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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 MARCH 31, 2003
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 Identification No.)
incorporation or organization)
1111 LOUISIANA (713) 207-1111
HOUSTON, TEXAS 77002 (Registrant's telephone number,
(Address and zip code of principal including area code)
executive offices)
-------------------------------
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 whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of May 2, 2003, Texas Genco Holdings, Inc., (Texas Genco) had 80,000,000
shares of common stock outstanding, including 64,764,240 shares which were held
by Utility Holding, LLC, a wholly owned subsidiary of CenterPoint Energy, Inc.
TEXAS GENCO HOLDINGS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements................................................................. 1
Statements of Consolidated Operations
Three Months Ended March 31, 2002 and 2003 (unaudited)................................ 1
Consolidated Balance Sheets
December 31, 2002 and March 31, 2003 (unaudited)...................................... 2
Statements of Consolidated Cash Flows
Three Months Ended March 31, 2002 and 2003 (unaudited)................................ 3
Notes to Unaudited Consolidated Financial Statements..................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations .............................................................................. 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 23
Item 4. Controls and Procedures............................................................. 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 25
Item 5. Other Information................................................................... 25
Item 6. Exhibits and Reports on Form 8-K.................................................... 26
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED OPERATIONS
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
2002 2003
--------- ---------
REVENUES:
Energy revenues ............................................. $ 240,482 $ 223,764
Capacity and other revenues ................................. 85,165 134,823
--------- ---------
Total ................................................... 325,647 358,587
--------- ---------
EXPENSES:
Fuel costs .................................................. 180,983 207,989
Purchased power ............................................. 48,366 11,994
Operation and maintenance ................................... 94,709 105,350
Depreciation and amortization ............................... 40,331 39,079
Taxes other than income taxes ............................... 13,014 11,291
--------- ---------
Total ................................................... 377,403 375,703
--------- ---------
OPERATING LOSS ............................................... (51,756) (17,116)
OTHER INCOME ................................................. 2 200
INTEREST EXPENSE, NET ........................................ 7,989 2,803
--------- ---------
LOSS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING
CHANGE................................................... (59,743) (19,719)
INCOME TAX BENEFIT ........................................... 25,049 8,837
--------- ---------
LOSS BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE ........... (34,694) (10,882)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX ........... -- 98,910
--------- ---------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS ........ $ (34,694) $ 88,028
========= =========
BASIC AND DILUTED EARNINGS PER SHARE:
Income from Continuing Operations Before Cumulative Effect of
Accounting Change ......................................... $ (0.43) $ (0.14)
Cumulative Effect of Accounting Change, net of tax ........... -- 1.24
--------- ---------
Net Income (Loss) Attributable to Common Shareholders ........ $ (0.43) $ 1.10
========= =========
See Notes to the Company's Interim Financial Statements
1
TEXAS GENCO HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
DECEMBER 31, MARCH 31,
------------- -------------
2002 2003
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................................ $ 578 $ 1,407
Customer accounts receivable..................................................... 68,604 76,204
Accounts receivable, other....................................................... 4,544 5,456
Materials and supplies........................................................... 92,869 91,029
Fuel stock and petroleum products................................................ 63,298 80,364
Prepaid expenses and other current assets........................................ 4,024 2,705
------------- -------------
Total current assets........................................................ 233,917 257,165
------------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET................................................. 3,980,770 4,159,035
------------- -------------
OTHER ASSETS:
Nuclear decommissioning trust.................................................... 162,576 157,778
Other............................................................................ 11,584 10,741
------------- -------------
Total other assets.......................................................... 174,160 168,519
------------- -------------
TOTAL ASSETS............................................................. $ 4,388,847 $ 4,584,719
============= =============
LIABILITES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable - affiliated companies, net.................................... $ 22,652 $ 11,663
Accounts payable, fuel........................................................... 76,399 89,279
Accounts payable, other.......................................................... 43,877 40,747
Notes payable - affiliated companies, net....................................... 86,186 188,285
Taxes and interest accrued....................................................... 38,591 8,197
Other............................................................................ 15,918 9,690
------------- -------------
Total current liabilities................................................... 283,623 347,861
------------- -------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net........................................... 813,246 861,535
Unamortized investment tax credit................................................ 170,569 167,532
Nuclear decommissioning reserve.................................................. 139,664 188,993
Deferred capacity auction revenue................................................ 48,721 46,844
Benefit obligations.............................................................. 15,751 16,089
Accrued reclamation costs........................................................ 39,765 3,898
Notes payable - affiliated companies, net....................................... 18,995 18,995
Other............................................................................ 34,470 40,901
------------- -------------
Total other liabilities..................................................... 1,281,181 1,344,787
------------- -------------
COMMITMENTS AND CONTINGENCIES (NOTE 4)
SHAREHOLDERS' EQUITY:
Common stock (80,000,000 shares outstanding at December 31, 2002 and March 31,
2003, respectively)............................................................
1 1
Additional paid-in capital....................................................... 2,878,502 2,878,502
Retained earnings (deficit)...................................................... (54,460) 13,568
------------- -------------
Total Shareholders' Equity.................................................. 2,824,043 2,892,071
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................... $ 4,388,847 $ 4,584,719
============= =============
See Notes to the Company's Interim Financial Statements
2
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
2002 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ............................................ $ (34,694) $ 88,028
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization ............................. 40,331 39,079
Fuel-related amortization ................................. 6,706 6,535
Deferred income taxes ..................................... (8,055) (4,971)
Cumulative effect of accounting change .................... -- (98,910)
Investment tax credit ..................................... (3,308) (3,037)
Changes in other assets and liabilities:
Accounts receivable ..................................... (77,198) (8,512)
Inventory ............................................... 9,187 (15,226)
Accounts payable ........................................ (68,284) 9,750
Accounts payable, affiliate ............................. (55,293) (10,989)
Taxes and interest accrued .............................. (122,073) (30,393)
Accrued reclamation costs ............................... 298 93
Benefit obligations ..................................... (8,832) 338
Deferred revenue from capacity auctions ................. 23,726 (1,877)
Other current assets .................................... 451 1,319
Other current liabilities ............................... 6,465 (6,229)
Other long-term assets .................................. 22,501 808
Other long-term liabilities ............................. 87,916 (2,736)
--------- ---------
Net cash used in operating activities ................ (180,156) (36,930)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ......................................... (76,946) (44,340)
--------- ---------
Net cash used in investing activities ................ (76,946) (44,340)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of common stock dividends ............................ -- (20,000)
Net change in capitalization activity ........................ 259,070 --
Increase in short-term notes payables, affiliate ............. -- 102,099
--------- ---------
Net cash provided by financing activities ............. 259,070 82,099
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ..................... 1,968 829
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .............. -- 578
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD .................... $ 1,968 $ 1,407
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest ..................................................... $ 383 $ 2,099
Income taxes ................................................. -- --
See Notes to the Company's Interim Financial Statements
3
TEXAS GENCO HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
General. Included in this Quarterly Report on Form 10-Q (Form 10-Q) of
Texas Genco Holdings, Inc. (Texas Genco or the Company) are the Company's
consolidated interim financial statements and notes (Interim Financial
Statements) including its wholly owned subsidiaries. The Interim Financial
Statements are unaudited, omit certain financial statement disclosures and
should be read with the Annual Report on Form 10-K of Texas Genco (Texas Genco
Form 10-K) for the year ended December 31, 2002.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America (GAAP) requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The Company'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 the Company'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.
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 represents the
portfolio of generating facilities owned 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 SEC as a "registered holding company"
under the Public Utility Holding Company Act of 1935 (1935 Act). 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%
4
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.
Basis of Presentation. The consolidated financial statements include the
operations of Texas Genco and its subsidiaries, which manage and operate the
Company's electric generation operations. 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 Texas deregulated electricity market (ERCOT market) at prices determined
by the market. Accordingly, the net loss before cumulative effect of accounting
change reflects the results of market prices for power. Included in operations
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. Various
allocation methodologies were employed during this period 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. Interest expense was calculated based on an allocation methodology
that charged the Company with financing and equity costs of CenterPoint Energy
in proportion to the Company's 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. 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.
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
for 2002 has been presented as if the 80 million shares were outstanding in
accordance with Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share." The number of shares outstanding for purposes of computing
both basic and diluted earnings per share is 80 million for the three months
ended March 31, 2002 and 2003.
The Company declared and paid a dividend of $0.25 per share of common stock
in the first quarter of 2003.
For information regarding certain environmental matters and legal
proceedings, see Note 4 herein.
5
(2) NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, the Company adopted 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.
The Company has identified retirement obligations for nuclear
decommissioning at the South Texas Project Electric Generating Station (South
Texas Project) and for lignite mine operations at the Jewett mine supplying the
Limestone electric generation facility. Prior to adoption of SFAS No. 143, the
Company had recorded liabilities for nuclear decommissioning and the reclamation
of the lignite mine. Liabilities were recorded for estimated decommissioning
obligations of $139.7 million and $39.7 million for reclamation of the lignite
at December 31, 2002. Upon adoption of SFAS No. 143 on January 1, 2003, the
Company reversed the $139.7 million previously accrued for the nuclear
decommissioning of the South Texas Project and recorded a plant asset of $99.1
million offset by accumulated depreciation of $35.8 million as well as a
retirement obligation of $186.7 million. The $16.3 million difference between
amounts previously recorded and the amounts recorded upon adoption of SFAS No.
143 is being deferred as a liability due to regulatory requirements. The Company
also reversed the $39.7 million it had previously recorded for the Jewett mine
reclamation and recorded a plant asset of $1.9 million offset by accumulated
depreciation of $0.4 million as well as a retirement obligation of $3.8 million.
The $37.4 million difference between amounts previously recorded and the amounts
recorded upon adoption of SFAS No. 143 was recorded as a cumulative effect of
accounting change. 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.
The following represents the balances of the asset retirement obligation as
of January 1, 2003 and the additions and accretion of the asset retirement
obligation for the three months ended March 31, 2003:
BALANCE, BALANCE,
JANUARY 1, LIABILITIES LIABILITIES CASH FLOW MARCH 31,
2003 INCURRED SETTLED ACCRETION REVISIONS 2003
---------- ----------- ----------- --------- --------- ---------
(IN MILLIONS)
Nuclear decommissioning..... $ 186.7 -- -- $ 2.2 -- $188.9
Jewett lignite mine......... 3.8 -- -- 0.1 -- 3.9
------- ------ ------ ----- ------ ------
$ 190.5 -- -- $ 2.3 -- $192.8
======= ====== ====== ===== ====== ======
The following represents the pro-forma effect on the Company's net income
for the three months ended March 31, 2002, as if the Company had adopted SFAS
No. 143 as of January 1, 2002:
THREE MONTHS ENDED
MARCH 31, 2002
------------------
(IN THOUSANDS)
Net loss as reported .................................. $ (34,694)
Pro-forma net loss..................................... (26,959)
DILUTED EARNINGS PER SHARE:
Net loss as reported .................................. $ (0.43)
Pro-forma net loss..................................... (0.34)
6
The following represents the Company's asset retirement obligations on a
pro-forma basis as if it had adopted SFAS No. 143 as of December 31, 2002:
AS REPORTED PRO-FORMA
----------- ---------
(IN MILLIONS)
Nuclear decommissioning................................ $ 139.7 $ 186.7
Jewett lignite mine.................................... 39.7 3.8
------- -------
Total................................................ $ 179.4 $ 190.5
======= =======
The Company has previously recognized removal costs as a component of
depreciation expense. Upon adoption of SFAS No. 143, the Company reversed $115
million of previously recognized removal costs as a cumulative effect of
accounting change. The total cumulative effect recognized upon adoption of SFAS
No. 143 was $99 million after- tax ($152 million pre-tax).
In April 2002, the Financial Accounting Standards Board (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. The Company has applied this guidance
as it relates to lease accounting and the accounting provisions related to debt
extinguishment. Upon adoption of SFAS No. 145, any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods will be reclassified. No such reclassification was required in the three
month period ended March 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) 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. 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, "Issues
Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities" (EITF No.
02-3) 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
7
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 did not materially affect the Company's consolidated
financial statements.
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 does not expect the
adoption of FIN 46 to have any material impact on its results of operations or
financial condition.
(3) RELATED PARTY TRANSACTIONS AND MAJOR CUSTOMERS
As of December 31, 2002, the Company had $86 million in short-term
borrowings and $19 million in long-term borrowings from CenterPoint Energy and
its subsidiaries. As of March 31, 2003, the Company had $188 million in
short-term borrowings and $19 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 the three months
ended March 31, 2003 was $4 million. For the three months ended March 31, 2003,
the effective interest rate on the borrowings was 11.5%. In addition, for the
three months end March 31, 2002, $9.5 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 and March
31, 2003, the Company had net accounts payable to affiliates of $23 million and
$12 million, respectively.
During the three months ended March 31, 2002 and 2003, the sales and
services by the Company to Reliant Resources and its subsidiaries totaled $171
million and $244 million, respectively. During the three months ended March 31,
2002 and 2003, the sales and services by the Company to CenterPoint Energy and
its affiliates totaled $60 million and $0, respectively. During the three months
ended March 31, 2003, the sales and services by the Company to BP Energy, a
major customer, totaled $38 million.
During the three months ended March 31, 2002, purchases of power by the
Company from Reliant Resources were $6 million. During the three months ended
March 31, 2003, purchases of natural gas by the Company from CenterPoint Energy
and its affiliates were $5 million.
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 $14 million
and $10 million for the three months ended March 31, 2002 and 2003,
respectively, and are included primarily in operation and maintenance expenses.
The 1935 Act generally prohibits borrowings by CenterPoint Energy from its
subsidiaries, including the Company.
(4) COMMITMENTS AND CONTINGENCIES
(a) ENVIRONMENTAL, LEGAL AND OTHER
Clean Air Standards. The Texas electric restructuring law and regulations
adopted by the Texas Commission on Environmental Quality in 2001 require
substantial reductions in emission of oxides of nitrogen (NOx) from electric
8
generating units. The Company is currently installing cost-effective controls at
its generating plants to comply with these requirements. Through March 31, 2003,
the Company has invested $582 million for NOx emission control, and plans to
make expenditures of up to approximately $200 million for the remainder of 2003
through 2007. The Texas electric restructuring law provides for stranded cost
recovery for expenditures incurred before May 1, 2003 to achieve the NOx
reduction requirements. Incurred costs include costs for which contractual
obligations have been made. The Texas Utility Commission has determined that the
Company's emission control plan is the most cost-effective option for achieving
compliance with applicable air quality standards for the Company's generating
facilities.
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 March 31, 2003. 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 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. CenterPoint Houston collects, through rates to
its electric utility customers, amounts designated for funding the
decommissioning trust, and pays the amounts to the Company. Funds collected are
deposited into a nuclear 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 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.
Supplier Suits. Texas Genco is currently engaged in a dispute with its fuel
supplier at its Limestone electric generating facility over the terms and
pricing for fuel supplied to that facility under a 1999 settlement agreement
between the parties and under ancillary obligations and over certain other
contractual issues between the parties. On May, 6, 2003, Texas Genco filed suit
for a declaratory judgment and damages against the supplier, Northwestern
Resources Co. (NWR), in Harris County, Texas, and NWR filed an amended petition
seeking a declaratory judgment in an action previously filed against Reliant
Energy in Limestone County, Texas. NWR claims Texas Genco has breached its
obligations under its commitments to burn lignite and by purchasing coal from
the Powder River Basin without first giving NWR a right of first refusal to
supply lignite at a price that permits the plant to generate electricity at a
cost that is equal to or less than the cost to generate electricity using coal
from the Powder River Basin as the fuel. NWR also contends that Texas Genco is
not entitled to certain production royalties from lignite leases held by Texas
Genco. In its suit, Texas Genco seeks
9
rulings that it has not breached its obligations regarding the purchase and
burning of Powder River Basin coal but that, instead, NWR has breached its
obligations by failing to pay production royalties and in other respects. The
ultimate outcome of this dispute cannot be determined at this time.
(b) 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 Reliant Resources Option will
equal the average daily closing price on The New York Stock Exchange 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-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 (NRC) license transfer
approval.
(5) SUBSEQUENT EVENTS
(a) South Texas Project
During a routine refueling and maintenance outage in early April 2003,
engineers found a small quantity of residue from reactor cooling water in the
South Texas Project Unit 1 reactor containment building. No other residue was
found in Unit 1 or in the plant's twin Unit 2 reactor when it was inspected
during a refueling outage in the fall of 2002. Upon discovery of the residue,
South Texas Project officials immediately reported their findings to the NRC.
The South Texas Project's managers and engineers are conferring with industry
experts to develop a corrective action plan. The NRC must approve any corrective
action plan before it is implemented.
Although Unit 1 was originally scheduled to be returned to service by May
2003, it will remain shut down until any necessary corrective action is
completed. While the unit remains out of service, the Company will meet its
existing power sales obligations from other generating units and/or from
purchases from third parties. A protracted outage at Unit 1 would adversely
affect the Company's operating results. Until inspections are completed and an
acceptable corrective action plan has been developed, the Company is unable to
predict the extent of the economic impact of this outage and when the unit will
be returned to service. The Company does not expect Unit 1 will return to
service before late summer of 2003.
(b) Declaration of Dividend
On May 8, 2003, the board of directors of the Company declared a quarterly
cash dividend of $0.25 per share of common stock, payable on June 20, 2003 to
holders of record as of the close of business on May 27, 2003.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in combination with the
Company's Interim Financial Statements and notes contained in this Form 10-Q.
OVERVIEW
We are one of the largest wholesale electric power generating companies in
the United States. As of March 31, 2003, the aggregate net generating capacity
of our portfolio of assets was 14,175 megawatts (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) required 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, Incorporated (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 (the
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, Inc. (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.
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 (the Distribution). As used herein, CenterPoint Energy
also refers to the former Reliant Energy for dates prior to the Restructuring.
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
resulted in returns substantially
11
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 and in
the first quarter of 2003 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.
Lack of bids for gas fired generation during the March 2003 capacity
auction for June, July and August capacity entitlements resulted in the decision
to keep our P.H. Robinson Unit 3 and Webster Unit 3 generating units in mothball
status through November 2003. The remaining six units mothballed in October
2002, totaling 2,470 MW, are expected to return to service by June 2003.
With an increasingly competitive wholesale energy market, the composition
and level of our operation and maintenance expense is likely to change.
RECENT DEVELOPMENTS
During a routine refueling and maintenance outage in early April 2003,
engineers found a small quantity of residue from reactor cooling water in the
South Texas Project Electric Generating Station (South Texas Project) Unit 1
reactor containment building. No other residue was found in Unit 1 or in the
plant's twin Unit 2 reactor when it was inspected during a refueling outage in
the fall of 2002. Upon discovery of the residue, South Texas Project officials
immediately reported their findings to the Nuclear Regulatory Commission (NRC).
The South Texas Project's managers and engineers are conferring with industry
experts to develop a corrective action plan. The NRC must approve any corrective
action plan before it is implemented.
Although Unit 1 was originally scheduled to be returned to service by May
2003, it will remain shut down until any necessary corrective action is
completed. While the unit remains out of service, we will meet our existing
power sales obligations from other generating units and/or from purchases from
third parties. A protracted outage at Unit 1 would adversely affect our
operating results. Until inspections are completed and an acceptable corrective
action plan has been developed, we are unable to predict the extent of the
economic impact of this outage and when the unit will be returned to service. We
do not expect Unit 1 (our share is 385 MW) will return to service before late
summer of 2003. In order to mitigate the financial impact of forced outages at
our generating units, we do not auction 750 MW of base-load capacity and 500 MW
of gas-fired capacity. However, nuclear generation from the South Texas Project
is our least expensive source of power because the cost of nuclear fuel is
substantially less than that of coal, lignite or natural gas. Accordingly, while
Unit 1 is shut down, we will be required to satisfy capacity entitlements with
significantly more expensive power and our ability to make opportunity sales and
serve gas auction entitlements from South Texas Project production will be
reduced. For example, our coal and lignite base-load capacity generally operates
at an approximate energy cost of between $16/Mwh and $17/Mwh and gas-fired
capacity ranges between $55/Mwh and $60/Mwh based on current natural gas prices,
while our nuclear generation capacity generally operates at an approximate
energy cost of between $4/Mwh and $5/Mwh.
12
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth our consolidated results of operations for
the three months ended March 31, 2002 and 2003, followed by a discussion of our
consolidated results of operations.
THREE MONTHS ENDED MARCH 31,
2002 2003
----------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES:
Energy revenues..................................................... $ 240,482 $ 223,764
Capacity and other revenues......................................... 85,165 134,823
----------- ----------
Total............................................................ 325,647 358,587
----------- ----------
EXPENSES:
Fuel costs.......................................................... 180,983 207,989
Purchased power..................................................... 48,366 11,994
Operation and maintenance........................................... 94,709 105,350
Depreciation and amortization....................................... 40,331 39,079
Taxes other than income taxes....................................... 13,014 11,291
----------- ----------
Total............................................................ 377,403 375,703
----------- ----------
OPERATING LOSS....................................................... (51,756) (17,116)
OTHER INCOME......................................................... 2 200
INTEREST EXPENSE, NET................................................ 7,989 2,803
----------- ----------
LOSS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE.. (59,743) (19,719)
INCOME TAX BENEFIT................................................... 25,049 8,837
----------- ----------
LOSS BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE...................
(34,694) (10,882)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX................... -- 98,910
----------- ----------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS................ $ (34,694) $ 88,028
=========== ==========
BASIC AND DILUTED EARNINGS PER SHARE:
Income from Continuing Operations Before Cumulative Effect of
Accounting Change................................................. $ (0.43) $ (0.14)
Cumulative Effect of Accounting Change, net of tax.................. -- 1.24
----------- ----------
Net Income (Loss) Attributable to Common Shareholders............... $ (0.43) $ 1.10
=========== ==========
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
We reported a loss before cumulative effect of accounting change of $11
million ($0.14 per diluted share) for the three months ended March 31, 2003
compared to a loss of $35 million ($0.43 per diluted share) for the three months
ended March 31, 2002. The $24 million improvement was primarily attributable to
increased gross margins as a result of higher capacity auction prices driven by
higher gas prices, partially offset by increased operation and maintenance
expenses due to unplanned forced outages in the first quarter of 2003 and higher
property insurance expense. The first quarter is typically our lowest performing
quarter due to seasonal revenue effects and the scheduling of planned
maintenance on our generating units. South Texas Project Unit 2 was taken out of
service in December 2002 as a result of non- safety related mechanical failures
and was returned to service on March 14, 2003. The added cost of replacement
energy negatively impacted gross margin by approximately $23 million for the
first quarter of 2003.
Operation and maintenance expense increased $10 million for the three
months ended March 31, 2003 as compared to the same period in 2002. The increase
was primarily due to the Unit 2 outage discussed above ($4 million), a scheduled
re-fueling outage on Unit 1 ($2 million) without a comparable outage in 2002 and
higher property insurance expense ($1 million).
Taxes other than income taxes decreased $2 million for the three months
ended March 31, 2003 as compared to the same period in 2002. This decrease was
attributable to a reduction in property taxes.
Interest expense decreased $5 million, or 65%, for the three months ended
March 31, 2003 from the comparable 2002 period primarily as a result of $9.5
million in intercompany interest allocated in 2002 prior to the Restructuring
13
of Reliant Energy and related to the remaining electric utility debt not
specifically identified with CenterPoint Energy's transmission and distribution
utility upon deregulation. This decrease was partially offset by interest
expense of $2.8 million on intercompany borrowings from CenterPoint Energy to
fund working capital requirements in the first quarter of 2003.
The effective tax rates for the three months ended March 31, 2003 and 2002
were 44.8% and 41.9%, respectively. The increase in the effective rate for the
three months ended March 31, 2003 compared to the three months ended March 31,
2002 was primarily the result of a decrease in the pretax loss, offset by
reduced benefits from state taxes and the amortization of investment tax
credits.
In connection with the adoption of Statement of Financial Accounting
Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations" (SFAS
No. 143), 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. The net difference between the amounts determined under
SFAS No. 143 and the previous method of accounting for estimated mine
reclamation costs was $37 million and has been recorded as a cumulative effect
of accounting change. Upon adoption of SFAS No. 143, we reversed $115 million of
previously recognized removal costs as a cumulative effect of accounting change.
The 2003 results include a $99 million after-tax ($152 million pre-tax) non-cash
gain ($1.24 per diluted share) from the adoption of SFAS No. 143. For additional
discussion of the adoption of SFAS No. 143, please read Note 2 to our Interim
Financial Statements.
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 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
14
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. Additionally, CenterPoint Energy expects that
a separate pension plan will be established for Texas Genco in 2004. Texas Genco
would receive an allocation of assets from the CenterPoint Energy pension plan
pursuant to rules and regulations under the Employee Retirement Income Security
Act of 1974 and record its pension obligations in accordance with SFAS No. 87,
"Employer's Accounting for Pensions." It is anticipated that a plan established
for Texas Genco would be underfunded and that such underfunding could be
significant. Changes in interest rates and the market values of the securities
held by the CenterPoint Energy pension plan during 2003 could materially,
positively or negatively, change the funding status of a plan established for
Texas Genco.
RELIANT RESOURCES OPTION
As part of Reliant Energy's business separation plan, Reliant Resources,
Inc. (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 (Reliant Resources Option). 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.
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 our 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
15
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 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 the Texas Genco Form 10-K, which is incorporated by reference herein.
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 independent system
operator, 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;
16
- 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 through March 2003 have
sold 81% of our available capacity for 2003. Reliant Resources purchased
entitlements to 63% of the available 2002 capacity and through March 2003 has
purchased 62% 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. Effective March 28, 2003, Texas
Genco, LP, our subsidiary, amended a Master Power Purchase and Sale Agreement
with a subsidiary of Reliant Resources, related to ERCOT power sales. Texas
Genco, LP was granted a security interest in accounts receivable and/or
securitization notes associated with the accounts receivable of certain
subsidiaries of Reliant Resources to secure up to $250 million in purchase
obligations.
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 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 DIRECTORS
David M. McClanahan, Gary L. Whitlock, Scott E. Rozzell and Robert J.
Cruikshank are directors and/or officers of CenterPoint Energy. As a result,
they may need to recuse themselves and not participate in board meetings where
actions are taken in connection with transactions or other relationships
involving both companies.
17
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Certain Factors Affecting
Future Earnings" in the Texas Genco Form 10-K, which is incorporated herein by
reference.
In addition to the factors incorporated by reference from the Texas Genco
Form 10-K, please read the discussion of the South Texas Project Unit 1 forced
outage under "-- Recent Developments."
LIQUIDITY AND CAPITAL RESOURCES
HISTORICAL CASH FLOWS
The net cash provided by/used in our operating, investing and financing
activities for the three months ended March 31, 2002 and 2003 is as follows (in
millions):
THREE MONTHS ENDED MARCH 31,
----------------------------
2002 2003
------------ --------------
Cash provided by (used in):
Operating activities............................. $ (180) $ (37)
Investing activities............................. (77) (44)
Financing activities............................. 259 82
CASH PROVIDED BY OPERATING ACTIVITIES
Net cash used in operating activities for the three months ended March 31,
2003 decreased $143 million as compared to the same period in 2002. This
decrease was primarily due to decreased accounts receivable as a result of a
decline in fuel billings to the regulated utility in 2003 and the change to a
deregulated environment in 2002 as well as decreased accounts payable as a
result of our having no cogeneration purchase requirements in 2003 in a
deregulated environment as compared to 2002. Additionally, in the first quarter
of 2002, the Company paid higher taxes associated with regulated revenues for
2001. These decreases were partially offset by an increase in inventory
primarily related to timing of deliveries in late 2001 and higher gas prices in
2003.
CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities for the three months ended March 31,
2003 decreased $33 million as compared to the same period in 2002 primarily due
to the completion of a major portion of the required environmental capital
expenditures for emissions of oxides of nitrogen (NOx) during 2002.
CASH PROVIDED BY FINANCING ACTIVITIES
Net cash provided by financing activities for the three months ended March
31, 2003 decreased $177 million as compared to the same period in 2002. The
decrease was primarily a result of reductions in transfers from CenterPoint
Energy to support our various requirements for working capital and capital
expenditures, partially offset by a dividend on our common stock in the first
quarter of 2003.
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.
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
18
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, CenterPoint Energy and Reliant Energy obtained
an order from the Securities and Exchange Commission (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 Public Utility Holding Company Act of 1935 (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 the Texas Genco 10-K, which is
incorporated by reference herein.
Capital Requirements. We anticipate investing up to $439 million in capital
expenditures during the years 2003 through 2007, including $40 million expended
during the three months ended March 31, 2003. We anticipate capital expenditures
to be approximately $109 million and $107 million in the remainder of 2003 and
2004, respectively.
Environmental expenditures for installation of equipment to reduce NOx
emissions are expected to decline between 2003 and 2007 in accordance with our
NOx emission reduction plan approved by the Texas Utility Commission.
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," in
Item 1 of the Texas Genco Form 10-K, which is incorporated by reference herein.
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;
- 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 our ability to pay
dividends, please read "Market for Common Stock and Related Stockholder Matters"
in Item 5 of the Texas Genco Form 10-K, which is incorporated by reference
herein.
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
19
- working capital requirements.
Money Pool. At December 31, 2002 and March 31, 2003, we had $86 million and
$188 million respectively, 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 Texas Genco Form 10-K, which
is incorporated by reference herein, 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. Additionally, we expect that a separate pension plan will be
established for Texas Genco in 2004. Texas Genco would receive an allocation of
assets from the CenterPoint Energy pension plan pursuant to rules and
regulations under the Employee Retirement Income Security Act of 1974 and record
its pension obligations in accordance with SFAS No. 87, "Employer's Accounting
for Pensions". It is anticipated that a plan established for Texas Genco would
be underfunded and that such underfunding could be significant. Changes in
interest rates and the market values of the securities held by the CenterPoint
Energy pension plan during 2003 could materially, positively or negatively,
change the funding status of a plan established for Texas Genco.
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. Accordingly, these accounting policies have been reviewed and
discussed with the audit committee of the board of directors.
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,
and March 31, 2003, $49 million and $47 million, respectively, of deferred
capacity revenue was recorded in our Consolidated Balance Sheets.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, which primarily include property, plant and equipment
(PP&E), comprise $4.2 billion or 91% of our total assets as of March 31, 2003.
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. 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
20
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, "Accounting for the Impairment or Disposal of Long-Lived
Assets." As of December 31, 2002, no impairment had been indicated.
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, we adopted 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.
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. Prior to adoption of SFAS
No. 143, we had recorded liabilities for nuclear decommissioning and the
reclamation of the lignite mine. Liabilities were recorded for estimated
decommissioning obligations of $139.7 million and $39.7 million for reclamation
of the lignite at December 31, 2002. Upon adoption of SFAS No. 143 on January 1,
2003, we reversed the $139.7 million previously accrued for the nuclear
decommissioning of the South Texas Project and recorded a plant asset of $99.1
million offset by accumulated depreciation of $35.8 million as well as a
retirement obligation of $186.7 million. The $16.3 million difference between
amounts previously recorded and the amounts recorded upon adoption of SFAS No.
143 is being deferred as a liability due to regulatory requirements. We also
reversed the $39.7 million we had previously recorded for the Jewett mine
reclamation and recorded a plant asset of $1.9 million offset by accumulated
depreciation of $0.4 million as well as a retirement obligation of $3.8 million.
The $37.4 million difference between amounts previously recorded and the amounts
recorded upon adoption of SFAS No. 143 was recorded as a cumulative effect of
accounting change. We have also identified other asset retirement obligations
that cannot be calculated because the assets associated with the retirement
obligations have an indeterminate life.
The following represents the balances of the asset retirement obligation as
of January 1, 2003 and the additions and accretion of the asset retirement
obligation for the three months ended March 31, 2003:
BALANCE, BALANCE,
JANUARY 1, LIABILITIES LIABILITIES CASH FLOW MARCH 31,
2003 INCURRED SETTLED ACCRETION REVISIONS 2003
---------- ----------- ----------- --------- --------- -----------
(IN MILLIONS)
Nuclear decommissioning..... $ 186.7 -- -- $ 2.2 -- $188.9
Jewett lignite mine......... 3.8 -- -- 0.1 -- 3.9
-------- ---- ----- ----- ---- ------
$ 190.5 -- -- $ 2.3 -- $192.8
======== ==== ===== ===== ==== ======
The following represents the pro-forma effect on our net income for the
three months ended March 31, 2002, as if we had adopted SFAS No. 143 as of
January 1, 2002:
THREE MONTHS ENDED
MARCH 31, 2002
----------------------
(IN THOUSANDS)
Net loss as reported .................................. $ (34,694)
Pro-forma net loss..................................... (26,959)
DILUTED EARNINGS PER SHARE:
Net loss as reported .................................. $ (0.43)
Pro-forma net loss..................................... (0.34)
21
The following represents our asset retirement obligations on a pro-forma
basis as if we had adopted SFAS No. 143 as of December 31, 2002:
AS REPORTED PRO-FORMA
----------- ---------
(IN MILLIONS)
Nuclear decommissioning................... $ 139.7 $ 186.7
Jewett lignite mine....................... 39.7 3.8
--------- -------
Total.................................... $ 179.4 $ 190.5
========= =======
We have previously recognized removal costs as a component of depreciation
expense. Upon adoption of SFAS No. 143, we reversed $115 million of previously
recognized removal costs as a cumulative effect of accounting change. The total
cumulative effect recognized upon adoption of SFAS No. 143 was $99 million
after-tax ($152 million pre-tax).
In April 2002, the Financial Accounting Standards Board (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 as it
relates to lease accounting and the accounting provisions related to debt
extinguishment. Upon adoption of SFAS No. 145, any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods presented will be reclassified. No such reclassification was required in
the three month period ended March 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) 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. We 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, "Issues
Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities" (EITF No.
02-3) 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
22
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. We do
not expect the adoption of FIN 45 to have a material impact on our results of
operations or financial condition.
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. We do not expect the adoption of
FIN 46 to have any material impact on our results of operations or financial
condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
We contributed $2.9 million in 2002 to trusts established to fund our share
of the decommissioning costs for the South Texas Project. The securities held by
the trusts for decommissioning costs had an estimated fair value of $158 million
as of March 31, 2003, of which approximately 48% 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 March 31,
2003, the fair value of the fixed-rate debt securities would decrease by
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 trusts
established to fund our share of the decommissioning costs for the South Texas
Project, which held debt and equity securities as of March 31, 2003. 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 March
31, 2003, the resulting loss in fair value of these securities would be
approximately $8 million. Currently, the risk of an economic loss is mitigated
as discussed above under "-- Interest Rate Risk."
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.
ITEM 4. 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
23
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.
24
PART II. OTHER INFORMATION
ITEM 1. 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 "Our Business --
Environmental Matters -- Asbestos" in Item 1 of the Texas Genco Form 10-K, which
is incorporated herein by reference.
ITEM 5 OTHER INFORMATION.
Forward-Looking Statements. 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.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:
- state and federal legislative and regulatory actions or developments,
including deregulation; re-regulation and restructuring of the market served
by the Electric Reliability Council of Texas, Inc. (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 we discuss in the Texas Genco Form 10-K, including those
outlined in "Risk Factors."
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.
25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
The following exhibits are filed herewith:
Exhibits not incorporated by reference to a prior filing are designated
by a cross (+); all exhibits not so designated are incorporated 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 Texas Genco Holdings, Inc.'s 1-31449 3.1
Articles of Incorporation ("Texas Genco") Form 10-K for the
year ended December 31, 2002
3.2 -- Amended and Restated Bylaws Texas Genco's Form 10-K for 1-31449 3.2
the year ended December 31, 2002
4.1 -- Specimen Stock Certificate Texas Genco's registration 1-31449 4.1
statement on Form 10
+99.1 -- Section 906 Certification of
David G. Tees
+99.2 -- Section 906 Certification of
Gary L. Whitlock
+99.3 -- Items incorporated by
reference from the Texas
Genco Form 10-K: "Our
Business--Regulation--Public
Utility Holding Company Act
of 1935" in Item 1, "Risk
Factors--Factors Related to
Operating Risks" in Item 1,
"Our Business--Environmental
Matters--Asbestos" in Item 1,
"Management's Discussion and
Analysis of Financial Condition
and Results of Operations
--Certain Factors Affecting
Future Earnings" in Item 7,
"Market for Common Stock and
Related Stockholder Matters"
in Item 5 and Notes 6(a) and 8
(b) Reports on Form 8-K.
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.
On April 23, 2003, we filed a Current Report on Form 8-K dated April 19,
2003, reporting the shutdown of a reactor at the South Texas Project Nuclear
Generating Station.
On April 24, 2003, we filed a Current Report on Form 8-K dated April 24,
2003, in which we announced first quarter 2003 earnings.
On May 1, 2003, we filed a Current Report on Form 8-K to furnish under Item
9 and Item 12 of that form transcripts of the earnings conference call held on
April 24, 2003.
26
SIGNATURES
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.
TEXAS GENCO HOLDINGS, INC.
By: /s/ James S. Brian
----------------------------------------
James S. Brian
Senior Vice President and Chief Accounting Officer
Date: May 13, 2003
27
CERTIFICATIONS
I, David G. Tees, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Texas Genco
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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
quarterly 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: May 13, 2003
By: /s/ David G. Tees
---------------------------------------------
David G. Tees
President and Chief Executive Officer
28
CERTIFICATIONS
I, Gary L. Whitlock, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Texas Genco
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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
quarterly 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: May 13, 2003
By: /s/ Gary L. Whitlock
-----------------------------------------------------------
Gary L. Whitlock
Executive Vice President and Chief Financial Officer
29
EXHIBIT INDEX
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ---------- ------------------------------ ---------------------------------- ------------ ---------
3.1 -- Amended and Restated Texas Genco Holdings, Inc.'s 1-31449 3.1
Articles of Incorporation ("Texas Genco") Form 10-K for the
year ended December 31, 2002
3.2 -- Amended and Restated Bylaws Texas Genco's Form 10-K for 1-31449 3.2
the year ended December 31, 2002
4.1 -- Specimen Stock Certificate Texas Genco's registration 1-31449 4.1
statement on Form 10
+99.1 -- Section 906 Certification of
David G. Tees
+99.2 -- Section 906 Certification of
Gary L. Whitlock
+99.3 -- Items incorporated by
reference from the Texas
Genco Form 10-K: "Our
Business--Regulation--Public
Utility Holding Company Act
of 1935" in Item 1, "Risk
Factors--Factors Related to
Operating Risks" in Item 1,
"Our Business--Environmental
Matters--Asbestos" in Item 1,
"Management's Discussion and
Analysis of Financial Condition
and Results of Operations--
Certain Factors Affecting
Future Earnings" in Item 7,
"Market for Common Stock and
Related Stockholder Matters"
in Item 5 and Notes 6(a) and 8