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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-31449
TEXAS GENCO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 76-0695920
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1111 LOUISIANA (713) 207-1111
HOUSTON, TEXAS 77002 (Registrant's telephone number,
(Address and zip code of including area code)
principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Common Stock, par value $.001 per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
CenterPoint Energy, Inc. owned all of the outstanding shares of common
stock of Texas Genco Holdings, Inc. (Company) as of the last business day of the
Company's most recent completed second fiscal quarter. The aggregate market
value of the voting stock held by non-affiliates of the Company was $243,071,014
as of February 25, 2003, using the definition of beneficial ownership contained
in Rule 13d-3 promulgated pursuant to the Securities Exchange Act of 1934 and
excluding shares held by directors and executive officers. As of February 25,
2003, the Company had 80,000,000 shares of Common Stock outstanding.
Portions of the definitive proxy statement relating to the 2003 Annual
Meeting of Shareholders of the Company, which will be filed with the Securities
and Exchange Commission within 120 days of December 31, 2002, are incorporated
by reference in Item 10, Item 11, Item 12 and Item 13 of Part III of this Form
10-K.
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TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 29
Item 3. Legal Proceedings........................................... 29
Item 4. Submission of Matters to a Vote of Security Holders......... 29
PART II
Item 5. Market for Common Stock and Related Stockholder Matters..... 29
Item 6. Selected Financial Data..................................... 31
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 32
Item 7A Quantitative and Qualitative Disclosures About Market
Risk........................................................ 46
Item 8. Financial Statements and Supplementary Data of the
Company..................................................... 47
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 68
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 68
Item 11. Executive Compensation...................................... 68
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 68
Item 13. Certain Relationships and Related Transactions.............. 68
PART IV
Item 14. Controls and Procedures..................................... 68
Item 15. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 69
i
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time we make statements concerning our expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those expressed or implied by these statements. You can generally identify
our forward-looking statements by the words "anticipate," "believe," "continue,"
"could," "estimate," "expect," "forecast," "goal," "intend," "may," "objective,"
"plan," "potential," "predict," "projection," "should," "will," or other similar
words.
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.
Some of the factors that could cause actual results to differ from those
expressed or implied by our forward-looking statements are described under "Risk
Factors" beginning on page 20 in Item 1 of this report.
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement, and we undertake no obligation to publicly update or revise any
forward-looking statements.
ii
PART I
ITEM 1. BUSINESS.
OUR BUSINESS
GENERAL
We are one of the largest wholesale electric power generating companies in
the United States. We own 60 generating units at 11 electric power generation
facilities located in Texas. We also own a 30.8% interest in the South Texas
Project Electric Generating Station (South Texas Project), a nuclear generating
station with two 1,250 megawatt (MW) nuclear generating units. As of December
31, 2002, the aggregate net generating capacity of our portfolio of assets was
14,175 MW. We sell electric generation capacity, energy and ancillary services
within the Electric Reliability Council of Texas, Inc. (ERCOT) market. The ERCOT
market consists of the majority of the population centers in the State of Texas
and facilitates reliable grid operations for approximately 85% of the demand for
power in the state.
In June 1999, the Texas legislature enacted legislation (Texas electric
restructuring law) which substantially amended the regulatory structure
governing electric utilities in Texas in order to encourage retail electric
competition. Under the Texas electric restructuring law, we ceased to be subject
to traditional cost-based regulation. Since January 1, 2002, we have been
selling generation capacity, energy and ancillary services to wholesale
purchasers at prices determined by the market. Accordingly, our historical
financial information and operating data, such as demand and fuel data, covering
periods prior to 2002 do not reflect what our financial position, results of
operations and cash flows would have been had our generation facilities been
operated during those periods under the current deregulated ERCOT market.
As a result of requirements under the Texas electric restructuring law and
agreements with our parent company, CenterPoint Energy, Inc. (CenterPoint
Energy), we are obligated to sell substantially all of our capacity and related
ancillary services through 2003 pursuant to capacity auctions. In these
auctions, we sell firm entitlements to capacity and ancillary services on a
forward basis dispatched within specified operational constraints. For more
information regarding our auctions, please read "Capacity Auctions and
Opportunity Sales" below.
CenterPoint Energy registered and became subject, with its subsidiaries, to
regulation as a registered holding company system under the Public Utility
Holding Company Act of 1935 (1935 Act). The 1935 Act directs the Securities and
Exchange Commission (SEC) to regulate, among other things, transactions among
affiliates, sales or acquisitions of assets, issuances of securities,
distributions and permitted lines of business.
Texas Genco Holdings, Inc. (Texas Genco) was incorporated in Texas in
August 2001. Our executive offices are located at 1111 Louisiana, Houston, Texas
77002, and our telephone number is (713) 207-1111. The generating assets of
Texas Genco are owned and operated by Texas Genco, LP, its indirect wholly owned
subsidiary. In this report, the terms "we," "us" or similar terms mean Texas
Genco and its subsidiaries, unless the context indicates otherwise, while
references to Texas Genco mean only the parent company.
We make available free of charge on our Internet website our annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after we electronically file such reports with, or furnish them to, the SEC. Our
website address is http://www.txgenco.com.
FORMATION, DISTRIBUTION AND RELIANT RESOURCES OPTION
Texas Genco is an indirect majority owned subsidiary of CenterPoint Energy.
Our portfolio of generation facilities was formerly owned by the unincorporated
electric utility division of Reliant Energy, Incorporated (Reliant Energy), the
predecessor of CenterPoint Energy Houston Electric, LLC (CenterPoint Houston).
CenterPoint Houston is an indirect wholly owned subsidiary of CenterPoint
Energy. Reliant Energy conveyed these facilities to us in accordance with a
business separation plan adopted in response to the Texas electric
1
restructuring law. For convenience, we describe our business in this report as
if we had owned and operated our generation facilities prior to the date they
were conveyed to us. On January 6, 2003, CenterPoint Energy distributed
approximately 19% of the 80,000,000 outstanding shares of Texas Genco's common
stock to CenterPoint Energy's common shareholders (distribution). CenterPoint
Energy now indirectly owns approximately 81% of the outstanding shares of Texas
Genco's common stock. For more information regarding our formation and the
distribution, please read "Background of the Distribution of Texas Genco Shares"
below.
A former subsidiary of CenterPoint Energy, Reliant Resources, Inc. (Reliant
Resources), has an option (Reliant Resources option) to purchase the shares of
Texas Genco common stock owned by CenterPoint Energy exercisable in January
2004. For more information regarding this option, please read "Reliant Resources
Option" below. CenterPoint Energy has stated that if Reliant Resources does not
exercise its option to purchase CenterPoint Energy's interest in Texas Genco in
2004, CenterPoint Energy will consider strategic alternatives for its interest,
including a possible sale.
THE ERCOT MARKET
The ERCOT market consists of the State of Texas, other than a portion of
the panhandle, a portion of the eastern part of the state bordering on Louisiana
and the area in and around El Paso. The ERCOT market represents approximately
85% of the demand for power in Texas and is one of the nation's largest power
markets. The ERCOT market includes an aggregate net generating capacity of
approximately 70,000 MW. There are only limited direct current interconnections
between the ERCOT market and other power markets in the United States.
The ERCOT market operates under the reliability standards set by the North
American Electric Reliability Council. The Public Utility Commission of Texas
(Texas Utility Commission) has primary jurisdiction over the ERCOT market to
ensure the adequacy and reliability of electricity supply across the state's
main interconnected power transmission grid. The ERCOT independent system
operator (ERCOT ISO) is responsible for maintaining reliable operations of the
bulk electric power supply system in the ERCOT market. Its responsibilities
include ensuring that electricity production and delivery are accurately
accounted for among the generation resources and wholesale buyers and sellers.
Unlike independent systems operators in other regions of the country, the ERCOT
market is not a centrally dispatched power pool and the ERCOT ISO does not
procure energy on behalf of its members other than to maintain the reliable
operations of the transmission system. Members are responsible for contracting
sales and purchases of power bilaterally. The ERCOT ISO serves as agent for
procuring ancillary services for those market participants who elect not to
provide their own ancillary services.
The amount by which power generating capacity exceeded peak demand (reserve
margin) in the ERCOT market has exceeded 20% since 2001, and the Texas Utility
Commission and the ERCOT ISO have forecasted the reserve margin for 2003 to
continue to exceed 20%. The commencement of commercial operation of new
facilities in the ERCOT market will increase the competitiveness of the
wholesale power market, which could have a material adverse effect on our
business, results of operations, financial condition and cash flows and the
market value of our assets.
Since January 1, 2002, any wholesale producer of electricity that qualifies
as a "power generation company" under the Texas electric restructuring law and
that can access the ERCOT electric grid is allowed to sell power in the ERCOT
market at unregulated rates. Transmission capacity, which may be limited, is
needed to effect power sales. In the ERCOT market, buyers and sellers enter into
bilateral wholesale capacity, energy and ancillary services contracts or may
participate in the centralized ancillary services market, which the ERCOT ISO
administers. Also, companies whose power generation facilities were formerly
part of integrated utilities, like us, are required to auction entitlements to
15% of their capacity. For additional information regarding these auctions,
please read "Capacity Auctions and Opportunity Sales--State Mandated Auctions"
below. Wholesale buyers and sellers may also engage in spot market transactions
in the ERCOT market. We expect the ERCOT market will be a very competitive
market under the framework established by the Texas electric restructuring law.
2
The transmission capacity available in the ERCOT market affects power
sales. The power transfer from generators to meet demand across a transmission
line is limited by the transfer capability of the line. Therefore, power sales
or purchases from one location to another may be constrained by the power
transfer capability between locations. A transmission path with significant
power flow, the loss of which may cause system reliability problems, is
identified as a commercially significant constraint. When scheduled power
transfers across transmission facility elements exceed the transfer capability
of such elements, the transmission facility is constrained and transmission
congestion is declared by the ERCOT ISO. Transmission congestion is then
resolved through the use of ancillary services and unit specific deployments to
reduce the transfer across the constrained facility. With the addition of new
loads, generators and transmission facilities and the re-rating of older
facilities, the commercially significant constraints and transfer capabilities
can change. Under current protocol, the commercially significant constraints and
the transfer capabilities along these paths are reassessed every year.
Currently, there are four congestion zones in the ERCOT market. The reserve
margins may vary by congestion zone. The ERCOT ISO has also instituted direct
assignment of congestion cost to those parties causing the congestion. This has
the potential to increase the power generator's exposure to the congestion costs
associated with transferring power between zones.
CAPACITY AUCTIONS AND OPPORTUNITY SALES
STATE MANDATED AUCTIONS
As a power generation company that has been unbundled from an integrated
electric utility, we are required by the Texas electric restructuring law to
sell at auction firm entitlements to 15% of our installed generation capacity on
a forward basis for varying terms of up to two years. We refer to the auctions
held to satisfy this requirement as "state mandated auctions." Our obligation to
conduct state mandated auctions will continue until January 1, 2007, unless
before that date the Texas Utility Commission determines that loads equal to or
exceeding 40% of the electric power consumed in 2000 before the onset of retail
competition in Texas by residential and small commercial customers in
CenterPoint Houston's service area are being served by retail electric providers
not affiliated or formerly affiliated with CenterPoint Energy. Reliant Resources
is deemed to be an affiliate of CenterPoint Energy for purposes of this test.
Reliant Resources is currently not permitted under the Texas electric
restructuring law to purchase capacity sold by us in the state mandated
auctions.
The capacity entitlements we are required to offer in the state mandated
auctions are determined by rules adopted by the Texas Utility Commission. Under
these rules, we are required to sell entitlements to 15% of our installed
generation capacity in blocks of 25 MW each. Texas Utility Commission rules
require 50% of the 25 MW blocks we sell in these auctions to consist of
one-month allocations, or "strips," 30% to consist of one-year strips, and 20%
to consist of two-year strips. Purchasers of our capacity entitlements offered
in the state mandated auctions may resell them to third parties, other than
Reliant Resources. We only auction entitlements to capacity dispatched within
specified operational constraints to specific zonal delivery points and the
entitlements do not convey any right to have power dispatched from a specific
generating unit. This enables us to dispatch our commitments in the most
cost-effective manner available. This also exposes us to the potential risk that
in the event one of our low-cost base-load facilities is shut down, we may be
required to satisfy our commitments with the output of higher cost facilities or
with replacement power purchased from third parties in the open market.
The types of capacity entitlements we offer in our state mandated auctions
include:
- base-load entitlements, representing our solid fuel and nuclear powered
generation capacity, that provide energy at a relatively low fixed price
and include limited ancillary services capabilities;
- intermediate entitlements, representing various gas-fired generation
capacity, that provide energy indexed to natural gas prices and at a
specified heat rate and include flexible ancillary service capabilities;
3
- cyclic entitlements, representing various other gas-fired generation
capacity, that provide energy indexed to natural gas prices and at a
specified heat rate and include flexible ancillary service capabilities;
and
- peaking entitlements, representing various smaller gas-fired generation
capacity, that provide energy indexed to natural gas prices and at a
specified heat rate and include limited ancillary service capabilities.
Each of these categories of capacity entitlements is generally designed to
have operating characteristics similar to the assumed underlying generating
units. For example, base-load entitlements can be started once a month, whereas
cyclic entitlements can be started up to 20 times a month.
CONTRACTUALLY MANDATED AUCTIONS
We are contractually obligated to auction entitlements to substantially all
of our capacity and related ancillary services available after the state
mandated auctions until the date on which the Reliant Resources option either is
exercised or expires. We refer to the auctions held to satisfy this obligation
as "contractually mandated auctions." We are, however, permitted to reduce the
amount of capacity we sell in the contractually mandated capacity auctions by
the amount of operating reserves required to back up our obligations under our
capacity auctions. Since we sell the majority of our capacity as firm
entitlements, we typically reserve 1,250 MW of our capacity as operating
reserves, which can be sold as interruptible power on a system-contingent basis.
Prior to each contractually mandated auction, we determine the types of
capacity entitlements we will auction after taking into consideration
anticipated market demand and the auction principles required under our
agreements with CenterPoint Energy. We intend to hold our contractually mandated
auctions during the same time periods as our state mandated auctions to the
extent market and other conditions permit. Under these principles we:
- are required to offer a variety of capacity entitlements and ancillary
services in the contractually mandated auctions so as to capture the full
value of our generation assets;
- may not withhold capacity from the ERCOT market, subject to the permitted
reductions described above;
- are required to offer a full array of ancillary services consistent with
the capability of our generating units; and
- may sell at terms acceptable to us in our sole discretion any capacity
that is not sold in the contractually mandated auctions or any capacity
entitlement not taken by the entitlement holder.
As described above under "-- State Mandated Auctions," we offer
entitlements to our base-load, intermediate, cyclic and peaking capacity in our
contractually mandated auctions. However, we may vary the terms and conditions
of the entitlements we sell in our contractually mandated auctions from those we
offer in our state mandated auctions. The scale and diversity of our generation
portfolio enables us to offer a greater variety of capacity entitlements than
some of our competitors. We attempt to increase the overall profitability of our
portfolio by offering capacity entitlements with a variety of operating
characteristics through our contractually mandated auctions.
Through 2003, Reliant Resources has the contractual right, but not the
obligation, to purchase 50% (but not less than 50%) of each type of capacity
entitlement we auction in the contractually mandated auctions at the prices
established in the auctions. To exercise this right, Reliant Resources is
required to notify us whether it elects to purchase 50% of the capacity
auctioned no later than three business days prior to the date of the auction. We
exclude the amount of capacity specified in Reliant Resources' notice from the
auction. We auction any portion of the capacity that Reliant Resources does not
reserve through its notice in the contractually mandated auctions.
4
Upon determination of the prices for the capacity entitlements we auction,
Reliant Resources is obligated to purchase the capacity it elected to reserve
from the auction process at the prices set during the auction for that
entitlement. If we auction capacity and ancillary services separately, Reliant
Resources is entitled to participate in 50% of the offered capacity of each. In
addition to its reservation of capacity, and whether or not it has reserved
capacity in the auction, Reliant Resources is entitled to participate in each
contractually mandated auction. If Reliant Resources exercises the Reliant
Resources option, we will not conduct any capacity auctions, other than as
required by Texas Utility Commission rules, between the option exercise date and
the option closing date without obtaining Reliant Resources' consent, which it
may not unreasonably withhold. If Reliant Resources does not exercise its
option, we will no longer be required to conduct contractually mandated auctions
following the expiration of that option.
AUCTION PRICING METHODOLOGY
Revenues derived from our capacity auctions come from two sources: capacity
payments and energy payments. Capacity payments are based on the final clearing
prices, in dollars per kilowatt-month, determined during the auctions. We bill
and collect for these capacity payments on a monthly basis just prior to the
month of the entitlement. Energy payments consist of a variety of charges
related to the fuel and ancillary services scheduled through our auctioned
capacity entitlements. The energy payments we collect for capacity entitlements
with underlying coal-fired, lignite-fired or nuclear capacity are based on a
preestablished price derived from the Texas Utility Commission's forecasted fuel
costs. The energy payments we collect for capacity entitlements with underlying
gas-fired capacity are calculated using specified heat rates and the published
Houston Ship Channel price for natural gas. Additional charges, referred to as
"adders," are included in the energy payments to cover additional costs we incur
when we are required to operate our facilities at less efficient operating
ranges. We bill for these energy payments on a monthly basis in arrears.
AUCTION RESULTS
We conducted our initial state mandated auctions and contractually mandated
auctions from September 2001 through January 2003. Thirty-one companies,
including Reliant Resources, registered and qualified to participate in these
auctions. As a result, we sold 91% of our available capacity for 2002 and 74% of
our available capacity for 2003. Our available capacity equals our total net
generating capacity less capacity withheld as operating reserves and capacity
that is subject to planned outages. The 3,400 MW of capacity that we have
"mothballed" as described below under "-- Recent Plant Mothballing" is included
in our available capacity only for the months of June through September 2003. We
intend to hold auctions to sell our remaining available capacity for 2003 in
March and July 2003.
Reliant Resources purchased entitlements to 63% of our available 2002
capacity and through January 2003, has purchased 58% of our available 2003
capacity. These purchases have been made either through the exercise by Reliant
Resources of its contractual rights to purchase 50% of the entitlements
auctioned in the contractually mandated auctions or through the submission of
bids in those auctions.
To date, the market-based prices established in our capacity auctions have
provided returns on our facilities substantially below historical regulated
returns experienced by our integrated utility in the past. As discussed under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations" in Item 7 of this report, the pricing of
our generation products is sensitive to gas prices. Higher gas prices in the
latter part of 2002 and early 2003 have positively influenced the prices
established in our recent capacity auctions. Generally, higher gas prices
increase the capacity prices for our base-load entitlements since these
entitlements are solid fuel with fixed fuel prices and prospective purchasers
face higher-cost and more volatile priced gas-fired generation alternatives.
OPPORTUNITY SALES
In addition to our capacity auctions, from time to time we sell energy on a
short-term basis from the generating capacity we use as operating reserves. Any
significant unforeseen outage at our base-load or other facilities could
adversely impact revenues generated by these sales. We seek to maximize our
opportunity sales
5
by seeking to optimize the dispatching of the various facilities in our
generating portfolio. For example, we can meet the gas-fired auction products
(intermediate, cyclic and peaking) with generation from our lower cost base-load
operating reserves when they are available, since entitlements to our auction
products convey no right to specific units. Thus, the capacity factor on the
base load capacity has a significant impact on the level of these opportunity
sales through the course of the year.
OUR GENERATION PORTFOLIO
OVERVIEW
We own 60 generating units at 11 electric power generation facilities
located in Texas. We also own a 30.8% interest in the South Texas Project, a
nuclear generating plant consisting of two 1,250 MW generating units. As of
December 31, 2002, the aggregate net generating capacity of our combined
portfolio of generation assets was 14,175 MW, which represents nearly 20% of the
total net generating capacity serving the ERCOT market.
SUMMARY OF OUR GENERATION FACILITIES (AS OF DECEMBER 31, 2002)
NET
GENERATING
CAPACITY NUMBER
GENERATION FACILITIES (IN MW)(1) OF UNITS DISPATCH TYPE FUEL
--------------------- ---------- --------- --------------- --------
W. A. Parish........................ 3,661 9 Base-load, Coal/Gas
Intermediate,
Cyclic, Peaking
Limestone........................... 1,612 2 Base-load Lignite
South Texas Project(2).............. 770 2 Base-load Nuclear
Cedar Bayou......................... 2,260 3 Intermediate Gas/Oil
P. H. Robinson(3)................... 2,213 4 Intermediate Gas
San Jacinto......................... 162 2 Intermediate Gas
T. H. Wharton(3).................... 1,254 18 Cyclic, Peaking Gas/Oil
S. R. Bertron....................... 844 6 Cyclic, Peaking Gas/Oil
Greens Bayou(3)..................... 760 7 Cyclic, Peaking Gas/Oil
Webster(3).......................... 387 2 Cyclic, Peaking Gas
Deepwater(3)........................ 174 1 Cyclic Gas
H. O. Clarke........................ 78 6 Peaking Gas
------ --
Total............................... 14,175 62
====== ==
---------------
(1) Net generating capacity equals gross maximum summer generating capability
less the electric energy consumed at the facility.
(2) Represents our 30.8% interest in the South Texas Project.
(3) In October 2002, we announced our plan to mothball all 2,213 MW of capacity
at our P.H. Robinson facility, 229 MW of capacity at our T.H. Wharton
facility, 406 MW of capacity at our Greens Bayou facility, 374 MW of
capacity at our Webster facility and all 174 MW of capacity at our Deepwater
facility through at least May 2003. Please read "-- Recent Plant
Mothballing."
BASE-LOAD AND INTERMEDIATE FACILITIES
W.A. Parish. Our W.A. Parish facility is the largest coal and gas-fired
power facility in the United States based on total MW of net generating
capacity. The facility consists of a coal-fired plant and a gas-fired plant each
located near Thompsons, Texas. The coal-fired plant includes four steam
generating units for base-load service with an aggregate net generating capacity
of 2,470 MW. Two of these units are 650 MW steam
6
units that were placed in commercial service in December 1977 and December 1978,
respectively. The other two units are 560 MW and 610 MW steam units that were
placed in commercial service in June 1980 and December 1982, respectively.
The gas-fired plant includes five generating units with an aggregate net
generating capacity of 1,191 MW. Two of these units are 174 MW steam units that
were placed in commercial service in June 1958 and December 1958, respectively.
These units were converted for daily cyclic operation and the life of the units
was extended in 1990 and 1991. The third unit at this plant is a 278 MW steam
unit that was placed in commercial service in March 1961. These three units
provide cyclic capacity. The fourth unit is a 552 MW steam unit for intermediate
service that was placed in service in June 1968. This plant also has a 13 MW gas
turbine generator unit available for peaking and emergency start-up purposes
that was placed in service in July 1967.
Limestone. Our Limestone facility is a lignite-fired base-load facility
located approximately 120 miles northwest of Houston. This plant includes two
steam generating units with an aggregate net generating capacity of 1,612 MW.
The first unit is an 846 MW steam unit that was placed in commercial service in
December 1985. The second unit is a 766 MW steam unit that was placed in
commercial operation in December 1986.
Cedar Bayou. Our Cedar Bayou facility is a gas and oil-fired intermediate
facility located east of Baytown, Texas. This plant includes three generating
units with an aggregate net generating capacity of 2,260 MW. Two of the units
are 750 MW steam units that were placed in service in December 1970 and March
1972, respectively. The third unit is a 760 MW steam unit that was placed in
service in December 1974.
P.H. Robinson. Our P. H. Robinson facility is a gas-fired intermediate
facility located east of San Leon, Texas. This plant consists of four steam
generating units with an aggregate net generating capacity of 2,213 MW. Two of
the units are 461 MW units that were placed in service in June 1966 and April
1967, respectively. The third unit is a 552 MW unit that was placed in service
in December 1968. The fourth unit is a 739 MW unit that was placed in service in
December 1973.
San Jacinto. Our San Jacinto facility is a 162 MW gas-fired intermediate
facility located in LaPorte, Texas that produces both steam and power. This
plant includes two cogeneration units and associated equipment. Both units began
commercial operation in April 1995. Each unit consists of a gas turbine that
drives an air-cooled generator with the exhaust from the gas turbine being sent
to a heat recovery steam generator.
CYCLIC AND PEAKING FACILITIES
T.H. Wharton. Our T. H. Wharton facility is a gas and oil-fired cyclic and
peaking facility located in Houston. This plant consists of 18 steam and gas
turbine units with an aggregate net generating capacity of 1,254 MW. This
facility includes a 229 MW steam unit for cyclic service that was placed in
commercial operation in June 1960 and a 13 MW small gas turbine unit for peaking
service that was placed in commercial operation in July 1967. In addition, six
57 MW gas turbines were placed in service at this facility in July 1972. An
additional two 57 MW gas turbines and two 104 MW steam turbines were installed
in August 1974 and were combined with the six gas turbines already in service to
develop two combined cycle units for intermediate service. An additional six 58
MW gas turbines for peaking service were placed in service in November 1975.
S.R. Bertron. Our S. R. Bertron facility is a gas and oil-fired cyclic and
peaking facility located in Deer Park, Texas. This plant consists of four steam
electric generating units, one auxiliary boiler for cyclic operations, and two
gas turbine generators with an aggregate net generating capacity of 844 MW. The
first two units at this plant are 174 MW steam units for cyclic service that
commenced commercial operation in April 1956 and March 1958, respectively. Both
of these units underwent cyclic conversion and life extension in 1989 and 1990.
The third and fourth units at this plant are 230 MW steam units that commenced
commercial operation in April 1959 and March 1960, respectively. Both of these
units are capable of swinging from an overnight minimum of 40 MW to their rated
maximum capacity during peak load hours. This facility also has
7
a 23 MW gas turbine generator and a 13 MW gas turbine generator. Both of these
units provide peaking service and commenced commercial operation in July 1967.
Greens Bayou. Our Greens Bayou facility is a gas and oil-fired cyclic and
peaking facility located northeast of Houston. This plant consists of one 406 MW
steam turbine unit, three 54 MW gas turbine units and three 64 MW gas turbine
units and has an aggregate net generating capacity of 760 MW. The 406 MW steam
turbine unit provides cyclic service and was placed in commercial service in
June 1973. The six gas turbine units provide peaking service and were placed in
commercial service in December 1976.
Webster. Our Webster facility is a gas-fired cyclic and peaking facility
located southeast of Houston between the towns of Webster and League City. This
plant has two units with an aggregate net generating capacity of 387 MW. One of
these units is a 374 MW steam unit for cyclic service that was placed in service
in May 1965 and the other is a 13 MW gas turbine for peaking service that was
placed in commercial operation in July 1967.
Deepwater. Our Deepwater facility is a gas-fired cyclic facility located
in southeastern Harris County, Texas. This facility consists of a 174 MW steam
unit that commenced commercial operation in 1955 and underwent a life extension
and conversion for cyclic operation in 1992.
H.O. Clarke. Our H.O. Clarke facility is a gas-fired peaking facility
located in Houston that began operation in 1943. This plant currently consists
of six simple-cycle air-cooled gas turbine generating units with an aggregate
net generating capacity of 78 MW that were placed in service in June 1968.
RECENT PLANT MOTHBALLING
In October 2002, we announced our plan to temporarily remove from service,
or "mothball," approximately 3,400 MW of our gas-fired generating units through
at least May 2003. We decided to mothball these units because of unfavorable
market conditions in the ERCOT market, including a surplus of generating
capacity and a lack of bids for the output of these units in our previous
capacity auctions. In connection with our plan, the ERCOT ISO has determined
that the mothballed units are not required for system reliability reasons
through May 2003.
The mothballed units represent approximately a third of our total gas-fired
generating capacity. The capacity to be mothballed includes all 2,213 MW of
capacity at our P.H. Robinson facility, 229 MW of capacity at our T.H. Wharton
facility, 406 MW of capacity at our Greens Bayou facility, 374 MW of capacity at
our Webster facility and all 174 MW of capacity at our Deepwater facility. Based
upon the results of our recent capacity auctions, we will return some or all of
the mothballed facilities to service during the summer of 2003.
In connection with the decision to mothball 3,400 MW of our gas-fired
generating units, we extended a voluntary early retirement package in November
2002 which was accepted by 94 of our employees. We do not believe the cost of
this package will have a material impact on our results of operations, financial
condition or cash flows.
SOUTH TEXAS PROJECT
General. The South Texas Project is one of the largest nuclear powered
generating facilities in the United States based on total MW of net generating
capacity. This facility is located near Bay City, Texas and consists of two
1,250 MW generating units, the first of which commenced operation in August 1988
and the second in June 1989. We own a 30.8% interest in the South Texas Project
and bear a corresponding 30.8% share of the capital and operating costs
associated with the project. The South Texas Project is owned as a tenancy in
common among us and three other co-owners. Each co-owner retains its undivided
ownership interest in the two nuclear-fueled generating units and the electrical
output from those units. We and the other three co-owners organized STP Nuclear
Operating Company (STPNOC) to operate and maintain the South Texas Project.
STPNOC is managed by a board of directors comprised of one director appointed by
each of the co-owners, along with the chief executive officer of STPNOC.
8
The two South Texas Project generating units operate under licenses granted
by the Nuclear Regulatory Commission (NRC) that expire in 2027 and 2028. These
licenses could potentially be extended for additional twenty-year terms if the
project satisfies NRC requirements.
Beginning in September 2002, an outage was commenced for one of the
generating units at the South Texas Project to replace its steam generators with
a model that is less susceptible to tube cracking. We expect this change will
restore the design life of the unit and increase the potential for an extension
of the South Texas Project's license. This unit was briefly returned to service
in December 2002. However, as a result of certain non-safety related mechanical
failures, the unit was removed from service in December 2002 and is expected to
return to service in the first quarter of 2003. The steam generators in the
other generating unit at the plant were replaced in the spring of 2000.
Decommissioning Trust. CenterPoint Houston has been authorized to collect
$2.9 million per year from customers using its transmission and distribution
services and is obligated to deposit the amount collected into an external trust
created to fund our 30.8% share of the decommissioning costs for the South Texas
Project. As of December 31, 2002, the amount in the external trust established
to fund our 30.8% interest was $163 million.
In July 1999, an outside consultant estimated our 30.8% share of the
decommissioning costs to be approximately $363 million in 1998 dollars. The
consultant's calculation of decommissioning costs for financial planning
purposes used the "DECON" methodology, one of the three alternatives acceptable
to the NRC, and assumed deactivation of the project's two generating units upon
the expiration of their 40-year operating licenses. The DECON methodology
involves removal of all radioactive material from the site following permanent
shutdown. The facility operator may then have unrestricted use of the site with
no further requirement for a license. The consultant's calculation also assumed
that the remainder of the plant systems and structures on site, not previously
removed in support of license termination, are dismantled and the site restored.
The owners of the South Texas Project must provide a report on the status
of decommissioning funding to the NRC every two years. The report compares
external trust funding levels to minimum decommissioning amounts calculated in
accordance with NRC requirements. We first determine our decommissioning cost
estimate by escalating the NRC's estimated decommissioning cost of $105 million
per unit, expressed in 1986 dollars, for the effects of inflation between 1986
and the recent year-end and then multiplying by 30.8% to reflect our share of
each unit of the South Texas Project. We then use this estimate to determine the
minimum required level of funding as of the most recent year-end. The
calculation of the NRC minimum funding level reflects that funding of the
external trusts occurs over the operating lives of the generating units.
Therefore, the minimum funding level is generally less than the estimated
decommissioning cost. The last report was submitted to the NRC in March 2001 and
showed that, as of December 31, 2000, the aggregate NRC minimum funding level
was $52.1 million. While the trust's funding levels have historically exceeded
minimum NRC funding requirements, we cannot assure you that the amounts held in
trust will be adequate to cover the actual decommissioning costs of the South
Texas Project. These costs may vary because of changes in the assumed date of
decommissioning and changes in regulatory requirements, technology and costs of
labor, materials and equipment.
The investment of the funds in the external trust is managed in accordance
with applicable laws and regulations and by a committee composed of our
representatives and representatives of CenterPoint Energy. Pursuant to the terms
of an agreement between Reliant Energy and Reliant Resources and the applicable
NRC regulations, the responsibility for the decommissioning trust transferred to
us at the time of Reliant Energy's corporate restructuring. In the event that
funds from the trust are inadequate to decommission the facilities, CenterPoint
Houston will be required to collect through rates or other authorized charges
all additional amounts required to fund our obligations relating to the
decommissioning of the South Texas Project. CenterPoint Energy is contractually
obligated to indemnify us from and against any obligations relating to the
decommissioning not otherwise satisfied through collections by CenterPoint
Houston. Following the completion of the decommissioning, if surplus funds
remain in the decommissioning trust, the excess will be refunded to the rate
payers of CenterPoint Houston or its successor.
9
TECHNICAL SERVICES AND SUPPORT FACILITIES
We have a central support facility that we use to support our generation
facilities and refer to as our "EDC facility." This facility includes office
space, a maintenance shop, a chemical lab, a warehouse facility and a fleet
maintenance garage. Reliant Resources leases a portion of this facility from us.
Under our technical services agreement with Reliant Resources, it is
obligated to provide engineering and technical support services and certain
environmental, safety and industrial health services to support the operation
and maintenance of our facilities. Reliant Resources is also obligated to
provide systems, technical, programming and consulting support services and
hardware maintenance, excluding plant-specific hardware, necessary to provide
generation system planning, dispatch, and settlement and communication with the
ERCOT ISO. We paid Reliant Resources approximately $28.3 million for providing
these services during 2002.
FUEL SUPPLIES
We rely primarily on natural gas, coal, lignite and uranium to fuel our
generation facilities. The fuel mix of our generating portfolio, based on actual
fuel usage during 2002, was approximately 60% coal and lignite, 28% natural gas,
and 12% nuclear for the year 2002. As of December 31, 2002, the fuel mix of our
generating portfolio based on the capacity of our facilities was approximately
66% natural gas, 29% coal and lignite and 5% nuclear. Based on our current
assumptions regarding the cost and availability of fuel, plant operation
schedules, load growth, load management and the impact of environmental
regulations, we do not expect the mix of fuel used by our generating portfolio
will vary materially during 2003 from prior levels. As a result of new air
emissions standards imposed by federal and state law, we anticipate having
higher levels of plant maintenance in 2003 and subsequent years associated with
the installation of environmental equipment. These factors could affect the mix
of our future fuel usage.
As a result of the Texas electric restructuring law, most of our energy
sales are now based on generation capacity entitlement auctions. Successful
bidders in these auctions are able to dispatch energy from their entitlements
within specified operational constraints. Under the terms of the capacity
auctions, successful bidders are required to make energy payments to cover a
variety of charges related to the fuel and ancillary services scheduled through
the auctioned entitlements.
NATURAL GAS
We have long-term natural gas supply contracts with several suppliers.
Substantially all of our long-term contracts contain pricing provisions based on
fluctuating spot market prices. In 2002, we purchased approximately 60% of our
natural gas requirements under these long-term contracts, including 42% under a
contract with Kinder Morgan Texas Pipelines, Inc. Our contract with Kinder
Morgan has expired. However, we have a letter of intent to execute a new
long-term contract with Kinder Morgan in the first quarter of 2003. We purchased
the remaining 40% of our natural gas requirements in 2002 on the spot market.
Based on current market conditions, we believe we will be able to replace the
supplies of natural gas covered under our long-term contracts when they expire
with gas purchased on the spot market or under new long-term or short-term
contracts. Our natural gas consumption and cost information for 2002 was as
follows:
2002 average daily consumption.............................. 385 Bbtu(1)
2002 peak daily consumption................................. 1,113 Bbtu
2002 average cost of natural gas............................ $3.32 per MMBtu(2)
---------------
(1) Billion British thermal units, or "Bbtu."
(2) Compared to $4.23 per million British thermal units, or "MMBtu," in 2001 and
$3.98 per MMBtu in 2000.
10
We lease gas storage facilities capable of storing 6.3 billion cubic feet
of natural gas, of which 4.2 billion cubic feet is working capacity. We use
these storage facilities to assist us in:
- managing the volatility of the gas requirements of our generating
facilities;
- meeting the gas requirements of our generating facilities during periods
of inadequate gas supplies; and
- managing our gas-related costs.
Our natural gas requirements are generally more volatile than our other
fuel requirements because we use natural gas to fuel our intermediate, cyclic
and peaking facilities and other more economical fuels to fuel our base-load
facilities. Since our intermediate and peaking facilities are dispatched to meet
the variations of demand for electricity, our gas requirements are highly
variable, on both an hour-to-hour and day-to-day basis. Although natural gas
supplies have been sufficient in recent years to supply our generating
portfolio, available supplies are subject to potential disruption due to weather
conditions, transportation constraints and other events. As a result of these
factors, supplies of natural gas may become unavailable from time to time or
prices may increase rapidly in response to temporary supply constraints or other
factors.
COAL AND LIGNITE
In 2002, we purchased approximately 80% of the fuel requirements for our
four coal-fired generating units at our W.A. Parish facility under two
fixed-quantity long-term supply contracts scheduled to expire in 2010 and 2011.
The price for coal was fixed under the first contract through the end of 2002,
after which the price is tied to spot market prices. The price for coal under
the second contract was approximately three times greater than the spot market
prices for coal as of December 31, 2002. The second contract does not
contemplate future prices being tied to spot market prices. The terms of this
contract result from the market conditions in effect during the 1970's when the
contract was entered into, including shortages of natural gas supplies,
increased demand for low sulfur coal as a result of new environmental
regulations and uncertainty regarding the future availability of long-term
sources of coal supply. The energy payments we collect for capacity entitlements
with underlying coal-fired capacity are based on a pre-established price based
on the Texas Utility Commission's forecasted fuel costs, which incorporate our
expected fuel costs under these long-term coal supply contracts. We purchase our
remaining coal requirements for our W.A. Parish facility under short-term
contracts. Despite the higher coal prices under these long-term contracts, our
fuel costs associated with delivering energy from our coal-fired facilities are,
based on recent natural gas prices, significantly lower than the fuel costs
associated with delivering energy from our gas-fired facilities. We have
long-term rail transportation contracts with Burlington Northern Santa Fe
Railroad and the Union Pacific Railroad Company to transport coal to our W.A.
Parish facility.
We obtain the lignite used to fuel the two generating units of our
Limestone facility from a surface mine adjacent to the facility. We own the
mining equipment and facilities and a portion of the lignite reserves located at
the mine. Mining operations are conducted by the owner of the remaining lignite
reserves. In the past, we have obtained our lignite requirements under a
long-term contract on a cost-plus basis. Since July 2002, we have obtained our
lignite requirements under an amended long-term contract with the owner/operator
at a fixed price determined annually that is expected to result in a cost of
generation at the Limestone facility equivalent to the cost of generating with
low sulfur Western coal. We expect the lignite reserves will be sufficient to
provide all of the lignite requirements of this facility through 2015. The
energy payments we collect for capacity entitlements with underlying
lignite-fired capacity are based on a pre-established price based on the Texas
Utility Commission's forecasted fuel costs, which incorporate our expected costs
under our lignite supply contract.
During 2002, we conducted a successful test burn of Wyoming coal at the
Limestone facility. We anticipate using a blend of lignite and Wyoming coal to
fuel our Limestone facility beginning in 2003 as a component of our oxides of
nitrogen (NOx) control strategy. A fuel unloading and handling system was
installed at the Limestone facility to accommodate the delivery of Wyoming coal.
We expect that we will obtain Wyoming coal through spot and long-term market
priced contracts. Our Limestone facility is connected with the Burlington
Northern Santa Fe Railroad.
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NUCLEAR
The South Texas Project satisfies its fuel supply requirements by acquiring
uranium concentrates, converting uranium concentrates into uranium hexafluoride,
enriching uranium hexafluoride, and fabricating nuclear fuel assemblies. We are
party to a number of contracts covering a portion of the fuel requirements of
the South Texas Project for uranium, conversion services, enrichment services
and fuel fabrication. Other than a fuel fabrication agreement that extends for
the life of the South Texas Project, these contracts have varying expiration
dates, and most are short to medium term (less than seven years). We believe
that sufficient capacity for nuclear fuel supplies and processing exists to
permit normal operations of the South Texas Project's nuclear powered generating
units. The energy payments we collect for capacity entitlements with underlying
nuclear capacity are based on a pre-established price based on the Texas Utility
Commission's forecasted costs, which incorporate our expected costs under these
contracts.
FUEL PIPELINE
We own an 87-mile fuel pipeline that can transport either fuel oil or gas.
As part of our system, we own over five million barrels of oil storage capacity
that can supply fuel oil to our Cedar Bayou, Greens Bayou, S.R. Bertron and T.H.
Wharton plants. For natural gas supply, our pipeline is connected to six of our
generation facilities and is interconnected with several of our suppliers. Our
pipeline provides us with added flexibility in managing the fuel supply
requirements of our generation facilities.
CPS JOINT OPERATING AGREEMENT
We have a joint operating agreement with the City Public Service Board of
San Antonio (CPS) to jointly dispatch our portfolio of generating units with
CPS' portfolio of 4,823 MW of generating capacity as a joint operating system to
meet our combined obligations. The combined system includes approximately 19,000
MW of generating capacity and provides us with added economies of scale and
production cost savings. A large portion of the benefit of joint operations is
due to San Antonio's significant amount of capacity at its coal-fired generation
facilities. We share the fuel cost savings realized under the agreement with the
City of San Antonio. We currently share the cost savings benefits equally with
CPS. The current agreement with CPS expires in 2009. Both parties are permitted
to sell their capacity outside of the joint operating system if it is
economically prudent to do so, in which case the parties would lose the
agreement's cost savings benefits with respect to those sales. The capacity of
CPS' generating facilities covered by the joint operating agreement is not
included in the capacity auctions described under "Capacity Auctions and
Opportunity Sales" above.
COMPETITION
The ERCOT market is highly competitive. We have approximately 80
competitors which include generation companies affiliated with Texas-based
utilities, independent power producers, municipal or co-operative generators and
wholesale power marketers. These competitors compete with us and each other by
buying and selling wholesale power in the ERCOT market, entering into bilateral
contracts and/or selling to aggregated retail customers. As of December 31,
2002, our facilities provided less than 20% of the aggregate net generating
capacity serving the ERCOT market. Our competition is based primarily on price
but we also may compete based on product flexibility. A number of our
competitors are building efficient, combined cycle power plants that are
generally not able to provide the operational flexibility, ancillary services
and fuel risk mitigation that our large diversified portfolio of generating
facilities can provide. In addition, we believe that there may be significant
excess generating capacity constructed in the ERCOT market over the next several
years. This overbuilding could result in lower prices for wholesale power in the
ERCOT market. For more information regarding this trend and other competitive
factors in the ERCOT market, please read "The ERCOT Market" above.
12
CUSTOMERS
Since January 1, 2002, we have sold power to wholesale purchasers,
including retail electric providers, at unregulated rates through our capacity
auctions. In addition to retail electric providers, our customers in the ERCOT
market include municipal utilities, electric co-operatives, power trading
organizations and other power generating companies. We are also a significant
provider to the ancillary services market operated by the ERCOT ISO. We expect
our mix of customers and the mix of participants will change significantly as
the ERCOT market evolves from one dominated by vertically integrated electric
utilities to one with utility-affiliated retail electric providers, new-entrant
retail electric providers, a greater participation by unregulated energy
merchants, and more generation capacity from independent generation companies.
Sales to Reliant Resources represented approximately 66% of Texas Genco's total
revenues in 2002.
INSURANCE
GENERAL
We carry insurance coverage consistent with companies engaged in similar
commercial operations with similar properties. Our insurance coverage includes:
- public liability insurance, covering liabilities to third parties for
bodily injury and property damage resulting from our operations;
- automobile liability insurance, for all owned, non-owned and hired
vehicles, covering liabilities to third parties for bodily injury and
property damage; and
- property insurance, subject to replacement cost of insured real and
personal property, including coverage for boiler and machinery
breakdowns, earthquake and flood damage, subject to certain sublimits.
We also maintain substantial excess liability insurance coverage above the
established primary limits for public general liability and automobile liability
insurance. Limits and deductibles are comparable to those carried by other
electric generation companies of similar size. However, our insurance policies
are subject to certain limits and deductibles and do not include business
interruption coverage. Adequate insurance coverage may not be available in the
future on commercially reasonable terms. Also, the insurance proceeds received
for any loss of or any damage to any of our generation facilities may not be
sufficient to restore the loss or damage without negative impact on our
financial condition and results of operations. The costs of our insurance
coverage have increased significantly during the past year and may continue to
increase in the future.
NUCLEAR
We and the other owners of the South Texas Project maintain nuclear
property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
Under the Price Anderson Act, the maximum liability to the public of owners
of nuclear power plants was $9.3 billion as of December 31, 2002. Owners are
required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. We and the other owners of the South Texas
Project currently maintain the required nuclear liability insurance and
participate in the industry retrospective rating plan under which the owners of
the South Texas Project are subject to maximum retrospective assessments in the
aggregate per incident of up to $88 million per reactor. The owners are jointly
and severally liable at a rate not to exceed $10 million per incident per year.
In addition, the security procedures at this facility have recently been
enhanced to provide additional protection against terrorist attacks.
13
We cannot assure you that all potential losses or liabilities associated
with the South Texas Project will be insurable, or that the amount of insurance
will be sufficient to cover them. Any substantial losses not covered by
insurance would have a material adverse effect on our financial condition,
results of operations and cash flows.
BACKGROUND OF THE DISTRIBUTION OF TEXAS GENCO SHARES
RELIANT ENERGY'S BUSINESS SEPARATION PLAN
The Texas electric restructuring law requires the restructuring of electric
utilities in Texas in order to separate their power generation, transmission and
distribution, and retail electric businesses into separate units. In March 2001,
the Texas Utility Commission approved a business separation plan for Reliant
Energy involving the separation of Reliant Energy's generation, transmission and
distribution, and retail businesses into three separate companies. Effective
August 31, 2002, Reliant Energy consummated a restructuring transaction in
accordance with its business separation plan in which it, among other things:
- conveyed all of its electric generating facilities to us;
- became a subsidiary of CenterPoint Energy; and
- converted into a limited liability company named CenterPoint Energy
Houston Electric, LLC, which we refer to as "CenterPoint Houston."
Although our portfolio of generating facilities was formerly owned by the
unincorporated electric utility division of Reliant Energy, for convenience, we
describe our business in this report as if we had owned and operated our
generation facilities prior to the date they were conveyed to us. The book value
of the net assets conveyed to us by Reliant Energy on August 31, 2002 was
approximately $2.8 billion.
CENTERPOINT HOUSTON'S STRANDED COST RECOVERY
Under the Texas electric restructuring law, transmission and distribution
utilities whose generation assets were "unbundled" pursuant to the law,
including CenterPoint Houston, are entitled to recover their "stranded costs"
associated with those assets. The Texas electric restructuring law defines
stranded costs as the positive excess of the regulatory net book value of the
utility's unbundled generation assets over the market value of those assets,
after taking specified factors into account. The law allows alternate methods
for establishing a market value for generation assets, including outright sale,
full or partial stock market valuation and asset exchanges. Under Reliant
Energy's business separation plan, Reliant Energy agreed that the fair market
value of our generating assets will be determined using the partial stock market
valuation method. CenterPoint Energy made the distribution in order to establish
a public market value for our shares that will be used in 2004 to calculate how
much CenterPoint Houston will be able to recover as stranded costs and to comply
with CenterPoint Energy's contractual obligations to Reliant Resources.
Beginning in January 2004, on a schedule established by the Texas Utility
Commission, investor-owned utilities in Texas may file to commence true-up
proceedings. One of the purposes of the true-up proceeding for CenterPoint
Energy will be to quantify the amount of stranded costs associated with our
generation assets. In the proceeding, the regulatory net book value of our
generating assets will be compared to the market value based on the partial
stock valuation method. The resulting difference, if positive, is stranded cost
that will be recoverable by CenterPoint Houston either through a transition
charge, which is a non-bypassable charge assessed to CenterPoint Houston's
customers, or through a securitization of such cost. Texas Genco is not entitled
to receive any payment or other benefits in connection with CenterPoint
Houston's recovery of stranded costs. In the true-up proceeding, the market
value of our assets will be based on the average daily closing price of Texas
Genco's common stock on The New York Stock Exchange for the 30 consecutive
trading days chosen by the Texas Utility Commission out of the last 120 days
immediately preceding the true-up filing, plus a control premium, up to a
maximum of 10%, to the extent included in the valuation determination made by
the Texas Utility Commission.
14
RELIANT RESOURCES OPTION
One of the objectives of Reliant Energy's business separation plan was to
separate Reliant Energy's operations into two unaffiliated publicly traded
companies with one company, CenterPoint Energy, holding Reliant Energy's
regulated energy delivery businesses and the other company, Reliant Resources,
holding its competitive energy services operations. As part of the business
separation plan, Reliant Resources was granted an option that may be exercised
between January 10, 2004 and January 24, 2004 to purchase all of the shares of
Texas Genco common stock owned by CenterPoint Energy. For more information
regarding the Reliant Resources Option, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Related Party
Transactions -- Reliant Resources Option" in Item 7 of this report.
REGULATION
We are subject to regulation by various federal, state and local
governmental agencies, including the regulations described below and under "The
ERCOT Market," "Capacity Auctions and Opportunity Sales -- State Mandated
Auctions" and "Environmental Matters -- Regulation" below.
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
As a subsidiary of a registered public utility holding company, we are
subject to a comprehensive regulatory scheme imposed by the SEC in order to
protect customers, investors and the public interest. Although the SEC does not
regulate rates and charges under the 1935 Act, it does regulate the structure,
financing, lines of business and internal transactions of public utility holding
companies and their system companies. In order to obtain financing, acquire
additional public utility assets or stock, or engage in other significant
transactions, we are generally required to obtain approval from the SEC under
the 1935 Act.
Prior to the restructuring of Reliant Energy pursuant to its business
separation plan, CenterPoint Energy and Reliant Energy obtained an order from
the SEC that authorized the restructuring transactions and granted CenterPoint
Energy certain authority with respect to system financing, dividends and other
matters. The financing authority granted by that order will expire on June 30,
2003, and CenterPoint Energy must obtain a further order from the SEC under the
1935 Act, related, among other things, to the financing activities of
CenterPoint Energy and its subsidiaries, including us, subsequent to June 30,
2003.
In a July 2002 order, the SEC limited the aggregate amount of our external
borrowings to $500 million. Our ability to pay dividends is restricted by the
SEC's requirement that common equity as a percentage of total capitalization
must be at least 30% after the payment of any dividend. In addition, the order
restricts our ability to pay dividends out of capital accounts to the extent
current or retained earnings are insufficient for those dividends. Under these
restrictions, we are permitted to pay dividends in excess of our current or
retained earnings in an amount up to $100 million.
In 2002, CenterPoint Energy Resources Corp., a subsidiary of CenterPoint
Energy, obtained authority from each state in which such authority was required
to restructure in a manner that would allow CenterPoint Energy to claim an
exemption from registration under the 1935 Act. CenterPoint Energy has concluded
that a restructuring would not be beneficial and has elected to remain a
registered holding company under the 1935 Act.
NUCLEAR REGULATORY COMMISSION
We are subject to regulation by the NRC with respect to the operation of
the South Texas Project. This regulation involves testing, evaluation and
modification of all aspects of plant operation in light of NRC safety and
environmental requirements. Continuous demonstrations to the NRC that plant
operations meet applicable requirements are also required. The NRC has the
ultimate authority to determine whether any nuclear powered generating unit may
operate.
We and the other owners of the South Texas Project are required by NRC
regulations to estimate from time to time the amounts required to decommission
that nuclear generating facility and are required to
15
maintain funds to satisfy that obligation when the plant ultimately is
decommissioned. CenterPoint Houston currently collects through its electric
rates amounts calculated to provide sufficient funds at the time of
decommissioning to discharge these obligations. Funds collected will be
deposited into a nuclear decommissioning trust. The beneficial ownership in the
decommissioning trust is held by us, as the licensee of the facility. While
current funding levels exceed NRC minimum requirements, no assurance can be
given that the amounts held in trust will be adequate to cover the actual
decommissioning costs of the South Texas Project. Such costs may vary because of
changes in the assumed date of decommissioning and changes in regulatory
requirements, technology and costs of labor, materials and waste burial. For
additional information regarding the decommissioning trust, please read "Our
Generation Portfolio -- South Texas Project -- Decommissioning Trust" above.
ENVIRONMENTAL MATTERS
REGULATION
We are subject to a number of federal, state and local laws and regulations
relating to the protection of the environment and the safety and health of
personnel and the public. These requirements relate to a broad range of our
activities, including:
- the discharge of pollutants into the air, water and soil;
- the identification, generation, storage, handling, transportation,
disposal, record keeping, labeling and reporting of, and the emergency
response in connection with, hazardous and toxic materials and wastes,
including asbestos, associated with our operations;
- noise emissions from our facilities; and
- safety and health standards, practices and procedures that apply to the
workplace and the operation of our facilities.
In order to comply with these requirements, we may need to spend
substantial amounts and devote other resources from time to time to:
- construct or acquire new equipment;
- acquire permits and/or marketable allowance or other emission credits for
facility operations;
- modify or replace existing and proposed equipment; and
- clean up or decommission waste disposal areas, fuel storage and
management facilities, and other locations and facilities, including
generation facilities.
If we do not comply with environmental requirements that apply to our
operations, regulatory agencies could seek to impose on us civil, administrative
and/or criminal liabilities as well as seek to curtail our operations. Under
some statutes, private parties could also seek to impose upon us civil fines or
liabilities for property damage, personal injury and possibly other costs.
Under the federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980 (CERCLA), owners and operators of facilities from which
there has been a release or threatened release of hazardous substances, together
with those who have transported or arranged for the disposal of those
substances, are liable for:
- the costs of responding to that release or threatened release; and
- the restoration of natural resources damaged by any such release.
AIR EMISSIONS
NOx Reduction Program. As part of the 1990 amendments to the Federal Clean
Air Act, requirements and schedules for compliance were developed for attainment
of health-based standards. As part of this
16
process, standards for NOx emissions, a product of the combustion process
associated with power generation, are being developed or have been finalized.
The Texas Commission on Environmental Quality (TCEQ) standards requires
reduction of emissions from our power generating units. The Texas electric
restructuring law, as well as regulations adopted by TCEQ in 2001, requires
substantial reductions in NOx emissions from electric generating units. We are
currently installing cost-effective controls at our generating plants to comply
with these requirements. As of December 31, 2002, we had invested $551 million
for NOx emission controls and we are planning to make expenditures of at least
$131 million in the years 2003 through 2005, with possible additional
expenditures after 2005. NOx control estimates for 2006 and 2007 have not been
finalized. The Texas Utility Commission has initially approved our NOx emission
reduction plan in the amount of $699 million as the most cost-effective
alternative in achieving compliance with applicable air quality standards for
our generation facilities. In addition, we are required to fund NOx reduction
projects for pipelines in East Texas at a cost of $16.2 million, which is
included in the amounts described above.
The Environmental Protection Agency (EPA) has announced its determination
to regulate hazardous air pollutants, including mercury, from coal-fired and
oil-fired steam electric generating units under the Clean Air Act. The EPA plans
to develop maximum achievable control technology (MACT) standards for these
types of units as well as for turbines, engines and industrial boilers. The
rulemaking for coal- and oil-fired steam electric generating units must be
completed by December 2004. Compliance with the rules will be required within
three years thereafter. The MACT standards that will be applicable to our units
cannot be predicted at this time and may adversely impact our operations. The
rulemaking for turbines is expected to be complete in August 2003 and for
engines and industrial boilers in 2004. Based on the rules currently proposed,
we do not anticipate a material adverse impact on our operations.
In 1998, the United States signed the United Nations Framework Convention
on Climate Change (Kyoto Protocol). The Kyoto Protocol calls for developed
nations to reduce their emissions of greenhouse gases. Carbon dioxide, which is
a major byproduct of the combustion of fossil fuel, is considered to be a
greenhouse gas. In 2002, President Bush withdrew the United States' support for
the Kyoto Protocol. Since this withdrawal, Congress has explored a number of
other alternatives for regulating domestic greenhouse gas emissions. If the
country re-enters and the United States Senate ultimately ratifies the Kyoto
Protocol and/or if the United States Congress adopts other measures for the
control of greenhouse gases, any resulting limitations on power plant carbon
dioxide emissions could have a material adverse impact on all fossil fuel fired
facilities, including ours.
The EPA is conducting a nationwide investigation regarding the historical
compliance of coal-fueled electric generating stations with various permitting
requirements of the Clean Air Act. Specifically, the EPA and the U.S. Department
of Justice have initiated formal enforcement actions and litigation against
several other utility companies that operate these stations, alleging that these
companies modified their facilities without proper preconstruction permit
authority. To date, we have not received requests for information related to
work activities conducted at our facilities. The EPA has not filed an
enforcement action or initiated litigation in connection with our facilities.
Nevertheless, any litigation, if pursued successfully by the EPA, could
accelerate the timing of emission reductions currently contemplated for the
facilities and result in the imposition of penalties.
In February 2001, the United States Supreme Court upheld previously adopted
EPA ambient air quality standards for fine particulate matter and ozone. While
attaining these new standards may ultimately require expenditures for air
quality control system upgrades for our facilities, regulations establishing
required controls are not expected until after 2005. Consequently, it is not
possible to determine the impact on our operations at this time.
In July 2002, the White House sent to the United States Congress a Bill
proposing the "Clear Skies Act of 2002" (Clear Skies Act), which is designed to
achieve long-term reductions of multiple pollutants produced from fossil
fuel-fired power plants. If enacted, the Clear Skies Act would target reductions
averaging 70% for sulfur dioxide, NOx and mercury emissions and would create a
gradually imposed market-based compliance program that would come into effect
initially in 2008 with full compliance required by 2018. Fossil fuel-fired power
plants owned by companies like us would be affected by the adoption of this
program, or other
17
legislation currently pending in Congress addressing similar issues. To comply
with such programs, we and other regulated entities could pursue a variety of
strategies including the installation of pollution controls, the purchase of
emission allowances, or the curtailment of operations.
WATER
In July 2000, the EPA issued final rules for the implementation of the
total maximum daily load (TMDL) program. The goal of the TMDL program is to
restore waters designated as impaired by identifying and restricting the loading
of pollutants contributing to the impairment. While we are not aware of any of
our facilities being directly affected by the current TMDL developments, there
is the potential that the establishment of TMDLs may eventually result in more
stringent discharge limits in our plant discharge permits. Such limits could
require our facilities to install additional water treatment facilities or
equipment, modify operational practices or implement other water quality
improvement measures. In October 2001, the EPA signed a final rule delaying the
effective date of the TMDL rule until April 30, 2003. In December 2002, the EPA
published a proposal rulemaking that would withdraw the July 2000 rule.
In April 2002, the EPA proposed rules under Section 316(b) of the Clean
Water Act relating to the design and operation of cooling water intake
structures. This proposal is the second of three current phases of rulemaking
dealing with Section 316(b) and generally would affect existing facilities that
use significant quantities of cooling water. Under the amended court deadline,
the EPA is to issue final rules for these Phase II facilities by February 2004.
While the requirements of the final rule cannot be predicted at this time, we
may be required to incur significant capital expenditures. We anticipate that
substantial comments and, if necessary, litigation will be filed by affected
parties to attempt to achieve an acceptable final regulation.
The EPA and the State of Texas periodically update water quality standards
in response to new toxicological data and the development of enhanced analytical
techniques that allow lower detection levels. The lowering of water quality
criteria for parameters such as arsenic, mercury and selenium could affect
generating facility discharge limitations and require our facilities to install
additional treatment equipment.
ASBESTOS
As a result of their age, many of our facilities contain significant
amounts of asbestos insulation, other asbestos-containing materials and
lead-based paint. Existing state and federal rules require the proper management
and disposal of these potentially toxic materials. We have developed a
management plan that includes proper maintenance of existing non-friable
asbestos installations, and removal and abatement of asbestos containing
materials where necessary because of maintenance, repairs, replacement or damage
to the asbestos itself. We have planned for the proper management, abatement and
disposal of asbestos and lead-based paint at our facilities.
Our facilities are the subject of a number of lawsuits filed by a large
number of individuals who claim injury due to exposure to asbestos while working
at sites along the Texas Gulf Coast. Most of these claimants have been third
party workers who participated in construction of various industrial facilities,
including power plants, and some of the claimants have worked at locations owned
by us. We anticipate that additional claims like those received may be asserted
in the future, and we intend to continue our practice of vigorously contesting
claims that we do not consider to have merit. Although their ultimate outcome
cannot be predicted at this time, we do not believe, based on our experience to
date, that these matters, either individually or in the aggregate, will have a
material adverse effect on our financial position, results of operations or cash
flows.
EMPLOYEES
As of December 31, 2002, we employed approximately 1,639 people. Of these
employees, approximately 1,102 were covered by a collective bargaining agreement
with the International Brotherhood of Electrical Workers Local 66 that extends
through September 2003.
18
EXECUTIVE OFFICERS
(AS OF MARCH 1, 2003)
NAME AGE POSITION
---- --- --------
David M. McClanahan....... 53 Chairman and Director
David G. Tees............. 58 President, Chief Executive Officer and Director
Scott E. Rozzell.......... 53 Executive Vice President, General Counsel and Corporate Secretary
Gary L. Whitlock.......... 53 Executive Vice President and Chief Financial Officer
James S. Brian............ 55 Senior Vice President and Chief Accounting Officer
Joseph B. McGoldrick...... 49 Corporate Vice President, Strategic Planning
DAVID M. MCCLANAHAN is the Chairman of our board of directors. Mr.
McClanahan has also served on the board of directors and as the President and
Chief Executive Officer of CenterPoint Energy since September 2002. He served as
the Vice Chairman of Reliant Energy from October 2000 to September 2002 and as
President and Chief Operating Officer of Reliant Energy's Delivery Group since
1999. He also served as the President and Chief Operating Officer of Reliant
Energy HL&P from 1997 to 1999. He has served in various other executive
capacities with Reliant Energy since 1986. He previously served as Chairman of
the Board of Directors of ERCOT and Chairman of the Board of the University of
St. Thomas. He currently serves on the boards of the Edison Electric Institute,
American Gas Association and Interstate Natural Gas Association of America.
DAVID G. TEES is our President and Chief Executive Officer and a member of
our board of directors. He served as Senior Vice President, Generation
Operations of Reliant Energy from 1998 through August 2002. He also served as
Vice President of Energy Production of Reliant Energy HL&P from 1986 through
1998. Mr. Tees has also served on the executive committee of the Edison Electric
Institute Energy Supply Subcommittee and presently represents CenterPoint Energy
as a Research Advisory Committee Member of the Electric Power Research Institute
and is the Chairman of the Board of the STP Nuclear Operating Company.
SCOTT E. ROZZELL is our Executive Vice President, General Counsel and
Corporate Secretary. Mr. Rozzell has also served as the Executive Vice
President, General Counsel and Corporate Secretary of CenterPoint Energy since
September 2002. He served as Executive Vice President and General Counsel of the
Delivery Group of Reliant Energy from March 2001 to September 2002. Prior to
joining Reliant Energy, Mr. Rozzell was a senior partner in the law firm of
Baker Botts L.L.P.
GARY L. WHITLOCK is our Executive Vice President and Chief Financial
Officer. Mr. Whitlock has also served as the Executive Vice President and Chief
Financial Officer of CenterPoint Energy since September 2002. He served as
Executive Vice President and Chief Financial Officer of the Delivery Group of
Reliant Energy from July 2001 to September 2002. Mr. Whitlock served as the Vice
President, Finance and Chief Financial Officer of Dow AgroSciences, a subsidiary
of The Dow Chemical Company from 1998 to 2001.
JAMES S. BRIAN is our Senior Vice President and Chief Accounting Officer.
Mr. Brian has also served as the Senior Vice President and Chief Accounting
Officer of CenterPoint Energy since August 2002. He served as Senior Vice
President, Finance and Administration of the Delivery Group of Reliant Energy
from 1999 to August 2002, and as Vice President and Chief Financial Officer of
Reliant Energy HL&P from 1997 to 1999. He has served in various executive
capacities with Reliant Energy since 1983.
JOSEPH B. MCGOLDRICK is our Corporate Vice President, Strategic Planning.
Mr. McGoldrick has also served as Corporate Vice President, Strategic Planning
of CenterPoint Energy since September 2002. He served as Corporate Vice
President, Strategic Planning of the Delivery Group of Reliant Energy from
November 2001 to August 2002. He served as Senior Vice President, Finance &
Administration for Reliant Energy Retail from 2000 to 2001. He has served in
various executive capacities with Reliant Energy since 1993.
19
RISK FACTORS
MARKET RISKS
OUR REVENUES AND RESULTS OF OPERATIONS ARE IMPACTED BY MARKET RISKS THAT ARE
BEYOND OUR CONTROL.
We sell electric generation capacity, energy and ancillary services in the
ERCOT market. Under the Texas electric restructuring law, we and other power
generators in Texas are not subject to traditional cost-based regulation and
therefore may sell electric generation capacity, energy and ancillary services
to wholesale purchasers at prices determined by the market. As a result, we are
not guaranteed any rate of return on our capital investments through mandated
rates, and our revenues and results of operations depend, in large part, upon
prevailing market prices for electricity in the ERCOT market. Market prices for
electricity, generation capacity, energy and ancillary services may fluctuate
substantially. Our gross margins are primarily derived from the sale of capacity
entitlements associated with our large, solid fuel base-load generating units,
including our Limestone and W. A. Parish facilities and our interest in the
South Texas Project. The gross margins generated from payments associated with
the capacity of these units are directly impacted by natural gas prices. Since
the fuel costs for our base-load units are largely fixed under long-term
contracts, they are generally not subject to significant daily and monthly
fluctuations. Because natural gas is the marginal fuel for facilities serving
the ERCOT market during most hours, gas prices have a significant influence on
the price of electric power. As a result, the price customers are willing to pay
for entitlements to our solid fuel-fired base-load capacity generally rises and
falls with natural gas prices.
Market prices in the ERCOT market may also fluctuate substantially due to
other factors. Such fluctuations may occur over relatively short periods of
time. Volatility in market prices may result from:
- oversupply or undersupply of generation capacity;
- power transmission or fuel transportation constraints or inefficiencies;
- weather conditions;
- seasonality;
- availability and market prices for natural gas, crude oil and refined
products, coal, enriched uranium and uranium fuels;
- changes in electricity usage;
- additional supplies of electricity from existing competitors or new
market entrants as a result of the development of new generation
facilities or additional transmission capacity;
- illiquidity in the ERCOT market;
- availability of competitively priced alternative energy sources;
- natural disasters, wars, embargoes, terrorist attacks and other
catastrophic events; and
- federal and state energy and environmental regulation and legislation.
THERE IS CURRENTLY A SURPLUS OF GENERATING CAPACITY IN THE ERCOT MARKET AND WE
EXPECT THE MARKET FOR WHOLESALE POWER TO BE HIGHLY COMPETITIVE.
The reserve margin in the ERCOT market has exceeded 20% since 2001, and the
Texas Utility Commission and the ERCOT ISO have forecasted the reserve margin
for 2003 to continue to exceed 20%. The commencement of commercial operation of
new facilities in the ERCOT market will increase the competitiveness of the
wholesale power market, which could have a material adverse effect on our
business, results of operations, financial condition and cash flows and the
market value of our assets.
Our competitors include generation companies affiliated with Texas-based
utilities, independent power producers, municipal and co-operative generators
and wholesale power marketers. The unbundling of vertically integrated utilities
into separate generation, transmission and distribution and retail businesses
20
pursuant to the Texas electric restructuring law could result in a significant
number of additional competitors participating in the ERCOT market. Some of our
competitors may have greater financial resources, lower cost structures, more
effective risk management policies and procedures, greater ability to incur
losses, greater potential for profitability from ancillary services, or greater
flexibility in the timing of their sale of generating capacity and ancillary
services than we do.
WE ARE SUBJECT TO OPERATIONAL AND MARKET RISKS ASSOCIATED WITH OUR CAPACITY
AUCTIONS.
We are obligated to sell substantially all of our available capacity and
related ancillary services through 2003 pursuant to capacity auctions. In these
auctions, we sell firm entitlements on a forward basis to capacity and ancillary
services dispatched within specified operational constraints. Although we have
reserved a portion of our aggregate net generation capacity from our capacity
auctions for planned or forced outages at our facilities, unanticipated plant
outages or other problems with our generation facilities could result in our
firm capacity and ancillary services commitments exceeding our available
generation capacity. As a result, we could be required to obtain replacement
power from third parties in the open market to satisfy our firm commitments,
that could result in significant additional costs. In addition, an unexpected
outage at one of our lower cost facilities could require us to run one of our
higher cost plants in order to satisfy our obligations even though the energy
payments for the dispatched power are based on the cost of our lower-cost
facilities.
We sell capacity entitlements in state mandated auctions and in our other
contractually mandated auctions. The mechanics, regulations and agreements
governing our capacity auctions are complex, and the auction process in which we
sell entitlements to our capacity is relatively new. The state mandated auctions
require, among other things, our capacity entitlements to be sold in
pre-determined amounts. The characteristics of the capacity entitlements we sell
in state mandated auctions are defined by rules adopted by the Texas Utility
Commission and therefore cannot be changed to respond to market demands or
operational requirements without approval by the Texas Utility Commission.
IF THE ERCOT MARKET DOES NOT FUNCTION IN THE MANNER CONTEMPLATED BY THE TEXAS
ELECTRIC RESTRUCTURING LAW, OUR BUSINESS PROSPECTS, RESULTS OF OPERATIONS,
FINANCIAL CONDITION AND CASH FLOWS COULD BE ADVERSELY IMPACTED.
The initiatives under the Texas electric restructuring law have had a
significant impact on the nature of the electric power industry in Texas and the
manner in which participants in the ERCOT market conduct their business. These
changes are ongoing and we cannot predict the future development of the ERCOT
market or the ultimate effect that this changing regulatory environment will
have on our business. Some restructured markets in other states have recently
experienced supply problems and extreme price volatility. If the ERCOT market
does not function as planned once the deregulation initiatives called for by the
Texas electric restructuring law have taken their full effect, our results of
operations, financial condition and cash flows could be adversely affected. In
addition, any market failures could lead to revisions or reinterpretations of
the Texas electric restructuring law, the adoption of new laws and regulations
applicable to us or our facilities and other future changes in laws and
regulations that may have a detrimental effect on our business.
As part of the transition to retail competition in Texas, the ERCOT market
has changed from operating with multiple control areas, each managed by one of
the utilities in the state, to a single control area managed by the ERCOT ISO.
The ERCOT ISO is responsible for maintaining reliable operations of the bulk
electric power supply system in the new combined control area. If the ERCOT ISO
is unable to successfully manage these functions, the ERCOT market may not
operate properly and our results of operations could be adversely affected. In
addition, the ERCOT ISO may impose or the Texas Utility Commission may require
price limitations, bidding rules and other mechanisms that could impact
wholesale prices in the ERCOT market and the outcomes of our capacity auctions.
21
OPERATING RISKS
THE OPERATION OF OUR POWER GENERATION FACILITIES INVOLVES RISKS THAT COULD
ADVERSELY AFFECT OUR REVENUES, COSTS, RESULTS OF OPERATIONS AND CASH FLOWS.
General. We are subject to various risks associated with operating our
power generation facilities, any of which could adversely affect our revenues,
costs, results of operations, financial condition and cash flows. These risks
include:
- operating performance below expected levels of output or efficiency;
- breakdown or failure of equipment or processes;
- disruptions in the transmission of electricity;
- shortages of equipment, material or labor;
- labor disputes;
- fuel supply interruptions;
- limitations that may be imposed by regulatory requirements, including,
among others, environmental standards;
- limitations imposed by the ERCOT ISO;
- violations of permit limitations;
- operator error; and
- catastrophic events such as fires, hurricanes, explosions, floods,
terrorist attacks or other similar occurrences.
A significant portion of our facilities was constructed many years ago.
Older generation equipment, even if maintained in accordance with good
engineering practices, may require significant capital expenditures to keep it
operating at high efficiency and to meet regulatory requirements. This equipment
is also likely to require periodic upgrading and improvement. Any unexpected
failure to produce power, including failure caused by breakdown or forced
outage, could result in reduced earnings.
The cost of repairing damage to our facilities due to storms, natural
disasters, wars, terrorist acts and other catastrophic events may adversely
impact our results of operations, financial condition and cash flows. The
occurrence or risk of occurrence of future terrorist activity may impact our
results of operations and financial condition in unpredictable ways. These
actions could also result in adverse changes in the insurance markets and
disruptions of power and fuel markets. In addition, our power generation
facilities and fuel supply could be directly or indirectly harmed by future
terrorist activity. The occurrence or risk of occurrence of future terrorist
attacks or related acts of war could also adversely affect the United States
economy. A lower level of economic activity could result in a decline in energy
consumption, which could adversely affect our revenues and margins and limit our
future growth prospects. Also, these risks could cause instability in the
financial markets and adversely affect our ability to access capital.
We employ experienced personnel to maintain and operate our facilities and
carry insurance to mitigate the effects of some of the operating risks described
above. Our insurance policies, however, are subject to certain limits and
deductibles and do not include business interruption coverage. Should one or
more of the events described above occur, revenues from our operations may be
significantly reduced or our costs of operations may significantly increase.
22
WE RELY ON POWER TRANSMISSION FACILITIES THAT WE DO NOT OWN OR CONTROL AND ARE
SUBJECT TO TRANSMISSION CONSTRAINTS WITHIN THE ERCOT MARKET. IF THESE
FACILITIES FAIL TO PROVIDE US WITH ADEQUATE TRANSMISSION CAPACITY, WE MAY NOT
BE ABLE TO DELIVER WHOLESALE ELECTRIC POWER TO OUR CUSTOMERS AND WE MAY INCUR
ADDITIONAL COSTS.
We depend on transmission and distribution facilities owned and operated by
our affiliate, CenterPoint Houston, and on transmission and distribution systems
owned by others to deliver the wholesale electric power we sell from our power
generation facilities to our customers, who in turn deliver power to the end
users. If transmission is disrupted, or if transmission capacity infrastructure
is inadequate, our ability to sell and deliver wholesale electric energy may be
adversely impacted.
The single control area of the ERCOT market is currently organized into
four congestion zones, referred to as the North, South, West and Houston zones.
These congestion zones are determined by physical constraints on the ERCOT
transmission system that make it difficult or impossible at times to move power
from a zone on one side of the constraint to the zone on the other side of the
constraint. All but two of our facilities are located in the Houston congestion
zone. Our Limestone facility is located in the North congestion zone and the
South Texas Project is located in the South congestion zone. We sell a portion
of the entitlements offered in our state mandated auctions to customers located
in congestion zones other than the Houston zone. Transmission congestion between
these zones could impair our ability to schedule power for transmission across
zonal boundaries, which are defined by the ERCOT ISO, thereby inhibiting our
efforts to match our facility scheduled outputs with our customer scheduled
requirements.
The ERCOT ISO has instituted rules that directly assign congestion costs to
the parties causing the congestion. Therefore, power generators participating in
the ERCOT market could be liable for the congestion costs associated with
transferring power between zones. We schedule our anticipated requirements based
on our own forecasted needs, which rely in part on demand forecasts made by our
customers. These forecasts may prove to be inaccurate. We could be deemed
responsible for congestion costs if we schedule delivery of power between
congestion zones during times when the ERCOT ISO expects congestion to occur
between the zones. If we are liable for congestion costs, our financial results
could be adversely affected. For more information about the ERCOT market, please
read "Our Business -- ERCOT Market Framework" above.
OUR RESULTS OF OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS COULD BE
ADVERSELY IMPACTED BY A DISRUPTION OF OUR FUEL SUPPLIES.
We rely primarily on natural gas, coal, lignite and uranium to fuel our
generation facilities. We purchase our fuel from a number of different suppliers
under long-term contracts and on the spot market. Under our capacity auctions,
we sell firm entitlements to capacity and ancillary services. Therefore, any
disruption in the delivery of fuel could prevent us from operating our
facilities to meet our auction commitments, which could adversely affect our
results of operations, financial condition and cash flows.
Delivery of natural gas to each of our natural gas-fired facilities
typically depends on the natural gas pipelines or distributors for that
location. As a result, we are subject to the risk that a natural gas pipeline or
distributor may suffer disruptions or curtailments in our ability to deliver
natural gas to it or that the amounts of natural gas we request are curtailed.
These disruptions or curtailments could adversely affect our ability to operate
our natural gas-fired generating facilities. We lease gas storage facilities
capable of storing approximately 6.3 billion cubic feet of natural gas, of which
4.2 billion cubic feet is working capacity.
We purchase coal from a limited number of suppliers. Generally, we seek to
maintain average coal reserves sufficient to operate our coal-fired facilities
for 30 days. We also have long-term rail transportation contracts with two rail
transportation companies to transport coal to our coal-fired facilities. Any
extended disruption in our coal supply, including those caused by transportation
disruptions, adverse weather conditions, labor relations or environmental
regulations affecting our coal suppliers, could adversely affect our ability to
operate our coal-fired facilities. We are also exposed to the risk that
suppliers that have agreed to provide us with fuel could breach their
obligations. Should these suppliers fail to perform, we may be forced to enter
into alternative arrangements at then-current market prices. As a result, our
results of operations, financial condition and cash flows could be adversely
affected.
23
TO DATE, WE HAVE SOLD A SUBSTANTIAL PORTION OF OUR AUCTIONED CAPACITY
ENTITLEMENTS TO SUBSIDIARIES OF RELIANT RESOURCES. ACCORDINGLY, OUR RESULTS OF
OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS COULD BE ADVERSELY AFFECTED IF
RELIANT RESOURCES DECLINED TO PARTICIPATE IN OUR FUTURE AUCTIONS OR FAILED TO
MAKE PAYMENTS WHEN DUE UNDER RELIANT RESOURCES' PURCHASED ENTITLEMENTS.
By participating in our contractually mandated auctions, subsidiaries of
Reliant Resources purchased entitlements to 63% of the aggregate 2002 capacity
and 58% of the aggregate 2003 capacity that we sold to date through our capacity
auctions. Reliant Resources has made these purchases either through the exercise
of its contractual rights to purchase 50% of the entitlements we auction in our
contractually mandated auctions or through the submission of bids. In the event
Reliant Resources declined to participate in our future auctions or failed to
make payments when due, our results of operations, financial condition and cash
flows could be adversely affected. In this regard, Reliant Resources has
reported that it is facing large maturities of debt over the next year, and its
securities ratings are now below investment grade.
WE MAY INCUR SUBSTANTIAL COSTS AND LIABILITIES AS A RESULT OF OUR OWNERSHIP OF
NUCLEAR FACILITIES.
We own a 30.8% interest in the South Texas Project, a nuclear powered
generation facility. As a result, we are subject to the risks associated with
the ownership and operation of nuclear facilities. These risks include:
- the potential harmful effects on the environment and human health
resulting from the operation of nuclear facilities and the storage,
handling and disposal of radioactive materials;
- limitations on the amounts and types of insurance commercially available
to cover losses that might arise in connection with nuclear operations;
and
- uncertainties with respect to the technological and financial aspects of
decommissioning nuclear plants at the end of their licensed lives;
The NRC has broad authority under federal law to impose licensing and
safety-related requirements for the operation of nuclear generation facilities.
In the event of non-compliance, the NRC has the authority to impose fines, shut
down a unit, or both, depending upon our assessment of the severity of the
situation, until compliance is achieved. Any revised safety requirements
promulgated by the NRC could necessitate substantial capital expenditures at
nuclear plants. In addition, although we have no reason to anticipate a serious
nuclear incident at the South Texas Project, if an incident did occur, it could
have a material adverse effect on our results of operations, financial condition
and cash flows.
OTHER RISKS
OUR HISTORICAL FINANCIAL RESULTS COVERING PERIODS PRIOR TO 2002 REPRESENT OUR
RESULTS AS PART OF AN INTEGRATED UTILITY OPERATING IN A REGULATED MARKET AND
ARE NOT REPRESENTATIVE OF OUR RESULTS AS A SEPARATE COMPANY OPERATING IN THE
RECENTLY DEREGULATED ERCOT MARKET. CONSEQUENTLY, OUR FUTURE FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ARE LIKELY TO VARY MATERIALLY FROM THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS PRESENTED IN THE HISTORICAL
FINANCIAL INFORMATION INCLUDED HEREIN.
We have limited experience operating as a stand-alone wholesale electric
power generation company in a deregulated market. Our generation facilities were
formerly owned by Reliant Energy, which conveyed these facilities to us in
accordance with a business separation plan adopted in response to the Texas
electric restructuring law.
The historical financial information covering periods prior to 2002 does
not reflect what our financial position, results of operations and cash flows
would have been had our generation facilities been operated under the current
deregulated ERCOT market. Although our generation facilities had a significant
operating history at the time they were conveyed to us, the historical financial
information relating to the operation of these facilities during periods prior
to 2002 reflects the sale of the power generated by the facilities as part of an
integrated utility at regulated rates. We currently sell the power generated by
these facilities at market-based prices in capacity auctions, and our revenues
currently depend, in large part, upon prevailing market
24
prices for electricity in the ERCOT market and the related results of the
auctions. To date, our capacity auctions have been consummated at market-based
prices that have resulted in returns substantially below the historical
regulated return on our facilities.
The historical financial information we have included herein also does not
reflect what our financial position, results of operations and cash flows would
have been had we been a separate entity during the periods presented. Our
historical costs and expenses included in our financial statements reflect
charges from Reliant Energy for centralized corporate services and operating
infrastructure costs as well as allocated costs of capital. These allocations
have been determined based on what we and Reliant Energy considered to be
reasonable reflections of the utilization of services provided to us or for the
benefits received by us. We may experience significant changes in our cost
structure, capitalization and operations as a result of our separation from
Reliant Energy, including increased costs associated with reduced economies of
scale and with being a publicly traded company.
WE MAY NOT HAVE ACCESS TO SUFFICIENT CAPITAL IN THE AMOUNTS AND AT THE TIMES
NEEDED TO FINANCE OUR BUSINESS.
To date, our capital has been provided by internally generated cash flows
and borrowings from a "money pool" through which we and certain of our
affiliates can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. The money pool's net funding requirements are generally met with
short-term borrowings of CenterPoint Energy. In the event CenterPoint Energy
were to experience liquidity problems or otherwise failed to perform, we may be
unable to obtain third party financing. At December 31, 2002, we had borrowings
of $86.2 million from the money pool. We can give no assurances that our current
and future capital structure, operating performance, financial condition and
cash flows will permit us to access the capital markets or to obtain other
financing as needed to meet our working capital requirements and projected
future capital expenditures on favorable terms. The amount of any debt issuance
by us is expected to be affected by the market's perception of our
creditworthiness, market conditions and factors affecting our industry. Our
projected future capital expenditures are substantial. Our ability to secure
third party credit lines or other debt financing may be adversely impacted by
the factors described in this section, including the nature of our business,
which may lead to volatility in our financial results and cash flows.
CenterPoint Energy has agreed to lend funds to us from time to time upon our
request until the earlier of the closing date on which Reliant Resources
acquires Texas Genco common stock from CenterPoint Energy pursuant to the
Reliant Resources option or upon the expiration of the Reliant Resources option.
Please read "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources -- Future Sources and
Uses of Cash -- Capital Requirements."
In addition, our ability to raise capital is restricted under our
agreements with CenterPoint Energy. These restrictions limit our ability to:
- issue additional equity securities;
- encumber our assets; or
- incur indebtedness, except to satisfy requirements for operating and
maintenance expenditures and other capital expenditures contemplated
under our agreements with CenterPoint Energy, to meet our working capital
needs, or to refinance indebtedness incurred for the foregoing purposes.
In connection with CenterPoint Energy's registration as a public utility
holding company under the 1935 Act, the SEC has limited the aggregate amount of
our external borrowings to $500 million. The SEC's financing order issued to
CenterPoint Energy under the 1935 Act also restricts our ability to pay
dividends out of capital accounts. Under these restrictions, we are permitted to
pay dividends out of our current or retained earnings, and we may also pay
dividends in an amount of up to $100 million in excess of our current or
retained earnings. This financing order expires on June 30, 2003. If CenterPiont
Energy is unable to obtain an extension of the financing order, we would
generally be unable to engage in any financing transactions, including the
refinancing of existing obligations after June 30, 2003.
25
We are an 81% owned subsidiary of CenterPoint Energy. As a result of this
relationship, the financial condition of CenterPoint Energy could affect our
access to capital, our credit standing and our financial condition.
OUR OPERATIONS ARE SUBJECT TO EXTENSIVE REGULATION. IF WE FAIL TO COMPLY WITH
APPLICABLE REGULATIONS OR OBTAIN OR MAINTAIN ANY NECESSARY GOVERNMENTAL PERMIT
OR APPROVAL, WE MAY BE SUBJECT TO CIVIL, ADMINISTRATIVE AND/OR CRIMINAL
PENALTIES WHICH COULD ADVERSELY IMPACT OUR RESULTS OF OPERATIONS, FINANCIAL
CONDITION AND CASH FLOWS.
Our operations are subject to complex and stringent energy, environmental
and other governmental laws and regulations. The acquisition, ownership and
operation of power generation facilities require numerous permits, approvals and
certificates from federal, state and local governmental agencies. These
facilities are subject to regulation by the Texas Utility Commission regarding
non-rate matters. Existing regulations may be revised or reinterpreted, new laws
and regulations may be adopted or become applicable to us or any of our
generation facilities or future changes in laws and regulations may have a
detrimental effect on our business.
Operation of the South Texas Project is subject to regulation by the NRC.
This regulation involves testing, evaluation and modification of all aspects of
plant operation in light of NRC safety and environmental requirements.
Continuous demonstrations to the NRC that plant operations meet applicable
requirements are also required. The NRC has the ultimate authority to determine
whether any nuclear powered generating unit may operate.
Water for certain of our facilities is obtained from public water
authorities. New or revised interpretations of existing agreements by those
authorities or changes in price or availability of water may have a detrimental
effect on our business.
If we fail to comply with regulatory requirements that apply to our
operations, regulatory agencies could seek to impose civil, administrative
and/or criminal liabilities or could take other actions seeking to curtail our
operations. These liabilities or actions could adversely impact our results of
operations, financial condition and cash flows.
OUR COSTS OF COMPLIANCE WITH ENVIRONMENTAL LAWS ARE SIGNIFICANT AND THE COST
OF COMPLIANCE WITH NEW ENVIRONMENTAL LAWS AND OUR EXPOSURE TO POTENTIAL
LIABILITIES ASSOCIATED WITH THE ENVIRONMENTAL CONDITION OF OUR FACILITIES
COULD ADVERSELY AFFECT OUR PROFITABILITY.
Our business is subject to extensive environmental regulation by federal,
state and local authorities. We are required to comply with numerous
environmental laws and regulations, and to obtain numerous governmental permits,
in operating our facilities. We may incur significant additional costs to comply
with these requirements. If we fail to comply with these requirements, we could
be subject to civil or criminal liability and fines. Existing environmental
regulations could be revised or reinterpreted, new laws and regulations could be
adopted or become applicable to us or our facilities, and future changes in
environmental laws and regulations could occur, including potential regulatory
and enforcement developments related to air emissions. If any of these events
occurs, our business, results of operations, financial condition and cash flows
could be adversely affected.
We may not be able to obtain or maintain from time to time all required
environmental regulatory approvals. If there is a delay in obtaining any
required environmental regulatory approvals or if we fail to obtain and comply
with them, we may not be able to operate our facilities or we may be required to
incur additional costs.
We are generally responsible for all on-site liabilities associated with
the environmental condition of our power generation facilities, regardless of
when the liabilities arose and whether the liabilities are known or unknown.
These liabilities may be substantial.
26
CHANGES IN TECHNOLOGY MAY MAKE OUR POWER GENERATION FACILITIES LESS
COMPETITIVE, WHICH COULD ADVERSELY IMPACT THEIR VALUE AND THE RESULTS OF OUR
OPERATIONS.
A significant portion of our generation facilities were constructed many
years ago and rely on older technologies. Some of our competitors may have newer
generation facilities and technologies that allow them to produce and sell power
more efficiently, which could adversely affect our results of operations,
financial condition and cash flows. In addition, research and development
activities are ongoing to improve alternate technologies to produce electricity,
including fuel cells, microturbines, windmills and photovoltaic (solar) cells.
It is possible that advances in these or other technologies will reduce the
current costs of electricity production to a level that is below that of our
generation facilities. If this occurs, our generation facilities will be less
competitive and the value of our power plants could be significantly impaired.
Also, electricity demand could be reduced by increased conservation efforts and
advances in technology that could likewise significantly reduce the value of our
power generation facilities.
OUR INSURANCE COVERAGE MAY NOT BE SUFFICIENT. INSUFFICIENT INSURANCE COVERAGE
AND INCREASED INSURANCE COSTS COULD ADVERSELY IMPACT OUR RESULTS OF
OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS.
We have insurance covering certain of our facilities, including property
damage insurance, commercial general public liability insurance, boiler and
machinery coverage and available replacement capacity in amounts that we
consider appropriate. However, our insurance policies are subject to certain
limits and deductibles and do not include business interruption coverage. We
cannot assure you that insurance coverage will be available in the future on
commercially reasonable terms or that the insurance proceeds received for any
loss of or any damage to any of our generation facilities will be sufficient to
restore the loss or damage without negative impact on our results of operations,
financial condition and cash flows. The costs of our insurance coverage have
increased significantly during the past year and may continue to increase in the
future.
We and the other owners of the South Texas Project maintain nuclear
property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
Under the federal Price Anderson Act, the maximum liability to the public of
owners of nuclear power plants was $9.3 billion as of December 31, 2002. Owners
are required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. We and the other owners of the South Texas
Project currently maintain the required nuclear liability insurance and
participate in the industry retrospective rating plan. In addition, the security
procedures at this facility have recently been enhanced to provide additional
protection against terrorist attacks. All potential losses or liabilities
associated with the South Texas Project may not be insurable, and the amount of
insurance may not be sufficient to cover them.
RISKS RELATED TO OUR RELATIONSHIPS WITH CENTERPOINT ENERGY AND RELIANT RESOURCES
WE WILL BE CONTROLLED BY CENTERPOINT ENERGY AS LONG AS IT OWNS A MAJORITY
OF OUR COMMON STOCK, AND OUR MINORITY SHAREHOLDERS WILL BE UNABLE TO AFFECT THE
OUTCOME OF SHAREHOLDER VOTING DURING THAT TIME. IF RELIANT RESOURCES EXERCISES
ITS OPTION TO ACQUIRE OUR STOCK OWNED BY CENTERPOINT ENERGY THAT IS EXERCISABLE
IN JANUARY 2004, WE WILL LIKEWISE BE CONTROLLED BY RELIANT RESOURCES AND OUR
MINORITY SHAREHOLDERS WILL BE UNABLE TO AFFECT THE OUTCOME OF A SHAREHOLDER
VOTE.
As a result of the January 6, 2003 distribution, CenterPoint Energy
indirectly owns approximately 81% of our outstanding common stock. As long as
CenterPoint Energy owns a majority of our outstanding common stock, it will
continue to be able to elect our entire board of directors, and our public
shareholders, by themselves, will not be able to affect the outcome of any
shareholder vote. Similarly, our public shareholders, by themselves, will not be
able to affect the outcome of any shareholder vote if Reliant Resources
exercises its option to acquire our common stock owned by CenterPoint Energy
that is exercisable in January 2004, as Reliant Resources would own
approximately 81% of our common stock in that event. For convenience, we
27
sometimes refer to CenterPoint Energy or Reliant Resources, as applicable, as
our "majority shareholder" when referring to either of them as the owner of 81%
or more of our common stock. In addition, CenterPoint Energy has stated that if
Reliant Resources does not exercise its option, CenterPoint Energy will consider
strategic alternatives for its interest in Texas Genco, including a possible
sale, which could result in a third party becoming the majority shareholder of
Texas Genco. Reliant Resources may choose not to exercise its option for a
number of reasons, including unfavorable market conditions or a lack of access
to capital.
Our majority shareholder, subject to any fiduciary duty owed to our
minority shareholders under Texas law and restrictions under a master separation
agreement between CenterPoint Energy and Reliant Resources, will be able to
control all matters affecting us.
In addition, our majority shareholder may enter into credit agreements,
indentures or other contracts that limit the activities of its subsidiaries.
While we would not likely be contractually bound by these limitations, our
majority shareholder would likely cause its representatives on our board to
direct our business so as not to breach any of these agreements.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH CENTERPOINT ENERGY
WITH RESPECT TO OUR PAST AND ONGOING RELATIONSHIPS, AND BECAUSE OF CENTERPOINT
ENERGY'S CONTROLLING OWNERSHIP INTEREST, WE MAY NOT BE ABLE TO RESOLVE THESE
CONFLICTS ON TERMS POSSIBLE IN ARM'S LENGTH TRANSACTIONS.
Conflicts of interest may arise between CenterPoint Energy and us in a
number of areas relating to our past and ongoing relationships, including
proceedings, actions and decisions of legislative bodies and administrative
agencies, and our dividend policy. The agreements we have entered into with
CenterPoint Energy may be amended in the future upon agreement of the parties.
While we are controlled by CenterPoint Energy, CenterPoint Energy may be able to
require us to amend these agreements. We may not be able to resolve any
potential conflicts with CenterPoint Energy, and even if we do, the resolution
may be less favorable than if we were dealing with an unaffiliated party.
CONTRACTUAL RESTRICTIONS ON THE OPERATION OF OUR BUSINESS MAY ADVERSELY AFFECT
OUR ABILITY TO COMPETE WITH COMPANIES THAT ARE NOT SUBJECT TO SIMILAR
RESTRICTIONS.
Effective December 31, 2000, Reliant Resources and Reliant Energy entered
into a master separation agreement that now governs the rights and obligations
of CenterPoint Energy and Reliant Resources in connection with the business
separation plan of Reliant Energy adopted in response to the Texas electric
restructuring law. Reliant Resources also has an option to purchase the shares
of our stock owned by us that is exercisable in January 2004. We have agreed to
comply with certain restrictions governing our operations as contemplated by the
master separation agreement and option agreement. These restrictions limit our
ability to:
- merge or consolidate with another entity;
- sell assets;
- enter into long-term agreements and commitments for the purchase of fuel
or the purchase or sale of power outside the ordinary course of business;
- engage in other businesses;
- construct or acquire new generation plants or capacity;
- engage in certain hedging transactions;
- encumber our assets;
- issue additional equity securities;
- pay special dividends; and
- make certain loans, investments or advances to, or engage in certain
transactions with, our affiliates.
28
IF RELIANT RESOURCES EXERCISES ITS OPTION TO ACQUIRE OUR STOCK OWNED BY
CENTERPOINT ENERGY IN 2004, THE TAX BASIS OF OUR ASSETS WILL BE ADJUSTED UPWARDS
OR DOWNWARDS TO REFLECT THE FAIR MARKET VALUE OF OUR BUSINESS AT THE TIME OF THE
PURCHASE.
We would be required to step up or step down the tax basis in all of our
assets following the date of the sale to be equivalent generally to the value of
the equity of our business, based upon the purchase price, plus the principal
amount of indebtedness at the time of the purchase. The resulting step-up or
step-down in the basis of our assets would impact our future tax liabilities. A
step-up would reduce our future tax liabilities, while a step-down would
increase our liabilities. We cannot currently project the impact of this tax
election because it is dependent on Reliant Resources' exercise of its option in
2004, and the purchase price to be paid by Reliant Resources in 2004, which is
not known at this time.
ITEM 2. PROPERTIES.
Our central support facility includes office space, a maintenance shop, a
chemical lab, a warehouse facility and a fleet maintenance garage. This facility
includes a total of approximately 521,000 square feet of space, of which
approximately 407,000 square feet is occupied by us and approximately 114,000
square feet is leased to Reliant Resources. We also lease approximately 7,100
square feet at CenterPoint Energy's principal office building.
In addition, we lease or own various real property and facilities relating
to our generation assets and other vacant real property unrelated to our
generation assets. We have described our principal generation and support
facilities under "Our Generation Portfolio" in Item 1 of this report, which
description is incorporated herein by reference. We believe we have satisfactory
title to our facilities in accordance with standards generally accepted in the
electric power industry, subject to exceptions that, in our opinion, would not
have a material adverse effect on the use or value of the facilities.
ITEM 3. LEGAL PROCEEDINGS.
We are, from time to time, a party to litigation arising in the normal
course of our business, most of which involves contract disputes or claims for
personal injury and property damage incurred in connection with our operations.
We are not currently involved in any litigation that we expect will have a
material adverse effect on our financial condition, results of operations and
cash flows. For a description of a number of lawsuits involving claims of
asbestos exposure at properties owned by us, please read "Environmental
Matters -- Asbestos" in Item 1 of this report, which description is incorporated
herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
In December 2002, CenterPoint Energy, as holder of all of the then
outstanding shares of common stock of Texas Genco, approved by written consent
(i) the amendment of Texas Genco's articles of incorporation to effect an
80,000-for-one stock split, and (ii) the subsequent amendment and restatement of
Texas Genco's articles of incorporation.
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
As of February 25, 2003, our common stock was held by approximately 55,169
shareholders of record. Our common stock is listed on the New York Stock
Exchange and is traded under the symbol "TGN."
On January 6, 2003, CenterPoint Energy distributed approximately 19% of the
80,000,000 outstanding shares of Texas Genco common stock to CenterPoint
Energy's shareholders of record as of the close of business on December 20,
2002, the record date for the distribution. Our common stock began trading
regular-way on the New York Stock Exchange on January 7, 2003. Accordingly, no
high and low sales price information is available for any full quarterly period
within the two most recent fiscal years.
29
We intend to pay regular quarterly cash dividends on our common stock. Our
board of directors will determine the amount of future dividends in light of:
- any applicable contractual restrictions governing our ability to pay
dividends, including our agreements with CenterPoint Energy to ensure its
compliance with the terms of the Reliant Resources option agreement;
- applicable legal requirements;
- our earnings and cash flows;
- our financial condition; and
- other factors our board of directors deems relevant.
On February 7, 2003, our board of directors declared an initial quarterly
cash dividend of $0.25 per share of common stock payable on March 20, 2003 to
shareholders of record as of the close of business on February 26, 2003.
In February 2003, CenterPoint Energy and Reliant Resources amended the
agreement governing the Reliant Resources option. Under the terms of the amended
agreement, Texas Genco is required to establish a dividend policy under which it
will distribute to its shareholders a dividend based on Texas Genco's earnings
and cashflows, subject to any limitations under corporate law or applicable
regulatory restrictions, its financial condition and other factors deemed
relevant by Texas Genco's board of directors. The dividend policy is required to
be set annually for each calendar year, with the initial annual dividend for
2003 expected to be $1.00. The established annual dividend amount may be revised
during any calendar year in the event Texas Genco's board of directors
reasonably concludes that circumstances would warrant a change or that an
adjustment is required to the dividend to satisfy its obligations to Texas
Genco. However, the annual dividend amount may only be increased by up to 10%
once during any calendar year. The annual dividend amount is required to be paid
through regular quarterly cash dividends. Under the amended option agreement,
Reliant Resources has agreed that this dividend policy will be maintained so
long as it owns less than 100% of Texas Genco's outstanding common stock. The
agreement also prohibits Texas Genco from paying any dividends in cash, stock or
property, other than pursuant to the dividend policy described above or
dividends payable solely in Texas Genco common stock.
In connection with CenterPoint Energy's registration as a public utility
holding company under the 1935 Act, the SEC has limited our ability to pay
dividends out of capital accounts. Under these restrictions, we are permitted to
pay dividends out of our current or retained earnings, and we may also pay
dividends in an amount of up to $100 million in excess of our current or
retained earnings.
CenterPoint Energy currently owns approximately 81% of Texas Genco's
outstanding common stock. In February 2003, CenterPoint Energy reached an
agreement with a syndicate of banks on a second amendment to its $3.85 billion
bank facility. Under the terms of the amendment, CenterPoint Energy agreed with
the banks to grant a security interest in its 81% stock ownership of Texas Genco
to secure its borrowings under the bank facility, which would require SEC
approval under the 1935 Act. CenterPoint Energy is seeking approval from the SEC
to grant the security interest.
30
ITEM 6. SELECTED FINANCIAL DATA.
The following tables present our selected financial data. The data set
forth below should be read together with "Management's Discussion and Analysis
of Financial Condition and Results of Operations," and our historical financial
statements and the notes to those statements included in this report. Our
selected financial data for each of the four years in the period ended December
31, 2002 are derived from our audited financial statements. Our selected
financial data for the year ended December 31, 1998 has been derived from our
unaudited financial statements. Our financial statements for periods prior to
January 1, 2002 are presented on a carve-out basis and represent the historical
financial position, results of operations and net cash flows of the historically
regulated generation-related business of Reliant Energy. Therefore, the
historical information included in our financial statements is not indicative of
our future performance and does not reflect what our financial position and
results of operations would have been had we operated as a separate, stand-alone
wholesale electric power generation company in a deregulated market during the
periods presented. Prior to January 1, 2002, our historical financial
information reflects the sale of power generated by our facilities as part of an
integrated utility at regulated rates. Since January 1, 2002, we have sold power
at market-based prices in capacity auctions. In addition, our historical costs
and expenses reflect charges from CenterPoint Energy for centralized corporate
services and operating infrastructure costs as well as allocated costs of
capital. We may experience significant changes in our cost structure,
capitalization and operations as a result of our separation from CenterPoint
Energy, including increased costs associated with reduced economies of scale,
obtaining third-party financing and being a publicly traded company.
YEAR ENDED DECEMBER 31,
-------------------------------------------
1998(1) 1999 2000 2001 2002
------- ------ ------ ------ ------
(IN MILLIONS)
INCOME STATEMENT DATA:
Revenues.......................................... $2,908 $2,816 $3,334 $3,411 $1,541
------ ------ ------ ------ ------
Expenses:
Fuel costs...................................... 1,065 1,170 1,644 1,304 989
Purchased power................................. 390 395 753 1,223 94
Operation and maintenance....................... 383 384 393 402 391
Depreciation and amortization................... 582 393 151 154 157
Taxes other than income taxes................... 88 79 63 63 43
------ ------ ------ ------ ------
Total...................................... 2,508 2,421 3,004 3,146 1,674
------ ------ ------ ------ ------
Operating Income (Loss)........................... 400 395 330 265 (133)
Other Income...................................... 3 14 1 2 3
Interest Expense, net............................. 103 71 59 65 26
------ ------ ------ ------ ------
Income (Loss) Before Income Taxes and
Extraordinary Item.............................. 300 338 272 202 (156)
Income Tax Expense (Benefit)...................... 101 113 100 74 (63)
------ ------ ------ ------ ------
Income (Loss) Before Extraordinary Item........... 199 225 172 128 (93)
Extraordinary Item, net of tax(2)................. -- (518) -- -- --
------ ------ ------ ------ ------
Net Income (Loss)................................. $ 199 $ (293) $ 172 $ 128 $ (93)
====== ====== ====== ====== ======
Earnings (Loss) Per Share(3)...................... $ 2.49 $(3.66) $ 2.15 $ 1.60 $(1.16)
====== ====== ====== ====== ======
---------------
(1) Interest expense for 1998 has been adjusted from the amounts previously
reported based on a revised allocation for interest costs.
(2) Represents a loss related to an accounting impairment of certain generating
facilities.
(3) The earnings per share figures are computed by dividing the net income
(loss) for each period by 80,000,000, the number of shares of Texas Genco
common stock outstanding after the 80,000-for-one stock split declared by
Texas Genco's Board of Directors, as effected on December 18, 2002.
31
YEAR ENDED DECEMBER 31,
------------------------
2000 2001 2002
------ ------ ------
(IN MILLIONS)
STATEMENT OF CASH FLOW DATA:
Cash provided by (used in):
Operating Activities................................... $ 433 $ 236 $(152)
Investing Activities................................... (252) (409) (245)
Financing Activities................................... (181) 173 398
DECEMBER 31,
------------------------------------------
1998 1999 2000 2001 2002
------ ------ ------ ------ ------
(IN MILLIONS)
BALANCE SHEET DATA:
Property, Plant and Equipment, net................ $4,717 $3,583 $3,667 $3,905 $3,981
Total Assets...................................... 5,003 3,914 4,032 4,323 4,389
Capitalization(1)................................. 3,102 2,331 2,323 2,624 --
Shareholder's Equity(1)........................... -- -- -- -- 2,824
---------------
(1) Upon the restructuring of Reliant Energy pursuant to its business separation
plan, effective August 31, 2002, our equity structure was changed to reflect
the contribution of CenterPoint Energy's electric generating facilities to
us.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in combination with
our consolidated financial statements and notes contained in Item 8 herein.
OVERVIEW
We are one of the largest wholesale electric power generating companies in
the United States. As of December 31, 2002, the aggregate net generating
capacity of our portfolio of assets was 14,175 MW. We sell electric generation
capacity, energy and ancillary services in the Electric Reliability Council of
Texas (ERCOT) market, which is the largest power market in the State of Texas.
The ERCOT market consists of the majority of the population centers in the State
of Texas and facilitates reliable grid operations for approximately 85% of the
demand for power in the state.
OUR SEPARATION FROM CENTERPOINT ENERGY
Legislation enacted by the Texas legislature in 1999 (Texas electric
restructuring law) requires the restructuring of electric utilities in Texas in
order to separate their power generation, transmission and distribution, and
retail electric provider businesses into separate units. In March 2001, the
Public Utility Commission of Texas (Texas Utility Commission) approved a
business separation plan for Reliant Energy involving the separation of Reliant
Energy's generation, transmission and distribution, and retail businesses into
three separate companies. Effective August 31, 2002, Reliant Energy consummated
a restructuring transaction (Reliant Restructuring) in accordance with its
business separation plan in which it, among other things:
- conveyed all of its electric generating facilities to us;
- became a subsidiary of CenterPoint Energy; and
- converted into a limited liability company named CenterPoint Energy
Houston Electric, LLC (CenterPoint Houston).
Although our portfolio of generating facilities was formerly owned by the
unincorporated electric utility division of Reliant Energy, for convenience, we
describe our business as if we had owned and operated our generation facilities
prior to the date they were conveyed to us. The book value of the net assets
conveyed to us by Reliant Energy on August 31, 2002 was approximately $2.8
billion.
32
On January 6, 2003, CenterPoint Energy distributed approximately 19% of the
80 million outstanding shares of Texas Genco's common stock to CenterPoint
Energy's shareholders (distribution). As used herein, CenterPoint Energy also
refers to the former Reliant Energy for dates prior to the Reliant
Restructuring.
The following discussion and analysis of our results of operations have
been derived from our audited historical financial statements and the notes to
those financial statements included herein, which we refer to collectively as
"our financial statements." Our financial statements were developed using a
number of assumptions to separate our operations from those of Reliant Energy,
which until January 1, 2002, operated our generation assets together with its
transmission and distribution facilities and retail operations as a vertically
integrated utility company. Please read Note 1 to our financial statements for a
discussion of these assumptions and the methodologies used to prepare our
financial statements. The historical financial information for 2000 and 2001
included in our financial statements may not be indicative of our future
performance and does not reflect what our financial position and results of
operations would have been had we operated as a separate, stand-alone wholesale
electric power generation company in a deregulated market during the periods
presented.
Prior to January 1, 2002, our revenues were calculated by unbundling the
generation component of revenue from CenterPoint Energy's historical bundled
rate for the generation and transmission, distribution and sale of energy and
adding any additional generation-related revenues of CenterPoint Energy, such as
wholesale activities that include ancillary services, trading and capacity
sales.
Our energy costs consist primarily of our fuel costs associated with
consuming nuclear fuel, gas, oil, lignite and coal to generate energy, as well
as our power purchases from the wholesale marketplace. The recent deregulation
of the ERCOT market has impacted our energy costs in several ways. As a result
of requirements under the Texas electric restructuring law and the terms of our
agreements with CenterPoint Energy, we are obligated to sell substantially all
of our available capacity and related ancillary services through 2003. In these
auctions, we sell on a forward basis firm entitlements to capacity and ancillary
services dispatched within specified operational constraints. Although we have
reserved a portion of our aggregate net generation capacity from our capacity
auctions for planned or forced outages at our facilities, unanticipated plant
outages or other problems with our generation facilities could result in our
firm capacity and ancillary services commitments exceeding our available
generation capacity. As a result, we could be required to obtain replacement
power from third parties in the open market to satisfy our firm commitments
which could involve the incurrence of significant additional costs. In addition,
an unexpected outage at one of our lower cost facilities could require us to run
one of our higher cost plants in order to satisfy our obligations. High
wholesale power prices for replacement power in the ERCOT market could increase
our energy costs and affect earnings and net cash flow.
In 2002, our capacity auctions were consummated at market-based prices that
have resulted in returns substantially below the historical regulated return on
our facilities that we have experienced in the past. However, we have begun to
see improvement in auction prices for our 2003 capacity entitlements. Since the
pricing of our generation products is sensitive to gas prices, higher gas prices
in the latter part of 2002 have positively influenced the prices in our recent
capacity auctions. Because we have a significant amount of low-cost base-load
solid fuel and nuclear generating units, higher gas prices generally increase
the profitability of our base-load capacity entitlements since prospective
purchasers face higher-cost gas-fired generation alternatives. With the higher
market prices and our efforts to reduce our operating costs, we expect to show
an improvement in profitability for 2003. However, we do not expect this
improvement will recover to the levels of our historical regulated returns in
the near future due in part to the current surplus of generating capacity in the
ERCOT market and changes to the economic conditions affecting our industry that
have occurred since our base-load facilities were originally constructed,
including the development of high efficiency gas-fired generating units.
With an increasingly competitive wholesale energy market, the composition
and level of our operation and maintenance expense is likely to change. To
develop our historical financial statements prior to 2002, we have separated the
operation and maintenance expense of the generation-related portion of
CenterPoint Energy's business from CenterPoint Energy's historical financial
statements. These expenses were either
33
specifically identified by function and reported accordingly or various
allocations were used to disaggregate common expenses.
RESULTS OF OPERATIONS
NET INCOME (LOSS)
The following table indicates our net income (loss) for the periods shown
(in millions):
YEAR ENDED DECEMBER 31,
------------------------
2000 2001 2002
------ ------ ------
Net Income (Loss)........................................... $172 $128 $(93)
Our net income for the year ended December 31, 2002 decreased $221 million
from the comparable 2001 period. This decrease primarily resulted from the
implementation of deregulation of the wholesale power segment of the ERCOT
market under the Texas electric restructuring law in 2002 resulting in
substantially lower revenues partially offset by reduced operations and
maintenance, and other tax expense.
Our net income for the year ended December 31, 2001 decreased $44 million
from the comparable 2000 period. This decrease was a result of the reduction in
rate base on which the regulatory return was calculated.
REVENUES
Revenues decreased $1.9 billion or 55% for the year ended December 31, 2002
from the comparable 2001 period. The decrease was primarily due to the change
from a regulatory method used to allocate the integrated utility revenue of
CenterPoint Energy for the 2001 period to the revenue generated in 2002 in the
deregulated ERCOT market. Our 2001 revenue was derived based on actual
recoverable operating expenses plus an allowed regulatory rate of return based
on the rate base while our 2002 revenue was derived from open market sales of
capacity and energy products at auction and spot market prices.
Revenues increased $77 million or 2% for the year ended December 31, 2001
from the comparable 2000 period. The increase was primarily due to an increase
in recoverable fuel related revenues of $131 million related to increased fuel
costs discussed below, partially offset by the reduction in the rate base on
which the regulatory return was calculated due to additional depreciation
expense related to these assets of $36 million and a decrease in other
recoverable operating expenses of $18 million.
FUEL AND PURCHASED POWER EXPENSES
Fuel and purchased power expenses decreased $1.4 billion or 57% for the
year ended December 31, 2002 from the comparable 2001 period. The decrease is
due primarily to lower natural gas prices ($4.23 and $3.32 per MMBtu or $842
million and $468 million in 2001 and 2002, respectively) and a reduction in
purchased power ($44.42 and $24.50 per MWh or $1.2 billion and $94 million in
2001 and 2002, respectively) related to overall demand reductions for output
from our facilities.
Fuel and purchased power expenses increased $130 million or 5% for the year
ended December 31, 2001 from the comparable 2000 period. The increase was due
primarily to increased purchased power volumes related to load balancing
requirements associated with the ERCOT market adopting a single control area and
a slightly higher average cost for purchased power ($44.26 and $44.42 per MWh or
$727 million and $1.2 billion in 2000 and 2001, respectively). This was offset
by a decline in the volume of natural gas used at a slightly higher average
price ($3.98 and $4.23 per MMBtu or $1.2 billion and $842 million in 2000 and
2001, respectively).
OPERATION AND MAINTENANCE EXPENSE
Operation and maintenance expense decreased $11 million or 3% for the year
ended December 31, 2002 from the comparable 2001 period. The decrease was
primarily due to an absence of major maintenance
34
outages at our W. A. Parish and Limestone solid fuel plants, several gas plants
and the South Texas Project in 2002 ($36 million in 2001). The decrease was
partially offset by costs related to an early retirement program implemented in
2002 ($12 million), business separation expenses ($7 million) and computer
systems necessary for operation in the deregulated market ($6 million).
Operation and maintenance expense increased $9 million or 2% for the year
ended December 31, 2001 from the comparable 2000 period. The increase was
primarily due to major maintenance outages at our Limestone, Cedar Bayou, San
Jacinto and T. H. Wharton generation facilities resulting in costs of $16
million during 2001 without corresponding outages in 2000. The outage cycles are
a part of our normal maintenance practice to ensure the reliability of our
generating portfolio. There are years in which the cycles result in more outages
occurring simultaneously than in other years. The increase was partially offset
by lower labor costs of $7 million related to lower staffing levels.
DEPRECIATION AND AMORTIZATION EXPENSE
Depreciation and amortization expense increased $3 million or 2% for the
year ended December 31, 2002 from the comparable 2001 period. Depreciation and
amortization expense increased $3 million or 2% for the year ended December 31,
2001 from the comparable 2000 period. The increases were due to normal increases
in property, plant and equipment.
INTEREST EXPENSE
Interest expense decreased $39 million or 60% for the year ended December
31, 2002 from the comparable 2001 period. The decrease was due to the change
from the allocation method based on capital structure used to calculate interest
expense in 2001 to the allocation of interest in 2002 based on the remaining
electric utility debt not specifically identified with CenterPoint Energy's
transmission and distribution utility upon deregulation. In connection with the
Reliant Restructuring and the conveyance of all of CenterPoint Energy's electric
generating facilities to us in August 2002, we did not assume any of CenterPoint
Energy's long-term debt.
Interest expense increased $6 million or 11% for the year ended December
31, 2001 from the comparable 2000 period. The increase was due to the underlying
change in the capital structure on which interest was allocated.
INCOME TAX EXPENSE (BENEFIT)
The effective tax rates for 2002 and 2001 were 40.3% and 36.5%,
respectively. The increase in the effective rate for 2002 compared to 2001 was
primarily the result of a reduced benefit from the amortization of investment
tax credits, offset by a decrease in state income taxes. The Company's state tax
liability changed from an income-based tax for 2001, to a capital-based tax for
2002, primarily as a result of the 2002 pre-tax loss, which resulted in the
reporting of the state tax as a component of the pre-tax loss for 2002 compared
to reporting the state tax expense as a component of income tax expense for
2001.
The effective tax rates for 2001 and 2000 were 36.5% and 36.8%,
respectively.
RELATED PARTY TRANSACTIONS
OUR RELATIONSHIPS WITH CENTERPOINT ENERGY
Separation Agreement. In connection with the distribution, we entered into
a separation agreement with CenterPoint Energy. This agreement contains
provisions governing our relationship with CenterPoint Energy following the
distribution and specifies the related ancillary agreements between us and
CenterPoint Energy. In addition, the separation agreement provides for
cross-indemnities intended to place sole financial responsibility on us and our
subsidiaries for all liabilities associated with the current and historical
business and operations we conduct, regardless of the time those liabilities
arose, and to place sole financial responsibility for liabilities associated
with CenterPoint Energy's other businesses with CenterPoint Energy
35
and its other subsidiaries. The separation agreement also contains
indemnification provisions under which we and CenterPoint Energy each indemnify
the other with respect to breaches by the indemnifying party of the separation
agreement or any ancillary agreements.
Transition Services Agreement. We have entered into a transition services
agreement with CenterPoint Energy under which CenterPoint Energy will provide us
through the earlier of such time as all services under the agreement are
terminated or CenterPoint Energy ceases to own a majority of our common stock,
various corporate support services that include accounting, finance, investor
relations, planning, legal, communications, governmental and regulatory affairs
and human resources, as well as information technology services and other
previously shared services such as corporate security, facilities management,
accounts receivable, accounts payable and payroll, office support services and
purchasing and logistics. These services will consist generally of the same
types of services as have been provided on an intercompany basis prior to this
distribution. The charges we will pay for the services will be on a basis
generally intended to allow CenterPoint Energy to recover the fully allocated
direct and indirect costs of providing the services, plus all out-of-pocket
costs and expenses, but without any profit to CenterPoint Energy, except to the
extent routinely included in traditional utility cost of capital. Pursuant to a
separate lease agreement, CenterPoint Energy has agreed to lease office space in
its principal office building in Houston, Texas to us for an interim period
expected to end no later than December 31, 2004.
Tax Allocation Agreement. We are members of the CenterPoint Energy
consolidated group for tax purposes, and we will continue to file a consolidated
federal income tax return with CenterPoint Energy while CenterPoint Energy
retains its 81% interest in us. Accordingly, we have entered into a tax
allocation agreement with CenterPoint Energy to govern the allocation of U.S.
income tax liabilities and to set forth agreements with respect to certain other
tax matters. CenterPoint Energy will be responsible for preparing and filing any
U.S. income tax returns required to be filed for any company or group of
companies of the CenterPoint Energy consolidated group, including all tax
returns for Texas Genco for so long as we are members of the CenterPoint Energy
consolidated group. CenterPoint Energy will also be responsible for paying the
taxes related to the returns it is responsible for filing. We will be
responsible for paying CenterPoint Energy our allocable share of such taxes.
CenterPoint Energy will determine all tax elections for tax periods during which
we are a member of the CenterPoint Energy consolidated group. Generally, if
there are tax adjustments related to us which relate to a tax return filed for a
period when we were a member of the CenterPoint Energy consolidated group, we
will be responsible for any increased taxes and we will receive the benefit of
any tax refunds.
Employee Benefit Plans. Our eligible employees currently participate in
CenterPoint Energy's employee benefit plans and programs in accordance with the
terms and conditions of such plans and programs, as may be amended or terminated
by CenterPoint Energy at any time.
RELIANT RESOURCES OPTION
As part of Reliant Energy's business separation plan, Reliant Resources was
granted an option that may be exercised between January 10, 2004 and January 24,
2004 to purchase all of the approximately 81% of the outstanding shares of Texas
Genco common stock currently owned by CenterPoint Energy. The terms of the
option agreement were amended in February 2003. The per share exercise price
under the Reliant Resources option will equal the average daily closing price of
Texas Genco common stock on The New York Stock Exchange over the 30 consecutive
trading days out of the last 120 trading days ending January 9, 2004 which
result in the highest average closing price. In addition, a control premium, up
to a maximum of 10%, will be added to the price to the extent a control premium
is included in the valuation determination made by the Texas Utility Commission
relating to the market value of Texas Genco. If the option closing has not
occurred within sixteen months of the option exercise, rights under the option
agreement will terminate. Reliant Resources will be entitled to rescind its
exercise of the option by giving notice to CenterPoint Energy on or before the
45th day following the option exercise date if Reliant Resources has been unable
by that date to secure financing for its purchase of the shares of Texas Genco
common stock on terms reasonably acceptable to Reliant Resources. Upon the
giving of such notice of rescission, the option period will be deemed to have
expired without exercise of the option.
36
The exercise price formula is based upon the generation asset valuation
methodology in the Texas electric restructuring law that we will use to
calculate the market value of Texas Genco. The exercise price is also subject to
adjustment based on the difference between the per share dividends we pay to
CenterPoint Energy during the period from January 6, 2003 through the option
closing date and our actual per share earnings during that period. To the extent
our per share dividends are less than our actual per share earnings during that
period, the per share option price will be increased. To the extent our per
share dividends exceed our actual per share earnings, the per share option price
will be reduced.
Reliant Resources has agreed that if it exercises its option, Reliant
Resources will purchase from CenterPoint Energy all notes and other payables
owed by us to CenterPoint Energy as of the option closing date, at their
principal amount plus accrued interest. Similarly, if there are notes or
payables owed to us by CenterPoint Energy as of the option closing date, Reliant
Resources will assume those obligations in exchange for a payment from
CenterPoint Energy of an amount equal to the principal plus accrued interest.
In the event Reliant Resources exercises its option, we would be required
to step-up or step-down the tax basis in all of its assets following the date of
the sale to be equivalent generally to the value of the equity of Texas Genco,
based upon the purchase price, plus the principal amount of Texas Genco's
indebtedness at the time of the purchase.
In connection with the Reliant Resources option, we are obligated to
operate and maintain our assets and otherwise conduct our business in the
ordinary course in a manner consistent with past practice and to make
expenditures for operations, maintenance, repair and capital expenditures
necessary to keep our assets in good condition and in compliance with applicable
laws, in a manner consistent with good electric generation industry practice. We
are also required to maintain customary levels of insurance, comply with laws
and contractual obligations and pay taxes when due. We may not permanently
retire generation units, but may "mothball" units if economically warranted.
Under an agreement with Reliant Resources, CenterPoint Energy has agreed to
maintain ownership of its approximate 81% interest in Texas Genco following the
distribution until exercise or expiration of the Reliant Resources option.
Reliant Resources has granted a waiver that would permit CenterPoint Energy to
grant a security interest in its 81% interest in Texas Genco to CenterPoint
Energy's creditors. In addition, we have agreed that we will not issue
additional equity securities. CenterPoint Energy has agreed to lend funds to us
for operating needs upon request from time to time following the distribution.
We may also obtain third-party financing if we so desire. Our agreements with
CenterPoint Energy contain covenants restricting our ability to:
- merge or consolidate with another entity;
- sell assets;
- enter into long-term agreements and commitments for the purchase of fuel
or the purchase or sale of power outside the ordinary course of business;
- engage in other businesses;
- construct or acquire new generation plants or capacity;
- engage in hedging transactions;
- encumber our assets;
- issue additional equity securities;
- pay special dividends; and
- make certain loans, investments or advances to, or engage in certain
transactions with, our affiliates.
Exercise of the Reliant Resources option will be subject to various
regulatory approvals, including Hart-Scott-Rodino antitrust clearance and NRC
license transfer approval. In certain circumstances involving a change in
control of us, the time at which the Reliant Resources option may be exercised
and the period over
37
which the exercise price is determined are accelerated, with corresponding
changes to the time and manner of payment of the exercise price.
For a description of the limitations on our ability to pay dividends,
please read "Market for Common Stock and Related Stockholder Matters" in Item 5
of this report.
TECHNICAL SERVICES AGREEMENT WITH RELIANT RESOURCES
Under a technical services agreement, Reliant Resources is obligated to
provide engineering and technical support services and environmental, safety and
industrial health services to support the operation and maintenance of our
facilities. Reliant Resources is also obligated to provide systems, technical,
programming and consulting support services and hardware maintenance (but
excluding plant-specific hardware) necessary to provide dispatch planning,
dispatch, and settlement and communication with the ERCOT ISO, as well as
general information technology services for us. The fees Reliant Resources
charges for these services are designed to allow it to recover its fully
allocated direct and indirect costs and to obtain reimbursement of all
out-of-pocket expenses. Expenses associated with capital investment in systems
and software that benefit both the operation of Reliant Resources' facilities
and our facilities will be allocated on an installed MW basis.
The technical services agreement will terminate on the first to occur of:
- the closing date on which Reliant Resources acquires the Texas Genco
shares from CenterPoint Energy, if the Reliant Resources option is
exercised;
- CenterPoint Energy's sale of Texas Genco, or all or substantially all of
our assets, if the Reliant Resources option is not exercised; or
- May 31, 2005, provided that if the Reliant Resources option is not
exercised, we may extend the term of this agreement until December 31,
2005.
CAPACITY AUCTIONS
Through 2003, Reliant Resources has the contractual right, but not the
obligation, to purchase 50% (but not less than 50%) of each type of capacity
entitlement we auction in our contractually mandated auctions at the prices
established in the auctions. To exercise this right, Reliant Resources is
required to notify us whether it elects to purchase 50% of the capacity
auctioned no later than three business days prior to the date of the auction. We
exclude the amount of capacity specified in Reliant Resources' notice from the
auction. We auction any portion of the capacity that Reliant Resources does not
reserve through its notice with the balance of the capacity we auction in the
contractually mandated auctions.
Upon determination of the auction prices for the capacity entitlements we
auction, Reliant Resources is obligated to purchase the capacity it elected to
reserve from the auction process at the prices set during the auction for that
entitlement. If we auction capacity and ancillary services separately, Reliant
Resources is entitled to participate in 50% of the offered capacity of each. In
addition to its reservation of capacity, and whether or not it has reserved
capacity in the auction, Reliant Resources is entitled to participate in each
contractually mandated auction. If Reliant Resources exercises the Reliant
Resources option, we will not conduct any capacity auctions, other than as
required by Texas Utility Commission rules, between the option exercise date and
the option closing date without obtaining Reliant Resources' consent, which it
may not unreasonably withhold. If Reliant Resources does not exercise its
option, we will cease to be required to conduct contractually mandated auctions
following the option exercise period.
We sold 91% of our available capacity for 2002 and 74% of our available
capacity for 2003. Reliant Resources purchased entitlements to 63% of the
available 2002 capacity and through January 2003 has purchased 58% of the
available 2003 capacity. These purchases were made either through the exercise
by Reliant Resources of its contractual rights to purchase 50% of the
entitlements auctioned in the contractually mandated auctions or through the
submission of bids in those auctions. In either case, these purchases were made
at market-based prices.
38
SOUTH TEXAS PROJECT DECOMMISSIONING TRUST
We are the beneficiary of the decommissioning trust that has been
established to provide funding for decontamination and decommissioning of the
South Texas Project in which we own a 30.8% interest. CenterPoint Houston
collects, through rates or other authorized charges to its electric utility
customers, amounts designated for funding the decommissioning trust, and
deposits these amounts into the decommissioning trust. Upon decommissioning of
the facility, in the event funds from the trust are inadequate, CenterPoint
Houston or its successor will be required to collect through rates or other
authorized charges to customers as contemplated by the Texas Utilities Code all
additional amounts required to fund our obligations relating to the
decommissioning of the facility. Following the completion of the
decommissioning, if surplus funds remain in the decommissioning trust, the
excess will be refunded to the ratepayers of CenterPoint Houston or its
successor.
COMMON DIRECTOR
Our Chairman, David M. McClanahan, is also a director and the chief
executive officer of CenterPoint Energy. As a result, he may need to recuse
himself and not participate in board meetings where actions are taken in
connection with transactions or other relationships involving both companies.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
Our past earnings and results of operations are not necessarily indicative
of our future earnings and results of operations. Any of the following factors
could adversely affect our business prospects, financial condition, operating
results and cash flows:
- state and federal legislative and regulatory actions or developments,
including deregulation; re-regulation and restructuring of the ERCOT
market; and changes in, or application of, environmental and other laws
or regulations to which we are subject;
- the effects of competition, including the extent and timing of the entry
of additional competitors in the ERCOT market;
- the results of our capacity auctions;
- the timing and extent of changes in commodity prices, particularly
natural gas;
- weather variations and other natural phenomena;
- unanticipated changes in operating expenses and capital expenditures;
- financial distress of our customers, including Reliant Resources;
- our access to capital and credit;
- political, legal and economic conditions and developments in the United
States; and
- other factors discussed in this report under "Risk Factors."
39
LIQUIDITY AND CAPITAL RESOURCES
HISTORICAL CASH FLOWS
The net cash provided by/used in our operating, investing and financing
activities for 2000, 2001 and 2002 is as follows (in millions):
YEAR ENDED DECEMBER 31,}
------------------------
2000 2001 2002
------ ------ ------
Cash provided by (used in):
Operating activities...................................... $ 433 $ 236 $(152)
Investing activities...................................... (252) (409) (245)
Financing activities...................................... (181) 173 398
CASH PROVIDED BY OPERATING ACTIVITIES
Net cash provided by operating activities in 2002 decreased $388 million
compared to 2001. The decrease primarily resulted from lower revenues in the
deregulated ERCOT market, increased accounts receivable from the sale of power
in the 2002 deregulated electricity market and lower taxes payable.
Net cash provided by operating activities in 2001 decreased $197 million
compared to 2000. This decrease primarily resulted from a reduction in base
revenue related to a decline in the rate base on which the regulatory return was
calculated and a decrease in fuel accounts payable related to the decrease in
the price of natural gas in 2001 as compared to 2000.
CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities decreased $164 million during 2002
compared to 2001.
Net cash used in investing activities increased $157 million during 2001
compared to 2000.
The decrease in 2002 compared to 2001 is from completing a major portion of
the NOx work on our solid fuel units at W.A. Parish and the re-scheduling of the
NOx installation on our gas units. The increase in 2001 compared to 2000 was due
primarily to increased capital expenditures for installation of equipment to
reduce emissions of oxides of nitrogen (NOx) from our generating units.
CASH PROVIDED BY FINANCING ACTIVITIES
Cash provided by financing activities increased $225 million during 2002
compared to 2001.
Cash provided by financing activities increased $354 million in 2001
compared to 2000.
The changes in cash flows provided by (used in) financing activities in
each of the periods discussed above were a result of transfers to and from our
parent company to support our various requirements for working capital and
capital expenditures.
FUTURE SOURCES AND USES OF CASH
We expect to meet our future capital requirements with cash flows from
operations, as well as a combination of intercompany loans from our affiliates
and external funding as necessary. From time to time we may use the proceeds of
our third party borrowings to repay intercompany indebtedness, make dividend
payments or for other corporate purposes. We have obtained consent from Reliant
Resources to grant security interests in our assets to lenders under third party
facilities. We believe that our cash flows from operations, intercompany loans
from our affiliates and our borrowing capability will be sufficient to meet the
operational needs of our business for the next twelve months. For a discussion
of factors that may impact our access to capital, please read "Risk
Factors -- Other Risks."
40
In February 2003, CenterPoint Energy reached an agreement with a syndicate
of banks on a second amendment to its $3.85 billion bank facility. Under the
terms of the amended bank facility, CenterPoint Energy agreed with the banks not
to permit us to incur indebtedness for borrowed money in an aggregate principal
amount at any one time outstanding in excess of $250 million. In addition,
CenterPoint Energy agreed that proceeds from the sale of any material portion of
our assets, subject to certain requirements, or our incurrence of indebtedness
for borrowed money in excess of specified levels would be used to prepay
outstanding indebtedness under the bank facility. Although we are not
contractually bound by these limitations, CenterPoint Energy would likely cause
its representatives on our board of directors to direct our business so as not
to breach the terms of the agreement.
Prior to the restructuring of Reliant Energy pursuant to its business
separation plan, CenterPoint Energy and Reliant Energy obtained an order from
the SEC that granted CenterPoint Energy certain authority with respect to
financing, dividends and other matters. The financing authority granted by that
order will expire on June 30, 2003, and CenterPoint Energy must obtain a further
order from the SEC under the 1935 Act in order for it and its subsidiaries,
including us, to engage in financing activities subsequent to that date. For
more information regarding the restrictions on our activities under the
financing order, please read "Our Business -- Regulation -- Public Utility
Holding Company Act of 1935" in Item 1 of this report.
Capital Requirements. The following table sets forth our capital
requirements for 2002, and estimates of our capital requirements for 2003
through 2007 (in millions).
2002 2003 2004 2005 2006 2007
---- ---- ---- ---- ---- ----
Environmental capital requirements......... $220 $ 98 $ 33 $ -- $ -- $ --
Other capital requirements................. 60 52 63 68 51 64
---- ---- ---- ---- ---- ----
Total capital requirements................. $280 $150 $ 96 $ 68 $ 51 $ 64
==== ==== ==== ==== ==== ====
Environmental expenditures for installation of equipment to reduce NOx
emissions are expected to decline between 2003 and 2004 in accordance with our
NOx emission reduction plan approved by the Texas Utility Commission.
Environmental compliance cost estimates for 2006 and 2007 have not been
finalized.
Contractual Obligations. The following table sets forth estimates of our
contractual obligations as of December 31, 2002 to make future payments for 2003
through 2007 and thereafter (in millions):
2008 AND
CONTRACTUAL OBLIGATIONS TOTAL 2003 2004 2005 2006 2007 THEREAFTER
----------------------- ------ ---- ---- ---- ---- ---- ----------
Fuel commitments................ $1,410 $292 $165 $169 $174 $167 $443
Operating lease commitments..... $ 110 $ 11 $ 11 $ 11 $ 10 $ 10 $ 57
Revenues derived from our capacity auctions come from two sources: capacity
payments and energy payments. Energy payments consist of a variety of charges
related to the fuel and ancillary services scheduled through our auctioned
capacity entitlements. We bill for these energy payments on a monthly basis in
arrears. We expect future collected energy payments will cover all of our future
fuel commitments.
Cash Flows From Operations -- Reliant Resources as a Significant
Customer. To date, we have sold a substantial portion of our auctioned capacity
entitlements to subsidiaries of Reliant Resources. For more information
regarding the impact that Reliant Resources' financial condition may have on our
cash flows, please read Risk Factors -- Factors Related to Operating Risks."
Dividend Policy. We intend to pay regular quarterly cash dividends on our
common stock. Our board of directors will determine the amount of future
dividends in light of:
- any applicable contractual restrictions governing our ability to pay
dividends, including our agreements with CenterPoint Energy to ensure its
compliance with the terms of the Reliant Resources option agreement;
41
- applicable legal requirements;
- our earnings and cash flows;
- our financial condition; and
- other factors our board of directors deems relevant.
On February 7, 2003, our board of directors declared an initial quarterly
cash dividend of $0.25 per share of common stock payable on March 20, 2003 to
shareholders of record as of the close of business on February 26, 2003. For a
description of certain contractual provisions governing Texas Genco's ability to
pay dividends, please read "Market for Common Stock and Related Stockholder
Matters" in Item 5 of this report.
We expect our liquidity and capital requirements will be affected by our:
- capital requirements related to environmental compliance and other
maintenance projects;
- dividend policy;
- debt service requirements; and
- working capital requirements.
Money Pool. At December 31, 2002, we had $86.2 million borrowed from
affiliates. We participate in a "money pool" through which we and certain of our
affiliates can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. The money pool's net funding requirements are generally met by
borrowings of CenterPoint Energy. The terms of the money pool are in accordance
with requirements applicable to registered public utility holding companies
under the 1935 Act. The money pool may not provide sufficient funds to meet our
cash needs.
Pension Plan. As discussed in Note 6(a) to the consolidated financial
statements, we participate in CenterPoint Energy's qualified non-contributory
pension plan covering substantially all employees. Pension expense for 2003 is
estimated to be $17 million based on an expected return on plan assets of 9.0%
and a discount rate of 6.75% as of December 31, 2002. Future changes in plan
asset returns, assumed discount rates and various other factors related to the
pension will impact our future pension expense and liabilities. We cannot
predict with certainty what these factors will be in the future.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are reasonable likely to occur could have a material
impact on the presentation of our financial condition or results of operations.
We base our estimates on historical experience and on various other assumptions
that we believe are reasonable under the circumstances, the results of which
form the basis for making judgments. These estimates may change as new events
occur, as more experience is acquired, as additional information is obtained and
as our operating environment changes. We believe the following critical
accounting policies involve the application of accounting estimates for which a
change in the estimate is inseparable from the effect of a change in accounting
principle.
ALLOCATION METHODOLOGIES USED TO DERIVE OUR FINANCIAL STATEMENTS ON A CARVE-OUT
BASIS
In 2000 and 2001, we employed various allocation methodologies to separate
the results of operations and financial condition of the generation-related
portion of CenterPoint Energy's business from CenterPoint Energy's historical
financial statements in order to prepare our financial statements. For 2000 and
2001,
42
revenues were allocated based on actual costs plus an allowed regulatory rate of
return based on regulated invested capital granted to CenterPoint Energy's
electric utility by the Texas Utility Commission. The allowed regulatory rate of
return was 9.844% for 2000 and 2001. Expenses, such as fuel, purchased power,
operations and maintenance, and depreciation and amortization, and assets, such
as property, plant and equipment, and inventory, were specifically identified by
function and allocated accordingly for our operations. We used various
allocations to disaggregate other common expenses, assets and liabilities
between our operations and CenterPoint Energy's regulated transmission and
distribution operations. We calculated interest expense based upon an allocation
methodology that charged us with financing and equity costs from CenterPoint
Energy in proportion to our share of total net assets prior to the effects of
deregulation discussed below. These methodologies reflect the impact of
deregulation on our assets and liabilities as of June 30, 1999; however, all
existing regulatory assets which are expected to be recovered as "stranded
costs" by our affiliated transmission and distribution utility, CenterPoint
Houston, after deregulation have been excluded from these financial statements.
Beginning January 1, 2002, CenterPoint Energy's generation business was
segregated from its electric utility as a separate reporting business segment
and began selling electricity in the ERCOT market at prices determined by the
market. Accordingly, for 2002, net income reflects the results of market prices
for power. Included in operations for 2002 are allocations from CenterPoint
Energy for corporate services that included accounting, finance, investor
relations, planning, legal, communications, governmental and regulatory affairs
and human resources, as well as information technology services and other
previously shared services such as corporate security, facilities management,
accounts receivable, accounts payable and payroll, office support services and
purchasing and logistics.
Management believes the estimates inherent in these allocation
methodologies to be reasonable. Had we actually existed as a separate company,
our results could have significantly differed from those presented herein. In
addition, the historical financial information included in our financial
statements is not indicative of our future performance and does not reflect what
our financial position and results of operations would have been had we operated
as a separate, stand-alone wholesale electric power generation company in a
deregulated market during the periods presented.
REVENUE RECOGNITION
Starting January 1, 2002, we have two primary components of revenue: (1)
capacity revenues, which entitle the owner to power, and (2) energy revenues,
which are intended to cover the costs of fuel for the actual electricity
produced. Capacity payments are billed and collected one month prior to actual
energy deliveries and are recorded as deferred revenue until the month of actual
energy delivery. At that point, the deferred revenue is reversed, and both
capacity and energy payment revenues are recognized. As of December 31, 2002 $49
million of deferred capacity revenue was recorded in our Consolidated Balance
Sheet.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, which primarily include property, plant and equipment
(PP&E), comprise $4.0 billion or 91% of our total assets as of December 31,
2002. We make judgments and estimates in conjunction with the carrying value of
these assets, including amounts to be capitalized, depreciation and amortization
methods and useful lives. We evaluate our PP&E for impairment whenever
indicators of impairment exist. During 2002, no such indicators of impairment
existed. Accounting standards require that if the sum of the undiscounted
expected future cash flows from a company's asset is less than the carrying
value of the asset, an asset impairment must be recognized. The amount of
impairment recognized is calculated by subtracting the fair value of the asset
from the carrying value of the asset.
As a result of the distribution of approximately 19% of Texas Genco's
common stock to CenterPoint Energy's shareholders on January 6, 2003, we
re-evaluated these assets for impairment as of December 31, 2002 in accordance
with SFAS No. 144. As of December 31, 2002, no impairment had been indicated.
43
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 142, which provides that goodwill
and certain intangibles with indefinite lives will not be amortized into results
of operations, but instead will be reviewed periodically for impairment and
written down and charged to results of operations only in the periods in which
the recorded value of goodwill and certain intangibles with indefinite lives is
more than its fair value. Adoption of SFAS No. 142 on January 1, 2002 did not
have any impact on our financial statements.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair value of
an asset retirement obligation to be recognized as a liability is incurred and
capitalized as part of the cost of the related tangible long-lived assets. Over
time, the liability is accreted to its present value each period, and the
capitalized cost is depreciated over the useful life of the related asset.
Retirement obligations associated with long-lived assets included within the
scope of SFAS No. 143 are those for which a legal obligation exists under
enacted laws, statutes and written or oral contracts, including obligations
arising under the doctrine of promissory estoppel. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002, with earlier application encouraged.
SFAS No. 143 requires entities to record a cumulative effect of change in
accounting principle in the income statement in the period of adoption. We
adopted SFAS No. 143 on January 1, 2003.
We have completed an assessment of the applicability and implications of
SFAS No. 143. As a result of the assessment, we have identified retirement
obligations for nuclear decommissioning at the South Texas Project and for
lignite mine operations at the Jewett mine supplying the Limestone electric
generation facility. Nuclear decommissioning and the lignite mine have recorded
liabilities under our previous method of accounting. Liabilities recorded for
estimated decommissioning obligations were $138 million and $140 million at
December 31, 2001 and 2002, respectively. Liabilities recorded for estimated
lignite mine reclamation costs were $28 million and $40 million at December 31,
2001 and 2002, respectively. We have also identified other asset retirement
obligations that cannot be calculated because the assets associated with the
retirement obligations have an indeterminate life.
We used an expected cash flow approach to measure our assets retirement
obligations under SFAS No. 143. The following amounts represent our asset
retirement obligations on a pro-forma basis as if we had adopted SFAS No. 143 as
of the respective dates:
DECEMBER 31,
-------------
2001 2002
----- -----
(IN MILLIONS)
Nuclear decommissioning..................................... $178 $187
Jewett lignite mine......................................... 2 4
---- ----
Total..................................................... $180 $191
==== ====
The net difference between the amounts determined under SFAS No. 143 and
our previous method of accounting for estimated nuclear decommissioning costs of
$16 million will be recorded as a liability. The net difference between the
amounts determined under SFAS No. 143 and our previous method of accounting for
estimated mine reclamation costs of $37 million will be recorded as a cumulative
effect of accounting change.
We have previously recognized removal costs as a component of depreciation
expense. Upon adoption of SFAS No. 143, we will reverse $115 million of
previously recognized removal costs as a cumulative effect of account change.
In August 2001, the FASB issued SFAS No. 144, SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. Adoption of SFAS No. 144 on January
1, 2002 did not have a material impact on our financial statements.
44
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent.
SFAS No. 145 also requires that capital leases that are modified so that the
resulting lease agreement is classified as an operating lease be accounted for
as a sale-leaseback transaction. The changes related to debt extinguishment are
effective for fiscal years beginning after May 15, 2002, and the changes related
to lease accounting are effective for transactions occurring after May 15, 2002.
We have applied this guidance prospectively as it relates to lease accounting
and will apply the accounting provisions related to debt extinguishment in 2003.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies Emerging Issues Task Force (EITF) No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF No. 94-3). The
principal difference between SFAS No. 146 and EITF No. 94-3 relates to the
requirements for recognition of a liability for costs associated with an exit or
disposal activity. SFAS No. 146 requires that a liability be recognized for a
cost associated with an exit or disposal activity when it is incurred. A
liability is incurred when a transaction or event occurs that leaves an entity
little or no discretion to avoid the future transfer or use of assets to settle
the liability. Under EITF No. 94-3, a liability for an exit cost was recognized
at the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002 with early application encouraged. We will apply the provisions of SFAS No.
146 to all exit or disposal activities initiated after December 31, 2002.
In June 2002, EITF reached a consensus on EITF No. 02-03 that all
mark-to-market gains and losses on energy trading contracts should be shown net
in the income statement whether or not settled physically. An entity should
disclose the gross transaction volumes for those energy-trading contracts that
are physically settled. The EITF did not reach a consensus on whether
recognition of dealer profit, or unrealized gains and losses at inception of an
energy-trading contract, is appropriate in the absence of quoted market prices
or current market transactions for contracts with similar terms. The FASB staff
indicated that until such time as a consensus is reached, the FASB staff will
continue to hold the view that previous EITF consensus do not allow for
recognition of dealer profit, unless evidenced by quoted market prices or other
current market transactions for energy trading contracts with similar terms and
counterparties. The consensus on presenting gains and losses on energy trading
contracts net is effective for financial statements issued for periods ending
after July 15, 2002. Upon application of the consensus, comparative financial
statements for prior periods should be reclassified to conform to the consensus.
Adoption of EITF No. 02-03 did not have an impact on our financial position or
results of operations.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. In addition, FIN 45 requires disclosures about the guarantees that
an entity has issued. The provision for initial recognition and measurement of
the liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 is not expected to materially affect
our consolidated financial statements. We have adopted the additional disclosure
provisions of FIN 45 in our consolidated financial statements as of December 31,
2002.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)" (EITF No. 94-3).
The principal difference between SFAS No. 146 and EITF No. 94-3 relates to the
requirements for recognition of a liability for costs associated with an exit or
disposal activity. SFAS No. 146 requires that a liability be recognized for a
cost associated with
45
an exit or disposal activity when it is incurred. A liability is incurred when a
transaction or event occurs that leaves an entity little or no discretion to
avoid the future transfer or use of assets to settle the liability. Under EITF
No. 94-3, a liability for an exit cost was recognized at the date of an entity's
commitment to an exit plan. In addition, SFAS No. 146 also requires that a
liability for a cost associated with an exit or disposal activity be recognized
at its fair value when it is incurred. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002 with early
application encouraged. We will apply the provisions of SFAS No. 146 to all exit
or disposal activities initiated after December 31, 2002.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
INTEREST RATE RISK
As discussed in Note 8(c) to our financial statements, we contributed $14.8
million per year in 2000 and 2001 to a trust established to fund our share of
the decommissioning costs for the South Texas Project. In 2002, we began
contributing $2.9 million per year to this trust. The securities held by the
trust for decommissioning costs had an estimated fair value of $163 million as
of December 31, 2002, of which approximately 49% were debt securities that
subject us to risk of loss of fair value with movements in market interest
rates. If interest rates were to increase by 10% from their levels at December
31, 2002, the decrease in fair value of the debt securities would be
approximately $1 million. In addition, the risk of an economic loss is mitigated
because CenterPoint Energy has agreed to indemnify us for any shortfall of the
trust to cover decommissioning costs.
EQUITY MARKET VALUE RISK
As discussed above under "-- Interest Rate Risk," we contribute to a trust
established to fund our share of the decommissioning costs for the South Texas
Project, which held debt and equity securities as of December 31, 2002. The
equity securities expose us to losses in fair value. If the market prices of the
individual equity securities were to decrease by 10% from their levels at
December 31, 2002, the resulting loss in fair value of these securities would be
approximately $8 million. Currently, the risk of an economic loss is mitigated
because CenterPoint Energy has agreed to indemnify us for any shortfall of the
trust to cover decommissioning costs.
COMMODITY PRICE RISK
Our gross margins are dependent upon the market price for power in the
ERCOT market. Our gross margins are primarily derived from the sale of capacity
entitlements associated with our large, solid fuel base-load generating units,
including our Limestone and W.A. Parish facilities and our interest in the South
Texas Project. The gross margins generated from payments associated with the
capacity of these units are directly impacted by natural gas prices. Since the
fuel costs for our base-load units are largely fixed under long-term contracts,
they are generally not subject to significant daily and monthly fluctuations.
However, the market price for power in the ERCOT market is directly affected by
the price of natural gas. Because natural gas is the marginal fuel of facilities
serving the ERCOT market during most hours, its price has a significant
influence on the price of electric power. As a result, the price customers are
willing to pay for entitlements to our solid fuel base-load capacity generally
rises and falls with natural gas prices.
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA OF THE COMPANY.
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED OPERATIONS
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
------------------------------------
2000 2001 2002
---------- ---------- ----------
REVENUES:
Revenues............................................... $3,333,550 $3,410,945 $ --
Energy revenues........................................ -- -- 1,093,714
Capacity and other revenues............................ -- -- 447,261
---------- ---------- ----------
Total............................................. 3,333,550 3,410,945 1,540,975
---------- ---------- ----------
EXPENSES:
Fuel costs............................................. 1,644,301 1,303,981 989,560
Purchased power........................................ 752,455 1,222,552 93,841
Operation and maintenance.............................. 392,489 401,677 391,465
Depreciation and amortization.......................... 151,098 154,248 156,740
Taxes other than income taxes.......................... 63,301 63,378 42,930
---------- ---------- ----------
Total............................................. 3,003,644 3,145,836 1,674,536
---------- ---------- ----------
OPERATING INCOME (LOSS).................................. 329,906 265,109 (133,561)
OTHER INCOME............................................. 1,379 2,100 3,423
INTEREST EXPENSE, NET.................................... 58,550 65,017 25,637
---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES........................ 272,735 202,192 (155,775)
Income Tax Expense (Benefit)............................. 100,346 73,804 (62,832)
---------- ---------- ----------
NET INCOME (LOSS)........................................ $ 172,389 $ 128,388 $ (92,943)
========== ========== ==========
BASIC AND DILUTED EARNINGS PER SHARE..................... $ 2.15 $ 1.60 $ (1.16)
========== ========== ==========
See Notes to the Company's Consolidated Financial Statements
47
TEXAS GENCO HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
DECEMBER 31,
-----------------------
2001 2002
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ -- $ 578
Customer accounts receivable.............................. -- 68,604
Accounts receivable, other................................ 38,173 4,544
Inventory................................................. 180,249 156,167
Prepayments and other current assets...................... 3,008 4,024
---------- ----------
Total current assets................................. 221,430 233,917
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, NET.......................... 3,904,853 3,980,770
---------- ----------
OTHER ASSETS:
Nuclear decommissioning trust............................. 168,982 162,576
Other..................................................... 27,481 11,584
---------- ----------
Total other assets................................... 196,463 174,160
---------- ----------
TOTAL ASSETS...................................... $4,322,746 $4,388,847
========== ==========
LIABILITIES, CAPITALIZATION AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Accounts payable, affiliated companies, net............... $ 48,426 $ 22,652
Accounts payable, fuel.................................... 100,725 76,399
Accounts payable, other................................... 95,210 43,877
Notes payable, affiliated companies, net.................. -- 86,186
Taxes and interest accrued................................ 122,687 38,591
Other..................................................... 14,661 15,918
---------- ----------
Total current liabilities............................ 381,709 283,623
---------- ----------
OTHER LIABILITIES:
Accumulated deferred income taxes, net.................... 900,746 813,246
Unamortized investment tax credit......................... 182,713 170,569
Nuclear decommissioning reserve........................... 137,542 139,664
Deferred capacity auction revenue......................... -- 48,721
Benefit obligations....................................... 33,174 15,751
Accrued reclamation costs................................. 28,431 39,765
Notes payable, affiliated companies, net.................. -- 18,995
Other..................................................... 34,415 34,470
---------- ----------
Total other liabilities.............................. 1,317,021 1,281,181
---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
CAPITALIZATION.............................................. 2,624,016 --
---------- ----------
SHAREHOLDER'S EQUITY:
Capital stock............................................. -- 1
Additional paid-in capital................................ -- 2,878,502
Retained deficit.......................................... -- (54,460)
---------- ----------
Total Shareholder's Equity........................... -- 2,824,043
---------- ----------
Total Capitalization and Shareholder's Equity........ 2,624,016 2,824,043
---------- ----------
TOTAL LIABILITIES, CAPITALIZATION AND
SHAREHOLDER'S EQUITY............................ $4,322,746 $4,388,847
========== ==========
See Notes to the Company's Consolidated Financial Statements
48
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
---------------------------------
2000 2001 2002
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)....................................... $ 172,389 $ 128,388 $ (92,943)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................ 151,098 154,248 156,740
Fuel-related amortization............................ 17,746 16,740 12,729
Deferred income taxes................................ 19,639 (29,194) (27,161)
Investment tax credit................................ (13,082) (13,106) (12,144)
Changes in other assets and liabilities:
Accounts receivable................................ 3,245 (19,554) (34,975)
Inventory.......................................... (8,696) (16,483) 24,082
Accounts payable................................... 142,669 (95,490) (75,659)
Accounts payable, affiliate........................ 19,227 19,743 (25,774)
Taxes and interest accrued......................... (37,767) 60,608 (84,096)
Accrued reclamation costs.......................... 1,162 8,505 11,334
Benefit obligations................................ 5,984 2,453 (17,423)
Deferred revenue from capacity auctions............ -- -- 48,721
Other current assets............................... 656 (491) (1,016)
Other current liabilities.......................... 4,020 (665) 1,257
Other long-term assets............................. (15,904) (5,822) 15,757
Other long-term liabilities........................ (29,405) 26,209 (51,756)
--------- --------- ---------
Net cash provided by (used in) operating
activities...................................... 432,981 236,089 (152,327)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................................... (252,301) (409,002) (245,246)
--------- --------- ---------
Net cash used in investing activities.............. (252,301) (409,002) (245,246)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in capitalization activity................... (180,680) 172,913 292,970
Increase in short-term notes payables, affiliate........ -- -- 86,186
Increase in long-term notes payable, affiliate.......... -- -- 18,995
--------- --------- ---------
Net cash provided by (used in) financing
activities...................................... (180,680) 172,913 398,151
--------- --------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS................. -- -- 578
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.......... -- -- --
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................ $ -- $ -- $ 578
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest................................................ $ 58,597 $ 64,267 $ 4,270
Income taxes............................................ 87,413 60,963 --
See Notes to the Company's Consolidated Financial Statements
49
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED CAPITALIZATION AND SHAREHOLDER'S EQUITY
(THOUSANDS OF DOLLARS)
TOTAL
CAPITALIZATION
ADDITIONAL TOTAL AND
CAPITAL PAID-IN RETAINED SHAREHOLDER'S SHAREHOLDER'S
STOCK CAPITAL DEFICIT EQUITY CAPITALIZATION EQUITY
------- ---------- -------- ------------- -------------- --------------
BALANCE AS OF DECEMBER 31,
1999......................... $-- $ -- $ -- $ -- $ 2,331,006 $2,331,006
Net income (1)............... -- -- -- -- 172,389 172,389
Net transfers to parent...... -- -- -- -- (180,680) (180,680)
-- ---------- -------- ---------- ----------- ----------
BALANCE AS OF DECEMBER 31,
2000......................... -- -- -- -- 2,322,715 2,322,715
Net income (1)............... -- -- -- -- 128,388 128,388
Net transfers from parent.... -- -- -- -- 172,913 172,913
-- ---------- -------- ---------- ----------- ----------
BALANCE AS OF DECEMBER 31,
2001......................... -- -- -- -- 2,624,016 2,624,016
Net loss (2)................. -- -- (54,460) (54,460) (38,483) (92,943)
Net transfers from parent.... 1 2,878,502 -- 2,878,503 (2,585,533) 292,970
-- ---------- -------- ---------- ----------- ----------
BALANCE AS OF DECEMBER 31,
2002......................... $1 $2,878,502 $(54,460) $2,824,043 $ -- $2,824,043
== ========== ======== ========== =========== ==========
---------------
(1) Net income included in Capitalization for 2000 and 2001, reflects the net
income derived from the allocation of revenue, operating expenses, other
income, interest expense and income tax expense from the rate regulated
electric utility of Reliant Energy, Incorporated, (Reliant Energy) the
predecessor of CenterPoint Energy Houston Electric, LLC (CenterPoint
Houston), which was comprised of transmission and distribution, generation
and retail components. For further discussion related to the basis of
presentation, See Note 1.
(2) Beginning January 1, 2002, Reliant Energy's electric generation business was
segregated in an unincorporated division from its other electric utility
operations as a separate reporting business segment. In June 1999, the Texas
legislature enacted a law that substantially amended the regulatory
structure governing electric utilities in Texas in order to encourage retail
electric competition (the Texas electric restructuring law). Under the Texas
electric restructuring law, the Company and other power generators in Texas
ceased to be subject to traditional cost-based regulation on January 1,
2002. Since that date, the Company has been selling generation capacity,
energy and ancillary services to wholesale purchasers at prices determined
by the market. Accordingly, for 2002, net loss reflects revenue received
from market-based power sales. Retained deficit at December 31, 2002
reflects the Company's net loss since August 31, 2002, the date of the
restructuring as discussed in Note 1. The Company's net loss prior to the
restructuring is reflected as a component of capitalization.
See Notes to the Company's Consolidated Financial Statements
50
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
Background. In June 1999, the Texas legislature enacted an electric
restructuring law which substantially amended the regulatory structure governing
electric utilities in Texas in order to encourage retail electric competition.
In December 2001, the shareholders of Reliant Energy, Incorporated (Reliant
Energy) approved a restructuring proposal that was submitted in response to the
Texas electric restructuring law and pursuant to which Reliant Energy would,
among other things, (1) convey its Texas electric generation assets to an
affiliated company, (2) become an indirect, wholly owned subsidiary of a new
public utility holding company, CenterPoint Energy, Inc. (CenterPoint Energy),
(3) be converted into a Texas limited liability company named CenterPoint Energy
Houston Electric, LLC (CenterPoint Houston) and (4) distribute the capital stock
of its operating subsidiaries to CenterPoint Energy. Texas Genco Holdings, Inc.
(Texas Genco or the Company) represents the portfolio of generating facilities
owned during the periods presented by these financial statements by the
unincorporated electric utility division of Reliant Energy.
On August 24, 2001, Reliant Energy incorporated Texas Genco, a Texas
corporation, as a wholly owned subsidiary. In February 2002, the Company issued
1,000 shares of its $1.00 par value common stock to Reliant Energy in exchange
for $1,000. In February 2002, Reliant Energy made a capital contribution of
$3,000 to the Company. During the period ended June 30, 2002, Reliant Energy
made a capital contribution of $14,000 to the Company for payment of general and
administrative expenses associated with maintaining its corporate structure. The
Company did not conduct any activities other than those mentioned above through
August 31, 2002.
Effective August 31, 2002, Reliant Energy completed the restructuring
described above. As a result, on that date Reliant Energy conveyed all of its
electric generating facilities to the Company, which was accounted for as a
business combination of entities under common control. The Company subsequently
became an indirect wholly owned subsidiary of CenterPoint Energy. CenterPoint
Energy is subject to regulation by the Securities and Exchange Commission as a
"registered holding company" under the Public Utility Holding Company Act of
1935. As used herein, CenterPoint Energy also refers to the former Reliant
Energy for dates prior to the restructuring.
As of January 1, 2002, CenterPoint Energy's electric utility unbundled its
businesses in order to separate its power generation, transmission and
distribution, and retail electric businesses into separate units. Under the
Texas electric restructuring law, as of January 1, 2002, the Company ceased to
be subject to traditional cost-based regulation. Since that date, the Company
has been selling generation capacity, energy and ancillary services to wholesale
purchasers at prices determined by the market. To facilitate a competitive
market, each power generation company affiliated with a transmission and
distribution utility is required to sell at auction firm entitlements to 15% of
the output of its installed generating capacity on a forward basis for varying
terms of up to two years (state mandated auctions). The Company's first state
mandated auction was held in September 2001 for power delivered beginning
January 1, 2002. This obligation continues until January 1, 2007 unless before
that date the Public Utility Commission of Texas (Texas Utility Commission)
determines that at least 40% of the quantity of electric power consumed in 2000
by residential and small commercial customers in CenterPoint Houston's service
area is being served by retail electric providers not affiliated with
CenterPoint Energy. Reliant Resources, Inc. (Reliant Resources) is deemed to be
an affiliate of CenterPoint Energy for purposes of this test. Reliant Resources
has an option (Reliant Resources Option) to purchase the shares of the Company's
common stock owned by CenterPoint Energy that is exercisable in January 2004. In
addition to the state mandated auctions, the Company is contractually obligated
to auction entitlements to all of its capacity and related ancillary services
available, subject to certain permitted reserves, until the date on which the
Reliant Resources Option is either exercised or expires (contractually mandated
auctions). Reliant Resources is entitled to purchase 50% (but no less than 50%
if it exercises this purchase entitlement) of each type of capacity entitlement
auctioned by the Company in the contractually mandated auctions at the prices
established in the auctions.
51
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Basis of Presentation. The consolidated financial statements include the
operations of Texas Genco Holdings, Inc. and its subsidiaries, which manage and
operate the Company's electric generation operations. The consolidated financial
statements of the Company are presented on a carve-out basis, and present the
historical financial position, results of operations and net cash flows of the
historically regulated generation-related business of CenterPoint Energy, and
are not indicative of the financial position, results of operations or net cash
flows that would have existed had the Company been an independent company
operating in the Texas deregulated electricity market (ERCOT market) for the two
years ended December 31, 2001. Beginning January 1, 2002, CenterPoint Energy's
generation business was segregated from CenterPoint Energy's electric utility as
a separate reporting business segment and began selling electricity in the ERCOT
market at prices determined by the market. Accordingly, for 2002, net loss
reflects the results of market prices for power. Included in operations for 2002
are allocations from CenterPoint Energy for corporate services that included
accounting, finance, investor relations, planning, legal, communications,
governmental and regulatory affairs and human resources, as well as information
technology services and other previously shared services such as corporate
security, facilities management, accounts receivable, accounts payable and
payroll, office support services and purchasing and logistics.
Certain information in these consolidated financial statements as of
December 31, 2002 and for each of the years in the two-year period ended
December 31, 2002 relating to the results of operations and financial condition
was derived from the historical financial statements of CenterPoint Energy which
have been prepared in accordance with accounting principles generally accepted
in the United States of America (GAAP). Various allocation methodologies were
employed during these periods to separate the results of operations and
financial condition of the generation-related portion of CenterPoint Energy's
business from CenterPoint Energy's historical financial statements. For 2000 and
2001, revenues were allocated based on the allowed regulatory rate of return on
regulated invested capital granted to CenterPoint Energy's electric utility by
the Texas Utility Commission. The allowed regulatory rate of return was 9.844%
for 2000 and 2001. Expenses during 2000 and 2001, such as fuel, purchased power,
operations and maintenance and depreciation and amortization, and assets, such
as property, plant and equipment and inventory, were specifically identified by
function and allocated accordingly for the Company's operations. Various
allocations were used to disaggregate other common expenses, assets and
liabilities between the Company and CenterPoint Energy's regulated transmission
and distribution operations as of December 31, 2001 and for the two-year period
then ended. Interest expense was calculated based upon an allocation methodology
that charged the Company with financing and equity costs from CenterPoint Energy
in proportion to its share of total net assets. Interest expense in 2002 through
August 31, 2002 was allocated based upon the remaining electric utility debt not
specifically identified with Reliant Energy's transmission and distribution
utility upon deregulation. Effective with the restructuring of Reliant Energy,
no long-term debt was assumed by the Company and interest is incurred on
borrowings from CenterPoint Energy. These methodologies reflect the impact of
deregulation on the Company's assets and liabilities as of June 30, 1999;
however, all existing regulatory assets which are expected to be recovered by
the transmission and distribution utility after deregulation have been excluded
from these consolidated financial statements.
Management believes these allocation methodologies to be reasonable. Had
the Company actually existed as a separate company, its results could have
significantly differed from those presented herein. In addition, future results
of operations, financial position and net cash flows are expected to materially
differ from the historical results presented.
Texas Genco's Board of Directors declared an 80,000-for-one stock split
that was effected on December 18, 2002. On January 6, 2003, CenterPoint Energy
distributed approximately 19% of the 80 million outstanding shares of Texas
Genco's common stock to CenterPoint Energy's shareholders. Earnings per share
has been presented as if the 80,000,000 shares were outstanding for all
historical periods in accordance with Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings Per Share."
52
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) USE OF ESTIMATES
The process of preparing financial statements in conformity with GAAP
requires the use of estimates and assumptions regarding certain types of assets,
liabilities, revenues and expenses. Also, such estimates relate to unsettled
transactions and events as of the date of the financial statements. Accordingly,
upon settlement, actual results may differ from estimated amounts. In addition
to these estimates, see Note 1 (Background and Basis of Presentation) for a
discussion of the estimates used and methodologies employed to derive the
Company's historical financial statements.
(b) INVENTORY
Inventory consists principally of materials and supplies, coal and lignite,
natural gas and fuel oil. Inventories used in the production of electricity are
valued at the lower of average cost or market except for coal and lignite, which
are valued under the last-in, first-out method. Below is a detail of inventory:
DECEMBER 31,
-------------------
2001 2002
-------- --------
(IN THOUSANDS)
Materials and supplies...................................... $ 93,442 $ 92,869
Coal and lignite............................................ 57,826 42,791
Natural gas................................................. 19,620 16,733
Fuel oil.................................................... 9,361 3,774
-------- --------
Total inventory................................... $180,249 $156,167
======== ========
(c) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at historical cost. Repair and
maintenance costs are charged to the appropriate expense accounts as incurred.
Property, plant and equipment includes the following:
ESTIMATED DECEMBER 31,
USEFUL LIVES -------------------------
(YEARS) 2001 2002
------------ ----------- -----------
(IN THOUSANDS)
Gas-fired generation facilities................ 30-60 $ 2,175,689 $ 2,274,317
Coal and lignite-fired generation facilities... 50 3,678,723 3,820,208
Nuclear generation facilities.................. 40 2,884,394 2,905,242
Nuclear fuel................................... 320,312 344,003
Other.......................................... 5-50 303,256 266,570
----------- -----------
Total................................ 9,362,374 9,610,340
Accumulated depreciation and amortization...... (5,457,521) (5,629,570)
----------- -----------
Property, plant and equipment, net... $ 3,904,853 $ 3,980,770
=========== ===========
Prior to the restructuring described in Note 1 (Background and Basis of
Presentation), substantially all of the Company's physical assets used in the
conduct of the business and operations of electric generation were subject to
liens securing CenterPoint Energy's First Mortgage Bonds. In connection with the
restructuring, these assets were released from the liens.
53
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) DEPRECIATION AND AMORTIZATION
Depreciation is computed using the straight-line method based on economic
lives or a regulatory mandated method prior to June 30, 1999. Depreciation and
amortization expense for 2000, 2001 and 2002 was $151 million, $154 million and
$157 million, respectively.
(e) CAPITALIZED INTEREST
Capitalized interest is reflected as a reduction to interest expense in the
Consolidated Statements of Operations. During the years ended December 31, 2000,
2001 and 2002, the Company capitalized interest of $3.9 million, $4.4 million
and $6.6 million, respectively.
(f) LONG-LIVED ASSETS AND INTANGIBLES
The Company periodically evaluates long-lived assets when events or changes
in circumstances indicate that the carrying value of these assets may not be
recoverable. The determination of whether an impairment has occurred is based on
an estimate of undiscounted cash flows attributable to the assets, as compared
to the carrying value of the assets. An impairment analysis of generating
facilities requires estimates of possible future market prices, load growth,
competition and many other factors over the lives of the facilities. A resulting
impairment loss is highly dependent on these underlying assumptions.
As a result of the distribution of approximately 19% of Texas Genco's
common stock to CenterPoint Energy's shareholders on January 6, 2003, the
Company re-evaluated these assets for impairment as of December 31, 2002 in
accordance with SFAS No. 144. As of December 31, 2002, no impairment had been
indicated.
(g) REVENUE RECOGNITION
Prior to January 1, 2002, revenues were derived based on actual costs plus
an allowed regulatory rate of return based on regulated invested capital. For
the periods subsequent to January 1, 2002, the Company has been accounted for as
a separate business segment of CenterPoint Energy selling electricity to
wholesale purchasers in the ERCOT market. Accordingly, revenues represent actual
results of CenterPoint Energy's generation business segment in 2002 operating in
a deregulated market. As of January 1, 2002, the Company has two primary
components of revenue: (1) capacity payments, which entitles the owner to power,
and (2) energy payments, which are intended to cover the costs of fuel for the
actual electricity produced. Capacity payments are billed and collected one
month prior to actual energy deliveries and are recorded as deferred revenue
until the month of actual energy delivery. At that point, the deferred revenue
is reversed, and both capacity and energy payment revenues are recognized. Prior
to 2002, all purchased power was part of the total load used to serve retail
customers of the integrated utility. Beginning in 2002, fuel costs and purchased
power are costs incurred to support sales of energy in the state mandated
auctions and contractually mandated auctions required by the Texas Utility
Commission, and the corresponding revenues are recorded as Energy revenues.
(h) RECLAMATION COSTS
The Company records liabilities related to future reclamation costs when
the activities are probable and the costs can be reasonably estimated. As of
December 31, 2001 and 2002, the Company has accrued costs related to future
reclamation obligations related to its lignite mine at its Limestone generating
facility of $28 million and $40 million, respectively.
54
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(i) INCOME TAXES
The Company is included in the consolidated income tax returns of
CenterPoint Energy. The Company calculates its income tax provision on a
separate return basis under a tax sharing agreement with CenterPoint Energy. The
Company uses the liability method of accounting for deferred income taxes and
measures deferred income taxes for all significant income tax temporary
differences. Current federal and state income taxes payable are payable to or
receivable from CenterPoint Energy.
(j) STATEMENT OF CONSOLIDATED CASH FLOWS
For purposes of reporting cash flows, the Company considers cash
equivalents to be short-term, highly liquid investments readily convertible to
cash.
(k) NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 142, which provides that goodwill
and certain intangibles with indefinite lives will not be amortized into results
of operations, but instead will be reviewed periodically for impairment and
written down and charged to results of operations only in the periods in which
the recorded value of goodwill and certain intangibles with indefinite lives is
more than its fair value. Adoption of SFAS No. 142 on January 1, 2002 did not
have any impact on the Company's consolidated financial statements.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair value of
an asset retirement obligation to be recognized as a liability is incurred and
capitalized as part of the cost of the related tangible long-lived assets. Over
time, the liability is accreted to its present value each period, and the
capitalized cost is depreciated over the useful life of the related asset.
Retirement obligations associated with long-lived assets included within the
scope of SFAS No. 143 are those for which a legal obligation exists under
enacted laws, statutes and written or oral contracts, including obligations
arising under the doctrine of promissory estoppel. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002, with earlier application encouraged.
SFAS No. 143 requires entities to record a cumulative effect of change in
accounting principle in the income statement in the period of adoption. The
Company adopted SFAS No. 143 on January 1, 2003.
The Company has completed an assessment of the applicability and
implications of SFAS No. 143. As a result of the assessment, the Company has
identified retirement obligations for nuclear decommissioning at the South Texas
Nuclear Project (South Texas Project) and for lignite mine operations at the
Jewett mine supplying the Limestone electric generation facility. Nuclear
decommissioning and the lignite mine have recorded liabilities under the
Company's previous method of accounting. Liabilities recorded for estimated
decommissioning obligations were $138 million and $140 million at December 31,
2001 and 2002, respectively. Liabilities recorded for estimated lignite mine
reclamation costs were $28 million and $40 million at December 31, 2001 and
2002, respectively. The Company has also identified other asset retirement
obligations that cannot be calculated because the assets associated with the
retirement obligations have an indeterminate life.
55
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company used an expected cash flow approach to measure its assets
retirement obligations under SFAS No. 143. The following amounts represent the
Company's asset retirement obligations on a pro-forma basis as if it had adopted
SFAS No. 143 as of the respective dates:
DECEMBER 31,
-------------
2001 2002
----- -----
(IN MILLIONS)
Nuclear decommissioning..................................... $178 $187
Jewett lignite mine......................................... 2 4
---- ----
Total..................................................... $180 $191
==== ====
The net difference between the amounts determined under SFAS No. 143 and
the Company's previous method of accounting for estimated nuclear
decommissioning costs of $16 million will be recorded as a liability. The net
difference between the amounts determined under SFAS No. 143 and the Company's
previous method of accounting for estimated mine reclamation costs of $37
million will be recorded as a cumulative effect of accounting change.
The Company has previously recognized removal costs as a component of
depreciation expense. Upon adoption of SFAS No. 143, the Company will reverse
$115 million of previously recognized removal costs as a cumulative effect of
accounting change.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144
provides new guidance on the recognition of impairment losses on long-lived
assets to be held and used or to be disposed of and also broadens the definition
of what constitutes a discontinued operation and how the results of a
discontinued operation are to be measured and presented. Adoption of SFAS No.
144 on January 1, 2002 did not have a material impact on the Company's
consolidated financial statements. See Note 2(f) for a discussion of the
impairment test performed at December 31, 2002.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent.
SFAS No. 145 also requires that capital leases that are modified so that the
resulting lease agreement is classified as an operating lease be accounted for
as a sale-leaseback transaction. The changes related to debt extinguishment will
be effective for fiscal years beginning after May 15, 2002, and the changes
related to lease accounting will be effective for transactions occurring after
May 15, 2002. The Company has applied this guidance prospectively as it relates
to lease accounting and will apply the accounting provisions related to debt
extinguishment in 2003.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies Emerging Issues Task Force (EITF) No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF No. 94-3). The
principal difference between SFAS No. 146 and EITF No. 94-3 relates to the
requirements for recognition of a liability for cost associated with an exit or
disposal activity. SFAS No. 146 requires that a liability be recognized for a
cost associated with an exit or disposal activity when it is incurred. A
liability is incurred when a transaction or event occurs that leaves an entity
little or no discretion to avoid the future transfer or use of assets to settle
the liability. Under EITF No. 94-3, a liability for an exit cost was recognized
at the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are
56
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
initiated after December 31, 2002 with early application encouraged. The Company
will apply the provisions of SFAS No. 146 to all exit or disposal activities
initiated after December 31, 2002.
In June 2002, the EITF reached a consensus on EITF No. 02-03 that all
mark-to-market gains and losses on energy trading contracts should be shown net
in the income statement whether or not settled physically. An entity should
disclose the gross transaction volumes for those energy-trading contracts that
are physically settled. The EITF did not reach a consensus on whether
recognition of dealer profit, or unrealized gains and losses at inception of an
energy-trading contract, is appropriate in the absence of quoted market prices
or current market transactions for contracts with similar terms. The FASB staff
indicated that until such time as a consensus is reached, the FASB staff will
continue to hold the view that previous EITF consensus do not allow for
recognition of dealer profit, unless evidenced by quoted market prices or other
current market transactions for energy trading contracts with similar terms and
counterparties. The consensus on presenting gains and losses on energy trading
contracts net is effective for financial statements issued for periods ending
after July 15, 2002. Upon application of the consensus, comparative financial
statements for prior periods should be reclassified to conform to the consensus.
Adoption of EITF No. 02-03 did not have any impact on the Company's financial
position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. In addition, FIN 45 requires disclosures about the guarantees that
an entity has issued. The provision for initial recognition and measurement of
the liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 is not expected to materially affect
the Company's consolidated financial statements. The Company has adopted the
additional disclosure provisions of FIN 45 in its consolidated financial
statements as of December 31, 2002.
In January 2003, the FASB issued FIN No. 46 "Consolidation of Variable
Interest Entities, an Interpretation of Accounting Research Bulletin No. 51"
(FIN 46). FIN 46 requires certain variable interest entities to be consolidated
by the primary beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. The Company is currently
evaluating the effect that the adoption of FIN 46 will have on its results of
operations and financial condition.
(3) RELATED PARTY TRANSACTIONS
As of December 31, 2002, the Company had $86.2 million in short-term
borrowings and $19.0 million in long-term borrowings from CenterPoint Energy and
its subsidiaries. Such borrowings are used for working capital purposes.
Interest expense associated with the borrowings for 2002 was $7.0 million. The
effective interest rate on the borrowings was 6.20%. In addition, through August
31, 2002 (the Restructuring), $25.2 million of interest expense was allocated to
the Company related to the remaining electric utility debt not specifically
identified with CenterPoint Energy's transmission and distribution utility upon
deregulation.
From time to time, the Company has advanced money to, or borrowed money
from, CenterPoint Energy or its subsidiaries. As of December 31, 2002, the
Company had net accounts payable to affiliates of $23 million.
57
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 2002, the sales and services by the Company to CenterPoint Energy
and its affiliates totaled $53 million. Purchases of natural gas by the Company
from CenterPoint Energy and its affiliates were $41 million in 2002.
CenterPoint Energy provides some corporate services to the Company. The
costs of services have been directly charged to the Company using methods that
management believes are reasonable. These methods include negotiated usage
rates, dedicated asset assignment, and proportionate corporate formulas based on
assets, operating expenses and employees. These charges are not necessarily
indicative of what would have been incurred had the Company not been an
affiliate. Amounts charged to the Company for these services were $47 million
for 2002 and are included primarily in operation and maintenance expenses.
The 1935 Act generally prohibits borrowings by CenterPoint Energy from its
subsidiaries, including the Company.
Separation Agreement. In connection with the distribution, the Company
entered into a separation agreement with CenterPoint Energy. This agreement
contains provisions governing the Company's relationship with CenterPoint Energy
following the distribution and specifies the related ancillary agreements
between the Company and CenterPoint Energy. In addition, the separation
agreement provides for cross-indemnities intended to place sole financial
responsibility on the Company and its subsidiaries for all liabilities
associated with the current and historical business and operations the Company
conducts, regardless of the time those liabilities arose, and to place sole
financial responsibility for liabilities associated with CenterPoint Energy's
other businesses with CenterPoint Energy and its other subsidiaries. The
separation agreement also contains indemnification provisions under which the
Company and CenterPoint Energy each indemnify the other with respect to breaches
by the indemnifying party of the separation agreement or any ancillary
agreements.
Transition Services Agreement. The Company has entered into a transition
services agreement with CenterPoint Energy under which CenterPoint Energy will
provide the Company through the earlier of such time as all services under the
agreement are terminated or CenterPoint Energy ceases to own a majority of the
Company's common stock, various corporate support services that include
accounting, finance, investor relations, planning, legal, communications,
governmental and regulatory affairs and human resources, as well as information
technology services and other previously shared services such as corporate
security, facilities management, accounts receivable, accounts payable and
payroll, office support services and purchasing and logistics. These services
will consist generally of the same types of services as have been provided on an
intercompany basis prior to this distribution. The charges the Company will pay
for the services will be on a basis generally intended to allow CenterPoint
Energy to recover the fully allocated direct and indirect costs of providing the
services, plus all out-of-pocket costs and expenses, but without any profit to
CenterPoint Energy, except to the extent routinely included in traditional
utility cost of capital. Pursuant to a separate lease agreement, CenterPoint
Energy has agreed to lease office space in its principal office building in
Houston, Texas to the Company for an interim period expected to end no later
than December 31, 2004.
Tax Allocation Agreement. The Company is a member of the CenterPoint
Energy consolidated group for tax purposes, and the Company will continue to
file a consolidated federal income tax return with CenterPoint Energy while
CenterPoint Energy retains its 81% interest in the Company. Accordingly, the
Company has entered into a tax allocation agreement with CenterPoint Energy to
govern the allocation of U.S. income tax liabilities and to set forth agreements
with respect to certain other tax matters. CenterPoint Energy will be
responsible for preparing and filing any U.S. income tax returns required to be
filed for any company or group of companies of the CenterPoint Energy
consolidated group, including all tax returns for the Company for so long as it
is a member of the CenterPoint Energy consolidated group. CenterPoint Energy
will also be responsible for paying the taxes related to the returns it is
responsible for filing. The Company will be responsible for paying CenterPoint
Energy its allocable share of such taxes. CenterPoint Energy will determine all
tax elections for tax periods during which the Company is a member of the
CenterPoint Energy consolidated group. Generally, if there are tax adjustments
related to the Company which relate to a tax return
58
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
filed for a period when the Company was a member of the CenterPoint Energy
consolidated group, the Company will be responsible for any increased taxes and
the Company will receive the benefit of any tax refunds.
(4) CAPITALIZATION
CenterPoint Energy has provided the necessary capital to finance the
Company's generation related business. The Company had net capitalization of
$2.6 billion at December 31, 2001. These amounts represent the amount of capital
investments made by Reliant Energy in its generation-related business and the
Company's allocated capitalization prior to the formation of the Company as a
separate entity. Interest expense for the two years ended December 31, 2001 was
calculated based upon an allocation methodology that charged the Company with
financing and equity costs from Reliant Energy in proportion to its share of
total net assets. Interest expense in 2002 through August 31, 2002 was allocated
based upon the remaining electric utility debt not specifically identified with
Reliant Energy's transmission and distribution utility upon deregulation.
Effective with the restructuring of Reliant Energy on August 31, 2002, no
long-term debt was assumed by the Company, and from that point interest has been
incurred only on short-term borrowings from CenterPoint Energy.
(5) JOINTLY OWNED ELECTRIC UTILITY PLANT
The Company owns a 30.8% interest in the South Texas Project, which
consists of two 1,250 MW nuclear generating units, and bears a corresponding
30.8% share of capital and operating costs associated with the project. The
South Texas Project is owned as a tenancy in common among the Company and three
other co-owners, with each owner retaining its undivided ownership interest in
the two nuclear-fueled generating units and the electrical output from those
units. The Company is severally liable, but not jointly liable, for the expenses
and liabilities of the South Texas Project. CenterPoint Energy and the other
three co-owners organized STP Nuclear Operating company (STPNOC) to operate and
maintain the South Texas Project. STPNOC is managed by a board of directors
comprised of one director appointed by each of the four owners, along with the
chief executive officer of STPNOC. The Company's share of direct expenses of the
South Texas Project is included in the corresponding operating expense
categories in the accompanying financial statements. As of December 31, 2001,
the total utility plant in service and construction work in progress for the
total South Texas Project was $5.8 billion and $120 million, respectively. As of
December 31, 2002, the total utility plant in service and construction work in
progress for the total South Texas Project was $5.8 billion and $158 million,
respectively. As of December 31, 2001 and 2002, Texas Genco's investment in the
South Texas Project was $316 million and $323 million, respectively, (net of
$2.2 billion accumulated depreciation which includes an impairment loss recorded
in 1999 of $745 million). As of December 31, 2001 and 2002, Texas Genco's
investment in nuclear fuel was $35 million (net of $286 million amortization)
and $42 million (net of $302 million amortization), respectively.
(6) EMPLOYEE BENEFIT PLANS
(A) PENSION
Substantially all of the Company's employees participate in CenterPoint
Energy's qualified non-contributory pension plan. The benefit accrual is in the
form of a cash balance of a specified percentage of annual pay plus accrued
interest. CenterPoint Energy's funding policy is to review amounts annually in
accordance with applicable regulations in order to achieve adequate funding of
projected benefit obligations. Pension expense is allocated to the Company based
on covered employees. Assets of the plan are not segregated or restricted by
CenterPoint Energy's participating subsidiaries and accrued obligations for the
Company employees would be the obligation of the retirement plan if the Company
were to withdraw. Pension benefit was $5 million and $1 million for the years
ended December 31, 2000 and 2001, respectively. The
59
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company recognized pension expense of $15 million for the year ended December
31, 2002, which includes $9 million of non-recurring expenses related to an
early retirement program.
In addition to the plan, the Company participates in CenterPoint Energy's
non-qualified pension plan, which allows participants to retain the benefits to
which they would have been entitled under the retirement plan except for
federally mandated limits on these benefits or on the level of salary on which
these benefits may be calculated. The expense associated with the non-qualified
pension plan was less than $1 million in 2000, 2001 and 2002.
(b) SAVINGS PLAN
The Company participates in CenterPoint Energy's qualified savings plan,
which includes a cash or deferred arrangement under Section 401(k) of the
Internal Revenue Code of 1986, as amended. Under the plan, participating
employees may contribute a portion of their compensation, on a pre-tax or
after-tax basis, generally up to a maximum of 16% of compensation. CenterPoint
Energy matches 75% of the first 6% of each employee's compensation contributed.
CenterPoint Energy may contribute an additional discretionary match of up to 50%
of the first 6% of each employee's compensation contributed. These matching
contributions are fully vested at all times. A substantial portion of the
matching contribution is initially invested in CenterPoint Energy common stock.
CenterPoint Energy allocates to the Company the savings plan benefit expense
related to the Company's employees.
Savings plan benefit expense was $10 million, $6 million and $9 million for
the years ended December 31, 2000, 2001 and 2002, respectively.
(c) POSTRETIREMENT BENEFITS
The Company's employees participate in CenterPoint Energy's plans which
provide certain healthcare and life insurance benefits for retired employees on
a contributory and non-contributory basis. Employees become eligible for these
benefits if they have met certain age and service requirements at retirement, as
defined in the plans. Under plan amendments effective in early 1999, health care
benefits for future retirees were changed to limit employer contributions for
medical coverage. Such benefit costs are accrued over the active service period
of employees.
The Company is required to fund a portion of its obligations in accordance
with rate orders. All other obligations are funded on a pay-as-you-go basis.
The net postretirement benefit cost includes the following components:
YEAR ENDED
DECEMBER 31,
------------------
2000 2001 2002
---- ---- ----
(IN MILLIONS)
Service cost -- benefits earned during the period........... $ 1 $ 1 $ 1
Interest cost on projected benefit obligation............... 6 6 3
Expected return on plan assets.............................. (3) (4) (1)
Net amortization............................................ 2 4 1
Benefit enhancement......................................... -- -- 3
--- --- ---
Net postretirement benefit cost............................. $ 6 $ 7 $ 7
=== === ===
Following are the Company's reconciliations of beginning and ending
balances of its postretirement benefit plans benefit obligation, plan assets and
funded status for 2001 and 2002.
60
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED
DECEMBER 31,
-------------
2001 2002
----- -----
(IN MILLIONS)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of year....................... $ 82 $ 89
Service cost................................................ 1 1
Interest cost............................................... 6 3
Benefits paid............................................... (1) --
Participant contributions................................... 1 --
Benefit enhancement......................................... -- 3
Transfer to affiliate....................................... -- (52)
Actuarial (gain) loss....................................... -- (3)
---- ----
Benefit obligation, end of year............................. $ 89 $ 41
==== ====
CHANGE IN PLAN ASSETS
Plan assets, beginning of year.............................. $ 34 $ 37
Benefits paid............................................... (1) --
Employer contributions...................................... 7 1
Participant contributions................................... 1 --
Transfer to affiliate....................................... -- (22)
Actual investment return.................................... (4) (1)
---- ----
Plan assets, end of year.................................... $ 37 $ 15
==== ====
RECONCILIATION OF FUNDED STATUS
Funded status............................................... $(52) $(26)
Unrecognized transition obligation.......................... 31 8
Unrecognized prior service cost............................. 14 13
Unrecognized actuarial loss................................. (10) (5)
---- ----
Net amount recognized at end of year........................ $(17) $(10)
==== ====
ACTUARIAL ASSUMPTIONS
Discount rate............................................... 7.25% 6.75%
Expected long-term rate of return on assets................. 9.5% 9.0%
For the year ended December 31, 2001, the assumed health care cost trend
rates were 7.5% for participants under age 65 and 8.5% for participants age 65
and over. For the year ended December 31, 2002, the assumed health cost trend
rate was increased to 12% for all participants. The health care cost trend rates
decline by .75% annually to 5.5% by 2011.
If the health care cost trend rate assumptions were increased or decreased
by 1%, the accumulated postretirement benefit obligation as of December 31, 2002
and the annual effect on the total of the service and interest costs would be
unchanged.
The Company's postretirement obligation is presented as a liability in the
Consolidated Balance Sheet under the caption Benefit Obligations.
61
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) POSTEMPLOYMENT BENEFITS
The Company provides postemployment benefits through CenterPoint Energy
plans for former or inactive employees, their beneficiaries and covered
dependents, after employment but before retirement (primarily health care and
life insurance benefits for participants in the long-term disability plan).
Postemployment benefits costs were less than $1 million for 2001 and 2002. The
Company recognized postemployment benefit income of $2 million for the year
ended December 31, 2000.
(e) OTHER NON-QUALIFIED PLANS
The Company participates in CenterPoint Energy's deferred compensation
plans which permit eligible participants to elect each year to defer a
percentage of up to 100% of that year's salary and that year's annual bonus.
Employees may elect to receive an early distribution of their deferral plus
interest after at least four years or any year, up to and including their age 65
retirement year. In general, employees who attain the age of 60 during
employment and participate in CenterPoint Energy's deferred compensation plans
may elect to have their deferred compensation amounts repaid in (a) 15 equal
annual installments commencing at the later of age 65 or termination of
employment or (b) a lump-sum distribution following termination of employment at
age 65. Interest generally accrues on deferrals at a rate equal to the average
Moody's Long-Term Corporate Bond Index plus 2%, determined annually until
termination when the rate is fixed at the rate in effect for the plan year
immediately prior to which a participant attains age 65. The Company recorded
interest expense related to its deferred compensation obligation of $2 million,
$0.8 million and $0.5 million for the years ended December 31, 2000, 2001 and
2002, respectively. The discounted deferred compensation obligation recorded by
the Company was $12 million and $4 million as of December 31, 2001 and 2002,
respectively.
(f) OTHER EMPLOYEE MATTERS
As of December 31, 2002, the Company employed approximately 1,639 people.
Of these employees, approximately 1,102 are covered by a collective bargaining
agreement with the International Brotherhood of Electrical Workers Local 66 that
extends through September 2003.
(7) INCOME TAXES
The Company's current and deferred components of income tax expense were as
follows:
YEAR ENDED DECEMBER 31,
------------------------------
2000 2001 2002
-------- -------- --------
(IN MILLIONS)
Current
Federal............................................ $ 59,346 $ 90,665 $(23,526)
State.............................................. 34,444 25,415 --
-------- -------- --------
Total current................................... 93,790 116,080 (23,526)
-------- -------- --------
Deferred
Federal............................................ 6,628 (42,199) (39,306)
State.............................................. (72) (77) --
-------- -------- --------
Income tax expense (benefit)......................... $100,346 $ 73,804 $(62,832)
======== ======== ========
62
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the federal statutory income tax rate to the effective
income tax rate is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
2000 2001 2002
-------- -------- ---------
(IN MILLIONS)
Income (loss) before income taxes................... $272,735 $202,192 $(155,775)
Federal statutory rate............................ 35% 35% 35%
-------- -------- ---------
Income tax expense (benefit) at statutory rate...... 95,457 70,767 (54,521)
-------- -------- ---------
Increase (decrease) in tax resulting from:
State income taxes, net of federal income tax
benefit........................................ 22,342 16,470 --
Amortization of investment tax credit............. (13,082) (13,106) (7,894)
Excess deferred taxes............................. (3,581) (4,353) --
Other, net........................................ (790) 4,026 (417)
-------- -------- ---------
Total........................................ 4,889 3,037 (8,311)
-------- -------- ---------
Income tax expense (benefit)........................ $100,346 $ 73,804 $ (62,832)
======== ======== =========
Effective Rate...................................... 36.8% 36.5% 40.3%
======== ======== =========
Following were the Company's tax effects of temporary differences between
the carrying amounts of assets and liabilities in the financial statements and
their respective tax bases:
DECEMBER 31,
-------------------
2001 2002
-------- --------
(IN MILLIONS)
Deferred tax assets:
Non-current:
Employee benefits...................................... $ 1,668 $ 4,588
Environmental reserves................................. 9,950 13,918
Other.................................................. 2,174 3,865
-------- --------
Total non-current deferred tax assets............. 13,792 22,371
-------- --------
Deferred tax liabilities:
Non-current:
Depreciation......................................... 908,387 829,125
Other................................................ 6,151 6,492
-------- --------
Total non-current deferred tax liabilities........ 914,538 835,617
-------- --------
Accumulated deferred income taxes, net............ $900,746 $813,246
======== ========
The Company is included in the consolidated income tax returns of
CenterPoint Energy. CenterPoint Energy's consolidated federal income tax returns
have been audited and settled through the 1996 tax year. The 1997, 1998 and 1999
consolidated federal income tax returns are currently under audit. No audit
adjustments that would impact the Company have been proposed for the current
audit cycle.
63
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES
(a) FUEL AND PURCHASED POWER COMMITMENTS
Fuel commitments include several long-term coal, lignite and natural gas
contracts. Minimum payment obligations related to coal and transportation
agreements and lignite mining and lease agreements that extend through 2012 are
approximately $292 million in 2003, $165 million in 2004, $169 million in 2005,
$174 million in 2006 and $167 million in 2007. Purchase commitments related to
purchased power are not material to the Company's operations. As of December 31,
2002, the pricing provisions in some of these contracts were above market.
(b) LEASE COMMITMENTS
The following table sets forth information concerning the Company's
obligations under non-cancelable long-term operating leases at December 31,
2002, which primarily consist of rental agreements for building space, data
processing equipment and vehicles, including major work equipment (in millions).
2003........................................................ $ 11
2004........................................................ 11
2005........................................................ 11
2006........................................................ 10
2007........................................................ 10
2008 and beyond............................................. 57
----
Total..................................................... $110
====
Total lease expense for all operating leases was $10 million, $10 million
and $11 million during 2000, 2001 and 2002, respectively.
(c) ENVIRONMENTAL, LEGAL AND OTHER
Clean Air Standards. Based on current limitations of the Texas Commission
on Environmental Quality (TCEQ) regarding emission of oxides of nitrogen (NOx)
in the Houston area, the Company anticipates investing up to $682 million for
emission control equipment through 2005, including $551 million expended from
January 1, 1999 through December 31, 2002, with possible additional expenditures
after 2005. NOx control estimates for 2006 and 2007 have not been finalized.
The Texas Utility Commission has determined that the Company's emission
control plan is the most effective control option. In addition, the Company is
required to provide $16.2 million in funding for certain NOx reduction projects
associated with East Texas pipeline companies.
Nuclear Insurance. The Company and the other owners of the South Texas
Project maintain nuclear property and nuclear liability insurance coverage as
required by law and periodically review available limits and coverage for
additional protection. The owners of the South Texas Project currently maintain
$2.75 billion in property damage insurance coverage, which is above the legally
required minimum, but is less than the total amount of insurance currently
available for such losses.
Under the Price Anderson Act, the maximum liability to the public of owners
of nuclear power plants was $9.3 billion as of December 31, 2002. Owners are
required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. The Company and the other owners currently
maintain the required nuclear liability insurance and participate in the
industry retrospective rating plan under which the owners of the South Texas
Project are subject to maximum retrospective assessments in the aggregate per
incident of up to $88 million per reactor. The owners are jointly and severally
liable at a rate not
64
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to exceed $10 million per incident per year. In addition, the security
procedures at this facility have recently been enhanced to provide additional
protection against terrorist attacks.
There can be no assurance that all potential losses or liabilities
associated with the South Texas Project will be insurable, or that the amount of
insurance will be sufficient to cover them. Any substantial losses not covered
by insurance would have a material effect on the Company's financial condition,
results of operations and cash flows.
Nuclear Decommissioning. The Company is the beneficiary of the
decommissioning trust that has been established to provide funding for
decontamination and decommissioning of the South Texas Project in which the
Company owns a 30.8% interest (see Note 5). CenterPoint Houston collects,
through rates or other authorized charges to its electric utility customers,
amounts designated for funding the decommissioning trust, and pays the amounts
to the Company. CenterPoint Energy deposits these amounts into the
decommissioning trust. Upon decommissioning of the facility, in the event funds
from the trust are inadequate, CenterPoint Houston or its successor will be
required to collect through rates or other authorized charges to customers as
contemplated by the Texas Utilities Code all additional amounts required to fund
the Company's obligations relating to the decommissioning of the facility.
Following the completion of the decommissioning, if surplus funds remain in the
decommissioning trust, the excess will be refunded to the ratepayers of
CenterPoint Houston or its successor. CenterPoint Energy is contractually
obligated to indemnify Texas Genco from and against any obligations relating to
the decommissioning not otherwise satisfied through collections by CenterPoint
Houston.
Joint Operating Agreement with City of San Antonio. The Company has a
joint operating agreement with the City Public Service Board of San Antonio
(CPS) to share savings from the joint dispatching of each party's generating
assets. Dispatching the two generating systems jointly results in savings of
fuel and related expenses because there is a more efficient utilization of each
party's lowest cost resources. The two parties equally share the savings
resulting from joint dispatch. The agreement terminates in 2009.
(d) OPTION TO PURCHASE CENTERPOINT ENERGY'S INTEREST IN THE COMPANY
Reliant Resources has an option (Reliant Resources Option) to purchase all
of the shares of common stock of the Company owned by CenterPoint Energy. The
Reliant Resources Option may be exercised between January 10, 2004 and January
24, 2004. The per share exercise price under the option will equal the average
daily closing price on the national exchange for publicly held shares of common
stock of the Company for the 30 consecutive trading days with the highest
average closing price for any 30 day trading period during the last 120 trading
days ending January 9, 2004, plus a control premium, up to a maximum of 10%, to
the extent a control premium is included in the valuation determination made by
the Texas Utility Commission relating to the market value of the Company. The
per share exercise price is also subject to adjustment based on the difference
between the per share dividends paid to CenterPoint Energy during the period
from January 6, 2003 through the option closing date and the Company's actual
per share earnings during that period. Reliant Resources has agreed that if it
exercises the Reliant Resources Option and purchases the shares of the Company's
common stock, Reliant Resources will also purchase from CenterPoint Energy all
notes and other payables owed by the Company to CenterPoint Energy as of the
option closing date, at their principal amount plus accrued interest. Similarly,
if there are notes or payables owed to the Company by CenterPoint Energy as of
the option closing date, Reliant Resources will assume those obligations in
exchange for a payment from CenterPoint Energy of an amount equal to the
principal plus accrued interest.
In the event that Reliant Resources exercises the Reliant Resources Option
in 2004, the Company would be required to step up or step down the tax basis in
all of its assets following the date of the sale to be equivalent generally to
the value of the equity of the Company (based upon the purchase price) plus the
principal amount of the Company's indebtedness at the time of the purchase. The
resulting step-up or step-
65
TEXAS GENCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
down in the basis of the Company's assets would impact its future tax
liabilities. A step-up would reduce the Company's future tax liabilities, while
a step-down would increase its liabilities. The Company cannot currently project
the impact of this tax election because it is dependent on (1) Reliant
Resources' exercise of its option in 2004, and (2) the purchase price to be paid
by Reliant Resources in 2004, which is not known at this time.
Exercise of the Reliant Resources Option by Reliant Resources will be
subject to various regulatory approvals, including Hart-Scott-Rodino antitrust
clearance and United States Nuclear Regulatory Commission license transfer
approval.
(9) UNAUDITED QUARTERLY INFORMATION
Summarized quarterly financial data is as follows:
YEAR ENDED DECEMBER 31, 2001
-------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN MILLIONS)
Revenues............................................ $977 $957 $898 $579
Operating income.................................... 29 95 116 25
Net income.......................................... 5 49 71 3
YEAR ENDED DECEMBER 31, 2002
-------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN MILLIONS)
Revenues............................................ $326 $414 $526 $275
Operating income (loss)............................. (52) (29) 7 (59)
Net income (loss)................................... (29) (24) 3 (43)
(10) GUARANTOR DISCLOSURES
As part of its normal business operations, Texas Genco, LP, a wholly owned
subsidiary, has also entered into power purchase and sale agreements to buy less
expensive power than Texas Genco's marginal cost of generation or to sell power
to another party who is willing to pay more than Texas Genco's marginal cost of
generation. Texas Genco has guaranteed the payment obligations of Texas Genco,
LP under certain of these agreements, typically for a one-year term. As of
December 31, 2002, Texas Genco had delivered 7 such guarantees with an aggregate
maximum potential exposure of $28.2 million and an aggregate carrying amount of
$-0-.
CenterPoint Energy has delivered guarantees in support of Texas Genco's
obligations to ERCOT under qualified scheduling entity and transmission
congestion rights agreements. These guarantees expire in October, 2003 and as of
December 31, 2002, have an aggregate maximum potential exposure of $45 million
and an aggregate carrying amount of $-0-.
(11) SUBSEQUENT EVENT
On February 7, 2003, the Company's board of directors declared an initial
quarterly cash dividend of $0.25 per share of common stock payable on March 20,
2003 to shareholders of record as of the close of business on February 26, 2003.
66
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Texas Genco Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of Texas Genco
Holdings, Inc., (the Company), an indirect wholly-owned subsidiary of
CenterPoint Energy, Inc., as of December 31, 2001 and 2002, and the related
statements of consolidated operations, cash flows and capitalization and
shareholder's equity for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company at December 31,
2001 and 2002, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Houston, Texas
February 28, 2003
67
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information called for by Item 10, to the extent not set forth in
"Executive Officers" in Item 1 of this Form 10-K, is or will be set forth in the
definitive proxy statement relating to Texas Genco's 2003 annual meeting of
shareholders pursuant to SEC Regulation 14A. Such definitive proxy statement
relates to a meeting of shareholders involving the election of directors and the
portions thereof called for by Item 10 are incorporated herein by reference
pursuant to Instruction G to Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
The information called for by Item 11 is or will be set forth in the
definitive proxy statement relating to Texas Genco's 2003 annual meeting of
shareholders pursuant to SEC Regulation 14A. Such definitive proxy statement
relates to a meeting of shareholders involving the election of directors and the
portions thereof called for by Item 11 are incorporated herein by reference
pursuant to Instruction G to Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information called for by Item 12 is or will be set forth in the
definitive proxy statement relating to Texas Genco's 2003 annual meeting of
shareholders pursuant to SEC Regulation 14A. Such definitive proxy statement
relates to a meeting of shareholders involving the election of directors and the
portions thereof called for by Item 12 are incorporated herein by reference
pursuant to Instruction G to Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for by Item 13 is or will be set forth in the
definitive proxy statement relating to Texas Genco's 2003 annual meeting of
shareholders pursuant to SEC Regulation 14A. Such definitive proxy statement
relates to a meeting of shareholders involving the election of directors and the
portions thereof called for by Item 13 are incorporated herein by reference
pursuant to Instruction G to Form 10-K.
PART IV
ITEM 14. CONTROLS AND PROCEDURES.
Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. Based
on that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information relating to us (including our consolidated
subsidiaries) required to be included in our periodic SEC filings. Subsequent to
the date of their evaluation, there were no significant changes in our internal
controls or in other factors that could significantly affect the internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
68
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements.
Statements of Consolidated Operations for the Three Years
Ended
December 31, 2002......................................... 47
Consolidated Balance Sheets at December 31, 2002 and 2001... 48
Statements of Consolidated Cash Flows for the Three Years
Ended
December 31, 2002......................................... 49
Statements of Consolidated Capitalization and Shareholder's
Equity for the Three Years Ended December 31,2002......... 50
Notes to Consolidated Financial Statements.................. 51
Independent Auditors' Report................................ 67
(a)(2) Financial Statement Schedules for the Three Years Ended
December 31, 2002.
The following schedules are omitted because of the absence of the
conditions under which they are required or because the required information is
included in the financial statements:
I, II, III, IV and V.
(a)(3) Exhibits
See Index of Exhibits on page 73.
(b) Reports on Form 8-K
On December 23, 2002, we filed a Current Report on Form 8-K dated December
20, 2002, containing Item 5 disclosure reporting that the Board of Directors of
CenterPoint Energy had declared a stock distribution of approximately 19% of the
80,000,000 outstanding shares of Texas Genco common stock to CenterPoint Energy
shareholders to take place on January 6, 2003.
On January 7, 2003, we filed a Current Report on Form 8-K dated January 6,
2003, containing Item 5 disclosure reporting that CenterPoint Energy had
distributed approximately 19% of the 80,000,000 outstanding shares of Texas
Genco common stock to CenterPoint Energy's common shareholders of record as of
the close of business on December 20, 2002.
On January 27, 2003, we filed a Current Report on Form 8-K dated January
27, 2003, containing Item 5 disclosure reporting that executives of Texas Genco
had hosted a live webcast of a conference call at 1:30 p.m. CST in which they
presented a general overview of Texas Genco's business.
69
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Houston, the State of Texas, on the twelfth day of March, 2003.
TEXAS GENCO HOLDINGS, INC.
(Registrant)
By: /s/ DAVID G. TEES
------------------------------------
David G. Tees
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 12, 2003.
SIGNATURE TITLE
--------- -----
/s/ DAVID G. TEES President, Chief Executive Officer and Director
------------------------------------------------ (Principal Executive Officer)
(David G. Tees)
/s/ GARY L. WHITLOCK Executive Vice President and Chief Financial
------------------------------------------------ Officer
(Gary L. Whitlock) (Principal Financial Officer)
/s/ JAMES S. BRIAN Senior Vice President and Chief Accounting Officer
------------------------------------------------ (Principal Accounting Officer)
(James S. Brian)
/s/ DAVID M. MCCLANAHAN Director
------------------------------------------------
(David M. McClanahan)
70
CERTIFICATIONS
I, David G. Tees, certify that:
1. I have reviewed this annual report on Form 10-K of Texas Genco Holdings,
Inc.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: March 12, 2003
By: /s/ DAVID G. TEES
----------------------------------
David G. Tees
President and Chief Executive
Officer
71
I, Gary L. Whitlock, certify that:
1. I have reviewed this annual report on Form 10-K of Texas Genco Holdings,
Inc.;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: March 12, 2003
By: /s/ GARY L. WHITLOCK
----------------------------------
Gary L. Whitlock
Executive Vice President and
Chief Financial Officer
72
TEXAS GENCO HOLDINGS, INC.
EXHIBITS TO THE ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2002
INDEX OF EXHIBITS
Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated herein by reference
to a prior filing as indicated.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
--------- ----------- -------------------------------- ------------ ---------
+3.1 -- Amended and Restated Articles
of Incorporation
+3.2 -- Amended and Restated Bylaws
4.1 -- Specimen Stock Certificate Texas Genco Holdings, Inc.'s 001-31449 4.1
("Texas Genco") registration
statement on Form 10
+10.1 -- Separation Agreement between
CenterPoint Energy, Inc.
("CenterPoint Energy") and
Texas Genco effective as of
August 31, 2002
10.2 -- Texas Genco Option Agreement CenterPoint Energy Houston 1-3187 10.4
Electric, LLC's (formerly
Reliant Energy, Incorporated)
("REI") quarterly report on Form
10-Q for the quarter ended March
31, 2001
+10.3 -- Transition Services Agreement
between CenterPoint Energy and
Texas Genco effective as of
August 31, 2002
10.4 -- Technical Services Agreement CenterPoint Houston's quarterly 001-31449 10.3
report on Form 10-Q for the
quarter ended March 31, 2001
+10.5 -- Tax Allocation Agreement
between CenterPoint Energy and
Texas Genco effective as of
August 31, 2002
10.6(a) -- Executive Benefit Plan of Houston Industries 1-7629 10(a)(1),(a)(2)
CenterPoint and First and Incorporated's ("HI") Form 10-Q and (a)(3)
Second Amendments thereto for the quarter ended March 31,
effective as of June 1, 1982, 1987
July 1, 1984 and May 7, 1986,
respectively
10.6(b) -- Third Amendment to Exhibit REI's Form 10-K for the year 1-3187 10(a)(2)
10.6(a) dated September 17, ended December 31, 2000
1999
10.7(a) -- Executive Life Insurance Plan HI's Form 10-K for the year 1-7629 10(q)
of CenterPoint effective as of ended December 31, 1993
January 1, 1994
73
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
--------- ----------- -------------------------------- ------------ ---------
10.7(b) -- First Amendment to Exhibit HI's Form 10-Q for the quarter 1-7629 10
10.7(a) effective as of January ended June 30, 1995
1, 1994
10.7(c) -- Second Amendment to Exhibit REI's Form 10-K for the year 1-3187 10(s)(3)
10.7(a) effective as of August ended December 31, 1997
6, 1997
10.8(a) -- Long-Term Incentive HI's Form 10-Q for the quarter 1-7629 10(c)
Compensation Plan of ended June 30, 1989
CenterPoint effective as of
January 1, 1989
10.8(b) -- First Amendment to Exhibit HI's Form 10-K for the year 1-7629 10(f)(2)
10.8(a) effective as of January ended December 31, 1989
1, 1990
10.8(c) -- Second Amendment to Exhibit HI's Form 10-K for the year 1-7629 10(u)(3)
10.8(a) effective as of ended December 31, 1992
December 22, 1992
10.8(d) -- Third Amendment to Exhibit REI's Form 10-K for the year 1-3187 10(m)(4)
10.8(a) effective as of August ended December 31, 1997
6, 1997
10.9 -- Retention Agreement effective REI's Form 10-K for the year 1-3187 10(jj)
October 15, 2001 between REI ended December 31, 2001
and David G. Tees
10.10(a) -- Deferred Compensation Plan of HI's Form 10-K for the year 1-7629 10((d)(3)
CenterPoint effective as of ended December 31, 1990
January 1, 1991
10.10(b) -- First Amendment to Exhibit HI's Form 10-K for the year 1-7629 10(j)(2)
10.10(a) effective as of ended December 31, 1991
January 1, 1991
10.10(c) -- Second Amendment to Exhibit HI's Form 10-Q for the quarter 1-7629 10(g)
10.10(a) effective as of March ended March 31, 1992
30, 1992
10.10(d) -- Third Amendment to Exhibit HI's Form 10-K for the year 1-7629 10(j)(4)
10.10(a) effective as of June ended December 31, 1993
2, 1993
10.10(e) -- Fourth Amendment to Exhibit HI's Form 10-K for the year 1-7629 10(j)(5)
10.10(a) effective as of ended December 31, 1993
December 1, 1993
10.10(f) -- Fifth Amendment to Exhibit HI's Form 10-K for the year 1-7629 10(j)(6)
10.10(a) effective as of ended December 31, 1994
September 7, 1994
10.10(g) -- Sixth Amendment to Exhibit HI's Form 10-Q for the quarter 1-7629 10(b)
10.10(a) effective as of August ended June 30, 1995
1, 1995
10.10(h) -- Seventh Amendment to Exhibit HI's Form 10-Q for the quarter 1-7629 10(d)
10.10(a) effective as of ended June 30, 1996
December 1, 1995
74
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
--------- ----------- -------------------------------- ------------ ---------
10.10(i) -- Eighth Amendment to Exhibit HI's Form 10-Q for the quarter 1-7629 10(d)
10.10(a) effective as of ended June 30, 1997
January 1, 1997
10.10(j) -- Ninth Amendment to Exhibit REI's Form 10-K for the year 1-3187 10(1)(10)
10.10(a) effective in part ended December 31, 1997
August 6, 1997, in part October
1, 1997 and in part January 1,
1998
10.10(k) -- Tenth Amendment to Exhibit REI's Form 10-K for the year 1-3187
10.10(a) effective as of ended December 31, 1997
September 3, 1997
10.11 -- Assignment and Assumption Texas Genco's registration 1-31449 10.11
Agreement for the Technical statement on Form 10
Services Agreement entered into
as of August 31, 2002, by and
between Texas Genco, LP and REI
10.12 -- Undertaking to Comply with Texas Genco's registration 1-31449 10.12
Certain Provisions of Option statement on Form 10
Agreement entered into as of
August 31, 2002 by Texas Genco
+10.13 -- Amendment No. 1 to Texas Genco
Option Agreement dated February
21, 2003
21.1 -- Subsidiaries of Texas Genco Texas Genco's registration 1-31449 21.1
statement on Form 10
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