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EX-32.1 - EXHIBIT 32.1 - GenOn Energy, Inc. | c03882exv32w1.htm |
EX-31.2 - EXHIBIT 31.2 - GenOn Energy, Inc. | c03882exv31w2.htm |
EX-31.1 - EXHIBIT 31.1 - GenOn Energy, Inc. | c03882exv31w1.htm |
EXCEL - IDEA: XBRL DOCUMENT - GenOn Energy, Inc. | Financial_Report.xls |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
OR
o | 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 1-16455
RRI Energy, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 76-0655566 | |
(State or Other Jurisdiction of
Incorporation or Organization) |
(I.R.S. Employer Identification No.) |
1000 Main Street
Houston, Texas 77002
(Address of Principal Executive Offices) (Zip Code)
(Address of Principal Executive Offices) (Zip Code)
(832) 357-3000
(Registrants Telephone Number, Including Area Code)
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
As of July 21, 2010, the latest practicable date for determination, RRI Energy, Inc. had
353,429,469 shares of common stock outstanding and no shares of treasury stock.
TABLE OF CONTENTS
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Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32.1 | ||||||||
EX-101 INSTANCE DOCUMENT | ||||||||
EX-101 SCHEMA DOCUMENT | ||||||||
EX-101 CALCULATION LINKBASE DOCUMENT | ||||||||
EX-101 LABELS LINKBASE DOCUMENT | ||||||||
EX-101 PRESENTATION LINKBASE DOCUMENT | ||||||||
EX-101 DEFINITION LINKBASE DOCUMENT |
i
Table of Contents
SAFE HARBOR-FORWARD-LOOKING INFORMATION
This report contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Forward-looking statements are statements that contain projections, assumptions or
estimates about our revenues, income, capital structure and other financial items, our plans and
objectives for future operations or about our future economic performance, possible transactions,
dispositions, financings or offerings, and overview of economic and market conditions. In many
cases, you can identify forward-looking statements by terminology such as anticipate, estimate,
believe, think, continue, could, intend, may, plan, potential, predict, should,
will, expect, objective, projection, forecast, goal, guidance, outlook, effort,
target and other similar words. However, the absence of these words does not mean that the
statements are not forward-looking.
Actual results may differ materially from those expressed or implied by the forward-looking
statements as a result of many factors or events, including, but not limited to, the following:
| Demand and market prices for electricity, capacity, fuel and emission allowances |
| The timing and extent of changes in commodity prices |
| Limitations on our ability to set rates at market prices |
| Legislative, regulatory and/or market developments |
| Changes in environmental regulations that constrain our operations or increase our compliance costs |
| Competition in the wholesale power markets |
| Operating without long-term power sales agreements |
| Ineffective hedging activities |
| Our ability to obtain adequate fuel supply and/or transmission services |
| Interruption or breakdown of our plants |
| Failure of third parties to perform contractual obligations |
| Failure to meet our debt service obligations or restrictive covenants |
| Changes in the wholesale power market or in our evaluation of our plants |
| The outcome of pending or threatened lawsuits, regulatory proceedings, tax proceedings and investigations |
| Weather-related events or other events beyond our control |
| Financial and economic market conditions and our access to capital and |
| The successful and timely completion of the proposed merger with Mirant Corporation, which could be materially and adversely affected by, among other things, the following: |
| obtaining mutually acceptable debt financing | ||
| resolving any litigation brought in connection with the proposed merger | ||
| the timing and terms and conditions of required governmental and regulatory approvals | ||
| the ability to maintain relationships with employees, suppliers or customers as well as the ability to integrate the businesses and realize cost savings |
Other factors that could cause our actual results to differ from our projected results are
discussed or referred to in the Risk Factors sections of this report and of our most recent
Annual Report on Form 10-K filed with the Securities and Exchange Commission. Each forward-looking
statement speaks only as of the date of the particular statement and we undertake no obligation to
update or revise any forward-looking statement, whether as a result of new information, future
events or otherwise. Our filings and other important information are also available on our
investor page at www.rrienergy.com.
ii
Table of Contents
PART I.
FINANCIAL INFORMATION
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RRI ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(thousands of dollars, except per share amounts) | ||||||||||||||||
Revenues: |
||||||||||||||||
Revenues (including $(56,755), $(21,842), $49,085 and $(26,130) unrealized gains (losses)) |
$ | 400,198 | $ | 389,777 | $ | 1,004,908 | $ | 855,961 | ||||||||
Expenses: |
||||||||||||||||
Cost of sales (including $(8,841), $28,486, $12,422 and $(10,969) unrealized gains (losses)) |
264,998 | 280,067 | 531,799 | 604,741 | ||||||||||||
Operation and maintenance |
183,204 | 156,964 | 343,619 | 314,110 | ||||||||||||
General and administrative |
35,470 | 27,645 | 56,188 | 56,659 | ||||||||||||
Western states litigation and similar settlements |
| | 17,000 | | ||||||||||||
Gains on sales of assets and emission and exchange allowances, net |
(619 | ) | (1,241 | ) | (1,036 | ) | (20,171 | ) | ||||||||
Long-lived assets impairments |
| | 247,715 | | ||||||||||||
Depreciation and amortization |
69,148 | 67,646 | 131,468 | 135,504 | ||||||||||||
Total operating expense |
552,201 | 531,081 | 1,326,753 | 1,090,843 | ||||||||||||
Operating Loss |
(152,003 | ) | (141,304 | ) | (321,845 | ) | (234,882 | ) | ||||||||
Other Income (Expense): |
||||||||||||||||
Debt extinguishments gains |
| 844 | | 844 | ||||||||||||
Interest expense |
(36,588 | ) | (45,067 | ) | (82,629 | ) | (91,986 | ) | ||||||||
Interest income |
150 | 721 | 366 | 969 | ||||||||||||
Other, net |
1,063 | (530 | ) | 2,623 | 62 | |||||||||||
Total other expense |
(35,375 | ) | (44,032 | ) | (79,640 | ) | (90,111 | ) | ||||||||
Loss from Continuing Operations Before Income Taxes |
(187,378 | ) | (185,336 | ) | (401,485 | ) | (324,993 | ) | ||||||||
Income tax expense (benefit) |
(11,232 | ) | (81,644 | ) | 50,852 | (115,520 | ) | |||||||||
Loss from Continuing Operations |
(176,146 | ) | (103,692 | ) | (452,337 | ) | (209,473 | ) | ||||||||
Income from discontinued operations |
4,029 | 907,258 | 3,514 | 861,626 | ||||||||||||
Net Income (Loss) |
$ | (172,117 | ) | $ | 803,566 | $ | (448,823 | ) | $ | 652,153 | ||||||
Basic/Diluted Earnings (Loss) per Share: |
||||||||||||||||
Loss from continuing operations |
$ | (0.50 | ) | $ | (0.30 | ) | $ | (1.28 | ) | $ | (0.60 | ) | ||||
Income from discontinued operations |
0.01 | 2.59 | 0.01 | 2.46 | ||||||||||||
Net income (loss) |
$ | (0.49 | ) | $ | 2.29 | $ | (1.27 | ) | $ | 1.86 | ||||||
See Notes to our Unaudited Consolidated Interim Financial Statements
1
Table of Contents
RRI ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2010 | December 31, 2009 | |||||||
(thousands of dollars, except per share amounts) | ||||||||
(unaudited) | ||||||||
ASSETS |
||||||||
Current Assets: |
||||||||
Cash and cash equivalents |
$ | 563,183 | $ | 943,440 | ||||
Restricted cash |
2,897 | 24,093 | ||||||
Accounts and notes receivable, principally customer, net |
155,760 | 152,569 | ||||||
Inventory |
278,382 | 331,584 | ||||||
Derivative assets |
129,973 | 132,062 | ||||||
Margin deposits |
149,000 | 198,582 | ||||||
Prepayments and other current assets |
92,637 | 86,844 | ||||||
Current assets of discontinued operations ($23,394 and $55,855 of margin deposits) |
55,901 | 108,476 | ||||||
Total current assets |
1,427,733 | 1,977,650 | ||||||
Property, plant and equipment, gross |
5,933,586 | 6,330,879 | ||||||
Accumulated depreciation |
(1,652,470 | ) | (1,728,566 | ) | ||||
Property, Plant and Equipment, net |
4,281,116 | 4,602,313 | ||||||
Other Assets: |
||||||||
Other intangibles, net |
293,803 | 305,913 | ||||||
Derivative assets |
45,239 | 53,138 | ||||||
Prepaid lease |
267,942 | 277,370 | ||||||
Other ($27,648 and $33,793 accounted for at fair value) |
196,572 | 239,078 | ||||||
Long-term assets of discontinued operations |
3,528 | 5,232 | ||||||
Total other assets |
807,084 | 880,731 | ||||||
Total Assets |
$ | 6,515,933 | $ | 7,460,694 | ||||
LIABILITIES AND EQUITY |
||||||||
Current Liabilities: |
||||||||
Current portion of long-term debt |
$ | 106 | $ | 404,505 | ||||
Accounts payable, principally trade |
105,053 | 142,787 | ||||||
Derivative liabilities |
91,973 | 151,461 | ||||||
Margin deposits |
15,064 | 2,860 | ||||||
Other |
184,348 | 169,898 | ||||||
Current liabilities of discontinued operations ($0 and $11,000 of margin deposits) |
23,620 | 58,452 | ||||||
Total current liabilities |
420,164 | 929,963 | ||||||
Other Liabilities: |
||||||||
Derivative liabilities |
38,793 | 61,436 | ||||||
Other |
284,868 | 260,547 | ||||||
Long-term liabilities of discontinued operations |
14,165 | 13,700 | ||||||
Total other liabilities |
337,826 | 335,683 | ||||||
Long-term Debt |
1,949,717 | 1,949,771 | ||||||
Commitments and Contingencies |
||||||||
Temporary Equity Stock-based Compensation |
6,287 | 6,890 | ||||||
Stockholders Equity: |
||||||||
Preferred stock; par value $0.001 per share (125,000,000 shares authorized;
none outstanding) |
| | ||||||
Common stock; par value $0.001 per share (2,000,000,000 shares authorized; 353,426,741 and 352,785,985 issued) |
114 | 114 | ||||||
Additional paid-in capital |
6,267,849 | 6,259,248 | ||||||
Accumulated deficit |
(2,421,212 | ) | (1,972,389 | ) | ||||
Accumulated other comprehensive loss |
(44,812 | ) | (48,586 | ) | ||||
Total stockholders equity |
3,801,939 | 4,238,387 | ||||||
Total Liabilities and Equity |
$ | 6,515,933 | $ | 7,460,694 | ||||
See Notes to our Unaudited Consolidated Interim Financial Statements
2
Table of Contents
RRI ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30, | ||||||||
2010 | 2009 | |||||||
(thousands of dollars) | ||||||||
Cash Flows from Operating Activities: |
||||||||
Net income (loss) |
$ | (448,823 | ) | $ | 652,153 | |||
Income from discontinued operations |
(3,514 | ) | (861,626 | ) | ||||
Loss from continuing operations |
(452,337 | ) | (209,473 | ) | ||||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
131,468 | 135,504 | ||||||
Deferred income taxes |
50,220 | (115,850 | ) | |||||
Net changes in energy derivatives |
(58,911 | ) | 37,099 | |||||
Gains on sales of assets and emission and exchange allowances, net |
(1,036 | ) | (20,171 | ) | ||||
Western states litigation and similar settlements |
17,000 | | ||||||
Long-lived assets impairments |
247,715 | | ||||||
Amortization of deferred financing costs |
3,447 | 3,497 | ||||||
Other, net |
(1,051 | ) | 8,245 | |||||
Changes in other assets and liabilities: |
||||||||
Accounts and notes receivable, net |
(843 | ) | 126,059 | |||||
Inventory |
50,419 | 12,610 | ||||||
Margin deposits, net |
61,786 | (50,402 | ) | |||||
Net derivative assets and liabilities |
(629 | ) | (21,965 | ) | ||||
Accounts payable |
(19,416 | ) | (7,453 | ) | ||||
Other current assets |
(4,448 | ) | 2,529 | |||||
Other assets |
2,373 | 9,073 | ||||||
Taxes payable/receivable |
(2,101 | ) | (4,936 | ) | ||||
Other current liabilities |
1,171 | (4,207 | ) | |||||
Other liabilities |
2,015 | 3,322 | ||||||
Net cash provided by (used in) continuing operations from operating activities |
26,842 | (96,519 | ) | |||||
Net cash provided by discontinued operations from operating activities |
26,131 | 508,602 | ||||||
Net cash provided by operating activities |
52,973 | 412,083 | ||||||
Cash Flows from Investing Activities: |
||||||||
Capital expenditures |
(49,898 | ) | (114,964 | ) | ||||
Proceeds from sales of assets, net |
7,193 | 35,931 | ||||||
Proceeds from sales of emission and exchange allowances |
123 | 19,175 | ||||||
Purchases of emission allowances |
| (5,662 | ) | |||||
Restricted cash |
4,546 | (57 | ) | |||||
Other, net |
3,300 | 1,500 | ||||||
Net cash used in continuing operations from investing activities |
(34,736 | ) | (64,077 | ) | ||||
Net cash provided by (used in) discontinued operations from investing activities |
(4,402 | ) | 299,004 | |||||
Net cash provided by (used in) in investing activities |
(39,138 | ) | 234,927 | |||||
Cash Flows from Financing Activities: |
||||||||
Payments of long-term debt |
(399,809 | ) | (44,780 | ) | ||||
Proceeds from issuances of stock |
1,890 | 2,309 | ||||||
Net cash used in continuing operations from financing activities |
(397,919 | ) | (42,471 | ) | ||||
Net cash used in discontinued operations from financing activities |
| (225,300 | ) | |||||
Net cash used in financing activities |
(397,919 | ) | (267,771 | ) | ||||
Net Change in Cash and Cash Equivalents, Total Operations |
(384,084 | ) | 379,239 | |||||
Less: Net Change in Cash and Cash Equivalents, Discontinued Operations |
(3,827 | ) | (103,359 | ) | ||||
Cash and Cash Equivalents at Beginning of Period, Continuing
Operations |
943,440 | 1,004,367 | ||||||
Cash and Cash Equivalents at End of Period, Continuing Operations |
$ | 563,183 | $ | 1,486,965 | ||||
Supplemental Disclosure of Cash Flow Information: |
||||||||
Cash Payments: |
||||||||
Interest paid (net of amounts capitalized) for continuing operations |
$ | 98,000 | $ | 95,105 | ||||
Income taxes paid (net of income tax refunds received) for continuing operations |
2,754 | 3,582 |
See Notes to our Unaudited Consolidated Interim Financial Statements
3
Table of Contents
RRI ENERGY, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(1) Background and Basis of Presentation
(a) Background.
RRI Energy refers to RRI Energy, Inc. and we, us and our refer to RRI Energy, Inc. and
its consolidated subsidiaries. We provide energy, capacity, ancillary and other energy services to
wholesale customers in competitive energy markets in the United States through our ownership and
operation of and contracting for power generation capacity. Our business consists of four
reportable segments. See note 17. Our consolidated interim financial statements and notes
(interim financial statements) are unaudited, omit certain disclosures and should be read in
conjunction with our audited consolidated financial statements and notes in our Form 10-K.
See note 2 for discussion of our proposed merger with Mirant Corporation (Mirant).
(b) Basis of Presentation.
Estimates. Management makes estimates and assumptions to prepare financial statements in
conformity with accounting principles generally accepted in the United States of America (GAAP)
that affect:
| the reported amounts of assets, liabilities and equity |
| the reported amounts of revenues and expenses |
| our disclosure of contingent assets and liabilities at the date of the financial statements |
Actual results could differ from those estimates.
We evaluate our estimates and assumptions on an ongoing basis using historical experience and
other factors, including the current economic environment, which we think to be reasonable under
the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate.
Adjustments and Reclassifications. The interim financial statements reflect all normal
recurring adjustments necessary, in managements opinion, to present fairly our financial position
and results of operations for the reported periods. Amounts reported for interim periods, however,
may not be indicative of a full year period because of seasonal fluctuations in demand for
electricity and energy services, changes in commodity prices, and changes in regulations, timing of
maintenance and other expenditures, dispositions, changes in interest expense and other factors.
Inventory. We value fuel inventories at the lower of average cost or market. We reduce these
inventories as they are used in the production of electricity or sold. We recorded $1 million and
$35 million during the three months ended June 30, 2010 and 2009, respectively, for lower of
average cost or market valuation adjustments in cost of sales and recorded $3 million and $59
million during the six months ended June 30, 2010 and 2009, respectively.
New Accounting Pronouncement Improving Disclosures about Fair Value Measurements.
Effective for the first quarter of 2010, this guidance requires disclosures of significant
transfers in and out of Levels 1 and 2. In addition, it clarifies existing disclosure requirements
regarding inputs and valuation techniques as well as the appropriate level of disaggregation for
fair value measurements disclosures. See note 4. Effective for the first quarter of 2011
financial statements, this guidance requires separate presentation of purchases, sales, issuances
and settlements within the Level 3 reconciliation.
(2) Proposed Merger with Mirant
On April 11, 2010, we entered into an Agreement and Plan of Merger with Mirant. We have
formed a new wholly-owned subsidiary that will merge with and into Mirant upon closing. As a
result, Mirant will be a wholly-owned subsidiary of RRI Energy.
Upon closing the merger, each issued and outstanding share of Mirant common stock, including
restricted shares held in reserve under the Chapter 11 plan of reorganization for Mirant, will
convert into the right to receive
2.835 shares of common stock of RRI Energy, including the preferred share purchase rights
granted under the Rights Agreement dated January 15, 2001, between RRI Energy and The Chase
Manhattan Bank as Rights Agent. Mirant stock options and other equity awards will convert upon
completion of the merger into vested stock options and equity awards with respect to RRI Energy
common stock, after giving effect to the exchange ratio. The exchange ratio is fixed but subject
to adjustment for a proposed reverse stock split.
4
Table of Contents
The merger is intended to qualify as a tax-free reorganization under the Internal Revenue Code
of 1986, as amended, so that none of RRI Energy, Mirant or any of the Mirant stockholders generally
will recognize any gain or loss in the transaction, except that Mirant stockholders will recognize
gain with respect to cash received in lieu of fractional shares of RRI Energy common stock.
Completion of the merger is contingent upon, among other things, (a) approvals by stockholders
of both companies, (b) effectiveness of a registration statement on Form S-4 and approval of the
New York Stock Exchange listing for the RRI Energy common stock to be issued in the merger, (c)
expiration or termination of the applicable Hart-Scott-Rodino Act waiting period, (d) required
regulatory approvals from the FERC and the New York Public Service Commission and (e) mutually
acceptable debt financing in an amount sufficient to fund the refinancing transactions contemplated
by the merger agreement.
Each of RRI Energy and Mirant is also subject to restrictions on its ability to solicit
alternative acquisition proposals, provide information and engage in discussion with third parties,
except under limited circumstances to permit RRI Energys or Mirants board of directors to comply
with its fiduciary duties. The merger agreement contains termination rights for both RRI Energy
and Mirant and further provides that, upon termination of the merger agreement under specified
circumstances, RRI Energy or Mirant may be required to pay the other party a termination fee of
either $37 million or $58 million depending on the nature of the termination.
We anticipate completing the merger before the end of 2010. Except for specific references to
the pending merger, the disclosures contained in this report on Form 10-Q relate solely to RRI
Energy. Information concerning the proposed merger is included in the joint proxy
statement/prospectus contained in the registration statement on Form S-4, as amended and filed with
the Securities and Exchange Commission in connection with the merger.
(3) Stock-based Compensation
Our compensation expense for our stock-based incentive plans was:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Stock-based
incentive plans
compensation
expense
(pre-tax)
(1) |
$ | 5 | (2) | $ | 1 | $ | 7 | (2) | $ | 4 | ||||||
(1) | See note 10 to our consolidated financial statements in our Form 10-K for information about our stock-based incentive plans compensation expense/income. | |
(2) | During the three and six months ended June 30, 2010, we recorded $2 million of expense related to the modification of our outstanding time-based stock options in contemplation of the merger. See note 2 for discussion of the merger. |
During March 2010, the compensation committee of our board of directors granted (a)
917,746 time-based restricted stock options (exercise price of $4.28 per share which vest in three
equal installments during March 2011, 2012 and 2013), (b) 462,500 time-based restricted stock
options (exercise price of $4.20 per share which vest in three equal installments during March
2011, 2012 and 2013), (c) 909,423 time-based restricted stock units (which vest during March 2013),
(d) 317,890 time-based cash units (which vest during March 2013) and (e) 690,123 performance-based
cash units (which vest during March 2013) to employees under our stock and incentive plans. The
performance-based cash units, which are liability-classified awards, are each payable into a cash
amount equal to the market value of one share of our common stock based on the three-year average
total shareholder return for the period beginning March 3, 2010 and ending March 3, 2013 compared
to the relative three-year average total shareholder return for the same period of a group of our
peer companies. The Monte Carlo simulation valuation model is used, on each reporting measurement
date, to estimate the fair value of these performance-based cash awards.
No tax benefits related to stock-based compensation were realized during the three and six
months ended June 30, 2010 and 2009 because of our net operating loss carryforwards.
5
Table of Contents
(4) Fair Value Measurements
Fair Value Hierarchy and Valuation Techniques. We apply recurring fair value measurements to
our financial assets and liabilities. In determining fair value, we generally use a market
approach and incorporate assumptions that market participants would use in pricing the asset or
liability, including assumptions about risk and/or the risks inherent in the inputs to the
valuation techniques. These inputs can be readily observable, market corroborated, or generally
unobservable internally developed inputs. Based on the observability of the inputs used in our
valuation techniques, our financial assets and liabilities are classified as follows:
Level 1:
|
Level 1 represents unadjusted quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date. This category primarily includes our energy derivative instruments that are exchange-traded or that are cleared and settled through the exchange. Our cash equivalents and available-for-sale and trading securities are also valued using Level 1 inputs. | |
Level 2:
|
Level 2 represents quoted market prices for similar assets or liabilities in active markets, quoted market prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data. This category includes emission allowances futures that are exchange-traded and over-the-counter (OTC) derivative instruments such as generic swaps, forwards and options. | |
Level 3:
|
This category includes our energy derivative instruments whose fair value is estimated based on internally developed models and methodologies utilizing significant inputs that are generally less readily observable from objective sources (such as implied volatilities and correlations). Our OTC, complex or structured derivative instruments that are transacted in less liquid markets with limited pricing information are included in Level 3. Examples are coal contracts, longer term natural gas contracts and options valued using implied or internally developed inputs. |
The fair value measurements of these derivative assets and liabilities are based largely
on unadjusted indicative quoted prices from independent brokers in active markets who regularly
facilitate our transactions. An active market is considered to have transactions with sufficient
frequency and volume to provide pricing information on an ongoing basis. Derivative instruments
for which fair value is calculated using quoted prices that are deemed not active or that have been
extrapolated from quoted prices in active markets are classified as Level 3. For certain natural
gas and power contracts, we adjust seasonal or calendar year quoted prices based on historical
observations to represent fair value for each month in the season or calendar year, such that the
average of all months is equal to the quoted price. A derivative instrument that has a tenor that
does not span the quoted period is considered an unobservable Level 3 measurement.
We evaluate and validate the inputs we use to estimate fair value by a number of methods,
including validating against market published prices and daily broker quotes obtainable from
multiple pricing services. For OTC derivative instruments classified as Level 2, indicative quotes
obtained from brokers in liquid markets generally represent fair value of these instruments. We
think these price quotes are executable. Adjustments to the quotes are adjustments to the bid or
ask price depending on the nature of the position to appropriately reflect exit pricing and are
considered a Level 3 input to the fair value measurement. In less liquid markets such as coal, in
which a single brokers view of the market is used to estimate fair value, we consider such inputs
to be unobservable Level 3 inputs. We do not use third party sources that determine price based on
market surveys or proprietary models.
We value some of our OTC, complex or structured derivative instruments using a variety of
valuation models, which utilize inputs that may not be corroborated by market data and vary in
complexity depending on the contractual terms of, and inherent risks in, the instrument being
valued. We use both industry-standard models as well as internally developed proprietary valuation
models that consider various assumptions, such as market prices for power and fuel, price shapes,
volatilities and correlations as well as other relevant factors. When such inputs are significant
to the fair value measurement, the derivative assets or liabilities are classified as Level 3 when
we do not have corroborating market evidence to support significant valuation model inputs and
cannot verify the model to market transactions. We think the transaction price is the best
estimate of fair value at inception under the exit price methodology. Accordingly, when a pricing
model is used to value such an instrument, the resulting value is adjusted so the model value at
inception equals the transaction price. Valuation models are typically impacted by Level 1 or
Level 2 inputs that can be observed in the market, as well as unobservable Level 3 inputs.
Subsequent to initial recognition, we update Level 1 and Level 2 inputs to reflect observable
market changes. Level 3 inputs are
updated when corroborated by available market evidence. In the absence of such evidence,
managements best estimate is used.
See note 7 for discussion of our fair value measurements for some non-financial assets.
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Fair Value of Derivative Instruments and Certain Other Assets. We apply recurring fair value
measurements to our financial assets and liabilities. Fair value measurements of our financial
assets and liabilities by class are as follows:
June 30, 2010 | ||||||||||||||||||||
Total | ||||||||||||||||||||
Level 1(1) | Level 2(1) | Level 3 | Reclassifications(2) | Fair Value | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Derivative assets: |
||||||||||||||||||||
Power |
$ | 39 | $ | 38 | $ | 2 | $ | | $ | 79 | ||||||||||
Power basis |
| 1 | 2 | | 3 | |||||||||||||||
Capacity energy |
| | 4 | | 4 | |||||||||||||||
Natural gas |
54 | | 1 | | 55 | |||||||||||||||
Natural gas basis |
23 | | | | 23 | |||||||||||||||
Coal |
| | 9 | | 9 | |||||||||||||||
Other |
| | | 2 | 2 | |||||||||||||||
Total derivative assets |
$ | 116 | $ | 39 | $ | 18 | $ | 2 | $ | 175 | ||||||||||
Derivative liabilities: |
||||||||||||||||||||
Power |
$ | 6 | $ | 98 | $ | 1 | $ | | $ | 105 | ||||||||||
Power basis |
| 1 | | | 1 | |||||||||||||||
Natural gas |
| | 3 | | 3 | |||||||||||||||
Natural gas basis |
14 | | | | 14 | |||||||||||||||
Coal |
| | 4 | | 4 | |||||||||||||||
Emissions |
| 2 | | | 2 | |||||||||||||||
Other |
| | | 2 | 2 | |||||||||||||||
Total derivative liabilities |
$ | 20 | $ | 101 | $ | 8 | $ | 2 | $ | 131 | ||||||||||
Cash equivalents(3) |
$ | 563 | $ | | $ | | $ | | $ | 563 | ||||||||||
Other assets(4) |
$ | 28 | $ | | $ | | $ | | $ | 28 |
(1) | Transfers between Level 1 and Level 2 are recognized as of the beginning of the reporting period. There were no significant transfers during the six months ended June 30, 2010. | |
(2) | Reclassifications are required to reconcile to our consolidated balance sheet presentation. | |
(3) | Represent investments in money market funds and are included in cash and cash equivalents in our consolidated balance sheet. | |
(4) | Include $11 million in available-for-sale securities (shares in a public exchange) and $17 million in trading securities (rabbi trust investments (which are comprised of mutual funds) associated with our non-qualified deferred compensation plans for key and highly compensated employees). |
December 31, 2009 | ||||||||||||||||||||
Total | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Reclassifications(1) | Fair Value | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Total derivative assets |
$ | 137 | $ | 46 | $ | 4 | $ | (2 | ) | $ | 185 | |||||||||
Total derivative liabilities |
49 | 134 | 32 | (2 | ) | 213 | ||||||||||||||
Cash equivalents(2) |
965 | | | | 965 | |||||||||||||||
Other assets(3) |
34 | | | | 34 |
(1) | Reclassifications are required to reconcile to our consolidated balance sheet presentation. | |
(2) | Represent investments in money market funds and are included in cash and cash equivalents and restricted cash in our consolidated balance sheet. We had $943 million of cash equivalents included in cash and cash equivalents and $22 million of cash equivalents included in restricted cash. | |
(3) | Include $13 million in available-for-sale securities (shares in a public exchange) and $21 million in trading securities (rabbi trust investments (which are comprised of mutual funds) associated with our non-qualified deferred compensation plans for key and highly compensated employees). |
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The following is a reconciliation of changes in fair value of net commodity derivative
assets and liabilities classified as Level 3:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net Derivatives (Level 3) | Net Derivatives (Level 3) | |||||||||||||||
(in millions) | ||||||||||||||||
Balance, beginning of period (net asset (liability)) |
$ | 16 | $ | (153 | ) | $ | (28 | ) | $ | (114 | ) | |||||
Total gains (losses) realized/unrealized
included in earnings (1) |
(3 | ) | (12 | ) | 41 | (79 | ) | |||||||||
Purchases, issuances and settlements (net) |
(3 | ) | 48 | (3 | ) | 76 | ||||||||||
Transfers into Level 3(2) |
| | | | ||||||||||||
Transfers out of Level 3(2) |
| | | | ||||||||||||
Balance, end of period (net asset (liability)) |
$ | 10 | $ | (117 | ) | $ | 10 | $ | (117 | ) | ||||||
Changes in unrealized gains (losses) relating to derivative assets and liabilities still held as of June 30, 2010 and 2009: |
||||||||||||||||
Revenues |
$ | (4 | ) | $ | | $ | 9 | $ | (2 | ) | ||||||
Cost of sales |
1 | (5 | ) | 18 | (54 | ) | ||||||||||
Total |
$ | (3 | ) | $ | (5 | ) | $ | 27 | $ | (56 | ) | |||||
(1) | Recorded in revenues and cost of sales. | |
(2) | Recognized as of the beginning of the reporting period. |
Nonperformance Risk. Derivative assets are discounted for credit risk using a yield
curve representative of the counterpartys probability of default. The counterpartys default
probability is based on a modified version of published default rates, taking 20-year historical
default rates from Standard & Poors and Moodys and adjusting them to reflect a rolling five-year
average. Fair value measurement of our derivative liabilities reflects the nonperformance risk
related to that liability, which is our own credit risk. We derive our nonperformance risk by
applying our credit default swap spread against the respective derivative liability.
Fair Value of Other Financial Instruments. The fair values of cash, accounts receivable and
payable and margin deposits approximate their carrying amounts. Values of our debt for continuing
operations (see note 9) are:
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying Value | Fair Value(1) | Carrying Value | Fair Value(1) | |||||||||||||
(in millions) | ||||||||||||||||
Fixed rate debt |
$ | 1,950 | $ | 1,912 | $ | 2,355 | $ | 2,333 | ||||||||
Total debt |
$ | 1,950 | $ | 1,912 | $ | 2,355 | $ | 2,333 | ||||||||
(1) | We based the fair values of our fixed rate debt on market prices and quotes from an investment bank. |
See note 5.
(5) Derivative Instruments and Hedging Activities
Changes in commodity prices prior to the energy delivery period are inherent in our business.
Accordingly, we may enter selective hedges, including originated transactions, to (a) seek
potential value greater than what is available in the spot or day-ahead markets, (b) address
operational requirements or (c) seek a specific financial objective. For our risk management
activities, we use derivative and non-derivative contracts that provide for settlement in cash or
by delivery of a commodity. We use derivative instruments such as futures, forwards, swaps and
options to execute our hedge strategy. We may also enter into derivatives to manage our exposure
to changes in prices of emission and exchange allowances.
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Table of Contents
We account for our derivatives under one of three accounting methods (mark-to-market, accrual
(under the normal purchase/normal sale exception to fair value accounting) or cash flow hedge
accounting) based on facts and circumstances. See note 4 for discussion on fair value
measurements.
A derivative is recognized at fair value in the balance sheet whether or not it is designated
as an accounting hedge, except for derivative contracts designated as normal purchase/normal sale
exceptions, which are not in our consolidated balance sheet or results of operations prior to
settlement resulting in accrual accounting treatment.
Realized gains and losses on derivative contracts used for risk management purposes and not
held for trading purposes are reported either on a net or gross basis based on the relevant facts
and circumstances. Hedging transactions that do not physically flow are included in the same
caption as the items being hedged.
A summary of our derivative activities and classification in our results of operations is:
Primary | ||||||||
Risk | Purpose for Holding or | Transactions that | Transactions that | |||||
Instrument | Exposure | Issuing Instrument (1) | Physically Flow/Settle (2) | Financially Settle (3) | ||||
Power futures, forward,
|
Price risk | Power sales to customers | Revenues | Revenues | ||||
swap and option contracts
|
Power purchases related to operations | Cost of sales | Revenues | |||||
Power purchases/sales related to legacy trading and non-core asset management positions(4) | Revenues | Revenues | ||||||
Natural gas and fuel futures, forward, swap and
|
Price risk | Natural gas and fuel sales related to operations | Revenues/Cost of sales | Cost of sales | ||||
option contracts
|
Natural gas sales related to power generation(5) | N/A(6) | Revenues | |||||
Natural gas and fuel purchases related to operations | Cost of sales | Cost of sales | ||||||
Natural gas and fuel purchases/sales related to legacy trading and non-core asset management positions(4) | Cost of sales | Cost of sales | ||||||
Emission and exchange allowances futures(7)
|
Price risk | Purchases/sales of emission and exchange allowances | N/A(6) | Revenues/Cost of sales |
(1) | The purpose for holding or issuing does not impact the accounting method elected for each instrument. | |
(2) | Includes classification of unrealized gains and losses for derivative transactions reclassified to inventory or intangibles upon settlement. | |
(3) | Includes classification for mark-to-market derivatives and amounts reclassified from accumulated other comprehensive income/loss related to cash flow hedges. | |
(4) | See discussion below regarding trading activities. | |
(5) | Natural gas financial swaps and options transacted to economically hedge generation in the PJM region (in our East Coal and East Gas segments). | |
(6) | N/A is not applicable. | |
(7) | Includes emission and exchange allowances futures for sulfur dioxide (SO2), nitrogen oxide (NOx) and carbon dioxide (CO2). |
In addition to price risk, we are exposed to credit and operational risk. We have a risk
control framework to manage these risks, which include: (a) measuring and monitoring these risks,
(b) review and approval of new transactions relative to these risks, (c) transaction validation and
(d) portfolio valuation and reporting. We use mark-to-market valuation, value-at-risk and other
metrics in monitoring and measuring risk. Our risk control framework includes a variety of
separate but complementary processes, which involve commercial and senior management and our Board
of Directors. See note 6 for further discussion of our credit policy.
Earnings Volatility from Derivative Instruments. We procure power, natural gas, coal, oil,
natural gas transportation and storage capacity and other energy-related commodities to support our
business. We may experience volatility in our earnings resulting from contracts receiving accrual
accounting treatment while related derivative instruments are marked to market through earnings.
As discussed in note 1(b), our financial statements include estimates and assumptions made by
management throughout the reporting periods and as of the balance sheet dates. It is reasonable
that subsequent to the balance sheet date of June 30, 2010, changes, some of which could be
significant, have occurred in the inputs to our various fair value measures, particularly relating
to commodity price movements.
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Table of Contents
Unrealized gains and losses on energy derivatives consist of both gains and losses on energy
derivatives during the current reporting period for derivative assets or liabilities that have not
settled as of the balance sheet date and the reversal of unrealized gains and losses from prior
periods for derivative assets or liabilities that settled prior to the balance sheet date during
the current reporting period.
Cash Flow Hedges. During the first quarter of 2007, we de-designated our remaining cash flow
hedges; therefore, as of June 30, 2010 and December 31, 2009, we do not have any designated cash
flow hedges. The fair value of our de-designated cash flow hedges are deferred in accumulated
other comprehensive loss, net of tax, to the extent the contracts have been effective as hedges,
until the forecasted transactions affect earnings. At the time the forecasted transactions affect
earnings, we reclassify the amounts in accumulated other comprehensive loss into earnings.
Amounts included in accumulated other comprehensive loss are:
June 30, 2010 | ||||||||
Expected to be | ||||||||
Reclassified into | ||||||||
Results of | ||||||||
At the End of the | Operations | |||||||
Period | in Next 12 Months | |||||||
(in millions) | ||||||||
De-designated cash flow hedges, net of tax(1)(2) |
$ | 26 | $ | 13 | ||||
(1) | No component of the derivatives gain or loss was excluded from the assessment of effectiveness. | |
(2) | During the three and six months ended June 30, 2010 and 2009, $0 was recognized in our results of operations as a result of the discontinuance of cash flow hedges because it was probable that the forecasted transaction would not occur. |
Presentation of Derivative Assets and Liabilities. We present our derivative assets and
liabilities on a gross basis (regardless of master netting arrangements with the same
counterparty). Cash collateral amounts are also presented on a gross basis.
As of June 30, 2010, our commodity derivative assets and liabilities include amounts for
non-trading and trading activities as follows:
Derivative Assets | Derivative Liabilities | Net Derivative | ||||||||||||||||||
Current | Long-Term | Current | Long-Term | Assets (Liabilities) | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Non-trading |
$ | 106 | $ | 45 | $ | (75 | ) | $ | (39 | ) | $ | 37 | ||||||||
Trading |
24 | | (17 | ) | | 7 | ||||||||||||||
Total derivatives |
$ | 130 | $ | 45 | $ | (92 | ) | $ | (39 | ) | $ | 44 | ||||||||
We have the following derivative commodity contracts outstanding as of June 30, 2010:
Notional Volumes (2) | ||||||||||
Commodity | Unit (1) | Current | Long-term | |||||||
(in millions) | ||||||||||
Power |
MWh | (6 | ) | (3 | ) | |||||
Capacity energy |
MWh | (1 | ) | (1 | ) | |||||
Natural gas (3) |
MMBtu | 14 | 12 | |||||||
Natural gas basis |
MMBtu | (1 | ) | | ||||||
Coal |
MMBtu | 83 | 133 |
(1) | MWh is megawatt hours and MMBtu is million British thermal units. | |
(2) | Negative amounts indicate net forward sales. | |
(3) | Includes current and long-term volumes related to purchases of put options. |
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The income (loss) associated with our energy derivatives during the three and six months
ended June 30, 2010 and 2009 is:
Three Months Ended June 30, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Derivatives Not Designated as Hedging Instruments | Revenues | Cost of Sales | Revenues | Cost of Sales | ||||||||||||
(in millions) | ||||||||||||||||
Non-Trading Commodity Contracts: |
||||||||||||||||
Unrealized(1) |
$ | (57 | ) | $ | (2 | ) | $ | (22 | ) | $ | 31 | |||||
Realized(2)(3)(4) |
62 | (44 | ) | 81 | (66 | ) | ||||||||||
Total non-trading |
$ | 5 | $ | (46 | ) | $ | 59 | $ | (35 | ) | ||||||
Trading Commodity Contracts: |
||||||||||||||||
Unrealized(1) |
$ | | $ | (7 | ) | $ | | $ | (2 | ) | ||||||
Realized(2) |
| (8 | ) | | 1 | |||||||||||
Total trading |
$ | | $ | (15 | ) | $ | | $ | (1 | ) | ||||||
Six Months Ended June 30, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Derivatives Not Designated as Hedging Instruments | Revenues | Cost of Sales | Revenues | Cost of Sales | ||||||||||||
(in millions) | ||||||||||||||||
Non-Trading Commodity Contracts: |
||||||||||||||||
Unrealized(1) |
$ | 49 | $ | 24 | $ | (26 | ) | $ | (9 | ) | ||||||
Realized(2)(3)(4) |
149 | (112 | ) | 187 | (74 | ) | ||||||||||
Total non-trading |
$ | 198 | $ | (88 | ) | $ | 161 | $ | (83 | ) | ||||||
Trading Commodity Contracts: |
||||||||||||||||
Unrealized(1) |
$ | | $ | (12 | ) | $ | | $ | (2 | ) | ||||||
Realized(2) |
| (3 | ) | | 20 | |||||||||||
Total trading |
$ | | $ | (15 | ) | $ | | $ | 18 | |||||||
(1) | As discussed above, during 2007, we de-designated our remaining cash flow hedges; during the three and six months ended June 30, 2010 and 2009, previously measured ineffectiveness gains/losses in revenues reversing related to settlement of the derivative contracts were insignificant. | |
(2) | Does not include realized gains or losses associated with cash month transactions, non-derivative transactions or derivative transactions that qualify for the normal purchase/normal sale exception. | |
(3) | Excludes settlement value of fuel contracts classified as inventory upon settlement. | |
(4) | Includes gains or losses from de-designated cash flow hedges reclassified from accumulated other comprehensive loss related to settlement of the derivative contracts. See note 8. |
Trading Activities. Prior to March 2003, we engaged in proprietary trading activities.
Trading positions entered into prior to our decision to exit this business are being closed on
economical terms or are being retained and settled over the contract terms. In addition, we have
current transactions relating to non-core asset management, such as gas storage and transportation
contracts not tied to generation assets, which are classified as trading activities. The income
(loss) associated with these transactions is:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Revenues |
$ | | $ | | $ | | $ | | ||||||||
Cost of sales |
| 5 | 1 | 16 | ||||||||||||
Total(1) |
$ | | $ | 5 | $ | 1 | $ | 16 | ||||||||
(1) | Includes realized and unrealized gains and losses on both derivative instruments and non-derivative instruments. |
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(6) Credit Risk
We have a credit policy that governs the management of credit risk, including the
establishment of counterparty credit limits and specific transaction approvals. Credit risk is
monitored daily and the financial condition of our counterparties is reviewed periodically. We try
to mitigate credit risk by entering into contracts that permit netting and allow us to terminate
upon the occurrence of certain events of default. We measure credit risk as the replacement cost
for our derivative positions plus amounts owed for settled transactions.
Our credit exposure is based on (a) derivative assets and accounts receivable from our
counterparties (each included in our consolidated balance sheet) and (b) contracts classified as
normal purchase/normal sale and non-derivative contractual commitments (each not included in our
consolidated balance sheet except for any related accounts receivable), all after taking into
consideration netting within each contract and any master netting contracts with counterparties.
We think this represents the maximum potential loss we could incur if our counterparties to the
contracts discussed above failed to perform according to their contract terms.
As of June 30, 2010, our credit exposure is summarized as follows:
Exposure | Credit | Number of | Net Exposure of | |||||||||||||||||
Before | Collateral | Exposure | Counterparties | Counterparties | ||||||||||||||||
Credit Rating Equivalent | Collateral(1) | Held(2) | Net of Collateral | >10% | >10% | |||||||||||||||
(dollars in millions) | ||||||||||||||||||||
Investment grade |
$ | 260 | $ | 10 | $ | 250 | 3 | (3) | $ | 169 | ||||||||||
Non-investment grade |
3 | | 3 | | | |||||||||||||||
No external ratings: |
||||||||||||||||||||
Internally rated Investment grade |
30 | | 30 | 1 | (4) | 29 | ||||||||||||||
Internally rated Non-investment grade |
15 | 12 | 3 | | | |||||||||||||||
Total |
$ | 308 | $ | 22 | $ | 286 | 4 | $ | 198 | |||||||||||
(1) | The table includes amounts related to certain contracts classified as discontinued operations in our consolidated balance sheets. These contracts settle through the expiration date in 2013. | |
(2) | Collateral consists of cash, standby letters of credit and other forms approved by management. | |
(3) | These counterparties are two utility companies and a power grid operator. | |
(4) | This counterparty is a financial institution. |
As of December 31, 2009, three investment grade counterparties (a power grid operator, a
utility company and a financial institution) represented 56% ($138 million) of our credit exposure
net of collateral held. As of December 31, 2009, we had $45 million of collateral held.
Based on our current credit ratings, any additional collateral postings that would be required
from us as a result of a credit downgrade would be immaterial.
We have cash collateral posted and letters of credit issued as follows:
June 30, 2010 | December 31, 2009 | |||||||||||||||
Cash | Letters of Credit (1) | Cash | Letters of Credit (1) | |||||||||||||
(in millions) | ||||||||||||||||
Commodity contracts(2) |
$ | 123 | $ | 53 | $ | 207 | $ | 52 | ||||||||
Derivative contracts receiving mark-to-market accounting treatment(2)(3) |
$ | 48 | $ | 3 | $ | 97 | $ | 5 | ||||||||
Other(4) |
$ | 34 | $ | | $ | 47 | $ | |
(1) | See note 9. | |
(2) | Includes activity for both continuing and discontinued operations. | |
(3) | These amounts are included in the amounts above for commodity contracts. | |
(4) | Represents cash posted under surety bonds related to environmental obligations to the Pennsylvania Department of Environmental Protection. |
12
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(7) Long-Lived Assets Impairments
We periodically evaluate the recoverability of our long-lived assets (property, plant and
equipment and intangible assets), which involves significant judgment and estimates, when there are
certain indicators that the carrying value of these assets may not be recoverable. As of June 30,
2010, we had $4.6 billion of long-lived assets. This estimate affects all segments, which hold 99%
of our total net property, plant and equipment and net intangible assets. Our East Coal segment
holds the largest portion of our net property, plant and equipment and net intangible assets at 58%
of our consolidated total. We did not evaluate the recoverability of our long-lived assets
(property, plant and equipment and intangible assets) during the three months ended June 30, 2010
as there were no additional events or changes in circumstances from March 31, 2010 that indicated
that the carrying value of such assets may not be recoverable. See notes 2(g), 4 and 5 to our
consolidated financial statements in our Form 10-K for further discussion.
Based on the further decline of commodity prices, our asset recoverability review was updated
from December 31, 2009 to March 31, 2010. Our asset recoverability review as of March 31, 2010
indicated that two plants, our Elrama plant and our Niles plant (each in our East Coal segment),
needed to be measured at fair value to determine if impairments existed.
As of March 31, 2010, following our current methodology (as described below), we had three
additional plants and related intangible assets with a combined carrying value of $344 million,
where the undiscounted cash flows were close to the carrying values. If market conditions or
environmental and regulatory assumptions change negatively in the future, it is likely that these
three plants (and possibly others) could be impaired.
Key Assumptions. The following summarizes some of the most significant estimates and
assumptions used in evaluating our plant level undiscounted cash flows as of March 31, 2010. The
ranges for the fundamental view assumptions are to account for variability by year and region.
March 31, 2010 | ||
Undiscounted Cash Flow Scenarios Weightings: |
||
5-year market forecast with escalation(1)(2) |
50% | |
5-year market forecast with fundamental view(1) |
50% | |
Range of Assumptions in Fundamental View: |
||
Demand for power growth per year |
1%-2% | |
After-tax rate of return on new construction(3) |
6.5%-9.5% | |
Spread between natural gas and coal prices, $/MMBtu (4) |
$3-$5 |
(1) | For each scenario, the first five years of cash flows are the same. | |
(2) | We assumed an annual 2.5% escalation percentage beyond year five. | |
(3) | The low to mid part of the range represents natural gas-fired plants required returns and the mid to high part of the range represents coal-fired and nuclear plants required returns. | |
(4) | Natural gas and coal prices are prior to transportation costs. |
We estimate the undiscounted cash flows of our plants based on a number of subjective
factors, including: (a) appropriate weighting of undiscounted cash flow scenarios, as shown in the
table above, (b) forecasts of future power generation margins, (c) estimates of our future cost
structure, (d) environmental assumptions, (e) time horizon of cash flow forecasts and (f) estimates
of terminal values of plants, if necessary, from the eventual disposition of the assets. We did
not include the cash flows associated with our economic hedges in our PJM region (East Coal and
East Gas segments) as these cash flows are not specific to any one plant.
Under the 5-year market forecast with escalation scenario, we use the following data: (a)
forward market curves for commodity prices as of March 16, 2010 for the first five years, (b) cash
flow projections through the plants estimated remaining useful life and (c) escalation factor of
cash flows of 2.5% per year after year five.
Under the 5-year market forecast with fundamental view scenario, we model all of our plants
and those of others in the regions in which we operate using these assumptions: (a) forward market
curves for commodity prices as of March 16, 2010 for the first five years; (b) ranges shown in the
table above used in developing our fundamental view beyond five years; (c) the markets in which we
operate will continue to be deregulated and earn margins based on forward or projected market
prices; (d) projected market prices for energy and capacity will be set by the forecasted available
supply and level of forecasted demandnew supply will enter markets when market prices and
associated returns, including any assumed subsidies for renewable energy, are sufficient to achieve
minimum return requirements; (e) minimum return requirements on future construction of new
generation facilities, as shown in the table above, will likely be driven or influenced by
utilities, which we expect will have a lower cost of capital than merchant generators; (f) various
ranges of environmental regulations, including those for SO2, NOx and greenhouse gas
emissions; and (g) cash flow projections through the plants estimated remaining useful life.
Fair Value. Generally, fair value will be determined using an income approach or a
market-based approach. Under the income approach, the future cash flows are estimated as described
above and then discounted using a risk-adjusted rate. Under a market-based approach, we may also
consider prices of similar assets, consult with brokers or employ other valuation techniques.
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The following are key assumptions used in our fair value analyses as of March 31, 2010 for our
two plants for which the undiscounted cash flows did not exceed the net book value of the
long-lived assets.
Elrama | Niles | |||||||
Valuation approach weightings: |
||||||||
Income approach |
100 | % | 100 | % | ||||
Market-based approach |
0 | % | 0 | % | ||||
Risk-adjusted discount rate for the estimated cash flows |
15 | % | 15 | % |
We only used the income approach as we think no relevant market data exists for these two
plants for which we were required to estimate fair value. The discount rates reflect the
uncertainty of the plants cash flows and their inability to support meaningful amounts of debt,
and was determined considering factors such as the potential for future capacity revenues and
regulatory, commodity and macroeconomic conditions.
We determined that our Elrama plant, which consists of property, plant and equipment, was
impaired by $193 million as of March 31, 2010. We determined that our Niles plant, which consists
of property, plant and equipment, was impaired by $55 million as of March 31, 2010. These
impairments were primarily as a result of the further decline in commodity prices. We think the
remaining net book values of $68 million for Elrama and $26 million for Niles represent our best
estimates of fair values as of March 31, 2010.
Certain disclosures are required about nonfinancial assets and liabilities measured at fair
value on a nonrecurring basis. This applies to our long-lived assets for which we were required to
determine fair value. A fair value hierarchy exists for inputs used in measuring fair value that
maximizes the use of observable inputs (Level 1 or Level 2) and minimizes the use of unobservable
inputs (Level 3) by requiring that the observable inputs be used when available. See note 4 for
further discussion about the three levels. These assets are classified in their entirety based on
the lowest level of input that is significant to the fair value measurement. Our assessment of the
significance of a particular input to the fair value measurement requires judgment and affects the
valuation of fair value and the assets placement within the fair value hierarchy levels.
Q1 2010 | ||||||||||||||||
March 31, 2010 | Impairment | |||||||||||||||
Level 1 | Level 2 | Level 3 | Charges | |||||||||||||
(in millions) | ||||||||||||||||
Elrama property, plant and equipment(1) |
$ | | $ | | $ | 68 | $ | 193 | ||||||||
Niles property, plant and equipment(2) |
| | 26 | 55 | ||||||||||||
Total |
$ | | $ | | $ | 94 | $ | 248 | ||||||||
(1) | Elrama is in our East Coal segment. | |
(2) | Niles is in our East Coal segment. |
Effect if Different Assumptions Used. The estimates and assumptions used to determine
whether long-lived assets are recoverable or whether impairment exists are subject to a high degree
of uncertainty. Different assumptions as to power prices, fuel costs, our future cost structure,
environmental assumptions and remaining useful lives and ultimate disposition values of our plants
would result in estimated future cash flows that could be materially different than those
considered in the recoverability assessments as of March 31, 2010 and could result in having to
estimate the fair value of other plants.
Use of a different risk-adjusted discount rate would result in fair value estimates for the
two plants for which we recorded an impairment during the three months ended March 31, 2010 that
could be materially greater than or less than the fair value estimates as of March 31, 2010. Any
future fair value estimates for our Elrama and Niles long-lived assets that are greater than the
fair value estimates as of March 31, 2010 will not result in reversal of the first quarter 2010
impairment charges.
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(8) Comprehensive Income (Loss)
The components of total comprehensive income (loss) are:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Net income (loss) |
$ | (172 | ) | $ | 803 | $ | (449 | ) | $ | 652 | ||||||
Other comprehensive income (loss), net of tax: |
||||||||||||||||
Deferred benefits |
(4 | ) | 1 | (3 | ) | 1 | ||||||||||
Reclassification of net deferred loss from cash flow hedges into net income/loss |
3 | 3 | 8 | 8 | ||||||||||||
Unrealized gains (losses) on available-for-sale securities |
| 2 | (1 | ) | 3 | |||||||||||
Comprehensive income (loss) |
$ | (173 | ) | $ | 809 | $ | (445 | ) | $ | 664 | ||||||
(9) Debt
Outstanding debt:
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||
Weighted | Weighted | |||||||||||||||||||||||
Average | Average | |||||||||||||||||||||||
Stated | Stated | |||||||||||||||||||||||
Interest | Interest | |||||||||||||||||||||||
Rate(1) | Long-term | Current | Rate(1) | Long-term | Current | |||||||||||||||||||
(in millions, except interest rates) | ||||||||||||||||||||||||
Facilities, Bonds and Notes: |
||||||||||||||||||||||||
RRI Energy: |
||||||||||||||||||||||||
Senior secured revolver due 2012 |
2.28 | % | $ | | $ | | 1.98 | % | $ | | $ | | ||||||||||||
Senior secured notes due 2014 |
6.75 | 279 | | 6.75 | 279 | | ||||||||||||||||||
Senior unsecured notes due 2014 |
7.625 | 575 | | 7.625 | 575 | | ||||||||||||||||||
Senior unsecured notes due 2017 |
7.875 | 725 | | 7.875 | 725 | | ||||||||||||||||||
Subsidiary Obligations: |
||||||||||||||||||||||||
Orion Power Holdings, Inc. senior notes due 2010 (unsecured)(2) |
| | 12.00 | | 400 | |||||||||||||||||||
PEDFA(3) fixed-rate bonds due 2036 |
6.75 | 371 | | 6.75 | 371 | | ||||||||||||||||||
Total facilities, bonds and notes |
1,950 | | 1,950 | 400 | ||||||||||||||||||||
Other: |
||||||||||||||||||||||||
Adjustment to fair value of debt(4) |
| | | 5 | ||||||||||||||||||||
Total other debt |
| | | 5 | ||||||||||||||||||||
Total debt |
$ | 1,950 | $ | | $ | 1,950 | $ | 405 | ||||||||||||||||
(1) | The weighted average stated interest rates are as of March 31, 2010 or December 31, 2009. | |
(2) | We paid off this debt in May 2010. | |
(3) | PEDFA is the Pennsylvania Economic Development Financing Authority. These bonds were issued for our Seward plant. | |
(4) | Debt acquired in the Orion Power acquisition was adjusted to fair value as of the acquisition date. Included in interest expense is amortization of $1 million and $3 million for valuation adjustments for debt during the three months ended June 30, 2010 and 2009, respectively, and $5 million and $6 million during the six months ended June 30, 2010 an 2009, respectively. |
Amounts borrowed and available for borrowing under our revolving credit agreements as of
June 30, 2010 are:
Total Committed | Drawn | Letters | Unused | |||||||||||||
Credit | Amount | of Credit | Amount | |||||||||||||
(in millions) | ||||||||||||||||
RRI Energy senior secured revolver due 2012 |
$ | 500 | $ | | $ | | $ | 500 | ||||||||
RRI Energy letter of credit facility due 2014 |
250 | | 88 | 162 | ||||||||||||
Total |
$ | 750 | $ | | $ | 88 | $ | 662 | ||||||||
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(10) Earnings (Loss) Per Share
The amounts used in the basic and diluted earnings (loss) per common share computations are
the same:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Loss from
continuing
operations (basic
and diluted) |
$ | (177 | ) | $ | (103 | ) | $ | (453 | ) | $ | (209 | ) | ||||
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(shares in thousands) | ||||||||||||||||
Weighted
average shares
outstanding (basic
and diluted) |
353,473 | 350,665 | 353,390 | 350,577 | ||||||||||||
We excluded the following items from diluted earnings (loss) per common share because of the
anti-dilutive effect:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(shares in thousands) | ||||||||||||||||
Shares excluded from the calculation of diluted earnings/loss per share |
230 | (1) | 438 | (1) | 189 | (1) | 442 | (1) | ||||||||
Shares excluded from the calculation of diluted earnings/loss per
share because the exercise price exceeded the average market price |
6,168 | (2) | 6,217 | (2) | 4,787 | (2) | 7,086 | (2) |
(1) | Potential shares include stock options and restricted stock. | |
(2) | Includes stock options. |
(11) Income Taxes
(a) Tax Rate Reconciliation.
A reconciliation of the federal statutory income tax rate to the effective income tax rate for
our continuing operations is:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Federal statutory rate |
(35 | )% | (35 | )% | (35 | )% | (35 | )% | ||||||||
Additions (reductions) resulting from: |
||||||||||||||||
Federal valuation allowance |
26 | (1) | (8 | )(2) | 40 | (3) | | |||||||||
State income taxes, net of federal income taxes |
(1 | ) (4) | (1 | )(5) | 5 | (6) | (1 | )(7) | ||||||||
Other |
4 | | 3 | | ||||||||||||
Effective rate |
(6 | )% | (44 | )% | 13 | % | (36 | )% | ||||||||
(1) | Of this percentage, $47 million (26%) relates to additional valuation allowance. | |
(2) | Of this percentage, $(16) million (8%) relates to a reduction in valuation allowance. | |
(3) | Of this percentage, $159 million (40%) relates to additional valuation allowance. | |
(4) | Of this percentage, $6 million (3%) relates to additional valuation allowance. | |
(5) | Of this percentage, $9 million (5%) relates to additional valuation allowance. | |
(6) | Of this percentage, $38 million (9%) relates to additional valuation allowance. | |
(7) | Of this percentage, $15 million (5%) relates to additional valuation allowance. |
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(b) Valuation Allowances.
We assess our future ability to use federal, state and foreign net operating loss
carryforwards, capital loss carryforwards and other deferred tax assets using the
more-likely-than-not criteria. These assessments include an evaluation of our recent history of
earnings and losses, future reversals of temporary differences and identification of other sources
of future taxable income, including the identification of tax planning strategies in certain
situations.
Our valuation allowances for deferred tax assets are:
Federal | State | |||||||
(in millions) | ||||||||
As of December 31, 2009 |
$ | 129 | $ | 135 | ||||
Changes in valuation allowances |
112 | 32 | ||||||
As of March 31, 2010 |
241 | 167 | ||||||
Changes in valuation allowance |
47 | 6 | ||||||
As of June 30, 2010 |
$ | 288 | $ | 173 | ||||
(c) Income Tax Uncertainties.
We may only recognize the tax benefit for financial reporting purposes from an uncertain tax
position when it is more-likely-than-not that, based on the technical merits, the position will be
sustained by taxing authorities or the courts. The recognized tax benefits are measured as the
largest benefit having a greater than fifty percent likelihood of being realized upon settlement
with a taxing authority. We classify accrued interest and penalties related to uncertain income
tax positions in income tax expense/benefit.
Our unrecognized federal and state tax benefits changed during the six months ended June 30,
2010 as follows (in millions):
Balance, December 31, 2009 |
$ | 3 | ||
Increases related to prior years |
12 | |||
Decreases related to prior years |
(11 | ) | ||
Increases related to current year |
| |||
Settlements |
| |||
Lapses in the statute of limitations |
| |||
Balance, June 30, 2010 |
$ | 4 | ||
Our unrecognized federal and state tax benefits did not change significantly during the six
months ended June 30, 2009.
We expect to continue discussions with taxing authorities regarding tax positions related to
the following, and think it is reasonably possible some of these matters could be resolved in the
next 12 months; however, we cannot estimate the range of changes that might occur: (a) the $351
million charge during 2005 to settle certain civil litigation and claims relating to the Western
states energy crisis; and (b) the timing of tax deductions as a result of negotiations with respect
to California-related revenue, depreciation and emission allowances.
We are in ongoing discussions with the Internal Revenue Service (IRS) regarding the timing of
revenue recognition and tax deductions with respect to certain California-related items in our 2002
short taxable period return (subsequent to our separation from CenterPoint Energy, Inc.
(CenterPoint)). The IRS has informed us it expects to issue a notice of denial of our
administrative claim for refund involving these California-related items and we expect to institute
refund litigation with respect to this claim in the U.S. District Court or U.S. Court of Federal
Claims. In order to set a jurisdictional prerequisite to institute such a refund suit, we expect
to make a payment of approximately $60 million to $65 million (which includes an asserted tax
liability of $38 million plus interest) sometime during the next twelve months and record a related
receivable. If the IRS were to ultimately prevail in this matter, there would be an increase to
our income tax expense. The payment will be refunded with interest if we are successful in the
litigation.
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(12) Guarantees and Indemnifications
We have guaranteed some non-qualified benefits of CenterPoints existing retirees at September
20, 2002. The estimated maximum potential amount of future payments under the guarantee is
approximately $52 million as of June 30, 2010 and no liability is recorded in our consolidated
balance sheet for this item.
We also guarantee the PEDFA fixed-rate bonds, which are included in our consolidated balance
sheet as outstanding debt ($371 million are in our consolidated balance sheets as of June 30, 2010
and December 31, 2009). Our guarantees are secured by the same collateral as our senior secured
6.75% notes. The guarantees require us to comply with covenants similar to those in the senior
secured 6.75% notes indenture. The PEDFA bonds will become secured by certain assets of our Seward
power plant if the collateral supporting both the senior secured 6.75% notes and our guarantees are
released. Our maximum potential obligation under the guarantees is for payment of the principal
and related interest charges at a fixed rate of 6.75%. During 2009, we purchased $129 million ($92
million of which was classified as discontinued operations) of the PEDFA bonds and are the holder
of these repurchased bonds. Therefore, the net amount payable by us would not exceed the amount of
PEDFA bonds outstanding, excluding the PEDFA bonds we hold. See note 9.
We guaranteed payments to a third party relating to energy sales during December 2000 from El
Dorado Energy, LLC, a former investment. In April 2010, the third party agreed to settle
litigation arising from the 2000-2001 energy crises. Based on estimates from the third party and
as a result, we recorded a $17 million charge during the three months ended March 31, 2010, which
is included in Western states litigation and similar settlements in our statement of operations and
other current liabilities in our consolidated balance sheet as of June 30, 2010. The third partys
settlement has not yet been filed with nor approved by the FERC. We currently expect to make this
payment during 2010 or early 2011. This estimate is subject to change.
In connection with the sale of our Northeast C&I contracts in December 2008, we guaranteed
some former customers performance to the buyer. We estimate the most probable maximum potential
amount of future payments under the guarantee is $9 million as of June 30, 2010. As of June 30,
2010 and December 31, 2009, we have recorded an insignificant amount in our consolidated balance
sheets associated with this guarantee.
We enter into contracts that include indemnification and guarantee provisions. In general, we
enter into contracts with indemnities for matters such as breaches of representations and
warranties and covenants contained in the contract and/or against certain specified liabilities.
Examples of these contracts include asset purchase and sales agreements, service agreements and
procurement agreements. In our debt agreements, we typically indemnify against liabilities that
arise from the preparation, entry into, administration or enforcement of the agreement.
Except as otherwise noted, we are unable to estimate our maximum potential exposure under
these agreements until an event triggering payment occurs. We do not expect to make any material
payments under these agreements.
(13) Contingencies
We are party to many legal proceedings, some of which may involve substantial amounts. Unless
otherwise noted, we cannot predict the outcome of the matters described below.
(a) Pending Natural Gas Litigation.
We are party to seven lawsuits, several of which are class action lawsuits, in state and
federal courts in Kansas, Missouri, Nevada and Wisconsin. These lawsuits relate to alleged conduct
to increase natural gas prices in violation of antitrust and similar laws. The lawsuits seek
treble or punitive damages, restitution and/or expenses. The
lawsuits also name a number of unaffiliated energy companies as parties. In April 2010, in a
related lawsuit, the Tennessee Supreme Court reversed the Court of Appeals and dismissed all
claims.
(b) Environmental Matters.
New Source Review Matters. The United States Environmental Protection Agency (EPA) and
various states are investigating compliance of coal-fueled electric generating plants with the
pre-construction permitting requirements of the Clean Air Act known as New Source Review. In
2000 and 2001, we responded to the EPAs information requests related to five of our plants, and in
December 2007, we received supplemental requests for two of those plants. In September 2008, we
received an EPA request for information related to two additional plants and in October 2009, we
received supplemental requests for those two plants. The EPA agreed to share information relating
to its investigations with state environmental agencies. In January 2009, we received a Notice of
Violation (NOV) from the EPA alleging that past work at our Shawville, Portland and Keystone plants
violated the agencys regulations regarding New Source Review.
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In December 2007, the New Jersey Department of Environmental Protection (NJDEP) filed suit
against us in the United States District Court in Pennsylvania, alleging that New Source Review
violations occurred at one of our plants located in Pennsylvania. The suit seeks installation of
best available control technologies for each pollutant, to enjoin us from operating the plant if
it is not in compliance with the Clean Air Act and civil penalties. The suit also names three past
owners of the plant as defendants. In March 2009, the Connecticut Department of Environmental
Protection became an intervening party to the suit.
We think that the projects listed by the EPA and the projects subject to the NJDEP suit were
conducted in compliance with applicable regulations. However, any final finding that we violated
the New Source Review requirements could result in significant capital expenditures associated with
the implementation of emissions reductions on an accelerated basis and possible penalties. Most of
these work projects were undertaken before our ownership of those facilities. We think we are
indemnified by or have the right to seek indemnification from the prior owners for certain losses
and expenses that we may incur from activities occurring prior to our ownership.
Ash Disposal Landfill Closures. We are responsible for environmental costs related to the
future closures of seven ash disposal landfills. We recorded the estimated discounted costs ($19
million and $18 million as of June 30, 2010 and December 31, 2009, respectively) associated with
these environmental liabilities as part of our asset retirement obligations. See note 2(m) to our
consolidated financial statements in our Form 10-K.
Remediation Obligations. We are responsible for environmental costs related to site
contamination investigations and remediation requirements at four power plants in New Jersey. We
recorded the estimated long-term liability for the remediation costs of $8 million as of June 30,
2010 and December 31, 2009.
Conemaugh Actions. In April 2007, PennEnvironment and the Sierra Club filed a citizens suit
against us in the United States District Court, Western District of Pennsylvania to enforce
provisions of the water discharge permit for the Conemaugh plant, of which we are the operator and
have a 16.45% interest. PennEnvironment and the Sierra Club seek civil penalties, remediation and
an injunction against further violations. We are confident that the Conemaugh plant has operated
and will continue to operate in material compliance with its water discharge permit, its consent
order agreement with the Pennsylvania Department of Environmental Protection, and related state and
federal laws. In December 2009, the District Court ordered that the case be dismissed.
PennEnvironment and the Sierra Club have requested that the court reconsider its ruling. If
PennEnvironment and the Sierra Club are ultimately successful, we could incur additional capital
expenditures associated with the implementation of discharge reductions and penalties, which we do
not think would be material.
Global Warming. In February 2008, the Native Village of Kivalina and the City of Kivalina,
Alaska filed a suit in the United States District Court for the Northern District of California
against us and 23 other electric generating and oil and gas companies. The lawsuit seeks damages
of up to $400 million for the cost of relocating the village allegedly because of global warming
caused by the greenhouse gas emissions of the defendants. In late 2009, the District Court ordered
that the case be dismissed and the plaintiffs appealed. We are also a party to Comer v. Murphy
Oil, where a group of Mississippi residents and landowners allege the defendants greenhouse gas
emissions contributed to the force of Hurricane Katrina. The plaintiffs have not specified the
amount of damages they are seeking. In May 2010, the United States Court of Appeals for the Fifth
Circuit ordered that the case be dismissed with prejudice. While we think claims such as these
lack legal merit, it is possible that this trend of climate change litigation may continue.
(c) Other.
Excess Mitigation Credits. From January 2002 to April 2005, CenterPoint applied excess
mitigation credits (EMCs) to its monthly charges to retail energy providers. The PUCT imposed
these credits to facilitate the transition to competition in Texas, which had the effect of
lowering the retail energy providers monthly charges payable to CenterPoint. CenterPoint
represents that the portion of those EMCs credited to our former Texas retail business totaled $385
million. In its stranded cost case, CenterPoint sought recovery of all EMCs credited to all retail
electric providers, including our former Texas retail business, and the PUCT ordered that relief.
On appeal, the Texas Third Court of Appeals ruled that CenterPoints stranded cost recovery should
exclude EMCs credited to our former Texas retail business for price-to-beat customers. The case is
now before the Texas Supreme Court. In November 2008, CenterPoint asked us to agree to suspend any
limitations periods that might exist for possible claims against us or our former Texas retail
business if it is ultimately not allowed to include in its stranded cost calculation EMCs credited
to our former Texas retail business. We agreed to suspend only unexpired deadlines, if any, that
may apply to a CenterPoint claim relating to EMCs credited to our former Texas retail business.
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CenterPoint Indemnity. We have agreed to indemnify CenterPoint against certain losses
relating to the lawsuits described in note 13(a) under Pending Natural Gas Litigation.
Texas Franchise Audit. The state of Texas has issued assessment orders indicating an
estimated tax liability of approximately $59 million (including interest and penalties of $21
million) relating primarily to the sourcing of receipts for 2000 through 2006. We are contesting
the audit assessments related to this issue.
Refund Contingency Related to Transportation Rates. In September 2008, Kern River Gas
Transmission Company (Kern), a natural gas pipeline company, and certain of its shippers entered
into a settlement agreement regarding Kerns transportation rates to which we were a party. The
agreement resulted in a refund to us of $30 million during 2008 (recorded as a current liability).
In 2009, the Federal Energy Regulatory Commission (FERC) rejected the settlement agreement and
directed Kern to recalculate the refunds. We do not expect any adjustments to be material.
(d) Proposed Merger with Mirant.
In April 2010, RRI Energy together with Mirant and Mirants board of directors were named
defendants in four purported class action lawsuits filed in the Superior Court of Fulton County,
Georgia, brought on behalf of proposed classes consisting of holders of Mirant common stock,
excluding defendants and their affiliates. RRI Energy Holdings, Inc., a wholly-owned subsidiary of
RRI Energy formed for the purpose of effecting the merger, was also named a defendant in three of
the lawsuits. In three of the actions, amended complaints have been filed adding allegations that
the defendants breached their fiduciary duties by failing to disclose certain information in the
preliminary joint proxy statement/prospectus of RRI Energy and Mirant, which is a part of the
Registration Statement of RRI Energy that was filed with the Securities and Exchange Commission.
The complaints allege, among other things, that the merger agreement was the product of breaches of
fiduciary duties by the individual defendants, in that it allegedly does not provide for the best
value reasonable under the circumstances for Mirants public stockholders, and that the other
defendants aided and abetted the individual defendants breaches of fiduciary duties. The
complaints seek, among other things, (a) a declaration that the merger agreement was entered into
in breach of the defendants duties, (b) to enjoin defendants from consummating the merger, (c)
rescission of the merger if it is consummated and/or (d) granting the class members any profits or
benefits allegedly improperly received by defendants. Motions to dismiss each of the four
complaints for failure to state a claim have been filed on behalf of all of the defendants. We
think that the allegations of the complaints are without merit and that we have substantial
meritorious defenses to the claims made in these actions.
(14) Pension and Postretirement Benefits
We sponsor multiple defined benefit pension plans. We provide subsidized postretirement
benefits to some bargaining employees but generally do not provide them to non-bargaining
employees. See note 11 to our consolidated financial statements in our Form 10-K for additional
information about pension and postretirement benefits.
Pension | Postretirement | |||||||||||||||
Three months ended June 30, | Three months ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Service cost |
$ | 1 | $ | 2 | $ | | $ | 1 | ||||||||
Interest cost |
1 | 1 | 1 | | ||||||||||||
Expected return on plan assets |
(2 | ) | (1 | ) | | | ||||||||||
Net amortization(1) |
1 | 1 | | 1 | ||||||||||||
Net periodic benefit costs |
$ | 1 | $ | 3 | $ | 1 | $ | 2 | ||||||||
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Pension | Postretirement | |||||||||||||||
Six months ended June 30, | Six months ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Service cost |
$ | 2 | $ | 3 | $ | | $ | 1 | ||||||||
Interest cost |
3 | 3 | 2 | 2 | ||||||||||||
Expected return on plan assets |
(3 | ) | (2 | ) | | | ||||||||||
Net amortization(1) |
1 | 2 | | 1 | ||||||||||||
Net periodic benefit costs |
$ | 3 | $ | 6 | $ | 2 | $ | 4 | ||||||||
(1) | Net amortization amount includes prior service costs and actuarial gains and losses. |
(15) Collective Bargaining Agreements
As of June 30, 2010, approximately 45% of our employees are subject to collective bargaining
agreements. Less than five percent of our employees are subject to collective bargaining
agreements that will expire by June 30, 2011.
(16) Supplemental Guarantor Information
Our wholly-owned subsidiaries are either (a) full and unconditional guarantors, jointly and
severally, or (b) non-guarantors of the senior secured notes. Orion Power Holdings, Inc. and its
consolidated subsidiaries became guarantors in June 2010 as a result of the pay off of its senior
notes in May 2010. We have reclassified 2009 disclosures to be comparable to 2010.
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Condensed Consolidating Statements of Operations.
Three Months Ended June 30, 2010 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments (1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Revenues |
$ | | $ | 404 | $ | 146 | $ | (150 | ) | $ | 400 | |||||||||
Cost of sales |
| 346 | 69 | (150 | ) | 265 | ||||||||||||||
Operation and maintenance |
| 100 | 84 | | 184 | |||||||||||||||
General and administrative |
| 21 | 14 | | 35 | |||||||||||||||
Gains on sales of assets and emission and exchange allowances, net |
| (1 | ) | | | (1 | ) | |||||||||||||
Depreciation and amortization |
| 55 | 14 | | 69 | |||||||||||||||
Total |
| 521 | 181 | (150 | ) | 552 | ||||||||||||||
Operating loss |
| (117 | ) | (35 | ) | | (152 | ) | ||||||||||||
Loss of equity investments of consolidated subsidiaries |
(45 | ) | (34 | ) | | 79 | | |||||||||||||
Interest expense |
(33 | ) | (3 | ) | (1 | ) | | (37 | ) | |||||||||||
Interest income (expense) affiliated companies, net |
20 | (4 | ) | (16 | ) | | | |||||||||||||
Other, net |
| 1 | | | 1 | |||||||||||||||
Total other expense |
(58 | ) | (40 | ) | (17 | ) | 79 | (36 | ) | |||||||||||
Loss from continuing operations before income taxes |
(58 | ) | (157 | ) | (52 | ) | 79 | (188 | ) | |||||||||||
Income tax expense (benefit) |
117 | (92 | ) | (4 | ) | (32 | ) | (11 | ) | |||||||||||
Loss from continuing operations |
(175 | ) | (65 | ) | (48 | ) | 111 | (177 | ) | |||||||||||
Income from discontinued operations |
3 | 1 | 1 | | 5 | |||||||||||||||
Net loss |
$ | (172 | ) | $ | (64 | ) | $ | (47 | ) | $ | 111 | $ | (172 | ) | ||||||
Three Months Ended June 30, 2009 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments (1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Revenues |
$ | | $ | 387 | $ | 116 | $ | (113 | ) | $ | 390 | |||||||||
Cost of sales |
| 321 | 71 | (111 | ) | 281 | ||||||||||||||
Operation and maintenance |
| 89 | 70 | (2 | ) | 157 | ||||||||||||||
General and administrative |
| 7 | 21 | | 28 | |||||||||||||||
Gains on sales of assets and emission and exchange allowances, net |
| (2 | ) | | | (2 | ) | |||||||||||||
Depreciation and amortization |
| 55 | 12 | | 67 | |||||||||||||||
Total |
| 470 | 174 | (113 | ) | 531 | ||||||||||||||
Operating loss |
| (83 | ) | (58 | ) | | (141 | ) | ||||||||||||
Loss of equity investments of consolidated subsidiaries |
(70 | ) | (37 | ) | | 107 | | |||||||||||||
Debt extinguishments gains |
1 | | | | 1 | |||||||||||||||
Interest expense |
(36 | ) | (10 | ) | (1 | ) | 2 | (45 | ) | |||||||||||
Interest income |
1 | | | | 1 | |||||||||||||||
Interest income (expense) affiliated companies, net |
18 | (4 | ) | (12 | ) | (2 | ) | | ||||||||||||
Other, net |
| (1 | ) | | | (1 | ) | |||||||||||||
Total other expense |
(86 | ) | (52 | ) | (13 | ) | 107 | (44 | ) | |||||||||||
Loss from continuing operations
before income taxes |
(86 | ) | (135 | ) | (71 | ) | 107 | (185 | ) | |||||||||||
Income tax benefit |
(18 | ) | (36 | ) | (29 | ) | 1 | (82 | ) | |||||||||||
Loss from continuing operations |
(68 | ) | (99 | ) | (42 | ) | 106 | (103 | ) | |||||||||||
Income (loss) from discontinued operations |
871 | (2 | ) | 37 | | 906 | ||||||||||||||
Net income (loss) |
$ | 803 | $ | (101 | ) | $ | (5 | ) | $ | 106 | $ | 803 | ||||||||
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Table of Contents
Six Months Ended June 30, 2010 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments (1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Revenues |
$ | | $ | 1,013 | $ | 311 | $ | (319 | ) | $ | 1,005 | |||||||||
Cost of sales |
| 718 | 131 | (317 | ) | 532 | ||||||||||||||
Operation and maintenance |
| 193 | 153 | (2 | ) | 344 | ||||||||||||||
General and administrative |
| 29 | 27 | | 56 | |||||||||||||||
Western states litigation and similar settlements |
| 17 | | | 17 | |||||||||||||||
Gains on sales of assets and emission and exchange allowances, net |
| (1 | ) | | | (1 | ) | |||||||||||||
Long-lived assets impairments |
| 248 | | | 248 | |||||||||||||||
Depreciation and amortization |
| 105 | 26 | | 131 | |||||||||||||||
Total |
| 1,309 | 337 | (319 | ) | 1,327 | ||||||||||||||
Operating loss |
| (296 | ) | (26 | ) | | (322 | ) | ||||||||||||
Loss of equity investments of consolidated subsidiaries |
(284 | ) | (61 | ) | | 345 | | |||||||||||||
Interest expense |
(66 | ) | (16 | ) | (1 | ) | | (83 | ) | |||||||||||
Interest income (expense) affiliated companies, net |
41 | (10 | ) | (31 | ) | | | |||||||||||||
Other, net |
| 3 | | | 3 | |||||||||||||||
Total other expense |
(309 | ) | (84 | ) | (32 | ) | 345 | (80 | ) | |||||||||||
Loss from continuing operations before income taxes |
(309 | ) | (380 | ) | (58 | ) | 345 | (402 | ) | |||||||||||
Income tax expense (benefit) |
143 | (107 | ) | 15 | | 51 | ||||||||||||||
Loss from continuing operations |
(452 | ) | (273 | ) | (73 | ) | 345 | (453 | ) | |||||||||||
Income from discontinued operations |
3 | | 1 | | 4 | |||||||||||||||
Net loss |
$ | (449 | ) | $ | (273 | ) | $ | (72 | ) | $ | 345 | $ | (449 | ) | ||||||
Six Months Ended June 30, 2009 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments (1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Revenues |
$ | | $ | 838 | $ | 289 | $ | (271 | ) | $ | 856 | |||||||||
Cost of sales |
| 689 | 184 | (268 | ) | 605 | ||||||||||||||
Operation and maintenance |
| 189 | 128 | (3 | ) | 314 | ||||||||||||||
General and administrative |
| 16 | 41 | | 57 | |||||||||||||||
Gains on sales of assets and emission and exchange allowances, net |
| (20 | ) | | | (20 | ) | |||||||||||||
Depreciation and amortization |
| 110 | 25 | | 135 | |||||||||||||||
Total |
| 984 | 378 | (271 | ) | 1,091 | ||||||||||||||
Operating loss |
| (146 | ) | (89 | ) | | (235 | ) | ||||||||||||
Loss of equity investments of consolidated subsidiaries |
(177 | ) | (59 | ) | | 236 | | |||||||||||||
Debt extinguishments gains |
1 | | | | 1 | |||||||||||||||
Interest expense |
(74 | ) | (21 | ) | | 3 | (92 | ) | ||||||||||||
Interest income |
1 | | | | 1 | |||||||||||||||
Interest income (expense) affiliated companies, net |
35 | (7 | ) | (25 | ) | (3 | ) | | ||||||||||||
Total other expense |
(214 | ) | (87 | ) | (25 | ) | 236 | (90 | ) | |||||||||||
Loss from continuing operations
before income taxes |
(214 | ) | (233 | ) | (114 | ) | 236 | (325 | ) | |||||||||||
Income tax benefit |
(11 | ) | (59 | ) | (49 | ) | 3 | (116 | ) | |||||||||||
Loss from continuing operations |
(203 | ) | (174 | ) | (65 | ) | 233 | (209 | ) | |||||||||||
Income (loss) from discontinued operations |
855 | 10 | (4 | ) | | 861 | ||||||||||||||
Net income (loss) |
$ | 652 | $ | (164 | ) | $ | (69 | ) | $ | 233 | $ | 652 | ||||||||
(1) | These amounts relate to either (a) eliminations and adjustments recorded in the normal consolidation process or (b) reclassifications recorded as a result of differences in classifications at the subsidiary levels compared to the consolidated level. |
23
Table of Contents
Condensed Consolidating Balance Sheets.
June 30, 2010 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments (1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
ASSETS |
||||||||||||||||||||
Current Assets: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 523 | $ | | $ | 40 | $ | | $ | 563 | ||||||||||
Restricted cash |
| 2 | 1 | | 3 | |||||||||||||||
Accounts and notes receivable, principally customer, net |
13 | 140 | 8 | (5 | ) | 156 | ||||||||||||||
Accounts and notes receivable affiliated companies |
2,566 | 612 | 151 | (3,329 | ) | | ||||||||||||||
Inventory |
| 181 | 97 | | 278 | |||||||||||||||
Derivative assets |
| 110 | 20 | | 130 | |||||||||||||||
Other current assets |
33 | 143 | 78 | (12 | ) | 242 | ||||||||||||||
Current assets of discontinued operations |
17 | 52 | | (13 | ) | 56 | ||||||||||||||
Total current assets |
3,152 | 1,240 | 395 | (3,359 | ) | 1,428 | ||||||||||||||
Property, Plant and Equipment, net |
| 3,526 | 755 | | 4,281 | |||||||||||||||
Other Assets: |
||||||||||||||||||||
Other intangibles, net |
| 201 | 93 | | 294 | |||||||||||||||
Notes receivable affiliated companies |
911 | 566 | | (1,477 | ) | | ||||||||||||||
Equity investments of consolidated subsidiaries |
1,991 | 223 | 18 | (2,232 | ) | | ||||||||||||||
Derivative assets |
| 44 | 4 | (3 | ) | 45 | ||||||||||||||
Other long-term assets |
41 | 747 | 359 | (683 | ) | 464 | ||||||||||||||
Long-term assets of discontinued operations |
| 4 | | | 4 | |||||||||||||||
Total other assets |
2,943 | 1,785 | 474 | (4,395 | ) | 807 | ||||||||||||||
Total Assets |
$ | 6,095 | $ | 6,551 | $ | 1,624 | $ | (7,754 | ) | $ | 6,516 | |||||||||
LIABILITIES AND EQUITY |
||||||||||||||||||||
Current Liabilities: |
||||||||||||||||||||
Current portion of long-term debt |
$ | | $ | | $ | | $ | | $ | | ||||||||||
Accounts payable, principally trade |
| 82 | 23 | | 105 | |||||||||||||||
Accounts and notes payable affiliated companies |
| 2,707 | 622 | (3,329 | ) | | ||||||||||||||
Derivative liabilities |
| 36 | 56 | | 92 | |||||||||||||||
Other current liabilities |
14 | 176 | 26 | (17 | ) | 199 | ||||||||||||||
Current liabilities of discontinued operations |
2 | 35 | | (13 | ) | 24 | ||||||||||||||
Total current liabilities |
16 | 3,036 | 727 | (3,359 | ) | 420 | ||||||||||||||
Other Liabilities: |
||||||||||||||||||||
Notes payable affiliated companies |
| 933 | 544 | (1,477 | ) | | ||||||||||||||
Derivative liabilities |
| | 42 | (3 | ) | 39 | ||||||||||||||
Other long-term liabilities |
688 | 202 | 78 | (683 | ) | 285 | ||||||||||||||
Long-term liabilities of discontinued operations |
4 | 10 | | | 14 | |||||||||||||||
Total other liabilities |
692 | 1,145 | 664 | (2,163 | ) | 338 | ||||||||||||||
Long-term Debt |
1,579 | 371 | | | 1,950 | |||||||||||||||
Commitments and Contingencies |
||||||||||||||||||||
Temporary Equity Stock-based Compensation |
6 | | | | 6 | |||||||||||||||
Total Stockholders Equity |
3,802 | 1,999 | 233 | (2,232 | ) | 3,802 | ||||||||||||||
Total Liabilities and Equity |
$ | 6,095 | $ | 6,551 | $ | 1,624 | $ | (7,754 | ) | $ | 6,516 | |||||||||
24
Table of Contents
December 31, 2009 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments (1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
ASSETS |
||||||||||||||||||||
Current Assets: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 922 | $ | 10 | $ | 16 | $ | (5 | ) | $ | 943 | |||||||||
Restricted cash |
| 12 | 7 | 5 | 24 | |||||||||||||||
Accounts and notes receivable, principally customer, net |
10 | 134 | 12 | (3 | ) | 153 | ||||||||||||||
Accounts and notes receivable affiliated companies |
2,210 | 554 | 150 | (2,914 | ) | | ||||||||||||||
Inventory |
| 237 | 95 | | 332 | |||||||||||||||
Derivative assets |
| 100 | 32 | | 132 | |||||||||||||||
Other current assets |
48 | 166 | 81 | (9 | ) | 286 | ||||||||||||||
Current assets of discontinued operations |
129 | 95 | 5 | (121 | ) | 108 | ||||||||||||||
Total current assets |
3,319 | 1,308 | 398 | (3,047 | ) | 1,978 | ||||||||||||||
Property, Plant and Equipment, net |
| 3,833 | 769 | | 4,602 | |||||||||||||||
Other Assets: |
||||||||||||||||||||
Other intangibles, net |
| 209 | 97 | | 306 | |||||||||||||||
Notes receivable affiliated companies |
1,067 | 551 | | (1,618 | ) | | ||||||||||||||
Equity investments of consolidated subsidiaries |
1,991 | 277 | 18 | (2,286 | ) | | ||||||||||||||
Derivative assets |
| 48 | 5 | | 53 | |||||||||||||||
Other long-term assets |
41 | 722 | 365 | (611 | ) | 517 | ||||||||||||||
Long-term assets of discontinued operations |
| 5 | | | 5 | |||||||||||||||
Total other assets |
3,099 | 1,812 | 485 | (4,515 | ) | 881 | ||||||||||||||
Total Assets |
$ | 6,418 | $ | 6,953 | $ | 1,652 | $ | (7,562 | ) | $ | 7,461 | |||||||||
LIABILITIES AND EQUITY |
||||||||||||||||||||
Current Liabilities: |
||||||||||||||||||||
Current portion of long-term debt |
$ | | $ | 405 | $ | | $ | | $ | 405 | ||||||||||
Accounts payable, principally trade |
| 113 | 30 | | 143 | |||||||||||||||
Accounts and notes payable affiliated companies |
| 2,364 | 550 | (2,914 | ) | | ||||||||||||||
Derivative liabilities |
| 76 | 76 | | 152 | |||||||||||||||
Other current liabilities |
10 | 149 | 25 | (12 | ) | 172 | ||||||||||||||
Current liabilities of discontinued operations |
9 | 162 | 8 | (121 | ) | 58 | ||||||||||||||
Total current liabilities |
19 | 3,269 | 689 | (3,047 | ) | 930 | ||||||||||||||
Other Liabilities: |
||||||||||||||||||||
Notes payable affiliated companies |
| 1,074 | 544 | (1,618 | ) | | ||||||||||||||
Derivative liabilities |
| | 61 | | 61 | |||||||||||||||
Other long-term liabilities |
572 | 237 | 63 | (611 | ) | 261 | ||||||||||||||
Long-term liabilities of discontinued
operations |
3 | 11 | | 14 | ||||||||||||||||
Total other liabilities |
575 | 1,322 | 668 | (2,229 | ) | 336 | ||||||||||||||
Long-term Debt |
1,579 | 371 | | | 1,950 | |||||||||||||||
Commitments and Contingencies |
||||||||||||||||||||
Temporary Equity Stock-based
Compensation |
7 | | | | 7 | |||||||||||||||
Total Stockholders Equity |
4,238 | 1,991 | 295 | (2,286 | ) | 4,238 | ||||||||||||||
Total Liabilities and Equity |
$ | 6,418 | $ | 6,953 | $ | 1,652 | $ | (7,562 | ) | $ | 7,461 | |||||||||
(1) | These amounts relate to either (a) eliminations and adjustments recorded in the normal consolidation process or (b) reclassifications recorded as a result of differences in classifications at the subsidiary levels compared to the consolidated level. |
25
Table of Contents
Condensed Consolidating Statements of Cash Flows.
Six Months Ended June 30, 2010 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments(1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Cash Flows from Operating Activities: |
||||||||||||||||||||
Net cash provided by (used in) continuing operations from operating activities |
$ | (6 | ) | $ | 39 | $ | (6 | ) | $ | | $ | 27 | ||||||||
Net cash provided by discontinued operations from operating activities |
10 | 15 | 1 | | 26 | |||||||||||||||
Net cash provided by (used in) operating activities |
4 | 54 | (5 | ) | | 53 | ||||||||||||||
Cash Flows from Investing Activities: |
||||||||||||||||||||
Capital expenditures |
| (35 | ) | (15 | ) | | (50 | ) | ||||||||||||
Investments in, advances to and from and distributions from subsidiaries, net(2) |
(404 | ) | 424 | | (20 | ) | | |||||||||||||
Proceeds from sales of assets, net |
| 7 | | | 7 | |||||||||||||||
Proceeds from sales (purchases) of emission allowances |
| 6 | (6 | ) | | | ||||||||||||||
Restricted cash |
| (1 | ) | 1 | 5 | 5 | ||||||||||||||
Other, net |
| 3 | | | 3 | |||||||||||||||
Net cash provided by (used in) continuing operations from investing activities |
(404 | ) | 404 | (20 | ) | (15 | ) | (35 | ) | |||||||||||
Net cash used in discontinued operations from investing activities |
(1 | ) | (1 | ) | (5 | ) | 3 | (4 | ) | |||||||||||
Net cash provided by (used in) investing activities |
(405 | ) | 403 | (25 | ) | (12 | ) | (39 | ) | |||||||||||
Cash Flows from Financing Activities: |
||||||||||||||||||||
Payments of long-term debt |
| (400 | ) | | | (400 | ) | |||||||||||||
Changes in notes with affiliated companies,
net(3) |
| (75 | ) | 55 | 20 | | ||||||||||||||
Proceeds from issuances of stock |
2 | | | | 2 | |||||||||||||||
Net cash provided by (used in) continuing operations from financing activities |
2 | (475 | ) | 55 | 20 | (398 | ) | |||||||||||||
Net cash provided by discontinued operations from financing activities |
| 3 | | (3 | ) | | ||||||||||||||
Net cash provided by (used in) financing activities |
2 | (472 | ) | 55 | 17 | (398 | ) | |||||||||||||
Net Change in Cash and Cash Equivalents, Total Operations |
(399 | ) | (15 | ) | 25 | 5 | (384 | ) | ||||||||||||
Less: Net Change in Cash and Cash Equivalents, Discontinued Operations |
| (5 | ) | 1 | | (4 | ) | |||||||||||||
Cash and Cash Equivalents at Beginning of Period, Continuing Operations |
922 | 10 | 16 | (5 | ) | 943 | ||||||||||||||
Cash and Cash Equivalents at End of Period, Continuing Operations |
$ | 523 | $ | | $ | 40 | $ | | $ | 563 | ||||||||||
26
Table of Contents
Six Months Ended June 30, 2009 | ||||||||||||||||||||
RRI Energy | Guarantors | Non-Guarantors | Adjustments(1) | Consolidated | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Cash Flows from Operating Activities: |
||||||||||||||||||||
Net cash provided by (used in) continuing operations from operating activities |
$ | (75 | ) | $ | 7 | $ | (28 | ) | $ | | $ | (96 | ) | |||||||
Net cash provided by discontinued operations from operating activities |
135 | 53 | 320 | | 508 | |||||||||||||||
Net cash provided by operating activities |
60 | 60 | 292 | | 412 | |||||||||||||||
Cash Flows from Investing Activities: |
||||||||||||||||||||
Capital expenditures |
| (71 | ) | (44 | ) | | (115 | ) | ||||||||||||
Investments in, advances to and from and distributions from subsidiaries, net(2) |
(64 | ) | | | 64 | | ||||||||||||||
Proceeds from sales of assets, net |
| 36 | | | 36 | |||||||||||||||
Proceeds from sales (purchases) of emission allowances |
| 42 | (28 | ) | | 14 | ||||||||||||||
Other, net |
| 1 | | | 1 | |||||||||||||||
Net cash provided by (used in) continuing operations from investing activities |
(64 | ) | 8 | (72 | ) | 64 | (64 | ) | ||||||||||||
Net cash provided by (used in) discontinued operations from investing activities |
701 | 4 | (418 | ) | 12 | 299 | ||||||||||||||
Net cash provided by (used in) investing activities |
637 | 12 | (490 | ) | 76 | 235 | ||||||||||||||
Cash Flows from Financing Activities: |
||||||||||||||||||||
Payments of long-term debt |
(45 | ) | | | | (45 | ) | |||||||||||||
Changes in notes with affiliated companies,
net(3) |
| (8 | ) | 72 | (64 | ) | | |||||||||||||
Proceeds from issuances of stock |
2 | | | | 2 | |||||||||||||||
Net cash provided by (used in) continuing operations from financing activities |
(43 | ) | (8 | ) | 72 | (64 | ) | (43 | ) | |||||||||||
Net cash used in discontinued operations from financing activities |
(147 | ) | (63 | ) | (3 | ) | (12 | ) | (225 | ) | ||||||||||
Net cash provided by (used in) financing activities |
(190 | ) | (71 | ) | 69 | (76 | ) | (268 | ) | |||||||||||
Net Change in Cash and Cash Equivalents, Total Operations |
507 | 1 | (129 | ) | | 379 | ||||||||||||||
Less: Net Change in Cash and Cash Equivalents, Discontinued Operations |
| | (104 | ) | | (104 | ) | |||||||||||||
Cash and Cash Equivalents at Beginning of Period, Continuing Operations |
970 | | 34 | | 1,004 | |||||||||||||||
Cash and Cash Equivalents at End of Period, Continuing Operations |
$ | 1,477 | $ | 1 | $ | 9 | $ | | $ | 1,487 | ||||||||||
(1) | These amounts relate to either (a) eliminations and adjustments recorded in the normal consolidation process or (b) reclassifications recorded as a result of differences in classifications at the subsidiary levels compared to the consolidated level. | |
(2) | Net investments in, advances to and from and distributions from subsidiaries are classified as investing activities. | |
(3) | Net changes in notes with affiliated companies are classified as financing activities for subsidiaries of RRI Energy and as investing activities for RRI Energy. |
27
Table of Contents
(17) Reportable Segments
Segments. We have four reportable segments: East Coal, East Gas, West and Other. The East
Gas, West and Other segments consist primarily of gas plants while the East Coal segment is our
coal plants. Each of our generation plants is an operating segment and based on similar economic
and other characteristics, we have aggregated them into these four reportable segments. The key
earnings drivers we use for internal performance reporting and external communication exhibit how
each segment has similar economic characteristics. Key earnings drivers include economic
generation (amount of time our plants are economical to operate), commercial capacity factor
(generation as a percentage of economic generation), unit margin and other margin. All plants are
impacted by supply and demand. Our coal plants (East Coal) are further impacted by gas/coal
spreads (the added difference between the price of natural gas and the price of coal).
Accordingly, we have aggregated the plants by fuel type and further by geographic region.
In each of our segments, we sell electricity, capacity, ancillary and other energy services
from our plants in hour-ahead, day-ahead and forward markets in bilateral and independent system
operator markets. All products and services are related to the generation and availability of
power, consisting of (a) power generation revenues, (b) capacity revenues and (c) natural gas sales
revenues.
Open Gross Margin. Our segment profitability measure is open gross margin. Open gross margin
consists of (a) open energy gross margin and (b) other margin. Open gross margin excludes hedges
and other items and unrealized gains/losses on energy derivatives. Open energy gross margin is
calculated using the day-ahead and real-time market power sales prices received by the plants less
market-based delivered fuel costs. Open energy gross margin is (a)(i) economic generation
multiplied by (ii) commercial capacity factor (which equals generation) multiplied by (b) open
energy unit margin. Economic generation is estimated generation at 100% plant availability based
on an hourly analysis of when it is economical to generate based on the price of power, fuel,
emission allowances and variable operating costs. Economic generation can vary depending on the
comparison of market prices to our cost of generation. It will decrease if there are fewer hours
when market prices exceed the cost of generation. It will increase if there are more hours when
market prices exceed the cost of generation. Other margin represents power purchase agreements,
capacity payments, ancillary services revenues and selective commercial strategies relating to
optimizing our assets.
Items Excluded from Open Gross Margin. We have two primary items that are excluded from our
segment measure of open gross margin: (a) hedges and other items and (b) unrealized gains/losses
on energy derivatives. Each of these items is included in our consolidated revenues or cost of
sales and is described more fully below. We think that excluding these items from our segment
profitability measure provides a more meaningful representation of our economic performance in the
reporting period and is therefore useful to us and others in facilitating the analysis of our
results of operations from one period to another. Hedges and other items and unrealized
gains/losses on energy derivatives are also not a function of the operating performance of our
generation assets, and excluding their impacts helps isolate the operating performance of our
generation assets under prevailing market conditions.
Hedges and Other Items. We may enter selective hedges, including originated transactions, to
(a) seek potential value greater than what is available in the spot or day-ahead markets, (b)
address operational requirements
or (c) seek a specific financial objective. Hedges and other items primarily relate to
settlements of power and fuel hedges, long-term natural gas transportation contracts, storage
contracts and long-term tolling contracts. They are primarily derived based on methodology
consistent with the calculation of open energy gross margin in that a portion of this item
represents the difference between the margins calculated using the day-ahead and real-time market
power sales prices received by the plants less market-based delivered fuel costs and the actual
amounts paid or received during the period. See note 5.
Unrealized Gains/Losses on Energy Derivatives. We use derivative instruments to manage
operational or market constraints and to increase the return on our generation assets. We record
in our consolidated statement of operations non-cash gains/losses based on current changes in
forward commodity prices for derivative instruments receiving mark-to-market accounting treatment
which will settle in future periods. We refer to these gains and losses prior to settlement, as
well as ineffectiveness on cash flow hedges, as unrealized gains/losses on energy derivatives.
In some cases, the underlying transactions being economically hedged receive accrual accounting
treatment, resulting in a mismatch of accounting treatments. Since the application of
mark-to-market accounting has the effect of pulling forward into current periods non-cash
gains/losses relating to and reversing in future delivery periods, analysis of results of
operations from one period to another can be difficult. See note 5.
28
Table of Contents
Financial data for our segments and consolidated are as follows:
Adjustments | ||||||||||||||||||||||||||||
East | East | Discontinued | and | |||||||||||||||||||||||||
Coal | Gas | West | Other | Operations | Eliminations | Consolidated | ||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||
Three months ended June 30, 2010 |
||||||||||||||||||||||||||||
Revenues from external
customers(1) |
$ | 244 | $ | 119 | $ | 74 | $ | 14 | $ | (51 | )(2) | $ | 400 | (3) | ||||||||||||||
Open energy gross
margin |
$ | 68 | $ | 10 | $ | | $ | | $ | 78 | ||||||||||||||||||
Other margin |
50 | 52 | 18 | 8 | 128 | |||||||||||||||||||||||
Open gross margin(4) |
$ | 118 | $ | 62 | $ | 18 | $ | 8 | $ | 206 | (5) | |||||||||||||||||
Gains on sales of assets and
emission and exchange allowances,
net |
$ | | $ | | $ | 1 | $ | | $ | | $ | 1 | ||||||||||||||||
Three months ended
June 30, 2009 |
||||||||||||||||||||||||||||
Revenues from external
customers(1) |
$ | 196 | $ | 110 | $ | 69 | $ | 28 | $ | (13 | )(2) | $ | 390 | (6) | ||||||||||||||
Open energy gross margin |
$ | 43 | $ | 5 | $ | 8 | $ | | $ | 56 | ||||||||||||||||||
Other margin |
41 | 44 | 17 | 14 | 116 | |||||||||||||||||||||||
Open gross margin(4) |
$ | 84 | $ | 49 | $ | 25 | $ | 14 | $ | 172 | (7) | |||||||||||||||||
Gains on sales of assets and
emission and exchange allowances,
net |
$ | | $ | | $ | 1 | $ | | $ | 1 | $ | 2 | ||||||||||||||||
Six months ended June 30, 2010
(unless otherwise indicated) |
||||||||||||||||||||||||||||
Revenues from external
customers(1) |
$ | 531 | $ | 265 | $ | 125 | $ | 29 | $ | 55 | (2) | $ | 1,005 | (8) | ||||||||||||||
Open energy gross margin |
$ | 156 | $ | 10 | $ | | $ | | $ | 166 | ||||||||||||||||||
Other margin |
99 | 101 | 30 | 14 | 244 | |||||||||||||||||||||||
Open gross margin(4) |
$ | 255 | $ | 111 | $ | 30 | $ | 14 | $ | 410 | (9) | |||||||||||||||||
Long-lived assets impairments |
$ | 248 | (10) | $ | | $ | | $ | | $ | | $ | 248 | |||||||||||||||
Gains on sales of assets and
emission and exchange allowances,
net |
$ | | $ | | $ | 1 | $ | | $ | | $ | 1 | ||||||||||||||||
Total assets as of June 30, 2010 |
$ | 3,123 | (11) | $ | 1,283 | (11) | $ | 169 | (11) | $ | 609 | (11) | $ | 60 | $ | 1,272 | (12) | $ | 6,516 | |||||||||
Six months ended June 30, 2009
(unless otherwise indicated) |
||||||||||||||||||||||||||||
Revenues from external
customers(1) |
$ | 468 | $ | 255 | $ | 113 | $ | 47 | $ | (27 | )(2) | $ | 856 | (13) | ||||||||||||||
Open energy gross margin |
$ | 135 | $ | 6 | $ | 9 | $ | | $ | 150 | ||||||||||||||||||
Other margin |
75 | 82 | 28 | 27 | 212 | |||||||||||||||||||||||
Open gross margin(4) |
$ | 210 | $ | 88 | $ | 37 | $ | 27 | $ | 362 | (14) | |||||||||||||||||
Gains on sales of assets and
emission and exchange allowances,
net |
$ | | $ | | $ | 3 | $ | | $ | 17 | (15) | $ | 20 | |||||||||||||||
Total assets as of December 31,
2009 |
$ | 3,446 | (11) | $ | 1,316 | (11) | $ | 175 | (11) | $ | 623 | (11) | $ | 113 | $ | 1,788 | (12) | $ | 7,461 |
(1) | All revenues are in the United States. | |
(2) | Primarily relates to unrealized gains/losses on energy derivatives, hedges and other items and other revenues not specifically identified to a particular plant or reportable segment. |
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(3) | Includes $285 million in revenues from one counterparty, which represented 71% of our consolidated revenues. This counterparty is included in our East Coal and East Gas segments. Additionally, includes $41 million in revenues from a second counterparty, which represented 10% of our consolidated revenues. This counterparty is included in our East Coal and East Gas segments. As of June 30, 2010, $66 million and $26 million was outstanding from these counterparties, respectively, and collected in July 2010. | |
(4) | Represents our segment profitability measure. | |
(5) | Excludes $(5) million and $(66) million of hedges and other items and unrealized losses on energy derivatives, respectively, that are included in our consolidated revenues or cost of sales. | |
(6) | Includes $234 million in revenues from one counterparty, which represented 60% of our consolidated revenues. This counterparty is included in our East Coal and East Gas segments. Additionally, includes $44 million in revenues from a second counterparty, which represented 11% of our consolidated revenues. This counterparty is included in all of our segments. | |
(7) | Excludes $(70) million and $7 million of hedges and other items and unrealized gains on energy derivatives, respectively, that are included in our consolidated revenues or cost of sales. | |
(8) | Includes $560 million in revenues from one counterparty, which represented 56% of our consolidated revenues. This counterparty is included in our East Coal and East Gas segments. | |
(9) | Excludes $2 million and $61 million of hedges and other items and unrealized gains on energy derivatives, respectively, that are included in our consolidated revenues or cost of sales. | |
(10) | Includes $193 million and $55 million related to the Elrama and Niles plants, respectively. | |
(11) | Primarily relates to property, plant and equipment, inventory and emission allowances. East Coal segment also includes the prepaid REMA leases of $327 million and $336 million as of June 30, 2010 and December 31, 2009, respectively. Other segment also includes our equity method investment in Sabine Cogen, LP of $18 million and $19 million as of June 30, 2010 and December 31, 2009, respectively. | |
(12) | Represents assets not assigned to a segment. Includes primarily cash and cash equivalents, accounts and notes receivable, derivative assets, margin deposits, certain property, plant and equipment related to corporate assets and other assets. | |
(13) | Includes $531 million in revenues from one counterparty, which represented 62% of our consolidated revenues. This counterparty is included in our East Coal and East Gas segments. Additionally, includes $99 million in revenues from a second counterparty, which represented 12% of our consolidated revenues. This counterparty is included in all of our segments. | |
(14) | Excludes $(74) million and $(37) million of hedges and other items and unrealized losses on energy derivatives, respectively, that are included in our consolidated revenues or cost of sales. | |
(15) | Primarily relates to gains on sales of CO2 exchange allowances and SO2 emission allowances. |
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Open gross margin for all segments |
$ | 206 | $ | 172 | $ | 410 | $ | 362 | ||||||||
Hedges and other items |
(5 | ) | (70 | ) | 2 | (74 | ) | |||||||||
Unrealized gains (losses) on
energy derivatives |
(66 | ) | 7 | 61 | (37 | ) | ||||||||||
Operation and maintenance |
(184 | ) | (157 | ) | (344 | ) | (314 | ) | ||||||||
General and administrative |
(35 | ) | (28 | ) | (56 | ) | (57 | ) | ||||||||
Western states litigation and
similar settlements |
| | (17 | ) | | |||||||||||
Gains on sales of assets and
emission and exchange allowances,
net |
1 | 2 | 1 | 20 | ||||||||||||
Long-lived assets impairments |
| | (248 | ) | | |||||||||||
Depreciation and amortization |
(69 | ) | (67 | ) | (131 | ) | (135 | ) | ||||||||
Operating loss |
(152 | ) | (141 | ) | (322 | ) | (235 | ) | ||||||||
Debt extinguishments gains |
| 1 | | 1 | ||||||||||||
Interest expense |
(37 | ) | (45 | ) | (83 | ) | (92 | ) | ||||||||
Interest income |
| 1 | | 1 | ||||||||||||
Other, net |
1 | (1) | (1 | ) (1) | 3 | (1) | | (1) | ||||||||
Loss from continuing operations
before income taxes |
$ | (188 | ) | $ | (185 | ) | $ | (402 | ) | $ | (325 | ) | ||||
(1) | Includes $1 million and $(1) million during the three months ended June 30, 2010 and 2009, respectively, and $3 million and $0 during the six months ended June 30, 2010 and 2009, respectively, which relates to our equity method investment in Sabine Cogen, LP, which is included in our Other segment. |
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(18) Discontinued Operations
(a) Retail Energy Segment.
General. In May 2009, we sold our Texas retail business for $363 million in cash, including
the value of the net working capital. In December 2009, we sold our Illinois commercial,
industrial and governmental/institutional
(C&I) contracts and, in December 2008, we sold our C&I contracts in the PJM and New York
areas. We will have discontinued operations activity related to these sales through various dates
ending in 2013.
Use of Proceeds and Assumptions Related to Debt, Deferred Financing Costs and Interest Expense
on Discontinued Operations. As required by our debt agreements, offers to purchase secured notes
and PEDFA bonds at par were made with a portion of the net proceeds. We purchased $261 million of
the outstanding debt ($169 million of the secured notes and $92 million of the PEDFA bonds) in
2009. These amounts and activity were classified in discontinued operations. We also classified
as discontinued operations the related deferred financing costs and interest expense on this debt.
We allocated $4 million and $8 million of related interest expense during the three and six months
ended June 30, 2009, respectively, to discontinued operations.
(b) Other Discontinued Operations.
Subsequent to the sale of our New York plants in February 2006, we continue to have
(a) insignificant settlements with the independent system operator and (b) various state and local
tax issues. In addition, we periodically record amounts for contingent consideration for the 2003
sale of our European energy operations. These amounts are classified as discontinued operations in
our results of operations and balance sheets, as applicable.
(c) All Discontinued Operations.
The following summarizes certain financial information of the businesses reported as
discontinued operations:
Retail Energy | New York | European | ||||||||||||||
Segment | Plants | Energy | Total | |||||||||||||
(in millions) | ||||||||||||||||
Three Months Ended June 30,
2010 |
||||||||||||||||
Revenues |
$ | | $ | | $ | | $ | | ||||||||
Income before income tax
expense/benefit |
6 | (1) | | | 6 | |||||||||||
Three Months Ended June 30,
2009 |
||||||||||||||||
Revenues |
$ | 499 | $ | | $ | | $ | 499 | ||||||||
Income before income tax
expense/benefit |
1,314 | (2)(3) | | 9 | 1,323 | |||||||||||
Six Months Ended June 30, 2010 |
||||||||||||||||
Revenues |
$ | 1 | $ | | $ | | $ | 1 | ||||||||
Income before income tax
expense/benefit |
10 | (4) | | | 10 | |||||||||||
Six Months Ended June 30, 2009 |
||||||||||||||||
Revenues |
$ | 2,014 | $ | 2 | $ | | $ | 2,016 | ||||||||
Income before income tax
expense/benefit |
1,257 | (3)(5) | 3 | 9 | 1,269 |
(1) | Includes $2 million of unrealized gains on energy derivatives. | |
(2) | Includes $35 million of unrealized gains on energy derivatives. | |
(3) | Includes $1.2 billion gain on sale (of which $1.1 billion relates to derivatives). | |
(4) | Includes $5 million of unrealized gains on energy derivatives. | |
(5) | Includes $189 million of unrealized losses on energy derivatives. |
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The following summarizes the assets and liabilities related to our discontinued operations:
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
(in millions) | ||||||||
Current Assets: |
||||||||
Cash and cash equivalents |
$ | | $ | 4 | ||||
Accounts receivable, net |
8 | 6 | ||||||
Derivative assets |
25 | 41 | ||||||
Margin deposits |
23 | 56 | ||||||
Accumulated deferred income taxes, net of
federal valuation allowance of $1 million and
$1 million |
| | ||||||
Other current assets |
| 1 | ||||||
Total current assets |
56 | 108 | ||||||
Other Assets: |
||||||||
Derivative assets |
4 | 5 | ||||||
Total long-term assets |
4 | 5 | ||||||
Total Assets |
$ | 60 | $ | 113 | ||||
Current Liabilities: |
||||||||
Accounts payable, principally trade |
$ | 2 | $ | 2 | ||||
Derivative liabilities |
20 | 35 | ||||||
Other current liabilities |
2 | 21 | ||||||
Total current liabilities |
24 | 58 | ||||||
Other Liabilities: |
||||||||
Derivative liabilities |
3 | 5 | ||||||
Other liabilities |
11 | 9 | ||||||
Total long-term liabilities |
14 | 14 | ||||||
Total Liabilities |
$ | 38 | $ | 72 | ||||
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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our Form 10-K. This includes
non-GAAP financial measures, which are not standardized; therefore it may not be possible to
compare these financial measures with other companies non-GAAP financial measures having the same
or similar names. These non-GAAP financial measures, which are discussed further in
Consolidated Results of Operations and
Liquidity and Capital Resources, reflect an additional way of viewing aspects of our
operations and financial position that, when viewed with our GAAP results, may provide a more
complete understanding of factors and trends affecting our business. Investors should review our
consolidated financial statements and publicly filed reports in their entirety and not rely on any
single financial measure.
Business Overview
Strategy. We provide energy, capacity, ancillary and other energy services to wholesale
customers in competitive power generation markets in the United States. Our objective is to be the
best performing, best positioned generator in competitive electricity markets.
The power generation industry is deeply cyclical and capital intensive. Given the nature of
the industry, we think scale and diversity are important long term. Given these beliefs, our
strategy is to:
| Maintain a capital structure that positions us to manage through the cycles |
| Focus on operational excellence |
| Employ a flexible plant-specific operating model through the cycle |
| Utilize a disciplined capital investment approach |
| Create value from industry consolidation |
The current market environment is challenging given the pace of economic and power demand
recovery, possible legislative and regulatory environmental matters and the uncertainty in the
financial markets. Additionally, current commodity prices and spreads are depressed relative to
historical levels. While we think these conditions will improve, the timing is uncertain. Our
primary focus is on managing the risks of operating in this current environment.
We continue to take actions to navigate the current market challenges, capture the value of
our existing assets and position us for the longer term market recovery, while maximizing cash flow
and building ample liquidity. Some of these actions include:
| Focusing on operating efficiency and effectiveness |
| Implementing flexible plant-specific operating models |
| Implementing a modest hedging program to achieve a high probability of achieving free cash flow breakeven or better even if market conditions deteriorate further |
We are regularly assessing the impact on our business of a wide variety of economic and
commodity price scenarios, and think we have the ability to operate through an extended downturn.
Key Earnings Drivers. Our financial results are significantly impacted by supply and demand
fundamentals in the regions in which we operate as well as the spread between gas and coal prices.
Plants with lower costs dispatch ahead of higher cost plants to meet demand, with the price of
electricity being set by the last plant dispatched.
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The specific factors that drive our margins include the prices of power, capacity, natural
gas, coal and fuel oil, the cost of emission allowances and transmission, as well as weather and
economic factors, many of which are volatile. Our ability to control these factors is limited, and
in most instances, the factors are beyond our control. We have the most control over the
percentage of time that our plants are available to run when it is economical for them to do so
(commercial capacity factor). Our key earnings drivers and various factors that affect these
earnings drivers include:
Economic generation (amount of time our plants are economical to operate)
| Supply and demand fundamentals |
| Plant fuel type and efficiency |
| Absolute and relative cost of fuels used in power generation |
Commercial capacity factor (generation as a percentage of economic generation)
| Operations excellence effectiveness |
| Maintenance practices |
| Planned and unplanned outages |
Unit margin
| Supply and demand fundamentals |
| Commodity prices and spreads |
| Plant fuel type and efficiency |
Other margin (primarily capacity sales)
| Supply and demand fundamentals |
| Power purchase agreements sold to others |
| Ancillary services |
| Equipment performance |
Costs
| Operating efficiency |
| Maintenance practices |
| Generation asset fuel type |
| Planned and unplanned outages |
Hedges
| Hedging strategy |
| Volumes |
| Commodity prices |
| Effectiveness |
Effectiveness and Efficiency Measures. Consistent with our flexible plant-specific operating
model, our objective is to operate each plant to capture the maximum value at the lowest economical
cost over time. This year we began using total margin capture factor to measure our effectiveness
of achieving this objective. Total margin capture factor is calculated by dividing open gross
margin generated by the plants by the total available open gross margin assuming 100% availability.
Likewise, we began measuring our efficiency of capturing margin utilizing total controllable costs
per MWh generated and total controllable costs per MW of generation capacity. These costs metrics
include operation and maintenance expense (excluding the REMA lease expense and severance expense)
and general and administrative expense (excluding severance expense and merger-related costs) as
well as maintenance capital expenditures. See these measures below under Consolidated Results
of Operations.
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Recent Events
In this section, we present recent and potential events that have impacted or could in the
future impact our results of operations, financial condition or liquidity. In addition to the
events described below, a number of other factors could affect our future results of operations,
financial condition or liquidity, including changes in natural gas prices, plant availability,
weather and other factors. See Risk Factors in Item 1A of this report and our Form 10-K.
Proposed Merger with Mirant. On April 11, 2010, we entered into a definitive merger agreement
in which the companies would combine in a stock-for-stock transaction. We have formed a new
wholly-owned subsidiary that
will merge with and into Mirant upon closing. As a result, Mirant will be a wholly-owned
subsidiary of RRI Energy.
Upon closing the merger, each issued and outstanding share of Mirant common stock will convert
into the right to receive 2.835 shares of our common stock. Mirant stock options and other equity
awards will convert upon completion of the merger into vested stock options and equity awards with
respect to our common stock, after giving effect to the exchange ratio. The exchange ratio is
fixed but subject to adjustment for a proposed reverse stock split.
Completion of the merger is contingent upon, among other things, (a) approvals by stockholders
of both companies, (b) effectiveness of a registration statement on Form S-4 and approval of the
New York Stock Exchange listing for the RRI Energy common stock to be issued in the merger,
(c) expiration or termination of the applicable Hart-Scott-Rodino Act waiting period, (d) required
regulatory approvals from the FERC and the New York Public Service Commission (NYPSC) and
(e) mutually acceptable debt financing in an amount sufficient to fund the refinancing transactions
contemplated by the merger agreement.
On May 28, 2010, we filed with the Securities and Exchange Commission a registration statement
on Form S-4, as amended on July 6, 2010, which includes a preliminary joint proxy
statement/prospectus relating to the proposed merger. After the registration statement has been
declared effective by the Securities and Exchange Commission, we and Mirant expect to send the
joint proxy statement/prospectus contained in the registration statement to our respective
stockholders and each hold a special stockholder meeting to approve the proposals related to the
merger.
On May 14, 2010, we and Mirant filed a joint application with the FERC under Section 203 of
the Federal Power Act and Part 33 of the regulations of the FERC. On June 14, 2010, we and Mirant
filed notification of the proposed transaction with the Federal Trade Commission and the Department
of Justice (DOJ) under the Hart-Scott-Rodino Act. On July 15, 2010, we received a request for
additional information from the DOJ. The additional information requested is to assist the DOJ on
their review of the merger. On July 20, 2010, the NYPSC issued an order declaring that it will not
further review the merger.
We and Mirant are in the process of arranging mutually acceptable debt financing as
contemplated under the merger agreement. We, together with Mirant, have entered into agreements pursuant to which financial institutions have committed to provide a $750 million to
$1.0 billion five-year revolving credit facility, subject to customary conditions to closing,
including:
| the consummation of the merger; |
| the receipt of at least $1.9 billion in gross cash proceeds from the issuance of senior unsecured notes and term loan borrowings; and |
| the closing of the credit facility on or before December 31, 2010. |
The revolving credit facility and term loan facility, and the subsidiary guarantees thereof,
will be senior secured obligations of RRI Energy (proposed to be renamed GenOn Energy, Inc. in
connection with the merger) and certain of its subsidiaries; provided, however, that Mirant
Americas Generation and its subsidiaries (other than Mirant Mid-Atlantic and Mirant Energy Trading
and their subsidiaries) will guarantee the revolving credit facility and term loan only to the
extent permitted under the indenture for the senior notes of Mirant Americas Generation. The
participating financial institutions, or affiliates thereof, have also agreed:
| to use commercially reasonable efforts to arrange a syndication of a $500 million term loan; and |
| to act as underwriters or placement agents in connection with the proposed offering of senior unsecured notes. |
We anticipate closing the proposed note offering into escrow. Upon consummation of the merger
and satisfaction of the other escrow conditions, such notes will be senior unsecured obligations of
RRI Energy (GenOn Energy, Inc.).
We anticipate completing the merger before the end of 2010. Except for specific references to
the pending merger, the disclosures contained in this report on Form 10-Q relate solely to
RRI Energy. Information concerning the proposed merger is included in the joint proxy
statement/prospectus contained in the registration statement on Form S-4, as amended and filed with
the Securities and Exchange Commission in connection with the merger.
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Impairments of Long-Lived Assets. In March 2010, we evaluated our plants including the
related intangible assets for potential impairments. We determined that two plants (Elrama and
Niles) undiscounted cash flows did not exceed the carrying value of the net property, plant and
equipment. Thus, we estimated each plants fair value and determined we incurred pre-tax
impairment charges of $248 million. See note 4 to our consolidated financial statements in our
Form 10-K, note 7 to our interim financial statements and New Accounting Pronouncements,
Significant Accounting Policies and Critical Accounting Estimates Critical Accounting Estimates.
Environmental Matters. In June 2010, the EPA finalized the revised primary national ambient
air quality standard for SO2. The EPA expects to determine nonattainment areas using
the revised standard by mid-2012, with attainment required five years thereafter. It is possible
that additional SO2 emission control measures may be necessary if our plants are in or
near nonattainment areas. In addition, in July 2010, the EPA proposed the Transport Rule to
replace the Clean Air Interstate Rule (CAIR) and plans to finalize this rule in 2011. Each of
the Transport Rules three alternative proposals, if finalized, would impose more stringent NOx and
SO2 emission reductions than were required under CAIR, in particular starting in 2014.
The EPAs preferred alternative includes a cap and trade
approach and includes incentives to retire older, uncontrolled coal
plants. In June 2010, the EPA finalized the Greenhouse Gas Tailoring
rule. As a result, we could be subject to new source review permitting requirements (determined on
a case by case basis) for greenhouse gas emissions beginning in 2011 with respect to investments,
if any, to modify our plants.
The
effect of more stringent environmental rules, including those
described above, if implemented, is that many older coal plants
without emission controls, including some of ours, will likely be
retired. Combined with compressed spreads between gas and coal
prices, we believe the amount of retirements would increase. We also
expect to see an increase in investments on emissions controls,
potentially including some of our fleet.
However,
any such retirements could contribute to improving supply and demand
fundamentals for the remaining fleet and higher capacity and energy
prices. Any resulting increased demand for gas could increase the
spread between gas and coal prices, which would also benefit the
remaining coal fleet.
The impact on our business of these regulations and pending
regulations and whether we make any potential investments remains uncertain. As environmental
regulations evolve, we will continue to assess the recoverability of our long-lived assets
(property, plant and equipment and intangible assets). See Business Environmental Matters in
Item 1, Risk Factors in Item 1A and Managements Discussion and Analysis of Financial Condition
and Results of Operations Business Overview Pending Environmental Matters in Item 7 of our
Form 10-K.
Financial Reform Legislation. President Obama signed into law financial reform legislation
that will impose new regulations on over-the-counter derivatives, which includes requirements for
clearing swaps through a derivatives clearing organization. The majority of our existing hedges
have been cleared through a derivatives clearing organization. Many requirements of the
legislation will be clarified in regulations yet to be issued.
RPM Auctions. In 2010, we have captured approximately $450 million in additional minimum
sales commitments for future periods. These commitments were obtained in the PJM Markets
reliability pricing model (RPM) auctions of which approximately $400 million represent future
capacity revenues for 2013 and 2014.
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Consolidated Results of Operations
Non-GAAP Performance Measures. In analyzing and planning for our business, we supplement our
use of GAAP financial measures with some non-GAAP financial measures. We present open gross
margin, our segment profitability measure, open energy gross margin and other margin on a
consolidated basis. We also present earnings (loss) before interest, taxes, depreciation and
amortization (EBITDA), adjusted EBITDA and Open EBITDA, which we consider performance measures
rather than liquidity measures. We think the measures of total controllable costs per MWh
generated and total controllable costs per MW of generation capacity provide meaningful measures of
our efficiency, which, beginning in 2010, we use to communicate with others about earnings outlook
and results. We have metrics on both a per-MWh and a per-MW capacity basis because we have plants
that primarily earned capacity revenues and others that also produce material amounts of energy
revenue. We use these non-GAAP financial measures in communications with investors, analysts,
rating agencies, banks and other parties. We think these non-GAAP financial measures provide
meaningful representations of our consolidated operating performance and are useful to us and
others in facilitating the analysis of our results of operations from one period to another. In
addition, many analysts and investors use EBITDA to evaluate financial performance. The
adjustments to arrive at these non-GAAP financial measures are described below. Management thinks
(a) these adjusted items are not representative of our ongoing business operations, (b) excluding
them provides a more meaningful representation of our results of operations and (c) it is useful to
us and others to make these adjustments to facilitate the analysis of our results of operations
from one period to another.
Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009
Our loss from continuing operations before income taxes for the three months ended June 30,
2010 was $188 million compared to $185 million in the same period in 2009. Hedges and other items
increased by $65 million primarily as a result of improved coal hedge results in our East Coal
segment. In addition, open gross margin increased by $34 million primarily as a result of higher
unit margins (higher power prices) and RPM capacity payments in our East Coal segment. These
increases were offset by (a) a $73 million net change in unrealized gains/losses on energy
derivatives and (b) a $28 million increase in operation and maintenance expense, excluding
severance, primarily as a result of planned outages in our East Coal segment.
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Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
East coal open gross margin(1) |
$ | 118 | $ | 84 | $ | 34 | ||||||
East gas open gross margin(1) |
62 | 49 | 13 | |||||||||
West open gross margin(1) |
18 | 25 | (7 | ) | ||||||||
Other open gross margin(1) |
8 | 14 | (6 | ) | ||||||||
Total(2) |
206 | 172 | 34 | |||||||||
Operation and maintenance, excluding severance(3)(4) |
(182 | ) | (154 | ) | (28 | ) | ||||||
General and administrative, excluding severance and
merger-related costs(4)(5) |
(21 | ) | (27 | ) | 6 | |||||||
Other, net |
1 | (1 | ) | 2 | ||||||||
Open EBITDA(2) |
4 | (10 | ) | 14 | ||||||||
Hedges and other items(6)(7) |
(5 | ) | (70 | ) | 65 | |||||||
Gains on sales of assets and emission and exchange allowances,
net(8) |
1 | 2 | (1 | ) | ||||||||
Adjusted EBITDA(2) |
| (78 | ) | 78 | ||||||||
Unrealized gains (losses) on energy derivatives(7)(9) |
(66 | ) | 7 | (73 | ) | |||||||
Severance(10) |
(2 | ) | (4 | ) | 2 | |||||||
Merger-related costs(11) |
(14 | ) | | (14 | ) | |||||||
Debt extinguishments gains(12) |
| 1 | (1 | ) | ||||||||
EBITDA(2) |
(82 | ) | (74 | ) | (8 | ) | ||||||
Depreciation and amortization |
(69 | ) | (67 | ) | (2 | ) | ||||||
Interest expense, net |
(37 | ) | (44 | ) | 7 | |||||||
Loss from continuing operations before income taxes |
(188 | ) | (185 | ) | (3 | ) | ||||||
Income tax benefit |
11 | 82 | (71 | ) | ||||||||
Loss from continuing operations |
(177 | ) | (103 | ) | (74 | ) | ||||||
Income from discontinued operations |
5 | 906 | (901 | ) | ||||||||
Net income (loss) |
$ | (172 | ) | $ | 803 | $ | (975 | ) | ||||
(1) | Represents our segment profitability measure. | |
(2) | The most directly comparable GAAP financial measure is income (loss) from continuing operations before income taxes. | |
(3) | The most directly comparable GAAP financial measure is operation and maintenance expense. | |
(4) | We exclude severance charges incurred in connection with (a) repositioning the company in connection with the sale of our retail business and (b) implementing our plant-specific operating model. We also exclude merger-related costs, including financial advisory fees, legal costs, stock-based compensation expense related to the modification of our stock options and other merger-related expenses. We think this adjusted measure helps to provide a meaningful representation of our ongoing operating performance, which we use to communicate with others about earnings outlook and results. | |
(5) | The most directly comparable GAAP financial measure is general and administrative expense. | |
(6) | Described below under Hedges and Other Items. | |
(7) | Hedges and other items and unrealized gains/losses on energy derivatives are not a function of the operating performance of our generation assets, and excluding their impacts helps isolate the operating performance of our generation assets under prevailing market conditions. | |
(8) | We periodically sell emission and exchange allowances inventory in excess of our forward power sales commitments if the price is above our view of their value. We think that excluding the gains from such sales, as well as gains and losses on asset sales, is useful because these gains/losses are not directly tied to the operating performance of our generation assets, and excluding them helps to isolate the operating performance of our generation assets under prevailing market conditions. | |
(9) | Described below under Unrealized Gains (Losses) on Energy Derivatives. | |
(10) | Includes severance classified in operation and maintenance and general and administrative expenses. | |
(11) | Includes merger-related costs classified in general and administrative expense. | |
(12) | We exclude charges incurred in connection with refinance or purchase of debt, including the accelerated amortization of deferred financing costs, because these charges result from our efforts to increase our financial flexibility and are not a function of our operating performance. |
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
Diluted Earnings (Loss) per Share |
||||||||||||
Loss from continuing operations |
$ | (0.50 | ) | $ | (0.30 | ) | $ | (0.20 | ) | |||
Income from discontinued operations |
0.01 | 2.59 | (2.58 | ) | ||||||||
Net income (loss) |
$ | (0.49 | ) | $ | 2.29 | $ | (2.78 | ) | ||||
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Operational and Financial Data.
Open Energy Unit Margin | ||||||||||||||||||||||||
Generation (GWh) (1) | ($/MWh) (2) | Total Margin Capture Factor (3) | ||||||||||||||||||||||
Three Months Ended June 30, | Three Months Ended June 30, | Three Months Ended June 30, | ||||||||||||||||||||||
Segment | 2010 | 2009 | 2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
East Coal |
4,704.9 | 4,682.3 | $ | 14.45 | $ | 9.18 | 78.3 | % | 81.1 | % | ||||||||||||||
East Gas |
694.4 | 477.8 | 14.40 | 10.46 | 91.2 | 92.1 | ||||||||||||||||||
West |
5.3 | 97.0 | | 82.47 | 92.1 | 90.0 | ||||||||||||||||||
Other |
37.5 | 62.3 | | | NM | (4) | NM | (4) | ||||||||||||||||
Total |
5,442.1 | 5,319.4 | $ | 14.33 | $ | 10.53 | 83.6 | % | 86.7 | % | ||||||||||||||
(1) | Excludes generation related to power purchase agreements. | |
(2) | Represents open energy gross margin divided by generation. See Open Gross Margin below. | |
(3) | Total margin capture factor is calculated by dividing open gross margin generated by the plants by the total available open gross margin, assuming 100% availability. See Open Gross Margin below. | |
(4) | NM is not meaningful. |
Revenues.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Revenues |
$ | 457 | $ | 412 | $ | 45 | (1) | |||||
Unrealized gains (losses) on energy derivatives |
(57 | ) | (22 | ) | (35 | )(2) | ||||||
Total revenues |
$ | 400 | $ | 390 | $ | 10 | ||||||
(1) | Increase primarily as a result of (a) higher power and natural gas sales prices and (b) higher RPM capacity payments. These increases were partially offset by lower natural gas sales volumes. | |
(2) | See footnote 1 under Unrealized Gains (Losses) on Energy Derivatives. |
Cost of Sales.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Cost of sales |
$ | 256 | $ | 310 | $ | (54 | )(1) | |||||
Unrealized (gains) losses on energy derivatives |
9 | (29 | ) | 38 | (2) | |||||||
Total cost of sales |
$ | 265 | $ | 281 | $ | (16 | ) | |||||
(1) | Decrease primarily as a result of (a) lower prices paid for coal, (b) lower natural gas volumes purchased and (c) additional costs in 2009 to reduce fixed price coal commitments for future periods. These decreases were partially offset by higher prices paid for natural gas. | |
(2) | See footnote 1 under Unrealized Gains (Losses) on Energy Derivatives. |
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Open Gross Margin. Our segment profitability measure is open gross margin. Open gross margin
consists of (a) open energy gross margin and (b) other margin. Open gross margin excludes hedges
and other items and unrealized gains/losses on energy derivatives. Open energy gross margin is
calculated using the day-ahead and real-time market power sales prices received by the plants less
market-based delivered fuel costs. Open energy gross margin is (a)(i) economic generation
multiplied by (ii) commercial capacity factor (which equals generation) multiplied by (b) open
energy unit margin. Economic generation is estimated generation at 100% plant availability based
on an hourly analysis of when it is economical to generate based on the price of power, fuel,
emission allowances and variable operating costs. Economic generation can vary depending on the
comparison of market prices to our cost of generation. It will decrease if there are fewer hours
when market prices exceed the cost of generation. It will increase if there are more hours when
market prices exceed the cost of generation. Other margin represents power purchase agreements,
capacity payments, ancillary services revenues and selective commercial strategies relating to
optimizing our assets.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
East Coal |
||||||||||||
Open energy gross margin |
$ | 68 | $ | 43 | $ | 25 | (1) | |||||
Other margin |
50 | 41 | 9 | |||||||||
Open gross margin |
$ | 118 | $ | 84 | $ | 34 | ||||||
East Gas |
||||||||||||
Open energy gross margin |
$ | 10 | $ | 5 | $ | 5 | ||||||
Other margin |
52 | 44 | 8 | |||||||||
Open gross margin |
$ | 62 | $ | 49 | $ | 13 | ||||||
West |
||||||||||||
Open energy gross margin |
$ | | $ | 8 | $ | (8 | ) | |||||
Other margin |
18 | 17 | 1 | |||||||||
Open gross margin |
$ | 18 | $ | 25 | $ | (7 | ) | |||||
Other |
||||||||||||
Open energy gross margin |
$ | | $ | | $ | | ||||||
Other margin |
8 | 14 | (6 | ) | ||||||||
Open gross margin |
$ | 8 | $ | 14 | $ | (6 | ) | |||||
Total |
||||||||||||
Open energy gross margin(2) |
$ | 78 | $ | 56 | $ | 22 | ||||||
Other margin(2) |
128 | 116 | 12 | |||||||||
Open gross margin(2) |
$ | 206 | $ | 172 | $ | 34 | ||||||
(1) | Increase primarily as a result of higher unit margins (higher power prices). | |
(2) | The most directly comparable GAAP financial measure is income (loss) from continuing operations before income taxes. See Non-GAAP Performance Measures. |
Included in revenues or cost of sales are two items (a) hedges and other items and
(b) unrealized gains/losses on energy derivatives that are not included in open gross margin. See
notes 4, 5 and 17 to our interim financial statements for further discussion. The analyses of
these items are included below.
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Table of Contents
Hedges and Other Items. We may enter selective hedges, including originated transactions, to
(a) seek potential value greater than what is available in the spot or day-ahead markets,
(b) address operational requirements or (c) seek a specific financial objective. Hedges and other
items primarily relate to settlements of power and fuel hedges, long-term natural gas
transportation contracts, storage contracts and long-term tolling contracts. They are primarily
derived based on methodology consistent with the calculation of open energy gross margin in that a
portion of this item represents the difference between the margins calculated using the day-ahead
and real-time market power sales prices received by the plants less market-based delivered fuel
costs and the actual amounts paid or received during the period.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Power |
$ | 7 | $ | 18 | $ | (11 | ) | |||||
Fuel |
(7 | ) | (82 | ) | 75 | (1) | ||||||
Tolling/other |
(5 | ) | (6 | ) | 1 | |||||||
Hedges and other items income (loss) |
$ | (5 | ) | $ | (70 | ) | $ | 65 | ||||
(1) | Increase primarily as a result of (a) $41 million driven by improved results of fuel hedges in 2010 as compared to 2009 and additional costs incurred in 2009 to reduce fixed price coal commitments for future periods in our East Coal segment and (b) $34 million reduction in lower market valuation adjustments to fuel inventory in our East Coal segment. |
Unrealized Gains (Losses) on Energy Derivatives. We use derivative instruments to manage
operational or market constraints and to increase the return on our generation assets. We record
in our consolidated statement of operations non-cash gains/losses based on current changes in
forward commodity prices for derivative instruments receiving mark-to-market accounting treatment
which will settle in future periods. We refer to these gains and losses prior to settlement, as
well as ineffectiveness on cash flow hedges, as unrealized gains/losses on energy derivatives.
In some cases, the underlying transactions being economically hedged receive accrual accounting
treatment, resulting in a mismatch of accounting treatments. Since the application of
mark-to-market accounting has the effect of pulling forward into current periods non-cash
gains/losses relating to and reversing in future delivery periods, analysis of results of
operations from one period to another can be difficult.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Revenues unrealized |
$ | (57 | ) | $ | (22 | ) | $ | (35 | ) | |||
Cost of sales unrealized |
(9 | ) | 29 | (38 | ) | |||||||
Net unrealized gains (losses) on energy derivatives |
$ | (66 | ) | $ | 7 | $ | (73 | )(1) | ||||
(1) | Net change primarily as a result of $45 million in losses driven by the reversal of previously recognized unrealized gains on energy derivatives which settled during the period and $28 million in losses from changes in prices on our energy derivatives marked to market. |
Operation and Maintenance.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Plant operation and maintenance |
$ | 145 | $ | 111 | $ | 34 | (1) | |||||
REMA leases |
15 | 15 | | |||||||||
Taxes other than income and insurance |
9 | 11 | (2 | ) | ||||||||
Information Technology, Risk and
other salaries and benefits |
9 | 10 | (1 | ) | ||||||||
Commercial Operations |
4 | 4 | | |||||||||
Severance |
2 | 3 | (1 | ) | ||||||||
Other, net |
| 3 | (3 | ) | ||||||||
Operation and maintenance |
$ | 184 | $ | 157 | $ | 27 | ||||||
(1) | Increase primarily as a result of a $39 million increase in planned outages and projects spending primarily in our East Coal segment. |
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Table of Contents
General and Administrative.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Salaries and benefits |
$ | 14 | $ | 15 | $ | (1 | ) | |||||
Merger-related costs |
14 | | 14 | |||||||||
Professional fees, contract
services and information systems
maintenance |
4 | 6 | (2 | ) | ||||||||
Rent and utilities |
3 | 3 | | |||||||||
Other, net |
| 4 | (4 | ) | ||||||||
General and administrative |
$ | 35 | $ | 28 | $ | 7 | ||||||
Efficiency Measures Total Controllable Costs.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(dollars in millions, except per MWh and per MW data) | ||||||||||||
Operation and maintenance, excluding severance(1) |
$ | 182 | $ | 154 | $ | 28 | ||||||
REMA lease expense |
(15 | ) | (15 | ) | | |||||||
General and administrative, excluding severance and
merger-related costs(1) |
21 | 27 | (6 | ) | ||||||||
Maintenance capital expenditures |
14 | 16 | (2 | ) | ||||||||
Total Controllable Costs |
$ | 202 | $ | 182 | $ | 20 | ||||||
TWh generation |
5.4 | 5.3 | 0.1 | |||||||||
Total Controllable Costs/MWh |
$ | 37 | $ | 34 | $ | 3 | ||||||
MW capacity (2) |
14,581 | 14,563 | 18 | |||||||||
Total Controllable Costs ($ thousands)/MW capacity |
$ | 13.9 | $ | 12.5 | $ | 1.4 | ||||||
(1) | Excludes severance charges incurred in connection with (a) repositioning the company in connection with the sale of our retail business and (b) implementing our plant-specific operating model. We also exclude merger-related costs classified in general and administrative. | |
(2) | MW capacity changed from June 30, 2009 to June 30, 2010 as a result of MW re-ratings that occurred during the fourth quarter of 2009. |
Total Controllable Costs Reconciliation. There is no single directly comparable GAAP
financial measure that reflects controllable costs; however, these costs metrics are calculated by
aggregating operation and maintenance expense, general and administrative expense as well as
capital expenditures. We exclude from operation and maintenance expense and general and
administrative expense severance charges incurred in connection with (a) repositioning the company
in connection with the sale of our retail business and (b) implementing our plant-specific
operating model. We exclude from general and administrative expense merger-related costs,
including financial advisory fees, legal costs, stock-based compensation expense related to the
modification of our stock options and other merger-related expenses. We also exclude (a) the REMA
lease expense because of its financing nature and (b) capital expenditures other than maintenance
because maintenance capital expenditures are more routine and closely related to current year
operations.
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Table of Contents
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(dollars in millions, except per MWh and per MW data) | ||||||||||||
Operation and maintenance (O&M) |
$ | 184 | $ | 157 | $ | 27 | ||||||
General and administrative (G&A) |
35 | 28 | 7 | |||||||||
Capital expenditures |
32 | 60 | (28 | ) | ||||||||
Total operation and maintenance, general
and administrative and capital
expenditures |
$ | 251 | $ | 245 | $ | 6 | ||||||
Total Controllable Costs |
$ | 202 | $ | 182 | $ | 20 | ||||||
REMA lease expense in operation and maintenance |
15 | 15 | | |||||||||
Severance included in operation and maintenance |
2 | 3 | (1 | ) | ||||||||
Severance included in general and administrative |
| 1 | (1 | ) | ||||||||
Merger-related costs included in general and
administrative |
14 | | 14 | |||||||||
Environmental capital expenditures |
12 | 37 | (25 | ) | ||||||||
Capitalized interest |
6 | 7 | (1 | ) | ||||||||
Total operation and maintenance, general
and administrative and capital
expenditures |
$ | 251 | $ | 245 | $ | 6 | ||||||
TWh generation |
5.4 | 5.3 | 0.1 | |||||||||
Total O&M, G&A and capital expenditure/MWh |
$ | 46 | $ | 46 | $ | | ||||||
MW capacity (1) |
14,581 | 14,563 | 18 | |||||||||
Total O&M, G&A and capital expenditures
($ thousands)/MW capacity |
$ | 17.2 | $ | 16.8 | $ | 0.4 | ||||||
(1) | MW capacity changed from June 30, 2009 to June 30, 2010 as a result of MW re-ratings that occurred during the fourth quarter of 2009. |
Gains on Sales of Assets and Emission and Exchange Allowances, Net. This amount did not
change significantly.
Depreciation and Amortization.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Depreciation on plants |
$ | 58 | $ | 56 | $ | 2 | (1) | |||||
Other, net depreciation |
3 | 4 | (1 | ) | ||||||||
Depreciation |
61 | 60 | 1 | |||||||||
Amortization of emission allowances |
8 | 6 | 2 | |||||||||
Other, net amortization |
| 1 | (1 | ) | ||||||||
Amortization |
8 | 7 | 1 | |||||||||
Depreciation and amortization |
$ | 69 | $ | 67 | $ | 2 | ||||||
(1) | Increase primarily as a result of $8 million in early retirements of plant components at our Cheswick plant. This increase was partially offset by reduced depreciation expense of $7 million as a result of our December 31, 2009 and March 31, 2010 long-lived assets impairments (see note 7 to our interim financial statements). |
Debt Extinguishments Gains. This represents gains on extinguishments of our senior secured
notes.
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Table of Contents
Interest Expense.
Three Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Fixed-rate debt |
$ | 40 | $ | 52 | $ | (12 | )(1) | |||||
Deferred financing costs |
1 | 1 | | |||||||||
Amortization of fair
value adjustment of
acquired debt |
(1 | ) | (3 | ) | 2 | |||||||
Capitalized interest |
(6 | )(2) | (7 | )(3) | 1 | |||||||
Other, net |
3 | 2 | 1 | |||||||||
Interest expense |
$ | 37 | $ | 45 | $ | (8 | ) | |||||
(1) | Decrease as a result of a reduction in fixed-rate debt primarily due to $400 million in payments of the Orion Power Holdings, Inc. senior notes in May 2010. | |
(2) | Relates primarily to environmental capital expenditures for SO2 emission reductions at our Cheswick plant. | |
(3) | Relates primarily to environmental capital expenditures for SO2 emission reductions at our Cheswick and Keystone plants. |
Other, Net. This amount did not change significantly.
Income Tax Expense (Benefit). See note 11 to our interim financial statements. A
reconciliation of the federal statutory income tax rate to the effective income tax rate is:
Three Months Ended June 30, | ||||||||
2010 | 2009 | |||||||
Federal statutory rate |
(35 | )% | (35 | )% | ||||
Additions (reductions) resulting from: |
||||||||
Federal valuation allowance |
26 | (1) | (8 | )(2) | ||||
State income taxes, net of federal income taxes |
(1 | )(3) | (1 | )(4) | ||||
Other |
4 | | ||||||
Effective rate |
(6 | )% | (44 | )% | ||||
(1) | Of this percentage, $47 million (26%) relates to additional valuation allowance. | |
(2) | Of this percentage, $(16) million (8%) relates to a reduction in valuation allowance. | |
(3) | Of this percentage, $6 million (3%) relates to additional valuation allowance. | |
(4) | Of this percentage, $9 million (5%) relates to additional valuation allowance. |
Income from Discontinued Operations. See note 18 to our interim financial statements.
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Table of Contents
Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009
Our loss from continuing operations before income taxes for the six months ended June 30, 2010
compared to the same period in 2009 increased by $77 million primarily due to (a) $248 million
long-lived assets impairments recorded in 2010, (b) $32 million increase in operation and
maintenance expense, excluding severance, primarily as a result of planned outages in our East Coal
and West segments and (c) an estimated $17 million charge for Western states litigation and similar
settlements recorded in 2010. These items were partially offset by (a) $98 million net change in
unrealized gains/losses on energy derivatives, (b) $76 million increase in hedges and other items
primarily as a result of improved coal hedge results in our East Coal segment and (c) $48 million
increase in open gross margin primarily as a result of RPM capacity payments in our East Coal and
East Gas segments and higher power prices driving improved generation partially offset by higher
planned outages in our East Coal segment.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
East coal open gross margin(1) |
$ | 255 | $ | 210 | $ | 45 | ||||||
East gas open gross margin(1) |
111 | 88 | 23 | |||||||||
West open gross margin(1) |
30 | 37 | (7 | ) | ||||||||
Other open gross margin(1) |
14 | 27 | (13 | ) | ||||||||
Total(2) |
410 | 362 | 48 | |||||||||
Operation and maintenance, excluding severance(3)(4) |
(342 | ) | (310 | ) | (32 | ) | ||||||
General and administrative, excluding severance and
merger-related costs(4)(5) |
(42 | ) | (56 | ) | 14 | |||||||
Other, net |
3 | | 3 | |||||||||
Open EBITDA(2) |
29 | (4 | ) | 33 | ||||||||
Hedges and other items(6)(7) |
2 | (74 | ) | 76 | ||||||||
Gains on sales of assets and emission and exchange allowances,
net(8) |
1 | 20 | (19 | ) | ||||||||
Adjusted EBITDA(2) |
32 | (58 | ) | 90 | ||||||||
Unrealized gains (losses) on energy derivatives(7)(9) |
61 | (37 | ) | 98 | ||||||||
Western states litigation and similar settlements(10) |
(17 | ) | | (17 | ) | |||||||
Severance(11) |
(2 | ) | (5 | ) | 3 | |||||||
Merger-related costs(12) |
(14 | ) | | (14 | ) | |||||||
Long-lived assets impairments(13) |
(248 | ) | | (248 | ) | |||||||
Debt extinguishments gains(14) |
| 1 | (1 | ) | ||||||||
EBITDA(2) |
(188 | ) | (99 | ) | (89 | ) | ||||||
Depreciation and amortization |
(131 | ) | (135 | ) | 4 | |||||||
Interest expense, net |
(83 | ) | (91 | ) | 8 | |||||||
Loss from continuing operations before income taxes |
(402 | ) | (325 | ) | (77 | ) | ||||||
Income tax (expense) benefit |
(51 | ) | 116 | (167 | ) | |||||||
Loss from continuing operations |
(453 | ) | (209 | ) | (244 | ) | ||||||
Income from discontinued operations |
4 | 861 | (857 | ) | ||||||||
Net income (loss) |
$ | (449 | ) | $ | 652 | $ | (1,101 | ) | ||||
(1) | Represents our segment profitability measure. | |
(2) | The most directly comparable GAAP financial measure is income (loss) from continuing operations before income taxes. | |
(3) | The most directly comparable GAAP financial measure is operation and maintenance expense. | |
(4) | We exclude severance charges incurred in connection with (a) repositioning the company in connection with the sale of our retail business and (b) implementing our plant-specific operating model. We also exclude merger-related costs, including financial advisory fees, legal costs, stock-based compensation expense related to the modification of our stock options and other merger-related expenses. We think this adjusted measure helps to provide a meaningful representation of our ongoing operating performance, which we use to communicate with others about earnings outlook and results. | |
(5) | The most directly comparable GAAP financial measure is general and administrative expense. | |
(6) | Described below under Hedges and Other Items. | |
(7) | Hedges and other items and unrealized gains/losses on energy derivatives are not a function of the operating performance of our generation assets, and excluding their impacts helps isolate the operating performance of our generation assets under prevailing market conditions. | |
(8) | We periodically sell emission and exchange allowances inventory in excess of our forward power sales commitments if the price is above our view of their value. We think that excluding the gains from such sales, as well as gains and losses on asset sales, is useful because these gains/losses are not directly tied to the operating performance of our generation assets, and excluding them helps to isolate the operating performance of our generation assets under prevailing market conditions. |
45
Table of Contents
(9) | Described below under Unrealized Gains (Losses) on Energy Derivatives. | |
(10) | We exclude charges related to settlement of actions in our legacy Western states and similar matters. See note 12 to our interim financial statements. | |
(11) | Includes severance classified in operation and maintenance and general and administrative expenses. | |
(12) | Includes merger-related costs classified in general and administrative expense. | |
(13) | Impairment charges are related to our Elrama and Niles long-lived assets totaling $248 million. See note 7 to our interim financial statements. | |
(14) | We exclude charges incurred in connection with refinance or purchase of debt, including the accelerated amortization of deferred financing costs, because these charges result from our efforts to increase our financial flexibility and are not a function of our operating performance. |
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
Diluted Earnings (Loss) per Share |
||||||||||||
Loss from continuing operations |
$ | (1.28 | ) | $ | (0.60 | ) | $ | (0.68 | ) | |||
Income from discontinued operations |
0.01 | 2.46 | (2.45 | ) | ||||||||
Net income (loss) |
$ | (1.27 | ) | $ | 1.86 | $ | (3.13 | ) | ||||
Operational and Financial Data.
Open Energy Unit Margin | ||||||||||||||||||||||||
Generation (GWh) | ($/MWh) | Total Margin Capture Factor | ||||||||||||||||||||||
Six Months Ended June 30, | Six Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
Segment | 2010 | 2009 | 2010 | 2009 | 2010 | 2009 | ||||||||||||||||||
East Coal |
10,078.3 | 9,768.0 | $ | 15.48 | $ | 13.82 | 78.7 | % | 81.9 | % | ||||||||||||||
East Gas |
787.4 | 634.1 | 12.70 | 9.46 | 91.4 | 92.1 | ||||||||||||||||||
West |
26.5 | 225.1 | | 39.98 | 86.6 | 87.0 | ||||||||||||||||||
Other |
37.5 | 62.3 | | | NM | (1) | NM | (1) | ||||||||||||||||
Total |
10,929.7 | 10,689.5 | $ | 15.19 | $ | 14.03 | 83.0 | % | 85.9 | % | ||||||||||||||
(1) | NM is not meaningful. |
Revenues.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Revenues |
$ | 956 | $ | 882 | $ | 74 | (1) | |||||
Unrealized gains (losses) on energy derivatives |
49 | (26 | ) | 75 | (2) | |||||||
Total revenues |
$ | 1,005 | $ | 856 | $ | 149 | ||||||
(1) | Increase primarily as a result of (a) higher power and natural gas sales prices and (b) higher RPM capacity payments. These increases were partially offset by lower natural gas sales volumes. | |
(2) | See footnote 1 under Unrealized Gains (Losses) on Energy Derivatives. |
Cost of Sales.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Cost of sales |
544 | 594 | (50 | )(1) | ||||||||
Unrealized (gains) losses on energy derivatives |
(12 | ) | 11 | (23 | )(2) | |||||||
Total cost of sales |
$ | 532 | $ | 605 | $ | (73 | ) | |||||
(1) | Decrease primarily as a result of (a) lower prices paid for coal, (b) lower natural gas volumes purchased and (c) additional costs in 2009 to reduce fixed price coal commitments for future periods. These decreases were partially offset by higher prices paid for natural gas. | |
(2) | See footnote 1 under Unrealized Gains (Losses) on Energy Derivatives. |
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Open Gross Margin.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
East Coal |
||||||||||||
Open energy gross margin |
$ | 156 | $ | 135 | $ | 21 | (1) | |||||
Other margin |
99 | 75 | 24 | (2) | ||||||||
Open gross margin |
$ | 255 | $ | 210 | $ | 45 | ||||||
East Gas |
||||||||||||
Open energy gross margin |
$ | 10 | $ | 6 | $ | 4 | ||||||
Other margin |
101 | 82 | 19 | (2) | ||||||||
Open gross margin |
$ | 111 | $ | 88 | $ | 23 | ||||||
West |
||||||||||||
Open energy gross margin |
$ | | $ | 9 | $ | (9 | ) | |||||
Other margin |
30 | 28 | 2 | |||||||||
Open gross margin |
$ | 30 | $ | 37 | $ | (7 | ) | |||||
Other |
||||||||||||
Open energy gross margin |
$ | | $ | | $ | | ||||||
Other margin |
14 | 27 | (13 | )(3) | ||||||||
Open gross margin |
$ | 14 | $ | 27 | $ | (13 | ) | |||||
Total |
||||||||||||
Open energy gross margin(4) |
$ | 166 | $ | 150 | $ | 16 | ||||||
Other margin(4) |
244 | 212 | 32 | |||||||||
Open gross margin(4) |
$ | 410 | $ | 362 | $ | 48 | ||||||
(1) | Increase primarily as a result of higher power prices driving improved generation. This increase is partially offset by higher planned outages. | |
(2) | Increase primarily as a result of RPM capacity payments. | |
(3) | Decrease primarily as a result of expiration of a power purchase agreement in December 2009. | |
(4) | The most directly comparable GAAP financial measure is income (loss) from continuing operations before income taxes. See Non-GAAP Performance Measures. |
Hedges and Other Items.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Power |
$ | 8 | $ | 31 | $ | (23 | )(1) | |||||
Fuel |
(12 | ) | (135 | ) | 123 | (2) | ||||||
Tolling/other |
6 | 30 | (24 | )(3) | ||||||||
Hedges and other items income (loss) |
$ | 2 | $ | (74 | ) | $ | 76 | |||||
(1) | Decrease primarily as a result of $26 million decline in hedges of generation. | |
(2) | Increase primarily as a result of (a) $87 million driven by improved results of fuel hedges in 2010 as compared to 2009 and additional costs incurred in 2009 to reduce fixed price coal commitments for future periods in our East Coal segment and (b) $34 million reduction in lower market valuation adjustments to fuel inventory in our East Coal segment. | |
(3) | Decrease primarily as a result of $28 million decline in gas transportation margins. |
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Unrealized Gains (Losses) on Energy Derivatives.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Revenues unrealized |
$ | 49 | $ | (26 | ) | $ | 75 | |||||
Cost of sales unrealized |
12 | (11 | ) | 23 | ||||||||
Net unrealized gains (losses) on energy derivatives |
$ | 61 | $ | (37 | ) | $ | 98 | (1) | ||||
(1) | Net change primarily as a result of $90 million in gains from changes in prices on our energy derivatives marked to market and $8 million in gains driven by the reversal of previously recognized unrealized losses on energy derivatives which settled during the period. |
Operation and Maintenance.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Plant operation and maintenance |
$ | 266 | $ | 226 | $ | 40 | (1) | |||||
REMA leases |
30 | 30 | | |||||||||
Taxes other than income and insurance |
20 | 22 | (2 | ) | ||||||||
Information Technology, Risk and
other salaries and benefits |
17 | 17 | | |||||||||
Commercial Operations |
7 | 9 | (2 | ) | ||||||||
Severance |
2 | 4 | (2 | ) | ||||||||
Other, net |
2 | 6 | (4 | ) | ||||||||
Operation and maintenance |
$ | 344 | $ | 314 | $ | 30 | ||||||
(1) | Increase primarily as a result of a $51 million increase in planned outages and projects spending primarily in our East Coal and West segments. This increase was partially offset by a $7 million decrease in base operation and maintenance expense as a result of the implementation of our plant-specific operating model primarily in our East Coal, East Gas and Other segments. |
General and Administrative.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Salaries and benefits |
$ | 26 | $ | 32 | $ | (6 | ) | |||||
Merger-related costs |
14 | | 14 | |||||||||
Professional fees, contract
services and information systems
maintenance |
8 | 12 | (4 | ) | ||||||||
Rent and utilities |
6 | 7 | (1 | ) | ||||||||
Other, net |
2 | 6 | (4 | ) | ||||||||
General and administrative |
$ | 56 | $ | 57 | $ | (1 | ) | |||||
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Efficiency Measures Total Controllable Costs.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(dollars in millions, except per MWh and per MW data) | ||||||||||||
Operation and maintenance, excluding severance(1) |
$ | 342 | $ | 310 | $ | 32 | ||||||
REMA lease expense |
(30 | ) | (30 | ) | | |||||||
General and administrative, excluding severance and
merger-related costs(1) |
42 | 56 | (14 | ) | ||||||||
Maintenance capital expenditures |
20 | 35 | (15 | ) | ||||||||
Total Controllable Costs |
$ | 374 | $ | 371 | $ | 3 | ||||||
TWh generation |
10.9 | 10.7 | 0.2 | |||||||||
Total Controllable Costs/MWh |
$ | 34 | $ | 35 | $ | (1 | ) | |||||
MW capacity (2) |
14,581 | 14,563 | 18 | |||||||||
Total Controllable Costs ($ thousands)/MW capacity |
$ | 25.6 | $ | 25.5 | $ | 0.1 | ||||||
(1) | Excludes severance charges incurred in connection with (a) repositioning the company in connection with the sale of our retail business and (b) implementing our plant-specific operating model. We also exclude merger-related costs classified in general and administrative. | |
(2) | MW capacity changed from June 30, 2009 to June 30, 2010 as a result of MW re-ratings that occurred during the fourth quarter of 2009. |
Total Controllable Costs Reconciliation.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(dollars in millions, except per MWh and per MW data) | ||||||||||||
Operation and maintenance (O&M) |
$ | 344 | $ | 314 | $ | 30 | ||||||
General and administrative (G&A) |
56 | 57 | (1 | ) | ||||||||
Capital expenditures |
50 | 115 | (65 | ) | ||||||||
Total operation and maintenance, general
and administrative and capital
expenditures |
$ | 450 | $ | 486 | $ | (36 | ) | |||||
Total Controllable Costs |
$ | 374 | $ | 371 | $ | 3 | ||||||
REMA lease expense in operation and maintenance |
30 | 30 | | |||||||||
Severance included in operation and maintenance |
2 | 4 | (2 | ) | ||||||||
Severance included in general and administrative |
| 1 | (1 | ) | ||||||||
Merger-related costs included in general and
administrative |
14 | | 14 | |||||||||
Environmental capital expenditures |
22 | 66 | (44 | ) | ||||||||
Capitalized interest |
8 | 14 | (6 | ) | ||||||||
Total operation and maintenance, general
and administrative and capital
expenditures |
$ | 450 | $ | 486 | $ | (36 | ) | |||||
TWh generation |
10.9 | 10.7 | 0.2 | |||||||||
Total O&M, G&A and capital expenditure/MWh |
$ | 41 | $ | 45 | $ | (4 | ) | |||||
MW capacity |
14,581 | 14,563 | 18 | |||||||||
Total O&M, G&A and capital expenditures
($ thousands)/MW capacity |
$ | 30.9 | $ | 33.4 | $ | (2.5 | ) | |||||
Western States Litigation and Similar Settlements. See note 12 to our interim financial
statements.
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Gains on Sales of Assets and Emission and Exchange Allowances, Net.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
CO2 exchange allowances |
$ | | $ | 10 | $ | (10 | ) | |||||
SO2 and NOx emission allowances |
| 7 | (7 | ) | ||||||||
Other, net |
1 | 3 | (2 | ) | ||||||||
Gains on sales of assets and
emission and exchange allowances,
net |
$ | 1 | $ | 20 | $ | (19 | ) | |||||
Long-lived Assets Impairments. See note 7 to our interim financial statements.
Depreciation and Amortization.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Depreciation on plants |
$ | 112 | $ | 111 | $ | 1 | (1) | |||||
Other, net depreciation |
6 | 8 | (2 | ) | ||||||||
Depreciation |
118 | 119 | (1 | ) | ||||||||
Amortization of emission allowances |
12 | 14 | (2 | ) | ||||||||
Other, net amortization |
1 | 2 | (1 | ) | ||||||||
Amortization |
13 | 16 | (3 | ) | ||||||||
Depreciation and amortization |
$ | 131 | $ | 135 | $ | (4 | ) | |||||
(1) | Increase primarily as a result of (a) $8 million in early retirements of plant components at our Cheswick plant and (b) $3 million of additional depreciation expense related to an equipment upgrade at our Keystone plant. These increases were partially offset by reduced depreciation expense of $10 million as a result of our December 31, 2009 and March 31, 2010 long-lived assets impairments (see note 7 to our interim financial statements). |
Debt Extinguishments Gains. This represents gains on extinguishments of our senior secured
notes.
Interest Expense.
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Fixed-rate debt |
$ | 88 | $ | 105 | $ | (17 | )(1) | |||||
Deferred financing costs |
3 | 3 | | |||||||||
Amortization of fair
value adjustment of
acquired debt |
(5 | ) | (6 | ) | 1 | |||||||
Capitalized interest |
(8 | )(2) | (14 | )(3) | 6 | |||||||
Other, net |
5 | 4 | 1 | |||||||||
Interest expense |
$ | 83 | $ | 92 | $ | (9 | ) | |||||
(1) | Decrease as a result of a reduction in fixed-rate debt primarily due to (a) $400 million in payments of the Orion Power Holdings, Inc. senior notes in May 2010 and (b) purchases of senior secured 6.75% notes in 2009. | |
(2) | Relates primarily to environmental capital expenditures for SO2 emission reductions at our Cheswick plant. | |
(3) | Relates primarily to environmental capital expenditures for SO2 emission reductions at our Cheswick and Keystone plants. |
Other, Net. This amount did not change significantly.
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Income Tax Expense (Benefit). See note 11 to our interim financial statements. A
reconciliation of the federal statutory income tax rate to the effective income tax rate is:
Six Months Ended June 30, | ||||||||
2010 | 2009 | |||||||
Federal statutory rate |
(35 | )% | (35 | )% | ||||
Additions (reductions) resulting from: |
||||||||
Federal valuation allowance |
40 | (1) | | |||||
State income taxes, net of federal income taxes |
5 | (2) | (1 | )(3) | ||||
Other |
3 | | ||||||
Effective rate |
13 | % | (36 | )% | ||||
(1) | Of this percentage, $159 million (40%) relates to additional valuation allowance. | |
(2) | Of this percentage, $6 million (3%) relates to additional valuation allowance. | |
(3) | Of this percentage, $15 million (5%) relates to additional valuation allowance. |
Income from Discontinued Operations. See note 18 to our interim financial statements.
Liquidity and Capital Resources
Overview. We are committed to a strong balance sheet and ample liquidity that will enable us
to avoid distress in cyclical troughs and access capital markets throughout the cycle. We think
our liquidity has and continues to exceed the level required to achieve this goal. As of July 19,
2010, we had total available liquidity of $1.3 billion, comprised of cash and cash equivalents
($597 million), unused borrowing capacity ($500 million) and letters of credit capacity
($162 million).
Gross Debt Goal. Our goal for gross debt (total GAAP debt plus our REMA operating leases) is
$1.25 billion to $1.75 billion. The comparable target for total GAAP debt, based on the current
balance for our REMA leases of $423 million, is approximately $800 million to $1.3 billion. As of
June 30, 2010, we had gross debt of $2.4 billion and GAAP debt of $2 billion. Our gross debt and
GAAP debt were reduced by $400 million in May 2010 through the retirement of our Orion Power senior
notes. We think that the non-GAAP measure gross debt is a useful and relevant measure of our
financial obligations and the strength and flexibility of our capital structure.
In the future, we could use a variety of means to achieve our gross debt goal, including
retirements at maturity, open market purchases, call provisions and tender offers.
Cash Flows. During the six months ended June 30, 2010, we generated $27 million in operating
cash flows from continuing operations, including the net changes in margin deposits of $62 million
(cash inflow). See Historical Cash Flows for further detail of our cash flows from
operating activities and explanation of our $35 million and $398 million use of cash from investing
activities from continuing operations and use of cash from financing activities from continuing
operations, respectively, during the six months ended June 30, 2010.
See note 11(c) to our interim financial statements regarding an expected income tax cash
payment of approximately $60 to $65 million relating to California-related matters in the next
twelve months.
We continue to monitor our business and hedging with the goal of at least breaking even on a
free cash flow basis irrespective of the commodity price environment. Based on our assessment of
the economic environment and volatility in commodity markets, we have hedged, with swaps,
approximately 30% and 31% of estimated power generation from our PJM coal plants (which are in our
East Coal segment) for 2010 and 2011 (based on MWh), respectively. We have hedged an additional
5%, 13% and 7% of this estimated power generation for 2010, 2011 and 2012, respectively, with
financial options to retain meaningful energy margin upside for market improvements.
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Non-GAAP Cash Flows Measures.
Six Months Ended June 30, | ||||||||
2010 | 2009 | |||||||
(in millions) | ||||||||
Operating cash flow from continuing operations |
$ | 27 | $ | (96 | ) | |||
Change in margin deposits, net(1) |
(62 | ) | 50 | |||||
Adjusted cash flow used in continuing operations |
(35 | ) | (46 | ) | ||||
Capital expenditures |
(50 | ) | (115 | ) | ||||
Proceeds from sales of emission and exchange allowances(2) |
| 19 | ||||||
Purchases of emission allowances(2) |
| (5 | ) | |||||
Free cash flow used in continuing operations |
$ | (85 | ) | $ | (147 | ) | ||
(1) | We post collateral to support a portion of our commodity sales and purchase transactions. The collateral provides assurance to counterparties that contractual obligations will be fulfilled. As the obligations are fulfilled, the collateral is returned. We commonly use both cash and letters of credit as collateral. The use of cash as collateral appears as an asset on the balance sheet and as a use of cash in operating cash flow. When cash collateral is returned, the asset is eliminated from the balance sheet and it appears as a source of cash in operating cash flow. We think that it is useful to exclude changes in margin deposits, since changes in margin deposits reflect the net inflows and outflows of cash collateral and are driven by hedging levels and changes in commodity prices, not by the cash flow generated by the business related to sales and purchases in the reporting period. | |
(2) | The cash flows from sales and purchases of emission and exchange allowances are classified as investing cash flows for GAAP purposes; however, we purchase and sell emission and exchange allowances in connection with the operation of our generating assets. As part of our effort to operate our business efficiently, we periodically sell emission and exchange allowances inventory in excess of our forward power sales commitments if the price is above our view of their value. Consistent with subtracting capital expenditures (which is a GAAP investing cash flow activity) in calculating free cash flow, we add sales and subtract purchases of emission and exchange allowances. |
Our non-GAAP cash flow measures may not be representative of the amount of residual cash flow,
if any, that is available to us for discretionary expenditures, since they may not include
deductions for all non-discretionary expenditures. We think, however, that our non-GAAP cash flow
measures are useful because they provide a representation of our cash flows from the applicable
period available to service debt on a normalized basis, both before and after capital expenditures
and emission and exchange allowances activity. The most directly comparable GAAP financial measure
is operating cash flow from continuing operations.
Other. See Risk Factors in Item 1A and Managements Discussion and Analysis of Financial
Condition and Results of Operations Liquidity and Capital Resources in Item 7 of our Form 10-K
and notes 7 and 15 to our consolidated financial statements in our Form 10-K. Also see Risk
Factors in Item 1A of this report.
Credit Risk
By extending credit to our counterparties, we are exposed to credit risk. For discussion of
our credit risk policy and exposures, see note 6 to our interim financial statements.
Off-Balance Sheet Arrangements
As of June 30, 2010, we have no off-balance sheet arrangements.
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Historical Cash Flows
Cash Flows Operating Activities
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Operating loss |
$ | (322 | ) | $ | (235 | ) | $ | (87 | ) | |||
Depreciation and amortization |
131 | 135 | (4 | ) | ||||||||
Western states litigation and similar settlements |
17 | | 17 | |||||||||
Gains on sales of assets and emission allowances, net |
(1 | ) | (20 | ) | 19 | |||||||
Long-lived assets impairments |
248 | | 248 | |||||||||
Net changes in energy derivatives |
(59 | ) (1) | 37 | (2) | (96 | ) | ||||||
Margin deposits, net |
62 | (50 | ) | 112 | ||||||||
Change in accounts and notes receivable and accounts
payable, net |
(20 | ) | 119 | (139 | ) | |||||||
Change in inventory |
50 | 13 | 37 | |||||||||
Net option premiums purchased |
| (24 | ) | 24 | ||||||||
Interest payments, net of capitalized interest |
(98 | ) | (95 | ) | (3 | ) | ||||||
Income tax payments, net of refunds |
(3 | ) | (4 | ) | 1 | |||||||
Prepaid lease obligation |
9 | 8 | 1 | |||||||||
Construction deposit refund |
| 15 | (15 | ) | ||||||||
Other, net |
13 | 5 | 8 | |||||||||
Net cash provided by (used in) continuing
operations from operating activities |
27 | (96 | ) | 123 | ||||||||
Net cash provided by discontinued operations from
operating activities |
26 | 508 | (482 | ) | ||||||||
Net cash provided by operating activities |
$ | 53 | $ | 412 | $ | (359 | ) | |||||
(1) | Includes unrealized gains on energy derivatives of $61 million. | |
(2) | Includes unrealized losses on energy derivatives of $37 million. | |
(3) | Represents exchange transactions financially settled within three business days prior to the contractual delivery month. |
Our cash provided by operating activities is affected by, among other things, changes in
energy prices and fluctuations in our working capital requirements. Net cash provided by operating
activities from continuing operations increased by $123 million for the six months ended June 30,
2010, compared to the same period in 2009, primarily as a result of the following:
| Open Gross Margin. Open gross margin provided an increase in cash of $48 million as a result of (a) higher power prices driving improved generation in our East Coal segment and (b) RPM capacity payments in our East Coal and East Gas segments during 2010, partially offset by a decrease resulting from the expiration of a power purchase agreement in our Other segment in December 2009. See Consolidated Results of Operations for the six months ended June 30, 2010 compared to six months ended June 30, 2009 for additional discussion of our performance. |
| Hedges and Other Items. Hedges and other items provided an increase in cash of $42 million, which excludes lower market valuation adjustments to fuel inventory, primarily as a result of improved results of fuel hedges in 2010 as compared to 2009 and additional costs incurred in 2009 to reduce fixed price coal commitments for future periods in our East Coal segment. The increase was partially offset by declines in hedges of generation and gas transportation margins. See Consolidated Results of Operations for the six months ended June 30, 2010 compared to six months ended June 30, 2009 for additional discussion of our performance. |
| Margin Deposits. Margin deposits provided an increase in cash of $112 million primarily as a result of the return of collateral posted with certain counterparties compared to an increase in initial margin requirements related to a new hedging strategy during 2009. |
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| Inventory. Cash used for inventory decreased by $71 million, which excludes lower market valuation adjustments to fuel inventory, primarily as a result of a reduction of coal and materials and supply inventory in 2010. |
| Option premiums purchased. Cash used for options premiums decreased by $24 million. |
These increases in cash provided by and decreases in cash used in operating activities were
partially offset by the following:
| Operations and maintenance expense. Operations and maintenance expense increased by $30 million primarily as a result of an increase in planned outages and projects spending primarily at our East Coal and West segments. See Consolidated Results of Operations for the six months ended June 30, 2010 compared to six months ended June 30, 2009 for additional discussion of our performance. |
| Net accounts receivable and payable. The net cash flows of accounts receivable and payable decreased by $139 million primarily as a result of (a) the implementation of weekly settlements for the PJM Market in June 2009, (b) the timing of collections of receivables related to coal sales in early 2009 and (c) gas sales prices in 2009. |
Cash Flows Investing Activities
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Capital expenditures |
$ | (50 | ) | $ | (115 | ) | $ | 65 | (1) | |||
Proceeds from sales of assets |
7 | 36 | (29 | ) | ||||||||
Proceeds from sales of emission and exchange
allowances |
| 19 | (19 | ) | ||||||||
Purchases of emission allowances |
| (5 | ) | 5 | ||||||||
Restricted cash |
5 | | 5 | |||||||||
Other, net |
3 | 1 | 2 | |||||||||
Net cash used in continuing operations from
investing activities |
(35 | ) | (64 | ) | 29 | |||||||
Net cash provided by (used in) discontinued
operations from investing activities |
(4 | ) | 299 | (303 | ) | |||||||
Net cash provided by (used in) investing activities |
$ | (39 | ) | $ | 235 | $ | (274 | ) | ||||
(1) | Decrease primarily due to (a) $50 million decrease in environmental capital expenditures (including capitalized interest) primarily for SO2 emission reductions at our Cheswick and Keystone plants, which are included in our East Coal segment (the scrubber project of our Keystone plant was completed in 2009, the scrubber project for our Cheswick plant was halted in mid-2009 and was resumed and completed in 2010) and (b) $15 million decrease in maintenance capital expenditures. |
Cash Flows Financing Activities
Six Months Ended June 30, | ||||||||||||
2010 | 2009 | Change | ||||||||||
(in millions) | ||||||||||||
Payments of long-term debt |
$ | (400 | )(1) | $ | (45 | )(2) | $ | (355 | ) | |||
Proceeds from issuances of stock |
2 | 2 | | |||||||||
Net cash used in continuing operations
from financing activities |
(398 | ) | (43 | ) | (355 | ) | ||||||
Net cash used in discontinued
operations from financing activities |
| (225 | ) | 225 | ||||||||
Net cash used in financing activities |
$ | (398 | ) | $ | (268 | ) | $ | (130 | ) | |||
(1) | Includes $400 million in payments of the Orion Power Holdings, Inc. senior notes. | |
(2) | Includes $45 million of purchases of senior secured notes. |
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New Accounting Pronouncements, Significant Accounting Policies and Critical Accounting Estimates
New Accounting Pronouncements
See notes 1 and 4 to our interim financial statements.
Significant Accounting Policies
See note 2 to our consolidated financial statements in our Form 10-K.
Critical Accounting Estimates
See Managements Discussion and Analysis of Financial Condition and Results of Operations
Accounting Estimates New Accounting Pronouncements, Significant Accounting Policies and Critical
Accounting Estimates Critical Accounting Estimates in Item 7 in our Form 10-K and note 2 to our
consolidated financial statements in our Form 10-K.
Long-Lived Assets.
We consider the estimate used to assess the recoverability of our long-lived assets (property,
plant and equipment and intangible assets) a critical accounting estimate. See notes 2(g), 4 and 5
to our consolidated financial statements in our Form 10-K. See note 7 to our interim financial
statements for further discussion regarding our $248 million impairment charges for our Elrama and
Niles plants (each in our East Coal segment) recognized during the three months ended March 31,
2010.
Following our current methodology, we had three additional plants and related intangible
assets with a combined carrying value of $344 million, where the undiscounted cash flows were close
to the carrying values. If market conditions or environmental and regulatory assumptions change
negatively in the future, it is likely that these three plants (and possibly others) could be
impaired.
Effect if Different Assumptions Used. The estimates and assumptions used to determine whether
long-lived assets are recoverable or whether impairment exists are subject to a high degree of
uncertainty. Different assumptions as to power prices, fuel costs, our future cost structure,
environmental assumptions and remaining useful lives and ultimate disposition values of our plants
would result in estimated future cash flows that could be materially different than those
considered in the recoverability assessments as of March 31, 2010 and could result in having to
estimate the fair value of other plants.
Use of a different risk-adjusted discount rate would result in fair value estimates for the
two plants for which we recorded an impairment during the three months ended March 31, 2010 that
could be materially greater than or less than the fair value estimates as of March 31, 2010. Any
future fair value estimates for our Elrama and Niles long-lived assets that are greater than the
fair value estimates as of March 31, 2010 will not result in reversal of the first quarter 2010
impairment charges.
The undiscounted cash flow scenarios we considered in assessing the recoverability of our
long-lived assets are those which we think are most likely to occur based on market data as of
March 31, 2010. If we had solely utilized the 5-year market forecast with escalation scenario, the
carrying value of three additional plants and related intangible assets ($259 million) would have
been greater than the undiscounted cash flows. This would have necessitated fair value estimates
for those plants which could have resulted in an impairment loss of approximately $200 million
based on the key assumptions used in our fair value analyses as of March 31, 2010. Alternatively,
if we had solely utilized the 5-year market forecast with fundamental view, the carrying value of
one plant and related intangible assets ($108 million) would have been greater than the
undiscounted future cash flows. This would have necessitated fair value estimates for that plant
which could have resulted in an impairment loss of approximately $75 million based on the key
assumptions used in our fair value analyses as of March 31, 2010.
As of March 31, 2010, the discounted cash flow scenarios we considered in determining the fair
values of our Elrama and Niles long-lived assets are those which we think are most representative
of a market participant view. If we had solely utilized the 5-year market forecast with escalation
scenario, the fair value of the Elrama long-lived assets would have been $47 million (resulting in
an impairment of $214 million as opposed to $193 million recognized). Alternatively, if we had
solely utilized the 5-year market forecast with fundamental view, the fair value of the Elrama
long-lived assets would have been $89 million (resulting in an impairment of $172 million as
opposed to $193 million recognized). If we had solely utilized the 5-year market forecast with
escalation scenario, the fair value of the Niles long-lived assets would have been $25 million
(resulting in an impairment of $56 million as opposed to $55 million recognized). Alternatively,
if we had solely utilized the 5-year market forecast with
fundamental view, the fair value of the Niles long-lived assets would have been $28 million
(resulting in an impairment of $53 million as opposed to $55 million recognized).
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risks and Risk Management
Our primary market risk exposure relates to fluctuations in commodity prices. See
Quantitative and Qualitative Disclosures About Market Risk in Item 7A of our Form 10-K and
notes 4 and 5 to our interim financial statements.
Non-Trading Market Risks
Commodity Price Risk
As of June 30, 2010, the fair values of the contracts related to our net non-trading
derivative assets and liabilities are (asset (liability)):
Twelve | ||||||||||||||||||||||||||||
Months | ||||||||||||||||||||||||||||
Ending | ||||||||||||||||||||||||||||
June 30, | Remainder | 2015 and | Total fair | |||||||||||||||||||||||||
Source of Fair Value | 2011 | of 2011 | 2012 | 2013 | 2014 | thereafter | value | |||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||
Prices actively
quoted (Level 1) |
$ | 55 | $ | 32 | $ | | $ | | $ | | $ | | $ | 87 | ||||||||||||||
Prices provided by
other external
sources (Level 2) |
(33 | ) | (15 | ) | (14 | ) | | | | (62 | ) | |||||||||||||||||
Prices based on
models and other
valuation methods
(Level 3) |
9 | 3 | | | | | 12 | |||||||||||||||||||||
Total
mark-to-market
non-trading
derivatives |
$ | 31 | $ | 20 | $ | (14 | ) | $ | | $ | | $ | | $ | 37 | |||||||||||||
The fair values shown in the table above are subject to significant changes as a result of
fluctuating commodity forward market prices, volatility and credit risk. Market prices assume a
functioning market with an adequate number of buyers and sellers to provide liquidity.
Insufficient market liquidity could significantly affect the values that could be obtained for
these contracts, as well as the costs at which these contracts could be hedged. For further
discussion of how we arrive at these fair values, see note 4 to our interim financial statements
and Managements Discussion and Analysis of Financial Condition and Results of Operations New
Accounting Pronouncements, Significant Accounting Policies and Critical Accounting
Estimates Critical Accounting Estimates in Item 7 of our Form 10-K.
A hypothetical 10% movement in the underlying energy prices would have the following potential
loss impacts on our non-trading derivatives:
As of | Market Prices | Earnings Impact | Fair Value Impact | |||||||||
(in millions) | ||||||||||||
June 30, 2010 |
10% increase | $ | (44 | ) | $ | (44 | ) | |||||
December 31, 2009 |
10% increase | (47 | ) | (47 | ) |
Interest Rate Risk
As of June 30, 2010 and December 31, 2009, we have no variable rate debt outstanding. We earn
interest income, for which the interest rates vary, on our cash and cash equivalents and net margin
deposits. During the six months ended June 30, 2010 and twelve months ended December 31, 2009, we
had no variable rate interest expense and our interest income was $0 and $2 million, respectively.
If interest rates decreased by one percentage point from their June 30, 2010 and December 31,
2009 levels, the fair values of our fixed rate debt from continuing operations would have increased
by $120 million and $126 million, respectively.
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Trading Market Risks
As of June 30, 2010, the fair values of the contracts related to our legacy trading and
non-core asset management positions and recorded as net derivative assets and liabilities are
(asset (liability)):
Twelve | ||||||||||||||||||||||||||||
Months | ||||||||||||||||||||||||||||
Ending | ||||||||||||||||||||||||||||
June 30, | Remainder | 2015 and | Total fair | |||||||||||||||||||||||||
Source of Fair Value | 2011 | of 2011 | 2012 | 2013 | 2014 | thereafter | value | |||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||
Prices actively
quoted (Level 1) |
$ | 9 | $ | | $ | | $ | | $ | | $ | | $ | 9 | ||||||||||||||
Prices provided by
other external
sources (Level 2) |
| | | | | | | |||||||||||||||||||||
Prices based on
models and other
valuation methods
(Level 3) |
(2 | ) | | | | | | (2 | ) | |||||||||||||||||||
Total |
$ | 7 | $ | | $ | | $ | | $ | | $ | | $ | 7 | ||||||||||||||
The fair values in the above table are subject to significant changes based on fluctuating
market prices and conditions. See the discussion above related to non-trading derivative assets
and liabilities for further information on items that impact our portfolio of trading contracts.
Our consolidated realized and unrealized margins relating to trading activities, including
both derivative and non-derivative instruments, are (income (loss)):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(in millions) | ||||||||||||||||
Realized |
$ | 7 | $ | 7 | $ | 13 | $ | 18 | ||||||||
Unrealized |
(7 | ) | (2 | ) | (12 | ) | (2 | ) | ||||||||
Total |
$ | | $ | 5 | $ | 1 | $ | 16 | ||||||||
An analysis of these net derivative assets and liabilities is:
Six Months Ended June 30, | ||||||||
2010 | 2009 | |||||||
(in millions) | ||||||||
Fair value of contracts outstanding, beginning of period |
$ | 19 | $ | 30 | ||||
Contracts realized or settled |
(13 | )(1) | (18 | )(2) | ||||
Changes in fair values attributable to market price and other market
changes |
1 | 16 | ||||||
Fair value of contracts outstanding, end of period |
$ | 7 | $ | 28 | ||||
(1) | Amount includes realized gain of $13 million. | |
(2) | Amount includes realized gain of $18 million. |
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The daily value-at-risk for our legacy trading and non-core asset management positions is:
2010(1) | 2009 | |||||||
(in millions) | ||||||||
As of June 30 |
$ | | $ | 1 | ||||
Three months ended June 30: |
||||||||
Average |
| 2 | ||||||
High |
| 2 | ||||||
Low |
| 1 | ||||||
Six months ended June 30: |
||||||||
Average |
| 2 | ||||||
High |
1 | 4 | ||||||
Low |
| 1 |
(1) | The major parameters for calculating daily value-at-risk remain the same during 2010 as disclosed in Quantitative and Qualitative Disclosures About Market Risk in Item 7A of our Form 10-K. |
Fair Value Measurements
In determining fair value for our derivative assets and liabilities, we generally use the
market approach and incorporate assumptions that market participants would use in pricing the asset
or liability, including assumptions about risk and/or the risks inherent in the inputs to the
valuation techniques.
A fair value hierarchy exists for inputs used in measuring fair value that maximizes the use
of observable inputs (Level 1 or Level 2) and minimizes the use of unobservable inputs (Level 3) by
requiring that the observable inputs be used when available. Derivative instruments classified as
Level 2 primarily include emission allowances futures that are exchanged-traded and
over-the-counter (OTC) derivative instruments such as generic swaps, forwards and options. The
fair value measurements of these derivative assets and liabilities are based largely on unadjusted
indicative quoted prices from independent brokers in active markets who regularly facilitate our
transactions. An active market is considered to have transactions with sufficient frequency and
volume to provide pricing information on an ongoing basis. Derivative instruments for which fair
value is calculated using quoted prices that are deemed not active or that have been extrapolated
from quoted prices in active markets are classified as Level 3. For certain natural gas and power
contracts, we adjust seasonal or calendar year quoted prices based on historical observations to
represent fair value for each month in the season or calendar year, such that the average of all
months is equal to the quoted price. A derivative instrument that has a tenor that does not span
the quoted period is considered an unobservable Level 3 measurement.
We evaluate and validate the inputs we use to estimate fair value by a number of methods,
including validating against market published prices and daily broker quotes obtainable from
multiple pricing services. For OTC derivative instruments classified as Level 2, indicative quotes
obtained from brokers in liquid markets generally represent fair value of these instruments. We
think these price quotes are executable. Adjustments to the quotes are adjustments to the bid or
ask price depending on the nature of the position to appropriately reflect exit pricing and are
considered a Level 3 input to the fair value measurement. In less liquid markets such as coal, in
which a single brokers view of the market is used to estimate fair value, we consider such inputs
to be unobservable Level 3 inputs. We do not use third party sources that determine price based on
market surveys or proprietary models.
We report our derivative assets and liabilities, for which the normal purchase/normal sale
exception has not been made, at fair value and consider it to be a critical accounting estimate
because these estimates are highly susceptible to change from period to period and are dependent on
many subjective factors, including:
| estimated forward market price curves |
| valuation adjustments relating to time value |
| liquidity valuation adjustments |
| credit adjustments, based on the credit standing of the counterparties and our own non-performance risk |
Derivative assets are discounted for credit risk using a yield curve representative of the
counterpartys probability of default. The counterpartys default probability is based on a
modified version of published default rates, taking 20-year historical default rates from Standard
& Poors and Moodys and adjusting them to reflect a rolling five-year average. For derivative
liabilities, fair value measurement reflects the nonperformance risk related
to that liability, which is our own credit risk. We derive our nonperformance risk by
applying our credit default swap spread against the respective derivative liability.
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To determine the fair value for Level 3 energy derivatives where there are no market quotes or
external valuation services, we rely on various modeling techniques. We use a variety of valuation
models, which vary in complexity depending on the contractual terms of, and inherent risks in, the
instrument being valued. We use both industry-standard models as well as internally developed
proprietary valuation models that consider various assumptions such as market prices for power and
fuel, price shapes, ancillary services, volatilities and correlations as well as other relevant
factors. There is inherent risk in valuation modeling given the complexity and volatility of
energy markets. Therefore, it is possible that results in future periods may be materially
different as contracts are ultimately settled.
For additional information regarding our derivative assets and liabilities, see notes 4 and 5
to our interim financial statements.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial
officer, have evaluated the effectiveness of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (1934 Act)) as of June 30,
2010, the end of the period covered by this Form 10-Q. Based on this evaluation, our chief
executive officer and chief financial officer concluded that, as of June 30, 2010, our disclosure
controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the 1934 Act) during the period ended June 30, 2010, that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
PART II.
OTHER INFORMATION
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See note 13 to our interim financial statements in this Form 10-Q.
ITEM 1A. RISK FACTORS
Failure to complete our merger with Mirant could negatively impact our future business and
financial results.
On April 11, 2010, we announced the execution of a merger agreement with Mirant. Before the
merger may be completed, the parties must satisfy all conditions set forth in the agreement,
including the arrangement of mutually acceptable debt financing, obtaining stockholder approval in
connection with the proposed transaction, receipt of approvals from the FERC and the New York
Public Service Commission and expiration or termination of the applicable Hart-Scott-Rodino Act
waiting period. Obtaining the financing is dependent on numerous factors, including capital market
conditions, credit availability from financial institutions and both parties financial
performance. Furthermore, purported class actions have been brought on behalf of holders of Mirant
common stock. If these actions or similar actions that may be brought are successful, the merger
could be delayed or prevented. See note 13(d) to our interim financial statements for discussion
of pending litigation related to the merger.
Satisfying the conditions to and completion of the merger may take longer than expected and
could cost more than we expect. We cannot make any assurances that we will be able to satisfy all
the conditions to the merger or succeed in any litigation brought in connection with the merger.
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If the merger with Mirant is not completed, our financial results may be adversely affected
because of a number of risks, including, but not limited to, the following:
| under circumstances specified in the merger agreement, we may be required to pay Mirant a termination fee of either $37 million or $58 million depending on the nature of the termination |
| we will be required to pay costs relating to the merger, including legal, accounting, financial advisory, filing and printing costs, whether or not the merger is completed |
| we could also be subject to litigation related to any failure to complete the merger |
If completed, our merger with Mirant may not achieve its intended results.
We entered into the merger agreement with the expectation that the merger would result in
various benefits, including, among other things, cost savings and operating efficiencies.
Achieving the anticipated benefits of the merger is subject to a number of uncertainties, including
whether our businesses can be integrated in an efficient and effective manner. Failure to achieve
these anticipated benefits could result in increased costs and decreases in the amount of expected
revenues generated by the combined company.
We will be subject to various uncertainties and contractual restrictions while the merger with
Mirant is pending that could adversely affect our and the combined companys financial results.
Uncertainty about the effect of the merger with Mirant on employees, suppliers, customers and
others may have an adverse effect on us and the combined company. These uncertainties may impair
our ability to attract, retain and motivate key personnel until the merger is completed and for a
period of time thereafter, and could cause suppliers, customers and others that deal with us to
seek to change existing business relationships. Employee retention and recruitment may be
particularly challenging prior to the completion of the merger, as employees and prospective
employees may experience uncertainty about their future roles with the combined company.
The pursuit of the merger and the preparation for the integration of Mirant into our company
may place a significant burden on our management and internal resources. Any significant diversion
of management attention away from ongoing business and any difficulties encountered in the merger
integration process could adversely affect our and the combined companys financial results.
In addition, the merger agreement restricts us, without Mirants consent, from making certain
acquisitions and dispositions and taking other specified actions. These restrictions may prevent
us from pursuing attractive business opportunities and making other changes to our business prior
to completion of the merger or termination of the merger agreement.
ITEM 6. EXHIBITS
Exhibits.
See Index of Exhibits.
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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.
RRI ENERGY, INC. (Registrant) |
||||
July 30, 2010 | By: | /s/ Thomas C. Livengood | ||
Thomas C. Livengood | ||||
Senior Vice President and Controller
(Duly Authorized Officer and Chief Accounting Officer) |
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INDEX OF EXHIBITS
The exhibits with the cross symbol (+) are filed with the Form 10-Q. The exhibits with the
asterisk symbol (*) are compensatory arrangements filed pursuant to Item 601(b)(10)(iii) of
Regulation S-K. The representations, warranties and covenants contained in the exhibits were made
only for purposes of such exhibits, as of specific dates, solely for the benefit of the parties
thereto, may be subject to limitations agreed upon by those parties and may be subject to standards
of materiality that differ from those applicable to investors. Investors should read such
representations, warranties and covenants (or any descriptions thereof contained in the exhibits)
in conjunction with information provided elsewhere in this filing and in our other filings and
should not rely solely on such information as characterizations of our actual state of facts.
SEC File or | ||||||||||||
Exhibit | Report or Registration | Registration | Exhibit | |||||||||
Number | Document Description | Statement | Number | Reference | ||||||||
2.1 | Agreement and Plan of Merger, dated as of
April 11, 2010, by and among RRI Energy,
Inc., Mirant Corporation and RRI Energy
Holdings, Inc. (This filing excludes
schedules and exhibits, which the
registrant agrees to furnish
supplementally to the Securities and
Exchange Commission upon request.)
|
RRI Energy, Inc.s Current Report on Form 8-K, filed April 12, 2010 | 1-16455 | 2.1 | ||||||||
3.1 | Third Restated Certificate of Incorporation
|
RRI Energy, Inc.s Quarterly Report on Form 10-Q for the period ended June 30, 2007 | 1-16455 | 3.1 | ||||||||
3.2 | Sixth Amended and Restated Bylaws
|
RRI Energy, Inc.s | 1-16455 | 3.2 | ||||||||
Quarterly Report on Form 10-Q for the period ended June 30, 2009 | ||||||||||||
4.1 | Registrant has omitted instruments with
respect to long-term debt in an amount
that does not exceed 10% of the
registrants total assets and its
subsidiaries on a consolidated basis and
hereby undertakes to furnish a copy of any
such agreement to the Securities and
Exchange Commission upon request |
|||||||||||
*10.1 | Retention
Incentive Agreement between RRI Energy, Inc. and Mark M. Jacobs,
dated April 11, 2010 |
RRI Energy, Inc.s Registration Statement on Form S-4 filed May 28, 2010 | 333-167192 | 10.2 | ||||||||
*10.2 | Amendment
to Change in Control Agreement, dated April 11, 2010, between
RRI Energy, Inc. and Mark M. Jacobs |
RRI Energy, Inc.s Registration Statement on Form S-4 filed May 28, 2010 | 333-167192 | 10.3 | ||||||||
*10.3 | Amendment
to Change in Control Agreement, dated April 11, 2010, between
RRI Energy, Inc. and Michael L. Jines |
RRI Energy, Inc.s Registration Statement on Form S-4 filed May 28, 2010 | 333-167192 | 10.4 | ||||||||
+31.1 | Certification of the Chief Executive
Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
|||||||||||
+31.2 | Certification of the Chief Financial
Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
|||||||||||
+32.1 | Certification of Chief Executive Officer
and Chief Financial Officer pursuant to
Subsections (a) and (b) of Section 1350,
Chapter 63 of Title 18, United States Code
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 |
|||||||||||
+101 | Interactive Data File |
62