - 29 10
Other, net 4 3 (1) -
----------- ------------ ------------- ------------
Total other expense, net (372) (55) (81) (60)
----------- ------------ ------------- ------------
(Loss) Income From Continuing Operations
Before Income Taxes and Minority Interest (188) 193 (213) 464
Provision (Benefit) for Income Taxes 16 54 (17) 142
Minority Interest 18 16 34 30
----------- ------------ ------------- ------------
(Loss) Income From Continuing Operations (222) 123 (230) 292
----------- ------------ ------------- ------------
Income from Discontinued Operations, net of tax provision
of $1 for both the three months ended June 30, 2002 and
2001, and $3 and $2 for the six months ended June 30,
2002 and 2001, respectively 2 1 4 12
----------- ------------ ------------- ------------
Net (Loss) Income $(220) $ 124 $ (226) $ 304
=========== ============ ============= ============
(Loss) Earnings Per Share:
Basic $ (0.55) $ 0.36 $ (0.56) $ 0.90
Diluted $ (0.55) $ 0.36 $ (0.56) $ 0.88
The accompanying notes are an integral part of these condensed consolidated
statements.
5
MIRANT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Note A)
(Restated)
At June 30, At December 31,
ASSETS: 2002 2001
----------------- -------------------
(in millions)
Current Assets:
Cash and cash equivalents $ 957 $ 860
Receivables:
Customer accounts, less provision for uncollectibles
of $154 and $159 for 2002 and 2001, respectively 1,605 1,957
Other, less provision for uncollectibles
of $26 and $32 for 2002 and 2001, respectively 370 774
Notes receivable 30 24
Energy marketing and risk management assets (Note G) 1,106 911
Derivative hedging instruments (Notes C and G) 167 253
Deferred income taxes 453 405
Inventories 344 363
Assets held for sale (Note J) - 193
Other 305 380
----------------- -------------------
Total current assets 5,337 6,120
----------------- -------------------
Property, Plant and Equipment:
Property, plant and equipment 4,601 4,356
Less accumulated provision for depreciation and depletion (424) (333)
----------------- -------------------
4,177 4,023
Leasehold interest, net of accumulated amortization
of $338 and $297 for 2002 and 2001, respectively 1,721 1,751
Construction work in progress 1,664 1,921
Investment in suspended construction 509 -
----------------- -------------------
Total property, plant and equipment, net 8,071 7,695
----------------- -------------------
Noncurrent Assets:
Investments (Note H) 731 2,247
Notes and other receivables, less provision for uncollectibles
of $125 and $116 for 2002 and 2001, respectively 377 287
Energy marketing and risk management assets (Note G) 735 508
Goodwill, net of accumulated amortization
of $293 and $275 for 2002 and 2001, respectively (Notes A and B) 3,445 3,195
Other intangible assets, net of accumulated amortization
of $57 and $70 for 2002 and 2001, respectively (Notes A and B) 583 865
Derivative hedging instruments (Notes C and G) 132 95
Deferred income taxes 202 423
Other 214 252
----------------- -------------------
Total noncurrent assets 6,419 7,872
----------------- -------------------
Total assets $ 19,827 $ 21,687
================= ===================
The accompanying notes are an integral part of these
condensed consolidated statements.
6
MIRANT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Note A)
(Restated)
At June 30, At December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY: 2002 2001
----------------- -------------------
(in millions, except share data)
Current Liabilities:
Short-term debt $ 94 $ 55
Current portion of long-term debt (Note F):
Sual and Pagbilao project loans 1,117 1,201
Mirant Asia-Pacific 14 792
Mirant Holdings Beteiligungsgesellschaft (Note H) - 566
Other 39 45
Accounts payable and accrued liabilities 2,101 2,586
Taxes accrued 11 152
Energy marketing and risk management liabilities (Note G) 1,136 862
Obligations under energy delivery and purchase commitments (Note I) 608 635
Derivative hedging instruments (Notes C and G) 117 232
Accrued restructuring charges 248 -
Liabilities related to assets held for sale (Note J) - 25
Other 151 151
----------------- -------------------
Total current liabilities 5,636 7,302
----------------- -------------------
Noncurrent Liabilities:
Notes payable (Note F) 3,988 3,751
Other long-term debt (Note F) 1,976 2,068
Energy marketing and risk management liabilities (Note G) 640 633
Deferred income taxes 105 76
Obligations under energy delivery and purchase commitments (Note I) 1,141 1,376
Derivative hedging instruments (Notes C and G) 55 47
Other 369 354
----------------- -------------------
Total noncurrent liabilities 8,274 8,305
----------------- -------------------
Minority Interest in Subsidiary Companies 293 281
Company Obligated Mandatorily Redeemable Securities of a
Subsidiary Holding Solely Parent Company Debentures 345 345
Commitments and Contingent Matters (Notes I and L)
Stockholders' Equity:
Common stock, $.01 par value, per share 4 4
Authorized -- 2,000,000,000 shares
Issued -- June 30, 2002: 402,084,743 shares;
-- December 31, 2001: 400,880,937 shares
Treasury -- June 30, 2002: 100,000 shares
-- December 31, 2001: 100,000 shares
Additional paid-in capital 4,900 4,886
Retained earnings 452 678
Accumulated other comprehensive loss (75) (112)
Treasury stock, at cost (2) (2)
----------------- -------------------
Total stockholders' equity 5,279 5,454
----------------- -------------------
Total liabilities and stockholders' equity $ 19,827 $ 21,687
================= ===================
The accompanying notes are an integral part of these
condensed consolidated statements.
7
MIRANT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
Accumulated
Additional Other
Common Paid-In Retained Comprehensive Treasury Comprehensive
Stock Capital Earnings Loss Stock Loss
------------- ------------- ------------- ----------------- ----------- -----------------
(in millions)
Balance, December 31, 2001, as
previously reported $ 4 $ 4,886 $ 729 $ (119) $ (2)
Restatement adjustments (Note A) - - (51) 7 -
------------- ------------- ------------- ------------------------------
Balance, December 31, 2001, as
restated 4 4,886 678 (112) (2)
Net loss - - (226) - - $ (226)
Other comprehensive income (Note C) - - - 37 - 37
-----------------
Comprehensive loss $ (189)
=================
Issuance of common stock - 14 - - -
------------- ------------- ------------- ----------------- -----------
Balance, June 30, 2002 $ 4 $ 4,900 $ 452 $ (75) $ (2)
============= ============= ============= ================= ===========
The accompanying notes are an integral part of these
condensed consolidated statements.
8
MIRANT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Six Months
Ended June 30,
2002 2001
--------------- --------------
(in millions)
Cash Flows from Operating Activities:
Net (loss) income $ (226) $ 304
--------------- --------------
Adjustments to reconcile net (loss) income to net cash
provided by (used in)operating activities:
Equity in income of affiliates (120) (123)
Dividends received from equity investments 20 75
Depreciation and amortization 171 194
Obligations under energy delivery and purchase commitments (261) (148)
Impairment loss 317 93
Energy marketing and risk management activities, net (141) (28)
Restructuring charge 555 -
Deferred income taxes 142 183
Gain on sales of assets (309) (2)
Minority interest 23 31
Other, net 31 29
Changes in certain assets and liabilities, excluding effects
from acquisitions:
Receivables, net 666 1,665
Other current assets 122 (95)
Other assets 6 13
Accounts payable and accrued liabilities (466) (2,028)
Taxes accrued (146) 77
Other current liabilities (2) 32
Other liabilities (29) (32)
--------------- ---------------
Total adjustments 579 (64)
--------------- ---------------
Net cash provided by operating activities 353 240
--------------- ---------------
Cash Flows from Investing Activities:
Capital expenditures (811) (650)
Cash paid for acquisitions (68) (651)
Issuance of notes receivable (177) (103)
Repayments on notes receivable 107 377
Disposal of Southern Company affiliates and other companies - (77)
Proceeds from the sale of investments, net 1,968 -
Property insurance proceeds 7 -
Other (18) -
--------------- ---------------
Net cash provided by (used in) investing activities 1,008 (1,104)
--------------- ---------------
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt 1,322 3,044
Repayment of long-term debt (2,653) (2,193)
Proceeds from issuance of common stock 14 27
Capital contributions from minority interests 17 11
Payment of dividends to minority interests (7) (1)
Issuance of short-term debt, net 37 130
Change in debt service reserve fund 7 12
--------------- ---------------
Net cash (used in) provided by financing activities (1,263) 1,030
--------------- ---------------
Effect of Exchange Rate Changes on Cash and
Cash Equivalents (1) 19
--------------- ---------------
Net Increase in Cash and Cash Equivalents 97 185
Cash and Cash Equivalents, beginning of period 860 1,049
--------------- ---------------
Cash and Cash Equivalents, end of period $ 957 $ 1,234
=============== ===============
Supplemental Cash Flow Disclosures:
Cash paid for interest, net of amounts capitalized $ 209 $ 244
Refunds received for income taxes $ (84) $ (27)
Business Acquisitions:
Fair value of assets acquired $ 71 $ 1,002
Less cash paid 68 651
--------------- ---------------
Liabilities assumed $ 3 $ 351
=============== ===============
The accompanying notes are an integral part of these condensed consolidated statements.
9
MIRANT CORPORATION AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A. Accounting and Reporting Policies
Adjustments to Previously Issued Financial Statements. The Company has
identified accounting errors in its previously issued financial statements,
primarily related to its risk management and marketing operations and has
restated its December 31, 2001 balance sheet, reducing retained earnings for
after tax charges totaling approximately $51 million. The principal reasons and
effects of the adjustments on the accompanying 2001 balance sheet from amounts
previously reported are summarized below (in millions):
Increase (Decrease)
December 31, 2001
Retained Earnings
---------------------------
Receivables - Other (a)......................... $ (117)
Current deferred income tax assets (b)........... 47
Non-current deferred income tax liabilities (c).. 25
Other, net....................................... (6)
----
$ (51)
====
(a) reflects the correction of the overstatement of a natural gas asset and
the correction of accrued revenues at December 31, 2001.
(b) reflects the income tax benefits related to the corrections discussed
in (a) above.
(c) reflects the correction of $42 million of excess income tax provisions
recorded in Asia, offset by $17 million of additional income tax expenses
related to WPD.
The Company has also reduced both energy marketing and risk management
assets and liabilities in the accompanying 2001 consolidated balance sheets by
$820 million to eliminate intracompany transactions. These adjustments do not
have any effect on the Company's consolidated results of operations or cash
flows.
The Company has engaged its independent auditors to reaudit the Company's
2000 and 2001 financial statements to address these and other accounting errors
that have been identified, which are expected to result in a restatement of its
statement of income for either or both of 2000 and 2001 and potentially for
interim periods in 2001 and 2002. In addition, the Company would have been
required to have its independent auditors reaudit the Company's 2000 and 2001
financial statements as a result of the Company's adoption of SFAS No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets," and the change
in reporting energy trading activities required by EITF Issue 02-3, "Accounting
for Contracts Involved in Energy Trading and Risk Management Activities," both
of which require significant modifications to the Company's previously issued
financial statements.
The specific interim periods within previous years to which $70 million of
the charges (described in (a) and (b) above) relate have not been determined at
this time; accordingly, their effect has not been reflected in the accompanying
2001 interim condensed consolidated statement of income. The interim periods to
which the $70 million relates will be determined in connection with the reaudit.
Rather than correct the 2001 results of operations and cash flows to reflect a
portion of these accounting errors, the Company has presented the comparative
2001 amounts as previously reported until the review of accounting issues is
resolved and the reaudit is completed. The Company expects to correct the
financial statements, as needed, for each reporting period in 2000 or 2001.
Until the reaudit is completed, the Company does not believe it is appropriate
to revise the historical results for the interim periods. There may be
significant changes in previously reported amounts of operating revenues,
operating income, equity in income of affiliates, provision for income taxes,
net income and operating cash flows.
10
The Company has also restated its previously reported results of operations
for the first quarter of 2002 to a net loss of $6 million from an originally
reported net loss of $42 million. These corrections have been reflected in the
accompanying 2002 unaudited condensed consolidated statements of income. The
Company has restated its previously reported first quarter 2002 statement of
cash flows, increasing originally reported cash provided from operations by $46
million to reflect cash receipts and disbursements in the appropriate period,
and increasing cash provided by investing activities by $11 million.
A summary comparison of the previously reported and restated first quarter
2002 unaudited condensed consolidated statement of income follows (in millions):
Three Months Ended March Three Months Ended March 31,
31, 2002, as Previously 2002, as Restated
Reported
----------------------------- ------------------------------
Operating revenues...... $ 7,037 $ 6,908
Operating expenses...... 6,465 6,298
----------- ----------
Gross margin............ 572 610
Other................... (614) (616)
--------- ----------
Net loss ............... $ (42) $ (6)
========== ==========
Basis of Accounting. These unaudited condensed consolidated financial statements
should be read in conjunction with Mirant's audited 2000 and 2001 consolidated
financial statements and the accompanying footnotes which are contained in the
Company's annual report on Form 10-K, as amended on Form 10-K/A, for the year
ended December 31, 2001. As previously discussed, the Company has engaged its
independent auditors to reaudit its 2000 and 2001 financial statements.
The results for interim periods are not necessarily indicative of the
results for the entire year. Specifically, Mirant has sold its investments in
Bewag and WPD, which contributed substantial earnings to the Company's
historical results of operations in the first and fourth fiscal quarters.
Certain prior-year amounts have been reclassified to conform with current-year
financial statement presentation.
Management believes that the accompanying unaudited condensed consolidated
financial statements as of June 30, 2002 and for the three and six months then
ended reflect adjustments, consisting of normal recurring items, necessary for a
fair presentation of results for those interim periods presented.
Accounting Changes. In July 2001, the FASB issued SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." These
pronouncements significantly change the accounting for business combinations,
goodwill and intangible assets. SFAS No. 141 establishes that all business
combinations will be accounted for using the purchase method; use of the
pooling-of-interests method is no longer allowed. The statement further
clarifies the criteria to recognize intangible assets separately from goodwill.
The provisions of SFAS No. 141 are effective for all business combinations
initiated after June 30, 2001 and for business combinations accounted for using
the purchase method for which the acquisition date was before July 1, 2001. SFAS
No. 142 addresses financial accounting and reporting for acquired goodwill and
other intangible assets and, generally, adopts a non-amortization and periodic
impairment-analysis approach to goodwill and indefinitely-lived intangibles.
SFAS No. 142 is effective for the Company's 2002 fiscal year or for business
combinations initiated after June 30, 2001. Mirant adopted these statements on
January 1, 2002.
Upon initial application of SFAS No. 141, Mirant reassessed the
classification of its intangible assets and determined that trading rights
resulting from business combinations did not meet the new criteria for
recognition apart from goodwill. Effective January 1, 2002, trading rights
related to business combinations were reclassified to goodwill as required by
the Statement. The reclassification increased goodwill by $194 million, net of
accumulated amortization of $18 million.
11
As a result of the adoption of SFAS No. 142, Mirant discontinued
amortization of goodwill effective January 1, 2002. During the first quarter of
2002, Mirant completed the transitional impairment test required by SFAS No. 142
and did not record any impairments of goodwill. Net income and earnings per
share (basic and diluted) for the three and six months ended June 30, 2001 have
been adjusted below to exclude amortization related to goodwill and trading
rights recognized in business combinations (in millions, except per share data).
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
--------------------------------- --------------------------------
Earnings Per Share Earnings Per Share
Net Income Basic Diluted Net Income Basic Diluted
---------- ------ ------- ---------- ----- -------
As reported..................................... $ 124 $ 0.36 $ 0.36 $ 304 $0.90 $ 0.88
Effect of goodwill and trading rights
Amortization.................................... 19 0.06 0.05 38 0.11 0.10
------- ------- ------ ------- ------ -------
As adjusted..................................... $ 143 $ 0.42 $ 0.41 $ 342 $1.01 $ 0.98
===== ======= ====== ====== ===== ======
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The provisions of SFAS No. 143
are effective for the Company's 2003 fiscal year. Mirant has not yet determined
the financial statement impact of this statement.
In October 2001, the FASB issued SFAS No. 144 which supersedes SFAS No.121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," and APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 amends
accounting and reporting standards for the disposal of segments of a business
and addresses various issues related to the accounting for impairments or
disposals of long-lived assets. Mirant adopted SFAS No. 144 on January 1, 2002.
Prior to SFAS No. 144, the disposition of State Line would not have been
classified as a discontinued operation. Because SFAS No. 144 expanded the
breadth of transactions subject to discontinued operations classification, the
disposition of State Line is now required to be presented as a discontinued
operation (Note J).
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to
recognize certain costs associated with exit or disposal activities when they
are incurred rather than at the date of a commitment to an exit or disposal
plan. Examples of costs covered by the standard include lease termination costs
and certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. The
provisions of SFAS No. 146 are effective for exit or disposal activities that
are initiated after December 31, 2002. Mirant will adopt SFAS No. 146 on January
1, 2003 and does not believe that it will have a material impact on its
financial statements.
In June 2002, the EITF reached consensus on certain issues related to EITF
Issue 02-3. The Task Force reached a consensus that gains and losses on energy
trading contracts (accounted for pursuant to SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended, and EITF Issue
98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management
Activities,") should be reported net in the statements of income. Upon
application of the consensus, comparative financial statements for prior periods
are required to be reclassified. The reclassification will not impact Mirant's
gross margin or net income, but rather will reduce equally, operating revenues
and cost of fuel, electricity and other products line items in the consolidated
statements of income.
12
In October 2002, the Task Force reached the following consensus related to
EITF Issue 02-3:
o EITF Issue 98-10 was rescinded. Accordingly, energy-related contracts
that are not accounted for pursuant to SFAS No. 133 such as
transportation contracts, storage contracts and tolling agreements,
should be accounted for as executory contracts using the accrual method
of accounting and not at fair value. Energy-related contracts that do
meet the definition of a derivative pursuant to SFAS No. 133 should
continue to be carried at fair value. Additionally, the Task Force
observed that accounting for energy-related inventory at fair value by
analogy to the consensus in EITF Issue 98-10 was no longer appropriate
and that such inventory should be carried at the lower of cost or
market in accordance with Accounting Research Bulletin ("ARB") No. 43,
"Restatement and Revision of Accounting Research Bulletins," and not at
fair value.
o The consensus reached is required to be applied prospectively to energy
trading contracts entered into after October 25, 2002.
Additionally, the consensus should be applied to all energy trading
contracts and energy related inventory that existed on October 25, 2002
in periods beginning after December 15, 2002. Changes to the accounting
for existing contracts as a result of the rescission of EITF
Issue 98-10 should be reported as a cumulative effect of a change in
accounting principle in accordance with APB 20. Changes in accounting
for energy-related inventory should also be reported as a cumulative
effect of a change in accounting principle in accordance with APB
Opinion No. 20, "Accounting Changes," unless information to calculate
the impact of the change is not available. In that case, the carrying
value of the energy-related inventory becomes the cost basis of the
inventory at the effective date.
o The Task Force also reached a consensus that its previous conclusion on
reporting gains and losses on derivatives in the statements of income
should be expanded to include all trading activities. That is, gains
and losses on any derivative contracts within the scope of SFAS No. 133
that are held for trading purposes should be reported net in the
statements of income. The original consensus on net reporting of gains
and losses on energy trading contracts is required for financial
statements for periods ending after July 15, 2002.
o The Task Force agreed to rescind its previous consensus on EITF Issue
02-3 that required additional disclosures for energy trading contracts
and activities and asked the FASB to reconsider the disclosures
required by SFAS No. 133.
Mirant estimates that the implementation of the EITF consensus in respect
of netting all revenues and expenses on energy trading activities, would have
reduced revenues and cost of fuel, electricity and other products by
approximately $5 billion and $10 billion for the three and six months ended June
30, 2002, respectively and approximately $6 billion and $13 billion for the
three and six months ended June 30, 2001, respectively.
The Company has not yet determined the impact of ceasing use of the fair
value (or mark-to-market) method of accounting for non-derivative energy trading
contracts and energy-related inventory held for trading purposes. The Company
currently has certain storage and transportation agreements accounted for under
the mark-to-market method of accounting under EITF 98-10, for which such
accounting will cease upon adoption of EITF 02-3. The Company does not have
long-term tolling agreements accounted for under the mark-to-market method of
accounting under EITF 98-10.
Concentration of Revenues and Credit Risk. For the three and six months ended
June 30, 2002, revenues earned from a single customer did not exceed 10% of
Mirant's total operating revenues. For the three and six months ended June 30,
2001, revenues earned from Enron through energy marketing and risk management
operations approximated 24% and 19%, respectively, of Mirant's total operating
revenues.
As of June 30, 2002, no amounts owed from a single customer represented
more than 10% of Mirant's total credit exposure. The Company's total credit
exposure is computed as total accounts and notes receivable, adjusted for energy
marketing and risk management and derivative hedging activities and netted
against offsetting payables and posted collateral, as appropriate.
13
Receivables Recovery. During the six months ended June 30, 2002, Mirant received
$29 million as final payment related to receivables that were assumed in
conjunction with the Mirant Asia-Pacific Limited business acquisition. During
the six months ended June 30, 2001, Mirant received $10 million related to these
receivables. At the time of the Mirant Asia-Pacific Limited business
acquisition, Mirant did not place value on the receivables due to the uncertain
credit standing of the party with whom the receivables were secured.
Capitalization of Interest Cost. Mirant capitalizes interest on projects during
the advanced stages of development and the construction period, in accordance
with SFAS No. 34, "Capitalization of Interest Cost," as amended by SFAS No. 58,
"Capitalization of Interest Cost in Financial Statements That Include
Investments Accounted for by the Equity Method." The Company determines which
debt instruments represent a reasonable measure of the cost of financing
construction assets in terms of interest cost incurred that otherwise could have
been avoided. These debt instruments and associated interest cost are included
in the calculation of the weighted average interest rate used for determining
the capitalization rate. Upon commencement of commercial operations of the plant
or project, capitalized interest, as a component of the total cost of the plant,
is amortized over the estimated useful life of the plant or the life of the
cooperation period of the various energy conversion agreements ("ECAs"). For the
three and six months ended June 30, 2002, the Company incurred $137 million and
$294 million, respectively, in interest costs, of which $30 million and $68
million, respectively, were capitalized and included in construction work in
process. For the three and six months ended June 30, 2001, the Company incurred
$154 million and $305 million, respectively, in interest costs, of which $11
million and $19 million were capitalized and included in construction work in
process. The remaining interest was expensed during the periods.
As part of Mirant's restructuring plan announced in March of 2002, Mirant
suspended construction on several projects and no longer capitalizes interest on
these projects. The construction cost related to these projects is shown as
"Investment in suspended construction" on the unaudited condensed consolidated
balance sheet.
B. Goodwill and Other Intangible Assets
During the six months ended June 30, 2002, goodwill was increased by $58
million related to purchase accounting adjustments for JPSCo. Management
currently believes there is no impairment of goodwill; however, Mirant's
announced asset sale program and the overall conditions impacting the energy
sector may materially impact the book value of goodwill in future periods. As of
June 30, 2002, the North America Group's goodwill was $2.01 billion and the
International Group's goodwill was $1.44 billion.
Substantially all of Mirant's other intangible assets are subject to
amortization. Other intangible assets are being amortized on a straight-line
basis over the related useful lives, up to 40 years. There were no material
acquisitions of intangible assets during the second quarter of 2002. Effective
January 1, 2002, trading rights related to business combinations were
reclassified to goodwill. The reclassification decreased other intangible assets
by $227 million, net of accumulated amortization of $18 million. These
provisions of SFAS No. 141 do not apply to asset acquisitions, therefore trading
rights resulting from asset acquisitions continue to be recognized apart from
goodwill. During the three and six months ended June 30, 2002, Mirant
transferred $0 and $36 million, net of accumulated amortization of $4 million,
in development rights to construction work in process. Intangible asset
amortization expense was approximately $6 million for the
14
second quarter and $13 million for the six months ended June 30, 2002. The
components of other intangible assets as of June 30, 2002 and December 31, 2001
were as follows (in millions):
June 30, 2002 December 31, 2001(as restated)
-------------------------------- -------------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
----------------- -------------- ----------------- -------------------
Trading rights................. .. $ 207 $ (31) $ 453 $ (45)
Development rights.............. 252 (9) 292 (9)
Emissions allowances............ 131 (6) 131 (4)
Other intangibles............... 50 (11) 59 (12)
--------- ---------- ---------- -------
Total other intangible assets. $ 640 $ (57) $ 935 $ (70)
======= ========= ======= ======
Assuming no future acquisitions, dispositions or impairments of intangible
assets, amortization expense is estimated to be $25 million for the year ended
December 31, 2002 and for each of the following four years.
C Comprehensive Income (Loss)
Comprehensive income (loss) includes unrealized gains and losses on certain
derivatives that qualify as cash flow hedges and hedges of net investments, as
well as the translation effects of foreign net investments. The following table
sets forth the comprehensive income (loss) for the three and six months ended
June 30, 2002 and 2001 (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- ----------------------
2002 2001 2002 2001
------------- ----------- ------------- --------
Net (loss) income................. $(220) $ 124 $ (226) $ 304
Other comprehensive income....... 27 441 37 50
--------- --------- ------------ --------
Comprehensive (loss) income...... $(193) $ 565 $ (189) $ 354
========= ========= =========== ========
Components of accumulated other comprehensive loss consisted of the following
(in millions):
Balance, December 31, 2001, as restated.............................. $ (112)
Other comprehensive income for the period:
Net change in fair value of derivative hedging instruments, net
of tax effect of $30............................................. 44
Reclassification to earnings, net of tax effect of $20 (Note G) (30)
Cumulative translation adjustment ................................. 22
Share of affiliates' OCI........................................... 1
--------------
Other comprehensive income........................................... 37
--------------
Balance, June 30, 2002......................................... $ (75)
==============
The $75 million balance of accumulated other comprehensive loss at June 30,
2002 includes the impact of $106 million related to interest rate hedges and
interest rate swap breakage costs and $96 million of foreign currency
translation losses, offset by $120 million of gains on commodity price
management hedges and $7 million representing Mirant's share of accumulated
other comprehensive income of unconsolidated affiliates.
Mirant estimates that $39 million ($62 million of commodity hedge gains,
$24 million of interest related losses and $1 million of currency gains) of net
derivative after-tax gains included in OCI as of June 30, 2002 will be
reclassified into earnings or otherwise settled within the next twelve months as
certain transactions relating to commodity contracts, foreign denominated
contracts and interest payments are realized.
15
D. Write-Down of Assets
As part of its strategic restructuring, Mirant sold its 49% ownership
interest in WPD in September 2002. As a result, Mirant recorded a write-down of
approximately $306 million, including $11 million of related income tax
benefits, during the second quarter of 2002 to reflect the difference between
the carrying value of its investment and its fair value. In the second quarter
of 2001, Mirant wrote off its remaining investment in EDELNOR of $88 million
($57 million after tax).
E. Earnings (Loss) Per Share
Mirant calculates basic earnings (loss) per share by dividing the income
(loss) available to common stockholders by the weighted average number of common
shares outstanding. The following table shows the computation of basic earnings
(loss) per share for the three and six months ended June 30, 2002 and 2001 (in
millions, except per share data). Diluted earnings (loss) per share gives effect
to stock options, as well as the assumed conversion of convertible trust
preferred securities and related after-tax interest expense addback to net
income of approximately $3 million for the three months ended June 30, 2001 and
$7 million for the six months ended June 30, 2001. Because of the net loss for
the three and six months ended June 30, 2002, the anti-dilution provisions of
SFAS No. 128, "Earnings per Share," preclude stating diluted loss per share
above basic loss per share.
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
(Loss) Income from continuing operations........... $(222) $ 123 $ (230) $ 292
Discontinued operations............................ 2 1 4 12
------- --------- ---------- -------
Net (loss) income.................................. (220) $ 124 $ (226) $ 304
------- ======== ========== =======
Basic
Weighted average shares outstanding ............... 401.9 340.1 401.5 339.4
(Loss) earnings per share from:
Continuing operations....................... $ (0.55) $ 0.36 $ (0.57) $ 0.86
Discontinued operations..................... 0.00 0.00 0.01 0.04
------- -------- ---------- ----------
Net (loss) income........................... $ (0.55) $ 0.36 $ (0.56) $ 0.90
========= ======= =========== =========
Diluted
Weighted average shares outstanding .............. 340.1 339.4
Shares due to assumed exercise of stock
options and equivalents ........................ 4.2 2.9
Shares due to assumed conversion of trust
preferred securities............................ 12.5 12.5
----- ------
Adjusted shares................................... 356.8 354.8
===== ======
(Loss) earnings per share from:
Continuing operations $ (0.55) $ 0.36 $ (0.57) $ 0.85
Discontinued operations 0.00 0.00 0.01 0.03
---------- -------- --------- --------
Net (loss) income $ (0.55) $ 0.36 $ (0.56) $ 0.88
========= ======== ========= =======
F. Debt
At June 30, 2002, Mirant and its subsidiaries had revolving credit
facilities with various lending institutions totaling approximately $3.20
billion of commitments. At June 30, 2002, commitment amounts utilized under such
facilities (including drawn amounts and letters of credit) totaled $2.26 billion
and were comprised of the following: commitments of $42 million drawn under the
facility expiring in 2002, commitments of $775 million drawn or utilized under
facilities expiring in 2003 (which included amounts outstanding under Mirant
Corporation's 364-Day Credit Facility with an initial termination date of July
2002) and commitments of $1.45 billion drawn or utilized under the facilities
expiring in 2004 and beyond. Under its $1.125 billion 364-Day Credit Facility,
Mirant Corporation elected in July 2002 to convert all revolving credit advances
16
outstanding into a term loan maturing not later than the first anniversary of
the termination date (See Note L - Subsequent Events). Except for the credit
facility of Mirant Canada Energy Marketing, an indirect, wholly owned subsidiary
of Mirant Corporation, borrowings under these facilities are recorded as
long-term debt in the accompanying unaudited condensed consolidated balance
sheets. The credit facilities generally require payment of commitment fees based
on the unused portion of the commitments. The schedule below summarizes the
revolving credit facilities held by Mirant Corporation and its subsidiaries as
of June 30, 2002 (in millions).
Utilized Amount Letters of
Facility Excluding Letters Credit Amount
Company Amount of Credit Outstanding Available
------------ ------------------- ------------- --------------
Mirant Corporation ................ $ 2,700 $ 925 $1,074 $ 701
Mirant Americas Generation......... 300 73 - 227
Mirant Canada Energy Marketing..... 46 42 - 4
Mirant Americas Energy Capital..... 150 150 - -
------------ ------------------- ------------- --------------
Total............................ $ 3,196 $ 1,190 $1,074 $ 932
============ =================== ============= ==============
Each of Mirant's credit facilities contain various covenants including,
among other things, (i) limitations on (a) dividends, redemptions and
repurchases of capital stock, (b) the incurrence of indebtedness and liens and
(c) limitations on the sale of assets, and (ii) affirmative covenants to (a)
provide annual audited and quarterly unaudited financial statements prepared in
accordance with US GAAP and (b) comply with legal requirements in the conduct of
its business. In addition to other covenants and terms, each of Mirant's credit
facilities includes minimum debt service coverage and a maximum leverage
covenant. As of June 30, 2002, there were no events of default under such credit
facilities.
In connection with its review of the previously disclosed accounting
issues, the Company identified various errors affecting the Company's historical
financial statements. The Company believes that the errors it has identified do
not constitute a breach of a covenant or an event of default under its credit
facilities. If the Company were in default, or the type or amount of any
adjustments arising from the announced reaudit of the Company's historical
financial statements were to result in an event of default under its credit
facilities, the lenders would have the right to accelerate the Company's
obligations under its credit facilities. Any such acceleration would trigger
cross-acceleration provisions in a substantial portion of the Company's other
consolidated indebtedness. In such event, the Company would be required to seek
waivers or other relief from its lenders and, absent such relief, approximately
$4.5 billion of the Company's consolidated debt would be classified as
short-term debt and could be accelerated. Further, in the event that its lenders
accelerated such indebtedness, the Company can provide no assurances that it
would be able to refinance such indebtedness in the existing credit markets and
would likely have to seek bankruptcy court or other protection from its
creditors.
Mirant Canada Energy Marketing has extended its credit facility to June 30,
2003. The revolving credit facility of approximately $46 million (denominated as
70 million Canadian dollars) had outstanding borrowings of $42 million, at an
interest rate of 4.06% at June 30, 2002. The credit facility is guaranteed by
Mirant Corporation and is secured by a letter of credit in the amount of $46
million and security interests in the real and personal property of Mirant
Canada Energy Marketing.
In February 2002, Mirant, Mirant Americas Energy Marketing, Perryville and
the lenders under its credit facility, entered into the following transactions:
(i) an indirect, wholly owned subsidiary of Mirant Corporation made a
subordinated loan of $48 million to Perryville, (ii) Mirant Corporation agreed
to guarantee the obligations of Mirant Americas Energy Marketing under the
tolling agreement, (iii) Perryville (with the consent of its lenders) and Mirant
Americas Energy Marketing lowered the ratings threshold in the tolling agreement
with respect to Mirant Corporation, relating to the ratings below which Mirant
Americas Energy Marketing agreed to post a letter of credit or other credit
support, and (iv) the parties agreed to certain additional terms in support of
the syndication of the credit facility. In June 2002, Mirant completed the sale
17
of its 50%ownership interest in Perryville to Cleco, which holds the remaining
50% ownership interest in Perryville. Cleco assumed Mirant's $13 million future
equity commitment to Perryville and paid approximately $55 million in cash to
Mirant as repayment of its subordinated loan, invested capital to date and other
miscellaneous costs. In connection with the existing project financing, Mirant
agreed to make a $25 million subordinated loan to the project. In addition,
Mirant retains certain obligations as a project sponsor, some of which are
subject to indemnification by Cleco. Effective August 23, 2002, Mirant Americas
Energy Marketing and Perryville, with the consent of the project lenders,
restructured the tolling agreement between the parties to remove the requirement
to post a letter of credit or other credit support in the event of a downgrade
from S&P or Moody's. In connection with the restructuring, Mirant Americas made
a $100 million subordinated loan to Perryville, the proceeds of which were used
to repay the existing $25 million subordinated loan owed to a Mirant subsidiary
and to repay $75 million of senior debt of the project. In addition, Mirant
Americas guaranteed the obligations of Mirant Americas Energy Marketing under
the tolling agreement up to the amount of the subordinated loan. The obligations
of Mirant Americas Energy Marketing under the tolling agreement continue to be
guaranteed by Mirant Corporation.
West Georgia Generating Company, LLC ("West Georgia"), a wholly owned
subsidiary acquired by Mirant in August 2001, has an approximately $144 million
project finance credit facility ($144 million drawn balance at June 30, 2002).
Under the terms of that credit facility, West Georgia is required to deliver
audited financial statements to the lenders thereunder within 120 days of fiscal
year end. On May 24, 2002, within the thirty day cure period under the credit
agreement, the agent under the credit facility extended the period for delivery
of such audited financial statements until the end of July. In July 2002, the
required audited financial statements were delivered to the lenders as required
under the terms of the credit facility.
In February 2002, Mirant completed the sale of its 44.8% indirect interest
in Bewag for approximately $1.63 billion. Mirant received approximately $1.06
billion in net proceeds after repayment of approximately $550 million in related
debt. The net proceeds were used for general corporate purposes, capital
expenditures and repayment of certain drawn balances on revolving credit
facilities.
In March 2002, Mirant Americas Energy Capital transferred the borrowing
base assets under its credit facility to a special purpose vehicle and granted
security interests in such assets. The special purpose vehicle is consolidated
with Mirant.
As part of its strategic restructuring, Mirant negotiated certain deferrals
under its equipment purchase facility. Because the term of the deferred
fabrication period for certain turbines exceeds the agreed fabrication period as
permitted within the equipment procurement facilities, the Company will not have
the option to enter into a lease arrangement for this equipment, thereby forcing
Mirant to exercise its purchase option. Consequently, Mirant has included a $35
million liability for these turbines in "Other long-term debt" on its unaudited
condensed consolidated balance sheet.
On January 23, 2002, Mirant Asia-Pacific, an indirect, wholly owned
subsidiary of Mirant Corporation, borrowed $192 million under a new credit
facility to repay, in part, its prior $792 million credit facility. The
repayment of the balance of the prior credit facility was funded by Mirant
Corporation. In March 2002, Mirant Asia-Pacific secured a second tranche of $62
million which has been used to repay part of the funding from Mirant
Corporation. The new credit facility contains various business and financial
covenants including, among other things, (i) limitations on dividends and
distributions, including a prohibition on dividends if Mirant ceases to be rated
investment grade by at least two of Fitch, S&P and Moody's, (ii) mandatory
prepayments upon the occurrence of certain events, including certain asset sales
and certain breaches of the Sual and the Pagbilao energy conversion agreements,
(iii) limitations on the ability to make investments and to sell assets, (iv)
limitations on transactions with affiliates of Mirant and (v) maintenance of
minimum debt service coverage ratios. As a result of the recent downgrades by
Fitch and S&P, Mirant Asia-Pacific is prohibited under the terms of its credit
facility from making distributions to Mirant Corporation.
18
Each of the lenders under the Sual and Pagbilao facilities has executed
temporary waivers of default with respect to the obligations to provide specific
levels of insurance coverage which extend to the insurance renewal date of
November 1, 2002. Effective as of October 24 and 28, 2002 for the Sual and
Pagbilao facilities, respectively, each of the lenders has agreed to amend the
insurance provisions of the loan agreements. The amendments state that, in the
event Sual and Pagbilao do not obtain the levels of insurance specified in the
loan agreements, Sual and Pagbilao will not be held in breach of the agreements
provided they obtain all of the insurance coverage that is reasonably available
and commercially feasible in the insurance market for similarly situated
facilities, as certified by the lenders' insurance advisor. To avoid breaching
the agreements, the coverage obtained must further be in amounts above threshold
levels defined in the amendments. The Company believes that with these
amendments (and the levels of minimum thresholds defined in the amendments) it
will be able to obtain insurance coverage in the future that will allow it to
remain in continued compliance with the loan agreements. The insurance coverage
obtained for the November 1, 2002 renewal satisfies the amended terms of the
loan agreements.
G. Financial Instruments
Energy Marketing and Risk Management Activities
Mirant provides energy marketing and risk management services to its
customers in the North American markets. These services are provided through a
variety of exchange-traded and OTC energy and energy-related contracts, such as
forward contracts, futures contracts, option contracts and financial swap
agreements.
These contractual commitments are presented as energy marketing and risk
management assets and liabilities in the accompanying unaudited condensed
consolidated balance sheets and are accounted for using the mark-to-market
method of accounting in accordance with SFAS No. 133, and EITF No. 98-10.
Accordingly, they are reflected at fair value in the accompanying
unaudited condensed consolidated balance sheets. The net changes in their market
values are recognized in income in the period of change. Attention is drawn to
"Accounting Changes" in Note A - Accounting and Reporting Policies, where the
EITF reached consensus on certain issues related to EITF Issue 02-3, under
EITF Issues No. 98-10 and No. 00-17, 'Measuring the Fair Value of Energy-Related
Contracts in Applying Issue No. 98-10.'" EITF Issues No. 98-10 and No. 00-17
address various aspects of the accounting for contracts involved in energy
trading and risk management activities(See Note A).
The Company, through its energy marketing and risk management operations,
engages in risk management activities with counterparties. All such transactions
and related expenses are recorded on a trade-date basis. Financial instruments
and contractual commitments related to these activities are accounted for using
the mark-to-market method of accounting. Under the mark-to-market method of
accounting, financial instruments and contractual commitments are recorded at
fair value in the accompanying unaudited condensed consolidated balance sheets.
The determination of fair value considers various factors, including closing
exchange or over-the-counter market price quotations, time value and volatility
factors underlying options and contractual commitments.
During the first quarter of 2002, Mirant substantially exited its European
trading and marketing business. The volumetric weighted average maturity, or
weighted average tenor of the North American portfolio, at June 30, 2002 was 3.3
years. The net notional amount, or net open position, of the energy marketing
and risk management assets and liabilities at June 30, 2002 was approximately 3
million equivalent megawatt-hours. The notional amount is indicative only of the
volume of activity and not of the amount exchanged by the parties to the
financial instruments. Consequently, these amounts are not a measure of market
risk.
19
Certain financial instruments that Mirant uses to manage risk exposure to
energy prices for its North American generation portfolio do not meet the hedge
criteria under SFAS No. 133 and therefore, the fair values of these instruments
are included in energy marketing and risk management assets and liabilities in
the accompanying unaudited condensed consolidated balance sheets.
The fair values and average values of Mirant's energy marketing and risk
management assets and liabilities as of June 30, 2002, net of credit reserves,
are included in the following table (in millions). The average values are based
on a monthly average for 2002.
Energy Marketing and Risk Energy Marketing and Risk
Management Assets Management Liabilities
---------------------------- -----------------------------
Average Value at Average Value at
Value June 30, 2002 Value June 30, 2002
-------------- -------------- -------------- -------------
Energy commodity instruments:
Electricity..................... $ 503 $ 492 $ 403 $ 389
Natural gas..................... 1,033 1,306 1,148 1,347
Crude oil....................... 11 19 11 18
Other........................... 36 24 36 22
---------- -------------- ------------- --------------
Total......................... 1,583 1,841 1,598 1,776
========== ============== ============= ==============
In October 2001, the Company entered into a prepaid gas transaction with a
counterparty and a simultaneous natural gas swap with a third-party independent
to the prepaid gas transaction. The prepaid gas transaction resulted in the
receipt of payments in 2001 in exchange for financial settlements to be made
over a future three-year period. Approximately 10% of the contract notional
quantity will settle in 2002 and 2003, respectively, and the remaining 80% will
settle in 2004 based on fixed notional quantities of gas defined in the
agreement at natural gas index prices on the date of each settlement. The
natural gas swap served to fix the price of the gas to be settled under the
prepaid gas agreement. At the date the transaction was consummated, the notional
fixed future natural gas settlements totaled approximately $250 million and the
fair value of such gas settlements was approximately $225 million. Since this
transaction results in fixed payments through 2004 and no market price risk to
the Company, its impact has been disclosed separately above.
Derivative Hedging Instruments
Mirant uses derivative instruments to manage exposures arising from changes
in interest rates, commodity prices and foreign currency exchange rates.
Mirant's objectives for holding derivatives are to minimize these risks using
the most effective methods to eliminate or reduce the impacts of these
exposures.
Derivative gains and losses arising from cash flow hedges that are included
in OCI are reclassified into earnings in the same period as the settlement of
the underlying transaction. After-tax derivative net losses of $3 million and
net gains of $30 million during the three and six months ended June 30, 2002,
respectively, were reclassified as follows (in millions):
Three Months Six Months
Ended June 30, Ended June 30,
2002 2002
------------------ -----------------
Reclassified to operating income....... $ 6 $ 71
Reclassified to interest expense....... (10) (21)
Tax benefit (provision)................ 1 (20)
------- --------
Net reclassification to earnings (Note C) $ (3) $ 30
======= ========
The derivative gains and losses reclassified to earnings were partly offset
by realized gains and losses arising from the settlement of the underlying
physical transactions being hedged. Under SFAS No. 133, transactions may meet
the requirements for hedge treatment but may be less than 100% effective. For
example, a derivative instrument specifying one commodity delivery location may
be used to hedge a risk at a different commodity delivery location. The price
differential between the two locations is considered the ineffective portion of
the hedge. Any changes in the fair value of the ineffective portion must be
recorded currently in earnings. During the three and six months ended June 30,
2002, an immaterial amount of pre-tax gains and $8 million of pre-tax losses
arising from hedge ineffectiveness were recognized in other expense. The maximum
term over which Mirant is hedging exposures to the variability of cash flows is
through 2012.
Interest Rate Hedging
Mirant's policy is to manage interest expense using a combination of fixed-
and variable-rate debt. To manage this mix in a cost-efficient manner, Mirant
enters into interest rate swaps in which it agrees to exchange, at specified
intervals, the difference between fixed- and variable-interest amounts
calculated by reference to agreed-upon notional principal amounts. These swaps
20
are designated to hedge underlying debt obligations. For qualifying hedges, the
changes in the fair value of gains and losses of the swaps are deferred in OCI,
net of tax, and the interest rate differential is reclassified from OCI to
interest expense as an adjustment over the life of the swaps. Gains and losses
resulting from the termination of qualifying hedges prior to their stated
maturities are recognized ratably over the original remaining life of the
hedging instrument, provided the underlying hedged transactions are still
probable. Otherwise, the gains and losses will be recorded currently in
earnings.
Commodity Price Hedging
Mirant enters into commodity financial instruments and other contracts in
order to hedge its exposure to market prices for electricity expected to be
produced by its generation assets. These contracts are primarily physical
forward sales but may also include options and other financial instruments.
Mirant also uses commodity financial instruments and other contracts to hedge
its exposure to market prices for natural gas, coal and other fuels expected to
be utilized by its generation assets. These contracts primarily include futures,
options, and swaps. Where these contracts are derivatives and are designated as
cash flow hedges, the gains and losses are deferred in OCI and are then
recognized in earnings in the same period as the settlement of the underlying
physical transaction.
At June 30, 2002, Mirant had a net commodity derivative hedging asset of
approximately $182 million. The fair value of its commodity derivative hedging
instruments is determined using various factors, including closing exchange or
over-the-counter market price quotations, time value and volatility factors
underlying options and contractual commitments.
At June 30, 2002, these contracts relate to periods through 2010. The net
notional amount, or net open position, of the derivative hedging instruments at
June 30, 2002 was 9 million equivalent megawatt-hours. The notional amount is
indicative only of the volume of activity and not of the amount exchanged by the
parties to the financial instruments. Consequently, this amount is not a measure
of market risk.
Power sales agreements and other contracts that are used to mitigate
exposure to commodity prices but which either do not meet the definition of a
derivative or are excluded under certain exceptions under SFAS No. 133 are not
included in derivative hedging instruments in the accompanying unaudited
condensed consolidated balance sheets.
Foreign Currency Hedging
From time to time, Mirant uses cross-currency swaps and currency forwards
to hedge its net investments in certain foreign subsidiaries. Gains or losses on
these derivatives designated as hedges of net investments are reflected in OCI,
net of tax, and net of the translation effects.
Mirant also utilizes currency forwards intended to offset the effect of
exchange rate fluctuations on forecasted transactions arising from contracts
denominated in a foreign currency. From time to time, Mirant utilizes
cross-currency swaps that offset the effect of exchange rate fluctuations on
foreign currency denominated debt and fixes the interest rate exposure. Certain
other assets are exposed to foreign currency risk. Mirant designates currency
forwards as hedging instruments used to hedge the impact of the variability in
exchange rates on accounts receivable denominated in certain foreign currencies.
When these hedging strategies qualify as cash flow hedges, the gains and losses
on the derivatives are deferred in OCI, net of tax, until the forecasted
transaction affects earnings. The reclassification is then made from OCI to
earnings to the same revenue or expense category as the hedged transaction.
21
Interest Rate and Currency Derivatives
The interest rates noted in the following table represent the range of
fixed interest rates that Mirant pays on the related interest rate swaps. On
virtually all of these interest rate swaps, Mirant receives floating interest
rate payments at LIBOR. The currency derivatives mitigate Mirant's exposure
arising from certain foreign currency transactions, such as cross border sales
and foreign equity investments.
Year of Maturity Number of Notional Unrealized
Type or Termination Interest Rates Counterparties Amount (Loss) Gain
--------------------------- -------------------- ---------------- -------------------- ------------ ------------------
(in millions)
Interest rate swaps.... 2003-2012 3.85%-7.12% 3 $549 $ (48)
Currency forwards...... 2002-2004 -- 3 1CAD163 (1)
2003 -- 1 (pound)58 (8)
2002-2003 -- 1 2$13 1
-----------
$ (56)
==========
(pound) - Denotes British pounds sterling
CAD - Denotes Canadian dollar
1 CAD contracts with a notional amount of CAD153 million are included in fair
value of energy marketing and risk management liabilities because hedge
accounting criteria are not met. 2 USD based contracts are utilized by a foreign
subsidiary to hedge U.S. dollar denominated sales contracts.
The unrealized gain/loss for interest rate swaps is determined based on
the estimated amount that Mirant would receive or pay to terminate the swap
agreement at the reporting date based on third-party quotations. The
unrealized gain/loss for currency forwards is determined based on current
foreign exchange rates.
H. Business Developments
Asset Sales
In February 2002, Mirant completed the sale of its 44.8% indirect interest
in Bewag for approximately $1.63 billion. Mirant received approximately $1.06
billion in net proceeds after repayment of approximately $550 million in related
debt. The after-tax gain on the sale of Mirant's investment in Bewag was $167
million. The net proceeds were used for general corporate purposes, capital
expenditures and repayment of certain drawn balances on revolving credit
facilities.
In May 2002, Mirant completed the sale of its 60% ownership interest in the
750 MW Kogan Creek power project, located near Chinchilla in southeast
Queensland, Australia, and associated coal deposits for approximately $29
million. The after-tax gain on the sale of Mirant's investment in Kogan Creek
was approximately $17 million.
In May 2002, Mirant completed the sale of its 9.99% ownership interest in
SIPD, located in the Shandong Province, China, for approximately $120 million.
The after-tax loss on the sale of Mirant's investment in SIPD was approximately
$9 million.
In June 2002, Mirant completed the sale of its State Line generating
facility for approximately $181 million plus an adjustment for working capital.
The asset was sold at approximately book value.
In June 2002, Mirant completed the sale of its 50% ownership interest in
Perryville to Cleco, which holds the remaining 50% ownership interest in
Perryville. Cleco assumed Mirant's $13 million future equity commitment to
Perryville and paid approximately $55 million in cash to Mirant as repayment of
its subordinated loan, invested capital to date and other miscellaneous costs.
22
The investment was sold at approximately book value based on the value of the
investment at the date of sale. At such time, in connection with the existing
project financing, Mirant agreed to make a $25 million subordinated loan to the
project. In addition, Mirant retains certain obligations as a project sponsor,
some of which are subject to indemnification by Cleco. The obligations retained
by Mirant and not subject to indemnity relate primarily to the existing 20-year
tolling agreement with Mirant Americas Energy Marketing as described in Note I.
Effective August 23, 2002, Mirant Americas Energy Marketing and Perryville, with
the consent of the project lenders, restructured the tolling agreement between
the parties to remove the requirement to post a letter of credit or other credit
support in the event of a downgrade from S&P or Moody's. In connection with the
restructuring, Mirant Americas made a $100 million subordinated loan to
Perryville, the proceeds of which were used to repay the existing $25 million
subordinated loan owed to a Mirant subsidiary and to repay $75 million of senior
debt of the project. In addition, Mirant Americas guaranteed the obligations of
Mirant Americas Energy Marketing under the tolling agreement up to the amount of
the subordinated loan. The obligations of Mirant Americas Energy Marketing under
the tolling agreement are guaranteed by Mirant Corporation.
Commencement of Operation
In June 2002, the Ilijan facility located in the Philippines, in which
Mirant has a 20% ownership interest, commenced commercial operations.
Restructuring Charge
As a result of changing market conditions including constrained access to
capital markets attributable primarily to the Enron bankruptcy and Moody's
December 2001 downgrade of Mirant's credit rating, Mirant adopted a plan to
restructure its operations by exiting certain business operations (including its
European trading and marketing business), canceling and suspending planned power
plant developments, closing business development offices and severing employees.
During the three and six months ended June 30, 2002, Mirant recorded pre-tax
restructuring charges of $28 million and $590 million, respectively.
During the three and six months ended June 30, 2002, Mirant recorded the
following components of the restructuring charge, respectively (in millions):
Three Months Six Months Ended
Ended June 30, June 30, 2002
2002*
------------------ ------------------
Write-downs of capital previously invested, either directly into
Construction or in progress payments on equipment........... $ -- $ 285
Costs to cancel equipment orders and service agreements per
Contract terms.............................................. -- 246
Severance of approximately 500 employees worldwide and other
Employee termination-related charges ....................... 26 57
Costs incurred to suspend construction projects in progress.... 2 2
---------- ---------
Total ..................................................... $ 28 $ 590
======== ======
* Net of adjustments
Mirant anticipates that it will record additional pre-tax restructuring
charges of approximately $90 million in future periods, primarily over the next
two quarters. These costs are associated with the cancellation of additional
power plant developments, additional employee severance and related costs to be
incurred in the near future. As of June 30, 2002, Mirant has terminated 451
employees as part of its restructuring. At June 30, 2002, Mirant's restructuring
accrual balance was approximately $247 million. During the three months ended
June 30, 2002, Mirant adjusted the accrual as a result of revisions to
restructuring estimates (primarily relating to severance for U.S. expatriates,
European office closures and pension costs) and utilized the accrual as
summarized in the following table. Mirant made net adjustments to the accrual
balance of less than $1 million that offset the original restructuring expense.
Balance at Adjustments' P&L Impact Balance at
March 31, 2002 Increases Decreases Utilization June 30, 2002
------------------------------------------------------------------
(in millions)
Costs to cancel equipment and projects....... $256 $ -- $ -- $(22) $234
Costs to sever employees and other
Employee-termination related costs........ 24 10 (10) (11) 13
------------------------------------------------------------------
Total1................................... $280 $10 $(10) $(33) $247
==================================================================
1Beginning accrual balance includes $13 million of long-term accruals
previously included in other long-term liabilities at March 31, 2002, that
were reclassified as short-term accruals during the second quarter.
23
I. Commitments and Contingent Matters
Litigation and Other Contingencies
With respect to each of the following matters, the Company cannot
currently determine the outcome of the proceedings or the amounts of any
potential losses from such proceedings. Refer to Note L - Subsequent Events for
recent litigation and other contingencies occurring after June 30, 2002.
Western Power Markets Investigations: Several governmental entities have
launched investigations into the western power markets, including activities by
Mirant and several of its wholly owned subsidiaries. Those governmental entities
include the FERC, the U.S. Department of Justice, the CPUC, the California
Senate, the California State Auditor, California's Electricity Oversight Board,
the General Accounting Office of the U.S. Congress, the San Joaquin District
Attorney and the Attorney General's offices of Washington, Oregon and
California. These investigations, some of which are civil and some criminal,
have resulted in the issuance of civil investigative demands, subpoenas,
document requests, requests for admission, and interrogatories directed to
several of Mirant's entities. In addition, the CPUC has had personnel onsite on
a periodic basis at Mirant's California generating facilities since December
2000. Each of these civil investigative demands, subpoenas, document requests,
requests for admission, and interrogatories, as well as the plant visits, could
impose significant compliance costs on Mirant or its subsidiaries. Despite the
various measures taken to protect the confidentiality of sensitive information
provided to these agencies, there remains a risk of governmental disclosure of
the confidential, proprietary and trade secret information obtained by these
agencies throughout this process.
In September 2002, the CPUC issued a report that purported to show that on
days in the fall of 2000 through the spring of 2001 during which the CAISO had
to declare a system emergency requiring interruption of interruptible load or
imposition of rolling blackouts, Mirant and the other four out of state
purchasers of generation in California had generating capacity that either was
not operated or was out of service due to an outage and that could have avoided
the problem if operated. The report identified two specific days on which Mirant
allegedly had capacity available that was not used or that was on outage and
that if operated could have avoided the system emergency. Mirant has publicly
responded to the report pointing out a number of material inaccuracies and
errors that it believes cause the CPUC's conclusions to be wrong with respect to
Mirant.
California Attorney General Litigation: On March 11, 2002, the California
Attorney General filed a civil suit against Mirant and several of its wholly
owned subsidiaries in San Francisco Superior Court. The lawsuit alleges that
between 1998 and 2001 the companies effectively double-sold their capacity by
selling both ancillary services and energy from the same generating units, such
that if called upon, the companies would have been unable to perform their
contingent obligations under the ancillary services contracts. The California
Attorney General claims that this alleged behavior violated both the tariff of
the CAISO and, more importantly, the California Unfair Competition Act. The suit
seeks both restitution and penalties in unspecified amounts. Mirant removed this
suit to United States District Court for the Northern District of California.
This suit has been consolidated for joint administration with the California
Attorney General suits filed on April 9, 2002, and April 15, 2002. Mirant has
filed a motion seeking dismissal of the claims.
On March 20, 2002, the California Attorney General filed a complaint with
the FERC against certain power marketers and their affiliates, including Mirant
and several of its wholly owned subsidiaries, alleging that market-based sales
of energy made by such generators were in violation of the Federal Power Act
because such transactions were not appropriately filed with the FERC. The
24
complaint requests, among other things, refunds for any prior short-term sales
of energy that are found to not be just and reasonable along with interest on
any such refunded amounts. On May 31, 2002, the FERC issued an order dismissing
the California Attorney General's complaint, and the FERC denied the California
Attorney General's request for rehearing on September 23, 2002. The California
Attorney General has appealed that dismissal to the United States Court of
Appeals for the Ninth Circuit.
On April 9, 2002, the California Attorney General filed a second civil suit
against Mirant and several of its wholly owned subsidiaries in San Francisco
Superior Court. The lawsuit alleges that the companies violated the California
Unfair Competition Act by failing to properly file their rates, prices, and
charges with the Federal Energy Regulatory Commission as required by the Federal
Power Act, and by charging unjust and unreasonable prices in violation of the
Federal Power Act. The complaint seeks unspecified penalties, costs and attorney
fees. Mirant removed this suit to United States District Court for the Northern
District of California. This suit has been consolidated for joint administration
with the California Attorney General suits filed on March 11, 2002 and April 15,
2002. Mirant has filed a motion seeking dismissal of the claims.
On April 15, 2002, the California Attorney General filed a third civil
lawsuit against Mirant and several of its wholly owned subsidiaries in the U.S.
District Court for the Northern District of California. The lawsuit alleges that
Mirant's acquisition and possession of its Potrero and Delta power plants has
substantially lessened, and will continue to substantially lessen, competition
in violation of the Clayton Act and the California Unfair Competition Act. The
lawsuit seeks equitable remedies in the form of divestiture of the plants and
injunctive relief, as well as monetary damages in unspecified amounts to include
disgorgement of profits, restitution, treble damages, statutory civil penalties
and attorney fees. This suit has been consolidated for joint administration with
the California Attorney General suits filed on March 11, 2002 and April 9, 2002.
Mirant has filed a motion seeking dismissal of the claims.
Defaults by SCE and Pacific Gas and Electric, and the Bankruptcies of Pacific
Gas and Electric and the PX: On January 16 and 17, 2001, the credit and debt
ratings of SCE and Pacific Gas and Electric were lowered by Moody's and S&P to
"junk" status. On January 16, 2001, SCE suspended indefinitely certain payment
obligations to the PX and to the CAISO. Pacific Gas and Electric similarly
suspended payments. The failure of SCE and Pacific Gas and Electric to make
these payments prevented the PX and CAISO from making payments to Mirant. As of
June 30, 2002, the total amount owed to Mirant by the CAISO and the PX as a
result of these defaults was $352 million. During 2000 and 2001, Mirant took
provisions in relation to these and other uncertainties arising from the
California power markets of $295 million pre-tax.
On March 9, 2001, as a result of the nonpayments of SCE and Pacific Gas and
Electric, the PX ceased operation and filed for bankruptcy protection. Mirant
Americas Energy Marketing was appointed as a member of the official Participants
Committee in the PX bankruptcy proceeding. The PX's ability to repay its debt is
directly dependent on the extent to which it receives payment from Pacific Gas
and Electric and SCE and on the outcome of its litigation with the California
State government.
On April 6, 2001, Pacific Gas and Electric filed a voluntary petition under
Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of California in San Francisco. It is not known at this time
what effect the bankruptcy filing will have on the ultimate recovery of amounts
owed to Mirant. On September 20, 2001, Pacific Gas and Electric filed a proposed
plan of reorganization. Subsequently the CPUC proposed a competing plan.
Although the plans differ in material respects, each contemplates payment of one
hundred percent of all approved claims. Regardless of which plan gets approved,
Mirant does not expect any payment to be made to it for power sold by it into
the PX or CAISO markets and repurchased by Pacific Gas and Electric until the
FERC issues a final ruling in the Western Power Markets Price Mitigation and
Refund Proceedings.
On March 1, 2002, SCE paid approximately $870 million to the PX in
satisfaction of all claims of or through the PX and the CAISO through
approximately January 18, 2001. The PX is not expected to make any payment to
25
Mirant until the bankruptcy judge so orders, and the judge is not expected to
rule until after the FERC issues a final ruling in the refund proceeding. Mirant
cannot now determine the timing of such payment or the extent to which such
payment would satisfy its claims.
RMR Agreements: Mirant's subsidiaries acquired generation assets from Pacific
Gas and Electric in April 1999, subject to RMR agreements. These agreements
allow the CAISO, under certain conditions, to require certain of Mirant's
subsidiaries to run the acquired generation assets in order to support the
reliability of the California electric transmission system. Under the RMR
agreements, Mirant recovers a portion of the annual fixed revenue requirement
(the "Annual Requirement") of the generation assets through fixed charges to the
CAISO, and Mirant depends on revenues from sales of the output of the units at
market prices to recover the remainder. The portion of the Annual Requirement
that can be recovered through fixed charges to the CAISO is subject to the
FERC's review and approval both as to the percentage and the amount of the
Annual Requirement to which the percentage is applied.
Mirant assumed the RMR agreements from Pacific Gas and Electric prior to the
outcome of a FERC proceeding initiated in October 1997 (the "Fixed Portion
Proceeding"). The Fixed Portion Proceeding will determine the percentage to be
paid to Mirant by the CAISO under the RMR agreements of a $159 million Annual
Requirement that was in effect through December 31, 2001, as well as any future
Annual Requirement in effect through the final disposition of the Fixed Portion
Proceeding. This $159 million Annual Requirement was negotiated as part of a
prior settlement of a FERC rate proceeding. In the Fixed Portion Proceeding,
Mirant contended that the amount paid by the CAISO should reflect an allocation
based on the CAISO's right to call on the units (as defined by the RMR
agreements) and the CAISO's actual calls, which would have resulted in the CAISO
paying approximately $120 million, or 75% of the settled Annual Requirement in
effect through December 31, 2001. Mirant currently collects 50% of the Annual
Requirement from the CAISO, which charges are subject to refund once the FERC
determines the percentage of the Annual Requirement that should be recovered by
Mirant from the CAISO. The decision in the Fixed Portion Proceeding will affect
the amount the CAISO will pay to Mirant for the period from June 1, 1999 through
the final disposition of the Fixed Portion Proceeding, including any appeals. On
June 7, 2000, the administrative law judge ("ALJ") in the Fixed Portion
Proceeding issued an initial decision providing for the CAISO to pay
approximately 3% of the Annual Requirement to Mirant. On July 7, 2000, Mirant
appealed the ALJ's decision and the matter is pending at the FERC.
In the Fall of 2001, Mirant filed with the FERC to increase the Annual
Requirement for the generating assets subject to the RMR agreements from the
$159 million amount that had been in effect to $199 million. That increase took
effect January 1, 2002, subject to refund of any amount that the FERC may
determine in a proceeding (the "Annual Requirement Proceeding") separate from
the Fixed Portion Proceeding to be in excess of just and reasonable rates. The
CAISO and Pacific Gas and Electric, which buys from the CAISO the electricity
sold to the CAISO by Mirant under the RMR agreements, have contested the
increase in the Annual Requirement at the FERC. The parties have reached a
settlement agreement in principle regarding the increase in the Annual
Requirement. Once all the details of the settlement agreement have been
finalized, the agreement will be filed with the FERC for its approval. If
finalized and approved by the FERC, the settlement agreement in principle would
result in refunds being made by Mirant of a portion of the Annual Requirement
currently being collected by Mirant. Mirant expects that the amount of such
refunds would not vary materially from the amounts currently being reserved by
Mirant with respect to the Annual Requirement issue. The percentage that
ultimately results from the Fixed Portion Proceeding, discussed above, will be
applied to the Annual Requirement for 2002 in the Annual Requirement Proceeding.
Mirant has also exercised its right under the RMR agreements to recover
100% of the Annual Requirement specific to the Potrero plant through fixed
charges to the CAISO beginning January 1, 2002. The Annual Requirement of the
Potrero plant constitutes $35 million of the total $199 million Annual
Requirement currently in effect for 2002, subject to refund as subsequently
26
determined in the Annual Requirement Proceeding. As part of their challenge to
the increase in the Annual Requirement in the Annual Requirement Proceeding,
discussed above, the CAISO and Pacific Gas and Electric have contested the
increase in the Annual Requirement for the Potrero plant. This issue is also
part of the settlement agreement in principle that has been reached by the
parties.
If Mirant is unsuccessful in its appeal of the ALJ's decision in the Fixed
Portion Proceeding, it will be required to refund certain amounts of the Annual
Requirement paid by the CAISO for the period from June 1, 1999 through the final
disposition of the appeal. If the challenges filed by the CAISO and Pacific Gas
and Electric in the Annual Requirement Proceeding to the increases in the Annual
Requirement for the generating assets are successful or if the settlement
agreement in principle is finalized and approved by the FERC, Mirant will be
required to refund certain additional amounts of the Annual Requirement paid by
the CAISO for the period from January 1, 2002 until the final determination of
the appropriate Annual Requirement for those generating assets or until final
approval of the settlement agreement in principle. Mirant estimates that the
amount of these refunds from both the Fixed Portion Proceeding and the Annual
Requirement Proceeding, as of June 30, 2002, would have been approximately $267
million. This amount does not include interest that may be payable in the event
of a refund. If resolution of the Fixed Portion Proceeding and Annual
Requirement Proceeding results in refunds of that magnitude, no effect on net
income for the periods under review would result as adequate reserves have been
recorded. If Mirant is unsuccessful in its appeal of the ALJ's initial decision
in the Fixed Portion Proceeding, Mirant plans to pursue other options available
under the RMR agreements to mitigate the impact of the ALJ's decision upon its
future operations.
Western Power Markets Price Mitigation and Refund Proceedings: On June 19, 2001,
the FERC issued an order that provides for price mitigation in all hours in
which power reserves fall below 7%. During these emergency hours, the FERC will
use a formula based on the marginal costs of the highest cost generator called
on to run to determine the overall market clearing price. This price mitigation
includes all spot market sales in markets throughout the Western System
Coordinating Council. This price mitigation was implemented on June 20, 2001 and
was in effect until July 11, 2002, at which time the formula was replaced by a
hard cap of $91.87/MWh, which was in place until October 30, 2002. The FERC
requires that all public and non-public utilities which own or control
non-hydroelectric generation in California must offer power in the CAISO's spot
markets, to the extent the output is not scheduled for delivery in the hour.
On July 25, 2001, the FERC issued an order requiring hearings to determine
the amount of any refunds and amounts owed for sales made to the CAISO/PX from
October 2, 2000 through June 20, 2001. The administrative law judge has
concluded evidentiary hearings in this proceeding, and the parties are awaiting
the issuance of an initial decision by that administrative law judge. In
addition, parties have appealed the FERC's June 19, 2001 and July 25, 2001
orders to the United States Court of Appeals for the Ninth Circuit, seeking
review of various issues, including expanding the potential refund date to
include periods prior to October 2, 2000. Any such expansion of the refund
period could significantly increase Mirant's refund exposure in this proceeding.
In response to an order by the Ninth Circuit allowing the California parties to
include additional evidence in the record regarding purported market
manipulation, on September 6, 2002, the California parties filed a motion for
additional discovery in the refund case on the issue of purported market
manipulation. That motion is pending with the FERC.
In the July 25, 2001 order, the FERC also ordered that a preliminary
evidentiary proceeding be held to develop a factual record on whether there have
been unjust and unreasonable charges for spot market bilateral sales in the
Pacific Northwest from December 25, 2000 through June 20, 2001. In the
proceeding, the DWR filed to recover certain refunds from parties, including one
of Mirant's subsidiaries, for bilateral sales of electricity to the DWR at the
California/Oregon border, claiming that such sales took place in the Pacific
Northwest. The refunds sought from Mirant and of its subsidiaries totaled
approximately $90 million. A FERC ALJ concluded a preliminary evidentiary
hearing related to possible refunds for power sales in the Pacific Northwest. In
a preliminary ruling issued September 24, 2001, the ALJ indicated that she would
27
order no refunds because the complainants had failed to prove any exercise of
market power or that any prices were unjust or unreasonable. The FERC may accept
or reject this preliminary ruling and the FERC's decision may itself be
appealed. On May 13, 2002 and May 24, 2002, the City of Tacoma, Washington and
the City of Seattle, Washington, respectively, filed to reopen the evidentiary
record in this proceeding as a result of the contents of three internal Enron
Power Marketing, Inc. memoranda that had been obtained and publicly released by
the FERC as part of its continuing investigation. The Company cannot predict the
outcome of these proceedings. If the Company was required to refund such
amounts, its subsidiaries would be required to refund amounts previously
received pursuant to sales made on their behalf during the refund periods. In
addition, its subsidiaries would be owed amounts for purchases made on their
behalf from other sellers in the Pacific Northwest.
Additionally, on February 13, 2002, the FERC directed its staff to
undertake a fact-finding investigation into whether any entity manipulated
short-term prices in electric energy or natural gas markets in the West or
otherwise exercised undue influence over wholesale prices in the West, for the
period January 1, 2000 forward. Information from this investigation could be
used in any existing or future complaints before the FERC involving long-term
power sales contracts relevant to the matters being investigated, including the
California refund proceeding. On August 13, 2002, the FERC Staff issued an
initial report regarding its preliminary findings. The report recommended that
the FERC initiate separate proceedings to further investigate specific instances
of inappropriate conduct by several companies, none of which are affiliated with
Mirant. In addition, the report recommended that the natural gas indices used
for purposes of calculating potential refunds in the California refund case be
replaced with indices at a different location plus a transportation component.
On August 13, 2002, the FERC in the California refund proceeding requested
comments from parties on whether the gas indices in the existing formula for
calculating refunds should be replaced with different gas indices (plus
transportation costs) as recommended by the FERC Staff in its report. If the
FERC adopts the Staff's recommended gas formula for purposes of calculating
refunds, it would increase Mirant's refund exposure in the California refund
case.
Lastly, the initial report of the FERC staff described its investigation of
the effect on spot electric prices in the West of trading strategies employed by
Enron subsidiaries and other entities but could not quantify the exact economic
impact. The FERC staff will continue to investigate whether the questionable
trading strategies had an indirect effect on other products sold in the West,
such as long-term contracts. The staff report also recommended imposition of
certain limitations on entities with market-based rate authority designed to
prohibit trading strategies based on the submission of false information or the
omission of material information to the FERC, independent system operators, or
other market participants. The staff report is a preliminary report, and the
staff continues to investigate a variety of matters. The Company cannot predict
the impact of the initial staff report on any FERC action that might be taken in
this investigation docket or any other ongoing proceeding at the FERC.
Subsequent to the issuance of the FERC Staff's report, three companies that
sell natural gas at wholesale have announced that certain of their employees did
not correctly report transactional information to the trade press that publish
natural gas spot price data. Mirant cannot at this time predict what effect, if
any, such misreporting of information to the trade press will have upon the use
of spot price data published by the trade press in the ongoing proceeding before
FERC or upon other transactions to which Mirant is a party that utilize such
published spot price data as part of the price terms. The FERC Staff has
requested information from various market participants, including Mirant,
regarding the reporting of transactional information to the trade press.
On July 17, 2002, the FERC issued an order adopting new market design rules
("Market Design 2002") applicable to the California wholesale power markets as
well as price caps and other requirements that are applicable to all West-wide
wholesale power markets. Key elements of the Market Design 2002 that were
supposed to be in place on October 1, 2002 included an increase in the amount
sellers of electricity at wholesale may bid to the CAISO from $91.87/MWh to
$250/MWh on bids into the California real-time energy and ancillary services
28
markets, and a FERC imposed maximum price of $250/MWh for all spot market sales
in the western markets. The FERC delayed implementation of the increase in the
price cap until October 30, 2002. Sellers are still required to offer all
available uncommitted capacity for sale in the region. The FERC also put in
place, effective October 31, 2002, procedures in the CAISO market that will
mitigate prices whenever a supplier bids greater than established thresholds.
DWR Power Purchases: On January 17, 2001, the Governor of California issued an
emergency proclamation giving the DWR authority to enter into arrangements to
purchase power in order to mitigate the effects of electrical shortages in the
state. The DWR began purchasing power under that authority the next day. On
February 1, 2001, the Governor of California signed Assembly Bill No. 1X
authorizing the DWR to purchase power in the wholesale markets to supply retail
consumers in California on a long-term basis. The Bill became effective
immediately upon its execution by the Governor. The Bill did not, however,
address the payment of amounts owed for power previously supplied to the CAISO
or PX for purchase by SCE and Pacific Gas and Electric. The CAISO and PX have
not paid the full amounts owed to Mirant's subsidiaries for power delivered to
the CAISO and PX in prior months and are expected to pay less than the full
amount owed on further obligations coming due in the future for power provided
to the CAISO for sales that were not arranged by the DWR. The ability of the DWR
to make future payments is subject to the DWR having a continued source of
funding, whether from legislative or other emergency appropriations, from a bond
issuance or from amounts collected from SCE and Pacific Gas and Electric for
deliveries to their customers. On May 22, 2001, Mirant entered into a 19-month
agreement with the DWR to provide the State of California with approximately 500
MW of electricity during peak hours through December 31, 2002.
On February 25, 2002, the CPUC and the California Electricity Oversight
Board ("EOB") filed separate complaints at the FERC against certain sellers of
energy under long-term agreements with the California DWR, including the
contract entered into by Mirant with the DWR dated May 22, 2001, alleging that
the terms of these contracts are unjust and unreasonable and that the contracts
should be abrogated or the prices under the contracts should be reduced. In
particular, the EOB claims that the contracts should be voidable at the option
of the State of California. The complaints allege that the DWR was forced to
enter into these long-term contracts due to dysfunctions in the California
market and the alleged market power of the sellers.
Two lawsuits have also been filed that seek relief for contracts between
the California DWR and certain marketers of electricity, including the May 22,
2001 contract between DWR and Mirant, that allegedly contain unfair terms. The
plaintiffs allege that the terms of the contracts are unjust and unreasonable
and that the DWR was forced to enter into these long-term contracts due to
dysfunctions in the California market and alleged market power of the sellers.
Plaintiffs seek, among other things, a declaration that the contracts are void
and unenforceable, enjoinment of the enforcement and performance of those
contracts and restitution for funds allegedly obtained wrongfully under the
contracts. The captions of each of the cases follow:
CAPTION DATE FILED COURT OF ORIGINAL FILING
McClintock, et al. v. Vikram May 1, 2002 Superior Court of California - Los Angeles County
Budraja, et al.
Millar, et al. v. Allegheny May 13, 2002 Superior Court of California - San Francisco County
Energy Supply Company, LLC, et al.
The Millar suit has been removed by the defendants to the United States
District Court for the Northern District of California. On October 11, 2002,
the federal judicial panel on multidistrict litigation ordered the Millar suit
to be transferred to the United States District Court for the Southern
District of California and consolidated for purposes of pretrial proceedings
with the six rate payer suits already pending before that court described
below in "California Rate Payer Litigation." The McClintock suit has been
stayed pending a resolution of a separate action challenging the long term
contracts that were entered into by the DWR, which suit does not include
Mirant or any of its subsidiaries as parties.
29
California Rate Payer Litigation: A total of sixteen lawsuits have been filed
asserting claims under California law based on allegations that certain owners
of electric generation facilities in California and energy marketers, including
Mirant, Mirant Americas Energy Marketing, Mirant Delta and Mirant Potrero,
engaged in various unlawful and anti-competitive acts that served to manipulate
wholesale power markets and inflate wholesale electricity prices in California.
One of the suits, the Hansen suit, has been voluntarily dismissed, and the other
fifteen suits remain pending.
Six of those suits were filed between November 27, 2000 and May 2, 2001 in
various California Superior Courts. Three of these suits seek class action
status, while two of the suits are brought on behalf of all citizens of
California. One lawsuit alleges that, as a result of the defendants' conduct,
customers paid approximately $4 billion more for electricity than they otherwise
would have and seeks an award of treble damages as well as other injunctive and
equitable relief. One lawsuit also names certain of Mirant's officers
individually as defendants and alleges that the state had to spend more than $6
billion purchasing electricity and that if an injunction is not issued, the
state will be required to spend more than $150 million per day purchasing
electricity. The other suits likewise seek treble damages and equitable relief.
One such suit names Mirant Corporation itself as a defendant. A listing of these
six cases is as follows:
CAPTION DATE FILED COURT OF ORIGINAL FILING
People of the State of California January 18, 2001 Superior Court of California - San Francisco County
v. Dynegy, et al.
Gordon v. Reliant Energy, Inc., November 27, 2000 Superior Court of California-San Diego County
et al.
Hendricks v. Dynegy Power November 29, 2000 Superior Court of California - San Diego County
Marketing, Inc., et al.
Sweetwater Authority, et al. v. January 16, 2001 Superior Court of California - San Diego County
Dynegy, Inc., et al.
Pier 23 Restaurant v. PG&E Energy January 24, 2001 Superior Court of California - San Francisco County
Trading, et al.
Bustamante, et al. v. Dynegy, May 2, 2001 Superior Court of California - Los Angeles County
Inc., et al.
These six suits were coordinated for purposes of pretrial proceedings
before the Superior Court for San Diego County. In the Spring of 2002, two of
the defendants filed crossclaims against other market participants who were not
parties to the actions. Some of those crossclaim defendants then removed the six
coordinated cases to the United States District Court for the Southern District
of California. The plaintiffs have filed motions seeking to have the actions
remanded to the California state court, and the defendants have filed motions
seeking to have the claims dismissed.
Seven additional rate payer lawsuits were filed between April 23, 2002 and
May 24, 2002 alleging that certain owners of electric generation facilities in
California, as well as certain energy marketers, including Mirant and several of
its subsidiaries, engaged in various unlawful and fraudulent business acts that
served to manipulate wholesale markets and inflate wholesale electricity prices
in California. The suits are related to events in the California wholesale
electricity market occurring over the last three years. Each of the complaints
alleges violation of California's Unfair Competition Act. The RDJ Farms
complaint also alleges violation of California's anti-trust statute. Each of the
plaintiffs seeks class action status for their respective case. The actions
30
seek, among other things, restitution, compensatory and general damages, and to
enjoin the defendants from engaging in illegal conduct. The captions of each of
these seven cases follow:
CAPTION DATE FILED COURT OF ORIGINAL FILING
T&E Pastorino Nursery, et al. v. April 23, 2002 Superior Court of California - San Mateo County
Duke Energy Trading and
Marketing, LLC, et al.
RDJ Farms, Inc., et al. v. May 10, 2002 Superior Court of California - San Joaquin County
Allegheny Energy Supply Company,
LLC, et al.
Century Theatres, Inc., et al. May 14, 2002 Superior Court of California - San Francisco County
v. Allegheny Energy Supply
Company, LLC, et al.
El Super Burrito, Inc., et al. May 15, 2002 Superior Court of California - San Mateo County
v. Allegheny Energy Supply
Company, LLC, et al.
Leo's Day and Night Pharmacy, et May 21, 2002 Superior Court of California - San Francisco County
al. v. Duke Energy Trading and
Marketing, LLC, et al.
J&M Karsant Family Limited May 21, 2002 Superior Court of California - Alameda County
Partnership, et al. v. Duke
Energy Trading and Marketing, LLC, et al.
Bronco Don Holdings, LLP, et al. May 24, 2002 Superior Court of California - San Francisco County
v. Duke Energy Trading and
Marketing, LLC, et al.
Each of the seven cases has been removed by the defendants to United States
District Courts in California. The RDJ Farms suit was removed to the United
States District Court for the Eastern District of California, and the other six
cases were removed to the United States District Court for the Northern District
of California. On October 11, 2002, the federal judicial panel on multidistrict
litigation ordered the seven rate payer suits filed between April 23, 2002 and
May 24, 2002 to be transferred to the United States District Court for the
Southern District of California and consolidated for purposes of pretrial
proceedings with the six rate payer suits already pending before that court.
On June 3, 2002, a lawsuit, Hansen v. Dynegy Power Marketing, et al., was
filed in the Superior Court for the County of San Francisco against various
owners of electric generation facilities in California, including Mirant and
several of its subsidiaries, alleging substantially similar claims to the
ratepayer actions described above. The plaintiff sought class action status for
the lawsuit and purported to represent residential ratepayers located in various
public utility districts in the State of Washington. The complaint sought, among
other things, injunctive relief, disgorgement of profits, restitution and treble
damages. This action has been dismissed by the plaintiff.
On July 15, 2002, an additional rate payer lawsuit, Public Utility District
No. 1 of Snohomish Co. v. Dynegy Power Marketing, et al., was filed in the
United States District Court for the Central District of California against
various owners of electric generation facilities in California, including Mirant
and its subsidiaries, by Public Utility District No. 1 of Snohomish County,
which is a municipal corporation in the state of Washington that provides
electric and water utility service. The plaintiff public utility district
alleges that defendants violated California's antitrust statute by conspiring to
raise wholesale power prices, injuring plaintiff through higher power purchase
costs. The plaintiff also alleges that defendants acted both unfairly and
unlawfully in violation of California's Unfair Competition Act through various
unlawful and anticompetitive acts, including the purportedly wrongful
acquisition of plants, engagement in "Enron-style" trading, and withholding
power from the market. The plaintiff seeks restitution, disgorgement of profits,
injunctive relief, treble damages, and attorney's fees. The federal judicial
panel on multidistrict litigation has ordered the Snohomish suit to be
transferred to the United States District Court for the Southern District of
California and consolidated for purposes of pretrial proceedings with the six
rate payer suits already pending before that court.
31
On October 18, 2002, another rate payer lawsuit, Kurtz v. Duke Energy
Trading et al., was filed in the Superior Court for the County of Los Angeles.
The Kurtz suit alleges that certain owners of electric generation facilities in
California, as well as certain energy marketers, including Mirant and various of
its subsidiaries, engaged in various unlawful and fraudulent business acts that
served to manipulate wholesale markets and inflate wholesale electricity prices
in California since early 1998 in violation of California's Unfair Competition
Act. The Kurtz suit contains allegations of misconduct by the defendants,
including the Mirant entities, that are similar to the allegations made in the
previously filed rate payer suits, in the suits filed by the California Attorney
General on March 11, 2002, and April 15, 2002, and in the suits filed
challenging long-term agreements with the California DWR. The plaintiff seeks to
represent a class consisting of all persons and entities that purchased energy
that was sold into California by the defendants through sales to the CAISO, the
PX or the DWR. The action seeks, among other things, restitution, compensatory
and general damages, and to enjoin the defendants from engaging in illegal
conduct.
Shareholder Litigation: Twenty lawsuits have been filed since May 29, 2002
against Mirant and four of its officers alleging, among other things, that
defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder by making material misrepresentations
and omissions to the investing public regarding Mirant's business operations and
future prospects during the period from January 19, 2001 through May 6, 2002.
The suits have each been filed in the United States District Court for the
Northern District of Georgia, with the exception of the Thomas, Purowitz and
Delgado suits, which were filed in the United States District Court for the
Northern District of California. The complaints seek unspecified damages,
including compensatory damages and the recovery of reasonable attorneys' fees
and costs. Additional "copy cat" law suits may be filed. The captions of each of
the cases follow:
CAPTION DATE FILED
Kornfeld v. Mirant Corp., et al. May 29, 2002
Holzer v. Mirant Corp., et al. May 31, 2002
Abrams v. Mirant Corp., et al. June 1, 2002
Kellner v. Mirant Corp., et al. June 14, 2002
Sved v. Mirant Corp., et al. June 14, 2002
Teaford v. Mirant Corp., et al. June 14, 2002
Woff v. Mirant Corp., et al. June 14, 2002
Purowitz v. Mirant Corp., et al. June 10, 2002
Peruchi v. Mirant Corp., et al. June 14, 2002
Froelich v. Mirant Corp., et al. June 4, 2002
Rand v. Mirant Corp., et al. June 5, 2002
Thomas v. Mirant Corp., et al. June 18, 2002
Urgenson v. Mirant Corp., et al. June 18, 2002
Orlofsy v. Mirant Corp., et al. June 18, 2002
Jannett v. Mirant Corp. June 28, 2002
Green v. Mirant Corp., et al. July 9, 2002
Greenberg v. Mirant Corp., et al. July 16, 2002
Law v. Mirant Corp., et al. July 17, 2002
Russo v. Mirant Corp., et al. July 18, 2002
Delgado v. Mirant Corp., et al. October 4, 2002
32
The seventeen suits filed in the United States District Court for the
Northern District of Georgia have been consolidated.
Wallula Power Project: On June 20, 2002, Wallula Generation, LLC ("Wallula")
sent a letter to Mirant Americas Energy Marketing, a wholly-owned subsidiary of
Mirant, requesting a letter of credit in the amount of $166 million in
connection with a tolling arrangement pursuant to a Conversion Services
Agreement (the "Agreement") between Mirant Americas Energy Marketing and Wallula
for the planned Wallula Power Project to be constructed by Wallula in the State
of Washington by October 2004, which date could be extended pursuant to the
Agreement. Mirant Americas Energy Marketing disagreed with Wallula's
interpretation of the collateral and credit requirements of the Agreement. By
letter dated July 10, 2002, Wallula requested that Mirant arbitrate the issue of
whether Mirant was obligated to provide a letter of credit in the amount of $166
million. In September Mirant and Wallula entered into an agreement settling
their outstanding dispute. Under that settlement agreement, Mirant has paid
Wallula an amount that will not have a materially adverse impact on the Company.
In addition, the Agreement between Mirant Americas Energy Marketing and Wallula
has been terminated.
Enron Bankruptcy Proceedings: Since December 2, 2001, Enron and a number of its
subsidiaries have filed for bankruptcy. As of June 30, 2002, the total amount
owed to Mirant by Enron was approximately $82 million. Based on a reserve for
potential bad debts recorded in 2001, the Company does not expect the outcome of
the bankruptcy proceeding to have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
State Line: On July 28, 1998, an explosion occurred at the Company's State Line
plant causing a fire and substantial damage to the plant. The precise cause of
the explosion and fire has not been determined. Thus far, seven personal injury
lawsuits have been filed against Mirant, five of which were filed in Cook
County, Illinois. Mirant has settled the claims of five of these plaintiffs. The
terms of the settlements involve cash payments to the plaintiffs, with such
payments being fully covered by insurance. The outcome of these proceedings
cannot now be determined and an estimated range of loss cannot be made; however,
the Company has significant insurance coverage for losses occurring as a result
of the explosion.
Edison Mission Energy Litigation: On March 8, 2002, two subsidiaries of Edison
International (collectively, "EME") filed a breach of contract action against
Mirant Corporation and two of its subsidiaries in the Superior Court of Orange
County, California. In July 2001, Mirant and its subsidiaries entered into a
contract with EME to purchase its 50% ownership interest in EcoElectrica
Holdings Ltd. ("EcoElectrica"), a limited partnership owning a 540 MW liquefied
natural gas fired combined cycle cogeneration facility in Puerto Rico together
with various related facilities. EME alleges that Mirant and its subsidiaries
breached the purchase agreement by failing to complete the purchase of EME's
interest in EcoElectrica. The plaintiffs seek damages in excess of $50 million,
plus interest and attorney fees. At the same time Mirant and its subsidiaries
entered into the contract with EME, they entered into a separate agreement with
a subsidiary of Enron to purchase an additional 47.5% ownership interest in
EcoElectrica. That purchase also was not completed.
Environmental Information Requests: Along with several other electric generators
which own facilities in New York, in October 1999 Mirant New York received an
information request from the State of New York concerning the air quality
control implications of various repairs and maintenance activities at its Lovett
facility. Mirant New York responded fully to this request and provided all of
the information requested by the State. The State of New York issued notices of
violation to some of the utilities being investigated. The State issued a notice
of violation to the previous owner of Plant Lovett, Orange and Rockland
33
Utilities, alleging violations associated with the operation of Plant Lovett
prior to the acquisition of the plant by Mirant New York. To date, Mirant New
York has not received a notice of violation. Mirant New York disagrees with the
allegations of violations in the notice of violation issued to the previous
owner. The notice of violation does not specify corrective actions, which the
State of New York may require. If a violation is determined to have occurred at
Plant Lovett, Mirant New York may be responsible for the cost of purchasing and
installing emission control equipment, the cost of which may be material. Under
the sales agreement with Orange and Rockland Utilities for Plant Lovett, Orange
and Rockland Utilities is responsible for fines and penalties arising from any
violation associated with historical operations, but the state or federal
government could seek fines and penalties from Mirant New York, the cost of
which may be material. Mirant New York is engaged in discussions with the State
to explore a resolution of this matter.
In January 2001, the EPA, Region 3 issued a request for information to
Mirant concerning the air permitting implications of past repair and maintenance
activities at its Potomac River plant in Virginia and Chalk Point, Dickerson and
Morgantown plants in Maryland. The requested information concerns the period of
operations that predates Mirant's ownership of the plants. Mirant has responded
fully to this request. If a violation is determined to have occurred at any of
the plants, Mirant may be responsible for the cost of purchasing and installing
emission control equipment, the cost of which may be material. Under the sales
agreement with PEPCO for those plants, PEPCO is responsible for fines and
penalties arising from any violation associated with historical operations prior
to the Company's acquisition of the plants, but the state or federal government
could seek fines and penalties from Mirant, the cost of which may be material.
The Company cannot provide assurance that lawsuits or other administrative
actions against its power plants will not be filed or taken in the future. If an
action is filed against the Company or its power plants and it is judged to not
be in compliance, this could require substantial expenditures to bring the
Company's power plants into compliance and have a material adverse effect on its
financial condition, cash flows and results of operations.
In addition to the matters discussed above, Mirant is party to legal
proceedings arising in the ordinary course of business. In the opinion of
management, the disposition of these matters will not have a material adverse
impact on the Company's consolidated results of operations, cash flows or
financial position. The Company recognizes estimated losses from contingencies
when information available indicates that a loss is probable and the amount of
the loss is reasonably estimable in accordance with SFAS No. 5, "Accounting for
Contingencies."
Commitments and Capital Expenditures
Mirant has made firm commitments to buy materials and services in
connection with its ongoing operations and planned expansion and has made
financial guarantees relative to certain of its investments.
The material commitments are discussed in the following sections.
Energy Marketing and Risk Management
Mirant Corporation had approximately $906 million of trade credit support
commitments outstanding as of June 30, 2002, which included $614 million of
letters of credit, $3 million of net cash collateral posted and $289 million of
parent guarantees.
Mirant Corporation has also guaranteed the performance of its obligations
under a multi-year agreement entered into by Mirant Americas Energy Marketing
with Brazos Electric Power Cooperative ("Brazos"). Mirant Corporation's
guarantee was $60 million at June 30, 2002, a decrease of $5 million from
December 31, 2001. Mirant Corporation is subject to regulatory and commercial
risks under this energy requirements contract. Mirant Corporation believes, but
cannot guarantee, that it has adequately provided for the potential risks
related to this contract, which terminates at the end of 2003.
Mirant Corporation also has a guarantee related to Pan Alberta Gas, Ltd. of
$64 million issued in 2000 and outstanding at June 30, 2002.
34
Vastar, a subsidiary of BP, and Mirant Corporation had issued certain
financial guarantees made in the ordinary course of business, on behalf of
Mirant Americas Energy Marketing's counterparties, to financial institutions and
other credit grantors. Mirant Corporation has agreed to indemnify BP against
losses under such guarantees in proportion to Vastar's former ownership
percentage of Mirant Americas Energy Marketing. At June 30, 2002, such
guarantees amounted to approximately $85 million.
Mirant Americas Energy Marketing has a 20-year tolling agreement with
Perryville under which Perryville will sell all the electricity generated by the
facility to Mirant Americas Energy Marketing. At June 30, 2002, the total
estimated notional commitment under this agreement was approximately $1.07
billion over the 20-year life of the contract. Effective August 23, 2002, Mirant
Americas Energy Marketing and Perryville, with the consent of the project
lenders, restructured the tolling agreement between the parties to remove the
requirement to post a letter of credit or other credit support in the event of a
downgrade from S&P or Moody's. In connection with the restructuring, Mirant
Americas made a $100 million subordinated loan to Perryville, the proceeds of
which were used to repay an existing $25 million subordinated loan owed to a
Mirant subsidiary and to repay $75 million of senior debt of the project. In
addition, Mirant Americas guaranteed the obligations of Mirant Americas Energy
Marketing under the tolling agreement up to the amount of the subordinated loan.
The obligations of Mirant Americas Energy Marketing under the tolling agreement
are guaranteed by Mirant Corporation.
To the extent that Mirant Corporation does not maintain its current credit
ratings, it could be required to provide alternative collateral to certain risk
management and marketing counterparties based on the value of the Company's
portfolio at such time, in order to continue its current relationship with those
counterparties. Mirant could also be required to provide alternative collateral
related to committed pipeline capacity charges. Such collateral might be in the
form of cash and/or letters of credit. There is an additional risk that in the
event of a reduction of Mirant's credit rating that certain counterparties may,
without contractual justification, request additional collateral or terminate
their obligations to Mirant.
Turbine Purchases and Other Construction-Related Commitments
During the six months ended June 30, 2002, Mirant committed itself to a
strategic business plan designed to reduce capital spending and operating
expenses. As a result, the Company recorded restructuring charges in the six
months ended June 30, 2002 related to these changes. The reduced capital
spending plan results in material changes to Mirant's commitments under its
turbine purchase agreements and its turbine procurement facilities. Mirant has
canceled and intends to cancel certain turbines under its purchase agreements
and its off-balance sheet equipment procurement facilities by March 31, 2003.
The commitments for turbines that Mirant has canceled and intends to cancel are
included in Mirant's restructuring charge (Note H), and Mirant plans to formally
terminate the orders for these turbines at various times within one year of the
restructuring commitment date. Until these termination orders are issued Mirant
continues to have the option to purchase the turbines.
As of June 30, 2002, Mirant had agreements to purchase 35 turbines (26 gas
turbines and 9 steam turbines) to support the Company's ongoing and planned
construction efforts (see table on next page). In addition Mirant's other
construction-related commitments totaled approximately $758 million at June 30,
2002.
In addition to these commitments, Mirant, through certain of its
subsidiaries, has two off-balance sheet equipment procurement facilities. These
facilities are being used to fund equipment progress payments due under purchase
contracts that have been assigned to two separate, independent third-party
owners. For the first facility, which is a $1.8 billion notional value facility,
remaining contracts for 42 turbines (28 gas turbines and 14 steam turbines) have
been assigned to a third-party trust. For the second facility, which at June 30,
2002 was a Euro 550 million (approximately $544 million) notional value
35
facility, remaining contracts for four engineered equipment packages ("power
islands") have been assigned to a third-party owner incorporated in the
Netherlands.
As part of its strategic restructuring, Mirant negotiated certain deferrals
under both equipment purchase facilities. Because the term of the deferred
fabrication period for certain turbines included in the $1.8 billion notional
value facility exceeds the agreed fabrication period as permitted within the
equipment procurement facilities, the Company will not have the option to enter
into a lease arrangement for this equipment, thereby forcing Mirant to exercise
its purchase option. Consequently, Mirant has included a $35 million liability
for these turbines on the accompanying unaudited condensed consolidated balance
sheet. At June 30, 2002, Mirant Corporation's guarantees in connection with the
equipment procurement facilities, including certain payment obligations were
approximately $406 million with respect to the turbines for which the facilities
have a contractual obligation (excluding the $35 million which is now included
in "Other long-term debt" on its unaudited condensed consolidated balance
sheet). The $406 million was based on the drawn amounts related to all turbines
and power islands (including those to be terminated) included in the equipment
procurement facilities as of June 30, 2002.
The table below presents the components of Mirant's commitments on its
contracts and procurement facilities related to turbines and power islands.
Total
Purchase Procurement Turbines &
Commitments Facilities Power Islands
Turbine Count (Turbine) (Turbines)
---------------- ---------------- ---------------
Total contracted turbines/power islands at
December 31, 2001....................... 48 55 103
Turbines/power islands terminated during
the six months ended June 30, 2002...... (8) (9) (17)
Turbines/power islands placed in service
during the six months ended June 30, 2002 (5) - (5)
---------- ------- ----------
Total contracted turbines/power islands at
June 30, 2002......................... 35 46 81
Turbines / power islands to be terminated
or sold in the future per Restructuring (11) (35) (46)
--------- ------- ---------
Total remaining contracted turbines / power
islands at June 30, 2002 (after
Restructuring)........................ 24 11 35
====== ===== =====
Commitments for Remaining Contracted
Turbines / Power Islands after Restructuring
(in millions)
Total commitments at June 30, 2002 ........ $ 45 $510 $555
Cost to terminate at June 30, 2002.......... $ 7 $205 $212
Long-Term Service Agreements
Mirant has entered into long-term service agreements for the maintenance
and repair by third parties of many of its combustion-turbine generating plants.
Generally, these agreements may be terminated at little or no cost in the event
that the shipment of the associated turbine is canceled. As of June 30, 2002,
the minimum termination amounts for long-term service agreements associated with
completed and shipped turbines were $546 million. As of June 30, 2002, the total
estimated commitments for long-term service agreements associated with turbines
already completed and shipped were approximately $692 million. These commitments
are payable over the course of each agreement's term. The terms are projected to
range from ten to twenty years. Estimates for future commitments for long-term
service agreements are based on the stated payment terms in the contracts at the
time of execution. These payments are subject to an annual inflationary
adjustment.
As a result of the turbine cancellations as part of Mirant's restructuring,
the long-term service agreements associated with the canceled turbines will also
36
be canceled. However, as stated above, canceling the long-term service
agreements will result in little or no termination costs to Mirant. Mirant does
not intend to cancel long-term service agreements associated with turbines that
have already shipped. Consequently, the Company's restructuring should not have
an impact on the long-term service agreement commitments disclosed above.
Obligations Under Energy Delivery and Purchase Commitments
Under the asset purchase and sale agreement for the PEPCO generating
assets, Mirant assumed and recorded net obligations of approximately $2.3
billion representing the fair value (at the date of acquisition) of
out-of-market energy delivery and power purchase agreements, which consist of
five power purchase agreements ("PPAs") and two transition power agreements
("TPAs"). The PPAs are for a total capacity of 735 MW and expire over periods
through 2021. The TPA agreements state that Mirant will sell a quantity of
megawatthours over the life of the contracts based on PEPCO's load requirements
and expire in January 2005. As actual megawatthours are purchased or sold under
these agreements, Mirant releases a ratable portion of the obligation into gross
margin. For the three and six months ended June 30, 2002, the Company released
approximately $121 million and $234 million, pre-tax, respectively. As of June
30, 2002, the remaining obligations recorded in the unaudited condensed
consolidated balance sheet for the TPAs and PPAs totaled $1,105 million and $500
million, respectively, of which $469 million and $65 million, respectively, are
current. At June 30, 2002, the estimated notional commitments under the PPA
agreements were $1.58 billion based on the total remaining MW commitment at
contractual prices.
Other obligations under various agreements of approximately $144 million
are also included in the unaudited condensed consolidated balance sheet.
Fuel Commitments
Mirant has a contract with BP whereby BP is obligated to deliver fixed
quantities of natural gas at identified delivery points. The negotiated purchase
price of delivered gas is generally equal to the monthly spot rate then
prevailing at each delivery point. Effective July 26, 2002, Mirant and BP have
restructured their contract. The contract term has been extended to December 31,
2009, unless terminated sooner. Mirant has the ability to reduce the purchase
obligation on this contract annually. Based on current contract volumes, the
estimated minimum commitment for the term of this agreement based on current
spot prices is $2.2 billion as of September 30, 2002. The contract is now
subject to the North American Master Netting Agreement between Mirant and BP,
dated December 1, 2001 (the "Master Netting Agreement") and a new collateral
annex to the Master Netting Agreement. Together, the Master Netting Agreement
and Collateral Annex provide that the amounts due to BP under the contract will
be netted against payments due between Mirant and BP under various other gas and
power contracts, and that collateral will be posted by one party to the other
based on the net amount of exposure.
Mirant has fixed volumetric purchase commitments under fuel purchase and
transportation agreements totaling $554 million at June 30, 2002. These
agreements will continue to be in effect through 2012.
In addition, in April 2002, Mirant Mid-Atlantic entered into a long-term
fuel purchase agreement. The fuel supplier will convert coal feedstock received
at the Company's Morgantown facility into a synthetic fuel. Under the terms of
the agreement, Mirant Mid-Atlantic is required to purchase a minimum of 2.4
million tons of fuel per annum through December 2007. This minimum purchase
commitment became effective upon the commencement of operations of the synthetic
fuel plant in July 2002 at the Morgantown facility. The purchase price of the
fuel will vary with the delivered cost of the coal feedstock. Based on current
coal prices, it is expected that the annual purchase commitment will be
approximately $100 million.
In July 2002, in conjunction with the commencement of Mirant Mid-Atlantic's
minimum synthetic fuel purchase commitments, Mirant Americas Energy Marketing
arranged for the synthetic fuel supplier to contract with the coal supplier to
purchase coal directly from the supplier. Mirant Americas Energy Marketing's
minimum coal purchase commitments are reduced to the extent that the synthetic
fuel supplier purchases coal under this arrangement. Since the inception of this
arrangement, the synthetic fuel supplier has purchased 100% of Mirant Americas
Energy Marketing's minimum coal purchase commitment thereby reducing the amount
of coal purchased by Mirant Americas Energy Marketing under the contracts, which
are included in the fixed volumetric purchase commitment of $554 million noted
above.
Mirant New England Guarantee
In April 2002, Mirant Corporation issued a guarantee in the amount of $188
million for any obligations Mirant New England may incur under its Wholesale
37
Transition Service Agreement with Cambridge Electric Light Company and
Commonwealth Electric Company. Under the agreement, Mirant New England is
required to sell electricity at fixed prices to Cambridge and Commonwealth in
order for them to meet their supply requirements to certain retail customers.
Both the guarantee and the agreement expire in February 2005.
Operating Leases
Mirant has commitments under operating leases with various terms and
expiration dates. Expenses associated with these commitments totaled
approximately $40 million and $32 million during the three months ended June 30,
2002 and 2001, respectively, and approximately $76 million and $62 million
during the six months ended June 30, 2002 and 2001, respectively. As of June 30,
2002, estimated minimum rental commitments for non-cancelable operating leases
were $3.63 billion.
J. Discontinued Operations
In February 2002, Mirant announced that it had entered into an agreement to
sell its State Line generating facility for $181 million plus an adjustment for
working capital. The sale was completed in June 2002. State Line was previously
reported in Mirant's North America Group operations. In addition, income from
discontinued operations for the three months ended March 31, 2001 includes SE
Finance, which was contributed to Southern on March 5, 2001 as part of Mirant's
spin-off from Southern.
Mirant's results of discontinued operations for the three and six months
ended June 30, 2002 and 2001 were as follows (in millions):
For the Three Months For the Six Months
Ended June 30, Ended June,
2002 2001 2002 2001
---- ---- ---- ----
Revenue....................................$ 9 $ 13 $ 24 $ 27
Leveraged lease income..................... - - - 10
Expense................................... 6 11 15 20
Impairment loss............................ - - 2 -
Equity in income/(loss) of affiliates..... - - - (3)
----- ------ ----- -------
Pre-tax income............................. 3 2 7 14
Taxes...................................... 1 1 3 2
----- ------ ------ -------
Net income.................................$ 2 $ 1 $ 4 $ 12
===== ====== ====== =======
The table below presents the components of State Line's balance sheet
accounts classified as current assets and liabilities held for sale as of
December 31, 2001 (in millions):
Current Assets:
Accounts receivable.................... $ 5
Inventory.............................. 3
Other.................................. 1
Property, plant and equipment.......... 175
Intangibles............................ 9
-----
Total current assets held for sale.. $ 193
=====
Current Liabilities:
Taxes and other payables............... $ 10
Deferred taxes......................... 15
-----
Total current liabilities related to assets
held for sale $ 25
=====
38
K. Segment Reporting
With the sale of the Company's investment in Bewag and its restructuring,
Mirant has changed its principal business segments from Americas, Asia-Pacific
and Europe to North America and International. North America includes Mirant's
United States, Canadian and Caribbean operations, and International includes
Mirant's Asia-Pacific, European and Brazilian operations. The other reportable
business segment is Corporate.
Financial Data by Segment
For the Three Months Ended June 30, 2002 and 2001
(In Millions)
Corporate and
North America International Eliminations Consolidated
------------------- ------------------ ------------------ -------------------
2002 2001 2002 2001 2002 2001 2002 2001
--------- --------- -------- --------- --------- -------- --------- ---------
Operating Revenues:
Generation and energy marketing $5,862 $7,592 $ 133 $ 172 $ - $ - $5,995 $ 7,764
Distribution & integrated utility revenues 126 144 - - - - 126 144
Other 6 2 7 5 - - 13 7
--------- --------- -------- --------- --------- -------- --------- ---------
Total operating revenues 5,994 7,738 140 177 - - 6,134 7,915
Operating Expenses:
Cost of fuel, electricity and other products 5,550 7,079 4 48 - - 5,554 7,127
--------- --------- -------- --------- --------- -------- --------- ---------
Gross Margin 444 659 136 129 - - 580 788
Other Operating Expenses:
Depreciation and amortization 53 61 23 32 3 1 79 94
Maintenance 24 35 5 6 - - 29 41
Selling, general, and administrative 112 127 33 37 23 23 168 187
Impairment loss - 89 - - - - - 89
Restructuring charges 8 - 7 - 13 - 28 -
Gain on sales of assets, net - - (27) - - - (27) -
Other operating expenses 108 120 6 4 5 5 119 129
--------- --------- -------- --------- --------- -------- --------- ---------
Total other operating expenses 305 432 47 79 44 29 396 540
--------- --------- -------- --------- --------- -------- --------- ---------
Operating Income (Loss) 139 227 89 50 (44) (29) 184 248
Other Income (Expense):
Interest expense, net (33) (45) (22) (29) (37) (33) (92) (107)
Equity in income of affiliates 5 8 37 39 - - 42 47
Impairment loss on minority owned affiliates - - (317) - - - (317) -
Gain/(loss) on sales of assets, net (2) 1 (7) 1 - - (9) 2
Other 6 (3) 1 3 (3) 3 4 3
Income (Loss) From Continuing Operations
-------- ---------- -------- --------- --------- -------- --------- --------
Before Income Taxes and Minority Interest 115 188 (219) 64 (84) (59) (188) 193
Provision (Benefit) for income taxes 45 83 4 (10) (33) (19) 16 54
Minority interest 4 3 9 8 5 5 18 16
-------- ---------- -------- --------- --------- -------- --------- --------
Income (Loss) From Continuing Operations 66 102 (232) 66 (56) (45) (222) 123
Income From Discontinued Operations,
Net of Tax Benefit 2 1 - - - - 2 1
-------- ---------- -------- --------- --------- -------- --------- --------
Net Income (Loss) $ 68 $ 103 $ (232) $ 66 $ (56) $(45) $ (220) $ 124
======== ========== ======== ========= ========= ======== ========= ========
39
MIRANT CORPORATION AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Financial Data by Segment
For the Six Months Ended June 30, 2002 and 2001
(In Millions)
Corporate and
North America International Eliminations Consolidated
------------------- ----------------- ---------------- ----------------------
2002 2001 2002 2001 2002 2001 2002 2001
--------- --------- --------- ------- -------- ------- ---------- -----------
Operating Revenues:
Generation and energy marketing $ 12,208 $ 15,631 $ 568 $ 259 $ - $ - $12,776 $ 15,890
Distribution & integrated utility revenues 234 180 - - - - 234 180
Other 17 2 15 11 - - 32 13
--------- --------- --------- ------- -------- ------- ---------- -----------
Total operating revenues 12,459 15,813 583 270 - - 13,042 16,083
Operating Expenses:
Cost of fuel, electricity and other products 11,538 14,447 314 61 - - 11,852 14,508
--------- --------- --------- ------- -------- ------- ---------- -----------
Gross Margin 921 1,366 269 209 - - 1,190 1,575
Other Operating Expenses:
Depreciation and amortization 105 112 46 65 5 2 156 179
Maintenance 51 57 10 11 - - 61 68
Selling, general, and administrative 212 350 67 65 37 68 316 483
Impairment loss - 93 - - - - - 93
Restructuring charges 494 - 72 - 24 - 590 -
Gain on sales of assets, net - - (27) - - - (27) -
Other operating expenses 206 212 8 7 12 9 226 228
--------- --------- --------- ------- -------- ------- ---------- -----------
Total other operating expenses 1,068 824 176 148 78 79 1,322 1,051
--------- --------- --------- ------- -------- ------- ---------- -----------
Operating (Loss) Income (147) 542 93 61 (78) (79) (132) 524
Other Income (Expense):
Interest expense, net (66) (82) (51) (58) (77) (58) (194) (198)
Equity in income of affiliates 12 15 108 111 - - 120 126
Gain/(loss) on sales of assets, net (2) 1 284 1 - - 282 2
Impairment loss on minority owned affiliates - - (317) - - - (317) -
Other 11 (4) 20 11 (3) 3 28 10
(Loss) Income From Continuing Operations --------- --------- --------- ------- -------- ------- ---------- -----------
Before Income Taxes and Minority Interest (192) 472 137 126 (158) (134) (213) 464
(Benefit) Provision for income taxes (75) 198 119 (30) (61) (26) (17) 142
Minority interest 6 4 17 16 11 10 34 30
--------- --------- --------- ------- -------- ------- ---------- -----------
(Loss) Income From Continuing Operations (123) 270 1 140 (108) (118) (230) 292
Income From Discontinued Operations,
Net of Tax Benefit 4 7 - - - 5 4 12
--------- --------- --------- ------- -------- ------- ---------- -----------
Net (Loss) Income $ (119) $ 277 $ 1 $ 140 $(108) $(113) $ (226) $ 304
========= ========= ========= ======= ======== ======= ========== ===========
40
MIRANT CORPORATION AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Selected Balance Sheet Information by Segment
At June 30, 2002
(In Millions)
Corporate and
North America International Eliminations Total
---------------- --------------- --------------- -------------
Current assets $ 5,569 $ 706 $ (938) $ 5,337
Property, plant & equipment,
including leasehold interest 6,232 1,754 85 8,071
Total assets 16,178 4,599 (950) 19,827
Total debt 3,444 1,412 2,372 7,228
Common equity 6,140 2,553 (3,414) 5,279
41
L. Subsequent Events
Convertible Senior Notes
In July 2002, Mirant Corporation completed the issuance of $370 million of
convertible senior notes. The net proceeds from the offering, after deducting
underwriting discounts and commissions payable by Mirant, were $361 million.
The notes mature on July 15, 2007 with an annual interest rate of 5.75%.
Holders of the notes may convert their notes into 131.9888 shares of Mirant
common stock for each $1,000 principal amount of the notes at any time prior to
July 15, 2007. This conversion rate is equivalent to the initial conversion
price of $7.58 per share based on the issue price of the notes. Mirant has the
right to redeem for cash, some or all of the notes at any time on or after July
20, 2005, upon not less than 30 nor more than 60 days' notice by mail to holders
of the notes, for a price equal to 100% of the principal amount of the notes to
be redeemed plus any accrued and unpaid interest to the redemption date.
Liquidity
To enhance Mirant's liquidity and reduce reliance on external financing,
Mirant has designed and launched an additional phase for its restructuring plan.
In 2002, Mirant announced its plan to sell additional assets, including WPD, to
raise $700 million to $1 billion. In addition, Mirant's board has authorized the
expenditure of up to $500 million for the repurchase of debt securities as the
Company's liquidity permits through 2003.
In July 2002, Mirant Corporation fully drew the commitments under its
$1.125 billion 364-Day Credit Facility, and elected to convert all advances
outstanding into a term loan maturing in July 2003. Effective with the Company's
third quarter reporting, this Facility will be reclassified from long-term debt
to short-term debt as it will be due within 12 months. The Company expects that
this reclassification will potentially cause the Company to have a negative
working capital balance. The Company is evaluating various potential financing
transactions to repay and/or refinance the Facility prior to its maturity. As a
result of present market conditions and other factors, including the reaudit of
its historical financial statements, Mirant cannot provide assurance that it
will be successful in entering into a new credit facility. If Mirant is
successful in entering into a new credit facility, it expects the facility will
likely be smaller and will have higher pricing and more restrictive terms than
the current facility.
In July 2002, Mirant Corporation and Mirant Americas Generation drew down
most of their available revolving credit commitments. The schedule below
summarizes the outstanding borrowings under the credit facilities held by Mirant
Corporation and its subsidiaries as of September 30, 2002 (in millions).
Drawn Amount excluding Letters of
Company Letters of Credit Credit
Outstanding
-------------------------- ------------------
Mirant Corporation .................. $ 1,551(1) $1,048
Mirant Americas Generation........... 300 -
Miran Canada Energy Marketing....... 44 -
Mirant Americas Energy Capital....... 150 -
(1)Amount includes fully drawn commitments under Mirant's $1.125 billion 364-Day
Credit Facility that was converted in July 2002 to a term loan maturing in July
2003.
42
Income Taxes
The IRS has completed its audit of Mirant for all tax years through 1995.
The IRS is currently auditing the tax years 1996-1999. Subsequent to June 30,
2002, the IRS issued Notices of Proposed Adjustments for this period for several
tax return filing positions affecting taxable income. While Mirant believes it
has substantial authority for the positions it has taken, it continues to review
this situation. The negative liquidity impact of these adjustments, if accepted
by Mirant, could be as much as $100 million. Management has not yet determined
the income statement impact of these potential adjustments.
Turbine Commitments
In October 2002, Mirant terminated contracts for three turbines that Mirant
did not anticipate terminating as of June 30, 2002. At the termination in
October 2002, the total net termination expense of these turbines was
approximately $34 million.
Asset Sales
In July 2002, Mirant announced that it had entered into an agreement to
sell its Neenah generating facility ("Neenah") in the state of Wisconsin to
Alliant Energy Resources, Inc. for approximately $109 million. The sale of
Mirant's investment in Neenah will be near book value. The sale is expected to
close in the fourth quarter of 2002.
In August 2002, Mirant completed the sale of its wholly owned subsidiary
MAP Fuels Limited, which fully owned Allied Queensland Coalfields Pty Ltd.
("AQC"), in Queensland, Australia, for approximately $21 million. The asset was
sold at approximately book value. The sale included both the Wilkie Creek Coal
Mine and the Horse Creek coal deposits.
The table below presents the components of Neenah's and AQC's balance sheet
accounts as of June 30, 2002 (in millions):
Assets:
Accounts receivable.................... $ 4
Inventory.............................. 2
Prepayments............................ 3
Other current assets................... 9
Property, plant and equipment.......... 108
Intangibles............................ 5
------
Total assets........... $ 131
======
Liabilities:
Taxes and other payables............... $ 20
-----
Total liabilities.................. $ 20
=====
Write Down of Asset
In September 2002, Mirant recorded an after-tax write down of $37 million
reflecting the fair market value of Mirant Americas Production Company. Mirant
Americas Production Company is an oil and gas exploration, development and
production company that Mirant has a plan to sell within a year. Mirant Americas
Production Company is included in the North America Group.
Suspended Construction
In August 2002, Mirant announced suspension of construction of the 298 MW
natural gas-fired Mint Farm Generating Station in Longview, Washington due to
weak market conditions. The project was about 60% complete and had an expected
commercial operating date of June 2003. Costs incurred of $119 million are
43
included in "Construction work in progress" on Mirant's condensed consolidated
balance sheet at June 30, 2002. The site will be maintained to preserve the
completed work and allow for restart of construction when market conditions
become more favorable.
Commencement of Operations
In July 2002, Mirant commenced operation of the second phase at its
Zeeland, Michigan generating plant, operation at its Wrightsville, Arkansas
generating plant and operation of the first phase at its Sugar Creek generating
plant near Terre Haute, Indiana. Upon completion of the projects, $678 million
in costs were transferred from "Construction work in progress" to "Property,
plant and equipment."
In October 2002, JPSCo, in which Mirant has an 80% ownership interest,
commenced operation of a new unit at its Bogue generating plant in Montego Bay,
Jamaica. Upon completion of the project, approximately $80 million in costs were
transferred from "Construction work in progress" to "Property, plant and
equipment."
Pagbilao Put Options
The Pagbilao project shareholder agreement grants minority shareholders put
option rights, such that they can require Mirant Asia-Pacific Limited to
purchase their interests in the project. Two of the three Pagbilao project
minority shareholders have served notice of their intent to exercise their
respective put options which aggregate to 8.52% ownership interest in the
project. The current intent of Mirant is to fund the purchase of the put
interests with amounts available at Mirant Asia-Pacific and/or its subsidiaries.
Litigation
Shareholder Derivative Litigation: On July 2, 2002, Mirant received notice that
a purported shareholders' derivative lawsuit had been filed in the Superior
Court of Fulton County, Georgia against Mirant and its directors. Subsequently
two other purported shareholders' derivative suits were filed against Mirant,
its directors and certain officers of the Company. The Pettingill suit was filed
in the Court of the Chancery for New Castle County, Delaware and the White suit
in the Superior Court of Fulton County. The captions of each of the cases
follow:
CAPTION DATE FILED
Kester v. Correll, et al. June 26, 2002
Pettingill v. Fuller, et al. July 30, 2002
White v. Correll, et al. August 9, 2002
These lawsuits allege that the directors breached their fiduciary duties by
allowing the Company to engage in alleged unlawful or improper practices in the
California energy market during 2000 and 2001. The Company practices complained
of in the purported derivative lawsuits largely mirror those complained of in
the shareholder litigation, the rate payer litigation and the California
attorney general lawsuits that have been previously disclosed by the Company.
The Pettingill suit also alleges that the defendant officers engaged in insider
trading. The complaints seek unspecified damages on behalf of the Company,
including attorneys' fees, costs and expenses and punitive damages. The Kester
and White suits have been consolidated and stayed until discovery begins in the
seventeen consolidated suits pending in the United States District Court for the
Northern District of Georgia described in Shareholder Litigation in Note I. The
Pettingill suit is also stayed until discovery begins in those seventeen
consolidated suits.
SEC Informal Investigation and U.S. Department of Justice and CFTC Inquiries: In
August 2002, Mirant received a notice from the Division of Enforcement of the
Securities and Exchange Commission that it was conducting an investigation of
Mirant. The Division of Enforcement has asked for information and documents
44
relating to various topics such as accounting issues including the issues
announced on July 30, 2002 and August 14, 2002; energy trading matters
(including round trip trades); Mirant's accounting for transactions involving
special purpose entities; and information related to shareholder litigation.
Mirant intends to cooperate fully with the Securities and Exchange Commission.
In addition, the Company has been contacted by the U.S. Department of
Justice regarding the Company's disclosure of accounting issues and energy
trading matters. The Company has been asked to provide copies of the same
documents requested by the SEC in their informal inquiry, and it intends to
cooperate fully.
In August 2002, the Commodities Futures Trading Commission ("CFTC") asked
the Company for information about a small number of buy and sell transactions
occurring during 2001. The Company provided information regarding such trades to
the CFTC in mid August, none of which it considers to be wash trades. The CFTC
subsequently requested additional information, including information about all
trades conducted on the same day with the same counterparty that were
potentially offsetting during the period from January 1, 1999 through June 17,
2002.
Philippines IPP Review: Pursuant to the Electric Power Industry Reform Act of
2001 a governmental Inter-Agency Review Committee ("Committee") was established
to review all contracts with IPPs in the Philippines, including those of the
Company, to determine whether such contracts have provisions which are grossly
disadvantageous or onerous to the government of the Philippines. On July 5, 2002
it was reported that 29 of the 35 contracts reviewed had legal or financial
issues requiring further review or action. These included several of Mirant's
contracts. Mirant Philippines, the Power Sector Assets and Liabilities
Management Corporation ("PSALM"), the Department of Energy, and the Department
of Justice have entered into a letter agreement establishing a general framework
("Framework Agreement") for resolving all outstanding issues raised by the
Committee about Mirant's IPP contracts. The Department of Energy has announced
that the parties "have successfully resolved, through bilateral agreement,
between the Philippine Government and the firm, all outstanding issues" on
Mirant's IPP contracts. The key terms of the new agreements are: Pagbilao will
no longer nominate capacity beyond the plant's nominal capacity; Pagbilao will
agree to settle certain issues on interpretation of its ECA relating to
penalties resulting from forced outages and waive past claims relating thereto;
the ECAs for Navotas I and II will be terminated and Mirant will acquire rights
to the Navotas I and II plants in return for a net payment of approximately
US$12 million; Mirant will be free to sell Navotas and excess Pagbilao energy
output in the open market; and Sual and Pagbilao will waive their claims to be
reimbursed for local business taxes. The benefits to Mirant are confirmation
that the original contracts for Sual and Pagbilao remain intact and will be
reaffirmed; no resultant material net income impact; reduction in potential
penalty payments due to outages at Pagbilao; acquisition of ownership rights of
Navotas I and II; and facilitation of further energy sales from Sual, Pagbilao
and Navotas I and II. The Framework Agreement has numerous conditions precedent
and its implementation will require many other agreements involving project
companies, and in some cases other parties and government agencies. The parties
have agreed to complete the measures within 90 days from the date of the
Framework Agreement. Any issue with respect to Ilijan is outside the terms of
the Framework Agreement.
Panda-Brandywine, L.P. Power Purchase Agreement: On July 18, 2002, the Maryland
Court of Special Appeals ruled that a Power Purchase Agreement ("Panda PPA")
between Panda-Brandywine, L.P. ("Panda") and PEPCO had been improperly assigned
to Mirant and that PEPCO had improperly delegated its duties under the Panda PPA
to Mirant. The Panda PPA is a long term power purchase agreement that expires in
2021. At the time that Mirant purchased the Mid-Atlantic assets from PEPCO in
2000, Mirant and PEPCO entered into a contractual arrangement (the "Back-to-Back
45
Agreement") with respect to the Panda PPA under which (1) PEPCO agreed to resell
to Mirant all "capacity, energy, ancillary services and other benefits" to which
it is entitled from Panda under the Panda PPA; (2) Mirant agreed to pay PEPCO
each month all amounts due from PEPCO to Panda for the immediately preceding
month associated with such capacity, energy, ancillary services and other
benefits; and (3) PEPCO irrevocably and unconditionally appointed Mirant to deal
directly with Panda with respect to all matters arising under the Panda PPA.
Mirant has also entered into an agreement with PEPCO that the Back-to-Back
Agreement would be terminated and an adjustment would be made to the price paid
by Mirant under the asset purchase and sale agreement if the Back-to-Back
Agreement was found to be void by a binding court order within the period ending
in March 2005. The amount of the purchase price adjustment is to be set so as to
compensate PEPCO for the termination of the benefit to PEPCO of the back-to-back
arrangement while also holding Mirant economically indifferent from any such
court order. In December 2000, Mirant estimated that the charges to be paid by
PEPCO for electricity under the Panda PPA exceeded the then existing market
prices for electricity by $365 million on a net present value basis. In its July
18, 2002 decision, the Court of Special Appeals also ruled, however, that the
Maryland PSC has the authority to approve the transfer of rights, duties and
obligations under the Panda PPA to Mirant on public policy grounds despite the
assignment provision and remanded the case to the Maryland PSC. PEPCO and Panda
have each filed a petition seeking to appeal the decision made by the Court of
Special Appeals to the Maryland Court of Appeals, its highest court. Mirant does
not believe that it will ultimately be required to make the purchase price
adjustment, but the ultimate outcome cannot now be determined.
With respect to each of these lawsuits, the Company cannot currently
determine the outcome of the proceedings or the amounts of any potential losses
from such proceedings.
46
Independent Accountants' Review Report
The Board of Directors and Shareholders
Mirant Corporation:
We have reviewed the condensed consolidated balance sheet of Mirant Corporation
and subsidiaries as of June 30, 2002, and the related condensed consolidated
statements of income for the three-month and six-month periods ended June 30,
2002, and the related statements of stockholders' equity and cash flows for the
six-month period ended June 30, 2002. These condensed consolidated financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
The consolidated financial statements of the Company as of and for the year
ended December 31, 2001, were not audited by us and, accordingly, we do not
express an opinion or any form of assurance on the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 2001.
Additionally, the condensed consolidated statements of income for the
three-month and six-month periods ended June 30, 2001, and the related statement
of cash flows for the six-month period ended June 30, 2001, were not reviewed or
audited by us and, accordingly, we do not express an opinion or any form of
assurance on them.
/s/ KPMG LLP
Atlanta, Georgia
November 6, 2002
47
MIRANT CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
OVERVIEW
We are a global competitive energy company that delivers value primarily by
producing and selling electricity in the U.S., Philippines, China and the
Caribbean. In the U.S. we optimize the value of our extensive power plant asset
base by buying and selling power and natural gas utilizing our risk management
and marketing expertise. In the Philippines and China we have long-term
contracts to sell the majority of the power produced from our power plants and
in the Caribbean we also own fully integrated electric utilities with
generation, transmission and distribution capabilities. As of September 30,
2002, we owned or controlled more than 22,500 MW of electric generating capacity
around the world and expect to bring online approximately 1,200 MW by December
2003. In North America, we also control access to approximately 3.8 billion
cubic feet per day of natural gas production, more than 3.6 billion cubic feet
per day of natural gas transportation and approximately 49 billion cubic feet of
natural gas storage.
With the sale of our investments in Bewag, WPD and our restructuring, we
have changed our principal business segments from Americas, Asia-Pacific and
Europe to North America and International. North America includes our United
States, Canadian and Caribbean operations and International includes our
Asia-Pacific, European and Brazilian operations. The other reportable business
segment is Corporate. In the fourth quarter of 2002, we launched an additional
phase of our restructuring plan, which moved our Caribbean operations from our
North America Group to our International Group.
As a result of the ongoing downward trend in market conditions, we have
modified our business strategy to focus on our North American, Caribbean and
Philippines operations. As part of this new focus, we will continue to reduce
the level of our trading and marketing activity, particularly with respect to
physical natural gas, as well as continue our asset sales program. As a result
of this contraction, we expect to record additional restructuring charges during
the remainder of 2002. Our current portfolio of power plants and electric
utilities gives us a net ownership and leasehold interest of over 18,900 MW of
electric generating capacity around the world, and control of over 3,600 MW of
additional generating capacity through management contracts. Our business also
includes managing risks associated with market price fluctuations of energy and
energy-linked commodities. We use our risk management capabilities to optimize
the value of our U.S. asset portfolio and offer risk management services to gas
producers.
Changes in Senior Management
In August 2002, Larry Westbrook, was named as the Company's Senior Vice
President and Interim Principal Accounting Officer. Mr. Westbrook is a retired
Chief Financial Officer of the Southern Company and has primary responsibility
for overseeing the resolution of the accounting issues that were discussed in
the Company's August 14, 2002 Form 8-K. In September 2002, James Ward, Mirant's
Controller and Principal Accounting Officer, retired from service with the
Company.
In October 2002, the Company announced that at the end of October 2002,
Randy Harrison, Senior Vice President - East Region, would be retiring and that
Gary Morsches, Senior Vice President - West Region, would be leaving the
Company.
48
Accounting Errors and Reaudit of Historical Financial Statements
As disclosed in a press release dated July 30, 2002, the Company identified
several accounting issues related to its risk management and marketing
operations. Subsequent to its July 30, 2002 press release, the Company
determined that there is no $100 million overstatement of an account payable and
reconciled the potential $68 million overstatement of an accounts receivable
asset referenced in the July 30 press release. The resolution of the $68 million
item did, however, indicate that earnings for the first quarter of 2002 were
understated by $16 million, and previously reported second quarter 2002 earnings
were overstated by $16 million. This correction has been reflected in the
accompanying unaudited condensed consolidated statements of income.
The Company also determined the cumulative impact of the previously
disclosed $85 million overstatement of a natural gas asset and recorded
after-tax charges totaling $42 million in its December 31, 2001 retained
earnings balance. The specific interim periods within previous years to which
the $42 million relates have not been determined at this time; accordingly, the
December 31, 2001 retained earnings balance in the accompanying condensed
consolidated balance sheets has been adjusted but not the accompanying 2001
condensed consolidated statements of income. The interim periods to which the
$42 million relates will be determined in connection with the reaudit described
below.
As a result of the identification of the initial accounting issues described
in the July 30, 2002 press release, the Company retained the law firm of King &
Spalding with the support of a nationally recognized accounting firm to conduct
an independent review and to report to the Company's Audit Committee. King and
Spalding has concluded that there was no fraudulent conduct on the part of any
Mirant employee or officer related to the identified accounting issues.
In the course of resolving the previously announced accounting issues
discussed above, and the concurrent review of Mirant's interim financial
statements, errors affecting Mirant's historical financial statements were
identified.
A summary of these adjustments is as follows (in millions):
Increase (Decrease) in Net Income
----------------------------------------------------------
2001 and Prior First Quarter 2002 Second Quarter
2002
---------------- --------------------- -------------------
U.S. income taxes on Asian income (a)................... $ 42
Natural gas asset (b)................................... (42)
Other corrections of prior years' income................ (15)
Accrued power revenues (c) .............................. (29) $ 8 $ (7)
WPD income taxes (d)..................................... (17) 17
Other corrections of items impacting 2002 and prior year(s) 10 6 (10)
$68 million gas accrual (e)............................. 16 (16)
Accrued gas revenues (f)................................. 12 (8)
Accrued power sales (g).................................. (10)
Other corrections of items impacting 2002 interim results (6) 8
------- --------- ----------
Total corrections..................................... $(51) $36 $ (26)
======= ========= ==========
Finalization of WPD impairment upon September sale (42)
Total reduction of previously announced second quarter 2002
results of operations................................... $(68)
==========
(a) excess U.S. income tax on Asia income of $10 million in each of 1999 and
2000, and $22 million in 2001
(b) the cumulative impact of the previously disclosed $85 million overstatement
of a natural gas asset
(c) $48 million of overstated physical power sales were accrued through
December 31, 2001; $13 million of expenses and $11 million of revenues were
originally recorded in the first and second quarters of 2002, respectively,
related to this item
49
(d) $17 million of deferred tax expenses related to the Company's investment in
WPD were originally recorded in the second quarter of 2002. These expenses
relate to 1999, 2000 and 2001.
(e) earnings for the first quarter of 2002 were understated by $16 million, and
earnings for the second quarter of 2002 were overstated by $16 million
(f) correction of accrued gas revenues that decreased first quarter net loss by
$12 million and increased second quarter net loss by $8 million
(g) correction of our power revenue accrual in the second quarter increased our
net loss by $10 million
Second quarter 2002 loss from operations has been increased by $42 million
to reflect the September 2002 sales price of the Company's investment in WPD. In
addition, the 2002 condensed consolidated operating cash flows for the six month
period ended June 30, 2002 have been increased by $12 million and net cash
provided by investing activities increased by $35 million.
A summary of the adjustments to the previously filed first quarter 2002
unaudited condensed consolidated statement of income, and the previously
released statements of income for the three and six month periods ended June 30,
2002 follows (in millions):
Three Months Ended March 31, 2002 Three Months Ended June 30, Six Months Ended June 30,
2002 2002
----------------------------------- ------------------------------- ------------------------------
As Previously As Previously As As Previously As
Filed As Restated Released Reported Released Reported
----------------- ----------------- --------------- --------------- ---------------- -------------
Operating revenues....... $7,037 $6,908 $ 6,370 $ 6,134 $13,407 $ 13,042
Operating expenses....... 6,465 6,298 5,707 5,554 12,172 11,852
------ -------- -------- --------- ------- --------
Gross margin............. 572 610 663 580 1,235 1,190
Other.................... (614) (616) (815) (800) (1,429) (1,416)
------ -------- -------- ---------- ------------- -----------
Net (loss)................ $ (42) (6) $ (152) $ (220) $ (194) $ (226)
====== ======== ========= ========== ============= ============
The Company has also resolved its announced balance sheet reclassifications
that reduce both energy risk management and marketing assets and liabilities in
the Company's December 31, 2000 and 2001 consolidated balance sheets by $1.53
billion and $820 million, respectively. These reclassifications relate primarily
to intra-company eliminations and do not have any effect on the Company's
results of operations, revenues, expenses, net income, liquidity or cash flow.
The Company's independent auditors assessed the Company's internal controls
of its North American energy marketing and risk management operations as part of
the interim review for the second quarter. The independent auditors provided the
Company with detailed process improvement recommendations to address internal
control deficiencies in existence at June 30, 2002. The independent auditors
have advised the Audit Committee that these internal control deficiencies
constitute reportable conditions and, collectively, a material weakness as
defined in Statement on Auditing Standards No. 60. The Company has assigned the
highest priority to the short-term and long-term correction of these internal
control deficiencies. Management has discussed its proposed actions with the
Audit Committee and its independent auditors. The Company has implemented
corrective actions to mitigate the risk that these deficiencies could lead to
material misstatements in the Company's current financial statements. In
addition, the Company has performed additional procedures to enable the
completion of the independent auditors' review of the Company's interim
financial statements despite the presence of the control weaknesses as noted
above.
In October 2002, the Company engaged KPMG to reaudit the Company's 2000 and
2001 financial statements for two primary reasons: (i) to address accounting
errors identified during reviews of the Company's previously disclosed
accounting issues; and (ii) to enable its independent auditors to provide an
50
opinion on Mirant's 2000 and 2001 financial statements in accordance with the
new accounting standards of EITF Issue 02-3 and SFAS No. 144. The Company
expects the reaudit to result in a restatement of its statement of income for
either or both of 2000 and 2001 and potentially for interim periods in 2001 and
2002.
RESULTS OF OPERATIONS
Results of operations for the three and six months ended June 30, 2002
include amounts which were hedged with higher margins in 2001 than are currently
available based on forward curves. For example, our power sales agreement with
California DWR expires in December 2002 and is above current market prices. Our
inability to enter into contracts with similar margins is expected to adversely
impact our future operating results.
Since June 30, 2002 we have seen lower trading volumes in forward markets
for both gas and electricity. Trading volumes are expected to further decline as
a result of a number of our competitors exiting the trading business and as a
result of our plan to reduce significantly the size of our physical natural gas
operations.
SECOND QUARTER 2002 vs. SECOND QUARTER 2001
AND
YEAR-TO-DATE 2002 vs. YEAR-TO-DATE 2001
Significant income statement items appropriate for discussion include
the following:
Increase (Decrease)
Second Quarter Year-to-Date
----------------------- -------------------------
(in millions)
Operating revenues.................................. $(1,781) (23%) $(3,041) (19%)
Cost of fuel, electricity and other products..... (1,573) (22%) (2,656) (18%)
Gross margin..................................... (208) (26%) (385) (24%)
Other operating expenses
Depreciation and amortization................... (15) (16%) (23) (13%)
Maintenance..................................... (12) (29%) (7) (10%)
Selling, general and administrative............. (19) (10%) (167) (35%)
Impairment loss................................. (89) NM (93) NM
Restructuring charge............................ 28 NM 590 NM
Gain on sale of assets........................ 27 NM 27 NM
Other income/expense
Interest income................................. (21) (58%) (56) (64%)
Interest expense................................ (36) (25%) (60) (21%)
Gain/(loss) on sale of assets................... (11) NM 280 NM
Equity in income of affiliates.................. (5) (11%) (6) (5%)
Impairment loss on minority owned affiliates.... 317 NM 317 NM
Receivables recovery............................ - - 19 190%
Other........................................... 1 33% (1) NM
(Benefit) provision for income
taxes........................................... (38) (70%) (159) (112%)
Minority interest.................................. 2 13% 4 13%
Note: NM indicates not meaningful.
Operating revenues. Our operating revenues for the three and six months
ended June 30, 2002 were $6,134 million and $13,042 million, respectively, a
decrease of $1,781 million and $3,041 million over the same periods in 2001. The
following factors were responsible for the decrease in operating revenues:
51
o Revenues from generation and energy marketing products for the three and
six months ended June 30, 2002, were $5,995 million and $12,776 million,
respectively, compared to $7,764 million and $15,890 million for the same
periods in 2001. These decreases of $1,769 million and $3,114 million
resulted primarily from decreased prices for natural gas and power and
reduced generation primarily in the western U.S. offset somewhat by higher
sales volumes and the commencement of operations at our Michigan plant in
June 2001 and the commencement of the second phase of our Texas plant in
June 2001. In North America, the average price for power and natural gas
decreased more than 50% while sales volumes increased by more than 40% and
70%, respectively. In addition, our power production decreased by
approximately 15%. The decrease for the second quarter 2002 is also due to
exiting our European energy marketing operations. The year-to-date decrease
was partially offset by higher revenues from our European energy marketing
operations due to higher physical volumes in the German market in the first
quarter of 2002.
o Distribution and integrated utility revenues for the three and six months
ended June 30, 2002, were $126 million and $234 million, respectively,
compared to $144 million and $180 million for the same periods in 2001. The
decrease of $18 million for the three months ended June 30, 2002 was
primarily due to the elimination of revenue due to the sale of our Chilean
operations in December 2001. The increase of $54 million for the six months
ended June 30, 2002 was attributable to our Jamaican investment, which was
acquired in March 2001, offset somewhat by the elimination of revenue due
to the sale of our Chilean operations in December 2001.
o Other revenues for the three and six months ended June 30, 2002, were $13
million and $32 million, respectively, compared to $7 million and $13
million for the same periods in 2001. These increases of $6 million and $19
million were primarily attributable to revenues related to the gas and oil
operations we acquired from Castex in August 2001.
Cost of fuel, electricity and other products. Cost of fuel, electricity and
other products for the three and six months ended June 30, 2002, was $5,554
million and $11,852 million, respectively, compared to $7,127 million and
$14,508 million for the same periods in 2001. These decreases of $1,573 million
and $2,656 million were primarily attributable to decreased prices for natural
gas and power and reduced generation primarily in the western U.S., offset
somewhat by higher purchases and the commencement of operations at our Michigan
plant in June 2001 and the commencement of the second phase of our Texas plant
in June 2001. In North America the average price for power and natural gas
decreased more than 50% while sales volumes increased by more than 40% and 70%,
respectively. In addition, our power production decreased by approximately 15%.
The decrease for the second quarter is also due to exiting our European energy
marketing operations. The year to date decrease was partially offset by higher
costs from our European energy marketing operations due to higher physical
volumes in the German market in the first quarter of 2002 and the operating
expenses during the six months ended June 30, 2002 from our Jamaican investment
which was acquired in March 2001.
Gross margin. Gross margin for the three and six months ended June 30,
2002, was $580 million and $1,190 million, respectively, compared to $788
million and $1,575 million for the same periods in 2001. The decreases of $208
million and $385 million were primarily attributable to lower prices for
electricity as well as lower production from our assets in the western U.S.
offset somewhat by higher margins from our controlled assets in the central U.S.
Other operating expenses. Other operating expenses for the three and six
months ended June 30, 2002, were $396 million and $1,322 million, respectively,
a decrease of $144 million for the three months ended June 30, 2002 and an
increase of $271 million for the six months ended June 30, 2002 over the same
periods in 2001. The following factors were responsible for the changes in
operating expenses:
52
o Depreciation and amortization expense for the three and six months ended
June 30, 2002, was $79 million and $156 million, respectively, compared to
$94 million and $179 million for the same periods in 2001. These decreases
of $15 million and $23 million resulted primarily from the cessation of
amortization of goodwill and trading rights recognized in business
combinations of approximately $19 million and $38 million for the three and
six months ended June 30, 2002, respectively, offset by additional
depreciation from our Jamaican investment which was acquired in March 2001,
our West Georgia operation which was acquired in August 2001, from the
commencement of operations at our Michigan plant in June 2001 and from the
commencement of the second phase of our Texas plant in June 2001.
o Maintenance expense for the three and six months ended June 30, 2002, was
$29 million and $61 million, respectively, compared to $41 million and $68
million for the same periods in 2001. These decreases of $12 million and $7
million were primarily due to higher maintenance requirements in 2001 from
our plants in the western U.S. as a result of the increased demand on those
plants in that period.
o Selling, general and administrative expense for the three and six months
ended June 30, 2002, was $168 million and $316 million, respectively,
compared to $187 million and $483 million for the same periods in 2001. The
majority of the quarterly decrease of $19 million resulted from higher
stock related compensation in the second quarter of 2001 and reduced cost
due to exiting the European trading and marketing operations offset
somewhat by expenses from new acquisitions and assets coming on line. In
addition, the majority of the year-to-date decrease of $167 million
resulted from provisions for potential losses taken in the first quarter of
2001 related to uncertainties in the California power markets.
o Impairment loss for the three and six months ended June 30, 2001 was $89
million and $93 million, respectively. In the second quarter of 2001, we
wrote-off $88 million of our investment in our Chilean subsidiary, EDELNOR.
o Restructuring charge for the three and six months ended June 30, 2002, was
$28 million and $590 million, respectively. The components of the
restructuring charge for the three and six months ended June 30, 2002,
respectively, include:
- $0 and $285 million related to write-downs of capital previously
invested, either directly into construction or in progress payments on
equipment;
- $0 and $246 million related to costs to cancel equipment orders and
service agreements per contract terms;
- $26 million and $57 million related to the severance of approximately
500 employees worldwide and other employee termination-related
charges; and
- $2 million related to costs incurred to suspend construction projects
in progress.
o Gain on sale of assets for both the three and six months ended June 30,
2002 was $27 million. This resulted from the gain on the sale of our
investment in Kogan Creek in the second quarter of 2002.
Total other income (expense). Other expense for the three and six months
ended June 30, 2002 was $372 million and $81 million, respectively, compared to
other expense of $55 million and $60 million for the same periods in 2001. The
increase in other expense of $317 million and $21 million for the three and six
months ended June 30, 2002, respectively, was primarily due to the following:
o Interest income for the three and six months ended June 30, 2002, was $15
million and $32 million, respectively, compared to $36 million and $88
million for the same periods in 2001. These decreases of $21 million and
$56 million were primarily due to lower interest revenue from our loan
receivables related to Shajiao C and Hyder, lower overall bank balances and
lower interest rates earned on those balances. In addition, we had interest
income in the first quarter of 2001 of approximately $12 million from the
Capital Funding subsidiary transferred to Southern in March 2001.
53
o Interest expense for the three and six months ended June 30, 2002, was $107
million and $226 million, respectively, compared to $143 million and $286
million for the same periods in 2001. These decreases of $36 million and
$60 million were primarily due to higher capitalized interest during 2002.
Capitalized interest for the three and six months ended June 30, 2002 was
$30 million and $68 million, respectively, compared to $11 million and $19
million for the same periods in 2001. The increase in capitalized interest
resulted from higher levels of construction in progress in 2002. In
addition, we had interest expense in the first quarter of 2001 of
approximately $12 million from the Capital Funding subsidiary transferred
to Southern in March 2001.
o Gain/(loss) on sale of assets for the three and six months ended June 30,
2002, was $(9) million and $282 million, respectively, compared to $2
million for the same periods in 2001. The majority of the year-to-date
increase of $280 million resulted from the gain on the sale of our
investment in Bewag in February 2002 of $290 million. In addition, we
recognized a net loss of approximately $9 million on the sale of our
investments in SIPD and Perryville in the second quarter of 2002.
o Equity in income of affiliates for the three and six months ended June 30,
2002 and 2001 was $42 million and $120 million, respectively, compared to
$47 million and $126 million for the same periods in 2001. These decreases
were primarily due to the elimination of earnings from Bewag and SIPD
resulting from our sale of those assets in 2002, offset by higher current
year earnings from our Shajiao C venture due to forced outages in 2001 and
higher 2002 earnings from CEMIG primarily due to a tariff settlement.
o Impairment loss on minority owned affiliates for both the three and six
months ended June 30, 2002 was $317 million. We recorded a write-down of
approximately $317 million during the second quarter of 2002 for our
investment in WPD.
o Receivables of $29 million were recovered by us during the first quarter of
2002 as final payment related to receivables that were assumed in
conjunction with the Mirant Asia-Pacific Limited business acquisition.
During the first quarter of 2001, we received $10 million related to these
receivables. At the time of the purchase, we did not place value on the
receivables due to the uncertain credit standing of the party with whom the
receivables were secured.
(Benefit) provision for income taxes. The provision for income taxes for
the three months ended June 30, 2002 was $16 million and the benefit for the six
months ended June 30, 2002 was $17 million, compared to a provision of $54
million and $142 million for the same periods in 2001. This represents a
decrease of $38 million in the provision for income taxes for the three months
ended June 30, 2002 and a decrease of $159 million in the provision for the six
months ended June 30, 2002. Decreases in the provision for the quarter are
primarily due to a reduction in income offset by an additional tax impact
related to the impairment of WPD. In addition, 2001 results reflected a $32
million benefit related to our additional impairment charge for EDELNOR and
there were higher taxes in 2002 related to net gains on asset sales. The year to
date decrease is primarily due to restructuring charges taken in 2002, the
decrease in income generated in North America in the first quarter of 2002 and
additional provisions related to our consolidated tax position taken in the
first quarter of 2001. This change was partially offset by additional taxes
related to the gain on the sale of our investment in Bewag in February 2002 and
additional taxes in 2002 related to SIPD.
Minority interest. Minority interest for the three and six months ended
June 30, 2002 was $18 million and $34 million, compared to $16 million and $30
million for the same periods in 2001. The increases of $2 million and $4 million
were primarily attributable to higher income from Jamaica, Shajiao C and our
Philippine operations offset somewhat by elimination of income after the sale of
our investment in our Chilean subsidiary, EDELNOR.
54
Earnings
Our consolidated net loss for the three and six months ended June 30, 2002,
was $220 million ($0.55 per diluted share) and $226 million ($0.56 per diluted
share), respectively, compared to net income of $124 million ($0.36 per diluted
share) and $304 million ($0.88 per diluted share) for the corresponding periods
of 2001. The decrease in net income of $344 million for the three months ended
June 30, 2002 and the decrease in net income of $530 million for the six months
ended June 30, 2002 from the same periods in 2001 are attributable to our
business segments as follows:
North America
Net income for the North America Group totaled $68 million for the three
months ended June 30, 2002 and net loss totaled $119 million for the six months
ended June 30, 2002. This represents a decrease in income of $35 million and
$396 million from the same periods in 2001. The decrease for the quarter is
primarily attributable to decreased prices for natural gas and power and reduced
generation primarily in the western U.S. and a net restructuring charge of $6
million offset by the write-off of $57 million of our investment in our Chilean
subsidiary, EDELNOR, in the second quarter of 2001 and by the elimination of
goodwill amortization in 2002. In addition, the decrease for the year is
primarily attributable to a net restructuring charge of $300 million. In
addition, 2001 net income includes a $147 million ($245 million pre-tax)
provision for the uncertainties in the California power market recorded in the
first quarter of 2001. The total amount of provisions made in relation to these
uncertainties was $177 million ($295 million pre-tax). As of June 30, 2002, the
total amount owed to us by the CAISO and the PX was $352 million.
International
Net loss for the International Group totaled $232 million for the three
months ended June 30, 2002 and net income totaled $1 million for the six months
ended June 30, 2002, a decrease of $298 million and $139 million, respectively,
from the same periods in 2001. The decreases were primarily attributable to the
write-down of our investment in WPD of approximately $306 million ($317 million
pre-tax) in the second quarter of 2002. These decreases were also attributable
to the net restructuring charges of $3 million and $46 million for the three and
six months ended June 30, 2002, and lower income from operations of Bewag and
SIPD due to our sale of those assets in 2002. These decreases were offset
somewhat by the after-tax gain of $8 million from the sale of our interests in
SIPD and Kogan Creek in the second quarter of 2002, the after-tax gain of $167
million from the sale of our interest in Bewag in the first quarter of 2002 and
by the elimination of goodwill amortization and higher current year earnings
from our Shajiao C venture due to forced outages in 2001. The year-to-date
decreases were further offset by higher amounts received related to receivables
recoveries that were assumed in conjunction with the Mirant Asia-Pacific Limited
business acquisition and higher 2002 earnings from CEMIG primarily due to a
tariff settlement.
Corporate
After-tax corporate expenses produced a net loss from continuing operations
of $56 million and $108 million for the three and six months ended June 30,
2002; an increase of $11 million for the second quarter and a decrease of $5
million for the six months ended June 30, 2002. The increased costs for the
quarter resulted primarily from restructuring charges of $9 million and
increased interest expense in 2002 on corporate borrowings used to fund working
capital and construction. The year-to-date decrease resulted primarily from
higher compensation in 2001 and additional tax provisions related to our
consolidated tax position in 2001, offset somewhat by 2002 restructuring charges
of $16 million and increased interest expense in 2002 on corporate borrowings
used to fund working capital and construction.
55
FINANCIAL CONDITION
Liquidity and Capital Resources
Historically, we have obtained cash from operations, borrowings under
credit facilities and issuance of senior notes, proceeds from equity issuances,
capital contributions from Southern and proceeds from non-recourse project
financing. These funds have been used to finance operations, service debt
obligations, fund the acquisition, development and construction of generating
facilities and distribution businesses, finance capital expenditures and meet
other cash and liquidity needs. In addition, the Company has used cash and
letters of credit to meet the collateral requirements for its trading and
marketing activities. Over the next several years, we will be required to repay
bank credit facilities and capital market obligations which are significant.
Because of the general deteriorating conditions in our industry and because our
credit ratings have been lowered, we do not expect to be able to refinance these
obligations in the same amounts or on terms as favorable as our existing
borrowings. We expect that we will meet our liquidity needs through a
combination of re-financing transactions, use of our existing cash balances and
asset sales. In addition, planned contractions in the level of our trading and
marketing activity are expected to reduce the need for collateral posted through
letters of credit and cash. However, in the event we were unable to refinance a
substantial portion of our indebtedness, we could be required to seek bankruptcy
court or other protection from creditors.
The projects that we have developed typically required substantial capital
investment. Some of the projects and assets in which we have an interest have
been financed primarily with non-recourse debt that is repaid from the cash
flows of such project assets. Some of this debt is secured by interests in the
physical assets, major project contracts and agreements, cash accounts and, in
some cases, the ownership interest in that project subsidiary. These financing
structures are designed so that Mirant Corporation is not contractually
obligated to repay the debt of the subsidiary, that is, the debt is
"non-recourse" to Mirant Corporation and to its other subsidiaries not involved
in the project or asset. However, we have agreed to undertake limited financial
support for some of our subsidiaries in the form of limited obligations and
contingent liabilities such as guarantees of specific obligations. To the extent
we become liable under these guarantees or other agreements in respect of a
particular project or asset, we may choose to use distributions we receive from
other projects and assets or corporate borrowing capacity to satisfy these
obligations.
Operating Activities
Net cash provided by operating activities per our unaudited condensed
consolidated statements of cash flows totaled $353 million for the six months
ended June 30, 2002, as compared to $240 million for the same period in 2001.
This increase was due to the following items:
o We made payments in the first quarter of 2001 to fuel suppliers and others
of approximately $140 million, which were accrued in 2000 and related to
amounts owed to us and not collected from the CAISO and California PX.
o We received $189 million of net cash collateral in the first six months of
2002, compared to a net payment of cash collateral of $145 million in the
first six months of 2001. The receipts in 2002 were due primarily to a
reduction in our energy marketing credit exposure as a result of lower
prices in 2002 and expanding the use of our master netting agreements.
o We realized lower gross margins and a lower portion of our gross margin in
cash during the first six months of 2002 compared to the first six months
of 2001. This was attributable to higher prices and margins in 2001 as well
as a shorter tenor in our energy marketing and risk management net
positions in 2001.
56
Excluding the effects of working capital reflected as "Changes in certain
assets and liabilities, excluding effects from acquisitions" in our unaudited
condensed consolidated statements of cash flows, our operating cash flows for
the six months ended June 30, 2002 decreased by $406 million compared to the
same period in 2001. This decrease was primarily attributable to the significant
amount of cash realized in 2001 compared to 2002 due to higher prices and
margins in 2001.
For the six months ended June 30, 2002 and 2001, net income included the
release of approximately $141 million in after-tax provisions recorded in
connection with the PEPCO acquisition. Our after-tax funding obligation for the
energy delivery and purchase agreements associated with this acquisition was $38
million for the first six months of 2002 compared to $156 million for the same
period in 2001. The total after-tax assumed obligation recorded in purchase
accounting was $1.4 billion, which was our estimate of actual after-tax cash
payments we expected to make over the term of the contracts as a result of
assuming the out-of-market contracts from PEPCO, based on future price and
volume estimates at the time of our acquisition.
Investing Activities
Net cash provided by investing activities totaled $1,008 million for the
six months ended June 30, 2002, as compared to net cash used in investing
activities of $1,104 million for the same period in 2001. For the six months
ended June 30, 2002, we received proceeds from the sale of our indirect interest
in Bewag of approximately $1.63 billion and approximately $336 million from our
other asset sales. These inflows were offset by capital expenditures of
approximately $811 million. The 2001 investing activities included capital
expenditures in North America, acquisition of an additional 18.8% interest in
Bewag and the acquisition of our Jamaican subsidiary in March 2001. Cash flows
from investing activities also include the repayment of notes receivable in the
form of shareholder's loans to Shajiao C in the amount of $10 million in 2002
and $89 million in 2001. Of these amounts, we are entitled to approximately $9
million and $74 million respectively, after repayments to minority shareholders.
Financing Activities
Net cash used for financing activities totaled $1,263 million for the six
months ended June 30, 2002, as compared to net cash provided by financing
activities of $1,030 million for the same period in 2001. The decrease is
primarily attributable to net borrowings in 2001 to finance acquisitions and
construction activities compared to net repayments of long-term debt in 2002,
much of which was completed using the proceeds received from the sale of our
indirect interest in Bewag and other asset sales.
Our cash from operations, asset sales, existing credit facilities and cash
position, along with existing credit facilities at our subsidiaries, is expected
to provide sufficient liquidity for working capital and capital expenditures,
including letters of credit, over the next 12 months. In addition, we expect our
cash from operations will be sufficient to fund our interest costs on an ongoing
basis.
Our liquidity could be impacted by changing prices resulting from abnormal
weather, excess capacity, the ability to complete asset sales, changes in credit
ratings and other factors. In addition, a significant part of Mirant
Corporation's investments are in subsidiaries financed with project or
subsidiary level indebtedness to be repaid solely from the respective
subsidiary's cash flows. Subsidiaries financed in this manner are often
restricted by their respective project credit documents in their ability to pay
dividends and management fees periodically to Mirant Corporation. These
limitations usually require that debt service payments be current, debt service
coverage and leverage ratios be met and there be no default or event of default
under the relevant credit documents. There are also additional limitations that
are adapted to the particular characteristics of each subsidiary and its assets.
To enhance Mirant's liquidity and reduce reliance on external financing,
Mirant has designed and launched an additional phase for its restructuring plan.
57
In 2002,Mirant announced its plan to sell additional assets, including WPD, to
raise $700 million to $1 billion. Mirant's board has authorized the expenditure
of up to $500 million for the repurchase of debt securities as the Company's
liquidity permits through 2003.
Income Taxes
Due to the uncertainty regarding restructuring and foreign asset sales,
Mirant may not be in a position to fully utilize all of its future foreign tax
credits. Failure to fully utilize Mirant's foreign tax credits would have the
effect of increasing its effective tax rate, thereby decreasing the Company's
net income, and potentially cash flow in the affected periods. Mirant expects to
fully utilize all of its foreign tax credits through 2002.
In September 2002, the IRS refunded $195 million in overpaid income taxes
to Mirant for the tax period April 3 to December 31, 2001.
The IRS has completed its audit of Mirant for all tax years through 1995.
The IRS is currently auditing the tax years 1996-1999. Subsequent to June 30,
2002, the IRS issued Notices of Proposed Adjustments for this period for several
tax return filing positions affecting taxable income. While Mirant believes it
has substantial authority for the positions it has taken, it continues to review
this situation. The negative liquidity impact of these adjustments, if accepted
by Mirant, could be as much as $100 million. Management has not yet determined
the income statement impact of these potential adjustments.
Common Stock
The market price of our common stock at June 30, 2002 was $7.30 per share
and the book value was $13.13 per share based on the 402,084,743 shares
outstanding at June 30, 2002, representing a market-to-book ratio of 56%.
Credit Ratings
The following table presents the current credit ratings on Mirant and its
subsidiaries from the three major rating agencies. The outlooks for all credit
ratings are negative.
S&P Moody's Fitch
----- ------- ----------
Mirant Corporation...................... BB B1 BB
Mirant Americas Generation............... BB Ba3 BB
Mirant Mid-Atlantic...................... BB Ba3 BB+
Mirant Americas Energy Marketing......... BB Ba3 Not rated
Mirant Trust I........................... B B3 B+
On June 24, 2002, Fitch lowered its rating on Mirant's senior notes and
convertible senior notes to BBB- from BBB, and on October 15, 2002, Fitch
further lowered its rating on Mirant's senior notes and convertible senior notes
to BB from BBB-. Fitch,s new ratings on Mirant securities each include a
negative outlook. Fitch also lowered its rating on the following of the
Company's subsidiaries or subsidiary issues: Mirant Trust I, Mirant Americas
Generation and Mirant Mid-Atlantic.
On October 10, 2002, Moody's lowered its rating on Mirant's senior
unsecured debt to B1 from Ba1. Moody's new rating on Mirant debt includes a
negative outlook. Moody's also lowered its rating on the following of the
Company's subsidiaries or subsidiary issues: Mirant Americas Energy Marketing,
Mirant Trust I, Mirant Americas Generation and Mirant Mid-Atlantic.
58
On October 21, 2002, S&P lowered its rating on Mirant's senior unsecured
debt to BB from BBB-. S&P's new rating on Mirant debt includes a negative
outlook. S&P also lowered its rating on the following of the Company's
subsidiaries or subsidiary issues: Mirant Americas Energy Marketing, Mirant
Trust I, Mirant Americas Generation and Mirant Mid-Atlantic.
As a result of Moody's, Fitch and S&P lowering their ratings in October
2002 on our senior unsecured debt, as of October 30, 2002, we have had to post
approximately $150 million of new collateral in the form of cash and letters of
credit and have agreed to post approximately $90 million of additional
collateral. As a result of the recent downgrades by Fitch and S&P, Mirant
Asia-Pacific is prohibited under the terms of its credit facility from
making distributions to Mirant Corporation.
While the foregoing indicates the ratings from these agencies, we note that
these ratings are not a recommendation to buy, sell or hold our securities, that
the ratings may be subject to revision or withdrawal at any time by the
assigning rating organization and that each rating should be evaluated
independently of any other rating. There can be no assurance that a rating will
remain in effect for any given period of time or that a rating will not be
lowered or withdrawn entirely by a rating agency if, in its judgement,
circumstances so warrant. Further, we note that each of the rating agencies
continues to monitor Mirant's credit profile, with increased scrutiny arising
from the reported financial difficulties of other market participants, the
uncertainty and turmoil in the financial markets generally and in the energy
sector specifically and our pending reaudit. In addition, we note the risk
factors related to a downgrade in our credit ratings as disclosed in our Form
10-K filed in March 2002.
Turbine Commitments
In October 2002, Mirant terminated contracts for three turbines that Mirant
did not anticipate terminating as of June 30, 2002. At the termination in
October 2002, the total net termination expense of these turbines was
approximately $34 million.
As of June 30, 2002, Mirant disclosed total turbine commitments of $555
million with a termination cost of $212 million. If Mirant had anticipated the
termination of the above mentioned turbines, Mirant's total turbine commitments
as of June 30, 2002, would have been $462 million with a termination cost of
$178 million.
Asset Sales
In February 2002, we completed the sale of our 44.8% indirect interest in
Bewag for approximately $1.63 billion. We received approximately $1.06 billion
in net proceeds after repayment of approximately $550 million in related debt.
The after-tax gain on the sale of our investment in Bewag was $167 million. The
net proceeds were used for general corporate purposes, capital expenditures and
repayment of certain drawn balances on revolving credit facilities.
In May 2002, we completed the sale of our 60% ownership interest in the
Kogan Creek power project, located near Chinchilla in southeast Queensland,
Australia, and associated coal deposits for approximately $29 million. The
after-tax gain on the sale of our investment in Kogan Creek was approximately
$17 million.
In May 2002, we completed the sale of our 9.99% ownership interest in SIPD,
located in the Shandong Province, China, for approximately $120 million. The
after-tax loss on the sale of our investment in SIPD was approximately $9
million.
In June 2002, we completed the sale of our State Line generating facility
for approximately $181 million plus an adjustment for working capital. The asset
was sold at approximately book value.
59
In June 2002, we completed the sale of our 50% ownership interest in
Perryville to Cleco, which holds the remaining 50% ownership interest in
Perryville. In connection with such sale, Cleco assumed our $13 million future
equity commitment to Perryville and paid approximately $55 million in cash to us
as repayment of the subordinated loan, invested capital to date and other
miscellaneous costs. Our investment was sold at approximately book value based
on the value of the investment at the date of sale. At such time, in connection
with the existing project financing, we agreed to make a $25 million
subordinated loan to the project. Effective August 23, 2002, Mirant Americas
Energy Marketing and Perryville, with the consent of the project lenders,
restructured the tolling agreement between the parties to remove the requirement
to post a letter of credit or other credit support in the event of a downgrade
from S&P or Moody's. In connection with the restructuring, Mirant Americas made
a $100 million subordinated loan to Perryville, the proceeds of which were used
to repay the existing $25 million subordinated loan owed to a Mirant subsidiary
and to repay $75 million of senior debt of the project. In addition, we retain
certain obligations as a project sponsor, some of which are subject to
indemnification by Cleco. The obligations retained by us and not subject to
indemnity relate primarily to the existing 20-year tolling agreement between
Mirant Americas Energy Marketing and Perryville as described in "-Contractual
Obligations and Commitments - Energy Marketing and Risk Management." The
obligations of Mirant Americas Energy Marketing under the tolling agreement are
guaranteed by Mirant Corporation.
In July 2002, we announced that we had entered into an agreement to sell
our Neenah generating facility to Alliant Energy Resources, Inc. for
approximately $109 million. The sale of Mirant's investment in Neenah will be
near book value. The sale is expected to close in the fourth quarter of 2002.
In August 2002, we completed the sale of our wholly owned subsidiary, MAP
Fuels Limited, which fully owned Allied Queensland Coalfields Pty Ltd., in
Queensland, Australia, for approximately $21 million. The asset was sold at
approximately book value. The sale included both the Wilkie Creek Coal Mine and
the Horse Creek coal deposits.
In September 2002, we completed the sale of our 49% economic interest in,
and shared management control of, Western Power Distribution Holdings Limited
and WPD Investment Holdings (both identified jointly as WPD) for approximately
$235 million. The after-tax loss on the sale of our investment in WPD was
approximately $306 million. The WPD assets include the electricity distribution
networks for Southwest England and South Wales.
Write Down of Asset
In September 2002, Mirant recorded an after-tax write down of $37 million
reflecting the fair market value of Mirant Americas Production Company. Mirant
Americas Production Company is an oil and gas exploration, development and
production company that Mirant has a plan to sell within a year. Mirant Americas
Production Company is included in the North America Group.
Suspended Construction
In August 2002, we announced suspension in construction of the 298 MW
natural gas-fired Mint Farm Generating Station in Longview, Washington due to
weak market conditions. The project was about 60% complete and had an expected
commercial operating date of June 2003. Costs incurred of $119 million included
in "Construction work in progress" on Mirant's condensed consolidated balance
sheet at June 30, 2002. The site will be maintained to preserve the completed
work and allow for restart of construction when market conditions become more
favorable.
60
Commencement of Operations
In June 2002, the Ilijan facility located in the Philippines, in which
Mirant has a 20% ownership interest, commenced commercial operations.
In July 2002, we commenced operation of the second phase at our Zeeland,
Michigan generating plant, operation at our Wrightsville, Arkansas generating
plant and operation of the first phase at our Sugar Creek generating plant near
Terre Haute, Indiana. Upon completion of the projects, $678 million of costs
were transferred from "Construction work in progress" to "Property, plant and
equipment."
In October 2002, JPSCo, in which we have an 80% ownership interest,
commenced operation of a new unit at its Bogue generating plant in Montego Bay,
Jamaica. Upon completion of the project, approximately $80 million in costs were
transferred from "Construction work in progress" to "Property, plant and
equipment."
Available Liquidity and Related Debt to Capitalization Ratios
The following table contains our available liquidity as of June 30, 2002 and
December 31, 2001 (in millions):
Liquidity
---------------------------------------
As of June 30, As of December 31,
2002 2001
------------------ --------------------
Cash at Mirant Corporation.......... $ 397 $ 406
Cash at subsidiaries................ 560 454
Availability of credit facilities:
Mirant Corporation............... 701 867
Mirant Americas Generation........ 227 227
Mirant Canada Energy Marketing... 4 18
Cash at subsidiaries not available for
Immediate payment to parent (1). (383) (293)
------- ---------
Total ............................. $ 1,506 $1,679
======= =========
(1) Represents estimated cash at the subsidiary level that is required for
operating, working capital or investment purposes at the respective
subsidiary and that is not available for immediate payment to Mirant
Corporation.
The following table contains some of our key debt to capitalization ratios
as of June 30, 2002 and December 31, 2001:
June 30, December 31, 2001
2002
----------------- ------------------
Recourse Debt /Total Recourse Capital. 35.3% 34.9%
Total Debt /Total Capital............. 60.0% 62.3%
Balance Sheet Debt/Balance Sheet
58.9% 61.8%
Capital............................
Total Debt is calculated as the sum of Short-term Debt, Current Portion of
Long-term Debt, Notes Payable, Other Long-term Debt, and two balance sheet
adjustments to reflect the operating lease at Mirant Mid-Atlantic and 89.9% "the
guaranteed portion" of the drawn amounts on the equipment procurement
facilities. The Mirant Mid-Atlantic operating lease figure represents the
present value of the future lease payments discounted at 10%.Recourse Debt is
calculated as the portion of Total Debt that is a direct obligation of Mirant
Corporation or an obligation at a subsidiary that has a guarantee from Mirant
Corporation. Total Capital is calculated as the sum of Total Debt (as defined
above), Preferred Stock, Minority Interest in Subsidiaries, Company Obligated
Mandatorily Redeemable Securities of a Subsidiary Holding Solely Parent Company
Debentures, and Total Stockholders Equity.
61
Debt
The following table sets forth our short-term and long-term debt, excluding
the effects of hedges, as of December 31, 2001 and June 30, 2002 (in millions):
Recourse/ Stated
December 31, June 30, Non-recourse Interest Maximum
2001 2002 Rate Maturity Balance *
---------------------- --------------------------------------------------
(in millions) (in millions)
Short-term debt
Mirant Canada Energy Marketing (has
a Mirant Corp. guarantee).............. $ 26 $ 42 Recourse 4.06% Aug-02 $ 46
----------------------
Total recourse short-term debt........ 26 42
Jamaica Public Service Company............ - 2 Non-recourse 10.85% Nov-02
Jamaica Public Service Company............ - 4 Non-recourse 9.75% Mar-03
Jamaica Public Service Company............ - 3 Non-recourse 10.00% Oct-02
Jamaica Public Service Company............ 22 30 Non-recourse 9.00% Apr-03
Jamaica Public Service Company............ - 5 Non-recourse 10.00% Dec-02
Mirant Asia-Pacific Ltd - Mirant
Asia-Pacific Singapore Pte Ltd.......... 7 8 Non-recourse 5.00% On demand
----------------------
Total non-recourse short-term debt...... 29 52
----------------------
Total short-term debt..................... 55 94
Current portion of long-term debt
Mirant Americas, Inc. - deferred
acquisition price......................... 21 21 Recourse 0.00% Oct-02
----------------------
Total recourse current portion of
long-term debt...................... 21 21
Mirant Asia-Pacific....................... 792 14 Non-recourse L+3.75% Jan-07**
Mirant Holdings Beteiligungsgesellschaft
term loan................................. 566 - Non-recourse 5.14% Jun-02
Mirant Pagbilao project loan.............. 23 20 Non-recourse 10.25% Jan-07
Mirant Pagbilao project loan.............. 9 6 Non-recourse 9.75% Jan-03
Mirant Pagbilao project loan.............. 34 31 Non-recourse 10.25% Jan-07
Mirant Pagbilao project loan.............. 4 3 Non-recourse 9.50% Jan-04
Mirant Pagbilao project loan.............. 122 111 Non-recourse 7.46% Jan-07
Mirant Pagbilao project loan.............. 81 74 Non-recourse L+2.15% Jan-07
Mirant Pagbilao project loan.............. 101 92 Non-recourse 7.16% Jan-07
Mirant Sual project loan.................. 19 17 Non-recourse 9.70% Jul-06
Mirant Sual project loan.................. 352 335 Non-recourse 5.95% Jan-12
Mirant Sual project loan.................. 37 36 Non-recourse 8.26% Jan-12
Mirant Sual project loan.................. 105 100 Non-recourse 5.95% Jan-12
Mirant Sual project loan.................. 30 28 Non-recourse 8.78% Jan-12
Mirant Sual project loan.................. 102 97 Non-recourse 7.35% Jan-12
Mirant Sual project loan.................. 28 27 Non-recourse 10.56% Jan-12
Mirant Sual project loan.................. 37 36 Non-recourse 9.40% Jan-12
Mirant Sual project loan.................. 117 104 Non-recourse L+2.50% Jan-06
Mirant Asia-Pacific Ltd - Shajiao C....... - 1 Non-recourse 0.00% Jan-05
West Georgia Generating Company........... 5 5 Non-recourse 3.53% Dec-02
Capital Leases - Jamaica................. 9 9 Non-recourse 12.51% Aug-16
Jamaica Public Service Company............ 8 - Non-recourse 10.00% Feb-03
Mirant Grand Bahamas ..................... 1 1 Non-recourse L+1.25% Oct-02
Grand Bahama Power Company................ 1 1 Non-recourse L+1.00% Apr-03
Grand Bahama Power Company................ - 1 Non-recourse L+1.25% Feb-03
----------------------
Total non-recourse current portion of
long-term debt........................ 2,583 1,149
----------------------
Total current portion of long-term debt... 2,604 1,170
62
Notes Payable
Mirant Corporation senior notes .......... 200 200 Recourse 7.40% Jul-04
Mirant Corporation senior notes .......... 500 500 Recourse 7.90% Jul-09
Mirant Americas Energy Capital (has a
Mirant Corporation guarantee)............ 150 150 Recourse 4.06% Sep-04
Mirant Americas, Inc. - deferred
acquisition price........................ 22 22 Recourse 0.00% Oct-03
Mirant Americas, Inc. - deferred
acquisition price........................ 23 23 Recourse 0.00% Oct-04
----------------------
Total recourse notes payable............ 895 895
Mirant Asia-Pacific....................... - 240 Non-recourse L+3.75% Jan-07
Mirant Americas Generation - senior notes. 500 500 Non-recourse 7.625% May-06
Mirant Americas Generation - senior notes. 850 850 Non-recourse 8.300% May-11
Mirant Americas Generation - senior notes. 400 400 Non-recourse 9.125% May-31
Mirant Americas Generation - senior notes. 300 300 Non-recourse 7.20% Oct-08
Mirant Americas Generation - senior notes. 450 450 Non-recourse 8.50% Oct-21
Mirant Americas Generation - credit
facility.................................. - - Non-recourse L+1.25% Oct-04 50
Mirant Americas Generation - credit
facility.................................. 73 73 Non-recourse L+1.25% Oct-04 250
West Georgia Generating Company........... 140 140 Non-recourse 3.53% Dec-03***
Mirant Grand Bahamas ..................... 9 9 Non-recourse L+1.25% Aug-06
Mirant Grand Bahamas ..................... 6 6 Non-recourse L+1.25% Aug-04
Grand Bahama Power Company................ 18 17 Non-recourse L+1.00% Apr-05
Grand Bahama Power Company................ 13 12 Non-recourse L+1.25% Feb-07
Mirant Trinidad notes..................... 73 73 Non-recourse 10.20% Jan-06
Mirant Asia-Pacific Ltd - Shajiao C....... 27 26 Non-recourse 0.00% Jan-05
Unamortized debt premium/ discounts on
notes..................................... (3) (3) Non-recourse
----------------------
Total non-recourse notes payable........ 2,856 3,093
----------------------
Total notes payable....................... 3,751 3,988
Other long-term debt
Mirant Corporation convertible senior
debentures............................. 750 750 Recourse 2.50% Dec-21****
Mirant Corporation CSFB 364-day Revolving
Credit Facility........................ 1,075 775 Recourse L+1.05% Jul-03 1,125
Mirant Corporation CSFB 4-year Revolving
Credit Facility........................ - - Recourse L+1.00% Jul-05 1,125
Mirant Corporation Citibank C Credit
Facility............................... - 150 Recourse L+0.975% Apr-04 450
Mirant Americas Development Capital....... - 35 Recourse 3.38% Apr-04
----------------------
Total recourse other long-term debt..... 1,825 1,710
Jamaica Public Service Company............ - 80 Non-recourse 11.90% Aug-06
Jamaica Public Service Company............ - 51 Non-recourse 10.75% Sep-06
Jamaica Public Service Company............ - 1 Non-recourse 10.00% Feb-05
Jamaica Public Service Company............ 125 2 Non-recourse 4.50% Dec-30
Mirant Curacao Investments - deferred 0.00%
acquisition price..................... - 9 Non-recourse Apr-05
Capital Leases - Americas / Zeeland....... 10 11 Non-recourse 9.50% Dec-12
Capital Leases - Jamaica.................. 108 112 Non-recourse 12.51% 2016
----------------------
Total non-recourse other long-term debt. 243 266
----------------------
Total other long-term debt................ 2,068 1,976
TOTAL RECOURSE DEBT......................... 2,767 2,668
TOTAL NON-RECOURSE DEBT..................... 5,711 4,560
----------------------
TOTAL BALANCE SHEET DEBT.................... $ 8,478 $7,228
======================
* Maximum Balance is provided for revolving credit facilities. This number
reflects the total amounts available under each facility for bank draws and
letters of credit.
** Facility was refinanced in January and March 2002.
*** After the initial maturity in December 2003, all cash generated by the
project is used to repay indebtedness until final maturity in 2009.
**** The holders may require us to purchase all or a portion of their debentures
on June 15, 2004, June 15, 2006, June 15, 2011 and June 15, 2016 at a price
equal to 100% of the principal amount of the debentures to be purchased plus
accrued and unpaid interest to such purchase date.
63
We have revolving credit facilities with various lending institutions
totaling approximately $3.2 billion of commitments. At June 30, 2002,
commitments utilized under such facilities (including drawn amounts and letters
of credit) totaled $2.26 billion and are comprised of the following: commitments
of $42 million drawn under the facility expiring in 2002, commitments of $775
million drawn or utilized under facilities expiring in 2003 (which included
amounts outstanding under Mirant Corporation's 364-Day Credit Facility with an
initial termination date of July 2002) and commitments of $1.447 billion drawn
or utilized under the facilities expiring in 2004 and beyond.
In July 2002, Mirant Corporation fully drew the commitments under its
$1.125 billion 364-Day Credit Facility and elected to convert all revolving
credit advances outstanding into a term loan maturing in July 2003. Effective
with our third quarter reporting, this Facility will be reclassified from
long-term debt to short-term debt as it will be due within 12 months. The
Company expects that this reclassification will potentially cause the Company to
have a negative working capital balance. In order to mitigate concerns about a
negative working capital balance, the Company is evaluating various potential
financing transactions to repay and/or refinance the Facility prior to its
maturity. As a result of present market conditions and other factors, including
reaudit of its historical financial statements, Mirant cannot provide assurance
that it will be successful in entering into a new credit facility. If Mirant is
successful in entering into a new credit facility, it expects the facility will
likely be smaller and will have higher pricing and more restrictive terms than
the current facility.
In July 2002, Mirant Corporation and Mirant Americas Generation drew down
most of their available revolving credit commitments. The schedule below
summarizes the outstanding borrowings under the credit facilities held by Mirant
Corporation and its subsidiaries as of September 30, 2002 (in millions).
Drawn Amount
excluding Letters Letters of Credit
Company of Credit Outstanding
------------------- -------------------
Mirant Corporation .................... $ 1,551(1) $1,048
Mirant Americas Generation............. 300 -
Mirant Canada Energy Marketing......... 44 -
Mirant Americas Energy Capital......... 150 -
(1)Amount includes fully drawn commitments under Mirant's $1.125 billion 364-Day
Credit Facility that was converted in July 2002 to a term loan maturing in July
2003.
Except for the credit facility of Mirant Canada Energy Marketing, an
indirect wholly owned subsidiary of Mirant Corporation, borrowings under these
revolving facilities are recorded as long-term debt in the unaudited condensed
consolidated balance sheet as of June 30, 2002. The credit facilities generally
require payment of commitment fees based on the unused portion of the
commitments. The schedule below summarizes amounts available on these facilities
held by Mirant Corporation and the specified subsidiaries as of December 31,
2001, June 30, 2002 and September 30, 2002 (in millions).
Amount Available
--------------------------------------------------------
Company Facility December 31,
Amount September 30, 2002 June 30, 2002 2001
----------------------------------------- ------------------- ------------------- ----------------
Mirant Corporation *........... $2,700 $101 $ 701 $ 867
Mirant Americas Generation .... 300 - 227 227
Mirant Canada Energy Marketing. 46 1 4 18
Mirant Americas Energy Capital. 150 - - -
---------- ------------------- ------------------- ----------------
Total....................... $3,196 $ 102 $932 $1,112
========== =================== =================== ================
* At June 30, 2002, there was $1,999 million of utilized commitments which
included $1,074 million of letters of credit outstanding compared to $1,833
million of utilized commitments which included $758 million of letters of credit
outstanding at December 31, 2001. At September 30, 2002, there was $2,599
million of utilized commitments which included $1,048 million of letters of
credit outstanding.
64
Each of Mirant's credit facilities contains various covenants including,
among other things, (i) limitations on (a) dividends, redemptions and
repurchases of capital stock, (b) the incurrence of indebtedness and liens and
(c) limitations on the sale of assets, and (ii) affirmative covenants to (a)
provide annual audited and quarterly unaudited financial statements prepared in
accordance with US GAAP and (b) comply with legal requirements in the conduct of
its business. In addition to other covenants and terms, each of Mirant's credit
facilities includes minimum debt service coverage and a maximum leverage
covenant. As of June 30, 2002, there were no events of default under such credit
facilities.
In connection with its review of the previously disclosed accounting
issues, the Company identified various errors affecting the Company's historical
financial statements. The Company believes that the errors it has identified do
not constitute a breach of a covenant or an event of default under its credit
facilities. If the Company were in default, or the type or amount of any
adjustments arising from the announced reaudit of the Company's historical
financial statements were to result in an event of default under its credit
facilities, the lenders would have the right to accelerate the Company's
obligations under its credit facilities. Any such acceleration would trigger
cross-acceleration provisions in a substantial portion of the Company's other
consolidated indebtedness. In such event, the Company would be required to seek
waivers or other relief from its lenders and, absent such relief, approximately
$4.5 billion of the Company's consolidated debt would be classified as
short-term debt and could be accelerated. Further, in the event that its lenders
accelerated such indebtedness, the Company can provide no assurances that it
would be able to refinance such indebtedness in the existing credit markets and
would likely have to seek bankruptcy court or other protection from its
creditors.
Mirant Canada Energy Marketing has extended its credit facility to June 30,
2003. The revolving credit facility of approximately $46 million (denominated as
70 million Canadian dollars) had outstanding borrowings of $42 million, at an
interest rate of 4.06% at June 30, 2002. The credit facility is guaranteed by
Mirant Corporation and is secured by a letter of credit in the amount of $46
million and security interests in the real and personal property of Mirant
Canada Energy Marketing.
In February 2002, Mirant, Mirant Americas Energy Marketing, Perryville, the
lenders under its credit facility, entered into the following transactions:
(i) an indirect, wholly owned subsidiary of Mirant Corporation made a
subordinated loan of $48 million to Perryville, (ii) Mirant Corporation
agreed to guarantee the obligations of Mirant Americas Energy Marketing under
the tolling agreement, (iii) Perryville (with the consent of its lenders) and
Mirant Americas Energy Marketing lowered the ratings threshold in the tolling
agreement with respect to Mirant, related to the ratings below which Mirant
Americas Energy Marketing has agreed to post a letter of credit or other credit
support, and (iv) the parties agreed to certain additional terms in support of
the syndication of the credit facility. In June 2002, Mirant completed the sale
of its 50% ownership interest in Perryville to Cleco, which holds the remaining
50% ownership interest in Perryville. Cleco assumed Mirant's $13 million future
equity commitment to Perryville and paid approximately $55 million in cash to
Mirant as repayment of its subordinated loan, invested capital to date and other
miscellaneous costs. At such time, Mirant agreed to make a $25 million
subordinated loan to the project. Effective August 23, 2002, Mirant Americas
Energy Marketing and Perryville, with the consent of the project lenders,
restructured the tolling agreement between the parties to remove the requirement
to post a letter of credit or other credit support in the event of a downgrade
from S&P or Moody's. In connection with the restructuring, Mirant Americas made
a $100 million subordinated loan to Perryville, the proceeds of which were used
to repay the existing $25 million subordinated loan owed to a Mirant subsidiary
and to repay $75 million of senior debt of the project. In addition, Mirant
retains certain obligations as a project sponsor, some of which are subject to
indemnification by Cleco. The obligations retained by Mirant which are not
subject to indemnity relate primarily to the existing 20-year tolling agreement
with Mirant Americas Energy Marketing as described in "--Contractual Obligations
and Commitments - Energy Marketing and Risk Management."
65
In March 2002, Mirant Americas Energy Capital transferred the borrowing base
assets under its credit facility to a special purpose vehicle and granted
security interests in such assets. The special purpose vehicle is consolidated
with Mirant.
As part of its strategic restructuring, Mirant negotiated certain deferrals
under its equipment purchase facility. Because the term of the deferred
fabrication period for certain turbines exceeds the agreed fabrication period as
permitted within the equipment procurement facilities, Mirant will not have the
option to enter into a lease arrangement for this equipment, thereby forcing
Mirant to exercise its purchase option. Consequently, Mirant has included a $35
million liability for these turbines in "Other long-term debt" on its unaudited
condensed consolidated balance sheet.
On January 23, 2002, Mirant Asia-Pacific, an indirect, wholly owned
subsidiary of Mirant Corporation, borrowed $192 million under a new credit
facility to repay, in part, its prior $792 million credit facility. The
repayment of the balance of the prior credit facility was funded by Mirant
Corporation. In March 2002, Mirant Asia-Pacific secured a second tranche of $62
million which has been used to repay part of the funding from Mirant
Corporation. The new credit facility contains various business and financial
covenants including, among other things, (i) limitations on dividends and
distributions, including a prohibition on dividends if Mirant ceases to be rated
investment grade by at least two of Fitch, S&P and Moody's, (ii) mandatory
prepayments upon the occurrence of certain events, including certain asset sales
and certain breaches of the Sual and the Pagbilao energy conversion agreements,
(iii) limitations on the ability to make investments and to sell assets, (iv)
limitations on transactions with affiliates of Mirant and (v) maintenance of
minimum debt service coverage ratios. As a result of the recent downgrades by
Fitch and S&P, Mirant Asia-Pacific is prohibited under the terms of its credit
facility from making distributions to Mirant Corporation.
Each of the lenders under the Sual and Pagbilao facilities has executed
temporary waivers of default with respect to the obligations to provide specific
levels of insurance coverage which extend to the insurance renewal date of
November 1, 2002. Effective as of October 24 and 28, 2002 for the Sual and
Pagbilao facilities, respectively, each of the lenders has agreed to amend the
insurance provisions of the loan agreements. The amendments state that, in the
event Sual and Pagbilao do not obtain the levels of insurance specified in the
loan agreements, Sual and Pagbilao will not be held in breach of the agreements
provided they obtain all of the insurance coverage that is reasonably available
and commercially feasible in the insurance market for similarly situated
facilities, as certified by the lenders' insurance advisor. To avoid breaching
the agreements, the coverage obtained must further be in amounts above threshold
levels defined in the amendments. The Company believes that with these
amendments (and the levels of minimum thresholds defined in the amendments) it
will be able to obtain insurance coverage in the future that will allow it to
remain in continued compliance with the loan agreements. The insurance coverage
obtained for the November 1, 2002 renewal satisfies the amended terms of the
loan agreements.
West Georgia Generating Company, LLC ("West Georgia"), a wholly owned
subsidiary acquired by Mirant in August 2001, has an approximately $144 million
project finance credit facility ($144 million drawn balance at June 30, 2002).
Under the terms of that credit facility, West Georgia is required to deliver
audited financial statements to the lenders thereunder within 120 days of fiscal
year end. On May 24, 2002, within the thirty day cure period under the credit
agreement, the agent under the credit facility extended the period for delivery
of such audited financial statements until the end of July. In July 2002, the
required audited financial statements were delivered to the lenders as required
under the terms of the credit facility.
Convertible Senior Notes
In July 2002, Mirant Corporation completed the issuance of $370 million of
convertible senior notes. The net proceeds from the offering, after deducting
underwriting discounts and commissions payable by Mirant, were $361 million.
66
The notes mature on July 15, 2007 with an annual interest rate of 5.75%.
Holders of the notes may convert their notes into 131.9888 shares of Mirant
common stock for each $1,000 principal amount of the notes at any time prior to
July 15, 2007. This conversion rate is equivalent to the initial conversion
price of $7.58 per share based on the issue price of the notes. The initial
conversion rate may be subject to adjustment. Mirant has the right to redeem for
cash, some or all of the notes at any time on or after July 20, 2005, upon not
less than 30 nor more than 60 days' notice by mail to holders of the notes, for
a price equal to 100% of the principal amount of the notes to be redeemed plus
any accrued and unpaid interest to the redemption date.
Contractual Obligations and Commitments
Energy Marketing and Risk Management
Certain financial instruments that we use to manage risk exposure to energy
prices do not meet the hedge criteria under SFAS No. 133. The fair values of
these instruments are recorded in energy marketing and risk management assets
and liabilities on our accompanying unaudited condensed consolidated balance
sheets.
The following table provides a summary of the factors impacting the
change in net fair value of the energy marketing and risk management asset and
liability accounts during the six months ended June 30, 2002 (in millions).
Net fair value of portfolio at December 31, 2001.......................$ (76)
Gains (losses) recognized in the period, net (1)....................... 222
Contracts settled during the period, net............................... (134)
Change in fair value as a result of a change in valuation technique (2) -
Other changes in fair value, net (3).................................... (23)
Deferred option premiums, net........................................... 76
--------
Net fair value of portfolio at June 30, 2002........................... $ 65
========
(1) This amount includes approximately $11.5 million which represents
management's estimate of initial value of new contracts entered into in the
first six months of 2002.
(2) Mirant's modeling methodology has been consistently applied through the
second quarter of 2002.
(3) Consists primarily of purchase accounting and other adjustments to energy
marketing and risk management assets (liabilities).
The fair values and average values of our energy marketing and risk
management assets and liabilities, net of credit reserves, as of June 30, 2002
are included in the following table (in millions). The average values are based
on a monthly average for 2002.
Net Energy Marketing
Energy Marketing and Risk Energy Marketing and Risk and Risk Management
Management Assets Management Liabilities Assets (Liabilities)
------------------------------ --------------------------- --------------------------
Average Value at Average Value at Net Value at
Value June 30, 2002 Value June 30, 2002 June 30, 2002
Energy commodity ------------ ----------------- ------------- -------------- --------------------------
Instruments:
Electricity................. $ 503 $ 492 $ 403 $ 389 $ 103
Natural gas................. 1,033 1,306 1,148 1,347 (41)
Crude oil................... 11 19 11 18 1
Other....................... 36 24 36 22 2
Total..................... ---------- ----------------- ---------------- ------------ -----------------------
$1,583 $1,841 $1,598 $1,776 $ 65
========== ================= ================ ============ =======================
The following table represents the net energy and risk management assets
and liabilities by tenor, complexity and liquidity. As of June 30, 2002,
approximately 88% of the Net Value at 2003, excluding the prepaid gas
transaction discussed below, was calculated using low complexity models with
67
high price discovery. These include forwards, swaps and options at actively
traded locations. Also, as of June 30, 2002, approximately 80% of the Net Value
at 2003, excluding the prepaid gas transaction discussed below, was expected to
be realized by the end of 2003. Examples of medium and high complexity models
include natural gas storage and transportation renewal options, respectively.
Fair Value of Energy Marketing and Risk Management
Assets and Liabilities as of June 30, 2002
(in millions)
--------------------------------------------------------------------------------------------------
Low Complexity Models Medium Complexity Models High Complexity Models
Price Discovery Price Discovery Price Discovery
------------------------- ------------------------------ ------------------------------- ---------
High Medium Low High Medium Low High Medium Low Total
---- ------ --- ----- ------ --- ---- ------ --- -----
2002 $ 91 $ 3 $(2) $25 $ - $ - $ 1 $ - $ - $ 118
2003 84 13 5 9 1 - - - 1 113
2004 24 (11) 2 - 4 1 - - - 20
2005 24 (4) (17) - - 4 - - - 7
2006 33 (1) (20) - - 4 - - - 16
Thereafter .... - 4 (26) - 12 26 - - - 16
----- --------- ---- ----- ------- ------ ------ ------ ------ -------
Net assets
excluding
prepaid gas
transaction... $ 256 $ 4 $(58) $34 $ 17 $ 35 $ 1 $ - $ 1 $ 290
===== ===== ===== ==== ===== ===== ===== ===== ======
Adjustment for
prepaid gas
transaction (1) ($225)
-------
Net assets... $ 65
======
Model Complexity:
o Low - Transactions involving exchange, or exchange look-a-like products
with no operational or other constraints.
o Medium - Transactions involving some operational constraints, but where
these constraints are not the primary drivers of value/risk.
o High - Transactions involving much more complex operational and/or
contractual constraints, incorporating factors such as temperature, and
where these items can be the primary drivers of value/risk.
Level of Price Discovery:
o High - Large, liquid markets with multiple daily third-party and/or
exchange settled price quotes available.
o Medium - Less liquid markets with periodic external price quotes available,
or price levels which are validated, on a daily basis, indirectly as
temporal and/or locational spreads off of "High" price discovery data.
o Low - Illiquid markets with little or no external price quotes, or where
the underlying transactions constitute a large portion of the totality of
the transactions in the market.
1. In October 2001, the Company entered into a prepaid gas transaction with a
counterparty and a simultaneous natural gas swap with a third-party
independent to the prepaid gas transaction. The prepaid gas transaction
resulted in the receipt of payments in 2001 in exchange for financial
settlements to be made over a future three-year period. Approximately 10%
of the contract notional quantity will settle in 2002 and 2003,
respectively, and the remaining 80% will settle in 2004 based on fixed
notional quantities of gas defined in the agreement at natural gas index
prices on the date of each settlement. The natural gas swap served to fix
the price of the gas to be settled under the prepaid gas agreement. At the
date the transaction was consummated, the notional fixed future natural gas
settlements totaled approximately $250 million and the fair value of such
gas settlements was approximately $225 million. Since this transaction
results in fixed payments through 2004 and no market price risk to the
Company, its impact has been disclosed separately above.
Additionally, the process of model development, independent testing and
verification of model robustness, system implementation and security, and
version control are all covered by the oversight activities of our Model
Oversight Committee which is chaired by the Assistant Global Risk Control
Officer. Documentation covering this process, including independent testing of
model results by the Risk Control organization, is maintained for audit and
oversight purposes.
Mirant Corporation had approximately $906 million trade credit support
commitments outstanding as of June 30, 2002, which included $614 million of
letters of credit, $3 million of net cash collateral posted and $289 million of
parent guarantees.
Mirant Corporation has also guaranteed the performance of its obligations
under a multi-year agreement entered into by Mirant Americas Energy Marketing
with Brazos. Under the agreement, effective January 1999, Mirant Corporation
provides all the electricity required to meet the needs of the distribution
cooperatives served by Brazos. Mirant Corporation is entitled to the output of
Brazos' generation facilities and its rights to electricity under power purchase
agreements Brazos has entered into with third parties. Mirant Corporation's
guarantee was $60 million at June 30, 2002, a decrease of $5 million from
December 31, 2001. Mirant Corporation is subject to regulatory and commercial
risks under this energy requirements contract. Mirant Corporation believes that
it has adequately provided for the potential risks related to this contract,
which terminates at the end of 2003; however, no assurance can be given that
additional losses will not occur.
68
Mirant Corporation also has a guarantee related to Pan Alberta Gas of $64
million issued in 2000 and outstanding at June 30, 2002.
Vastar, a subsidiary of BP, and Mirant Corporation had issued financial
guarantees made in the ordinary course of business, on behalf of Mirant Americas
Energy Marketing's counterparties, to financial institutions and other credit
grantors. Mirant Corporation has agreed to indemnify BP against losses under
such guarantees in proportion to Vastar's former ownership percentage of Mirant
Americas Energy Marketing. At June 30, 2002, such guarantees amounted to
approximately $85 million.
Mirant Americas Energy Marketing has a 20-year tolling agreement with
Perryville in which Perryville will sell all the electricity generated by the
facility to Mirant Americas Energy Marketing. At June 30, 2002, the total
estimated notional commitment under this agreement was approximately $1.07
billion over the 20-year life of the contract. Effective August 23, 2002, Mirant
Americas Energy Marketing and Perryville, with the consent of the project
lenders, restructured the tolling agreement between the parties to remove the
requirement to post a letter of credit or other credit support in the event of a
downgrade from S&P or Moody's. In connection with the restructuring, Mirant
Americas made a $100 million subordinated loan to Perryville, the proceeds of
which were used to repay an existing $25 million subordinated loan owed to a
Mirant subsidiary and to repay $75 million of senior debt of the project. In
addition, Mirant Americas guaranteed the obligations of Mirant Americas Energy
Marketing under the tolling agreement up to the amount of the subordinated loan.
The obligations of Mirant Americas Energy Marketing under the tolling agreement
are guaranteed by Mirant Corporation.
To the extent that Mirant Corporation does not maintain its current credit
ratings, it could be required to provide alternative collateral to certain risk
management and energy marketing counterparties based on the value of our
portfolio at such time, in order to continue our current relationship with them.
Mirant could also be required to provide alternative collateral related to
committed pipeline capacity charges. Such collateral could be in the form of
cash and/or letters of credit. There is an additional risk that in the event of
a further reduction of Mirant's credit rating, certain counterparties may,
without contractual justification, request additional collateral or terminate
their obligations to Mirant. As of October 29, 2002, the Company has a credit
rating of B1 (non-investment grade), with a negative outlook by Moody's, BB
(non-investment grade) with a negative outlook by S&P and BB (non-investment
grade) with a negative outlook by Fitch. While the foregoing indicates the
ratings from the various agencies, we note that these ratings are not a
recommendation to buy, sell or hold the Company's securities and that each
rating should be evaluated independently of any other rating. There can be no
assurance that a rating will remain in effect for any given period of time or
that a rating will not be lowered or withdrawn entirely by a rating agency if,
in its judgment, circumstances so warrant. Further, the Company notes that,
given the reported financial difficulties of other market participants, the
uncertainty and turmoil in the financial markets generally and in the energy
sector specifically and the Company's pending accounting review, each of the
credit rating agencies continues to monitor its credit position closely. The
Company notes the risk factors related to a downgrade in the Company's credit
ratings as disclosed in its Annual Report on Form 10-K for the year ended
December 31, 2001, which was filed in March 2002.
Turbine Purchases and Other Construction-Related Commitments
During the six months ended June 30, 2002, Mirant committed itself to a
strategic business plan designed to reduce capital spending and operating
expenses. As a result, the Company recorded restructuring charges during the six
months ended June 30, 2002 related to these changes. The reduced capital
spending plan results in material changes to Mirant's commitments under its
turbine purchase agreements and its turbine procurement facilities. Mirant has
canceled and intends to cancel certain turbines under its purchase agreements
and its off-balance sheet equipment procurement facilities by March 31, 2003.
69
The commitments for turbines that Mirant has canceled and intends to cancel are
included in Mirant's restructuring charge, and Mirant plans to formally
terminate the orders for these turbines at various times within one year of the
restructuring commitment date. Until these termination orders are issued Mirant
continues to have the option to purchase the turbines.
As of June 30, 2002, Mirant had agreements to purchase 35 turbines (26 gas
turbines and 9 steam turbines) to support the Company's ongoing and planned
construction efforts (see table below). In addition Mirant's other
construction-related commitments totaled approximately $758 million at June 30,
2002.
In addition to these commitments, Mirant, through certain of its
subsidiaries, has two off-balance sheet equipment procurement facilities. These
facilities are being used to fund equipment progress payments due under purchase
contracts that have been assigned to two separate, independent third-party
owners. For the first facility, which is a $1.8 billion notional value facility,
remaining contracts for 42 turbines (28 gas turbines and 14 steam turbines) have
been assigned to a third-party trust. For the second facility, which at June 30,
2002 was a Euro 550 million (approximately $544 million) notional value
facility, remaining contracts for four engineered equipment packages ("power
islands") have been assigned to a third-party owner incorporated in the
Netherlands.
As part of its strategic restructuring, Mirant negotiated certain deferrals
under both equipment purchase facilities. Because the term of the deferred
fabrication period for certain turbines included in the $1.8 billion notional
value facility exceeds the agreed fabrication period as permitted within the
equipment procurement facilities, the Company will not have the option to enter
into a lease arrangement for this equipment, thereby forcing Mirant to exercise
its purchase option. Consequently, Mirant has included a $35 million liability
for these turbines on the accompanying unaudited condensed consolidated balance
sheet. At June 30, 2002, Mirant Corporation's guarantees in connection with the
equipment procurement facilities, including certain payment obligations were
approximately $406 million with respect to the turbines for which the facilities
have a contractual obligation (excluding the $35 million which is now included
in "Other long-term debt" on its unaudited condensed consolidated balance
sheet). The $406 million was based on the drawn amounts related to all turbines
and power islands (including those to be terminated) included in the equipment
procurement facilities as of June 30, 2002.
The table below presents the components of Mirant's commitments on its
contracts and procurement facilities related to turbines and power islands.
Purchase Procurement
Commitments Facilities Total Turbines &
Turbine Count (Turbine) (Turbines) Power Islands
--------------- ---------------- -------------------
Total contracted turbines/power islands at
December 31, 2001....................... 48 55 103
Turbines/power islands terminated during
the six months ended June 30, 2002...... (8) (9) (17)
Turbines/power islands placed in service
during the six months ended June 30, 2002 (5) - (5)
---------- ------- ----------
Total contracted turbines/power islands at
June 30, 2002......................... 35 46 81
Turbines / power islands to be terminated
or sold in the future per Restructuring (11) (35) (46)
--------- ------- ---------
Total remaining contracted turbines / power
islands at June 30, 2002 (after 24 11 35
====== ===== =====
Restructuring)..............................
Commitments for Remaining Contracted
Turbines / Power Islands after
Restructuring (in millions)
Total commitments at June 30, 2002 ........ $45 $510 $555
Cost to terminate at June 30, 2002.......... $ 7 $205 $212
70
Long-Term Service Agreements
We have entered into long-term service agreements for the maintenance and
repair by third parties of many of our combustion-turbine generating plants.
Generally these agreements may be terminated at little or no cost in the event
that the shipment of the associated turbine is canceled. As of June 30, 2002,
the minimum termination amounts for long-term service agreements associated with
completed and shipped turbines were $546 million. As of June 30, 2002, the total
estimated commitments for long-term service agreements associated with turbines
already completed and shipped were approximately $692 million. These commitments
are payable over the course of each agreement's term. The terms are projected to
range from ten to twenty years. Estimates for future commitments for long-term
service agreements are based on the stated payment terms in the contracts at the
time of execution. These payments are subject to an annual inflationary
adjustment.
As a result of the turbine cancellations as part of our restructuring, the
long-term service agreements associated with the canceled turbines will also be
cancelled. However, as stated above, canceling the long term service agreements
will result in little or no termination costs to us. We do not intend to cancel
long-term service agreements associated with turbines that have already shipped.
Consequently, our restructuring should not have an impact on the long-term
service agreement commitments disclosed above.
Obligations Under Energy Delivery and Purchase Commitments
Under the asset purchase and sale agreement for the PEPCO generating
assets, we assumed and recorded net obligations of approximately $2.3 billion
representing the fair value (at the date of acquisition) of out-of-market energy
delivery and power purchase agreements, which consist of five power purchase
agreements ("PPAs") and two transition power agreements ("TPAs"). The PPAs are
for a total capacity of 735 MW and expire over periods through 2021. At June 30,
2002, the estimated commitments under the PPA agreements were $1.58 billion
based on the total MW commitment at contractual prices. The TPA agreements state
that we will sell a quantity of megawatthours over the life of the contracts
based on PEPCO's load requirements and expire in January 2005. As actual
megawatthours are purchased or sold under these agreements, we release a ratable
portion of the obligation into gross margin. For the three and six months ended
June 30, 2002, we released approximately $121 million and $234 million, pre-tax,
respectively. As of June 30, 2002, the obligations recorded in the unaudited
condensed consolidated balance sheet for the TPAs and PPAs totaled $1,105
million and $500 million, respectively, of which $469 million and $65 million,
respectively, are current.
Other obligations under various agreements of approximately $144 million
are also included in the unaudited condensed consolidated balance sheet.
Fuel Commitments
Mirant has a contract with BP whereby BP is obligated to deliver fixed
quantities of natural gas at identified delivery points. The negotiated purchase
price of delivered gas is generally equal to the monthly spot rate then
prevailing at each delivery point. Because this contract is based on the monthly
spot price at the time of delivery, Mirant has the ability to sell the gas at
the same spot price, thereby offsetting the full amount of its commitment
related to this contract. Effective July 26, 2002, Mirant and BP have
restructured this contract. The contract term has been extended to December 31,
2009, unless terminated sooner. Mirant has the ability to reduce the purchase
obligation on this contract annually. Based on current contract volumes, the
estimated minimum commitment for the term of this agreement based on current
spot prices is $2.2 billion as of September 30, 2002. The contract is now
subject to the North American Master Netting Agreement between Mirant and BP,
dated December 1, 2001 (the "Master Netting Agreement") and a new collateral
annex to the Master Netting Agreement. Together, the Master
71
Netting Agreement and Collateral Annex provide that the amounts due to BP under
the contract will be netted against payments due between Mirant and BP under
various other gas and power contracts, and that collateral will be posted by one
party to the other based on the net amount of exposure.
We have fixed volumetric purchase commitments under fuel purchase and
transportation agreements totaling $554 million at June 30, 2002. These
agreements will continue to be in effect through 2012.
In addition, in April 2002, Mirant Mid-Atlantic entered into a long-term fuel
purchase agreement. The fuel supplier will convert coal feedstock received at
the Company's Morgantown facility into a synthetic fuel. Under the terms of the
agreement, Mirant Mid-Atlantic is required to purchase a minimum of 2.4 million
tons of fuel per annum through December 2007. Minimum purchase commitments
became effective upon the commencement of the synthetic fuel plant operation at
the Morgantown facility in July 2002. The purchase price of the fuel will vary
with the delivered cost of the coal feedstock. Based on current coal prices it
is expected that the annual purchase commitment will be approximately $100
million.
In July 2002, in conjunction with the commencement of Mirant Mid-Atlantic's
minimum synthetic fuel purchase commitments, Mirant Americas Energy Marketing
arranged for the synthetic fuel supplier to contract with the coal supplier to
purchase coal directly from the supplier. Mirant Americas Energy Marketing's
minimum coal purchase commitments are reduced to the extent that the synthetic
fuel supplier purchases coal under this arrangement. Since the inception of this
arrangement, the synthetic fuel supplier has purchased 100% of Mirant Americas
Energy Marketing's minimum coal purchase commitment thereby reducing the amount
of coal purchased by Mirant Americas Energy Marketing under the contracts, which
are included in the fixed volumetric purchase commitment of $554 million noted
above.
Operating Leases
We have commitments under operating leases with various terms and
expiration dates. Expenses associated with these commitments totaled
approximately $40 million and $32 million during the three months ended June 30,
2002 and 2001, respectively, and approximately $76 million and $62 million
during the six months ended June 30, 2002 and 2001, respectively. As of June 30,
2002, estimated minimum rental commitments for non-cancelable operating leases
were $3.63 billion. Of this amount, we have approximately $2.9 billion in total
notional minimum lease payments for the remaining life of the leases related to
the PEPCO acquisition. The leases are treated as operating leases for accounting
purposes whereby one of our subsidiaries records periodic lease rental expenses.
Mirant New England Guarantee
In April 2002, Mirant issued a guarantee in the amount of $188 million for
any obligations Mirant New England may incur under its Wholesale Transition
Service Agreement with Cambridge Electric Light Company and Commonwealth
Electric Company. Under the agreement, Mirant New England is required to sell
electricity at fixed prices to Cambridge and Commonwealth in order for them to
meet their supply requirements to certain retail customers. Both the guarantee
and the agreement expire in February 2005.
Litigation and Other Contingencies
Reference is made to Notes I and L to the financial statements filed as
part of this Form 10-Q relating to the following litigation matters and other
contingencies:
Litigation:
o Western Power Markets Investigations
o California Attorney General Litigation
o Defaults by SCE and Pacific Gas and Electric and the Bankruptcies of
Pacific Gas and Electric and the PX
o RMR Agreements
o Western Power Markets Price Mitigation and Refund Proceedings
o DWR Power Purchases
o California Rate Payer Litigation
o Shareholder Derivative Litigation
o Shareholder Litigation
o SEC Informal Investigation and U.S. Department of Justice and CFTC
Inquiries
o Enron Bankruptcy Proceedings
o State Line
o Edison Mission Energy Litigation
o Panda Brandywine, L.P. Power Purchase Agreement
o Environmental Information Requests
72
In addition to the proceedings described above, we experience routine
litigation from time to time in the normal course of our business, which is not
expected to have a material adverse effect on our consolidated financial
condition, cash flows or results of operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As part of our energy marketing and risk management activities, we enter
into a variety of contractual commitments, such as forward purchase and sale
agreements, futures, swaps, and option contracts. These contracts generally
require future settlement and are either executed on an exchange or marketed as
OTC instruments. Contractual commitments have widely varying terms and have
tenors that range from a few days to a number of years, depending on the
instrument.
Our accounting and financial statement presentation of contractual
commitments depends on both the type and purpose of the contractual commitment
held or issued. We record all contractual commitments used for energy marketing
purposes, including those used to hedge marketing positions, at fair value.
Consequently, changes in the amounts recorded in our unaudited condensed
consolidated balance sheets resulting from movements in fair value are included
in operating revenues in the period in which they occur. Contractual commitments
expose us to both market risk and credit risk.
Market Risk
Market risk is the potential loss that we may incur as a result of changes
in the fair value of a particular instrument or commodity. All financial and
commodities-related instruments, including derivatives, are subject to market
risk. Our exposure to market risk is determined by a number of factors,
including the size, tenor, composition and diversification of positions held and
the absolute and relative levels of commodity prices, interest rates, as well as
market volatility of the commodity prices and liquidity. For instruments such as
options, the time period during which the option may be exercised and the
relationship between the current market price of the underlying instrument and
the option's contractual strike or exercise price also affects the level of
market risk. We manage market risk by actively monitoring compliance with stated
risk management policies as well as monitoring the effectiveness of our hedging
policies and strategies through our risk oversight committees. Our risk
oversight committee reviews and monitors compliance with risk management
policies that limit the amount of total net exposure during the stated periods.
Our Global Risk Control Officer is a member of the risk oversight committee,
which also includes senior commercial, legal and finance management personnel as
members, thereby ensuring that information is communicated to our senior
management and audit committee as needed.
Market risk is a function not only of the behavior of the prices and the
structure of the markets for the commodities in which we operate, but it also
depends on the nature and complexity of the energy marketing and risk management
transactions that we enter. Therefore, a risk exists that our models do not
fully capture the essential details of the contractual arrangements. In order to
ensure that the model risk is properly controlled through a process of
systematic model development, deployment and control, we created and utilize a
Model Risk Oversight Committee, as described earlier in the Contractual
73
Obligations and Commitments section. The Model Risk Oversight Committee sets the
guidelines for the model development, testing, implementation process and
responsibilities. The Risk Control organization and the Mid-Office have the
joint responsibility for ensuring proper oversight and reporting of the values
and risks of transactions employing different models of value and risk. We
employ a systematic approach to the evaluation and management of the risks
associated with our energy marketing and risk management related contracts,
including Value-at-Risk ("VaR"). VaR is defined as the maximum loss that is not
expected to be exceeded with a given degree of confidence and over a specified
holding period. We use a 95% confidence interval and holding periods that vary
by commodity and tenor to evaluate our VaR exposure. A 95% confidence interval
means there is a 5% probability that the actual loss will be greater than the
estimated loss under the VaR. Therefore, we expect that the loss in our
portfolio value will not exceed our VaR for 95% of the time. A holding period is
the time period it would take to liquidate our portfolio. Our VaR measurement
takes into account the relative liquidity of different commodity positions
across different time horizons and locations through the use of different
holding periods. For very liquid commodity positions, such as natural gas for
delivery within one year, we use a five-day holding period, whereas for a less
liquid commodity position, such as physical coal, we employ a three-month
holding period. As a result, the VaR that we measure, monitor and report on a
daily basis is larger than what would be obtained using a one-day holding period
for all positions, commodities and commitments. We also incorporate seasonally
updated correlations between commodity prices in arriving at the portfolio VaR.
For the six months ended June 30, 2002, the average VaR, using various
holding periods and a 95% confidence interval, was $35.1 million and the VaR as
of June 30, 2002, was $43.8 million, compared to $54.4 million and $45.9 million
for the same periods in 2001. In order to enable comparison on a common base
with our peers in the sector, we also report the portfolio VaR levels using a
one-day holding period for all positions and commitments in our portfolio. Based
on a 95% confidence interval and employing a one-day holding period for all
positions, our portfolio VaR was $14.2 million at June 30, 2002 and the average
over the six months ended June 30, 2002 was $11.5 million, compared to $15.2
million and $17.5 million for the same periods in 2001. During the six months
ended June 30, 2002, the actual daily loss on a fair value basis exceeded the
corresponding one-day VaR calculation three times, which falls within our 95%
confidence interval. During the second quarter of 2002, we implemented a new
trading system to administer our natural gas transactions. As a result, the
natural gas component of our total VaR calculation was held constant for a
period of approximately 45 days. We believe this was a reasonable estimate of
our average VaR calculations for 2002 and we would not have had additional
instances of exceeding our VaR limits if the natural gas portion of the total
VaR calculation would not have been held flat. In addition to VaR, we utilize
additional risk control mechanisms such as commodity position limits and stress
testing of the total portfolio and its components. In stress testing, we stress
both the price and volatility curves for the entire portfolio in 10% increments
to determine the effects on the fair value.
The fair values of our energy marketing and risk management assets recorded
in the unaudited condensed consolidated balance sheet at June 30, 2002, were
comprised primarily of approximately 27% electricity and 71% natural gas. The
fair values of our energy marketing and risk management liabilities recorded in
the unaudited condensed consolidated balance sheet at June 30, 2002, were
comprised primarily of approximately 22% electricity and 76% natural gas.
Because of the expected contraction in our natural gas trading and marketing
activities, the percentage of natural gas positions would be expected to
decline.
Credit Risk
In conducting our energy marketing and risk management activities, we
regularly transact business with a broad range of entities and a wide variety of
end users, energy companies and financial institutions. To examine and manage
credit risk, we look at credit risk from our stance as being exposed to
potential default by our counterparties. Credit risk is measured by the loss we
would record if our counterparties failed to perform pursuant to the terms of
their contractual obligations, and the value of collateral held by us, if any,
was not adequate to cover such losses. We have established controls to determine
and monitor the creditworthiness of counterparties, as well as the quality of
pledged collateral and use master netting agreements whenever possible to
mitigate our exposure to counterparty credit risk. Master netting agreements
74
enable us to net certain assets and liabilities by counterparty. We also net
across product lines and against cash collateral, provided such provisions are
established in the master netting and cash collateral agreements. Additionally,
we may require counterparties to pledge additional collateral when deemed
necessary. We try to manage the portfolio of our positions such that the average
credit quality of our portfolio falls inside an authorized range. We use
published ratings of counterparties to guide us in the process of setting credit
levels, risk limits and contractual arrangements including master netting
agreements. Where external ratings are not available, we conduct internal
assessments of counterparties. The average credit quality is monitored on a
regular basis and reported to the risk oversight committee on a periodic basis
together with steps initiated to bring credit exposures into line within the
authorized range. The weighted average credit rating of the counterparties,
based on outstanding balances and management's internal assessment, included in
the net fair value of our energy marketing and risk management assets was BBB+
at June 30, 2002 and September 30, 2002.
We also monitor the concentration of credit risk from various positions,
including contractual commitments. Credit concentration risk exists when groups
of counterparties have similar business characteristics, and/or are engaged in
like activities that would cause their ability to meet their contractual
commitments to be adversely affected, in a similar manner, by changes in the
economy or other market conditions. We monitor credit concentration risk on both
an individual basis and a group counterparty basis.
In addition to continuously monitoring our credit exposure to our
counterparties, we also take appropriate steps to limit the exposures, initiate
actions to lower credit exposure and take credit reserves as appropriate. The
process of establishing and monitoring credit reserves is based on a standard
methodology of employing default probabilities to the current and potential
exposures by both settled and open contracts.
As of June 30, 2002, no amounts owed from a single customer represented
more than 10% of Mirant's total credit exposure. Our total credit exposure is
computed as total accounts and notes receivable, adjusted for energy marketing,
risk management and derivative hedging activities and netted against offsetting
payables and posted collateral as appropriate. Our overall exposure to credit
risk may be impacted, either positively or negatively, because our
counterparties may be similarly affected by changes in economic, regulatory or
other conditions.
Interest Rate Risk
Our policy is to manage interest expense using a combination of fixed- and
variable-rate debt. To manage this mix in a cost-efficient manner, we enter into
interest rate swaps in which we agree to exchange, at specified intervals, the
difference between fixed- and variable-interest amounts calculated by reference
to agreed-upon notional principal amounts. These swaps are designated to hedge
underlying debt obligations. For qualifying hedges, the changes in the fair
value of gains and losses of the swaps are deferred in OCI, net of tax, and the
interest rate differential is reclassified from OCI to interest expense as an
adjustment over the life of the swaps. Gains and losses resulting from the
termination of qualifying hedges prior to their stated maturities are recognized
ratably over the remaining life of the hedged instrument.
Foreign Currency Hedging
From time to time, we use cross-currency swaps and currency forwards to
hedge our net investments in certain foreign subsidiaries. Gains or losses on
these derivatives are designated as hedges of net investments and are offset
against the foreign currency translation effects reflected in OCI, net of tax.
We also utilize currency forwards intended to offset the effect of exchange
rate fluctuations on forecasted transactions arising from contracts denominated
in a foreign currency. From time to time we also utilize cross-currency swaps
that offset the effect of exchange rate fluctuations on foreign currency
denominated debt and fix the interest rate exposure. Certain other assets are
75
exposed to foreign currency risk. We designate currency forwards as hedging
instruments used to hedge the impact of the variability in exchange rates on
accounts receivable denominated in certain foreign currencies. When these
hedging strategies qualify as cash flow hedges, the gains and losses on the
derivatives are deferred in OCI, net of tax, until the forecasted transaction
affects earnings. The reclassification is then made from OCI to earnings in the
same revenue or expense category as the hedged transaction.
Interest Rate and Currency Derivatives
The interest rates noted in the following table represent the range of
fixed interest rates that Mirant pays on the related interest rate swaps. On
virtually all of these interest rate swaps, Mirant receives floating interest
rate payments at LIBOR. The currency derivatives mitigate Mirant's exposure
arising from certain foreign currency transactions, such as cross border sales
and foreign equity investments.
Year of Maturity Number of Notional Unrealized
Type or Termination Interest Rates Counterparties Amount (Loss) Gain
--------------------------- -------------------- ---------------- -------------------- ------------ ------------------
(in millions)
Interest rate swaps.... 2003-2012 3.85%-7.12% 3 $549 $ (48)
Currency forwards...... 2002-2004 - 3 1CAD163 (1)
2003 - 1 (pound)58 (8)
2002-2003 - 1 2$13 1
----------
$ (56)
(pound) - Denotes British pounds sterling
CAD - Denotes Canadian dollar
1 CAD contracts with a notional amount of CAD153 million are included in fair
value of energy marketing and risk management liabilities because hedge
accounting criteria are not met. 2 USD contracts are utilized by a foreign
subsidiary to hedge U.S. dollar denominated sales contracts.
The unrealized gain/loss for interest rate swaps is determined based on
the estimated amount that Mirant would receive or pay to terminate the swap
agreement at the reporting date based on third-party quotations. The
unrealized gain/loss for currency forwards is determined based on current
foreign exchange rates.
Controls and Procedures
Effective April 1, 2002, the Company implemented a new IT system ("ENDUR")
for its gas trading and marketing activities in North America. Because of
ENDUR's improved capabilities over the legacy systems, management views the
implementation of ENDUR as a significant change in internal controls. In
addition, the Company recently modified its power trading and marketing IT
system to improve reporting of realized and unrealized income associated with
power transactions.
The Company's independent auditors assessed the Company's internal controls
of its North American energy marketing and risk management operations as part of
the interim review for the second quarter. The Company has received detailed
process improvement recommendations during October 2002 from its independent
auditors which address internal control deficiencies in existence at June 30,
2002, the most significant of which relate to the Company's systems and
processes and include:
(i) Inadequate actualization analysis, documentation and internal
communication;
(ii) Inadequate reconciliation of the risk report and general ledger;
(iii) Inadequate systems integration and data reconciliation; and
(iv) Untimely balance sheet discrepancy resolution.
76
The Company's independent auditors have advised the Audit Committee that
these internal control deficiencies constitute reportable conditions and,
collectively, a material weakness as defined in Statement on Auditing Standards
No. 60 ("SAS No. 60"). The Company has assigned the highest priority to the
short-term and long-term correction of these internal control deficiencies.
Management has discussed its proposed actions with the Audit Committee and its
independent auditors. The Company has implemented corrective actions to mitigate
the risk that these deficiencies could lead to material misstatements in the
Company's current financial statements. In addition, the Company has performed
additional procedures to enable the completion of the independent auditors'
review of the Company's interim financial statements, despite the presence of
control weaknesses as noted above.
The following short-term corrective actions are being implemented:
(i) Additional training and replacement of certain individuals;
(ii) Additional management oversight and detailed reviews;
(iii)Reports submitted monthly to the CFO and CEO certifying that the balance
sheet reconciliations have been completed, the accounts appropriately
adjusted and any discrepancies listed;
(iv) Involvement of the Company's internal audit personnel to monitor certain
critical monthly and quarterly closing processes; and
(v) Use of outside resources to supplement Company employees in evaluating and
implementing the internal control recommendations.
Longer-term corrective actions, some of which the Company has already begun
to implement, will include:
(i) Implementation of the ENDUR system for power transactions in the second
quarter of 2003;
(ii) Evaluation of the feasibility of automated interfaces between the Company's
various systems, including risk management, scheduling and general ledger;
(iii)Process mapping and evaluation to assure timely review and reconciliation
between risk management systems and the Company's accounting systems;
(iv) Evaluation of accounting organization structure to align roles and
responsibilities with process and control changes;
(v) Re-evaluation of the role and resources devoted to internal auditing to
assure compliance with accounting requirements;
(vi) Re-evaluation of the Chief Risk Officer's duties to assure adequate
controls; and
(vii)Re-evaluation of the Company's Risk Oversight Committee's role and focus
to include monthly reporting and tracking of progress on the completion of
all controls enhancements and to ensure controls are appropriate for the
ongoing size and level of activities in the business.
Separately, the Company expects that the anticipated significant reduction
in its physical gas volumes and longer-term, structured transactions will have
an additional mitigating effect on the impact of the identified controls
weaknesses.
77
Apart from the changes made as a result of the evaluation noted above, no
significant changes have been made in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation. The Company continues to evaluate the effectiveness of
its overall controls and procedures and will take such further actions as
dictated by such continuing reviews.
Critical Accounting Estimates
The accounting policies described in the Company's Form 10-K and below are
viewed by management as "critical" because their correct application requires
the use of material estimates and because they have a material impact on its
financial results and position. To aid in the Company's application of these
critical accounting policies, management invests substantial human and financial
capital in the development and maintenance of models and other forecasting tools
and operates a robust environment of internal controls surrounding these areas
in particular. These tools, in part, facilitate the measurement of less liquid
financial instruments accounted for at fair value and ensure that such
measurements are applied consistently across periods. In addition, separate
tools enable management to forecast the Company's global income tax position to
ensure that tax charges are appropriate in each period.
Additionally, in 2002, the Company adopted SFAS Nos. 141, 142 and 144.
These new pronouncements, among other things, change the accounting model for
impairing the balance sheet value of assets held for use and held for sale, as
well as the book value of goodwill and other intangible assets. The Company's
announced asset sale program, as well as overall conditions affecting the
Company and its sector, may materially impact the carrying values of its
property plant and equipment, its construction work in progress, its investment
in suspended construction, its goodwill and its other intangible assets. The
Company will assess the book values of its goodwill late in the fourth quarter
of 2002, after completing its annual financial planning process for 2003. This
process provides management with the best information from which to analyze the
book values of its assets under the new accounting models prescribed by the
above-referenced GAAP. Management expects the outcome of these analyses to be
completed prior to reporting its 2002 results. Currently, Mirant does not
believe that the suspended "Construction work in progress" is subject to an
impairment loss under SFAS No. 144.
As discussed above, Mirant adopted SFAS No. 142 effective January 1, 2002.
SFAS No. 142 requires a two-step impairment analysis process. The first step of
the test compares the estimated fair value of a reporting unit to its net book
value to determine if there is potential goodwill impairment. If no impairment
is indicated in step one the test is complete. If the net book value of the
reporting unit exceeds the fair value in step one, the second step of the
impairment test is required. Step two measures the amount of the impairment
charge by comparing the estimated fair value of the reporting unit goodwill to
its book value. The excess of the book value of goodwill to its estimated fair
value is recognized as an impairment charge. Management currently believes there
is no impairment of goodwill; however, Mirant's announced asset sale program and
the overall conditions impacting the energy sector may materially impact the
book value of goodwill. This assessment may result in impairments at one or
more subsidiaries that do not result in impairments in Mirant's consolidated
financial statements.
Audit Committee Pre-Approval of Audit and Non-Audit Services
Mirant's Audit Committee has approved all audit and audit related services
performed by its independent auditor, KPMG. In addition, the Audit Committee has
delegated to its Chair the ability to pre-approve other non-audit services by
KPMG, and the Audit Committee Chair has pre-approved certain tax work. The fees
for such non-audit work for 2002 are not currently expected to exceed $1.3
million.
78
PART II OTHER INFORMATION
Item 1. Legal Proceedings
The discussions concerning the following legal matters is hereby
incorporated by reference from Notes I and L to the consolidated financial
statements that are a part of this quarterly report:
o Western Power Markets Mitigation and Refund Proceedings
o California Attorney General Litigation
o California Rate Payer Litigation
o Shareholder Litigation
o Environmental Information Requests
o Shareholder Derivative Litigation
o SEC Informal Investigation, U.S. Department of Justice and CFTC Inquiries
With respect to each of the preceding matters, we cannot currently
determine the outcome of the proceedings or the amounts of any potential losses
from such proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
We held our annual meeting of stockholders on April 25, 2002. The following
resolutions were voted upon at this meeting:
(1) Each nominee for director of Mirant for the term ending 2005 received
the requisite plurality of votes. The vote tabulation was as follows:
Nominees Shares for Shares Withheld
-------- ---------- ---------------
A. W. Dahlberg 336,535,961 5,443,747
Stuart E. Eizenstat 334,622,414 7,357,294
(2) Other directors whose term of office as director continued after our
annual meeting were A. D. Correll, Carlos Ghosn, S. Marce Fuller, David J.
Lesar, James F. McDonald and Ray M. Robinson.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
----------
10.66 Employee Retention Agreement with John W. Holden
15 KPMG Awareness Letter to Mirant Corporation
(b) Reports on Form 8-K.
--------------------
During the quarter ended June 30, 2002, we filed a Current Report on Form
8-K dated May 15, 2002. Items 4 and 7 were reported and no financial statements
were filed.
During the quarter ended June 30, 2002, we filed a Current Report on Form
8-K dated June 27, 2002. Items 5 and 7 were reported and no financial statements
were filed.
79
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on our behalf by the
undersigned thereunto duly authorized. The signature of the undersigned company
shall be deemed to relate only to matters having reference to such company and
any subsidiaries thereof.
MIRANT CORPORATION
By /s/ Raymond D. Hill
--------------------------------------
Raymond D. Hill
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: November 7, 2002
================================================================================
CERTIFICATIONS
I, Marce Fuller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Mirant Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
Date: November 7, 2002 /s/ S. Marce Fuller
--------------------------
S. Marce Fuller
President, Chief Executive Officer
(Principal Executive Officer)
--------------------------------------------------------------------------------
I, Raymond Hill, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Mirant Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
Date: November 7, 2002 /s/ Raymond D. Hill
-------------------------------
Raymond D. Hill
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)