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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 SEPTEMBER 30, 2004
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 incorporation or organization) (I.R.S. Employer Identification No.)
1111 LOUISIANA (713) 207-1111
HOUSTON, TEXAS 77002 (Registrant's telephone number, including area code)
(Address and zip code of principal 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 in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
As of November 1, 2004, 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 SEPTEMBER 30, 2004
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements................................................................ 1
Statements of Consolidated Operations
Three Months and Nine Months Ended September 30, 2003 and 2004 (unaudited)........... 1
Consolidated Balance Sheets
December 31, 2003 and September 30, 2004 (unaudited)................................. 2
Statements of Consolidated Cash Flows
Nine Months Ended September 30, 2003 and 2004 (unaudited)............................ 4
Notes to Unaudited Consolidated Financial Statements.................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 22
Item 4. Controls and Procedures............................................................. 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 23
Item 4. Submission of Matters to a Vote of Security Holders................................. 23
Item 6. Exhibits............................................................................ 23
i
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time, we make statements concerning our expectations,
beliefs, plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those expressed or implied by these statements. You can generally identify
our forward-looking statements by the words "anticipate," "believe," "continue,"
"could," "estimate," "expect," "forecast," "goal," "intend," "may," "objective,"
"plan," "potential," "predict," "projection," "should," "will," or other similar
words.
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in our forward-looking
statements:
- state and federal legislative and regulatory actions or
developments, including deregulation, re-regulation and
restructuring of the Electric Reliability Council of Texas (ERCOT)
market; and changes in, or application of, environmental or other
laws or regulations to which we are subject;
- various risks associated with operating our power generation
facilities including, but not limited to, breakdowns or failures of
equipment or processes, disruptions in the transmission of
electricity, fuel supply interruptions, labor disputes, operator
error, and catastrophic events such as fires, hurricanes,
explosions, floods or terrorist attacks;
- unanticipated expenses incurred as part of our efforts to satisfy
our forward sales obligations;
- the timing and extent of changes in commodity prices, particularly
natural gas;
- 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;
- weather variations and other natural phenomena;
- commercial bank and financial market conditions, and our access to
capital and credit;
- non-payment of our services due to financial distress of our
customers, including Reliant Energy, Inc. (formerly named Reliant
Resources, Inc.) (RRI);
- the successful consummation and timing of the sale of the company to
GC Power Acquisition LLC (GC Power Acquisition) pursuant to the
definitive agreement described under "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Recent
Events -- Definitive Agreement for the Sale of the Company" in Item
2 of this Quarterly Report on Form 10-Q;
- nonperformance by the counterparty to the master power purchase and
sale agreement our subsidiary, Texas Genco, LP, entered into in
connection with the execution of the definitive agreement for the
sale of the company to GC Power Acquisition; and
- other factors we discuss in "Risk Factors" beginning on page 18 of
the Texas Genco Holdings, Inc. Annual Report on Form 10-K for the
year ended December 31, 2003.
Additional risk factors are described in other documents we file with the
Securities and Exchange Commission.
ii
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement.
iii
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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2004 2003 2004
------------ -------------- ------------- -------------
REVENUES.......................................... $ 657,363 $ 637,885 $ 1,594,461 $ 1,629,732
--------- ---------- ----------- -----------
EXPENSES:
Fuel costs...................................... 365,913 315,644 923,220 765,951
Purchased power................................. 20,259 17,506 55,227 43,874
Operation and maintenance....................... 100,353 118,914 311,004 319,113
Depreciation and amortization................... 40,778 4,355 119,248 85,331
Write-down of assets............................ -- 649,000 -- 649,000
Taxes other than income taxes................... 5,084 8,721 27,858 33,099
--------- ---------- ----------- -----------
Total...................................... 532,387 1,114,140 1,436,557 1,896,368
--------- ---------- ----------- -----------
OPERATING INCOME (LOSS)........................... 124,976 (476,255) 157,904 (266,636)
OTHER INCOME...................................... 489 908 1,778 2,963
INTEREST EXPENSE, NET............................. (1,298) -- (6,923) (140)
--------- ---------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE..................... 124,167 (475,347) 152,759 (263,813)
INCOME TAX BENEFIT (EXPENSE)...................... (41,761) 164,088 (47,942) 93,562
--------- ---------- ----------- -----------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE............................... 82,406 (311,259) 104,817 (170,251)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET
OF TAX.......................................... -- -- 98,910 --
--------- ---------- ----------- -----------
NET INCOME (LOSS)................................. $ 82,406 $ (311,259) $ 203,727 $ (170,251)
========= ========== =========== ===========
BASIC AND DILUTED EARNINGS PER SHARE:
Income (Loss) Before Cumulative Effect of
Accounting Change............................ $ 1.03 $ (3.89) $ 1.31 $ (2.13)
Cumulative Effect of Accounting Change, net of
tax.......................................... -- -- 1.24 --
--------- ---------- ----------- -----------
Net Income (Loss)............................... $ 1.03 $ (3.89) $ 2.55 $ (2.13)
========= ========== =========== ===========
See Notes to the Company's Interim Financial Statements
1
TEXAS GENCO HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, SEPTEMBER 30,
2003 2004
------------- -------------
CURRENT ASSETS:
Cash............................................................................. $ 33 $ 65
Short-term investments........................................................... 44,525 336,991
Customer accounts receivable..................................................... 78,122 95,633
Accounts receivable, other....................................................... 3,716 2,812
Materials and supplies........................................................... 92,409 92,496
Fuel stock....................................................................... 77,283 63,801
Deferred tax asset............................................................... -- 1,592
Prepaid expenses................................................................. 2,104 3,823
Other current assets............................................................. 200 8,507
Assets held for sale............................................................. 3,654,005 2,965,953
------------- -------------
Total current assets........................................................ 3,952,397 3,571,673
------------- -------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment.................................................... 3,027,350 3,063,518
Less accumulated depreciation and amortization................................... (2,555,760) (2,585,907)
------------- -------------
Property, plant and equipment, net.......................................... 471,590 477,611
------------- -------------
OTHER ASSETS:
Nuclear decommissioning trust.................................................... 189,182 199,638
Other............................................................................ 26,462 22,992
------------- -------------
Total other assets.......................................................... 215,644 222,630
------------- -------------
TOTAL ASSETS............................................................. $ 4,639,631 $ 4,271,914
============= =============
See Notes to the Company's Interim Financial Statements
2
TEXAS GENCO HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY
DECEMBER 31, SEPTEMBER 30,
2003 2004
------------ -------------
CURRENT LIABILITIES:
Accounts payable - affiliated companies, net..................................... $ 7,802 $ 6,176
Accounts payable, fuel........................................................... 68,747 92,334
Accounts payable, other.......................................................... 40,165 27,306
Taxes and interest accrued....................................................... 107,605 117,524
Deferred capacity auction revenue................................................ 86,853 89,973
Non-trading derivative liabilities............................................... -- 4,548
Other............................................................................ 17,579 15,789
------------- -------------
Total current liabilities................................................... 328,751 353,650
------------- -------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net........................................... 844,545 565,849
Unamortized investment tax credit................................................ 150,533 141,880
Nuclear decommissioning reserve.................................................. 187,997 230,556
Non-trading derivative liabilities............................................... -- 112,366
Benefit obligations.............................................................. 18,399 106,295
Accrued reclamation costs........................................................ 6,000 4,489
Other............................................................................ 70,245 76,662
------------- -------------
Total other liabilities..................................................... 1,277,719 1,238,097
------------- -------------
COMMITMENTS AND CONTINGENCIES (NOTE 9)
SHAREHOLDERS' EQUITY:
Common stock (80,000,000 shares outstanding at December 31, 2003 and September 30,
2004, respectively)............................................................ 80 80
Additional paid-in capital....................................................... 2,917,365 2,887,193
Retained earnings (deficit) ..................................................... 115,716 (114,535)
Accumulated other comprehensive loss............................................. -- (92,571)
------------- -------------
Total shareholders' equity.................................................. 3,033,161 2,680,167
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................... $ 4,639,631 $ 4,271,914
============= =============
See Notes to the Company's Interim Financial Statements
3
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2003 2004
----------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................ $ 203,727 $ (170,251)
Cumulative effect of accounting change....................... (98,910) --
----------- -------------
Income (loss) before cumulative effect of accounting change.. 104,817 (170,251)
Adjustments to reconcile income (loss) before cumulative
effect of accounting change to net cash provided by
operating activities:
Depreciation and amortization............................. 119,248 85,331
Fuel-related amortization................................. 15,920 20,375
Amortization of deferred financing costs.................. -- 1,651
Deferred income taxes..................................... (15,202) (213,332)
Investment tax credit..................................... (9,109) (8,653)
Write-down of assets...................................... -- 649,000
Changes in other assets and liabilities:
Accounts receivable..................................... (40,439) (16,607)
Taxes receivable........................................ 4,368 --
Inventory............................................... (16,135) 13,395
Accounts payable........................................ 28,918 24,522
Accounts payable, affiliate............................. (17,543) (1,626)
Taxes and interest accrued.............................. 53,183 9,919
Accrued reclamation costs............................... 3,992 (1,511)
Benefit obligations..................................... 1,587 20,612
Deferred revenue from capacity auctions................. 6,838 3,120
Other current assets.................................... 2,453 (10,026)
Other current liabilities............................... 664 (1,790)
Other long-term assets.................................. (1,839) 2,291
Other long-term liabilities............................. (7,478) (6,919)
----------- -------------
Net cash provided by operating activities............ 234,243 399,501
----------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures and other............................... (117,181) (45,751)
----------- -------------
Net cash used in investing activities................ (117,181) (45,751)
----------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of common stock dividends............................ (60,000) (60,000)
Debt issuance costs.......................................... -- (1,252)
Decrease in short-term notes payable, affiliate.............. (56,831) --
Decrease in long-term notes payable, affiliate............... (424) --
----------- -------------
Net cash used in financing activities................ (117,255) (61,252)
----------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........... (193) 292,498
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............... 578 44,558
----------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD..................... $ 385 $ 337,056
=========== =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest..................................................... $ 7,705 $ 885
Income taxes................................................. -- 52,732
See Notes to the Company's Interim Financial Statements
4
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 for the year
ended December 31, 2003 (Texas Genco Form 10-K).
Background. The Company is an 81% owned subsidiary of CenterPoint Energy,
Inc. (CenterPoint Energy). CenterPoint Energy is subject to regulation by the
Securities and Exchange Commission (SEC) as a registered public utility holding
company under the Public Utility Holding Company Act of 1935, as amended (1935
Act). Texas Genco, LP (Genco LP), a wholly owned subsidiary of the Company that
owns and operates the Company's electric generating plants, is an exempt
wholesale generator pursuant to an order of the Federal Energy Regulatory
Commission (FERC). As a result, Genco LP is exempt from all provisions of the
1935 Act so long as it remains an exempt wholesale generator, and the Company is
no longer a public utility holding company under the 1935 Act. SEC approval
would be required, however, for CenterPoint Energy to issue and sell securities
for the purpose of funding the Company's operations, or for CenterPoint Energy
to guarantee the Company's securities. Also, SEC policy precludes the Company
from borrowing from CenterPoint Energy's utility subsidiaries. On July 21, 2004,
the Company entered into a definitive transaction agreement pursuant to which it
has agreed to be acquired in a multistep transaction by GC Power Acquisition LLC
(GC Power Acquisition), a newly formed entity owned in equal parts by investment
funds affiliated with The Blackstone Group, Hellman & Friedman LLC, Kohlberg,
Kravis Roberts & Co. L.P. and Texas Pacific Group, for approximately $3.65
billion in cash. For further discussion, see Note 2.
Basis of Presentation. The Interim Financial Statements include the
operations of Texas Genco Holdings, Inc. and its subsidiaries, which manage and
operate the Company's electric generation operations.
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.
Note 2(f) (Long-Lived Assets and Intangibles) and Note 8 (Commitments and
Contingencies) to the consolidated annual financial statements included in the
Texas Genco Form 10-K relate to certain contingencies. These notes, as updated
herein, are incorporated herein by reference.
For information regarding certain environmental matters and legal
proceedings, see Note 9 to the Interim Financial Statements.
(2) DEFINITIVE AGREEMENT FOR THE SALE OF THE COMPANY
On July 21, 2004, the Company entered into a definitive transaction
agreement pursuant to which it has agreed to be acquired in a multistep
transaction by GC Power Acquisition for approximately $3.65 billion in cash. The
5
transaction will be accomplished in two steps. In the first step, expected to be
completed in the fourth quarter of 2004, the Company will purchase the
approximately 19% of its shares owned by the public (other than shares held by
shareholders who validly perfect their dissenters' rights under Texas law) in a
cash-out merger at a price of $47.00 per share, without interest and less any
applicable withholding taxes (Public Company Merger). In connection with the
anticipated Public Company Merger, the Company has filed with the SEC a Rule
13e-3 transaction statement and a preliminary information statement on Schedule
14C containing information with respect to the transactions contemplated by the
definitive transaction agreement, including the Public Company Merger, and
related matters. Following the Public Company Merger, a subsidiary of the
Company that will own the Company's coal, lignite and gas-fired generation
plants will merge with a subsidiary of GC Power Acquisition. The closing of the
first step of the transaction is subject to several conditions, including the
mailing of a definitive information statement to our shareholders at least 20
days prior to the closing of the Public Company Merger, the receipt of debt
financing under the financing commitments described below, the expiration or
termination of any applicable waiting period under the antitrust laws (including
the Hart Scott Rodino Antitrust Improvement Act of 1976), which occurred on
September 17, 2004, and FERC's certification of the entity that will own Texas
Genco's coal, lignite and gas-fired generation plants as an "exempt wholesale
generator," which occurred on September 24, 2004. The definitive information
statement will be mailed to the Company's shareholders of record as of October
21, 2004. The Company's shareholders as of the effective date of the Public
Company Merger will have the right to either receive the cash consideration for
their shares described above or exercise dissenters' rights in connection with
the Public Company Merger by properly complying with the requirements of the
Texas Business Corporation Act. Within 10 days after the effectiveness of the
Public Company Merger, the Company must mail to all of its shareholders written
notice of the effectiveness of the Public Company Merger and of their right to
dissent from that transaction within 20 days after the date of the Company's
mailing of the notice.
In the second step of the transaction, expected to take place in the first
half of 2005 following receipt of approval by the Nuclear Regulatory Commission
(NRC), for which the application was filed on October 18, 2004, the Company, the
principal remaining asset of which, at that time, will be the Company's interest
in the South Texas Project Electric Generating Station (South Texas Project),
will merge with another subsidiary of GC Power Acquisition.
GC Power Acquisition has entered into a commitment letter with financing
sources, including Goldman Sachs Credit Partners, L.P., providing for up to $2.5
billion in the aggregate in debt financing for the transaction and a separate
overnight loan of $717 million to the Company to fund the Public Company merger
in the first step of the transaction, each subject to customary closing
conditions. This overnight loan is expected to be repaid with the proceeds of
the merger of a subsidiary of the Company that will own the Company's coal,
lignite and gas-fired generation plants with a subsidiary of GC Power
Acquisition. In addition, GC Power Acquisition's sponsor firms have committed
upon closing of the transaction to provide up to $1.08 billion in the aggregate
in equity funding for the transaction.
The transaction has been approved by the board of directors of the Company
acting upon the unanimous recommendation of a special committee composed of
independent members of the Company's board of directors. Utility Holding, LLC
(Utility Holding), a wholly owned subsidiary of CenterPoint Energy, acting in
its capacity as the holder of approximately 81% of Texas Genco's outstanding
shares of common stock, has executed a written consent irrevocably approving the
transaction agreement and the transactions it contemplates, including the Public
Company Merger. Because Utility Holding owns shares of Texas Genco's common
stock representing greater than two-thirds of the votes required for approval of
the transactions under Texas law, no further vote of Texas Genco's shareholders
is required or contemplated.
In connection with the transaction, a subsidiary of the Company, Genco LP,
entered into a master power purchase and sale agreement with a member of the
Goldman Sachs group. Under that agreement, Genco LP has sold forward a
substantial quantity of its available base-load capacity through 2008 and
pledged $175 million of its first mortgage bonds as collateral for its
obligations. Genco LP's obligations under the power purchase agreement will
continue regardless of whether the transaction is completed.
On July 23, 2004, two plaintiffs filed substantially identical lawsuits in
Harris County, Texas state district court. The suits, purportedly brought on
behalf of holders of the Company's common stock, name the Company and each of
its directors as defendants. Both plaintiffs allege, among other things,
self-dealing and breach of fiduciary duty by the defendants in entering into the
transaction agreement. As part of their allegations of self-dealing, both
plaintiffs claim that the Company's board of directors is controlled by
CenterPoint Energy, that the defendants improperly concealed the Company's
results of operations for the second quarter of 2004 until after the transaction
agreement was announced, and that in order to aid CenterPoint Energy, the
Company's board only searched for acquirers who would offer all-cash
consideration. Among other relief, the plaintiffs seek to enjoin the
6
transaction or, alternatively, rescind the transaction to the extent already
implemented. In August 2004, the cases were consolidated in state district court
in Harris County, Texas. The Company intends to vigorously defend against the
consolidated suits.
In the third quarter of 2004, the Company recorded an after-tax impairment
of approximately $426 million related to the write-down of coal, lignite and
gas-fired generation assets in connection with the first step of the sale
transaction. These assets have been classified in the Consolidated Balance
Sheets as "held for sale."
(3) PURCHASE OF ADDITIONAL SOUTH TEXAS PROJECT INTEREST
On September 3, 2004, Genco LP signed an agreement to purchase a portion
of AEP Texas Central Company's (AEP) 25.2% interest in the South Texas Project
for approximately $174 million. Once the purchase is complete, Genco LP will own
an additional 13.2% interest in the South Texas Project for a total of 44%, or
approximately 1,100 MW. This purchase agreement was entered into pursuant to
Genco LP's right of first refusal to purchase this interest triggered by AEP's
previously announced agreement to sell this interest to a third party. In
addition to AEP's ownership interest and Genco LP's current 30.8% ownership, the
2,500 MW nuclear plant is currently 28%-owned by City Public Service of San
Antonio and 16%-owned by Austin Energy. City Public Service of San Antonio is
purchasing AEP's remaining 12% ownership interest under its right of first
refusal. The sale is subject to certain regulatory approvals, including filing
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and action by
the NRC, the FERC, and the SEC. The Company expects to fund the purchase of its
share of AEP's interest, including reimbursements of draws under letters of
credit discussed in Note 7, with existing cash balances and cash expected to be
generated through operations. The Company expects to complete this transaction
by the end of the first quarter of 2005.
(4) NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. (FIN) 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. On December 24, 2003, the
FASB issued a revision to FIN 46 (FIN 46-R). For special-purpose entities
(SPE's) created before February 1, 2003, the Company applied the provisions of
FIN 46 or FIN 46-R as of December 31, 2003. The revised FIN 46-R is effective
for all other entities for financial periods ending after March 15, 2004. The
Company evaluated two purchase power contracts with qualifying facilities as
defined in the Public Utility Regulatory Policies Act of 1978 and concluded that
it was not required to consolidate the entities that own the qualifying
facilities.
On December 23, 2003, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 132 (Revised 2003), "Employer's Disclosures about Pensions
and Other Postretirement Benefits" (SFAS No. 132 (R)) which increases the
existing disclosure requirements by requiring more details about pension plan
assets, benefit obligations, cash flows, benefit costs and related information.
Companies are required to segregate plan assets by category, such as debt,
equity and real estate, and to provide certain expected rates of return and
other informational disclosures. SFAS No. 132 (R) also requires companies to
disclose various elements of pension and postretirement benefit costs in
interim-period financial statements for quarters beginning after December 15,
2003. The Company has adopted the disclosure requirements of SFAS No. 132 (R) in
Note 10 to these Interim Financial Statements.
On May 19, 2004, the FASB issued a FASB Staff Position (FSP) addressing
the appropriate accounting and disclosure requirements for companies that
sponsor a postretirement health care plan that provides prescription drug
benefits. The new guidance from the FASB was deemed necessary as a result of the
2003 Medicare prescription law which includes a federal subsidy for qualifying
companies. FSP FAS 106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FAS
106-2)," requires that the effects of the federal subsidy be considered an
actuarial gain and treated like similar gains and losses and requires certain
disclosures for employers that sponsor postretirement health care plans that
provide prescription drug benefits. The FASB's related existing guidance, FSP
FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003," will be
superseded upon the effective date of FAS 106-2. The effective date of the new
FSP is the first interim or annual period beginning after June 15, 2004, except
for certain nonpublic entities which have until fiscal years beginning
7
after December 15, 2004. The adoption of FAS 106-2 did not have a material
effect on the Company's results of operations or financial condition.
(5) DERIVATIVE FINANCIAL INSTRUMENTS
In connection with the definitive agreement for the sale of the Company
entered into on July 21, 2004, Genco LP entered into a master power purchase and
sale agreement with a member of the Goldman Sachs group. Under that agreement,
Genco LP has sold forward a substantial quantity of its available base-load
capacity through 2008 and pledged $175 million of its first mortgage bonds as
collateral for its obligations. Genco LP's obligations under the power
purchase agreement will continue regardless of whether the sale transaction is
completed. The Company has designated the master power purchase and sale
agreement as a cash flow hedge of the forecasted sale of base-load capacity
through 2008. During the three months ended September 30, 2004, no hedge
ineffectiveness was recognized in earnings from derivatives that qualify for and
are designated as cash flow hedges. As of September 30, 2004, the Company
expects $5 million in accumulated other comprehensive income to be reclassified
into net income during the next twelve months.
(6) COMPREHENSIVE INCOME (LOSS)
The following table summarizes the components of total comprehensive
income (loss):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
------------------ ------------------
(IN MILLIONS)
Net loss............................................. $ (311) $ (170)
Other comprehensive loss:
Minimum benefits liability......................... (17) (17)
Net deferred loss from cash flow hedges............ (76) (76)
----------- -----------
Other comprehensive loss............................. (93) (93)
----------- -----------
Comprehensive loss................................... $ (404) $ (263)
=========== ===========
(7) SHORT-TERM BORROWINGS
In September 2004, Genco LP amended its $75 million senior secured
revolving credit facility to increase the facility to $250 million. The facility
is secured by Genco LP's first mortgage bonds. The revolving credit facility
terminates on the earlier of March 2, 2005 or the date of the consummation of
the sale of Texas Genco's coal, lignite and gas-fired generation assets to GC
Power Acquisition. As of September 30, 2004, there were no borrowings
outstanding under the revolving credit facility. As of September 30, 2004,
letters of credit aggregating $182 million were issued under the facility in
favor of AEP, and are expected to be drawn upon in the first quarter of 2005 to
pay the purchase price of an additional interest in the South Texas Project as
further discussed in Note 3. The expiration date of the letters of credit is
August 29, 2005. Under the terms of the credit facility, the letters of credit
will be cash collateralized at 105% of their face amount upon the Company's sale
of its coal, lignite and gas-fired generation assets to GC Power Acquisition.
The Company expects to fund the cash collateral with a portion of the net
proceeds of the sale.
(8) RELATED PARTY TRANSACTIONS AND MAJOR CUSTOMERS
As of December 31, 2003 and September 30, 2004, the Company had net
accounts payable to affiliates of $8 million and $6 million, respectively.
During the three months ended September 30, 2003 and 2004, the sales and
services by the Company to Reliant Energy, Inc. (formerly named Reliant
Resources, Inc.) (RRI) and its subsidiaries totaled $496 million and $423
million, respectively. During the nine months ended September 30, 2003 and 2004,
the sales and services by the Company to RRI and its subsidiaries totaled $1.2
billion and $1 billion, respectively. During the three months and nine months
ended September 30, 2003 and 2004, there were no sales and services by the
Company to CenterPoint Energy and its affiliates. During the three months ended
September 30, 2003 and 2004, the sales and services by the Company to another
major customer totaled $67 million and $95 million, respectively. During the
nine months ended September 30, 2003 and 2004, the sales and services by the
Company to that customer totaled $160 million and $285 million, respectively.
8
During the three months ended September 30, 2003 and 2004, purchases of
natural gas by the Company from CenterPoint Energy and its affiliates were $14
million and $2 million, respectively. During the nine months ended September 30,
2003 and 2004, purchases of natural gas by the Company from CenterPoint Energy
and its affiliates were $23 million and $18 million, respectively.
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 $7 million and
$8 million for the three months ended September 30, 2003 and 2004, respectively,
and are included primarily in operation and maintenance expenses. Amounts
charged to the Company for these services were $24 million and $20 million for
the nine months ended September 30, 2003 and 2004, respectively, and are
included primarily in operation and maintenance expenses.
(9) COMMITMENTS AND CONTINGENCIES
Clean Air Standards. The 1999 Texas Electric Choice Law (Texas electric
restructuring law) and regulations adopted by the Texas Commission on
Environmental Quality (TCEQ) in 2001 require substantial reductions in emission
of oxides of nitrogen (NOx) from electric generating units. The Company is
currently installing cost-effective controls at its generating plants to comply
with these requirements. Through September 30, 2004, the Company has invested
$689 million for NOx emission control, and plans to make additional expenditures
of up to approximately $106 million during the remainder of 2004 through 2007.
Further revisions to these NOx requirements may result from the EPA's ongoing
review of these TCEQ rules and from the TCEQ's future rules, expected in 2007,
implementing the more stringent federal eight-hour ozone standard.
Asbestos. The Company has been named, along with numerous others, as a
defendant in several lawsuits filed by a large number of individuals who claim
injury due to exposure to asbestos while working at sites along the Texas Gulf
Coast. Most of these claimants have been workers who participated in
construction of various industrial facilities, including power plants, and some
of the claimants have worked at locations owned by the Company. The Company
anticipates that additional claims like those received may be asserted in the
future and intends to continue vigorously contesting claims which it does not
consider to have merit.
Texas Antitrust Action. In July 2003, Texas Commercial Energy filed in
federal court in Corpus Christi, Texas a lawsuit against Reliant Energy,
Incorporated (Reliant Energy), CenterPoint Energy and CenterPoint Energy Houston
Electric, LLC (CenterPoint Houston), as successors to Reliant Energy, Genco LP,
RRI, Reliant Electric Solutions, LLC, several other RRI subsidiaries and a
number of other participants in the Electric Reliability Council of Texas
(ERCOT) power market. The plaintiff, a retail electricity provider in the Texas
market served by ERCOT, alleged that the defendants conspired to illegally fix
and artificially increase the price of electricity in violation of state and
federal antitrust laws and committed fraud and negligent misrepresentation. The
lawsuit sought damages in excess of $500 million, exemplary damages, treble
damages, interest, costs of suit and attorneys' fees. The plaintiff's principal
allegations had previously been investigated by the Texas Utility Commission and
found to be without merit. In June 2004, the federal court dismissed the
plaintiff's claims and in July 2004, the plaintiff filed a notice of appeal. The
Company intends to contest the appeal. The ultimate outcome of this matter
cannot be predicted at this time.
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 $10.8 billion as of September 30, 2004.
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
9
South Texas Project are subject to maximum retrospective assessments in the
aggregate per incident of up to $100.6 million per reactor. The owners are
jointly and severally liable at a rate not to exceed $10 million per reactor per
year per incident.
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. CenterPoint Houston, as collection agent for the
nuclear decommissioning charge assessed on its transmission and distribution
customers, contributed $2.9 million in 2003 to trusts established to fund the
Company's share of the decommissioning costs for the South Texas Project, and
expects to contribute $2.9 million in 2004. There are various investment
restrictions imposed upon the Company by the Public Utility Commission of Texas
and NRC relating to the Company's nuclear decommissioning trusts. The Company
and CenterPoint Energy have each appointed two members to the Nuclear
Decommissioning Trust Investment Committee which establishes the investment
policy of the trusts and oversees the investment of the trusts' assets. The
securities held by the trusts for decommissioning costs had an estimated fair
value of $200 million as of September 30, 2004, of which approximately 37% were
fixed-rate debt securities and the remaining 63% were equity securities. In May
2004, an outside consultant estimated the Company's portion of decommissioning
costs to be approximately $456 million. While the funding levels currently
exceed minimum NRC requirements, no assurance can be given that the amounts held
in trust will be adequate to cover the actual decommissioning costs of the South
Texas Project. Such costs may vary because of changes in the assumed date of
decommissioning and changes in regulatory requirements, technology and costs of
labor, materials and equipment. Pursuant to the Texas electric restructuring
law, costs associated with nuclear decommissioning that have not been recovered
as of January 1, 2002, will continue to be subject to cost-of-service rate
regulation and will be charged to transmission and distribution customers of
CenterPoint Houston or its successor.
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 due to a more efficient utilization of each party's lowest cost
resources. The two parties currently share equally the savings resulting from
joint dispatch. The current agreement with CPS expires in 2009 and can be
terminated by either party at any time with 90 days' notice.
10
(10) EMPLOYEE BENEFIT PLANS
(a) Pension.
For the period January 1 through August 31, 2004, the Company's employees
participated in CenterPoint Energy's pension plan. However, effective September
1, 2004, the Company established a stand-alone pension plan for substantially
all employees of Texas Genco. As of the establishment of the new plan, Texas
Genco received its allocation of net pension obligations from CenterPoint
Energy. The funded status of the plan is as follows as of September 30, 2004 (in
millions):
RECONCILIATION OF FUNDED STATUS
Projected benefit obligation............................................ $ (148)
Plan assets ............................................................ 61
--------
Funded status........................................................... (87)
Unrecognized prior service cost......................................... (11)
Unrecognized net loss................................................... 51
--------
Net amount recognized................................................... $ (47)
========
AMOUNTS RECOGNIZED IN BALANCE SHEET
Benefit obligations..................................................... $ (68)
Accumulated other comprehensive income.................................. 21
--------
Net amount recognized................................................... $ (47)
========
ACTUARIAL ASSUMPTIONS
Discount rate........................................................... 6.25%
Expected return on plan assets.......................................... 9.00%
Rate of increase in compensation levels................................. 4.10%
ADDITIONAL INFORMATION
Accumulated benefit obligation.......................................... $ 129
Change in minimum liability adjustment included in other
comprehensive income.................................................. 21
December 31,
Measurement date used to determine plan obligations and assets......... 2003
During the fourth quarter of 2004, the Company received the results of an
actuarial valuation to determine the amount of CenterPoint Energy's pension plan
assets to be transferred to the new Texas Genco plan under the Employee Income
Security Act of 1974. From the actuarial valuation, it was determined that the
Company's share of existing plan assets was $39 million.
The new pension plan is underfunded. Pension contributions are not
required during 2004, but it is anticipated that $19 million in pension
contributions will be required during 2005.
Since the plan's funded status was not remeasured for accounting purposes,
the Company's net periodic cost was not impacted by the establishment of the
stand-alone plan. Net periodic cost for periods prior to September 1, 2004
represents solely the Company's participation in CenterPoint Energy's pension
plan.
11
The Company's net periodic cost was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2003 2004 2003 2004
---- ---- ---- ----
(IN MILLIONS)
Service cost.......................... $ 2 $ 2 $ 5 $ 5
Interest cost......................... 2 2 8 8
Expected return on plan assets........ (1) (2) (3) (5)
Net amortization...................... 1 1 3 1
---- ---- ---- ----
Net periodic cost..................... $ 4 $ 3 $ 13 $ 9
==== ==== ==== ====
CenterPoint Energy used the following assumptions to determine net
periodic cost relating to pension benefits allocated to the Company:
2003 2004
---- ----
Discount rate................................... 6.75% 6.25%
Expected return on plan assets.................. 9.00% 9.00%
Rate of increase in compensation levels......... 4.10% 4.10%
(b) Postretirement Benefits.
The Company's employees participate in CenterPoint Energy's postretirement
benefit plan. Net periodic cost in each of the three month periods ended
September 30, 2003 and 2004 was $1 million and $18 million (including $17
million of non-recurring curtailment costs attributable to the discontinued
participation of the Company's workforce in the plan as active employees). Net
periodic cost in each of the nine month periods ended September 30, 2003 and
2004 was $3 million and $20 million (including $17 million of non-recurring
curtailment costs attributable to the discontinued participation of the
Company's workforce in the plan as active employees), respectively. The Company
expects to contribute $1 million to CenterPoint Energy's postretirement benefits
plan in 2004. As of September 30, 2004, $1 million has been contributed.
(11) SUBSEQUENT EVENT
(a) Dividend Payment.
On November 4, 2004, the Company's board of directors declared a dividend
of $0.25 per share of common stock payable on December 20, 2004 to shareholders
of record as of the close of business on November 26, 2004. If the Public
Company Merger occurs on or prior to the record date, the dividend will not be
paid.
(b) Tax Legislation.
On October 22, 2004, the American Jobs Creation Act (the "Act") was signed
into law. The Act makes several sweeping changes to U.S. taxpayers engaged in
cross-border or manufacturing businesses, and some of the provisions of the Act
have retroactive effective dates. The Company is currently analyzing the impact
of this legislation, but believes that the Act has no material effect on its
financial position as of September 30, 2004.
12
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 Item 1 of this
Form 10-Q.
OVERVIEW
We are a wholesale electric power generating company that owns 60
generating units at 11 electric power generation facilities located in Texas. We
also own a 30.8% interest in the South Texas Project Electric Generating Station
(South Texas Project), a nuclear generating station with two 1,250 megawatt (MW)
nuclear generating units. As of September 30, 2004, the aggregate net generating
capacity of our portfolio of assets was 14,153 megawatts (MW), of which 2,585 MW
of gas-fired capacity was then mothballed. In May 2004, 403 MW of previously
mothballed gas-fired capacity was returned to service. The gas-fired capacity
that is currently mothballed is expected to remain mothballed through April
2005. 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 and encompasses the majority of the population
centers in the State of Texas. ERCOT facilitates reliable grid operations for
approximately 85% of the demand for power in the state.
We are an 81% owned subsidiary of CenterPoint Energy, Inc. (CenterPoint
Energy). CenterPoint Energy is a registered public utility holding company under
the Public Utility Holding Company Act of 1935, as amended (1935 Act). The 1935
Act and related rules and regulations impose a number of restrictions on the
activities of CenterPoint Energy and its subsidiaries. Texas Genco, LP (Genco
LP), our wholly owned subsidiary that owns and operates our electric generating
plants, is an exempt wholesale generator (EWG) pursuant to an order of the
Federal Energy Regulatory Commission (FERC). As a result, Genco LP is exempt
from all provisions of the 1935 Act so long as it remains an EWG, and we are no
longer a public utility holding company under the 1935 Act.
EXECUTIVE SUMMARY
RECENT EVENTS
DEFINITIVE AGREEMENT FOR THE SALE OF THE COMPANY
On July 21, 2004, we entered into a definitive transaction agreement
pursuant to which we have agreed to be acquired in a multistep transaction by GC
Power Acquisition for approximately $3.65 billion in cash. The transaction will
be accomplished in two steps. In the first step, expected to be completed in the
fourth quarter of 2004, we will purchase the approximately 19% of our shares
owned by the public (other than shares held by shareholders who validly perfect
their dissenters' rights under Texas law) in a cash-out merger at a price of
$47.00 per share, without interest and less any applicable withholding taxes
(Public Company Merger). In connection with the anticipated Public Company
Merger, we have filed with the SEC a Rule 13e-3 transaction statement and a
preliminary information statement on Schedule 14C containing information with
respect to the transactions contemplated by the definitive transaction
agreement, including the Public Company Merger, and related matters. Following
the Public Company Merger, one of our subsidiaries that will own our coal,
lignite and gas-fired generation plants will merge with a subsidiary of GC Power
Acquisition. The closing of the first step of the transaction is subject to
several conditions, including the mailing of a definitive information statement
to our shareholders at least 20 days prior to the closing of the Public Company
Merger, the receipt of debt financing under the financing commitments described
below, the expiration or termination of any applicable waiting period under the
antitrust laws (including the Hart Scott Rodino Antitrust Improvement Act of
1976), which occurred on September 17, 2004, and the FERC's certification of the
entity that will own our coal, lignite and gas-fired generation plants as an
"exempt wholesale generator", which occurred on September 24, 2004. The
definitive information statement will be mailed to our shareholders of record as
of October 21, 2004. Our shareholders as of the effective date of the Public
Company Merger will have the right to either receive the cash consideration for
their shares described above or exercise dissenters' rights in connection with
the Public Company Merger by properly complying with the requirements of the
Texas Business Corporation Act. Within 10 days after the effectiveness of the
Public Company Merger, we must mail to all of our shareholders written notice of
the effectiveness of the Public Company Merger and of their right to dissent
from that transaction within 20 days after the date of our mailing of the
notice.
13
In the second step of the transaction, expected to take place in the first
half of 2005 following receipt of approval by the Nuclear Regulatory Commission,
Texas Genco, the principal remaining asset of which, at that time, will be its
interest in the South Texas Project Electric Generating Station (South Texas
Project), will merge with another subsidiary of GC Power Acquisition.
GC Power Acquisition has entered into a commitment letter with financing
sources, including Goldman Sachs Credit Partners, L.P., providing for up to $2.5
billion in the aggregate in debt financing for the transaction and a separate
overnight loan of $717 million to us to fund the Public Company merger in the
first step of the transaction, each subject to customary closing conditions.
This overnight loan is expected to be repaid with the proceeds of the merger of
one of our subsidiaries that will own our coal, lignite and gas-fired generation
plants with a subsidiary of GC Power Acquisition. In addition, GC Power
Acquisition's sponsor firms have committed upon closing of the transaction to
provide up to $1.08 billion in the aggregate in equity funding for the
transaction.
The transaction has been approved by our board of directors acting upon
the unanimous recommendation of a special committee composed of independent
members of our board of directors. Utility Holding, LLC (Utility Holding), a
wholly owned subsidiary of CenterPoint Energy, acting in its capacity as the
holder of approximately 81% of our outstanding shares of common stock, has
executed a written consent irrevocably approving the transaction agreement and
the transactions it contemplates, including the Public Company Merger. Because
Utility Holding owns shares of our common stock representing greater than
two-thirds of the votes required for approval of the transactions under Texas
law, no further vote of our shareholders is required or contemplated.
In connection with the transaction, one of our subsidiaries, Genco LP,
entered into a master power purchase and sale agreement with a member of the
Goldman Sachs group. Under that agreement, Genco LP has sold forward a
substantial quantity of our available base-load capacity through 2008 and
pledged $175 million of our first mortgage bonds as collateral for our
obligations. Genco LP's obligations under the power purchase agreement will
continue regardless of whether the transaction is completed.
On July 23, 2004, two plaintiffs filed substantially identical lawsuits in
Harris County, Texas state district court. The suits, purportedly brought on
behalf of holders of our common stock, name us and each of our directors as
defendants. Both plaintiffs allege, among other things, self-dealing and breach
of fiduciary duty by the defendants in entering into the transaction agreement.
As part of their allegations of self-dealing, both plaintiffs claim that our
board of directors is controlled by CenterPoint Energy, that the defendants
improperly concealed our results of operations for the second quarter of 2004
until after the transaction agreement was announced, and that in order to aid
CenterPoint Energy, our board only searched for acquirers who would offer
all-cash consideration. Among other relief, the plaintiffs seek to enjoin the
transaction or, alternatively, rescind the transaction to the extent already
implemented. In August 2004, the cases were consolidated in state district court
in Harris County, Texas. We intend to vigorously defend against the consolidated
suits.
In the third quarter of 2004, we recorded an after-tax impairment of
approximately $426 million related to the write-down of coal, lignite and
gas-fired generation assets in connection with the first step of the sale
transaction. These assets are classified in the Consolidated Balance Sheets as
"held for sale."
AGREEMENT TO PURCHASE ADDITIONAL INTEREST IN THE SOUTH TEXAS PROJECT
On September 3, 2004, Genco LP signed an agreement to purchase a portion
of AEP Texas Central Company's (AEP) 25.2% interest in the South Texas Project
for approximately $174 million. Once the purchase is complete, Genco LP will own
an additional 13.2% interest in the South Texas Project for a total of 44%, or
approximately 1,100 MW. This purchase agreement was entered into pursuant to
Genco LP's right of first refusal to purchase this interest triggered by AEP's
previously announced agreement to sell this interest to a third party. In
addition to AEP's ownership interest and Genco LP's current 30.8% ownership, the
2,500 MW nuclear plant is currently 28%-owned by City Public Service of San
Antonio and 16%-owned by Austin Energy. City Public Service of San Antonio is
purchasing AEP's remaining 12% ownership interest under its right of first
refusal. The sale is subject to certain regulatory approvals, including filing
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and action by
the Nuclear Regulatory Commission, the FERC, and the SEC. We expect to fund the
purchase of our share of AEP's interest, including reimbursements of draws under
letters of credit discussed in Note 7 to our consolidated financial statements,
with existing cash balances and cash expected to be generated through
operations. We expect to complete this transaction by the end of the first
quarter of 2005.
3RD QUARTER 2004 HIGHLIGHTS
In the third quarter 2004, we reported a net loss of $311 million, or
$3.89 per diluted share, which includes an after-tax impairment charge of $426
million ($649 million pre-tax) related to the pending sale of our coal, lignite
14
and gas-fired generation plants to GC Power Acquisition. As a result of the
signing of the definitive agreement described above, and in accordance with
Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets," we ceased depreciation on our
coal, lignite and gas-fired generation plants at the time these assets were
considered "held for sale." This resulted in a decrease in depreciation expense
of $24 million after-tax ($37 million pre-tax) for the quarter. In accordance
with SFAS No. 106 "Employers' Accounting for Postretirement Benefits Other Than
Pensions," we also recorded a curtailment expense related to postretirement
benefits of $11 million after-tax ($17 million pre-tax), which is included in
operations and maintenance expense. Excluding these sale-related impacts, net
income for the third quarter of 2004 was $102 million, or $1.27 per share,
compared to $82 million, or $1.03 per share, for the same period of 2003
primarily due to higher capacity revenue during 2004 for base-load products
driven by continued high natural gas prices and their effect on wholesale
electricity prices in the ERCOT market.
2004 OUTLOOK
In our capacity auctions held through September 2004, we have sold forward
100% of our available firm base-load capacity for 2004, representing over $905
million of firm capacity revenue under contract. In addition, we have sold
gas-fired and non-firm base-load capacity bringing the total 2004 contracted
capacity revenues to over $1.12 billion. Available base-load capacity is defined
as our total base-load capacity less planned outages and less up to 750
megawatts of operating reserves. For 2005, we have sold forward in our capacity
auctions approximately 80% of our available firm base-load capacity, which
represents over $690 million of contracted firm base-load capacity revenue. In
addition, we have sold non-firm base-load capacity with revenues of
approximately $62 million, bringing the total 2005 contracted capacity revenues
to over $750 million. These amounts do not include forward sales of base-load
capacity under the master power purchase and sale agreement described above. In
addition to capacity sales, we have sold approximately $10 million of surplus
emission allowances in the first nine months of 2004, and will evaluate future
sales of emissions allowances as opportunities develop. Financial performance in
2004 and beyond is highly dependent on the operating performance of our
base-load generating units.
15
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth our consolidated results of operations for
the three months and nine months ended September 30, 2003 and 2004, followed by
a discussion of our consolidated results of operations.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2004 2003 2004
------------- ------------ ------------ ------------
(IN THOUSANDS)
REVENUES........................................... $ 657,363 $ 637,885 $ 1,594,461 $ 1,629,732
------------ ------------ ------------ ------------
EXPENSES:
Fuel costs....................................... 365,913 315,644 923,220 765,951
Purchased power.................................. 20,259 17,506 55,227 43,874
Operation and maintenance........................ 100,353 118,914 311,004 319,113
Depreciation and amortization.................... 40,778 4,355 119,248 85,331
Write-down of assets............................. -- 649,000 -- 649,000
Taxes other than income taxes.................... 5,084 8,721 27,858 33,099
------------ ------------ ------------ ------------
Total....................................... 532,387 1,114,140 1,436,557 1,896,368
------------ ------------ ------------ ------------
OPERATING INCOME (LOSS)............................ 124,976 (476,255) 157,904 (266,636)
OTHER INCOME....................................... 489 908 1,778 2,963
INTEREST EXPENSE, NET.............................. (1,298) -- (6,923) (140)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE...................... 124,167 (475,347) 152,759 (263,813)
INCOME TAX BENEFIT (EXPENSE)....................... (41,761) 164,088 (47,942) 93,562
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE................................ 82,406 (311,259) 104,817 (170,251)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF
TAX.............................................. -- -- 98,910 --
------------ ------------ ------------ ------------
NET INCOME (LOSS).................................. $ 82,406 $ (311,259) $ 203,727 $ (170,251)
============ ============ ============ ============
BASIC AND DILUTED EARNINGS PER SHARE:
Income (Loss) Before Cumulative Effect of
Accounting Change............................. $ 1.03 $ (3.89) $ 1.31 $ (2.13)
Cumulative Effect of Accounting Change, net of
tax........................................... -- -- 1.24 --
------------ ------------ ------------ ------------
Net Income (Loss)................................ $ 1.03 $ (3.89) $ 2.55 $ (2.13)
============ ============ ============ ============
Sales (MWH)........................................ 14,533,513 13,476,047 36,327,349 36,159,200
Generation (MWH)................................... 13,416,037 13,036,825 34,488,241 34,728,241
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
For the three months ended September 30, 2004, we reported a net loss of
$311 million, or $3.89 per diluted share, which includes an after-tax impairment
charge of $426 million ($649 million pre-tax) related to the pending sale of our
coal, lignite and gas-fired generation plants to GC Power Acquisition. As a
result of the signing of the definitive agreement described above, and in
accordance with Statement of Financial Accounting Standards (SFAS) No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets," we ceased
depreciation on our coal, lignite and gas-fired generation plants at the time
these assets were considered "held for sale." This resulted in a decrease in
depreciation expense of $24 million after-tax ($37 million pre-tax) for the
quarter. In accordance with SFAS No. 106 "Employers' Accounting for
Postretirement Benefits Other Than Pensions," we also recorded a curtailment
expense related to postretirement benefits of $11 million after-tax ($17 million
pre-tax), which is included in operations and maintenance expense. Excluding
these sale-related impacts, net income for the third quarter of 2004 was $102
million, or $1.27 per share, compared to $82 million, or $1.03 per share, for
the same period of 2003 primarily due to higher capacity revenue during 2004 for
base-load products driven by continued high natural gas prices and their effect
on wholesale electricity prices in the ERCOT market. Most of these base-load
products were sold in capacity auctions held when natural gas prices were higher
than when we sold our capacity for
16
2003. Energy revenues and fuel and purchased power costs declined in the third
quarter of 2004 as compared to the same period in 2003 reflecting a reduction in
planned and unplanned outages and therefore an increase in availability of our
base-load units in 2004 as well as lower demand for gas-fired generation
products in 2004. Excluding the curtailment expense of $11 million ($17 million
pre-tax) discussed above, operation and maintenance expenses were relatively
flat in the third quarter of 2004 as compared to the same period in 2003.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
For the nine months ended September 30, 2004, we reported a net loss of
$170 million, or $2.13 per diluted share, including the sale-related impacts
described above. Net income for the nine months ended September 30, 2003, was
$204 million, or $2.55 per share, including a non-cash gain of $99 million
($1.24 per share) from the adoption of Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations". Excluding the
sale-related impacts, net income for the nine months ended September 30, 2004
was $243 million, or $3.03 per share, and income before the cumulative effect of
an accounting change for the same period of 2003 was $105 million, or $1.31 per
share. Revenues increased $35 million in the first nine months of 2004 as
compared to the same period in 2003 due to higher capacity revenue for base-load
products driven by continued high natural gas prices and their effect on
wholesale electricity prices in the ERCOT market. Most of these base-load
products were sold in capacity auctions held when natural gas prices were higher
than when we sold our capacity for 2003. Fuel and purchased power costs declined
$169 million in the first nine months of 2004 as compared to the same period in
2003 reflecting a reduction in planned and unplanned outages during 2004 and
therefore an increase in availability of our base-load units as well as lower
demand for gas-fired generation products in 2004. Excluding the curtailment
expense recorded in the third quarter 2004 as discussed above, operation and
maintenance expenses decreased $9 million primarily due to the reduction in
planned and unplanned outages in the first nine months of 2004 as compared to
the same period in 2003, partially offset by increased payroll expense for
technical support personnel and transaction-related fees associated with the
expected sale of the company to GC Power Acquisition.
In connection with the adoption of Statement of Financial Accounting
Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations" (SFAS
No. 143), we completed an assessment of the applicability and implications of
SFAS No. 143. As a result of the assessment, we 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 nine months ended September 30, 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.
RELATED PARTY TRANSACTIONS
We have entered into a number of agreements with CenterPoint Energy that
govern our ongoing relationships with CenterPoint Energy, including providing
various services to us. Pursuant to the requirements of the 1935 Act,
CenterPoint Energy has formed a service company through which these services are
delivered. For information regarding our agreements and other relationships with
CenterPoint Energy, please read Note 8 to our Interim Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Related Party Transactions" in the Texas Genco Form 10-K.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read the factors listed under "Cautionary
Statement Regarding Forward-Looking Information" on Page ii of this Form 10-Q,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting Future Earnings" in Item 7 of Part II of
the Texas Genco Form 10-K and "Risk Factors" in Item 1 of Part I of the Texas
Genco Form 10-K, each of which is incorporated herein by reference.
17
LIQUIDITY AND CAPITAL RESOURCES
HISTORICAL CASH FLOWS
The net cash provided by/used in our operating, investing and financing
activities for the nine months ended September 30, 2003 and 2004 is as follows
(in millions):
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2003 2004
---------- -----------
Cash provided by (used in):
Operating activities............................. $ 234 $ 400
Investing activities............................. (117) (46)
Financing activities............................. (117) (61)
CASH PROVIDED BY OPERATING ACTIVITIES
Net cash provided by operating activities increased $166 million for the
nine months ended September 30, 2004 as compared to the same period in 2003
primarily as a result of higher capacity auction prices, which were driven by
continued high natural gas prices, as well as significantly lower fuel costs
resulting from improved availability of our base-load units in 2004.
CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities decreased $71 million for the nine
months ended September 30, 2004 as compared to the same period in 2003 primarily
related to a planned reduction in NOx emissions control expenditures.
CASH PROVIDED BY FINANCING ACTIVITIES
Cash used in financing activities decreased $56 million for the nine
months ended September 30, 2004 as compared to the same period in 2003 because
of the repayment of borrowings owed to CenterPoint Energy during 2003.
FUTURE SOURCES AND USES OF CASH
Our liquidity and capital requirements will be affected by our:
- capital requirements related to environmental compliance and other
projects;
- anticipated purchase of an additional interest in the South Texas
Project pursuant to the exercise of our right of first refusal as
described above under " -- Executive Summary -- Recent Events --
Agreement to Purchase Additional Interest in the South Texas
Project";
- dividend policy;
- pension contributions;
- debt service requirements; and
- working capital requirements.
As of September 30, 2004, we had temporary investments of $337 million. As
of September 30, 2004, we had no investments in CenterPoint Energy's money pool
for unregulated subsidiaries.
In September 2004, Genco LP amended its $75 million senior secured
revolving credit facility to increase the facility to $250 million. The
revolving credit facility terminates on the earlier of March 2, 2005 or the date
of the consummation of the sale of our coal, lignite and gas-fired generation
assets to GC Power Acquisition. Proceeds
18
from the revolving credit facility will be used to meet ongoing working capital
requirements and for other general corporate purposes. Borrowings under the
facility may be made at the London interbank offered rate (LIBOR) plus 100 basis
points. The facility is secured by a series of Genco LP's first mortgage bonds
in an aggregate principal amount of $250 million. All of our real and tangible
properties, subject to certain exclusions, are currently subject to the lien of
the first mortgage. As of September 30, 2004, there were no borrowings
outstanding under the revolving credit facility. As of September 30, 2004,
letters of credit aggregating $182 million were issued under the facility in
favor of AEP, and are expected to be drawn upon in the first quarter of 2005 to
pay the purchase price of an additional interest in the South Texas Project. The
expiration date of the letters of credit is August 29, 2005. Our existing cash
balances and cash expected to be generated by operations are expected to be used
to reimburse the draws under the letters of credit. Under the terms of the
credit facility, it is expected that the letters of credit will be cash
collateralized at 105% of their face amount upon the sale of our coal, lignite
and gas-fired generation assets to GC Power Acquisition. We expect to fund the
cash collateral with a portion of the net proceeds of the sale.
We believe that our existing cash balances, cash flows from operations,
including sales of available base-load capacity under the master power purchase
and sale agreement described above under " -- Executive Summary -- Recent Events
- -- Definitive Agreement for the Sale of the Company," and our external borrowing
capability will be sufficient to meet the operational needs of our business for
the next twelve months.
CenterPoint Energy's $2.3 billion bank facility limits our incurrence of
indebtedness for borrowed money to an aggregate principal amount not to exceed
$250 million outstanding at any time and requires that proceeds from the sale of
any material portion of our assets, proportionate to CenterPoint Energy's
ownership interest in us and subject to certain other requirements, be used to
prepay indebtedness under such credit facility. Our credit facility also limits
our incurrence of additional secured indebtedness for borrowed money to a
maximum of $175 million aggregate principal amount. Although we are not
contractually bound by the limitations in CenterPoint Energy's bank facility, we
expect that CenterPoint Energy would likely cause its representatives on our
board of directors to direct our business so as not to breach the terms of its
facility. CenterPoint Energy intends to seek a waiver from the lenders under its
bank facility to permit us to borrow up to $717 million under the overnight
bridge loan described below to fund the Public Company Merger.
Under the terms of the definitive transaction agreement for the sale of
the company to GC Power Acquisition, we have agreed to certain restrictions on
our ability to incur indebtedness. Under these restrictions, prior to closing of
the sale transaction we and our subsidiaries may not repurchase, repay or incur
any indebtedness, issue any securities in respect of indebtedness or assume,
guarantee, endorse or otherwise become responsible for the obligations or
indebtedness of any person, other than:
- as otherwise contemplated by the transaction agreement;
- as required by applicable law;
- items for which GC Power Acquisition has given its prior written
consent (which cannot be unreasonably withheld or delayed);
- borrowings under the $717 million overnight bridge loan financing
commitment relating to the anticipated Public Company Merger, as
described below;
- borrowings under our $250 million credit agreement:
- to fund the purchase price for an additional interest in the
South Texas Project pursuant to the exercise of the right of
first refusal described under "Executive Summary -- Recent
Events -- Agreement to Purchase Additional Interest in the
South Texas Project";
- to fund dividends or distributions allowed under the terms of
the transaction agreement, including regular quarterly cash
dividends not in excess of $0.25 per share per quarter; and
- to fund working capital requirements to meet operating cash
needs (up to $75 million in borrowings).
19
Cash Flows From Operations -- Reliant Energy, Inc. (formerly named Reliant
Resources, Inc. (RRI)) as a Significant Customer. To date, we have sold a
substantial portion of our auctioned capacity entitlements to subsidiaries of
RRI. Pursuant to a Master Power Purchase and Sale Agreement with a subsidiary of
RRI related to power sales in the ERCOT market, we have been granted a security
interest in accounts receivable and/or notes associated with the accounts
receivable of certain subsidiaries of RRI to secure up to $250 million in
purchase obligations. For more information regarding the impact that RRI's
financial condition may have on our cash flows, please read "Our Business --
Risk Factors " in Item 1 of the Texas Genco Form 10-K. This pledge agreement
with RRI will terminate with respect to new obligations incurred on and after
January 1, 2005. We expect that the sale of our coal, lignite and gas-fired
generation assets to GC Power Acquisition will close prior to January 1, 2005.
Overnight Bridge Loan Facility for the Public Company Merger. As described
under "- Executive Summary - Recent Events - Definitive Agreement for the Sale
of the Company," in connection with the Public Company Merger, all of the
15,235,760 outstanding shares of our common stock held by our shareholders other
than CenterPoint Energy (and those shareholders who validly perfect their
dissenters' rights under Texas law) will be converted into the right to receive
$47.00 per share in cash (without interest and less any applicable withholding
taxes), resulting in an aggregate payment of up to approximately $716 million.
Pursuant to GC Power Acquisition's debt financing letter, we have received a
commitment from Goldman Sachs Credit Partners, L.P. to provide us with an
overnight bridge loan of up to $717 million to finance the Public Company
Merger. The overnight bridge loan will mature within 72 hours of its funding.
The sale of our coal, lignite and gas fired generation plants to a subsidiary of
GC Power Acquisition is expected to close on the business day following the
Public Company Merger. We expect to use approximately $717 million of the $2,813
million of aggregate cash consideration we receive in the sale of our
non-nuclear assets to fund or repay borrowings used to fund the Public Company
Merger. A portion of the consideration for the sale of our non-nuclear assets
will be paid directly to the lenders under the overnight bridge loan facility to
the extent necessary to repay in full any amounts outstanding under that
facility. We would seek to obtain alternate financing if the overnight bridge
loan facility is not available to us, but we do not currently have any
alternative financing plans or arrangements.
Borrowings under the overnight bridge loan facility will bear interest at
one-day LIBOR plus 100 basis points. The overnight bridge loan facility will be
unsecured and guaranteed by all of our existing and subsequently acquired or
organized domestic subsidiaries. The overnight bridge loan facility will include
events of default as are usual and customary for a financing of its kind,
including, without limitation, the following:
- failure to make payments when due;
- defaults under certain other agreements or instruments of
indebtedness;
- breaches of representations and warranties; and
- bankruptcy.
We will pay all reasonable, documented out-of-pocket costs and expenses in
connection with the overnight bridge loan facility.
The closing of the Public Company Merger is conditioned on our access to
the overnight bridge loan facility, which is itself conditioned on, in addition
to customary corporate and documentation conditions, the closing and funding
into escrow of the debt financing for GC Power Acquisition's purchase of our
non-nuclear assets and the closing of documentation related to (but not the
funding of) a $475 million delayed draw term loan facility to fund GC Power
Acquisition's purchase of our nuclear assets in the last step of the sale
transaction.
Intercompany Borrowings. As a result of Genco LP's certification by the
FERC as an EWG under the 1935 Act, CenterPoint Energy has established a money
pool in which we, CenterPoint Energy and certain other unregulated subsidiaries
of CenterPoint Energy can participate. Except in an emergency situation (in
which CenterPoint Energy could provide funding pursuant to applicable SEC
rules), CenterPoint Energy would be required to obtain approval from the SEC to
issue and sell securities for purposes of funding our operations or for
CenterPoint Energy to guarantee any of our securities. There is no assurance
that CenterPoint Energy will have sufficient funds to meet our cash needs.
20
Pension Plan. As discussed in Note 6(b) to the consolidated annual
financial statements included in the Texas Genco Form 10-K (Texas Genco Notes),
we participated in CenterPoint Energy's qualified non-contributory pension plan
covering substantially all our employees through August 31, 2004. Pension
expense for 2004 is estimated to be $12 million based on an expected return on
plan assets of 9.0% and a discount rate of 6.25% as of December 31, 2003. 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.
On September 1, 2004, we established a separate pension plan whereby we
recorded a net pension liability of approximately $68 million in accordance with
SFAS No. 87, "Employer's Accounting for Pensions" that was transferred to us
from CenterPoint Energy. In October 2004, we received an allocation of assets
from the CenterPoint Energy pension plan pursuant to rules and regulations under
the Employee Retirement Income Security Act of 1974 amounting to $39 million.
Because the pension plan is underfunded, pension contributions of $19 million
are expected to be required in 2005.
OFF-BALANCE SHEET FINANCING
Other than operating leases, we have no off-balance sheet financing
arrangements.
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 reasonably likely to occur could have a material
impact on the presentation of our financial condition or results of operations.
The circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the effect of matters that are
inherently uncertain. Estimates and assumptions about future events and their
effects cannot be predicted with certainty. 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.
Our significant accounting policies are discussed in Note 2 of the Texas Genco
Notes. We believe the following accounting policy involves the application of
critical accounting estimates. Accordingly, these accounting estimates have been
reviewed and discussed with the audit committee of the board of directors.
IMPAIRMENT OF LONG-LIVED ASSETS
We review the carrying value of our long-lived assets, including
identifiable intangibles, whenever events or changes in circumstances indicate
that such carrying values may not be recoverable. Unforeseen events and changes
in circumstances and market conditions and material differences in the value of
long-lived assets and intangibles due to changes in estimates of future cash
flows, regulatory matters and operating costs could negatively affect the fair
value of our assets and result in an impairment charge.
Fair value is the amount at which the asset could be bought or sold in a
current transaction between willing parties and may be estimated using a number
of techniques, including quoted market prices or valuations by third parties,
present value techniques based on estimates of cash flows, or multiples of
earnings or revenue performance measures. The fair value of the asset could be
different using different estimates and assumptions in these valuation
techniques. Changes in any of these assumptions could result in an impairment
charge.
The fair value of our assets could be materially affected by a change in
the estimated future cash flows for these assets. We estimate future cash flows
using a probability-weighted approach based on the fair value of our common
stock, operating projections and estimates of how long we will retain these
assets.
21
In the third quarter of 2004, we recorded an after-tax impairment of
approximately $426 million related to the write-down of coal, lignite and
gas-fired generation assets in connection with the first step of the sale
transaction. These assets have been classified in the Consolidated Balance
Sheets as "held for sale."
NEW ACCOUNTING PRONOUNCEMENTS
See Note 4 to the Interim Financial Statements for a discussion of new
accounting pronouncements that affect us.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
As discussed in Note 9 to the Interim Financial Statements, CenterPoint
Energy Houston Electric, LLC (CenterPoint Houston), as collection agent for the
nuclear decommissioning charge assessed on its transmission and distribution
customers, contributed $2.9 million in 2003 and expects to contribute $2.9
million in 2004 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 $200 million as of
September 30, 2004, of which approximately 37% 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 September 30, 2004,
the fair value of the fixed-rate debt securities would decrease by approximately
$1 million.
EQUITY MARKET VALUE RISK
As discussed above under " -- Interest Rate Risk," CenterPoint Houston
contributes to trusts established to fund our share of the decommissioning costs
for the South Texas Project, which held approximately 63% of total assets in
equity securities as of September 30, 2004. 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 September 30, 2004, the resulting
loss in fair value of these securities would be approximately $12 million.
COMMODITY PRICE RISK
Our gross margins (revenues less fuel and purchase power costs) related to
unsold base-load capacity 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.
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.
As discussed in Note 2 to the Interim Financial Statements, Genco LP
entered into a master power purchase and sale agreement with a member of the
Goldman Sachs group in connection with the definitive agreement for the sale of
our company entered into on July 21, 2004. Under that agreement, Genco LP has
sold forward a substantial quantity of its available base-load capacity through
2008. We have designated the master power purchase and sale agreement as a cash
flow hedge of the forecasted sale of base-load capacity through 2008.
The sensitivity analysis performed on Genco LP's master power purchase
and sale agreement measures the potential loss based on a hypothetical 10%
movement in power prices. An increase of 10% in the market prices of electric
power from their September 30, 2004 levels would have decreased the fair value
of Genco LP's master power purchase and sale agreement from their levels on
that date by $196 million.
The above analysis of the Genco LP master power and sale agreement
utilized for hedging purposes does not include the favorable impact that the
same hypothetical price movement would have on Genco LP's forecasted sale of
base-load capacity to which the hedges relate. Therefore, the adverse impact to
the fair value of the Genco LP master power purchase and sale agreement held for
hedging purposes associated with the hypothetical changes in electric power
prices referenced above would be offset by a favorable impact to the underlying
hedged forecasted sale of base-load capacity.
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, of
the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures were effective as of September 30, 2004 to provide assurance that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms.
There has been no change in our internal controls over financial reporting
that occurred during the three months ended September 30, 2004 that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
22
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.
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. For a description of a lawsuit involving alleged violations of
state and federal antitrust laws, please read "Texas Antitrust Action" in Note 9
to our Interim Financial Statements, which is incorporated herein by reference.
For a description of lawsuits against the company and our board of directors
involving alleged self-dealing and breach of fiduciary duty, please read Note 2
to our Interim Financial Statements, which is incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 21, 2004, Utility Holding, acting in its capacity as the record
holder of 64,764,240 shares, or approximately 81%, of our outstanding common
stock, executed a written consent irrevocably approving the transaction
agreement with GC Power Acquisition and the transactions it contemplates. For
more information regarding the transaction agreement, please read "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Executive Summary -- Recent Events -- Definitive Agreement for the Sale of the
Company" in Item 2 of this report.
ITEM 6. 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. Pursuant to Item 601(b)(2) of Regulation S-K, Texas
Genco has not filed the exhibits and schedules to Exhibits 2.1 and 2.2. Texas
Genco hereby agrees to furnish a copy of any such exhibit or schedule to the
SEC upon request.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ------------------------------- -------------------------------- ------------ ---------
2.1 -- Transaction Agreement dated Texas Genco Holdings, Inc.'s 1-31449 10.1
July 21, 2004 among ("Texas Genco") Current
CenterPoint Energy, Inc., Report on Form 8-K dated July
Utility Holding, LLC, NN 21, 2004
Houston Sub, Inc., Texas
Genco Holdings, Inc., HPC
Merger Sub, Inc. and GC
Power Acquisition LLC
(excluding exhibits and
schedules thereto)
+2.2 -- Purchase and Sale Agreement
by and between AEP Texas
Central Company and City of
San Antonio acting by and
through The City Public
Service Board of San Antonio
and Texas Genco, L.P.,
dated as of September 3, 2003
3.1 -- Amended and Restated Texas Genco 's Form 10-K for 1-31449 3.1
Articles of Incorporation 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
4.2.1 -- $75,000,000 revolving credit CenterPoint Energy, Inc.'s 1-31447 10(pp)(1)
facility dated as of Form 10-K for the year ended
December 23, 2003 among December 31, 2003
Texas Genco, LP and the
banks names therein
+4.2.2 -- First Amendment to Exhibit
4.2.1, dated as of September
3, 2004
+10.1 -- Master Power Purchase and
Sale Agreement, dated July
21, 2004, by and between J.
Aron & Company and Texas
Genco, LP (including the
23
cover sheet, confirmation
letter, annexes and
schedules thereto) (portions
of this document have been omitted
pursuant to a request for
confidential treatment and
filed separately with the SEC)
+10.2 -- Texas Genco Retirement Plan,
as established effective
September 1, 2004
+10.3 -- Texas Genco Retirement
Trust, as established
effective September 1, 2004
+10.4 -- First Amendment to Texas
Genco Holdings, Inc.
Performance Unit Plan
(effective as of January 1,
2003), effective as of
October 1, 2004
+10.5 -- First Amendment to Texas
Genco Short Term Incentive
Plan (effective as of
January 1, 2004), effective
as of October 1, 2004
+10.6 -- Texas Genco Holdings, Inc.
Severance Benefits Plan
#2050 (effective June 1,
2004)
+10.7 -- Texas Genco Holdings, Inc.
Severance Benefits Plan
#2060 (effective October 1,
2004)
+10.8 -- Texas Genco Severance
Benefits Plan #2060 (as
amended and restated
effective October 1, 2004)
+31.1 -- Rule 13a-14(a)/15d-14(a)
Certification of David G.
Tees
+31.2 -- Rule 13a-14(a)/15d-14(a)
Certification of Gary L.
Whitlock
+32.1 -- Section 1350 Certification
of David G. Tees
+32.2 -- Section 1350 Certification
of Gary L. Whitlock
+99.1 -- Items incorporated by
reference from the Texas
Genco Form 10-K: "Risk
Factors" 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, and
Notes 2(f) and 8 to the
Texas Genco Notes
24
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: November 9, 2004
25
Exhibit Index
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. Pursuant to Item 601(b)(2) of Regulation S-K, Texas
Genco has not filed the exhibits and schedules to Exhibits 2.1 and 2.2. Texas
Genco hereby agrees to furnish a copy of any such exhibit or schedule to the
SEC upon request.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ----------- -------------------------------- ------------ ---------
2.1 -- Transaction Agreement dated Texas Genco Holdings, Inc.'s 1-31449 10.1
July 21, 2004 among ("Texas Genco") Current
CenterPoint Energy, Inc., Report on Form 8-K dated July
Utility Holding, LLC, NN 21, 2004
Houston Sub, Inc., Texas
Genco Holdings, Inc., HPC
Merger Sub, Inc. and GC
Power Acquisition LLC
(excluding exhibits and
schedules thereto)
+2.2 -- Purchase and Sale Agreement
by and between AEP Texas
Central Company and City of
San Antonio acting by and
through The City Public
Service Board of San Antonio
and Texas Genco, L.P.,
dated as of September 3, 2003
3.1 -- Amended and Restated Texas Genco 's Form 10-K for 1-31449 3.1
Articles of Incorporation 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
4.2.1 -- $75,000,000 revolving credit CenterPoint Energy, Inc.'s 1-31447 10(pp)(1)
facility dated as of Form 10-K for the year ended
December 23, 2003 among December 31, 2003
Texas Genco, LP and the
banks names therein
+4.2.2 -- First Amendment to Exhibit
4.2.1, dated as of September
3, 2004
+10.1 -- Master Power Purchase and
Sale Agreement, dated July
21, 2004, by and between J.
Aron & Company and Texas
Genco, LP (including the
cover sheet, confirmation
letter, annexes and
schedules thereto) (portions
of this document have been omitted
pursuant to a request for
confidential treatment and
filed separately with the SEC)
+10.2 -- Texas Genco Retirement Plan,
as established effective
September 1, 2004
+10.3 -- Texas Genco Retirement
Trust, as established
effective September 1, 2004
+10.4 -- First Amendment to Texas
Genco Holdings, Inc.
Performance Unit Plan
(effective as of January 1,
2003), effective as of
October 1, 2004
+10.5 -- First Amendment to Texas
Genco Short Term Incentive
Plan (effective as of
January 1, 2004), effective
as of October 1, 2004
+10.6 -- Texas Genco Holdings, Inc.
Severance Benefits Plan
#2050 (effective June 1,
2004)
+10.7 -- Texas Genco Holdings, Inc.
Severance Benefits Plan
#2060 (effective October 1,
2004)
+10.8 -- Texas Genco Severance
Benefits Plan #2060 (as
amended and restated
effective October 1, 2004)
+31.1 -- Rule 13a-14(a)/15d-14(a)
Certification of David G.
Tees
+31.2 -- Rule 13a-14(a)/15d-14(a)
Certification of Gary L.
Whitlock
+32.1 -- Section 1350 Certification
of David G. Tees
+32.2 -- Section 1350 Certification
of Gary L. Whitlock
+99.1 -- Items incorporated by
reference from the Texas
Genco Form 10-K: "Risk
Factors" 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, and
Notes 2(f) and 8 to the
Texas Genco Notes