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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to _______________
------------------------------
Commission file number 1-13265
RELIANT ENERGY RESOURCES CORP.
(Exact name of registrant as specified in its charter)
Delaware 76-0511406
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
-----------------------------
RELIANT ENERGY RESOURCES CORP. MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q
WITH THE REDUCED DISCLOSURE FORMAT.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of August 9, 2002, all 1,000 shares of Reliant Energy Resources Corp. common
stock were held by Reliant Energy, Incorporated.
RELIANT ENERGY RESOURCES CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.................................... 1
Statements of Consolidated Operations
Three Months and Six Months Ended June 30, 2001
and 2002 (unaudited)................................... 1
Consolidated Balance Sheets
December 31, 2001 and June 30, 2002 (unaudited)........... 2
Statements of Consolidated Cash Flows
Three Months and Six Months Ended June 30, 2001
and 2002 (unaudited)................................... 4
Notes to Unaudited Consolidated Financial Statements......... 5
Item 2. Management's Narrative Analysis of the Results
of Operations of Reliant Energy Resources Corp.
and Subsidiaries............................................ 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................... 18
Item 5. Other Information...................................... 18
Item 6. Exhibits and Reports on Form 8-K....................... 19
PART I. FINANCIAL INFORMATION
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED OPERATIONS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------------- ---------------------------------
2001 2002 2001 2002
----------- ----------- ----------- -----------
REVENUES ................................... $ 959,998 $ 868,471 $ 3,382,851 $ 2,110,750
EXPENSES:
Natural gas .............................. 712,925 583,526 2,704,448 1,445,105
Operation and maintenance ................ 180,829 164,788 340,574 329,501
Depreciation ............................. 36,203 38,412 72,028 74,989
Amortization ............................. 15,417 3,569 30,813 7,263
Taxes other than income
taxes .................................. 30,703 29,800 77,136 62,320
----------- ----------- ----------- -----------
Total .................................. 976,077 820,095 3,224,999 1,919,178
----------- ----------- ----------- -----------
OPERATING (LOSS) INCOME .................... (16,079) 48,376 157,852 191,572
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest expense ......................... (40,486) (38,056) (78,620) (73,633)
Distribution on trust
preferred securities ................... (7) (7) (14) (13)
Other, net ............................... 8,575 3,598 11,970 5,854
----------- ----------- ----------- -----------
Total .................................. (31,918) (34,465) (66,664) (67,792)
----------- ----------- ----------- -----------
(LOSS) INCOME BEFORE INCOME
TAXES .................................... (47,997) 13,911 91,188 123,780
Income Tax (Benefit)
Expense ............................... (14,383) 6,164 44,445 46,864
----------- ----------- ----------- -----------
NET (LOSS) INCOME .......................... $ (33,614) $ 7,747 $ 46,743 $ 76,916
=========== =========== =========== ===========
See Notes to RERC's Interim Financial Statements
1
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, JUNE 30,
2001 2002
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 16,425 $ 30,382
Accounts and notes receivable, principally customers, net .......... 479,279 316,233
Accrued unbilled revenue ........................................... 188,425 21,875
Accounts and notes receivable - affiliated companies, net .......... 39,393 100,077
Materials and supplies ............................................. 33,276 32,518
Fuel and petroleum products ........................................ 111,193 72,612
Non-trading derivative assets ...................................... 6,996 10,621
Other .............................................................. 17,932 10,279
----------- -----------
Total current assets ............................................. 892,919 594,597
----------- -----------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment ...................................... 3,669,037 3,752,866
Less accumulated depreciation ...................................... (521,960) (573,695)
----------- -----------
Property, plant and equipment, net ............................... 3,147,077 3,179,171
----------- -----------
OTHER ASSETS:
Goodwill, net ...................................................... 1,740,510 1,740,510
Other intangibles, net ............................................. 17,980 18,987
Prepaid pension asset .............................................. 94,022 87,716
Non-trading derivative assets ...................................... 2,234 811
Other .............................................................. 94,221 56,953
----------- -----------
Total other assets ............................................... 1,948,967 1,904,977
----------- -----------
TOTAL ASSETS ......................................................... $ 5,988,963 $ 5,678,745
=========== ===========
See Notes to RERC's Interim Financial Statements
2
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS) -- (CONTINUED)
(UNAUDITED)
LIABILITIES AND STOCKHOLDER'S EQUITY
DECEMBER 31, JUNE 30,
2001 2002
----------- -----------
CURRENT LIABILITIES:
Short-term borrowings ........................................................ $ 345,527 $ 147,671
Accounts payable, principally trade .......................................... 267,649 267,353
Interest accrued ............................................................. 44,795 44,528
Taxes accrued ................................................................ 53,693 25,442
Customer deposits ............................................................ 52,089 49,738
Non-trading derivative liabilities ........................................... 59,075 6,789
Other ........................................................................ 95,180 55,629
----------- -----------
Total current liabilities .............................................. 918,008 597,150
----------- -----------
OTHER LIABILITIES:
Accumulated deferred income taxes, net ....................................... 555,387 491,198
Benefit obligations .......................................................... 177,559 172,185
Non-trading derivative liabilities ........................................... 9,826 68
Notes payable - affiliated companies, net .................................... 27,311 27,340
Other ........................................................................ 152,696 136,958
----------- -----------
Total other liabilities .................................................. 922,779 827,749
----------- -----------
LONG-TERM DEBT ................................................................. 1,927,039 1,919,153
----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 11)
RERC OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF RERC ...... 555 555
----------- -----------
STOCKHOLDER'S EQUITY:
Common stock ................................................................. 1 1
Paid-in capital .............................................................. 2,255,395 2,255,395
Retained earnings ............................................................ 1,837 78,753
Accumulated other comprehensive loss ......................................... (36,651) (11)
----------- -----------
Total stockholder's equity ............................................... 2,220,582 2,334,138
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY .................................. $ 5,988,963 $ 5,678,745
=========== ===========
See Notes to RERC's Interim Financial Statements
3
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-----------------------------
2001 2002
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................................................................. $ 46,743 $ 76,916
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization ......................................................... 102,841 82,252
Deferred income taxes ................................................................. (3,686) (71,963)
Changes in other assets and liabilities:
Accounts and notes receivable, net .................................................. 650,994 329,596
Accounts receivable/payable, affiliates ............................................. (55,179) (79,064)
Inventory ........................................................................... (17,953) 39,339
Accounts payable .................................................................... (417,708) (296)
Fuel cost recovery .................................................................. 43,818 32,030
Interest and taxes accrued .......................................................... (86,640) (28,518)
Net non-trading derivative assets and liabilities ................................... 815 (52,979)
Other current assets ................................................................ 16,245 7,807
Other current liabilities ........................................................... (29,178) (41,386)
Other assets ........................................................................ (19,980) 81
Other liabilities ................................................................... 15,722 11,365
Other, net .......................................................................... 43,292 --
--------- ---------
Net cash provided by operating activities ......................................... 290,146 305,180
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .................................................................... (125,224) (117,991)
Other, net .............................................................................. (14,628) 14,100
--------- ---------
Net cash used in investing activities ............................................. (139,852) (103,891)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt .............................................................. (125,472) (6,633)
Proceeds from long-term debt ............................................................ 544,632 --
Decrease in short-term borrowings, net .................................................. (285,000) (197,856)
(Decrease) increase in notes with affiliates, net ....................................... (130,567) 18,410
Dividend ................................................................................ (400,000) --
Capital contribution from Reliant Energy ................................................ 236,000 --
Other, net .............................................................................. (3,054) (1,253)
--------- ---------
Net cash used in financing activities ............................................. (163,461) (187,332)
--------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ....................................... (13,167) 13,957
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD ....................................... 22,576 16,425
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD ............................................. $ 9,409 $ 30,382
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) ................................................... $ 70,922 $ 73,719
Income taxes ............................................................................ 114,071 153,360
See Notes to RERC's Interim Financial Statements
4
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Included in this Quarterly Report on Form 10-Q (Form 10-Q) for Reliant Energy
Resources Corp. (RERC Corp.), together with its subsidiaries (RERC), are RERC's
consolidated interim financial statements and notes (Interim Financial
Statements) including its wholly owned and majority owned subsidiaries. The
Interim Financial Statements are unaudited, omit certain financial statement
disclosures and should be read with the Amended Annual Report on Form 10-K/A of
RERC Corp. (RERC Corp. Form 10-K/A) for the year ended December 31, 2001 which
was filed with the Securities and Exchange Commission (SEC) on July 15, 2002 and
the Quarterly Report on Form 10-Q of RERC Corp. for the quarter ended March 31,
2002.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
RERC's Interim Financial Statements reflect all normal recurring adjustments
that are, in the opinion of management, necessary to present fairly the
financial position and results of operations for the respective periods. Amounts
reported in RERC's Statements of Consolidated Operations are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (a) seasonal variations in energy consumption, (b) timing of
maintenance and other expenditures and (c) acquisitions and dispositions of
assets and other interests. In addition, certain amounts from the prior year
have been reclassified to conform to RERC's presentation of financial statements
in the current year. These reclassifications do not affect earnings of RERC.
The following notes to the consolidated financial statements in the RERC
Corp. Form 10-K/A relate to certain contingencies. These notes, as updated
herein, are incorporated herein by reference:
Notes to Consolidated Financial Statements (RERC Corp. 10-K/A Notes): Note
3(f) (Regulatory Assets), Note 5 (Derivative Instruments) and Note 10
(Commitments and Contingencies).
For information regarding environmental matters and legal proceedings, see
Note 11.
(2) NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 141 "Business
Combinations" (SFAS No. 141). SFAS No. 141 requires business combinations
initiated after June 30, 2001 to be accounted for using the purchase method of
accounting and broadens the criteria for recording intangible assets separate
from goodwill. Recorded goodwill and intangibles will be evaluated against these
new criteria and may result in certain intangibles being transferred to
goodwill, or alternatively, amounts initially recorded as goodwill may be
separately identified and recognized apart from goodwill. RERC adopted the
provisions of the statement which apply to goodwill and intangible assets
acquired prior to June 30, 2001 on January 1, 2002. The adoption of SFAS No. 141
did not have a material impact on RERC's historical results of operations or
financial position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. SFAS No. 144 supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," while retaining many of the requirements of these two statements.
Under SFAS No. 144, assets held for sale that are a component of an entity will
be included in discontinued operations if the operations and cash flows will be
or have been eliminated from the ongoing operations of the entity and the entity
will not have any significant continuing involvement in the operations
prospectively. SFAS No. 144 did not materially change the methods used by RERC
to measure impairment losses on long-lived assets, but may result in
5
additional future dispositions being reported as discontinued operations than
was previously permitted. RERC adopted SFAS No. 144 on January 1, 2002.
See Note 3 for a discussion of RERC's adoption of SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended (SFAS No. 133),
on January 1, 2001. See Note 6 for a discussion of RERC's adoption of SFAS No.
142 "Goodwill and Other Intangible Assets" (SFAS No. 142) on January 1, 2002.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent.
SFAS No. 145 also requires 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. RERC will apply this guidance prospectively.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146 nullifies EITF
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)" (EITF No. 94-3). The principal difference between SFAS No. 146
and EITF No. 94-3 relates to the requirements for recognition of a liability for
cost associated with an exit or disposal activity. SFAS No. 146 requires that a
liability be recognized for a cost associated with an exit or disposal activity
when it is incurred. A liability is incurred when a transaction or event occurs
that leaves an entity little or no discretion to avoid the future transfer or
use of assets to settle the liability. Under EITF No. 94-3, a liability for an
exit cost was recognized at the date of an entity's commitment to an exit plan.
In addition, SFAS No. 146 also requires that a liability for a cost associated
with an exit or disposal activity be recognized at its fair value when it is
incurred. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002 with early application encouraged. RERC will
apply the provisions of SFAS No. 146 to all exit or disposal activities
initiated after December 31, 2002
(3) DERIVATIVE INSTRUMENTS
Adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative
after-tax increase in accumulated other comprehensive income of $38 million.
Cash Flow Hedges. During the six months ended June 30, 2002, there was no
hedge ineffectiveness recognized in earnings from derivatives that are
designated and qualify as cash flow hedges. No component of the derivative
instruments' gain or loss was excluded from the assessment of effectiveness.
During the six months ended June 30, 2002, a $0.9 million deferred loss was
recognized in earnings as a result of the discontinuance of a cash flow hedge
because it was no longer probable that the forecasted transaction would occur
due to credit problems of a customer. As of June 30, 2002, RERC expects a gain
of $4 million in accumulated other comprehensive income to be reclassified into
net income during the next twelve months.
(4) RELIANT ENERGY'S SEPARATION PLAN
Reliant Energy, Incorporated (Reliant Energy) is in the process of separating
its regulated and unregulated businesses into two publicly traded companies that
will be independent of each other: CenterPoint Energy, Inc. (CenterPoint Energy)
and Reliant Resources, Inc (Reliant Resources). In December 2000, Reliant Energy
transferred a significant portion of its unregulated businesses, including
certain businesses that had been subsidiaries of RERC, to Reliant Resources,
which, at the time, was a wholly owned subsidiary of Reliant Energy. Reliant
Resources conducted an initial public offering of approximately 20% of its
common stock in May 2001. In December 2001, Reliant Energy's shareholders
approved an agreement and plan of merger by which, subject to regulatory
approvals, the following will occur (which is referred to herein as the
Restructuring):
o CenterPoint Energy will become the holding company for the Reliant Energy
group of companies;
6
o Reliant Energy and its subsidiaries will become subsidiaries of
CenterPoint Energy; and
o each share of Reliant Energy common stock will be converted into one share
of CenterPoint Energy common stock.
After the Restructuring, Reliant Energy plans, subject to further corporate
approvals, market and other conditions, to complete the separation of its
regulated and unregulated businesses by distributing the shares of common stock
of Reliant Resources that CenterPoint Energy owns to the CenterPoint Energy's
shareholders (which is referred to herein as the Distribution). RERC currently
expects Reliant Energy to complete the Restructuring by August 31, 2002 and the
Distribution early in the fall of 2002. However, no assurance can be provided
that the Distribution will occur as described above or that it will occur within
this time period. From the consummation of the Restructuring until the
Distribution, RERC expects that CenterPoint Energy will do business under the
name Reliant Energy, Incorporated and that CenterPoint Energy's common stock
will trade under the symbol "REI."
On July 5, 2002, Reliant Energy received an order from the SEC approving
Reliant Energy's restructuring plan and the Distribution under the Public
Utility Holding Company Act of 1935 (1935 Act). On July 31, 2002, Reliant Energy
received a private letter ruling from the Internal Revenue Service which
confirms that the Distribution will be tax-free to Reliant Energy and its
shareholders.
Contemporaneous with the Restructuring, RERC expects CenterPoint Energy to
register and become subject, with its subsidiaries, to regulation as a
registered holding company system under the 1935 Act. The 1935 Act directs the
SEC to regulate, among other things, financings, sales or acquisitions of assets
and intra-system transactions.
In connection with the Restructuring, in order to enable CenterPoint Energy
ultimately to satisfy the requirements for an exemption from regulation as a
registered holding company under the 1935 Act, Reliant Energy is seeking
authority to divide the gas distribution businesses conducted by RERC Corp.'s
three unincorporated gas distribution divisions, Reliant Energy Entex, Reliant
Energy Arkla and Reliant Energy Minnegasco, among three separate entities. The
entity that will hold the Reliant Energy Entex assets will also hold ownership
of RERC Corp.'s natural gas pipelines and gathering business. Reliant Energy has
obtained approval of these transactions from the public service commissions of
Minnesota, Louisiana, Mississippi, Oklahoma and Arkansas. Although RERC Corp.
expects that this business restructuring of RERC Corp. can be completed, RERC
Corp. can provide no assurance that this will, in fact, occur, or that
CenterPoint Energy will ultimately be exempt from registration under the 1935
Act. For further information on the RERC Corp. restructuring, see "Our Business
in Item 1 of the RERC Corp. Form 10-K/A.
(5) REGULATORY MATTERS
(a) Arkla Rate Case.
In November 2001, Reliant Energy Arkla filed a rate request in Arkansas
seeking rates to yield approximately $47 million in additional annual revenue.
On August 9, 2002, a settlement was approved by the Arkansas Public Service
Commission (APSC) which will result in an increase in base rates of
approximately $32 million annually. In addition, the APSC approved a gas main
replacement surcharge which is expected to provide $2 million in 2003 and
additional amounts in subsequent years. The settlement provides for a new
residential rate design which increases the monthly customer charge. The new
rates are expected to be effective September 21, 2002.
(b) Oklahoma Rate Case.
In May 2002, Reliant Energy Arkla filed a rate change request for an increase
in rates that would yield approximately $13.7 million annually in Oklahoma. A
decision on this request is expected from the Oklahoma Corporation Commission no
later than early 2003.
(c) City of Tyler, Texas Hearing on Gas Costs.
By letter to Reliant Energy Entex dated July 31, 2002, the City of Tyler,
Texas expressed "serious concerns" regarding amounts that Entex has paid for gas
purchased for resale to residential and small commercial customers in that city
under supply agreements in effect since 1992. Entex's gas costs for its Tyler
system are recovered from customers pursuant to tariffs approved by the city and
filed with both the city and the Railroad Commission of Texas. In the July 31,
letter, the city forwarded various computations of what it believes to be
excessive costs ranging from approximately $2.8 million to $39.2 million. The
City has called a hearing for September 25, 2002 to consider these issues. The
Company believes (i) that all gas costs for Entex's Tyler distribution system
have been properly included and recovered from customers pursuant to Entex's
filed tariffs (ii) that the City has no legal or factual support for the
statements made in its letter and (iii) that the city has no authority to
require or demand refunds of any amounts Entex has charged its customers in the
City of Tyler.
7
(6) GOODWILL AND INTANGIBLES
In July 2001, the FASB issued SFAS No. 142, which provides for a
nonamortization approach, whereby goodwill and certain intangibles with
indefinite lives will not be amortized into results of operations, but instead
will be reviewed periodically for impairment and written down and charged to
results of operations only in the periods in which the recorded value of
goodwill and certain intangibles with indefinite lives is more than its fair
value. RERC adopted the provisions of the statement which apply to goodwill and
intangible assets acquired prior to June 30, 2001 on January 1, 2002.
With the adoption of SFAS No. 142, RERC ceased amortization of goodwill as
of January 1, 2002. A reconciliation of previously reported net income to the
amounts adjusted for the exclusion of goodwill amortization follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2001 2002 2001 2002
---- ---- ---- ----
(IN MILLIONS)
Reported net (loss) income .............................. $(34) $ 8 $ 47 $ 77
Add: Goodwill amortization, net of tax .................. 12 -- 24 --
---- ---- ---- ----
Adjusted net (loss) income .............................. $(22) $ 8 $ 71 $ 77
==== ==== ==== ====
The components of RERC's other intangible assets consist of the following:
DECEMBER 31, 2001 JUNE 30, 2002
----------------------------- -----------------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
(IN MILLIONS)
Land Use Rights ......................................... $ 7 $ (2) $ 7 $ (2)
Other ................................................... 15 (2) 16 (2)
---- ---- ---- ----
Total ................................................... $ 22 $ (4) $ 23 $ (4)
==== ==== ==== ====
RERC recognizes specifically identifiable intangibles when specific rights
and contracts are acquired. RERC amortizes other acquired intangibles on a
straight-line basis over the lesser of their contractual or estimated useful
lives. RERC has no intangible assets with indefinite lives recorded as of June
30, 2002.
Amortization expense for other intangibles for the three and six months
ended June 30, 2001 was $0.1 million and $0.3 million, respectively.
Amortization expense for other intangibles for the three and six months ended
June 30, 2002 was $0.2 million and $0.5 million, respectively. Estimated
amortization expense for the remainder of 2002 is approximately $0.6 million and
is approximately $1 million per year for the five succeeding fiscal years.
Goodwill as of June 30, 2002 by reportable business segment is as follows
(in millions):
AS OF
JUNE 30, 2002
-------------
Natural Gas Distribution....... $1,085
Pipelines and Gathering........ 601
Other Operations............... 54
------
Total........................ $1,740
======
As of June 30, 2002 RERC has completed its review of goodwill impairment
for its reporting units pursuant to SFAS No. 142. No impairment was indicated as
a result of this assessment.
(7) SHORT-TERM BORROWINGS
RERC Corp. has a receivables facility under which it sells certain of its
and its subsidiaries' customer accounts receivable. Advances under this facility
are reflected in the Consolidated Balance Sheets as short-term debt. In the
first quarter of 2002, RERC Corp. reduced its trade receivables facility from
$350 million to $150 million. Borrowings under the receivables facility
aggregating $196 million were repaid in January 2002 with proceeds from the
issuance of commercial paper under RERC Corp.'s $350 million revolving credit
facility and from the
8
liquidation of short-term investments. The $150 million RERC Corp. receivables
facility was scheduled to expire on August 14, 2002. RERC Corp. has extended the
facility to October 31, 2002, during which time RERC Corp. expects to negotiate
a new receivables facility with the financial institution that provides the
current facility. At June 30, 2002, RERC Corp. had $2.5 million of letters of
credit outstanding under the revolving credit facility. RERC had no commercial
paper or bank loans outstanding at June 30, 2002. RERC expects to evaluate
various alternatives for renewing or replacing this bank facility prior to its
scheduled expiration date of March 31, 2003.
(8) TRUST PREFERRED SECURITIES
A statutory business trust created by RERC Corp. (RERC Trust) has issued
convertible trust preferred securities, the terms of which, and the related
series of convertible junior subordinated debentures, are described below (in
millions):
AGGREGATE LIQUIDATION
AMOUNT
-------------------------- DISTRIBUTION MANDATORY
DECEMBER 31, JUNE 30, RATE/ REDEMPTION DATE/ JUNIOR SUBORDINATED
TRUST 2001 2002 INTEREST RATE MATURITY DATE DEBENTURES
----- ------------ -------- ------------- ---------------- -------------------
RERC Trust $ 1 $ 1 6.25% June 2026 6.25% Convertible Junior
Subordinated Debentures
due 2026
For additional information regarding the convertible preferred securities,
see Note 7 to the RERC Corp. 10-K/A Notes, which is incorporated herein by
reference. The sole asset of the trust consists of convertible junior
subordinated debentures of RERC Corp. having an interest rate and maturity date
that correspond to the distribution rate and mandatory redemption date of the
convertible preferred securities, and a principal amount corresponding to the
common and convertible preferred securities issued by the trust.
(9) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income:
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2001 2002 2001 2002
---- ---- ---- ----
(IN MILLIONS)
Net (loss) income ............................. $(34) $ 8 $ 47 $ 77
Other comprehensive (loss) income:
Additional minimum non-qualified pension
liability adjustment ....................... 3 -- 4 --
Cumulative effect of adoption of SFAS
No. 133 .................................... -- -- 38 --
Net deferred (loss) gain from cash flow
hedges ..................................... (50) (10) (60) 36
Reclassification of deferred (gain) loss
on derivatives realized in net income ...... (1) (3) (14) 1
---- ---- ---- ----
Other comprehensive (loss) income ............. (48) (13) (32) 37
---- ---- ---- ----
Comprehensive (loss) income ................... $(82) $ (5) $ 15 $114
==== ==== ==== ====
(10) RELATED PARTY TRANSACTIONS
From time to time, RERC has advanced money to, or borrowed money from,
Reliant Energy or its subsidiaries. As of December 31, 2001 and June 30, 2002,
RERC had net short-term receivables, included in accounts and notes
receivable-affiliated companies, totaling $132 million and $114 million,
respectively, partially offset by net accounts payable of $93 million and $14
million, respectively. As of December 31, 2001 and June 30, 2002, RERC had net
long-term borrowings, included in notes payable-affiliated companies, totaling
$27 million. For the three and six months ended June 30, 2001, RERC had net
interest income of $3 million and $5 million, respectively. For the three and
six months ended June 30, 2002, RERC had net interest income of $0.4 million and
$0.3 million, respectively.
In 2001 and 2002, RERC supplied natural gas to Reliant Energy Services,
Inc. (RES), now a subsidiary of Reliant Resources. For the three and six months
ended June 30, 2001, the sales and services by RERC to Reliant Energy and
9
its affiliates totaled $54 million and $133 million, respectively. For the three
and six months ended June 30, 2002, the sales and services by RERC to Reliant
Energy and its affiliates totaled $28 million and $42 million, respectively.
Purchases by RERC of natural gas from Reliant Energy and its affiliates were
$129 million and $431 million for the three and six months ended June 30, 2001,
respectively, and $51 million and $158 million for the three and six months
ended June 30, 2002, respectively.
Reliant Energy provides some corporate services to RERC, including various
corporate support services (including accounting, finance, investor relations,
planning, legal, communications, governmental and regulatory affairs and human
resources), information technology services and other shared services such as
corporate security, facilities management, accounts receivable, accounts
payable, payroll, office support services, customer care services and purchasing
and logistics. The costs of services have been directly charged or allocated to
RERC using methods that management believes are reasonable. These methods
include negotiated usage rates, dedicated asset assignment, and proportionate
corporate formulas based on assets, operating expenses and employees. These
charges and allocations are not necessarily indicative of what would have been
incurred had RERC been a separate entity. Amounts charged and allocated to RERC
for these services were $21 million and $38 million for the three and six months
ended June 30, 2001, respectively, and $25 million and $51 million for the three
and six months ended June 30, 2002, respectively, and are included primarily in
operation and maintenance expenses. Rent expense paid by RERC to Reliant Energy
for the three and six months ended June 30, 2001 was $0.4 million and $0.8
million, respectively, and $1.0 million and $1.9 million for the three and six
months ended June 30, 2002, respectively.
(11) ENVIRONMENTAL MATTERS AND LEGAL PROCEEDINGS
(a) Environmental Matters.
Hydrocarbon Contamination. On August 24, 2001, 37 plaintiffs filed suit
against Reliant Energy Gas Transmission Company, Inc. (REGT), Reliant Energy
Pipeline Services, Inc., RERC, RES, other Reliant Energy entities and third
parties (Docket No. 460, 916-Div. "B"), in the 1st Judicial District Court,
Caddo Parish, Louisiana. The petition has now been supplemented five times. As
of July 29, 2002, there were 649 plaintiffs, a majority of whom are Louisiana
residents. In addition to the Reliant Energy entities, the plaintiffs have sued
the State of Louisiana through its Department of Environmental Quality, several
individuals, some of whom are present employees of the State of Louisiana, the
Bayou South Gas Gathering Company, L.L.C., Martin Timber Company, Inc., and
several trusts. Additionally on April 4, 2002, two plaintiffs filed a separate
suit with identical allegations against the same parties (Docket No. 465,
944-Div. "B") in the same court.
The suits allege that, at some unspecified date prior to 1985, the defendants
allowed or caused hydrocarbon or chemical contamination of the Wilcox Aquifer
which lies beneath property owned or leased by certain of the defendants and
which is the sole or primary drinking water aquifer in the area. The primary
source of the contamination is alleged by the plaintiffs to be a gas processing
facility in Haughton, Bossier Parish, Louisiana known as the "Sligo Facility."
This facility was purportedly used for gathering natural gas from surrounding
wells, separating gasoline and hydrocarbons from the natural gas for marketing,
and transmission of natural gas for distribution. This site was originally
leased and operated by predecessors of REGT in the late 1940s and was operated
until Arkansas Louisiana Gas Company ceased operations of the plant in the late
1970s.
Beginning about 1985, the predecessors of certain Reliant Energy defendants
engaged in a voluntary remediation of any subsurface contamination of the
groundwater below the property they own or lease. This work has been done in
conjunction with and under the direction of the Louisiana Department of
Environmental Quality. The plaintiffs seek monetary damages for alleged damage
to the aquifer underlying their property, unspecified alleged personal injuries,
alleged fear of cancer, alleged property damage or dimunition of value of their
property, and, in addition, seek damages for trespass, punitive, and exemplary
damages. The quantity of monetary damages sought is unspecified. As of June 30,
2002, RERC is unable to estimate the monetary damages, if any, that the
plaintiffs may be awarded in these matters.
Manufactured Gas Plant Sites. RERC and its predecessors operated a
manufactured gas plant (MGP) until 1960 adjacent to the Mississippi River in
Minnesota, formerly known as Minneapolis Gas Works (MGW). RERC has substantially
completed remediation of the main site other than ongoing water monitoring and
treatment. The manufactured gas was stored in separate holders. RERC is
negotiating clean-up of one such holder. There are six
10
other former MGP sites in the Minnesota service territory. Remediation has been
completed on one site. Of the remaining five sites, RERC believes that two were
neither owned nor operated by RERC. RERC believes it has no liability with
respect to the sites it neither owned nor operated.
At June 30, 2002, RERC had accrued $23 million for remediation of the
Minnesota sites. At June 30, 2002, the estimated range of possible remediation
costs was $11 million to $49 million. The cost estimates of the MGW site are
based on studies of that site. The remediation costs for the other sites are
based on industry average costs for remediation of sites of similar size. The
actual remediation costs will be dependent upon the number of sites remediated,
the participation of other potentially responsible parties (PRP), if any, and
the remediation methods used.
Issues relating to the identification and remediation of MGPs are common in
the natural gas distribution industry. RERC has received notices from the United
States Environmental Protection Agency and others regarding its status as a PRP
for other sites. Based on current information, RERC has not been able to
quantify a range of environmental expenditures for potential remediation
expenditures with respect to other MGP sites.
Other Minnesota Matters. At June 30, 2002, RERC had recorded accruals of $5
million for other environmental matters in Minnesota for which remediation may
be required. At June 30, 2002, the estimated range of possible remediation costs
was $4 million to $8 million.
Mercury Contamination. RERC's pipeline and distribution operations have in
the past employed elemental mercury in measuring and regulating equipment. It is
possible that small amounts of mercury may have been spilled in the course of
normal maintenance and replacement operations and that these spills may have
contaminated the immediate area with elemental mercury. This type of
contamination has been found by RERC at some sites in the past, and RERC has
conducted remediation at these sites. It is possible that other contaminated
sites may exist and that remediation costs may be incurred for these sites.
Although the total amount of these costs cannot be known at this time, based on
experience by RERC and that of others in the natural gas industry to date and on
the current regulations regarding remediation of these sites, RERC believes that
the costs of any remediation of these sites will not be material to RERC's
financial position, results of operations or cash flows.
Potentially Responsible Party Notifications. From time to time RERC has
received notices from regulatory authorities or others regarding its status as a
PRP in connection with sites found to require remediation due to the presence of
environmental contaminants. Considering the information currently known about
such sites and the involvement of RERC in activities at these sites, RERC does
not believe that these matters will have a material adverse effect on RERC's
financial position, results of operations or cash flows.
(b) Other Legal Matters.
Natural Gas Measurement Lawsuits. In 1997, a suit was filed under the Federal
False Claim Act against RERC, REGT and Reliant Energy Field Services, Inc.
(REFS) alleging mismeasurement of natural gas produced from federal and Indian
lands. The suit seeks undisclosed damages, along with statutory penalties,
interest, costs, and fees. The complaint is part of a larger series of
complaints filed against 77 natural gas pipelines and their subsidiaries and
affiliates. An earlier single action making substantially similar allegations
against the pipelines was dismissed by the U.S. District Court for the District
of Columbia on grounds of improper joinder and lack of jurisdiction. As a
result, the various individual complaints were filed in numerous courts
throughout the country. This case was consolidated, together with the other
similar False Claim Act cases filed and transferred to the District of Wyoming.
Motions to dismiss were denied. The defendants intend to vigorously contest this
case.
In addition, RERC, REGT, REFS and Mississippi River Transmission Corporation
(MRT) have been named as defendants in a class action filed in May 1999 against
approximately 245 pipeline companies and their affiliates. The plaintiffs in the
case purport to represent a class of natural gas producers and fee royalty
owners who allege that they have been subject to systematic gas mismeasurement
by the defendants, including certain Reliant Energy entities, for more than 25
years. The plaintiffs seek compensatory damages, along with statutory penalties,
treble damages, interest, costs and fees. The action is currently pending in
state court in Stevens County, Kansas. Plaintiffs initially sued RES, but that
company was dismissed without prejudice on June 8, 2001. Other Reliant Energy
entities that were misnamed or duplicative have also been dismissed. MRT and
REFS have filed motions to
11
dismiss for lack of personal jurisdiction and are currently responding to
discovery on personal jurisdiction. All of the defendants have joined in a
motion to dismiss.
The defendants plan to raise significant affirmative defenses based on the
terms of the applicable contracts, as well as on the broad waivers and releases
in take or pay settlements that were granted by the producer-sellers of natural
gas who are putative class members.
Other. RERC is a party to litigation (other than that specifically noted)
which arises in the normal course of business. Management regularly analyzes
current information and, as necessary, provides accruals for probable
liabilities on the eventual disposition of these matters. Management believes
that the effects, if any, from the disposition of these matters will not have a
material adverse effect on RERC's financial position, results of operations or
cash flows.
(12) REPORTABLE BUSINESS SEGMENTS
Because RERC Corp. is a wholly owned subsidiary of Reliant Energy, RERC's
determination of reportable business segments considers the strategic operating
units under which Reliant Energy manages sales, allocates resources and assesses
performance of various products and services to wholesale or retail customers in
differing regulatory environments.
RERC's reportable business segments include the following: Natural Gas
Distribution, Pipelines and Gathering and Other Operations. For descriptions of
the reportable business segments, see Note 13 to the RERC Corp. 10-K Notes,
which is incorporated herein by reference.
Beginning in the first quarter of 2002, RERC began to evaluate performance on an
earnings (loss) before interest expense, interest income and income taxes (EBIT)
basis. Prior to 2002, RERC evaluated performance on operating income. EBIT, as
defined, is shown because it is a widely accepted measure of financial
performance used by analysts and investors to analyze and compare companies on
the basis of operating performance. EBIT is not defined under accounting
principles generally accepted in the United States (GAAP), and should not be
considered in isolation or as a substitute for a measure of performance prepared
in accordance with GAAP and is not indicative of operating income from
operations as determined under GAAP. Reportable business segments from previous
years have been restated to conform to the 2002 presentation. Additionally,
RERC's computation of EBIT may not be comparable to other similarly titled
measures computed by other companies, because all companies do not calculate it
in the same fashion.
The following table summarizes financial data for the reportable business
segments:
FOR THE THREE MONTHS ENDED JUNE 30, 2001
----------------------------------------------
REVENUES FROM
THIRD PARTIES NET
AND NON-RERC INTERSEGMENT
AFFILIATES REVENUES EBIT
------------- ------------ -------
(IN MILLIONS)
Natural Gas Distribution .......... $ 856 $ 32 $ (41)
Pipelines and Gathering ........... 50 46 34
Other Operations .................. -- -- --
Reconciling Eliminations .......... -- (78) (1)
Sales to Non-RERC Affiliates ...... 54 -- --
------- ------- -------
Consolidated ...................... $ 960 $ -- $ (8)
======= ======= =======
12
FOR THE THREE MONTHS ENDED JUNE 30, 2002
-----------------------------------------------------
REVENUES FROM
THIRD PARTIES NET
AND NON-RERC INTERSEGMENT
AFFILIATES REVENUES EBIT
------------- ------------ -------
(IN MILLIONS)
Natural Gas Distribution .................... $ 779 $ 18 $ 14
Pipelines and Gathering ..................... 61 41 41
Other Operations ............................ -- -- (3)
Reconciling Elimination ..................... -- (59) --
Sales to Non-RERC Affiliates ................ 28 -- --
------- ------- -------
Consolidated ................................ $ 868 $ -- $ 52
======= ======= =======
AS OF
FOR THE SIX MONTHS ENDED JUNE 30, 2001 DECEMBER 31,
2001
------------------------------------------------------ -------------
REVENUES FROM
THIRD PARTIES NET
AND NON-RERC INTERSEGMENT
AFFILIATES REVENUES EBIT TOTAL ASSETS
------------- ------------ ------- -------------
(IN MILLIONS)
Natural Gas Distribution .................... $3,125 $ 86 $ 96 $ 3,732
Pipelines and Gathering ..................... 125 101 73 2,361
Other Operations ............................ -- -- 1 495
Reconciling Eliminations .................... -- (187) -- (599)
Sales to Non-RERC Affiliates ................ 133 -- -- --
------ ------ ------ --------
Consolidated ................................ $3,383 $ -- $ 170 $ 5,989
====== ====== ====== ========
AS OF
FOR THE SIX MONTHS ENDED JUNE 30, 2002 JUNE 30, 2002
------------------------------------------------------ -------------
REVENUES FROM
THIRD PARTIES NET
AND NON-RERC INTERSEGMENT
AFFILIATES REVENUES EBIT TOTAL ASSETS
------------- ------------ ------- ------------
(IN MILLIONS)
Natural Gas Distribution .................... $1,957 $ 20 $ 124 $ 3,476
Pipelines and Gathering ..................... 112 82 79 2,371
Other Operations ............................ -- -- (2) 152
Reconciling Elimination ..................... -- (102) (3) (320)
Sales to Non-RERC Affiliates ................ 42 -- -- --
------ ------ ------ -------
Consolidated ................................ $2,111 $ -- $ 198 $ 5,679
====== ====== ====== =======
Reconciliation of Operating Income to EBIT and EBIT to Net Income:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
2001 2002 2001 2002
----- ----- ----- -----
(IN MILLIONS)
Operating (Loss) Income ............................ $ (16) $ 48 $ 158 $ 192
Other Income, net .................................. 8 4 12 6
----- ----- ----- -----
Earnings (Loss) Before Interest and ................ 170 198
Taxes ............................................ (8) 52
Interest Expense ................................... (40) (38) (79) (74)
----- ----- ----- -----
(Loss) Income Before Income Taxes .................. (48) 14 91 124
Income Tax (Benefit) Expense ....................... (14) 6 44 47
----- ----- ----- -----
Net (Loss) Income .................................. $ (34) $ 8 $ 47 $ 77
===== ===== ===== =====
13
MANAGEMENT'S NARRATIVE ANALYSIS OF
THE RESULTS OF OPERATIONS OF RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
The following narrative analysis should be read in combination with RERC
Corp.'s Interim Financial Statements and notes contained in this Form 10-Q.
Reliant Energy, Incorporated (Reliant Energy) is in the process of separating
its regulated and unregulated businesses into two publicly traded companies that
will be independent of each other: CenterPoint Energy, Inc. (CenterPoint Energy)
and Reliant Resources, Inc. (Reliant Resources). In December 2000, Reliant
Energy transferred a significant portion of its unregulated businesses to
Reliant Resources, which, at the time, was a wholly owned subsidiary of Reliant
Energy. Reliant Resources conducted an initial public offering of approximately
20% of its common stock in May 2001. In December 2001, Reliant Energy's
shareholders approved an agreement and plan of merger by which, subject to
regulatory approvals, the following will occur (which we refer to herein as the
Restructuring):
o CenterPoint Energy will become the holding company for the Reliant Energy
group of companies;
o Reliant Energy and its subsidiaries will become subsidiaries of
CenterPoint Energy; and
o each share of Reliant Energy common stock will be converted into one share
of CenterPoint Energy common stock.
After the Restructuring, Reliant Energy plans, subject to further corporate
approvals, market and other conditions, to complete the separation of its
regulated and unregulated businesses by distributing the shares of common stock
of Reliant Resources that CenterPoint Energy owns to the CenterPoint Energy's
shareholders (which we refer to herein as the Distribution). Reliant Energy's
goal is to complete the Restructuring and subsequent Distribution as quickly as
possible. RERC currently expects Reliant Energy to complete the Restructuring by
August 31, 2002 and the Distribution early in the fall of 2002. However, no
assurance can be provided that the Distribution will occur as described above or
that it will occur within this time period. From the consummation of the
Restructuring until the Distribution, RERC expects that CenterPoint Energy will
do business under the name Reliant Energy, Incorporated and that CenterPoint
Energy's common stock will trade under the symbol "REI."
On July 5, 2002, Reliant Energy received an order from the Securities and
Exchange Commission (SEC) approving Reliant Energy's restructuring plan and the
Distribution under the Public Utility Holding Company Act of 1935 (1935 Act). On
July 31, 2002, Reliant Energy received a private letter ruling from the Internal
Revenue Service which confirms that the Distribution will be tax-free to Reliant
Energy and its shareholders.
Contemporaneous with the Restructuring, RERC expects CenterPoint Energy to
register and become subject, with its subsidiaries, to regulation as a
registered holding company system under the 1935 Act. The 1935 Act directs the
SEC to regulate, among other things, financings, sales or acquisitions of assets
and intra-system transactions.
In connection with the Restructuring, in order to enable CenterPoint Energy
ultimately to satisfy the requirements for an exemption from regulation as a
registered holding company under the 1935 Act, Reliant Energy is seeking
authority to divide the gas distribution businesses conducted by RERC Corp.'s
three unincorporated gas distribution divisions, Reliant Energy Entex, Reliant
Energy Arkla and Reliant Energy Minnegasco, among three separate entities. The
entity that will hold the Reliant Energy Entex assets will also hold ownership
of RERC Corp.'s natural gas pipelines and gathering business. Reliant Energy has
obtained approval of these transactions from the public service commissions of
Minnesota, Louisiana, Mississippi, Oklahoma and Arkansas. Although RERC Corp.
expects that this business restructuring of RERC Corp. can be completed, RERC
Corp. can provide no assurance that this will, in fact, occur, or that
CenterPoint Energy will ultimately be exempt from registration under the 1935
Act. For further information on the RERC Corp. restructuring, see "Our Business
in Item 1 of the RERC Corp. Form 10-K/A.
RERC Corp. meets the conditions specified in General Instruction H(1)(a) and
(b) to Form 10-Q and is therefore permitted to use the reduced disclosure format
for wholly owned subsidiaries of reporting companies. Accordingly, RERC Corp.
has omitted from this report the information called for by Item 3 (Quantitative
and
14
Qualitative Disclosures About Market Risk) of Part I and the following Part II
items of Form 10-Q: Item 2 (Changes in Securities and Use of Proceeds), Item 3
(Defaults Upon Senior Securities) and Item 4 (Submission of Matters to a Vote of
Security Holders). The following discussion explains material changes in the
amount of revenue and expense items of RERC between the three months and six
months ended June 30, 2002 and the three months and six months ended June 30,
2001. Reference is made to Management's Narrative Analysis of the Results of
Operations of Reliant Energy Resources Corp. and its Subsidiaries in Item 7 of
the RERC Corp. Form 10-K/A.
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2001 2002 2001 2002
-------- -------- -------- --------
(IN MILLIONS)
Operating Revenues............ $ 960 $ 868 $ 3,383 $ 2,111
Operating Expenses............ (976) (820) (3,225) (1,919)
-------- -------- -------- --------
Operating (Loss) Income, net.. (16) 48 158 192
Other Income, net............. 8 4 12 6
-------- -------- -------- --------
Earnings (Loss) Before (8) 52 170 198
Interest and Taxes............
Interest Expense ............. (40) (38) (79) (74)
-------- -------- -------- --------
Income (Loss) Before Income (48) 14 91 124
Taxes.........................
Income Tax (Benefit) Expense.. (14) 6 44 47
-------- -------- -------- --------
Net (Loss) Income........... $ (34) $ 8 $ 47 $ 77
======== ======== ======== ========
For the second quarter of 2002, RERC's net income was $8 million compared to
a net loss of $34 million for the same period in 2001. The $42 million increase
was primarily due to:
o a significant reduction in bad debt expense in the Natural Gas
Distribution business segment as a result of improved collections and
lower gas prices in 2002. Higher gas prices and increased usage due to
colder weather in 2001 negatively impacted collections and resulted in an
increase in bad debt expense in 2001;
o decreased amortization expense of approximately $12 million as a result of
the discontinuance of goodwill amortization in accordance with Statement
of Financial Accounting Standards No. 142, "Accounting for Goodwill and
Intangible Assets" (SFAS No. 142); and
o changes in estimates of unbilled revenues and deferred gas costs, which
negatively impacted the second quarter of 2001.
For the first six months of 2002, RERC's net income was $77 million compared
to net income of $47 million for the same period in 2001. The $30 million
increase was primarily due to:
o a significant reduction in bad debt expense in the Natural Gas
Distribution business segment as discussed above;
o decreased amortization expense of approximately $24 million as a result
of the discontinuance of goodwill amortization in accordance with SFAS
No. 142 as discussed above; and
o changes in estimates of unbilled revenues and deferred gas costs in
2001 as discussed above.
The above items were partially offset by significantly milder weather,
decreased usage and increased project work expenses for construction management,
engineering, project planning and other services during the second quarter and
first six months of 2002 compared to 2001.
RERC's operating revenues for the quarter and six months ended June 30, 2002,
were $0.9 billion and $2.1 billion, respectively, compared to $1.0 billion and
$3.4 billion, respectively, for the same periods in 2001. The decrease for both
periods was primarily due to significantly milder weather, decreased usage and
lower gas prices in 2002 compared to 2001.
15
RERC's operating expenses for the quarter and six months ended June 30, 2002,
were $0.8 billion and $1.9 billion, respectively, compared to $1.0 billion and
$3.2 billion, respectively, for the same periods in 2001. These decreases were
primarily due to the same reasons for the decreases in revenues discussed above.
RERC's effective tax rate for the three months ended June 30, 2001 and 2002
was 30% and 44%, respectively. RERC reported a pretax loss for the second
quarter of 2001, which caused permanent differences that would normally increase
the effective tax rate (specifically, nondeductible goodwill) to instead reduce
it. For the second quarter of 2002, RERC's effective tax rate reflects the
discontinuation of goodwill amortization in accordance with SFAS No. 142, offset
by higher state tax expense than in the same period of 2001, when a state tax
benefit was recorded.
RERC's effective tax rate for the first six months of 2002 was 38% compared
to 49% for the same period in 2001. The decrease in the effective rate was
primarily due to the discontinuance of goodwill amortization in accordance with
SFAS No. 142 and other favorable adjustments.
Seasonality and Other Factors. RERC's results of operations are affected by
seasonal fluctuations in the demand for and, to a lesser extent, the price of
natural gas. RERC's results of operations are also affected by, among other
things, the actions of various federal and state governmental authorities having
jurisdiction over rates charged by RERC, competition in RERC's various business
operations, debt service costs and income tax expense.
For a discussion of certain other factors that may affect RERC's future
earnings, please read "Management's Narrative Analysis of Financial Condition
and Results of Operations of Reliant Energy Resources Corp. and its Consolidated
Subsidiaries -- Certain Factors Affecting Our Future Earnings --Factors
Affecting the Results of RERC Operations" in the RERC Form 10-K/A, which
information is incorporated herein by reference.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 141 "Business
Combinations" (SFAS No. 141). SFAS No. 141 requires business combinations
initiated after June 30, 2001 to be accounted for using the purchase method of
accounting and broadens the criteria for recording intangible assets separate
from goodwill. Recorded goodwill and intangibles will be evaluated against these
new criteria and may result in certain intangibles being transferred to
goodwill, or alternatively, amounts initially recorded as goodwill may be
separately identified and recognized apart from goodwill. We adopted the
provisions of the statement which apply to goodwill and intangible assets
acquired prior to June 30, 2001 on January 1, 2002. The adoption of SFAS No. 141
did not have a material impact on our historical results of operations or
financial position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. SFAS No. 144 supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," while retaining many of the requirements of these two statements.
Under SFAS No. 144, assets held for sale that are a component of an entity will
be included in discontinued operations if the operations and cash flows will be
or have been eliminated from the ongoing operations of the entity and the entity
will not have any significant continuing involvement in the operations
prospectively. SFAS No. 144 did not materially change the methods we use to
measure impairment losses on long-lived assets, but may result in additional
future dispositions being reported as discontinued operations than was
previously permitted. We adopted SFAS No. 144 on January 1, 2002.
See Note 3 for a discussion of our adoption of SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended (SFAS No. 133) on
January 1, 2001. See Note 6 for a discussion of our adoption of SFAS No. 142
"Goodwill and Other Intangible Assets" (SFAS No. 142) on January 1, 2002.
16
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. We will apply this guidance prospectively.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies EITF No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" (EITF No. 94-3). The principal difference between SFAS No.
146 and EITF No. 94-3 relates to the requirements for recognition of a liability
for cost associated with an exit or disposal activity. SFAS No. 146 requires
that a liability be recognized for a cost associated with an exit or disposal
activity when it is incurred. A liability is incurred when a transaction or
event occurs that leaves an entity little or no discretion to avoid the future
transfer or use of assets to settle the liability. Under EITF No. 94-3, a
liability for an exit cost was recognized at the date of an entity's commitment
to an exit plan. In addition, SFAS No. 146 also requires that a liability for a
cost associated with an exit or disposal activity be recognized at its fair
value when it is incurred. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002 with early application
encouraged. We will apply the provisions of SFAS No. 146 to all exit or disposal
activities initiated after December 31, 2002.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For a description of legal proceedings affecting RERC, please review Note 11
to RERC's Interim Financial Statements, Item 3 of the RERC Corp. Form 10-K/A and
Note 10 to the RERC Corp. 10-K/A Notes, which are incorporated herein by
reference.
ITEM 5. OTHER INFORMATION.
Forward-Looking Statements. From time to time, RERC Corp. makes statements
concerning its expectations, beliefs, plans, objectives, goals, strategies,
future events or performance and underlying assumptions and other statements,
which 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 the forward-looking statements by
the words "anticipate," "believe," "continue," "could," "estimate," "expect,"
"intend," "may," "plan," "potential," "predict," "should," "will," "forecast,"
"goal," "objective," "projection," or other similar words.
RERC Corp. has based its forward-looking statements on its management's
beliefs and assumptions based on information available to its management at the
time the statements are made. RERC Corp. cautions you that assumptions, beliefs,
expectations, intentions and projections about future events may and often do
vary materially from actual results. Therefore, RERC Corp. cannot assure you
that actual results will not differ materially from those expressed or implied
by its forward-looking statements.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:
o state, federal and international legislative and regulatory developments
and changes in, or application of environmental, siting and other laws and
regulations to which RERC Corp. is subject;
o timing of the implementation of our parent company's business separation
plan;
o the effects of competition, including the extent and timing of the entry
of additional competitors in our markets;
o industrial, commercial and residential growth in our service territories;
o our pursuit of potential business strategies, including acquisitions or
dispositions of assets;
o state, federal and other rate regulations in the United States;
o the timing and extent of changes in commodity prices, particularly natural
gas;
o weather variations and other natural phenomena;
o political, legal and economic conditions and developments in the United
States;
o financial market conditions and the results of our financing efforts;
o any direct or indirect effect on our business resulting from the September
11, 2001 terrorist attacks or any similar incidents or responses to such
incidents; and
o other factors we discuss in the RERC Corp. Form 10-K/A, including those
outlined in "Management's Narrative Analysis of Results of Operations of
Reliant Energy Resources Corp. and its Consolidated Subsidiaries --
Certain Factors Affecting Our Future Earnings."
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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 RERC Corp. undertakes no obligation to publicly update or revise
any forward-looking statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit 99 Items incorporated by reference from the RERC Corp. Form
10-K/A: Item 3 "Legal Proceedings," Item 7 "Management's
Narrative Analysis of the Results of Operations of Reliant
Energy Resources Corp. and its Consolidated Subsidiaries --
Certain Factors Affecting Our Future Earnings -- Factors
Affecting the Results of RERC Operations" and Notes 3(f)
(Regulatory Assets), 5 (Derivative Instruments), 7 (Trust
Preferred Securities), 10 (Commitments and Contingencies) and
13 (Reportable Segments) of the RERC Corp. 10-K/A Notes.
(b) Reports on Form 8-K.
None.
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SIGNATURE
Pursuant to the requirements 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.
RELIANT ENERGY RESOURCES CORP.
(Registrant)
By: /s/ Mary P. Ricciardello
-------------------------------
Mary P. Ricciardello
Senior Vice President and Chief
Accounting Officer
Date: August 14, 2002
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