<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 18, 2001
REGISTRATION NO. 333-48038
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
AMENDMENT NO. 4
TO
FORM S-1
Registration Statement Under the Securities Act of 1933
---------------------
RELIANT RESOURCES, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 4911 76-0655566
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
1111 LOUISIANA, HOUSTON, TEXAS 77002
(713) 207-3000
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
---------------------
HUGH RICE KELLY
SENIOR VICE PRESIDENT, GENERAL COUNSEL AND
CORPORATE SECRETARY
1111 LOUISIANA
HOUSTON, TEXAS 77002
(713) 207-3000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
---------------------
Copies to:
<TABLE>
<S> <C>
TIMOTHY S. TAYLOR JOHN S. WATSON
BAKER BOTTS L.L.P. VINSON & ELKINS L.L.P.
910 LOUISIANA 2300 FIRST CITY TOWER
ONE SHELL PLAZA 1001 FANNIN STREET
HOUSTON, TEXAS 77002-4995 HOUSTON, TEXAS 77002-6760
(713) 229-1234 (713) 758-2222
</TABLE>
---------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this registration statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box: [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [
] _________________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] _________________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [ ]
---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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--------------------------------------------------------------------------------
<PAGE> 2
The information in this preliminary prospectus is not complete and may be
changed. These securities may not be sold until the registration statement
filed with the Securities and Exchange Commission is effective. This
preliminary prospectus is not an offer
to sell nor does it seek an offer to buy these securities in any
jurisdiction where the offer or sale is not permitted.
Subject to Completion. Dated , 2001.
52,000,000 Shares
[RELIANT RESOURCES LOGO]
RELIANT RESOURCES, INC.
Common Stock
----------------------
This is an initial public offering of shares of common stock of Reliant
Resources, Inc. All of the 52,000,000 shares of common stock are being sold by
Reliant Resources.
Prior to this offering, there has been no public market for the common
stock. It is currently estimated that the initial public offering price per
share will be between $15.50 and $17.50. Reliant Resources intends to list the
common stock on the New York Stock Exchange under the trading symbol "RRI".
See "Risk Factors" on page 9 to read about factors you should consider
before buying shares of common stock.
----------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
----------------------
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Initial public offering price............................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to Reliant Resources............. $ $
</TABLE>
To the extent that the underwriters sell more than 52,000,000 shares of
common stock, the underwriters have the option to purchase up to an additional
7,800,000 shares from Reliant Resources at the initial public offering price
less the underwriting discount.
----------------------
The underwriters expect to deliver the shares in New York, New York on
, 2001.
GOLDMAN, SACHS & CO. CREDIT SUISSE FIRST BOSTON
ABN AMRO ROTHSCHILD LLC
BANC OF AMERICA SECURITIES LLC
DEUTSCHE BANC ALEX. BROWN
MERRILL LYNCH & CO.
UBS WARBURG LLC
----------------------
Prospectus dated , 2001.
<PAGE> 3
[INSIDE FRONT COVER PAGE -- DESCRIPTION OF ARTWORK]
The words "RETHINK," "RESHAPE" and "RESOURCE" are superimposed on the graphics
on the top half of the inside front cover page. The initial two letters "RE" of
each word are in 14.5 point font, and the remaining letters of each word are in
115 point font.
Six photographs are arranged across the center of the page in a montage. From
left to right and clockwise, the first photograph is of the Etiwanda plant in
California, the second is of a lightbulb, the third is of a part of the
Etiwanda plant, the fourth is of our trading floor, the fifth is of a gas
flame, and the sixth is of the skyline of downtown Houston.
The text "Reliant Resources(TM) 2001" appears in the bottom right corner of the
page.
[INSIDE FRONT COVER GATEFOLD -- DESCRIPTION OF ARTWORK]
The word "ASSETS" appears at the top center of the gatefold.
Under the word "ASSETS," text near the top center of the gatefold reads "Net
generation capacity has tripled to 12,707 MW since 1998."
A photograph of five of our employees on our trading floor appears in the top
left corner of the gatefold.
A photo of two people conducting a business transaction appears in the top
right corner of the gatefold.
The words "OUR STRATEGY" appear in the middle center of the gatefold.
Directly under the words "Our Strategy," the text reads "To aggressively pursue
growth opportunities in the restructuring electric markets where our
skills-based commercial approach provides us with a competitive advantage."
A photograph of the Etiwanda plant appears in the lower center of
the gatefold.
The word "TRADING" appears in the lower left corner of the gatefold above text
that reads "One of only six companies to rank in the top ten for both power
and natural gas trading."
The words "LONG-TERM CONTRACTS" appear in the lower right corner of the
gatefold above text that reads "Profit by marketing the capacity of other
generators."
[INSIDE BACK COVER -- DESCRIPTION OF ARTWORK]
A photograph of a house appears in the top right corner of the back cover.
Under the photograph, the words "SELECT RETAIL MARKETS" appear above text that
reads "Capitalize on the retail opportunities in Texas, and target additional
markets with favorable regulatory structures."
The Reliant Resources logo in white on a dark background appears in
the bottom right corner of the back cover page.
<PAGE> 4
PROSPECTUS SUMMARY
This summary highlights selected information described more fully elsewhere
in this prospectus. This summary does not contain all the information you should
consider before investing in our common stock. You should read the entire
prospectus, including the financial statements and related notes, before making
an investment decision with respect to our common stock.
OUR BUSINESS
We are a rapidly growing provider of electricity and energy services with a
focus on the competitive segments of the electric power industry in the United
States and Europe. We acquire, develop and operate electric power generation
facilities that are not subject to traditional cost-based regulation and
therefore can sell power at prices determined by the market. We acquired our
first power generation facilities in 1998 and have grown our aggregate net
generation capacity to 12,707 megawatts, or "MW," as of December 1, 2000. We
also trade and market power, natural gas and other energy-related commodities
and provide related risk management services. We refer to the combination of our
power generation operations and our trading, marketing and risk management
operations as our "wholesale business." We believe our trading, marketing, and
risk management skills complement our generation positions. The combination
provides greater scale and skill associated with the management of our fuel and
power positions, sophisticated commercial insights and understanding of the key
regions in which we participate, and a wider range of ways in which we
participate in the market and are able to meet customer needs.
We intend to become a provider of retail electric services in Texas when
the market opens to retail competition in January 2002 and in other U.S. markets
with favorable regulatory structures and profit opportunities thereafter. We
will initially succeed to a significant retail electric customer base in the
Houston, Texas metropolitan area. We intend to build our retail business
elsewhere by capitalizing on the skills and systems we are building for the
competitive market in Houston.
We believe that the combination of our high quality portfolio of power
generation assets, our sophisticated trading, marketing and risk management
operations and our anticipated retail electric customer base in Texas provides
us with the foundation to successfully capitalize on the attractive growth
opportunities in the deregulating electric power markets. We also engage in
other businesses, specifically eBusiness, communications and venture capital,
that we believe provide potential opportunities for future growth.
As of December 1, 2000, we owned or leased electric power generation
facilities with an aggregate net generating capacity of 12,707 MW located in
five regions of the United States and in the Netherlands. We also had 2,766 MW
of generating capacity under construction as of that date. The following table
describes our facilities.
<TABLE>
<CAPTION>
NET GENERATING CAPACITY (IN MW)
-----------------------------------------
REGION OPERATING UNDER CONSTRUCTION TOTAL
------ --------- ------------------ -----
<S> <C> <C> <C>
Mid-Atlantic.......................................... 4,262 -- 4,262
Southwest(1).......................................... 4,045 563 4,608
Midcontinent.......................................... 255 962 1,217
Florida............................................... 619 460 1,079
Texas(2).............................................. 50 781 831
Netherlands........................................... 3,476 -- 3,476
------ ----- ------
Total................................................. 12,707 2,766 15,473
====== ===== ======
</TABLE>
---------------
(1)We also have entered into an agreement to acquire a power generation facility
located in Nevada with a net generating capacity of 153 MW. We expect this
acquisition will close in June 2001.
(2) We also have an option, which is exercisable in January 2004, to acquire
Reliant Energy's 81% interest in a company owning 14,027 MW of net
generating capacity in Texas. For additional information regarding this
option, please read "Texas Genco Option."
1
<PAGE> 5
OUR MARKET OPPORTUNITY
Historically, electricity in the United States has been generated,
distributed and sold by regulated, vertically-integrated utilities with
government granted franchises to provide electric services to customers within
specific geographic areas. Retail electricity rates have traditionally been set
by regulatory authorities at levels intended to allow utilities to earn a
targeted rate of return on their invested capital. Similar to what occurred in
the U.S. telecommunications industry, the U.S. electric power industry is being
fundamentally transformed as a result of restructuring initiatives at both the
state and federal levels.
The current restructuring trend in the U.S. electric power industry,
including the unbundling of many vertically-integrated utilities, creates
attractive growth opportunities in the wholesale and retail electric markets.
These opportunities are summarized below.
- OPPORTUNITY TO DEVELOP ADDITIONAL GENERATION FACILITIES. Growth in demand
for power during the 1990s has significantly outpaced the addition of
power generating capacity in many U.S. markets. In addition,
environmental regulations continue to impact the economic viability of
some existing generating capacity. Consequently, we believe there are
significant opportunities for us to develop additional power generation
facilities.
- OPPORTUNITY TO ACQUIRE EXISTING GENERATION FACILITIES. From 1997 through
November 2000, approximately 120,000 MW of generating capacity have been
divested by vertically-integrated utilities responding to the changing
regulatory environment. We expect additional generating capacity to be
sold as more states restructure their electric markets and companies
continue to refine their strategic directions. We believe that these
divestitures will provide considerable opportunities for us to acquire
existing generating capacity.
- OPPORTUNITY TO MANAGE ENERGY-RELATED RISKS. Power industry restructuring
is changing the manner in which power is purchased. Under the traditional
regulatory framework, customers typically purchase power from a
vertically-integrated utility at prices that do not vary as a function of
usage pattern or the overall supply/demand balance in the market.
However, in competitive markets, customers have the opportunity to
purchase electricity from a variety of sources at market prices that
reflect the actual price of electricity at a given point in time. As a
result, end users are subject to greater volatility in power prices. We
believe that there are attractive opportunities for us, as a retail
electric provider and intermediary, to manage these risks for customers
and to structure products to meet their demand profiles and risk
tolerances.
2
<PAGE> 6
OUR STRATEGY
Our strategy is to aggressively pursue profitable opportunities in the
deregulating wholesale and retail electric markets in order to deliver superior
value to our stockholders. We actively pursue opportunities where we believe our
skills-based commercial approach provides us with a competitive advantage. We
currently do not have any plans to invest outside the United States and Europe.
OUR STRATEGY IN THE U.S. WHOLESALE MARKET
We plan to continue to expand our regional asset portfolios and commercial
positions in the United States and to maximize their profitability. In order to
achieve these goals, we plan to:
- Capitalize on significant market positions in targeted regions of the
United States that we believe have attractive market fundamentals and
growth opportunities.
- Target strategic asset portfolios in our regional markets based on
prevailing supply and demand fundamentals in order to be able to meet the
full electricity requirements of customers.
- Grow through a combination of disciplined acquisitions, development of
new facilities and long-term contracts.
- Apply our trading, marketing and risk management skills to complement the
value of our generation operations.
OUR STRATEGY IN THE EUROPEAN WHOLESALE MARKET
We plan to maximize the value of our European operations and position
ourselves for long-term growth opportunities in the European marketplace. In
order to achieve these goals, we plan to:
- Optimize our portfolio of generation assets in the Netherlands by
reducing operating, maintenance and administrative costs while increasing
operational flexibility and commercializing these assets in the
deregulating Dutch market.
- Apply our commercial capabilities and incumbent position in the
Netherlands to opportunistically participate in additional European
markets, initially in Northwest Europe.
OUR STRATEGY IN THE U.S. RETAIL MARKET
We plan to establish a significant retail electric business in Texas when
the market opens to retail competition, and elsewhere in the United States as
attractive retail opportunities develop thereafter. In order to achieve these
goals, we plan to:
- Maximize retention of customers we will succeed to in Houston by
capitalizing on the high level of consumer awareness and positive
perception of the Reliant Energy brand name.
- Aggressively pursue Texas customers outside of Reliant Energy's Houston
service territory by capitalizing on our competitive strengths and
providing creative product offerings to encourage them to choose us as
their retail electric provider.
- Leverage our retail experience to pursue opportunities in targeted
markets outside Texas that have favorable regulatory structures and
profit opportunities.
- Capitalize on our wholesale trading, marketing and risk management
expertise to enhance our competitive retail position.
3
<PAGE> 7
Increasing competition in the wholesale and retail segments of the electric
power industry may impede our ability to successfully implement our strategy. We
compete with numerous competitors in our wholesale markets. After the beginning
of retail electric competition in Texas in January 2002, we expect that our
retail electric operations will face significant competition from new retail
electric providers entering the Houston metropolitan area as well as retail
affiliates of incumbent utilities in other markets in Texas. We expect that we
will need to secure external sources of capital to finance our future
acquisition and development activities. Any failure to obtain future sources of
capital on commercially acceptable terms may limit our ability to successfully
implement our growth strategy. Our wholesale and retail energy businesses
operate in the deregulating segments of the electric power industry created by
restructuring initiatives at both the state and federal levels. We cannot
predict the future development of deregulation in these markets or the ultimate
effect that the changing regulatory environment will have on our businesses.
Existing regulations may be revised or reinterpreted and new laws or
regulations, including price regulations, may be adopted that adversely affect
our businesses and strategic opportunities.
OUR RELATIONSHIP WITH RELIANT ENERGY
We are currently a wholly owned subsidiary of Reliant Energy, Incorporated.
Reliant Energy is an international energy delivery and energy services company
based in Houston, Texas. Upon the completion of this offering, Reliant Energy
will own over 80% of the outstanding shares of our common stock. Reliant Energy
has announced that it currently plans to complete a spin-off of our company
within twelve months of the completion of this offering by distributing the
remaining shares of our common stock it owns to its shareholders. Following the
distribution, we expect Reliant Energy will remain engaged in the transmission
and distribution of electric power and the transportation and distribution of
natural gas. It will also remain engaged in power generation, subject to our
Texas Genco option.
We have entered into agreements with Reliant Energy related to the
separation of our businesses from Reliant Energy. These separation agreements
provide for the transfer of assets and liabilities relating to our businesses.
These agreements also govern interim and ongoing relationships with Reliant
Energy, including the provision by Reliant Energy to us of various interim
services.
Reliant Resources, Inc. was incorporated in Delaware in August 2000 as a
wholly owned subsidiary of Reliant Energy. We are the successor to businesses in
which subsidiaries of Reliant Energy have previously been engaged. Our executive
offices are located at 1111 Louisiana, Houston, Texas 77002, and our telephone
number is (713) 207-3000.
RISK FACTORS
You should carefully consider the competitive factors affecting our
businesses as well as the other risks described in the "Risk Factors" section of
this prospectus before investing in our common stock. Any of these risks could
impair our business, financial condition and operating results, which could
cause the trading price of our common stock to decline and could result in a
partial or total loss of your investment.
4
<PAGE> 8
THE OFFERING
The following information assumes that the underwriters do not exercise the
option we granted them to purchase additional shares of common stock in the
offering. Please read "Underwriting."
<TABLE>
<S> <C>
Shares offered............................... 52,000,000 shares
Shares outstanding after the offering........ 292,000,000 shares
Shares held by Reliant Energy after the
offering................................... 240,000,000 shares
Use of proceeds.............................. We intend to use the net proceeds from this
offering for general corporate purposes
including development activities and
acquisitions. Please read "Use of Proceeds."
New York Stock Exchange trading symbol....... We intend to list our common stock on the New
York Stock Exchange under the trading symbol
"RRI."
</TABLE>
The number of shares outstanding after this offering excludes shares available
for issuance upon exercise of options that have been or may be granted in the
future under our long-term incentive plan.
5
<PAGE> 9
SUMMARY FINANCIAL DATA
You should read the following summary financial data together with our
consolidated financial statements and the related notes, "Selected Financial
Data" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this prospectus. The summary
financial data set forth below for the years ended December 31, 1997, 1998 and
1999 and the nine months ended September 30, 2000, have been derived from our
consolidated audited financial statements.
Our pro forma income statement data for the nine months ended September 30,
2000 give effect to our May 2000 acquisition of 21 generating facilities from
Sithe Energies, Inc., or the "Mid-Atlantic Acquisition," the subsequent
sale-leaseback of three of these facilities, or the "Sale-Leaseback," and the
recapitalization of our Net Accounts and Notes Payable to Affiliates into
Stockholder's Equity, or the "Recapitalization." Our pro forma income statement
data for the year ended December 31, 1999 give effect to our October 1999
acquisition of N.V. UNA, the Mid-Atlantic Acquisition, the Sale-Leaseback and
the Recapitalization. Our pro forma balance sheet data as of September 30, 2000
give effect to the Recapitalization. Our pro forma, as adjusted balance sheet
data as of September 30, 2000 reflect the sale of shares of our common stock in
this offering as well as the estimated net proceeds from this offering. For
further information regarding the pro forma effects of these transactions,
please read our unaudited pro forma condensed consolidated financial statements
included elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------ ----------------------------
PRO FORMA PRO FORMA
1997 1998 1999 1999 1999 2000 2000
---- ---- ---- --------- ---- ---- ---------
(millions of dollars)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues............................ $1,321 $4,371 $8,053 $8,563 $5,827 $12,820 $12,986
Expenses:
Fuel and cost of gas sold......... 978 2,352 3,985 4,167 2,682 6,249 6,302
Purchased power................... 313 1,824 3,736 3,781 2,936 5,518 5,517
Operation and maintenance......... 17 65 159 308 123 288 367
General, administrative and
development..................... 20 78 94 97 43 158 172
Depreciation and amortization..... 2 15 43 127 16 130 144
------ ------ ------ ------ ------ ------- -------
Total...................... $1,330 $4,334 $8,017 $8,480 $5,800 $12,343 $12,502
------ ------ ------ ------ ------ ------- -------
Operating (Loss) Income............. $ (9) $ 37 $ 36 $ 83 $ 27 $ 477 $ 484
Other (Expense) Income:
Interest expense.................. (1) (2) (12) (91) -- (37) (37)
Interest income................... -- 1 2 43 1 11 11
Interest income (expense) --
affiliated companies, net....... 2 2 (8) -- -- (122) --
Gains (losses) from investments... -- -- 16 16 -- (17) (17)
(Losses) income of equity
investment of unconsolidated
subsidiaries.................... -- (1) (1) (1) (1) 33 33
Gains on sale of development
project......................... -- -- -- -- -- 18 18
Other, net........................ -- 1 (7) (8) (6) 2 2
------ ------ ------ ------ ------ ------- -------
Total Other Income
(Expense)................ $ 1 $ 1 $ (10) $ (41) $ (6) $ (112) $ 10
------ ------ ------ ------ ------ ------- -------
(Loss) Income Before Income Taxes
and Extraordinary Item............ $ (8) $ 38 $ 26 $ 42 $ 21 $ 365 $ 494
Income Tax (Benefit) Expense........ (2) 17 2 -- 12 120 166
------ ------ ------ ------ ------ ------- -------
(Loss) Income Before Extraordinary
Item.............................. $ (6) $ 21 $ 24 $ 42 $ 9 $ 245 $ 328
====== =======
Extraordinary Item, net of tax...... -- -- -- -- 7
------ ------ ------ ------ -------
Net (Loss) Income................... $ (6) $ 21 $ 24 $ 9 $ 252
====== ====== ====== ====== =======
</TABLE>
6
<PAGE> 10
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1999 2000
----------------- -----------------
(millions of shares)
<S> <C> <C>
PRO FORMA EARNINGS PER SHARE INFORMATION(1):
Basic and Diluted Earnings Before Extraordinary Item Per
Common Share.............................................. $0.17 $1.37
===== =====
Basic and Diluted Weighted Average Shares Outstanding....... 240 240
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
----------------------- -------------
1997 1998 1999 1999 2000
---- ---- ---- ---- ----
(millions of dollars) (million of
dollars)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF CASH FLOW DATA:
Cash Flows From Operating
Activities.......................... $ (22) $ (2) $ 86 $ 5 $ 234
Cash Flows From Investing
Activities.......................... (4) (365) (1,404) (104) (2,780)
Cash Flows From Financing
Activities.......................... 26 379 1,354 453 2,741
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 2000
--------------------------------------
PRO FORMA, AS
ACTUAL PRO FORMA ADJUSTED
------ --------- -------------
(millions of dollars)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and Cash Equivalents................................... $ 254 $ 254 $ 1,057
Property, Plant and Equipment, net.......................... 3,722 3,722 3,722
Total Assets(2)............................................. 9,856 9,856 10,659
Short-term Borrowings....................................... 204 204 204
Long-term Debt to Third Parties, including current
maturities................................................ 802 802 802
Accounts and Notes Payable -- Affiliated Companies, net..... 2,419 -- --
Stockholder's Equity........................................ 2,066 4,485 5,288
</TABLE>
---------------
(1)Prior to August 9, 2000, Reliant Resources, Inc. was not a separate legal
entity and therefore had no historical capital structure. Accordingly,
historical earnings per share have not been presented for the historical
consolidated statements of operations.
(2)See Note 5(a) to our consolidated financial statements for a discussion of
adjustments to amounts previously recorded in connection with the
Mid-Atlantic Acquisition purchase price allocation.
7
<PAGE> 11
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This prospectus, including the sections entitled "Prospectus Summary,"
"Risk Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Our Business," contains forward-looking statements.
These statements relate to future events, our future financial performance or
our projected business results and involve known and unknown risks and
uncertainties. Actual results may differ materially from those expressed or
implied by these statements. In some cases, you can identify our forward-looking
statements by the words "anticipates," "believes," "continue," "could,"
"estimates," "expects," "intends," "may," "plans," "potential," "predicts,"
"should," "will" or other similar words.
The following list identifies some of the factors that could cause actual
results to differ from those expressed or implied by our forward-looking
statements:
- state and federal legislative and regulatory developments, including
deregulation, re-regulation and restructuring of the electric utility
industry and changes in or application of environmental and other laws
and regulations to which we are subject,
- the effects of competition, including the extent and timing of the entry
of additional competitors in our markets,
- our pursuit of potential business strategies, including acquisitions or
dispositions of assets or the development of additional power generation
facilities,
- state, federal and other rate regulations in the United States and in
foreign countries in which we operate or into which we might expand our
operations,
- the timing and extent of changes in commodity prices and interest rates,
- weather variations and other natural phenomena,
- political, legal and economic conditions and developments in the United
States and in foreign countries in which we operate or into which we
might expand our operations, including the effects of fluctuations in
foreign currency exchange rates,
- financial market conditions and the results of our financing efforts,
- the performance of projects undertaken and the success of our efforts to
invest in and develop new opportunities, and
- other factors we discuss in this prospectus, including those outlined in
"Risk Factors."
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, actual results may differ materially from those
expressed or implied by our forward-looking statements.
8
<PAGE> 12
RISK FACTORS
You should carefully consider the risks described below as well as other
information contained in this prospectus before buying shares of our common
stock in this offering. These are the risks we consider to be material to your
decision whether to invest in our common stock at this time. There may be risks
that you view in a different way than we do, and we may omit a risk that we
consider immaterial but that you would consider important. If any of the
following risks occur, our business, financial condition or results of
operations could be materially harmed. In that case, the trading price of our
common stock could decline, and you may lose all or part of your investment.
RISKS RELATED TO OUR WHOLESALE BUSINESS
OUR REVENUES AND RESULTS OF OPERATIONS ARE SUBJECT TO MARKET RISKS THAT ARE
BEYOND OUR CONTROL.
We sell electricity from our power generation facilities into the spot
market or other competitive power markets or on a contractual basis. We are not
guaranteed any rate of return on our capital investments through mandated rates,
and our revenues and results of operations are likely to depend, in large part,
upon prevailing market prices for electricity in our regional markets and other
competitive markets. These market prices may fluctuate substantially over
relatively short periods of time. In addition, the Federal Energy Regulatory
Commission, or "FERC," which has jurisdiction over wholesale power rates, as
well as independent system operators that oversee some of these markets, may
impose price limitations, bidding rules and other mechanisms to address some of
the volatility in these markets. Most of our domestic power generation
facilities purchase fuel under short-term contracts or on the spot market. Fuel
prices may also be volatile, and the price we can obtain for power sales may not
change at the same rate as changes in fuel costs. These factors could have an
adverse impact on our revenues and results of operations.
Volatility in market prices for fuel and electricity may result from:
- weather conditions,
- seasonality,
- electricity usage,
- illiquid markets,
- transmission or transportation constraints or inefficiencies,
- availability of competitively priced alternative energy sources,
- demand for energy commodities,
- natural gas, crude oil and refined products, and coal production levels,
- natural disasters, wars, embargoes and other catastrophic events, and
- federal, state and foreign energy and environmental regulation and
legislation.
WE DO NOT ATTEMPT TO FULLY HEDGE OUR ASSETS OR POSITIONS AGAINST CHANGES IN
COMMODITY PRICES, AND OUR HEDGING PROCEDURES MAY NOT WORK AS PLANNED.
To lower our financial exposure related to commodity price fluctuations,
our trading, marketing and risk management operations routinely enter into
contracts to hedge a portion of our purchase and sale commitments, weather
positions, fuel requirements and inventories of natural gas, coal, crude oil and
refined products, and other commodities. As part of this strategy, we routinely
utilize fixed-price forward physical purchase and sales contracts, futures,
financial swaps and option contracts traded in the over-the-counter markets or
on exchanges. However, we do not expect to cover the entire exposure of our
assets or our positions to market price volatility and the coverage will vary
over time. To the extent we have unhedged positions, fluctuating commodity
prices can impact our financial results and financial position, either favorably
or unfavorably.
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At times we have open trading positions in the market, within established
guidelines, resulting from the management of our trading portfolio. To the
extent open trading positions exist, fluctuating commodity prices can impact our
financial results and financial position, either favorably or unfavorably.
The risk management procedures we have in place may not always be followed
or may not always work as planned. As a result of these and other factors, we
cannot predict with precision the impact that our risk management decisions may
have on our businesses, operating results or financial position. Although we
devote a considerable amount of management efforts to these issues, their
outcome is uncertain.
Our trading, marketing and risk management operations are exposed to the
risk that counterparties which owe us money or energy as a result of market
transactions will not perform their obligations. Should the counterparties to
these arrangements fail to perform, we might be forced to acquire alternative
hedging arrangements or honor the underlying commitment at then-current market
prices. In such event, we might incur additional losses to the extent of
amounts, if any, already paid to the counterparties.
In connection with our trading and marketing operations, we have guaranteed
or indemnified the performance of a portion of the obligations of our trading
and marketing subsidiaries. Some of these guarantees and indemnities are for
fixed amounts, others have a fixed maximum amount and others do not specify a
maximum amount. The obligations underlying these guarantees and indemnities are
recorded on our consolidated balance sheet as accounts payable, price risk
management liabilities (current liabilities) and price risk management
liabilities (other liabilities). These obligations make up a significant portion
of these line items. We might not be able to satisfy all of these guarantees and
indemnification obligations if they were to come due at the same time.
OUR ACQUISITION AND PROJECT DEVELOPMENT ACTIVITIES MAY NOT BE SUCCESSFUL, WHICH
WOULD IMPAIR OUR ABILITY TO EXECUTE OUR GROWTH STRATEGY.
Our business involves numerous risks relating to the acquisition,
development and construction of power generation facilities. We may not be able
to identify attractive acquisition or development opportunities or complete
acquisitions or development projects that we undertake. If we are not able to
identify and complete additional acquisitions and development projects, we will
not be able to successfully execute our growth strategy. In addition, the
success of our future acquisitions or development projects will depend on the
appropriateness of the prices we pay for them. If our assumptions underlying the
prices we pay for future acquisitions or development projects prove to be
materially inaccurate, there could be a significant impact on the financial
performance of the particular facility and possibly our entire company. The
following factors could cause our acquisition and development activities to be
unsuccessful:
- a limited number of potential acquisitions,
- competition,
- the applicable regulatory environment,
- inability to obtain additional capital on acceptable terms,
- inability to obtain required governmental permits and approvals,
- cost-overruns or delays in development that make continuation of a
project impracticable,
- inability to obtain combustion turbines at reasonable prices,
- inability to negotiate acceptable acquisition, construction, fuel supply
or other material agreements, and
- inability to hire and retain qualified personnel.
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Currently, we have power generation facilities under development or
construction and we intend to pursue additional development projects, including
the expansion of some of our existing facilities. Our completion of these
facilities is subject to the following substantial risks:
- changes in market prices,
- shortages and inconsistent qualities of equipment, material and labor,
- work stoppages,
- permitting and other regulatory matters,
- adverse weather conditions,
- unforeseen engineering problems,
- environmental and geological conditions, and
- unanticipated cost increases.
Any of these factors could give rise to delays, cost overruns or the termination
of the plant expansion, construction or development. Many of these risks cannot
be adequately covered by insurance. While we maintain insurance, obtain
warranties from vendors and obligate contractors to meet specified performance
standards, the proceeds of such insurance, warranties or performance guarantees
may not be adequate to cover lost revenues, increased expenses or liquidated
damages payments we may owe.
If we were unable to complete the development of a facility, we would
generally not be able to recover our investment in the project. The process for
obtaining initial environmental, siting and other governmental permits and
approvals is complicated, expensive, lengthy and subject to significant
uncertainties. In addition, construction delays and contractor performance
shortfalls can result in the loss of revenues and may, in turn, adversely affect
our results of operations. The failure to complete construction according to
specifications can result in liabilities, reduced plant efficiency, higher
operating costs and reduced earnings. We may not be successful in the
development or construction of power generation facilities in the future.
RECENT HIGH PRICES IN THE CALIFORNIA WHOLESALE POWER MARKETS HAVE NEGATIVELY
IMPACTED THE OPERATING RESULTS AND FINANCIAL STABILITY OF SOME OF CALIFORNIA'S
ELECTRIC UTILITIES. IF THESE UTILITIES DEFAULT ON THEIR OBLIGATIONS TO PAY FOR
THEIR PURCHASED POWER, OUR WHOLESALE POWER OPERATIONS SERVING THE CALIFORNIA
MARKET MAY FACE DELAYS IN THE COLLECTION OF PAYMENTS FOR POWER SOLD IN THOSE
MARKETS.
Our wholesale energy operations in California have been caught up in a
major crisis in that state's wholesale electric market in the year 2000. Driven
by a shortage of generation capacity, reduced hydroelectric power availability,
higher summer temperatures, higher natural gas prices, and a malfunctioning
wholesale power system, wholesale prices for electricity rose to unprecedented
levels of price and volatility. California's two largest utilities, however,
have been forced to continue selling power to retail customers at frozen rates
far below the high prevailing market prices, which by December 2000 caused these
utilities to publicly disclose their imminent inability to continue meeting
their payment obligations for purchased power without immediate regulatory
relief. To date, the FERC has refused requests to impose regulated prices on the
wholesale market, but did order sweeping changes in California's wholesale
markets. The California Public Utility Commission, however, commenced
rate-increase hearings and has stated that rates must rise to avert bankruptcy
filings by the utilities.
The third and fourth quarters of 2000 were marked by numerous regulatory
proceedings and by protracted conflict and controversy between and among state
and federal officials and agencies concerning these issues. Under such
conditions of public controversy, governmental actions are possible that could
impose adverse impacts on our revenues and results of operations.
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Additionally, agency actions to grant rate relief to California's two
largest utilities might not be completed, or adverse legislative action could be
taken, that might cause these utilities to seek protection under Chapter 11 of
the bankruptcy laws. This could cause significant delays in collecting our
receivables for pre-filing sales made through California's market channels to
these utilities.
WE INCUR SIGNIFICANT EXPENSES IN EVALUATING POTENTIAL ACQUISITIONS AND
DEVELOPMENT PROJECTS.
To implement our growth strategy, we must continue to actively pursue
acquisition and development opportunities. We often incur substantial expenses
in investigating and evaluating a potential business development opportunity
before we can determine whether the opportunity is feasible or economically
attractive. In addition, we expect to participate in many competitive bidding
processes or other negotiations for power generation facilities that require us
to incur substantial expenses without any assurance that our bids or proposals
will be accepted.
SOME OPPORTUNITIES TO ACQUIRE POWER GENERATION ASSETS MAY BE AVAILABLE ONLY IF
WE ARE ALSO WILLING TO ACQUIRE REGULATED UTILITY OPERATIONS.
In the current changing environment for the electric power industry,
integrated utility companies may become available for acquisition from time to
time. These potential acquisitions may present attractive opportunities to
acquire additional power generation assets. However, in order to consummate an
acquisition of this nature, we may be required to acquire the entire integrated
utility company. The entire company may include transmission and distribution
operations that continue to be subject to rate regulation. In addition, some
power generation assets that are available for acquisition may continue to be
subject to state regulation. To address the regulatory issues presented by such
an acquisition, we might seek to find another buyer for regulated operations of
the target company that we did not wish to own. Alternatively, if we were to
acquire regulated operations ourselves either on an interim or permanent basis,
we would need to find acceptable means of addressing constraints or obstacles
that may be imposed by applicable state regulatory regimes or by the 1935 Act.
These regulatory issues, or their solutions, may increase the complexity or
reduce the likelihood of closing a transaction of this type and acquiring the
power generation assets.
WE HAVE MADE SUBSTANTIAL INVESTMENTS IN OUR RECENT ACQUISITIONS AND DEVELOPMENT
PROJECTS, AND OUR SUCCESS DEPENDS ON OUR ABILITY TO SUCCESSFULLY INTEGRATE,
OPERATE AND MANAGE THESE ASSETS.
During the period from December 31, 1998 through December 1, 2000, we have
expanded our net generating capacity from 3,800 MW to 12,707 MW. In connection
with these acquisitions and projects, we have hired a substantial number of new
employees. We may not be able to successfully integrate all of the newly hired
employees, or profitably integrate, operate, maintain and manage our newly
acquired or developed power generation facilities in a competitive environment.
OPERATION OF POWER GENERATION FACILITIES INVOLVES SIGNIFICANT RISKS THAT COULD
NEGATIVELY AFFECT OUR REVENUES AND RESULTS OF OPERATIONS.
We are exposed to risks relating to the breakdown or failure of equipment
or processes, fuel supply interruptions, shortages of equipment, material and
labor, and operating performance below expected levels of output or efficiency.
A significant portion of our facilities were constructed many years ago. Older
generating equipment, even if maintained in accordance with good engineering
practices, may require significant capital expenditures to keep it operating at
peak efficiency. This equipment is also likely to require periodic upgrading and
improvement. Any unexpected failure to produce power, including failure caused
by breakdown or forced outage, could result in reduced earnings.
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WE WILL EXPERIENCE A SIGNIFICANT DECLINE IN OUR EUROPEAN ENERGY BUSINESS
SEGMENT'S REVENUES IN 2001.
On January 1, 2001, our Dutch subsidiary, N.V. UNA, or "UNA," began
operating in a competitive market. Consistent with our expectations at the time
we made the acquisition, we anticipate that UNA will experience a significant
decline in revenues in 2001 attributable to the deregulation of the market and
termination of an agreement with the other Dutch generators and the Dutch
distributors. In addition, the results of our European Energy segment will be
negatively impacted beginning in 2002 due to the imposition of a standard Dutch
corporate income tax rate, which is currently 35%, on the income of UNA. In 2000
and prior years, UNA's Dutch corporate income tax rate was zero percent.
OUR COSTS OF COMPLIANCE WITH ENVIRONMENTAL LAWS ARE SIGNIFICANT AND THE COST OF
COMPLIANCE WITH NEW ENVIRONMENTAL LAWS COULD ADVERSELY AFFECT OUR PROFITABILITY.
Our wholesale business is subject to extensive environmental regulation by
federal, state and local authorities. We are required to comply with numerous
environmental laws and regulations, and to obtain numerous governmental permits,
in operating our facilities. We may incur significant additional costs to comply
with these requirements. If we fail to comply with these requirements, we could
be subject to civil or criminal liability and fines. Existing environmental
regulations could be revised or reinterpreted, new laws and regulations could be
adopted or become applicable to us or our facilities, and future changes in
environmental laws and regulations could occur, including potential regulatory
and enforcement developments related to air emissions. If any of these events
occur, our business, operations and financial condition could be adversely
affected.
We may not be able to obtain or maintain from time to time all required
environmental regulatory approvals. If there is a delay in obtaining any
required environmental regulatory approvals or if we fail to obtain and comply
with them, the operation of our facilities could be prevented or become subject
to additional costs.
We are generally responsible for all on-site liabilities associated with
the environmental condition of our power generation facilities which we have
acquired and developed, regardless of when the liabilities arose and whether
they are known or unknown. These liabilities may be substantial.
WE RELY ON POWER TRANSMISSION FACILITIES THAT WE DO NOT OWN OR CONTROL. IF THESE
FACILITIES FAIL TO PROVIDE US WITH ADEQUATE TRANSMISSION CAPACITY, WE MAY NOT BE
ABLE TO DELIVER OUR WHOLESALE ELECTRIC POWER PRODUCTS TO OUR CUSTOMERS.
We depend on transmission and distribution facilities owned and operated by
utilities and other power companies to deliver the electricity we sell from our
power generation facilities to our customers, who, in turn deliver these
products to the ultimate consumers of the power. If transmission is disrupted,
or transmission capacity is inadequate, our ability to sell and deliver our
products may be hindered. Please read "Risks Related to Our Businesses
Generally" for a discussion of transmission regulation that can affect access to
and availability of transmission.
INCREASING COMPETITION IN THE WHOLESALE POWER MARKET MAY ADVERSELY AFFECT OUR
ABILITY TO MAKE FUTURE INVESTMENTS OR ACQUISITIONS.
The wholesale power industry has numerous competitors, some of which may
have more operating experience, more acquisition and development experience,
larger staffs and/or greater financial resources than we do. Like us, many of
our competitors are seeking attractive opportunities to acquire or develop power
generation facilities, both in the United States and abroad. This competition
may adversely affect our ability to make investments or acquisitions.
Industry restructuring requires or encourages the disaggregation of many
vertically-integrated utilities into separate generation, transmission and
distribution, and retail businesses. As a result, a significant number of
additional competitors could become active in the wholesale power generation
segment of our industry.
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While demand for electric energy services is generally increasing
throughout the United States, the rate of construction and development of new,
more efficient electric generation facilities may exceed increases in demand in
some regional electric markets. The commencement of commercial operation of new
facilities in the regional markets where we have facilities will likely increase
the competitiveness of the wholesale power market in those regions, which could
have a material negative effect on our business, results of operations and
financial condition.
RISKS RELATED TO OUR RETAIL ELECTRICITY BUSINESS
WE MAY LOSE A SIGNIFICANT NUMBER OF THE RETAIL CUSTOMERS WE WILL SUCCEED TO IN
THE HOUSTON METROPOLITAN AREA.
Beginning on January 1, 2002, all customers in Texas of investor-owned
utilities, and those of any municipal utility and electric cooperative that opts
to participate in the competitive marketplace, will be able to choose their
retail electric provider. Beginning on that date, we will provide retail
electric services to all customers of Reliant Energy's electric utility division
who do not take action to select another retail electric provider. Under the
market framework established by the Texas electric restructuring law enacted in
1999, we will initially be required to sell electricity to these Houston area
residential and small commercial customers at a specified price, which is
referred to in the law as the "price to beat," whereas other retail electric
providers will be allowed to sell electricity to these customers at any price.
We will not be permitted to offer electricity to these customers at a price
other than the price to beat until January 1, 2005, unless before that date the
Public Utility Commission of Texas, or "Texas Utility Commission," determines
that 40% or more of the amount of electric power that was consumed in 2000 by
the relevant class of customers is committed to be served by retail electric
providers other than us. Because we will not be able to compete for residential
and small commercial customers on the basis of price in the Houston area and
since we expect that the retail market framework established by the Texas
electric restructuring law will encourage competition from new retail electric
providers, we may lose a significant number of these customers to other
providers.
In addition, we intend to provide commodity and value-added energy
management services to the large commercial and industrial customers currently
served by Reliant Energy who do not take action to select another retail
electric provider beginning on January 1, 2002. We or any other retail electric
provider can offer to provide services to these customers at any negotiated
price. We believe that the market will be very competitive, and therefore, a
significant number of these customers may choose to be served by another retail
electric provider and any of these customers that select us to be their provider
may subsequently decide to switch to another provider.
IN MARKETS OUTSIDE OF HOUSTON, WE MAY FACE STRONG COMPETITION FROM INCUMBENT
UTILITIES AND OTHER COMPETITORS.
In most retail electric markets outside the Houston area, our principal
competitor may be the local incumbent utility company or its retail affiliate.
The incumbent utilities have the advantage of long-standing relationships with
their customers. In addition to competition from the incumbent utilities and
their affiliates, we may face competition from a number of other energy service
providers, including start-up companies focusing on Internet marketing and
online services, and other energy industry participants who may develop
businesses that will compete with us in both local and national markets. We also
may face competition from nationally branded providers of consumer products and
services. Some of these competitors or potential competitors may be larger and
better capitalized than we are.
SOME REGULATIONS GOVERNING THE RETAIL ELECTRIC MARKET IN TEXAS HAVE NOT YET BEEN
ADOPTED AND COULD HAVE A MATERIAL NEGATIVE IMPACT ON OUR BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION.
While the 1999 Texas electric restructuring law established the general
framework governing the retail electric market in Texas, the law requires the
Texas Utility Commission to issue a
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number of new rules and determinations implementing the law. Some of the
regulations governing the Texas retail electric market have not yet been adopted
by the Texas Utility Commission. These regulations, when they are developed and
adopted, may have a material negative impact on our business, results of
operations and financial condition.
WE MAY BE REQUIRED TO MAKE A SUBSTANTIAL PAYMENT TO RELIANT ENERGY IN EARLY
2004.
We will be required to make a payment to Reliant Energy in early 2004
unless the Texas Utility Commission determines that, on or prior to January 1,
2004, 40% or more of the amount of electric power that was consumed in 2000 by
residential or small commercial customers, as applicable, within Reliant
Energy's Houston service territory as of January 1, 2002 is committed to be
served by retail electric providers other than us. If the 40% test is not met
and a payment is required, the amount of this payment will not exceed, but could
be up to, $150 per customer multiplied by the number of residential or small
commercial customers, as the case may be, that we serve on January 1, 2004 in
Reliant Energy's traditional service territory, less the number of new retail
electric customers we serve in other areas of Texas. As of September 30, 2000,
Reliant Energy had approximately 1.5 million residential and small commercial
customers. In the master separation agreement, we have agreed to make this
payment, if any, to Reliant Energy.
WE WILL RELY ON THE INFRASTRUCTURE OF LOCAL UTILITIES OR INDEPENDENT
TRANSMISSION SYSTEM OPERATORS TO PROVIDE ELECTRICITY TO AND TO OBTAIN
INFORMATION ABOUT OUR RETAIL CUSTOMERS. ANY INFRASTRUCTURE FAILURE COULD
NEGATIVELY IMPACT OUR CUSTOMERS' SATISFACTION AND COULD HAVE A MATERIAL NEGATIVE
IMPACT ON OUR BUSINESS AND RESULTS OF OPERATIONS.
In Texas, we will be dependent on the local transmission and distribution
utilities for maintenance of the infrastructure through which we will deliver
electricity to our customers. Any infrastructure failure that interrupts or
impairs delivery of electricity to our customers could negatively impact the
satisfaction of our customers with our service. Additionally, in Texas, we will
be dependent on the local transmission and distribution utilities for the
reading of our customers' energy meters. We will be required to rely on the
local utility or, in some cases, the independent transmission system operator,
to provide us with our customers' information regarding energy usage, and we may
be limited in our ability to confirm the accuracy of the information. The
provision of inaccurate information by the local utilities or system operators
could have a material negative impact on our business and results of operations.
In connection with our entry into retail electric markets outside of Texas,
we may be required under the regulatory structure of the relevant market to rely
on utilities with which we may be competing to perform billing and collection
services, the services and functions described in the prior paragraph or other
services and functions. In addition, we may be required to enter into agreements
with local incumbent utilities for use of the local distribution systems and for
the creation and operation of functional interfaces necessary for us to serve
our customers. Any delay in these negotiations or our inability to enter into
reasonable agreements could delay or negatively impact our ability to serve
customers in those markets.
WE PLAN TO OFFER BUNDLED SERVICES TO OUR RETAIL CUSTOMERS AT FIXED PRICES AND
FOR FIXED TERMS. IF OUR COSTS TO OBTAIN THE COMMODITIES INCLUDED IN THESE
BUNDLED SERVICES EXCEED THE PRICES PAID BY OUR CUSTOMERS, OUR OPERATING RESULTS
COULD BE ADVERSELY AFFECTED.
We plan to offer retail customers a bundle of services that will include,
at a minimum, the electric commodity itself plus transmission, distribution, and
related service charges. To the extent that the prices we charge for this bundle
of services or for the various components of the bundle, either of which may be
fixed by contract with the customer for a period of time, differ from our
underlying cost to obtain the commodities or services, our results of operations
would be affected. We will encounter similar risks in selling bundled services
that include non-energy-related services, such as telecommunications, Internet
access, appliance repair, facilities management, and the like. In some cases, we
have little, if any, prior experience in selling these non-energy-related
services.
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IF THE SYSTEMS AND PROCESSES WE ARE DEVELOPING FOR OUR RETAIL BUSINESS ARE MORE
EXPENSIVE TO COMPLETE THAN EXPECTED OR DO NOT WORK AS PLANNED, OUR OPERATING
RESULTS MAY BE ADVERSELY AFFECTED.
The information systems and processes necessary to support sales, customer
service and electricity supply in competitive retail markets as envisioned in
Texas and elsewhere are new, complex and extensive. We are still developing
these systems and processes, and they may prove more expensive to complete than
planned and may not work as planned.
IF WE ARE DESIGNATED AS A "PROVIDER OF LAST RESORT" BY THE TEXAS UTILITY
COMMISSION, WE MAY BE OBLIGATED TO PROVIDE RETAIL ELECTRIC SERVICES AT PRICES
BELOW THOSE WE WOULD OTHERWISE CHARGE, WHICH COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.
The Texas electric restructuring law requires the Texas Utility Commission
to determine procedures and criteria for designating retail electric providers
to serve as providers of last resort in areas of the state in which retail
competition is in effect. A provider of last resort is required to offer a
standard retail electric service package for each class of customers designated
by the Texas Utility Commission at a rate approved by the Commission. It is also
required to provide the service package to any requesting retail customer in the
territory for which it is the provider of last resort. In the event that another
retail electric provider fails to serve any or all of its customers, the
provider of last resort is required to offer that customer the standard retail
service package for that customer class with no interruption of service to the
customer. So long as we choose to remain a retail electric provider, we may be
designated as a provider of last resort by the Texas Utility Commission. If we
are designated as the provider of last resort and the approved rate at which we
are required to offer the standard retail electric service package is less than
the price we would otherwise charge, our results of operations may be materially
adversely affected.
IF THE TEXAS UTILITY COMMISSION DELAYS THE OPENING OF THE TEXAS RETAIL ELECTRIC
MARKET TO COMPETITION, OUR RETAIL ELECTRIC BUSINESS MAY NOT GENERATE ANY
REVENUES DURING THE PERIOD OF DELAY.
While the Texas electric restructuring law calls for the implementation of
a competitive retail electric market in Texas beginning on January 1, 2002, the
law authorizes the Texas Utility Commission to delay the date on which the
retail electric market is opened to competition in any power region in Texas if
it determines that the region is unable to offer fair competition and reliable
service to all retail customer classes on that date. Most of the significant
dates in the Texas electric restructuring law are specified anniversaries of the
date on which the retail electric market is opened to competition. We have
assumed throughout this prospectus that open retail electric competition in
Texas will begin on January 1, 2002 and that the specified anniversaries are
January 1 of the appropriate year. To the extent that the Texas Utility
Commission delays the implementation of a competitive market beyond that date,
all references to the January 1, 2002 open competition date and the
anniversaries of this date shall refer to the date on which a competitive retail
electric market is implemented by the Texas Utility Commission and the
appropriate anniversary of that date, respectively. During any delay period, we
may not earn any revenue from our retail electric business.
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RISKS RELATED TO OUR BUSINESSES GENERALLY
OUR WHOLESALE AND RETAIL ENERGY BUSINESSES OPERATE IN THE DEREGULATING SEGMENTS
OF THE ELECTRIC POWER INDUSTRY CREATED BY RESTRUCTURING INITIATIVES AT BOTH
STATE AND FEDERAL LEVELS. IF THE PRESENT TREND TOWARDS COMPETITIVE RESTRUCTURING
OF THE ELECTRIC POWER INDUSTRY IS REVERSED, DISCONTINUED OR DELAYED, OUR
BUSINESS PROSPECTS AND FINANCIAL CONDITION COULD BE MATERIALLY ADVERSELY
IMPAIRED.
The regulatory environment applicable to the electric power industry has
recently undergone substantial changes as a result of restructuring initiatives
at both the state and federal levels. These initiatives have had a significant
impact on the nature of the industry and the manner in which its participants
conduct their business. We have targeted the deregulating wholesale and retail
segments of the electric power industry created by these initiatives. These
changes are ongoing and we cannot predict the future development of deregulation
in these markets or the ultimate effect that this changing regulatory
environment will have on our business.
Moreover, existing regulations may be revised or reinterpreted, new laws
and regulations may be adopted or become applicable to us or our facilities, and
future changes in laws and regulations may have a detrimental effect on our
business. Certain restructured markets have recently experienced supply problems
and price volatility. These supply problems and volatility have been the subject
of a significant amount of press coverage, much of which has been critical of
the restructuring initiatives. In some of these markets, including California,
proposals have been made by governmental agencies and/or other interested
parties to re-regulate areas of these markets which have previously been
deregulated. We cannot assure you that other proposals to re-regulate will not
be made or that legislative or other attention to the electric power
restructuring process will not cause the process to be delayed or reversed. If
the current trend towards competitive restructuring of the wholesale and retail
power markets is reversed, discontinued or delayed, our business prospects and
financial condition could be materially adversely impaired.
IF WE FAIL TO OBTAIN OR MAINTAIN ANY NECESSARY GOVERNMENTAL PERMIT OR APPROVAL,
OUR RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED.
Our operations are subject to complex and stringent energy, environmental
and other governmental laws and regulations. The acquisition, ownership and
operation of power generation facilities require numerous permits, approvals and
certificates from federal, state and local governmental agencies. The operation
of our generation facilities must also comply with environmental protection and
other legislation and regulations. At present, our operations are subject to
regulation in California, Florida, Illinois, Maryland, Nevada, New Jersey,
Pennsylvania and Texas. Most of our existing domestic generation facilities are
exempt wholesale generators, or "EWGs," which sell electricity exclusively into
the wholesale market. These facilities are subject to regulation by the FERC
regarding rate matters and by state public utility commissions regarding
non-rate matters. The FERC has authorized us to sell our generation from these
facilities at market prices. The FERC retains the authority to modify or
withdraw our market-based rate authority and to impose "cost of service" rates
if it determines that market pricing is not in the public interest. Any
reduction by the FERC of the rates we may receive for our generation activities
may materially adversely affect our results of operations.
CHANGES IN TECHNOLOGY MAY IMPAIR THE VALUE OF OUR POWER PLANTS AND MAY
SIGNIFICANTLY IMPACT OUR BUSINESS IN OTHER WAYS AS WELL.
Research and development activities are ongoing to improve alternative
technologies to produce electricity, including fuel cells, microturbines and
photovoltaic (solar) cells. It is possible that advances in these or other
alternative technologies will reduce the costs of electricity production from
these technologies to a level below that which we have forecasted. In addition,
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electricity demand could be reduced by increased conservation efforts and
advances in technology, which could likewise significantly reduce the value of
our power generation assets. Changes in technology could also alter the channels
through which retail electric customers buy electricity.
OUR RESULTS ARE SUBJECT TO QUARTERLY AND SEASONAL FLUCTUATIONS, WHICH MAY
ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
Our quarterly operating results have fluctuated in the past and will
continue to do so in the future as a result of the following factors:
- variations in levels of production due to price changes, weather and
seasonality,
- volatility of market prices of open trading positions,
- the timing and size of acquisitions, and
- the completion of development projects.
THE VALUE OF OUR FOREIGN GENERATING FACILITIES AND BUSINESSES MAY BE REDUCED BY
RISKS RELATED TO LAWS OF OTHER COUNTRIES, TAXES, ECONOMIC CONDITIONS,
FLUCTUATIONS IN CURRENCY RATES, POLITICAL CONDITIONS, POLICIES OF FOREIGN
GOVERNMENTS AND LABOR SUPPLY AND RELATIONS.
We currently have generation facilities in the Netherlands and trading,
marketing and risk management operations in Northwest Europe. Operations outside
the United States entail the following significant political and financial
risks, which vary by country:
- changes in laws or regulations,
- changes in foreign tax laws and regulations,
- changes in U.S. laws, including tax laws, related to foreign operations,
- changes in general economic conditions affecting each country,
- fluctuations in inflation and currency exchange rates,
- changes in government policies or personnel, and
- changes in labor relations in operations outside the United States.
Our actual results may be affected by the occurrence of any of these
events. The occurrence of any of these events could substantially reduce the
value of the impacted generating facilities or businesses.
RISKS RELATED TO OUR CORPORATE AND FINANCIAL STRUCTURE
IF WE ARE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, OUR ABILITY
TO PURSUE ATTRACTIVE ACQUISITION AND DEVELOPMENT ACTIVITIES COULD BE LIMITED.
Our business strategy anticipates significant future acquisitions and
development of additional generating facilities. We are continually reviewing
potential acquisitions and development projects, and may enter into significant
acquisitions or development projects in the near future. Any acquisition or
development project will likely require access to substantial capital from
outside sources on acceptable terms. We may also need external financing to fund
capital expenditures, including capital expenditures necessary to comply with
air emission regulations or other regulatory requirements. Depending on our
performance and market conditions prevailing at the time of any of these
acquisitions and development projects, we may not be able to arrange
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for necessary financing on terms that are acceptable to us, which could have the
effect of limiting our ability to pursue desirable acquisitions and development
opportunities.
Our ability to arrange debt financing and the costs of debt capital are
dependent on the following factors:
- general economic and capital market conditions,
- credit availability from banks and other financial institutions,
- investor confidence in us and our regional wholesale power markets,
- maintenance of acceptable credit ratings,
- the success of current projects,
- the perceived quality of new projects, and
- provisions of relevant tax and securities laws.
Future indebtedness may include terms that are more restrictive or
burdensome than those of our current indebtedness. This may negatively impact
our ability to operate our business, or severely restrict or prohibit
distributions from our subsidiaries.
In the past, a significant amount of our debt and equity capital needs has
been satisfied by Reliant Energy. Reliant Energy and some of its subsidiaries
have also periodically provided credit support to us. In addition, we believe
that we have obtained third-party financing on relatively favorable terms based
in part on Reliant Energy's ownership interest in us. Following this offering,
Reliant Energy will no longer provide financing or credit support except for
specified transactions or for a limited period of time. As a result, we may not
be able to obtain third-party financing on terms that are as favorable as we
have experienced in the past.
WE MAY WISH TO FINANCE FUTURE ACQUISITIONS BY ISSUING ADDITIONAL EQUITY
SECURITIES, WHICH COULD RESULT IN SIGNIFICANT DILUTION OF OUR STOCKHOLDERS.
ALSO, PRIOR TO OUR SEPARATION FROM RELIANT ENERGY, WE WILL GENERALLY BE UNABLE
TO ISSUE EQUITY SECURITIES WITHOUT RELIANT ENERGY'S PRIOR CONSENT.
In order to finance future acquisitions, we may wish to issue additional
equity securities in amounts which could be substantial. If we issue additional
equity securities, it may result in dilution of our stockholders, which could be
significant.
In order for the distribution of the remaining shares of our common stock
to be tax-free to Reliant Energy and its shareholders, Reliant Energy must own
at least 80% of all classes of our outstanding capital stock at the time of the
distribution. Therefore, prior to our separation from Reliant Energy, we will
not be able to issue equity or voting debt without Reliant Energy's prior
consent, and Reliant Energy is unlikely to give that consent so long as it still
intends to distribute the remaining shares to its shareholders. This limitation
could have the effect of limiting our ability to pursue desirable acquisitions
and development opportunities.
IF WE EXERCISE OUR OPTION TO PURCHASE THE CAPITAL STOCK OF TEXAS GENCO OWNED BY
RELIANT ENERGY, WE WILL OWE FIDUCIARY DUTIES TO TEXAS GENCO'S MINORITY
STOCKHOLDERS, WHICH MAY RESTRICT OUR CONTROL OVER TEXAS GENCO'S COMMERCIAL
RELATIONSHIPS AND OPERATIONS.
Reliant Energy has granted us an option to purchase in 2004 the 81%
interest it is expected to own in the entity owning the Texas generating assets
of Reliant Energy's electric utility division, which we refer to as "Texas
Genco." If we exercise this option, we will own a majority interest in a
substantial subsidiary that has public shareholders owning the remaining amount
of its common stock. Upon exercise of this option, we will owe fiduciary duties
to Texas Genco's
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minority stockholders which may restrict our control of Texas Genco and the
commercial relationships between Texas Genco and our other subsidiaries.
OUR HOLDING COMPANY STRUCTURE LIMITS OUR ACCESS TO THE FUNDS OF SOME OF OUR
SUBSIDIARIES WHICH WE MAY NEED TO SERVICE PARENT-LEVEL INDEBTEDNESS AND OTHER
CASH REQUIREMENTS.
Substantially all of our operations are conducted by our subsidiaries. Our
cash flow and our ability to service parent-level indebtedness when due is
dependent upon our receipt of cash dividends, distributions or other transfers
from our subsidiaries. The terms of some of our subsidiaries' indebtedness
restrict their ability to pay dividends or make restricted payments to us in
some circumstances. Specifically, our Channelview and El Dorado Energy
subsidiaries are each party to credit agreements used to finance construction of
their generation plants. Both the Channelview credit agreement and the El Dorado
Energy credit agreement allow the respective subsidiary to pay dividends or make
restricted payments only if specified conditions are satisfied, including
maintaining specified debt service coverage ratios and debt service reserve
account balances. In both cases, the amount of the dividends or restricted
payments that may be paid if the conditions are met is limited to a specified
level and may be paid only from a particular account. The Channelview
cogeneration facility is currently under construction and is not expected to
begin commercial operations until the third quarter of 2001. As of September 30,
2000, the permitted level of dividends or restricted payments that could be paid
under the El Dorado Energy credit agreement was approximately $18 million.
In addition, the ability of our subsidiary that owns our Mid-Atlantic power
generation facilities to pay dividends or make restricted payments to us is
restricted under the terms of three facility interest lease agreements. These
agreements allow our Mid-Atlantic subsidiary to pay dividends or make restricted
payments only if specified conditions are satisfied including maintaining
specified fixed charge coverage ratios. As of September 30, 2000, the permitted
level of dividends or restricted payments that could be paid under these
agreements was approximately $150 million.
RISKS RELATED TO OUR SEPARATION FROM RELIANT ENERGY
OUR BUSINESS AND YOUR INVESTMENT IN OUR STOCK MAY BE ADVERSELY AFFECTED IF
RELIANT ENERGY DOES NOT COMPLETE THE DISTRIBUTION OF OUR COMMON STOCK TO ITS
SHAREHOLDERS, BECAUSE WE WOULD REMAIN SUBJECT TO CONTROL BY RELIANT ENERGY.
Although Reliant Energy has advised us that it currently intends to
complete the distribution of our common stock to its shareholders within twelve
months of this offering, we cannot assure you whether or when the distribution
will occur. Reliant Energy is not obligated to complete the distribution and it
may decide not to do so.
Reliant Energy intends to seek a ruling from the Internal Revenue Service
that the distribution will be tax-free to Reliant Energy and its shareholders
and will qualify as a reorganization. At the time of this offering, Reliant
Energy does not have a ruling from the Internal Revenue Service regarding the
tax treatment of the distribution. If Reliant Energy does not obtain a favorable
tax ruling, it is not likely to make the distribution in the expected time frame
or, perhaps, at all. In order for the distribution to be tax-free, Reliant
Energy must satisfy various requirements, including owning at least 80% of all
classes of our outstanding capital stock at the time of the distribution.
Additionally, in connection with our separation from Reliant Energy and the
distribution of our stock by Reliant Energy, Reliant Energy plans to restructure
its remaining businesses and to register as a public utility holding company
under the Public Utility Holding Company Act of 1935, or the "1935 Act," which
will require SEC approval. The restructuring will also require the approval of
the Louisiana Public Service Commission. We cannot assure you that those
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approvals will be obtained. Reliant Energy will file a request with the SEC to
allow the distribution to proceed as contemplated by the separation agreements.
However, the SEC may impose conditions on or disapprove of the proposed
separation and any of the separation agreements.
If Reliant Energy becomes a registered public utility holding company under
the 1935 Act and does not complete the distribution of our common stock, our
businesses would be adversely affected. We would:
- be subject to regulatory restrictions as a subsidiary of a registered
public utility holding company,
- not be able to raise equity capital without compliance with regulatory
requirements, as well as approval by Reliant Energy, and
- be subject to limits on investments in EWGs and foreign utility
companies.
In addition, until the distribution occurs, the risks discussed below
relating to Reliant Energy's control of our company and the potential business
conflicts of interest between Reliant Energy and us will continue to be relevant
to you. If the distribution is delayed or not completed at all, the liquidity of
shares of our common stock in the market may be constrained unless and until
Reliant Energy elects to sell some of its significant ownership into the public
market. A lack of liquidity in our common stock may affect our stock price.
WE WILL BE CONTROLLED BY RELIANT ENERGY AS LONG AS IT OWNS A MAJORITY OF OUR
COMMON STOCK, AND OUR NEW MINORITY STOCKHOLDERS WILL BE UNABLE TO AFFECT THE
OUTCOME OF STOCKHOLDER VOTING DURING THAT TIME.
After the completion of this offering, Reliant Energy will own over 80% of
our outstanding common stock. As long as Reliant Energy owns a majority of our
outstanding common stock, Reliant Energy will continue to be able to elect our
entire board of directors without calling a special meeting. Investors in this
offering, by themselves, will not be able to affect the outcome of any
stockholder vote prior to the planned distribution of our common stock to
Reliant Energy's shareholders. As a result, Reliant Energy, subject to any
fiduciary duty owed to our minority stockholders under Delaware law, will be
able to control all matters affecting our company, including:
- the composition of our board of directors and, through the board, any
determination with respect to our business direction and policies,
including the appointment and removal of officers,
- determination of incentive compensation, which may affect our ability to
retain key employees,
- the allocation of business opportunities between Reliant Energy and us,
- any determinations with respect to mergers or other business
combinations,
- our acquisition or disposition of assets,
- our financing decisions and our capital raising activities,
- the payment of dividends on our common stock,
- amending our restated certificate of incorporation or bylaws, and
- determinations with respect to our tax returns.
In addition, Reliant Energy may enter into credit agreements, indentures or
other contracts that limit the activities of its subsidiaries. While we would
not likely be contractually bound by these limitations, Reliant Energy would
likely cause its representatives on our board to direct our business so as not
to breach any of these agreements. Moreover, the Texas Utility Commission and
the state regulatory commissions of Arkansas and Minnesota have imposed
limitations on the amount Reliant Energy or its subsidiaries may invest in
foreign utility companies and, in some
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cases, foreign electric wholesale generating companies. These limitations are
based upon Reliant Energy's consolidated net worth, retained earnings, and debt
and stockholders' equity.
OUR HISTORICAL FINANCIAL RESULTS AS A SUBSIDIARY OF RELIANT ENERGY MAY NOT BE
REPRESENTATIVE OF OUR RESULTS AS A SEPARATE COMPANY.
The historical financial information we have included in this prospectus
does not necessarily reflect what our financial position, results of operations
and cash flows would have been had we been a separate, stand-alone entity during
the periods presented. Our costs and expenses reflect charges from Reliant
Energy for centralized corporate services and infrastructure costs. These
allocations have been determined based on what we and Reliant Energy considered
to be reasonable reflections of the utilization of services provided to us or
for the benefits received by us. This historical financial information is not
necessarily indicative of what our results of operations, financial position and
cash flows will be in the future. We may experience significant changes in our
cost structure, funding and operations as a result of our separation from
Reliant Energy, including increased costs associated with reduced economies of
scale, and increased costs associated with being a publicly traded, stand-alone
company.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH RELIANT ENERGY WITH
RESPECT TO OUR PAST AND ONGOING RELATIONSHIPS, AND BECAUSE OF RELIANT ENERGY'S
CONTROLLING OWNERSHIP PRIOR TO THE DISTRIBUTION, WE MAY NOT BE ABLE TO RESOLVE
THESE CONFLICTS ON TERMS COMMENSURATE WITH THOSE POSSIBLE IN ARMS' LENGTH
TRANSACTIONS.
Conflicts of interest may arise between Reliant Energy and our company in a
number of areas relating to our past and ongoing relationships, including:
- solicitation and hiring of employees from each other,
- the timing and manner of any sales or distributions by Reliant Energy of
all or any portion of its ownership interest in our company,
- the nature and quality of transitional services Reliant Energy has agreed
to provide us,
- the business operations of Texas Genco,
- our business operations within Reliant Energy's Houston service territory
or other business opportunities that would compete with Reliant Energy,
- actions and decisions of legislative bodies and administrative agencies,
and
- our dividend policy.
Following this offering, the agreements we have entered into with Reliant
Energy may be amended upon agreement of the parties. While we are controlled by
Reliant Energy, Reliant Energy may be able to require us to agree to amendments
to these agreements. We may not be able to resolve any potential conflicts with
Reliant Energy, and even if we do, the resolution may be less favorable than if
we were dealing with an unaffiliated party.
OUR EXECUTIVE OFFICERS AND SOME OF OUR DIRECTORS MAY HAVE POTENTIAL CONFLICTS OF
INTEREST BECAUSE OF THEIR OWNERSHIP OF RELIANT ENERGY COMMON STOCK. IN ADDITION,
SOME OF OUR DIRECTORS WILL ALSO BE DIRECTORS OF RELIANT ENERGY.
Our executive officers and some of our directors own a substantial amount
of Reliant Energy common stock and options to purchase Reliant Energy common
stock. Ownership of Reliant Energy common stock by our directors and officers
after our separation from Reliant Energy could create, or appear to create,
potential conflicts of interest when directors and officers are faced with
decisions that could have different implications for Reliant Energy than they do
for us.
We expect that even after Reliant Energy distributes the shares of our
common stock it owns to its shareholders, two or three of our directors will
also be directors of Reliant Energy. One of
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these directors will be our chairman, president and chief executive officer.
These directors will owe fiduciary duties to the stockholders of each company.
As a result, in connection with any transaction or other relationship involving
both companies, these directors may need to recuse themselves and to not
participate in any board action relating to these transactions or relationships.
OUR ABILITY TO OPERATE OUR BUSINESSES MAY SUFFER IF WE DO NOT DEVELOP OUR OWN
INFRASTRUCTURE QUICKLY AND COST-EFFECTIVELY, AND WE CANNOT ASSURE YOU THAT THE
TRANSITIONAL SERVICES THAT RELIANT ENERGY HAS AGREED TO PROVIDE US WILL BE
SUFFICIENT FOR OUR NEEDS.
We currently use Reliant Energy's systems to support some of our
operations, including legal, accounting and treasury, human resources, payroll
and wide-area computer networks. We are in the process of creating our own
systems to replace Reliant Energy's systems. Any failure or significant downtime
in Reliant Energy's or our own information systems could prevent us from paying
our employees, billing our customers or performing other administrative services
on a timely basis and could harm our business.
Following this offering, Reliant Energy has agreed to provide some
transition services to us. For a description of these transition services,
please read "Agreements Between Us and Reliant Energy -- Transition Services
Agreement." The transition services agreement provides that interim corporate
support services will terminate no later than the time Reliant Energy completes
the disposition of the shares of our common stock it continues to own after this
offering. The agreement provides that information technology services and other
interim shared services may continue to be provided until December 31, 2004.
After the expiration of these various arrangements, we may not be able to
replace the transitional services with a comparable quality of service or on
terms and conditions as favorable as those we will receive from Reliant Energy.
Reliant Energy has wide discretion on what employees it will utilize to
provide services to us. Consequently, the quality and quantity of the services
we receive from Reliant Energy may not be as good as the services we received
prior to the effectiveness of the separation agreements.
OUR CREDIT RATING COULD DECLINE AS A RESULT OF OUR SEPARATION FROM RELIANT
ENERGY, AND AS A RESULT, WE MAY FACE INCREASED BORROWING COSTS, MORE RESTRICTIVE
COVENANTS AND REDUCED AMOUNTS OF CREDIT, WHICH MAY MAKE IT MORE DIFFICULT OR
EXPENSIVE TO PURSUE OUR GROWTH STRATEGY.
Our operation as a separate entity from Reliant Energy may have a negative
impact on our ability to obtain credit on terms similar to those we were able to
obtain prior to our separation from Reliant Energy. Historically, Reliant Energy
has provided financing and credit support to us and our project financing
activities. Following this offering, Reliant Energy will no longer provide
financing or credit support for our operations except for specified transactions
or for a limited period of time. In addition, we may increase the proportion of
debt in our overall capital structure as part of our growth plan. Increases in
our debt level may negatively affect our credit rating.
We have performance guarantees related to our trading, marketing and risk
management operations that require us to maintain an investment grade credit
rating. If our credit rating declines below investment grade, we will likely be
obligated to provide credit enhancement to the guaranteed party in the form of a
pledge of cash collateral, a letter of credit or other similar credit
enhancement. Furthermore, if our credit ratings decline below an investment
grade credit rating, our trading partners may refuse to trade with us or trade
only on terms less favorable to us.
Any of these events would likely result in increased borrowing costs, more
restrictive covenants and reduced lines of credit from lenders, suppliers and
counterparties, all of which would adversely affect our business and results of
operations and our ability to raise capital to pursue our growth strategy.
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IF WE TAKE ACTIONS WHICH CAUSE THE DISTRIBUTION OF OUR STOCK BY RELIANT ENERGY
TO ITS SHAREHOLDERS TO FAIL TO QUALIFY AS A TAX-FREE TRANSACTION, WE WILL BE
REQUIRED TO INDEMNIFY RELIANT ENERGY FOR ANY RESULTING TAXES. THIS POTENTIAL
OBLIGATION TO INDEMNIFY RELIANT ENERGY MAY PREVENT OR DELAY A CHANGE OF CONTROL
OF OUR COMPANY AFTER RELIANT ENERGY DISTRIBUTES OUR COMMON STOCK TO ITS
SHAREHOLDERS.
Reliant Energy intends to distribute its shares of our common stock to its
shareholders within twelve months of the completion of this offering. Prior to
the distribution, Reliant Energy intends to obtain a ruling from the Internal
Revenue Service that the distribution will be tax-free to Reliant Energy and its
shareholders and will qualify as a reorganization. Under an agreement between
our company and Reliant Energy, if we breach any representations in the
agreement relating to the ruling, take any action that causes our
representations in the agreement relating to the ruling to be untrue or engage
in a transaction after the distribution that causes the distribution to be
taxable to Reliant Energy, we will be required to indemnify Reliant Energy for
any resulting taxes. The amount of any indemnification payments would be
substantial, and we likely would not have sufficient financial resources to
achieve our growth strategy after making such payments.
Current tax law provides that, depending on the facts and circumstances,
the distribution of our stock by Reliant Energy, if it occurs, may be taxable to
Reliant Energy if our company undergoes a 50% or greater change in stock
ownership within two years after the distribution. Under agreements between our
company and Reliant Energy, Reliant Energy is entitled to require us to
reimburse any tax costs incurred by Reliant Energy as a result of a transaction
resulting in a change in control of our company. These costs may be so great
that they delay or prevent a strategic acquisition or change in control of our
company.
OUR DECONSOLIDATION FROM THE RELIANT ENERGY CONSOLIDATED TAX GROUP MAY RESULT IN
ADVERSE TAX CONSEQUENCES TO US.
Subsequent to the distribution of our common stock by Reliant Energy, if it
occurs, we will cease to be a member of the Reliant Energy consolidated tax
group. This separation will have both current and future income tax implications
to us. The event of deconsolidation itself will result in the triggering of
deferred intercompany gains. We will recognize taxable income related to these
gains, which will not have a material impact on our net income and cash flow.
In addition to the current income tax consequences triggered by the act of
deconsolidation discussed above, our separation from the Reliant Energy
consolidated tax group will change our overall future income tax posture. As a
result, we could be limited in our future ability to effectively use future tax
attributes. We have agreed with Reliant Energy that we will make a tax election
to forego the carry back of net operating losses, if any, we generate in our tax
years after deconsolidation to tax years when we were part of the Reliant Energy
consolidated group. We will be able to utilize such net operating losses in our
tax years after deconsolidation (subject to the applicable carryforward
limitation periods) but only to the extent of our income in such tax years.
RISKS RELATED TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK
SUBSTANTIAL SALES OF OUR COMMON STOCK MAY OCCUR IN CONNECTION WITH THE
DISTRIBUTION TO RELIANT ENERGY'S SHAREHOLDERS. THESE SALES COULD CAUSE OUR STOCK
PRICE TO DECLINE.
Reliant Energy currently intends to distribute all of the shares of our
common stock it owns to its shareholders within twelve months of this offering.
Substantially all of these shares will be eligible for immediate resale in the
public market. We cannot predict whether significant amounts of our common stock
will be sold in the open market in anticipation of, or following, the
distribution, or will be sold by Reliant Energy if the distribution does not
occur. We also cannot
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predict what level of demand there will be for shares of our common stock. In
addition, we have entered into a registration rights agreement, which provides
that if Reliant Energy does not distribute all of the shares of our common stock
that it owns to its shareholders, Reliant Energy and its transferees will have
the right to require us to register these shares under the U.S. securities laws
for sale into the public market. Any sales of substantial amounts of our common
stock in the public market, or the perception that these sales might occur,
whether as a result of the distribution or otherwise, could lower the market
price of our common stock. Further, if we issue additional equity securities to
raise additional capital, your ownership interest in our company may be diluted
and the value of your investment may be reduced. Please read "Shares Eligible
for Future Sale" for information about the number of shares that will be
outstanding and could be sold after this offering.
THE INITIAL PUBLIC OFFERING PRICE OF OUR COMMON STOCK MAY NOT BE INDICATIVE OF
THE MARKET PRICE OF OUR COMMON STOCK AFTER THIS OFFERING. IN ADDITION, OUR STOCK
PRICE MAY BE VOLATILE.
Prior to this offering, Reliant Energy held all of our outstanding common
stock, and therefore, there has been no public market for our common stock. We
cannot assure you that an active market for our common stock will develop or be
sustained after this offering. The initial public offering price of our common
stock will be determined by negotiations between us and representatives of the
underwriters, based on numerous factors which we discuss in the "Underwriting"
section of this prospectus. This price may not be indicative of the market price
for our common stock after this initial public offering. The market price of our
common stock could be subject to significant fluctuations after this offering,
and may decline below the initial public offering price. You may not be able to
resell your shares at or above the initial public offering price. The following
factors could affect our stock price:
- our operating and financial performance and prospects,
- quarterly variations in the rate of growth of our financial indicators,
such as earnings per share, net income and revenues,
- changes in revenue or earnings estimates or publication of research
reports by analysts,
- speculation in the press or investment community,
- strategic actions by us or our competitors, such as acquisitions or
restructurings,
- developments regarding the restructuring of the electric power industry,
- sales of our common stock by stockholders,
- actions by institutional investors or by Reliant Energy prior to its
distribution of our common stock,
- general market conditions, including fluctuations in commodity prices,
and
- domestic and international economic, legal and regulatory factors
unrelated to our performance.
The stock markets in general have experienced extreme volatility that has
often been unrelated to the operating performance of particular companies. These
broad market fluctuations may adversely affect the trading price of our common
stock.
OUR RIGHTS AGREEMENT AND PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW
MAY INHIBIT A TAKEOVER, WHICH COULD ADVERSELY AFFECT THE VALUE OF OUR COMMON
STOCK.
Our restated certificate of incorporation, bylaws and rights agreement, as
well as Delaware corporate law, contain provisions that could delay or prevent a
change of control or changes in our management that a stockholder might consider
favorable. These provisions generally become
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effective at the time Reliant Energy ceases to own a majority of our outstanding
common stock. These provisions apply even if the offer may be considered
beneficial by some of our stockholders. If a change of control or change in
management is delayed or prevented, the market price of our common stock could
decline.
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OUR SEPARATION FROM RELIANT ENERGY
In July 2000, Reliant Energy announced its intention to divide itself into
two publicly traded companies in order to separate its unregulated businesses
from its regulated businesses. This offering of our common stock is part of
Reliant Energy's separation plan. Within twelve months of the completion of this
offering, Reliant Energy intends to distribute our remaining stock to its
shareholders as part of its separation plan. Until Reliant Energy completes the
distribution of our common stock to its shareholders, we will continue to be a
subsidiary of Reliant Energy.
Reliant Energy is an international energy delivery and energy services
company based in Houston, Texas. Following the distribution of our shares, we
expect Reliant Energy will remain engaged in the transmission and distribution,
as well as generation, of electric power and the transportation and distribution
of natural gas.
SEPARATION AND TRANSITION SERVICES AGREEMENTS
We have entered into agreements with Reliant Energy providing for the
separation of its businesses, including a master separation agreement. These
agreements generally provide for the transfer from Reliant Energy to us of
assets relating to our businesses and the assumption by us of associated
liabilities. We have also entered into agreements governing various interim and
ongoing relationships between us and Reliant Energy, including transitional
services Reliant Energy will provide to us. For a summary description of these
agreements, please read "Agreements Between Us and Reliant Energy."
THE DISTRIBUTION BY RELIANT ENERGY OF OUR COMMON STOCK
After completion of this offering, Reliant Energy will own over 80% of the
outstanding shares of our common stock. Reliant Energy has announced that it
currently plans to complete its divestiture of our company within twelve months
of the completion of this offering by distributing all of the shares of our
common stock it owns to its shareholders. However, Reliant Energy is not
obligated to complete the distribution. For a description of consequences that
may result if Reliant Energy does not complete the distribution, please read
"Risk Factors -- Risks Related to Our Separation from Reliant Energy."
BUSINESS SEPARATION PLAN
The Texas Utility Commission has approved a business separation plan that
contemplates that our company will be the successor to Reliant Energy in retail
electric operations in the Houston metropolitan area when the Texas market opens
to competition. Reliant Energy filed the plan with the Commission to meet the
requirements of the Texas electric restructuring law adopted in 1999. The law
requires investor-owned electric utilities to separate their Texas electric
utility operations into three segments -- generation, transmission and
distribution, and retail sales -- under either common or separate ownership.
Reliant Energy will retain its Houston-area transmission and distribution
business, which will remain subject to traditional utility rate regulation, and
its associated generation assets, subject to the option described below.
TEXAS GENCO OPTION
In connection with the separation, Reliant Energy has granted us an option
to purchase the 81% interest it will have in the entity owning the Texas
generating assets of Reliant Energy's electric utility division, which we refer
to as "Texas Genco." These assets consist of 14,027 MW of aggregate net
generation capacity. This option will be exercisable by us in January 2004. For
a summary description of this option, please read "Texas Genco Option."
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USE OF PROCEEDS
We estimate that our net proceeds from this offering will be approximately
$803 million (approximately $925 million if the underwriters' over-allotment
option is exercised in full), after deducting underwriting discounts and
commissions and our estimated offering expenses. This estimate assumes an
initial public offering price of $16.50 per share, which is the mid-point of the
offering price range indicated on the cover page of this prospectus.
We intend to use the net proceeds from this offering initially to increase
our working capital. We expect to use these proceeds to fund capital
expenditures, including the funding of construction costs of, and combustion
turbine payments relating to, our generating facilities currently under
construction. We have estimated 2001 capital requirements of $1.2 billion,
including capital expenditures relating to four generating facilities under
construction with total remaining estimated costs of construction of $359
million. We also plan to continue to expand our portfolio of generation assets
through acquisitions of generation facilities. Depending on the timing of any of
these acquisitions, we may use a portion of the net proceeds from this offering
to finance one or more future acquisitions if the proceeds have not yet been
used to finance capital expenditures as of the date of such acquisitions. In
December 2000, we entered into an agreement to acquire a 153 MW power generating
facility, together with a power purchase agreement relating to an adjacent
facility, for an aggregate purchase price of $33 million. We anticipate this
acquisition will close in June 2001. We expect to finance future capital
expenditures that are not paid for with net proceeds from this offering with
cash from operations or other financing alternatives. For a discussion of these
alternatives, please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital
Resources -- Capital Requirements -- Other Sources/Uses of Cash."
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DIVIDEND POLICY
We do not intend to declare or pay any dividends on our common stock in the
foreseeable future. Instead, we intend to retain any future earnings for use in
our business. Our board of directors will determine the payment of future
dividends on our common stock, if any, and the amount of any dividends in light
of:
- any applicable contractual restrictions limiting our ability to pay
dividends,
- our earnings and cash flows,
- our financial condition, and
- other factors our board of directors deems relevant.
The terms of some of our subsidiaries' indebtedness restrict their ability
to pay dividends or make restricted payments to us in some circumstances.
Specifically, our Channelview and El Dorado Energy subsidiaries are each party
to credit agreements used to finance construction of their generation plants.
Both the Channelview credit agreement and the El Dorado Energy credit agreement
allow the respective subsidiary to pay dividends or make restricted payments
only if specified conditions are satisfied, including maintaining specified debt
service coverage ratios and debt service reserve account balances. In both
cases, the amount of the dividends or restricted payments that may be paid if
the conditions are met is limited to a specified level and may be paid only from
a particular account. The Channelview cogeneration facility is currently under
construction and is not expected to begin commercial operations until the third
quarter of 2001. As of September 30, 2000, the permitted level of dividends or
restricted payments that could be paid under the El Dorado Energy credit
agreement was approximately $18 million.
In addition, the ability of our subsidiary that owns our Mid-Atlantic power
generation facilities to pay dividends or make restricted payments to us is
restricted under the terms of three facility interest lease agreements. These
agreements allow our Mid-Atlantic subsidiary to pay dividends or make restricted
payments only if specified conditions are satisfied including maintaining
specified fixed charge coverage ratios. As of September 30, 2000, the permitted
level of dividends or restricted payments that could be paid under these
agreements was approximately $150 million.
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CAPITALIZATION
The following table sets forth our capitalization as of September 30, 2000.
Our capitalization is presented on:
- an actual basis,
- a pro forma basis to reflect the Recapitalization, and
- an as adjusted basis to reflect the sale of 52,000,000 shares of our
common stock in this offering as well as the estimated net proceeds from
this offering. The estimated net proceeds assumes an initial public
offering price of $16.50 per share, which is the mid-point of the
offering price range indicated on the cover page of this prospectus.
You should read the information in this table together with our
consolidated financial statements and the related notes and the information in
"Selected Financial Data," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Use of Proceeds" included elsewhere in
this prospectus.
<TABLE>
<CAPTION>
PRO FORMA, AS
ACTUAL PRO FORMA(1) ADJUSTED(1)
------ ------------ -------------
(millions of dollars)
<S> <C> <C> <C>
Current portion of long-term debt(2)........................ $ 1 $ 1 $ 1
Short-term borrowings(2).................................... 204 204 204
Accounts and short-term notes payable -- affiliated
companies, net(2)......................................... 2,180 -- --
Long-term notes payable -- affiliated companies, net(2)..... 239 -- --
Long-term debt(2)........................................... 801 801 801
Stockholder's equity........................................ 2,066 4,485 5,288
------ ------ ------
Total capitalization............................... $5,491 $5,491 $6,294
====== ====== ======
</TABLE>
---------------
(1) Please read our unaudited pro forma condensed consolidated financial
statements.
(2) For a description of our borrowings please read Notes 3 and 8 to our
consolidated financial statements.
30
<PAGE> 34
DILUTION
Our pro forma net tangible book value at September 30, 2000 was
approximately $3.2 billion, or $13.49 per share. Net tangible book value per
share represents our total tangible assets reduced by our total liabilities and
divided by the aggregate number of shares of our common stock outstanding.
Dilution in net tangible book value per share represents the difference between
the amount per share that you pay in this offering and the net tangible book
value per share immediately after this offering.
After giving effect to our sale of 52,000,000 shares of common stock in
this offering at an assumed initial public offering price of $16.50 per share,
which is the mid-point of the offering price range indicated on the cover page
of this prospectus, and after deducting an assumed underwriting discount and
estimated offering expenses payable by us, our pro forma as adjusted net
tangible book value at September 30, 2000 would have been approximately $4.0
billion, or $13.84 per share. This represents an immediate increase in pro forma
net tangible book value of $.35 per share to our existing stockholder and an
immediate dilution in pro forma net tangible book value of $2.66 per share to
new investors purchasing shares of common stock in this offering. The following
table illustrates this dilution per share:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $16.50
Pro forma net tangible book value per share as of
September 30, 2000..................................... 13.49
Increase in pro forma book value per share attributable to
new investors.......................................... .35
------
Pro forma as adjusted net tangible book value per share
after this offering....................................... $13.84
------
Dilution in pro forma net tangible book value per share to
new investors............................................. $ 2.66
======
</TABLE>
31
<PAGE> 35
SELECTED FINANCIAL DATA
The following tables present our selected consolidated financial data. The
data set forth below should be read together with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," our historical
consolidated financial statements and the notes to those statements included in
this prospectus. Our selected income statement data for the years ended December
31, 1997, 1998 and 1999 the nine months ended September 30, 2000, and the
selected balance sheet data as of December 31, 1998 and 1999 and September 30,
2000 are derived from our consolidated audited financial statements. The
historical financial information may not be indicative of our future performance
and does not reflect what our financial position and results of operations would
have been had we operated as a separate, stand-alone entity during the periods
presented. Our pro forma income statement data for the nine months ended
September 30, 2000 give effect to the Mid-Atlantic Acquisition, the Sale-
Leaseback and the Recapitalization. For more information regarding the
Mid-Atlantic Acquisition and the Sale-Leaseback, please read Note 5(a) to our
consolidated financial statements.
Our pro forma income statement data for the year ended December 31, 1999
give effect to our October 1999 acquisition of N.V. UNA, the Mid-Atlantic
Acquisition, the Sale-Leaseback and the Recapitalization. For more information
regarding the acquisition of UNA, please read Note 5(b) to our consolidated
financial statements.
Our pro forma balance sheet data as of September 30, 2000 give effect to
the Recapitalization. Our pro forma, as adjusted balance sheet data as of
September 30, 2000 reflect the sale of shares of our common stock in this
offering as well as the estimated net proceeds from this offering. For further
information regarding the pro forma effects of these transactions, please read
our unaudited pro forma condensed consolidated financial statements included
elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------------------------- -----------------------------
PRO FORMA PRO FORMA
1995 1996 1997(1) 1998(1) 1999(1) 1999 1999(1) 2000(1) 2000
---- ---- ------- ------- ------- --------- ------- ------- ---------
(millions of dollars)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues............................. $29 $32 $1,321 $4,371 $8,053 $8,563 $5,827 $12,820 $12,986
Expenses:
Fuel and cost of gas sold.......... -- -- 978 2,352 3,985 4,167 2,682 6,249 6,302
Purchased power.................... -- -- 313 1,824 3,736 3,781 2,936 5,518 5,517
Operation and maintenance.......... 28 30 17 65 159 308 123 288 367
General, administrative and
development...................... -- 1 20 78 94 97 43 158 172
Depreciation and amortization...... -- -- 2 15 43 127 16 130 144
--- --- ------ ------ ------ ------ ------ ------- -------
Total........................ $28 $31 $1,330 $4,334 $8,017 $8,480 $5,800 $12,343 $12,502
--- --- ------ ------ ------ ------ ------ ------- -------
Operating Income (Loss).............. $ 1 $ 1 $ (9) $ 37 $ 36 $ 83 $ 27 $ 477 $ 484
Other (Expense) Income:
Interest expense................... -- -- (1) (2) (12) (91) -- (37) (37)
Interest income.................... -- -- -- 1 2 43 1 11 11
Interest income (expense) --
affiliated companies, net........ -- -- 2 2 (8) -- -- (122) --
Gains (losses) from investments.... -- -- -- -- 16 16 -- (17) (17)
(Losses) income of equity
investments of unconsolidated
subsidiaries..................... -- -- -- (1) (1) (1) (1) 33 33
Gain on sale of development
project.......................... -- -- -- -- -- -- -- 18 18
Other, net......................... -- (2) -- 1 (7) (8) (6) 2 2
--- --- ------ ------ ------ ------ ------ ------- -------
Total Other (Expense)
Income..................... $-- $(2) $ 1 $ 1 $ (10) $ (41) $ (6) $ (112) $ 10
--- --- ------ ------ ------ ------ ------ ------- -------
Income (Loss) Before Income Taxes and
Extraordinary Item................. $ 1 $(1) $ (8) $ 38 $ 26 $ 42 $ 21 $ 365 $ 494
Income Tax Expense (Benefit)......... -- -- (2) 17 2 -- 12 120 166
--- --- ------ ------ ------ ------ ------ ------- -------
Income (Loss) Before Extraordinary
Item............................... $ 1 $(1) $ (6) $ 21 $ 24 $ 42 $ 9 $ 245 $ 328
====== =======
Extraordinary Item, net of tax....... -- -- -- -- -- -- 7
--- --- ------ ------ ------ ------ -------
Net Income (Loss).................... $ 1 $(1) $ (6) $ 21 $ 24 $ 9 $ 252
=== === ====== ====== ====== ====== =======
</TABLE>
32
<PAGE> 36
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
(SHARES IN MILLIONS)
<S> <C> <C>
PRO FORMA EARNINGS PER SHARE INFORMATION(5):
Basic and Diluted Earnings Before Extraordinary Item Per
Share..................................................... $0.17 $1.37
===== =====
Basic and Diluted Weighted Average Shares Outstanding....... 240 240
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------- -----------------
1995 1996 1997(1) 1998(1) 1999(1) 1999(1) 2000(1)
---- ---- ------- ------- ------- ------- -------
(millions of dollars)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF CASH FLOW DATA:
Cash Flows From Operating Activities................ $ -- $ 1 $ (22) $ (2) $ 86 $ 5 $ 234
Cash Flows From Investing Activities................ -- -- (4) (365) (1,404) (104) (2,780)
Cash Flows From Financing Activities................ -- (1) 26 379 1,354 453 2,741
OTHER OPERATING DATA:
EBITDA (2).......................................... $ 1 $ (1) $ (7) $ 52 $ 87 $ 36 $ 636
Net Power Generation Capacity (MW).................. -- -- -- 3,800 7,945 3,800 12,707
Wholesale Power Sales (MMWH)(3)..................... -- -- 12 65 112 77 132
Natural Gas Sales (Bcf)(4).......................... -- -- 366 1,115 1,746 1,265 1,707
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
DECEMBER 31, ----------------------------------
------------------------------------------- PRO FORMA, AS
1995 1996 1997 1998 1999 ACTUAL PRO FORMA ADJUSTED
---- ---- ---- ---- ---- ------ --------- -------------
(millions of dollars) (millions of dollars)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Property, Plant and Equipment,
net.......................... $ -- $ -- $ 5 $ 270 $ 2,407 $3,722 $3,722 $ 3,722
Total Assets(6)................ 13 15 822 1,409 5,624 9,856 9,856 10,659
Short-Term Borrowings.......... -- -- -- -- 170 204 204 204
Long-term Debt to Third
Parties, including current
maturities................... -- -- -- -- 460 802 802 802
Accounts and Notes Payable
(Receivable) -- Affiliated
Companies, net............... 1 1 (45) 17 1,333 2,419 -- --
Stockholder's Equity........... 14 13 291 652 741 2,066 4,485 5,288
</TABLE>
---------------
(1) Our results of operations include the results of the following acquisitions,
all of which were accounted for using the purchase method of accounting,
from their respective acquisition dates: Reliant Energy Services, Inc. and
Arkla Finance Corporation acquired in August 1997, the five generating
facilities in California substantially acquired in April 1998, a generating
facility in Florida and UNA both acquired in October 1999 and the
Mid-Atlantic Acquisition that occurred in May 2000.
(2) EBITDA represents earnings (loss) before interest expense, interest income,
income taxes, depreciation and amortization. EBITDA, as defined, is shown
because it is a widely accepted measure of financial performance used by
some analysts and investors to analyze and compare companies on the basis of
operating performance. It is not defined under generally accepted accounting
principles, and should not be considered in isolation or as a substitute for
a measure of performance prepared in accordance with GAAP in the United
States and is not indicative of operating income or cash flows from
operations as determined under GAAP. Additionally, our computation of EBITDA
may not be comparable to other similarly titled measures computed by other
companies, because all companies do not calculate it in the same fashion.
(3) Million megawatt hours.
(4) Billion cubic feet.
(5)Prior to August 9, 2000, Reliant Resources, Inc. was not a separate legal
entity and therefore had no historical capital structure. Accordingly,
historical earnings per share have not been presented for the historical
consolidated statements of operations.
(6)See Note 5(a) to our consolidated financial statements for a discussion of
adjustments to amounts previously recorded in connection with the
Mid-Atlantic Acquisition purchase price allocation.
33
<PAGE> 37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in combination with
"Risk Factors," "Selected Financial Data" and our historical consolidated
financial statements and the notes to those statements, which we refer to as our
"consolidated financial statements," included elsewhere in this prospectus.
OVERVIEW
We are a rapidly growing provider of electricity and energy services with a
focus on the deregulating competitive wholesale and retail segments of the
electric power industry in the United States and Europe. For a description of
risks associated with these deregulating segments, including the potential
impact of competitive factors in the wholesale power markets and the
deregulation of the retail electric markets in Texas, please read "Risk
Factors."
In this section we discuss our results of operations on a consolidated
basis and individually for each of our business segments. We also discuss our
liquidity and capital resources. Our financial reporting segments include
Wholesale Energy, European Energy, Retail Energy and Other Operations. For
segment reporting information, please read Notes 1 and 14 to our consolidated
financial statements. For a description of these segments, please read Note 1 to
our consolidated financial statements and "Our Business" included elsewhere in
this prospectus.
OUR SEPARATION FROM RELIANT ENERGY
In connection with our separation from Reliant Energy, Reliant Energy has
contributed to us, by conveyance or merger, our wholesale, retail and other
operations described in this prospectus. These operations consist of Reliant
Energy's or its direct and indirect subsidiaries':
- non-Texas power generation assets and related energy trading, marketing
and risk management operations in North America and Europe,
- retail electric operations, and
- other operations, including eBusiness group, communications business and
venture capital operations, which we refer to as "New Ventures."
Throughout the period covered by our consolidated financial statements,
these operations were conducted by Reliant Energy and its direct and indirect
subsidiaries.
The financial information discussed in this section is derived from the
consolidated historical financial statements of Reliant Energy, which include
the results of operations for all of Reliant Energy's businesses, including
those businesses which we do not own. In order to prepare our consolidated
financial statements contained in this prospectus and discussed in this section,
we carved-out the results of operations of the businesses that we own from
Reliant Energy's consolidated historical financial statements. Accordingly, the
results of operations discussed in this section include only revenues and costs
directly attributable to the businesses we own and operate. Some of these costs
are for facilities and services provided by Reliant Energy and for which our
operations have historically been charged based on usage or other allocation
factors. We believe these allocations are reasonable but they are not
necessarily indicative of the expenses that would have resulted if we had
actually operated independently of Reliant Energy. We may experience changes in
our cost structure, funding and operations as a result of our separation from
Reliant Energy, including increased costs associated with reduced economies of
scale, and increased costs associated with being a publicly traded, stand alone
company. We cannot currently predict, with any certainty, the actual amount of
increased costs we may incur, if
34
<PAGE> 38
any. All significant intercompany transactions and balances between our company
and our subsidiaries have been eliminated in our consolidated financial
statements.
Our results of operations for 1997 include the financial results of two
subsidiaries from their date of acquisition in August 1997. Separate audited
combined financial statements for these companies as of and for the seven months
ended July 31, 1997 are included in the financial statements elsewhere in this
prospectus under the caption "Reliant Energy Services, Inc. and Related
Company."
CONSOLIDATED RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------ ----------------
1997 1998 1999 1999 2000
------ ------ ------ ------ -------
(in millions)
<S> <C> <C> <C> <C> <C>
Revenues................................................ $1,321 $4,371 $8,053 $5,827 $12,820
Operating Expenses...................................... 1,330 4,334 8,017 5,800 12,343
------ ------ ------ ------ -------
Operating (Loss) Income................................. $ (9) $ 37 $ 36 $ 27 $ 477
Other (Income) Expense, net............................. (1) (1) 10 6 112
Income Tax (Benefit) Expense............................ (2) 17 2 12 120
------ ------ ------ ------ -------
(Loss) Income Before Extraordinary Gain................. $ (6) $ 21 $ 24 $ 9 $ 245
Extraordinary Gain, net of tax.......................... -- -- -- -- 7
------ ------ ------ ------ -------
Net (Loss) Income....................................... $ (6) $ 21 $ 24 $ 9 $ 252
====== ====== ====== ====== =======
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1999
Net Earnings. We reported consolidated net income of $252 million for the
nine months ended September 30, 2000 compared to consolidated net income of $9
million for the same period in 1999. The 2000 results included an extraordinary
gain of $7 million related to the early extinguishment of $272 million of
long-term debt. For further discussion of the extraordinary gain, please read
Note 8(b) to our consolidated financial statements.
Our consolidated income, before extraordinary gain, was $245 million for
the nine months ended September 30, 2000 compared to consolidated net income of
$9 million for the nine months ended September 30, 1999. The $236 million
increase in 2000 compared to 1999 was primarily due to increased earnings from
Wholesale Energy, the inclusion of earnings from the Mid-Atlantic generating
assets, which Wholesale Energy acquired in May 2000, and the inclusion of
earnings from European Energy, which was established in the fourth quarter of
1999 with the acquisition of UNA. The Mid-Atlantic generating assets and UNA
contributed $217 million and $69 million, respectively, to operating income for
the nine months ended September 30, 2000. For additional information on the
acquisition of the Mid-Atlantic generating assets and UNA, please read Notes
5(a) and 5(b) to our consolidated financial statements. The increases in 2000
earnings compared to 1999 earnings from Wholesale Energy and European Energy
were slightly offset by increased losses from Retail Energy and Other Operations
over the same period.
Beginning January 1, 2001, the Dutch wholesale electric market was
completely opened to competition. As a result, we expect a decline in power
prices. Consistent with our expectations at the time we made the acquisition of
UNA, we anticipate that we will experience a significant decline in revenues in
2001 attributable to the deregulation of the Dutch market and termination of the
agreement with the other Dutch generators and the Dutch distributors, referred
to as the "protocol". Please read "-- Results of Operations by Business
Segment -- European Energy."
Operating Income. For an explanation of changes in our operating income,
see the discussion below of operating (loss) income by segment.
35
<PAGE> 39
Other Income/Expense. We incurred net other expense of $112 million for
the nine months ended September 30, 2000 compared to $6 million for the same
period in 1999. The increase of $106 million in 2000 as compared to 1999
resulted primarily from an impairment loss of $27 million on marketable equity
securities classified as "available-for-sale" incurred in 2000 by Other
Operations, increased net interest expense on obligations to Reliant Energy and
its subsidiaries of $122 million and increased interest expense on obligations
to third parties of $37 million, each net of interest capitalized on
construction projects. Increased interest expense resulted primarily from higher
levels of long-term debt during the nine months ended September 30, 2000
compared to the same period in 1999. Increased debt levels were primarily
associated with borrowings for the funding of the acquisition of UNA in the
fourth quarter of 1999 and the first quarter of 2000, the acquisition of our
Mid-Atlantic generating facilities in the second quarter of 2000 and capital
expenditures. During the nine months ended September 30, 2000, we incurred a
pre-tax impairment loss of $27 million on marketable equity securities
classified as "available-for-sale" by Other Operations. Management's
determination to recognize this impairment resulted from a combination of events
occurring in 2000 related to this investment. Such events affecting the
investment included changes occurring in the investment's senior management,
announcement of significant restructuring charges and related downsizing for the
entity, reduced earnings estimates for this entity by brokerage analysts and the
bankruptcy of a competitor of the investment in the first quarter of 2000. These
events coupled with the stock market value of our investment in these securities
continuing to be below our cost basis, caused management to believe the decline
in fair value to be other than temporary. For further discussion of this
investment, please read Note 2(m) to our consolidated financial statements.
These increased expenses were partially offset by:
- an $18 million pre-tax gain in 2000 on the sale of our interest in one of
our development stage electric generation projects,
- $2 million of interest income earned by European Energy debt securities
classified as "trading" in the nine months ended September 30, 2000,
- an $8 million increase in interest income in 2000 earned on increased
deposits,
- a $4 million gain realized by Other Operations, which was a result of
distributions from venture capital investments,
- $6 million of unrealized holding gains from debt and equity securities
classified as "trading" in the nine months ended September 30, 2000,
- a $34 million increase in equity earnings in unconsolidated subsidiaries
of Wholesale Energy in 2000, and
- a $7 million option premium expense recorded in 1999 to economically
hedge foreign currency risks for the UNA purchase obligation.
Income Tax Expense. We calculate our income tax provision on a separate
return basis under a tax sharing agreement with Reliant Energy. Our deferred
income taxes are calculated using the liability method of accounting, which
measures deferred income taxes for all significant income tax temporary
differences. Our current federal and state income taxes are payable to or
receivable from Reliant Energy. Our federal statutory tax rate is 35%. During
the nine months ended September 30, 2000 and 1999, our effective tax rate was
33.0% and 58.8%, respectively. Our reconciling items from the federal statutory
tax rate to the effective tax rate totaled $7 million for the nine months ended
September 30, 2000. These items primarily related to income earned by UNA and
were partially offset by nondeductible goodwill, state income taxes and
valuation allowances. Our reconciling items from the federal statutory tax rate
to the effective tax rate totaled $5 million for the nine months ended September
30, 1999. These items primarily related to nondeductible goodwill and state
income taxes. In 2000 and prior years, under Dutch
36
<PAGE> 40
corporate income tax laws, the earnings of UNA were subject to a zero percent
Dutch corporate income tax rate as a result of the Dutch tax holiday related to
the Dutch electric industry. In 2002, all of European Energy's earnings will be
subject to the standard Dutch corporate income tax rate, which currently is 35%.
TWELVE MONTHS ENDED DECEMBER 31, 1999 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1998
Net Earnings. We reported consolidated earnings of $24 million and $21
million in 1999 and in 1998, respectively. The $3 million increase was due to
increased earnings from Other Operations, the inclusion in 1999 of three months
of earnings from European Energy and decreased income tax expense in 1999 as
compared to 1998. These increases were partially offset by decreased earnings
from Wholesale Energy and increased losses incurred by Retail Energy in 1999 as
compared to 1998.
Operating Income. For an explanation of changes in operating income, see
the discussion below of operating (loss) income by segment.
Other Income/Expense. We incurred net other expense of $10 million in 1999
as compared to other income of $1 million in 1998 due to the following items:
- a $10 million increase in net interest expense on obligations to Reliant
Energy and its subsidiaries, net of capitalized interest on construction
projects,
- a $10 million increase in interest expense on obligations to third
parties, net of interest capitalized on construction projects,
- a $7 million option premium expense recorded in 1999 to economically
hedge foreign currency risks related to the UNA purchase obligation,
- $9 million in distributions from venture capital investments of
marketable securities classified as "trading" by Other Operations in
1999, and
- a $7 million increase of unrealized holding gains recorded in 1999
resulting from debt and equity securities classified as "trading."
Interest expense increased as a result of higher levels of short-term and
long-term borrowings associated, in part, with the acquisition of UNA in the
fourth quarter of 1999 and capital expenditures.
Income Tax Expense. The effective tax rates for 1999 and 1998 were 9.6%
and 45.3%, respectively. The decrease in the effective tax rate in 1999 was
primarily due to the effect of the tax holiday relating to the Dutch electric
industry, which is applicable to income earned by UNA.
TWELVE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1997
Net Earnings. We reported consolidated net income for 1998 of $21 million
compared to a consolidated net loss of $6 million in 1997. The increase in net
earnings in 1998 was primarily the result of the inclusion of earnings in 1998
of Wholesale Energy's California generating facilities, which were acquired in
April and July of 1998. Increases in 1998 earnings were partially offset by
increased income tax expense in 1998 as compared to 1997.
Operating (Loss) Income. For an explanation of changes in operating
income, see the discussion below of operating (loss) income by segment.
Other Income/Expense. Net other income was $1 million in 1998 and in 1997.
37
<PAGE> 41
Income Tax Expense/Benefit. The effective tax rates for 1998 and 1997 were
45.3% and 27.8%, respectively. The increase in the effective tax rate in 1998
was primarily related to an increase in 1998 of state income tax and
non-deductible goodwill resulting from the acquisition of Reliant Energy
Services, Inc. in August 1997. For additional information regarding the
acquisition of Reliant Energy Services, Inc., please read Note 5(e) to our
consolidated financial statements.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following tables present operating income (loss) for each of our
business segments for the nine months ended September 30, 1999 and 2000 and for
the years ended December 31, 1997, 1998 and 1999.
<TABLE>
<CAPTION>
OPERATING (LOSS) INCOME
BY BUSINESS SEGMENT
--------------------------------------
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------- --------------
1997 1998 1999 1999 2000
---- ---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C> <C>
Wholesale Energy........................................... $(7) $40 $ 19 $39 $470
European Energy............................................ -- -- 34 -- 69
Retail Energy.............................................. (2) (2) (13) (10) (38)
Other Operations........................................... -- (1) (4) (2) (24)
--- --- ---- --- ----
Total Consolidated................................ $(9) $37 $ 36 $27 $477
=== === ==== === ====
</TABLE>
WHOLESALE ENERGY
Our Wholesale Energy segment includes our non-rate regulated power
generation operations in the United States and our wholesale energy trading,
marketing and risk management operations in North America.
As of September 30, 2000, we owned or leased electric power generation
facilities with an aggregate net generating capacity of 9,231 MW in the United
States. We acquired our first power generation facilities in April 1998, and
have increased our aggregate net generating capacity since December 31, 1998
through a combination of acquisitions and the development of new generating
projects. As of September 30, 2000, we had 2,766 MW of additional net generating
capacity under construction. For additional information regarding acquisitions
completed by Wholesale Energy, including the accounting treatment of these
acquisitions, please read Note 5 to our consolidated financial statements.
For a discussion of the factors that may affect the future results of
operations of Wholesale Energy, please read "Risk Factors -- Risks Related to
Our Wholesale Business."
38
<PAGE> 42
The following table provides summary data regarding the results of
operations of Wholesale Energy for the nine months ended September 30, 1999 and
2000 and for the years ended December 31, 1997, 1998 and 1999.
<TABLE>
<CAPTION>
WHOLESALE ENERGY
-------------------------------------------
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------ ----------------
1997 1998 1999 1999 2000
------ ------ ------ ------ -------
(in millions, except operations data)
<S> <C> <C> <C> <C> <C>
Operating Revenues...................................... $1,300 $4,338 $7,866 $5,798 $12,342
Operating Expenses:
Fuel and cost of gas sold............................. 978 2,352 3,924 2,682 6,063
Purchased power....................................... 313 1,824 3,729 2,936 5,505
Operation and maintenance............................. -- 35 101 91 130
General, administrative and development............... 14 73 72 35 104
Depreciation and amortization......................... 2 14 21 15 70
------ ------ ------ ------ -------
Total Operating Expenses....................... $1,307 $4,298 $7,847 $5,759 $11,872
------ ------ ------ ------ -------
Operating (Loss) Income................................. $ (7) $ 40 $ 19 $ 39 $ 470
====== ====== ====== ====== =======
Operations Data:
Net Generation Capacity (in MW)....................... -- 3,800 4,469 3,800 9,231
Electricity Wholesale Power Sales (in MMWH)........... 12 65 112 77 132
Natural Gas Sales (in Bcf)............................ 366 1,115 1,746 1,265 1,707
</TABLE>
Nine Months Ended September 30, 2000 Compared to Nine Months Ended
September 30, 1999. Wholesale Energy's operating income increased $431 million
for the nine months ended September 30, 2000 compared to the same period in
1999. The increase was primarily due to increased energy sales volumes, higher
prices for energy and ancillary services, and improved operating results from
trading and marketing activity in the western U.S. market (primarily California
and Nevada), as well as expansion of our generation operations into other
regions including the Mid-Atlantic United States (Pennsylvania, New Jersey and
Maryland), Florida and Texas.
Wholesale Energy's operating revenues increased $6.5 billion (113%) for the
nine months ended September 30, 2000, compared to the same period in 1999. The
increase was primarily due to an increase in gas sales prices and increased
power sales volumes. Increased gas sales volumes and increased power sales
prices in 2000 as compared to 1999 also contributed to the increase in revenues.
Wholesale Energy's fuel and cost of gas sold and purchased power costs increased
$3.4 billion and $2.6 billion, respectively, in the nine months ended September
30, 2000, compared to the same period in 1999. The increase in fuel and cost of
gas sold was primarily due to an increase in gas volumes purchased and an
increase in the price of gas. The increase in purchased power cost was primarily
due to a higher average cost of power and higher power volumes purchased.
Operation and maintenance expenses and general, administrative and development
costs for Wholesale Energy increased $39 million and $69 million, respectively,
in the nine months ended September 30, 2000, compared to the same period in
1999. This increase was primarily due to costs associated with the maintenance
of facilities acquired or placed into commercial operation during the period,
increased costs associated with developing new power generation projects and
higher staffing levels to support increased sales and expanded trading and
marketing efforts. Depreciation and amortization expense for the nine months
ended September 30, 2000 increased $55 million as compared to the same period in
1999 as a result of the acquisition of the Mid-Atlantic generating facilities
and other generating facilities after the third quarter of 1999.
Twelve Months Ended December 31, 1999 Compared to Twelve Months Ended
December 31, 1998. Wholesale Energy reported operating income of $19 million in
1999 compared to $40 million in 1998. The $21 million decrease was due primarily
to a decline in market prices for
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<PAGE> 43
electricity in the California market caused by milder than normal weather and
increased hydroelectric generation sold by competitors into the California
market. This decline more than offset significant increases in operating income
in the trading and marketing operations of Wholesale Energy in 1999. The
increases in trading and marketing operating income resulted primarily from
increases in volumes of gas, power and oil trading and slightly higher margins,
or revenue less cost of power sold, on power trading.
Operating revenues for Wholesale Energy were $7.9 billion in 1999, an 81%
increase from 1998 revenues of $4.3 billion. The increase in revenues was
primarily due to increased trading volumes for power, gas and oil. Higher sales
prices for both power and gas also contributed to increased revenues.
Fuel and cost of gas sold and purchased power costs increased $1.6 billion
and $1.9 billion, respectively, in 1999 as compared to 1998. The increase was
primarily due to the corresponding increase in trading sales volumes. An
increase in power and gas prices also contributed to the increase in costs.
Operation and maintenance expenses in 1999 increased $66 million as compared to
1998. The increase was primarily due to costs associated with the maintenance of
the operations in California, which we acquired in April and July 1998. General,
administrative and development costs in 1999 remained constant when compared to
1998. Depreciation and amortization in 1999 increased $7 million from 1998 due
primarily to a full year of depreciation and amortization for our California
operations as well as additional assets placed into operation during 1999.
Twelve Months Ended December 31, 1998 Compared to Twelve Months Ended
December 31, 1997. Wholesale Energy's operating income increased $47 million in
1998 as compared to 1997. The increase was primarily related to the inclusion of
income generated by the California operations, which we acquired during April
and July 1998. Improved 1998 results were partially offset by a $59 million
increase in general, administrative and development costs. We did not own power
generation facilities during 1997. Our trading, marketing and risk management
operations were acquired in August 1997 and therefore had operating results for
only five months of 1997.
Operating revenues increased $3.0 billion (234%) in 1998 as compared to
1997. The increase in revenues primarily resulted from an increase in 1998 as
compared to 1997 in power and gas sales volumes and power sales prices. The
benefit of increased natural gas sales volume was offset by lower gas sales
prices.
Fuel and cost of gas sold and purchased power costs increased by $1.4
billion and $1.5 billion, respectively, in 1998 as compared to 1997. The
increase in natural gas cost is primarily a result of increased gas sales
volumes. The increase in purchased power costs is a result of increased power
sales volume and a higher average cost of power.
Operations and maintenance expense increased $35 million in 1998 as
compared to 1997. The increase was primarily a result of the operation and
maintenance of acquired electric generating facilities during 1998. General,
administrative and development costs increased $59 million in 1998 as compared
to 1997. The increase resulted primarily from increased staffing support,
increased marketing support and increased reserves of $4 million for
uncollectible accounts related to specific trading counterparties. Depreciation
and amortization increased $12 million in 1998 as compared to 1997 as a result
of depreciation and amortization of fixed assets and goodwill related to the
electric generating facilities acquired during 1998.
EUROPEAN ENERGY
Our European Energy segment includes the operations of UNA and its
subsidiaries and our European trading, marketing and risk management operations.
We created European Energy in the fourth quarter of 1999 with the acquisition of
UNA and the formation of our European trading, marketing and risk management
operations. European Energy generates and sells power from its
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<PAGE> 44
generation facilities in the Netherlands and participates in the emerging
wholesale energy trading and marketing industry in Northwest Europe.
Effective October 7, 1999, we acquired UNA, a Dutch generation company, for
a net purchase price of $1.9 billion. From October 1, 1999, European Energy
operating results include the results of operations of UNA. The impact of UNA's
results of operations from October 1 through October 7, 1999 was immaterial to
our consolidated results of operations. For additional information regarding the
acquisition of UNA, please read Note 5(b) to our consolidated financial
statements.
In connection with our evaluation of the acquisition of UNA, we also began
to assess and formulate an employee severance plan to be undertaken as soon as
reasonably possible post-acquisition. The intent of this plan was to make UNA
competitive in the Dutch electricity market as it became deregulated on January
1, 2001. This plan was finalized, approved and completed in September 2000. At
that time, we recorded the severance liability as a purchase price adjustment in
the amount of $19 million.
UNA and the other major Dutch generators historically have operated under
an agreement, which is referred to as the "protocol," pursuant to which the
generators provided capacity and energy to distributors for a total combined
payment of NLG 3.4 billion ($1.4 billion, based on an exchange rate on September
30, 2000 of 2.50 NLG per U.S. dollar), plus compensation for actual fuel costs
over the period from 1997 through 2000. Effective January 1, 2001, these
agreements expired in all material aspects.
Beginning January 1, 2001, the Dutch wholesale electric market was
completely opened to competition and as a result, we expect a decline in power
prices. Consistent with our expectations at the time we made the acquisition, we
anticipate that UNA will experience a significant decline in revenues in 2001
attributable to the deregulation of the market and termination of the protocol.
For additional information on these and other factors that may affect the future
results of operations of European Energy, please read "Risk Factors -- Risks
Related to Our Wholesale Business -- We will experience a significant decline in
our European Energy business segment's revenues in 2001."
The following table provides summary data for the results of operations of
European Energy for the nine months ended September 30, 2000 and the three
months ended December 31, 1999.
<TABLE>
<CAPTION>
EUROPEAN ENERGY
---------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, 1999 SEPTEMBER 30, 2000
------------------ ------------------
(in millions)
<S> <C> <C>
Operating Revenues........................................ $153 $415
Operating Expenses:
Fuel and purchased power................................ 68 199
Operation and maintenance............................... 25 73
General and administrative.............................. 6 19
Depreciation and amortization........................... 20 55
---- ----
Total Operating Expenses......................... $119 $346
---- ----
Operating Income.......................................... $ 34 $ 69
==== ====
</TABLE>
For the nine months ended September 30, 2000, European Energy reported
operating income of $69 million. European Energy reported operating income of
$34 million for the three months ended December 31, 1999.
For information regarding foreign currency matters, please read Note 6 to
our consolidated financial statements, "Risk Factors -- Risks Related to Our
Businesses Generally -- The value of our foreign generating facilities and
businesses may be reduced by risks related to laws of other countries, taxes,
economic conditions, fluctuations in currency rates, political conditions,
policies
41
<PAGE> 45
of foreign governments and labor supply and relations" and "-- Quantitative and
Qualitative Disclosures about Market Risk."
RETAIL ENERGY
Our Retail Energy segment provides energy products and services to end-use
customers, ranging from residential and small commercial customers to large
commercial, institutional and industrial customers. In addition, Retail Energy
includes billing and remittance services provided to Reliant Energy's regulated
electric utility and two of its natural gas distribution divisions. Retail
Energy charges the regulated electric and gas utilities for these services at
cost. We will succeed to a significant electric retail customer base in the
Houston metropolitan area when the Texas market opens to competition in January
2002.
For a discussion of the factors that may affect the future results of
operations of Retail Energy, please read "Risk Factors -- Risks Related to Our
Retail Electricity Business."
The following table provides summary data regarding the results of
operations of Retail Energy for the nine months ended September 30, 1999 and
2000 and the years ended December 31, 1997, 1998 and 1999.
<TABLE>
<CAPTION>
RETAIL ENERGY
-----------------------------------
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
------------------ --------------
1997 1998 1999 1999 2000
---- ---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C> <C>
Operating Revenues.......................................... $21 $33 $ 34 $ 29 $ 59
Operating Expenses:
Operation and maintenance................................. 19 30 33 32 81
General and administrative................................ 4 5 14 7 14
Depreciation and amortization............................. -- -- -- -- 2
--- --- ---- ----- ----
Total Operating Expenses........................... $23 $35 $ 47 $ 39 $ 97
--- --- ---- ----- ----
Operating (Loss) Income..................................... $(2) $(2) $(13) $ (10) $(38)
=== === ==== ===== ====
</TABLE>
Nine Months Ended September 30, 2000 Compared to Nine Months Ended
September 30, 1999. Retail Energy's operating loss increased $28 million for
the nine months ended September 30, 2000 compared to the nine months ended
September 30, 1999. Operating revenues increased $30 million (103%) during the
nine months ended September 30, 2000 as compared to the same period in 1999.
This increase was primarily the result of the inclusion of revenues generated by
the operations acquired during November 1999, additional revenue generated by an
increase in the number of new energy service contracts and additional revenues
for the billing and remittance services provided to Reliant Energy. For the nine
months ended September 30, 2000 as compared to the same period in 1999,
operations and maintenance costs increased $49 million while general and
administrative costs increased $7 million. Increased operation and maintenance
costs resulted primarily from costs associated with servicing contracts acquired
during 1999 as well as new contracts entered into in 2000, costs incurred in
performing billing and remittance services for Reliant Energy, and costs related
to building an infrastructure necessary to prepare for competition in the retail
market in Texas. General and administrative costs increased as a result of
building the infrastructure necessary to prepare for competition in the retail
electric market in Texas.
Twelve Months Ended December 31, 1999 Compared to Twelve Months Ended
December 31, 1998. Retail Energy incurred an operating loss of $13 million in
1999 as compared to an operating loss of $2 million in 1998. The $11 million
decline in operating results in 1999 as compared to 1998 resulted from a $9
million increase in general and administrative expenses and a $3 million
increase in operational and maintenance expenses in 1999 as compared to 1998,
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<PAGE> 46
partially offset by a $1 million (3%) increase in revenues in 1999 generated by
the operations acquired during November 1999 and an increase in the number of
energy contracts serviced. General and administrative costs increased as a
result of increased staffing, systems and marketing costs to prepare for
entrance into the retail electricity market in Texas.
Twelve Months Ended December 31, 1998 Compared to Twelve Months Ended
December 31, 1997. Retail Energy recorded an operating loss of $2 million in
1998 as well as in 1997. Revenue increased $12 million (57%) in 1998 primarily
as a result of an increase in the number of energy contracts serviced. In 1998,
operation and maintenance and general and administrative costs increased $11
million and $1 million, respectively, as compared to 1997. Operation and
maintenance increased as a result of costs associated with servicing new
contracts.
OTHER OPERATIONS
Our Other Operations segment includes the operations of our eBusiness
group, our communications business, New Ventures and unallocated corporate
costs.
The following table provides summary data for the results of operations for
Other Operations for the nine months ended September 30, 1999 and 2000 and for
the years ended December 31, 1997, 1998 and 1999.
<TABLE>
<CAPTION>
OTHER OPERATIONS
--------------------------------------
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------- --------------
1997 1998 1999 1999 2000
---- ---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C> <C>
Operating Revenues.......................................... $-- $-- $-- $-- $ 4
Operating Expenses:
Operation and maintenance................................. -- -- -- -- 4
General and administrative................................ -- -- 2 1 21
Depreciation and amortization............................. -- 1 2 1 3
--- --- --- --- ----
Total Operating Expenses........................... $-- $ 1 $ 4 $ 2 $ 28
--- --- --- --- ----
Operating Loss.............................................. $-- $(1) $(4) $(2) $(24)
=== === === === ====
</TABLE>
Nine Months Ended September 30, 2000 Compared to Nine Months Ended
September 30, 1999. During the nine months ended September 30, 2000, Other
Operations had operating revenues of $4 million from its communications
business, which was formed in June 1999. Increased general and administrative
and operation and maintenance costs in the nine months ended September 30, 2000
of $25 million compared to $1 million for the same period in 1999, resulted
primarily from start-up costs related to our eBusiness and communications
businesses. The increase in depreciation and amortization of $2 million is
primarily related to increased capital expenditures in 2000 as compared to the
same period in 1999.
Twelve Months Ended December 31, 1999 Compared to Twelve Months Ended
December 31, 1998. Other Operations incurred operating losses of $4 million and
$1 million in 1999 and 1998, respectively. The increase in loss in 1999 compared
to 1998 was primarily due to incurred start-up costs of the eBusiness and
communications businesses in 1999.
Twelve Months Ended December 31, 1998 Compared to Twelve Months Ended
December 31, 1997. Other Operations incurred an operating loss of $1 million in
1998 compared to an operating loss of $0.3 million in 1997.
RELIANT ENERGY SERVICES, INC. AND RELATED COMPANY
In August 1997, Reliant Energy acquired Reliant Energy Resources Corp. and
its subsidiaries, including a trading and marketing company that conducted
business under the name
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<PAGE> 47
"NorAm Energy Services" prior to February 1999. Two subsidiaries of Reliant
Energy Resources Corp., Reliant Energy Services, Inc. (formerly NorAm Energy
Services) and Arkla Finance Corporation, are included in our results of
operations since their date of acquisition. For further discussion of the
acquisition of Reliant Energy Resources Corp., or "RERC," by Reliant Energy in
August 1997, please read Note 5(e) to our consolidated financial statements. For
the seven months ended July 31, 1997 (prior to the date of acquisition),
revenues and natural gas costs of these subsidiaries were $1.6 billion each.
Their operation and maintenance, and general and administrative and other costs
were $15 million and $10 million, respectively, resulting in an operating loss
of $25 million. Other income for the seven-month period was $2 million resulting
from net interest income on notes receivable from affiliated companies of $3
million, partially offset by interest and other expenses of $1 million. An
income tax benefit of $9 million was recorded and net loss was $14 million.
Operating loss was $25 million primarily as a result of high gas costs,
hedging losses associated with first quarter 1997 sales under peaking contracts,
and losses from the sale of natural gas that was held in storage and unhedged in
the first quarter of 1997.
The following table presents selected financial data for the combined
financial condition and results of operations of Reliant Energy Services, Inc.
and Arkla Finance Corporation prior to our acquisition.
<TABLE>
<CAPTION>
YEAR ENDED SEVEN MONTHS
DECEMBER 31, ENDED JULY 31,
-------------- --------------
1995 1996 1997
---- ---- ----
(in millions)
<S> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues.................................................... $855 $2,148 $1,593
Operating Income (Loss)..................................... 2 12 (25)
Net Income (Loss)........................................... 11 14 (14)
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 31, JULY 31,
-------------- --------
1995 1996 1997
---- ---- ----
(in millions)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Total Assets................................................ $401 $ 577 $ 644
Owner's Net Investment...................................... 199 200 189
</TABLE>
CERTAIN FACTORS AFFECTING OUR FUTURE EARNINGS
The level of our future earnings depends on a number of factors, including:
- state and federal legislative and regulatory developments, including
deregulation, re-regulation and restructuring of the electric utility
industry,
- the effects of competition,
- our success in achieving our business strategies,
- the performance of our generation projects under development and the
success of our efforts to invest in and develop new opportunities,
- the timing and extent of changes in commodity prices and interest rates,
- weather variations and other natural phenomena,
- national and regional economic conditions, and
- financial market conditions and the results of our financing efforts.
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<PAGE> 48
COMPETITION AND RESTRUCTURING OF THE WHOLESALE ELECTRICITY MARKET
The regulatory environment applicable to the electric power industry has
recently undergone substantial changes as a result of restructuring initiatives
at both the state and federal levels. These initiatives have had a significant
impact on the nature of the industry and the manner in which its participants
conduct their business. These changes are ongoing and we cannot predict the
future development of deregulation in the industry or the ultimate effect that
this changing regulatory environment will have on our business.
Moreover, existing regulations may be revised or reinterpreted, new laws
and regulations may be adopted or become applicable to us or our facilities, and
future changes in laws and regulations may have a detrimental effect on our
business. Some restructured markets have recently experienced supply problems
and price volatility. These supply problems and volatility have been the subject
of a significant amount of press coverage, much of which has been critical of
the restructuring initiatives. In some of these markets, including California,
proposals have been made by governmental agencies and/or other interested
parties to re-regulate areas of these markets which have previously been
deregulated. We cannot predict whether other proposals to re-regulate will be
made or that legislative or other attention to the electric power restructuring
process will cause the process to be delayed or reversed. If the current trend
towards competitive restructuring of the electric power industry is reversed,
discontinued or delayed, our business prospects and results of operations could
be materially adversely impaired.
The wholesale power industry has numerous competitors. In addition, as a
result of industry restructuring, a significant number of additional competitors
created by the disaggregation of vertically-integrated utilities could become
active in the wholesale power generation business. Like us, many of our
competitors are seeking attractive opportunities to acquire or develop power
generation facilities, both in the United States and abroad. This competition
may adversely affect our ability to make investments or acquisitions.
While demand for electric energy services is generally increasing
throughout the United States, the rate of construction and development of new,
more efficient electric generation facilities may exceed increases in demand in
some regional electric markets. The commencement of commercial operation of new
facilities in the regional markets where we have facilities will likely increase
the competitiveness of the wholesale power market in those regions, which could
have a material negative effect on our business and result of operations.
COMPETITION AND RESTRUCTURING OF THE RETAIL ELECTRICITY MARKET
The Texas electric restructuring law substantially amends the regulatory
structure governing electric utilities in Texas in order to allow full retail
competition beginning on January 1, 2002 in the service territory of all
investor-owned electric utilities. Please read "Our Business -- Our Retail
Energy Business Segment -- Market Framework -- Texas" for a description of the
retail electricity market framework established by the Texas electric
restructuring law. Under this framework, we will initially be required to sell
electricity to the residential and small commercial customers of Reliant
Energy's electric utility division in the Houston metropolitan area at a
specified price, which is referred to in the law as the "price to beat," whereas
other retail electric providers will be allowed to sell electricity to these
customers at any price. We will not be permitted to offer electricity to these
customers at a price other than the price to beat until January 1, 2005, unless
before that date the Texas Utility Commission determines that 40% or more of the
amount of electric power that was consumed in 2000 by the relevant class of
customers is committed to be served by retail electric providers other than us.
Because we will not be able to compete for residential and small commercial
customers on the basis of price in the Houston area and because we expect that
the retail market framework established by the Texas electric restructuring law
will encourage competition from new retail electric providers, we may lose a
significant number of these customers to other providers. Also, we expect that
our
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<PAGE> 49
retail electric operations will face significant competition from retail
affiliates of incumbent utilities in other markets in Texas
While the Texas electric restructuring law calls for the implementation of
a competitive retail electric market in Texas beginning on January 1, 2002, the
law authorizes the Texas Utility Commission to delay the date on which the
retail electric market is opened to competition in any power region in Texas if
it determines that the region is unable to offer fair competition and reliable
service to all retail customer classes on that date. During any delay period, we
may not earn any revenue from our retail electric business.
OUR EUROPEAN OPERATIONS
Beginning January 1, 2001, UNA began operating in a competitive market.
Consistent with our expectations at the time we made the acquisition, we
anticipate that UNA will experience a significant decline in revenues in 2001
attributable to the deregulation of the market and termination of an agreement
with the other Dutch generators and the Dutch distributors. In addition, the
results of our European Energy segment will be negatively impacted beginning in
2002 due to the imposition of a standard Dutch corporate income tax rate, which
is currently 35%, on the income of UNA. In 2000 and prior years, UNA's Dutch
corporate income tax rate was zero percent.
Historically, UNA and the other Dutch generators have sold their generating
output through the coordinating body for the Dutch electricity generating
sector, N.V. Samenwerkende elecktriciteits-produktiebedrijven, which we refer to
in this prospectus as "SEP." Over the years, SEP has incurred "stranded" costs
as a result of a perceived need to cover anticipated shortages in energy
production supply. SEP stranded costs consist primarily of investments in
alternative energy sources and fuel and power purchase contracts currently
estimated to be uneconomical. Legislation has been approved by the Dutch
parliament which would transfer the liability for the stranded costs from SEP to
its four shareholders, one of which is UNA. For information regarding this
legislation, please read Note 11(f) to our consolidated financial statements.
In connection with our acquisition of UNA, the selling shareholders of UNA
agreed to indemnify UNA for certain stranded costs in an amount not to exceed
NLG 1.4 billion (approximately $560 million based on an exchange rate of 2.50
NLG per U.S. dollar as of September 30, 2000), which may be increased in certain
circumstances at our option up to NLG 1.9 billion (approximately $760 million).
Of the total consideration we paid for the shares of UNA, NLG 900 million
(approximately $360 million) has been placed by the selling shareholders in an
escrow account to secure the indemnity obligations. Although our management
believes that the indemnity provision will be sufficient to fully satisfy UNA's
ultimate share of any stranded cost obligation, this judgment is based on
numerous assumptions regarding the ultimate outcome and timing of the resolution
of the stranded cost issue, the former shareholders timely performance of their
obligations under the indemnity arrangement, and the amount of stranded costs
which at present is not determinable. Any shortfall in the indemnity provision
could have a material adverse effect on our results of operations.
ENVIRONMENTAL EXPENDITURES
We are subject to numerous environmental laws and regulations, which
require us to incur substantial costs to operate existing facilities, construct
and operate new facilities, and mitigate or remove the effect of past operations
on the environment. In order to comply with these
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<PAGE> 50
requirements, we may need to spend substantial amounts and devote other
resources from time to time to:
- construct or acquire new equipment,
- acquire permits and/or marketable allowances or other emission credits
for facility operations,
- modify or replace existing and proposed equipment,
- acquire emissions credits and allowances, and
- clean up or decommission waste disposal areas, fuel storage and
management facilities and other locations and facilities, including coal
mine refuse piles and generation facilities.
We anticipate investing up to $550 million in capital and other special
project expenditures between 2000 and 2026 for environmental compliance. If we
do not comply with environmental requirements that apply to our operations,
regulatory agencies could seek to impose civil, administrative and/or criminal
liabilities on us, as well as seek to curtail our operations. Existing
environmental regulations could be revised or reinterpreted, new laws and
regulations could be adopted or become applicable to us or our facilities, and
future changes in environmental laws and regulations could occur, including
potential regulatory and enforcement developments related to air emissions. If
any of these events occur, our business and results of operations could be
materially adversely affected.
OTHER CONTINGENCIES
Please read "Our Business -- Legal Proceedings" for a description of
certain legal and regulatory proceedings affecting us, including two class
action lawsuits recently filed against sellers of electricity in California
alleging violations of state antitrust laws and state laws against unfair and
unlawful business practices.
LIQUIDITY AND CAPITAL RESOURCES
FINANCIAL STRATEGY
Our cash needs have historically been met by a combination of cash from
operations, borrowings under credit facilities, borrowings and capital
contributions from Reliant Energy and its subsidiaries and proceeds from
non-recourse project or acquisition financing. These funds have been used to
finance operations, service debt obligations, fund acquisitions, finance the
development and construction of generating facilities, finance start-up
operations and capital expenditures and meet other cash and liquidity needs.
From time to time, excess cash generated by our businesses have been advanced to
Reliant Energy and Reliant Energy has provided funds to cover our working
capital needs. After this offering, we do not expect to pay cash dividends to
Reliant Energy and we do not expect Reliant Energy to make further equity
capital contributions to us. Please read "Agreements Between Us and Reliant
Energy -- Master Separation Agreement" and "Risk Factors -- Risks Related to Our
Corporate and Financial Structure."
We plan to meet our future capital needs by opportunistically accessing
various capital market and other financing alternatives that are available to us
from time to time. These alternatives may include commercial paper, traditional
bank lines of credit, receivable facilities, debt offerings, non-recourse
project financings, joint venture financings, debt/equity hybrid offerings and
equity offerings.
In 2001, we plan to establish additional liquidity facilities with a number
of domestic and international banks to provide borrowing capacity and letters of
credit. We may also establish various bridge or temporary facilities to fund
projects or acquisitions on an interim basis until we are able to arrange
optimal permanent financing.
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<PAGE> 51
Reliant Energy has obtained waivers under its and its subsidiaries' credit
facilities allowing for this offering, as well as various other restructuring
steps. Prior to the expected distribution of the shares of our common stock
owned by Reliant Energy to its shareholders, Reliant Energy will need to obtain
other waivers or amendments under various credit facilities of Reliant Energy
and its subsidiaries.
Our indebtedness to Reliant Energy and its subsidiaries at September 30,
2000 was $2.4 billion. All of the outstanding indebtedness that we owe to
Reliant Energy and its subsidiaries will be converted into equity before the
completion of this offering without the issuance of any additional shares to
Reliant Energy. Based upon our anticipated liquidity needs from the date of this
offering until the expected date of distribution by Reliant Energy of the
remaining shares of our common stock to its shareholders, we expect that we may
advance funds to or borrow funds from Reliant Energy or its subsidiaries. These
investments or borrowings are expected to bear interest at market-based rates.
CAPITAL REQUIREMENTS
Credit Facilities. As of September 30, 2000, subsidiaries of Reliant
Energy Power Generation, Inc. and UNA had credit facilities that provided for an
aggregate of $1.8 billion in committed credit (including the E 600 million
facility discussed below). As of September 30, 2000, $1.3 billion was
outstanding under these facilities, $385 million of which was to support letters
of credit. The remaining unused credit facilities totaled $473 million. These
credit facilities contain various business and financial covenants requiring us
to, among other things, (a) maintain a ratio of net debt to the sum of net debt
and total equity of not more than 0.60 to 1.00 and (b) maintain a stated ratio
of EBITDA to net finance charges during stated periods. We are in compliance
with our respective covenants under these credit agreements. We do not expect
these covenants to materially limit our ability to borrow under these
facilities. For further information on the material terms of these credit
facilities, please read Note 8 to our consolidated financial statements.
Between December 2000 and January 2001, we entered into a total of nine
credit facilities with financial institutions which provide for an aggregate of
$1.4 billion in committed credit. The facilities became effective on January 2,
2001 and expire on October 1, 2001. Interest rates on the borrowings are based
on the prime rate plus a margin, the Federal Funds Effective Rate plus a margin,
LIBOR plus a margin, a base rate or a rate determined through a bidding process.
These facilities contain various business and financial covenants requiring us
to, among other things, maintain a ratio of net debt to the sum of net debt,
shareholder's equity and subordinated affiliate debt not to exceed 0.60 to 1.00.
Such covenants are not anticipated to materially restrict us from borrowing
funds under such facilities. The facilities are subject to commitment and usage
fees that are calculated based on the outstanding amounts under the facilities.
Acquisition of UNA. On March 1, 2000, we funded the $982 million remaining
UNA purchase obligation. We obtained a portion of the funds for this purchase
from a E 600 million ($596 million) three-year term loan facility established in
February 2000.
Indemnification of UNA Stranded Costs. In connection with the acquisition
of UNA, the selling shareholders of UNA agreed to indemnify UNA for some
specified stranded costs in an amount not to exceed NLG 1.4 billion ($560
million based on a September 30, 2000 exchange rate of 2.5 NLG per U.S. dollar).
This amount may be increased in some circumstances at our option up to NLG 1.9
billion ($760 million). Of the total consideration we paid for the shares of
UNA, NLG 900 million ($360 million) has been placed in an escrow account to
secure these indemnity obligations. We believe that the indemnity provision will
be sufficient to cover UNA's ultimate share of any stranded cost obligation.
This belief is based on numerous assumptions regarding the ultimate outcome and
timing of the resolution of the stranded cost issue, the former shareholders'
timely performance of their obligations under the indemnity arrangement,
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and the amount of stranded costs, which at present is not determinable. For
further discussion of UNA stranded costs, please read Note 11(f) to our
consolidated financial statements.
Acquisition of Mid-Atlantic Assets. On May 12, 2000, we completed the
acquisition of our Mid-Atlantic assets from Sithe Energies, Inc. for an
aggregate purchase price of $2.1 billion. The acquisition was originally
financed through bridge loans from Reliant Energy and $1.0 billion was
subsequently converted to equity. In August 2000, we sold to, and leased back
from, each of the three owner-lessors in separate lease transactions our
respective 16.45%, 16.67% and 100% interests in the Conemaugh, Keystone and
Shawville generating stations, respectively, which we acquired as part of the
Mid-Atlantic acquisition. For further discussion of these lease transactions,
please read Note 11(c) to our consolidated financial statements. As
consideration for the sale of our interest in each of the facilities, we
received a total of $1.0 billion in cash that was used to repay indebtedness
owed by us to Reliant Energy. We will continue to make lease payments through
2029. The lease terms expire in 2034. Cash lease payments are scheduled as
follows (in millions):
<TABLE>
<S> <C>
November 1, 2000 to December 31, 2000....................... $ 1
2001........................................................ 259
2002........................................................ 137
2003........................................................ 77
2004........................................................ 84
2005........................................................ 75
2006 and beyond............................................. 1,187
------
$1,820
======
</TABLE>
Channelview Project. Our 781 MW gas-fired, combined cycle, cogeneration
plant located in Channelview, Texas, which is currently under construction, is
expected to cost $423 million. Of this amount, $223 million had been incurred as
of September 30, 2000. The project has been financed through funds received
under the terms of a committed equity bridge facility, which totals $92 million,
and a non-recourse debt facility aggregating $369 million.
Acquisition of Sunrise Power Plant. In December 2000, we entered into an
agreement with Nevada Power Company to purchase the Sunrise Power Plant, a 153
MW facility, located near Las Vegas, Nevada, together with Nevada Power's rights
under a power purchase agreement covering 222 MW of generation capacity from an
adjacent generation facility. The purchase price for both the plant and Nevada
Power's rights under the power purchase agreement is approximately $33 million.
We anticipate this acquisition will close in June 2001.
Other Generating Projects. As of September 30, 2000, we had an additional
four generating facilities under construction. Total estimated costs of
constructing these facilities are $1 billion. As of September 30, 2000, we had
incurred $641 million of the total projected costs of these projects, which were
funded primarily through borrowings from Reliant Energy and its subsidiaries. We
expect to spend $150 million during the remainder of 2000 on these projects.
These projects are not currently financed with third parties. In addition, as of
September 30, 2000, we have $223 million in commitments to purchase combustion
turbines that are associated with projects not currently under construction. We
believe that our current level of cash and borrowing capability and the proceeds
from this offering will be sufficient to fund these commitments.
Naming Rights to Houston Sports Complex. In October 2000, we acquired the
naming rights for the new football stadium for the Houston Texans, the National
Football League's newest franchise. In addition, the naming rights cover the
entertainment and convention facilities included in the complex with the
stadium. The agreement extends for 32 years. In addition to naming rights, the
agreement provides us with significant sponsorship rights. The aggregate cost of
the naming rights was approximately $300 million. During the fourth quarter of
2000, we incurred an obligation to pay $12 million in order to secure the
long-term commitment and for the initial
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advertising of which $10 million of the $12 million will be expensed in the
Statement of Consolidated Operations. Starting in 2002, when the new stadium is
operational, we will pay $9.5 million each year through 2032 for annual
advertising.
Payment to Reliant Energy. We will be required to make a payment to
Reliant Energy in early 2004 unless the Texas Utility Commission determines
that, on or prior to January 1, 2004, 40% or more of the amount of electric
power that was consumed in 2000 by residential or small commercial customers, as
applicable, within Reliant Energy's Houston service territory as of January 1,
2002 is committed to be served by retail electric providers other than us. If
the 40% test is not met and a payment is required, the amount of this payment
will not exceed, but could be up to, $150 per customer multiplied by the number
of residential or small commercial customers, as the case may be, that we serve
on January 1, 2004 in Reliant Energy's traditional service territory, less the
number of new retail electric customers we serve in other areas of Texas. As of
September 30, 2000, Reliant Energy had approximately 1.5 million residential and
small commercial customers. In the master separation agreement with Reliant
Energy, we have agreed to make this payment, if any, to Reliant Energy.
Environmental Issues. We anticipate investing up to $550 million in
capital and other special project expenditures between 2000 and 2026 for
environmental compliance. Out of this amount, we anticipate expenditures to be
approximately $25 million and $50 million in 2001 and 2002, respectively.
Other Sources/Uses of Cash. Our liquidity and capital requirements are
affected primarily by capital expenditures, debt service requirements and varied
working capital needs associated with trading, marketing and risk management
operations. We expect to continue to bid in future acquisitions of independent
power projects and privatizations of generation facilities. We expect any
resulting capital requirements to be met with excess cash flows from operations,
as well as proceeds from debt and equity offerings, project financings and other
borrowings. Additional capital expenditures depend upon the nature and extent of
future project commitments, some of which may be substantial. We believe that
our current level of cash and borrowing capability and the proceeds from this
offering, along with future cash flows from operations, will be sufficient to
meet the existing operational needs of our business for the next twelve months.
The capital requirements for 1999 were, and are estimated for 2000 through
2004 to be, as follows:
<TABLE>
<CAPTION>
1999 2000(1) 2001 2002 2003 2004
---- ------- ---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Wholesale Energy..................................... $ 501 $1,985 $ 722 $303 $117 $ 26
European Energy...................................... 839 1,006 13 13 11 11
Retail Energy........................................ 55 44 61 46 49 58
Other Operations..................................... -- 70 81 66 52 53
Payments of debt to third parties(2)................. -- 305 21 209 529 35
Mid-Atlantic generating assets operating lease
payments........................................... -- 1 259 137 77 84
Major maintenance cash outlays....................... 11 65 59 59 58 70
------ ------ ------ ---- ---- ----
Total....................................... $1,406 $3,476 $1,216 $833 $893 $337
====== ====== ====== ==== ==== ====
</TABLE>
---------------
(1) In August 2000, we sold to and leased back from owner-lessors, interests in
three Mid-Atlantic generating facilities. As consideration for the sale, we
received $1.0 billion in cash, which was used to repay indebtedness to
Reliant Energy. The expenditures for the acquisitions of these Mid-Atlantic
generating facilities have been excluded from the 2000 capital requirements.
(2) Includes accelerated cash repayments of debt in the first nine months of
2000.
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The following table summarizes the net cash provided by (used in)
operating, investing and financing activities for the nine months ended
September 30, 1999 and 2000 and for the years ended December 31, 1997, 1998 and
1999.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
---------------------- ---------------
1997 1998 1999 1999 2000
---- ---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C> <C>
Cash Provided by (Used in):
Operating activities...................................... $(22) $ (2) $ 86 $ 5 $ 234
Investing activities...................................... (4) (365) (1,404) (104) (2,780)
Financing activities...................................... 26 379 1,354 453 2,741
</TABLE>
CASH USED IN/PROVIDED BY OPERATING ACTIVITIES
Net cash provided by operating activities during the nine months ended
September 30, 2000 increased $229 million compared to the same period in 1999.
This increase primarily resulted from proceeds from the sale of an investment in
marketable debt securities by UNA, improved operating results of Wholesale
Energy's California generating facilities, incremental cash flows provided by
UNA, acquired in the fourth quarter of 1999, and cash flows from the
Mid-Atlantic generating facilities, acquired in the second quarter of 2000,
partially offset by changes in working capital.
Net cash provided by operating activities during the year ended December
31, 1999 increased $88 million compared to the same period in 1998 primarily due
to changes in working capital and improved operating cash flows from the
domestic trading and marketing operations.
Net cash used in operating activities during the year ended December 31,
1998 decreased $20 million over the same period in 1997 primarily due to
incremental cash flows provided by our domestic trading and marketing operations
and Wholesale Energy's California generating facilities, which were acquired in
two separate transactions in April and July 1998.
CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities increased $2.7 billion during the
nine months ended September 30, 2000 compared to the same period in 1999. This
increase was primarily due to the funding of the remaining purchase obligation
for UNA for $982 million on March 1, 2000 and the purchase of the Mid-Atlantic
generation facilities for $2.1 billion on May 12, 2000, as well as increased
capital expenditures related to the construction of domestic power generation
projects. Proceeds from the sale-leaseback of three of our Mid-Atlantic
generation facilities partially offset these increases.
Net cash used in investing activities increased $1.0 billion for the year
ended December 31, 1999 compared to the same period in 1998. This increase was
primarily due to:
- the $833 million cash payment in 1999 related to the acquisition of UNA,
- the $188 million cash payment for the acquisition of our generating
facility located in Florida, and
- increased capital expenditures.
Net cash used in investing activities increased $361 million during the
year ended December 31, 1998 compared to the same period in 1997. This increase
was due primarily to the acquisition of the California generating facilities for
$292 million in April and July 1998.
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CASH PROVIDED BY FINANCING ACTIVITIES
Cash flows provided by financing activities increased $2.3 billion during
the nine months ended September 30, 2000 compared to the same period in 1999.
The increase resulted primarily from an increase in contributions and borrowings
from Reliant Energy and its subsidiaries and net proceeds from long-term debt
from third parties. We utilized the net borrowings incurred during the first
nine months of 2000 to fund the remaining UNA purchase obligation, to fund the
acquisition of the Mid-Atlantic generating facilities, to support increased
capital expenditures by Wholesale Energy and for general corporate purposes. We
obtained the funds for the remaining UNA purchase obligation on March 1, 2000,
in part from a E600 million (approximately $596 million) term loan facility that
expires in March 2003 and through short-term borrowings and excess operating
cash flows. Funds for the acquisition of the Mid-Atlantic generating facilities
were made available through loans from Reliant Energy, of which $1.0 billion of
these loans were subsequently converted to equity and $1.0 billion was repaid
with the proceeds from the Mid-Atlantic sale-leaseback transactions.
Cash flows provided by financing activities increased $975 million during
the year ended December 31, 1999 compared to 1998. This increase was primarily
due to increased borrowings from Reliant Energy offset by a $170 million
distribution from Other Operations to a subsidiary of Reliant Energy. The funds
used to make this distribution were received from loan repayments to us by a
subsidiary of Reliant Energy. We utilized net borrowings incurred and
contributions from Reliant Energy or its subsidiaries received during 1999
primarily to fund $833 million of the UNA purchase obligation, to fund the
acquisition of a generating facility located in Florida and to support increased
capital expenditures.
Cash flows provided by financing activities increased $353 million during
the year ended December 31, 1998 compared to 1997. This increase was primarily
due to increased Reliant Energy contributions. We utilized net funds received
during 1998 primarily to fund the acquisition of the California generating
facilities.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
IMPACT OF CHANGES IN INTEREST RATES, FOREIGN CURRENCY EXCHANGE RATES, EQUITY
MARKET VALUES AND COMMODITY PRICES
We are exposed to various market risks. These risks are inherent in our
financial statements and arise from transactions entered into in the normal
course of business. We enter into derivative financial instruments to mitigate
the impact of changes in electricity and fuel prices on our operating results
and cash flows and we enter into cross-currency swaps and options to hedge our
net investments in foreign subsidiaries.
INTEREST RATE RISK
We issued long-term debt and have obligations under bank facilities and
notes payable to affiliated companies which subject us to the risk of loss
associated with movements in market interest rates.
Our floating-rate obligations, including amounts borrowed from Reliant
Energy and its subsidiaries, under credit facilities aggregated zero, $1.3
billion and $3.3 billion at December 31, 1998 and 1999 and September 30, 2000,
respectively. For further information please read Notes 3 and 8 to our
consolidated financial statements. Net floating rate obligations borrowed from
Reliant Energy and its subsidiaries amounted to zero, $1.3 billion and $2.3
billion at December 31, 1998 and 1999 and September 30, 2000, respectively.
These floating-rate obligations expose us to the risk of increased interest
expense in the event of increases in short-term interest rates. If the floating
rates were to increase by 10% from September 30, 2000 rates,
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our combined interest expense to Reliant Energy and its subsidiaries would
increase by a total of $1.6 million each month in which such increase continued.
If the floating rates were to increase by 10% from December 31, 1999 rates, our
interest expense to Reliant Energy and its subsidiaries would increase by $0.6
million each month in which such increase continued.
Our floating-rate obligations borrowed from third parties aggregated zero,
$69 million and $942 million at December 31, 1998 and 1999 and September 30,
2000, respectively. These floating-rate obligations expose us to the risk of
increased interest expense in the event of increases in short-term interest
rates. If the floating rates were to increase by 10% from September 30, 2000
rates, our combined interest expense to third parties would increase by a total
of $0.6 million each month in which such increase continued. If the floating
rates were to increase by 10% from December 31, 1999 rates, our combined
interest expense to third parties would increase by $40,000 each month in which
such increase continued.
At December 31, 1998 and 1999 and September 30, 2000, we had issued
fixed-rate debt aggregating zero, $560 million and $143 million, respectively.
As of December 31, 1998 and 1999 and September 30, 2000, fair values were
estimated to be equivalent to the carrying amounts of these instruments. These
instruments are fixed-rate and, therefore, do not expose us to the risk of loss
in earnings due to changes in market interest. However, the fair value of these
instruments would increase by $10.7 million and $2.2 million if interest rates
were to decline by 10% from their rates at December 31, 1999 and September 30,
2000, respectively. At September 30, 2000, fixed rate debt included $80 million
of indebtedness to Reliant Energy. If interest rates on this fixed rate
indebtedness were to decline by 10% from the September 30, 2000 rates, the fair
value of these obligations would increase by $0.7 million. In general, such an
increase in fair value would impact earnings and cash flows only if we were to
reacquire all or a portion of these instruments in the open market prior to
their maturity.
Pursuant to the master separation agreement with Reliant Energy, all
indebtedness that we owe to Reliant Energy and its subsidiaries will be
converted into equity before the completion of this offering without the
issuance of any additional shares to Reliant Energy.
UNA held an investment in fixed-rate debt securities, which had a book
value and estimated fair value of $129 million as of December 31, 1999. This
investment subjected us to risk of loss of fair value and earnings with
movements in market interest rates. These debt securities were sold for $123
million in the second quarter of 2000.
FOREIGN CURRENCY EXCHANGE RATE RISK
Our European operations expose us to risk of loss in the fair value of our
European investments due to the fluctuation in foreign currencies relative to
our reporting currency, the U.S. dollar. We account for adjustments resulting
from translation of our investments that have functional currencies other than
the U.S. dollar as a charge or credit directly to a separate component of
Stockholder's Equity and Accumulated Other Comprehensive Loss. As of September
30, 2000, we have entered into foreign currency swaps and have issued Euro
denominated debt to hedge our net investment in UNA. Changes in the value of the
swap and debt are recorded as foreign currency translation adjustments as a
component of Stockholder's Equity and Accumulated Other Comprehensive Loss. As
of December 31, 1999 and September 30, 2000, we had recorded a $0.2 million gain
and an $11 million loss, respectively, in cumulative net translation
adjustments. The cumulative translation adjustments will be realized in earnings
and cash flows only upon the disposition of the related investments. We had no
cumulative translation adjustments recorded prior to December 31, 1999.
We have substantially hedged our net investment in our European
subsidiaries through a combination of Euro denominated borrowings and various
derivative instruments. During the normal course of business, we review our
currency hedging strategies and determine the
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<PAGE> 57
hedging approach we deem appropriate based upon the circumstances of each
individual situation.
EQUITY MARKET VALUES RISK
We have an investment in Cisco Systems, Inc., or "Cisco", which is
classified as "trading" under Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS
No. 115). As of December 31, 1999 and September 30, 2000, the value of the Cisco
investment was $14 million. In January 2000, we entered into financial
instruments (a put option and a call option) to manage price risks related to
our investment in Cisco. Changes in the market value of the equity securities
and the hedges would substantially offset each other and have no material impact
on our earnings or cash flows. We also have an investment in Itron, Inc., or
"Itron", which is classified as "available-for-sale" under SFAS No. 115. As of
December 31, 1998 and 1999 and September 30, 2000, the value of the Itron
investment was $11 million, $9 million and $9 million, respectively. The Itron
investment exposes us to losses in the fair value of Itron common stock. A 10%
decline in the market value per share of Itron common stock from the December
31, 1998 and 1999 and September 30, 2000 levels would have decreased the fair
value by $1 million each period.
COMMODITY PRICES RISK
Trading and marketing operations often involve market risks associated with
managing energy commodities and establishing open positions in the energy
markets primarily on a short-term basis. These risks fall into three different
categories: price and volume volatility, credit risk of trading counterparties
and adequacy of the control environment for trading. We routinely enter into
futures, forward contracts, swaps and options to hedge purchase and sale
commitments, fuel requirements and inventories of natural gas, coal,
electricity, oil, emission allowances, weather derivatives and other commodities
and to minimize the risk of market fluctuations on our marketing and risk
management operations. We assess the risk of our non-trading derivatives, or
"Energy Derivatives", using a sensitivity analysis method and we assess the risk
of our trading derivatives, or "Trading Derivatives", using the value-at-risk,
or "VAR", method in order to maintain our total exposure within
management-prescribed limits (both methods are described below).
The sensitivity analysis performed on our Energy Derivatives measures the
potential loss in earnings based on a hypothetical 10% movement in energy
prices. An increase of 10% in the market prices of natural gas and electric
power from their December 31, 1998 and 1999 and September 30, 2000 levels would
have decreased the fair value of our Energy Derivatives, from their levels on
those respective dates, by $5 million, $15 million, and $50 million,
respectively.
The above analysis of the Energy Derivatives utilized for hedging purposes
does not include the favorable impact that the same hypothetical price movement
would have on our physical purchases and sales of natural gas and electric power
to which the hedges relate. Furthermore, the Energy Derivative portfolio is
managed to complement the physical transaction portfolio, reducing overall risks
within limits. Therefore, the adverse impact to the fair value of the portfolio
of Energy Derivatives held for hedging purposes associated with the hypothetical
changes in commodity prices referenced above would be offset by a favorable
impact on the underlying hedged physical transactions, assuming:
- the Energy Derivatives are not closed out in advance of their expected
term,
- the Energy Derivatives continue to function effectively as hedges of the
underlying risk and
- as applicable, anticipated underlying transactions settle as expected.
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If any of the above mentioned instances occur, a loss on the financial
instruments may occur, or the options might be worthless as determined by the
prevailing market value on their termination or maturity date, whichever comes
first.
Trading Derivatives held by our trading and marketing operations consist of
physical forwards, swaps, options and exchange-traded futures and options in
natural gas, electricity, crude oil and refined products and weather
derivatives, and are exposed to losses in fair value due to changes in the price
and volatility of the underlying derivatives. We utilize the variance/covariance
model of VAR, which is a probabilistic model that measures the risk of loss to
earnings in market sensitive instruments. The variance/covariance model relies
on statistical relationships to describe how changes in different markets can
affect a portfolio of instruments with different characteristics and market
exposures. We use the delta-approximation method for reporting option positions.
VAR models are relatively sophisticated; however, the quantitative risk
information is limited by the parameters established in creating the model. The
instruments being evaluated could have features that may trigger a potential
loss in excess of calculated amounts if changes in commodity prices exceed the
confidence level of the model used. The VAR methodology employs a seasonally
adjusted volatility-based approach with the following critical parameters:
volatility estimates, appropriate market-oriented holding periods and seasonally
adjusted correlation estimates. The holding period (typically one day) is our
estimate of the length of time that will be needed to liquidate the positions.
The volatility and the correlation estimates measure the impact of adverse price
movements both at an individual position level as well as at the total portfolio
level. The confidence level established for our purposes is 95%. For example, if
VAR is calculated at $10 million, we may state with a 95% confidence level that
if prices move against our positions, our pre-tax loss in liquidating our
portfolio would not exceed $10 million. With respect to Trading Derivatives, our
highest, lowest and average monthly VAR during the nine months ended September
30, 2000 was $12 million, $1 million and $5 million, respectively. For the years
ended December 31, 1998 and 1999, our highest, lowest and average monthly VAR
was less than $5 million.
We cannot assure you that market volatility, failure of counterparties to
meet their contractual obligations, transactions entered into after the date of
this prospectus or a failure of risk controls will not lead to significant
losses from our marketing and risk management activities. Please read "Risk
Factors -- Risks Related to Our Wholesale Business -- We do not attempt to fully
hedge our assets or positions against changes in commodity prices, and our
hedging procedures may not work as planned."
RISK OVERSIGHT
We control the scope of our trading, marketing and risk management
operations through a comprehensive set of policies and procedures involving
senior levels of our management. Our board of directors sets the risk limit
parameters and the audit committee of the board has oversight for the ongoing
evaluation of the adequacy of the risk control organization and policies. A risk
oversight committee, comprised of corporate and business segment officers,
oversees all of our activities which include commodity price, credit, foreign
currency, equity and interest rate risk, including our trading, marketing and
risk management operations. The committee also proposes VAR limits to our board
of directors. Our board of directors ultimately sets our aggregate VAR limit. We
have a corporate risk control organization, headed by a chief risk control
officer, which is assigned responsibility for executing and enforcing the
policies, procedures and limits and evaluating the risks inherent in proposed
transactions. Key risk control activities include credit review and approval,
credit and performance risk measurement and monitoring, validation of
transactions, portfolio valuation, and daily portfolio reporting including
mark-to-market valuation, VAR and other risk measurement metrics.
To the extent an open position exists, fluctuating commodity prices can
impact financial results and financial position, either favorably or
unfavorably. As a result, we cannot predict with
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<PAGE> 59
precision the impact that our risk management decisions may have on our
businesses, operating results or financial position.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2001, we are required to adopt Statement of Financial
Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended (SFAS No. 133), which establishes accounting and
reporting standards for derivative instruments, including some specified hedging
instruments embedded in other contracts and for hedging activities. This
statement requires that derivatives be recognized at fair value in the balance
sheet and that changes in fair value be recognized either currently in earnings
or deferred as a component of other comprehensive income, depending on the
intended use of the derivative, its resulting designation and its effectiveness.
In addition, in June 2000, the Financial Accounting Standards Board issued an
amendment that narrows the applicability of the pronouncement to some purchase
and sales contracts and allows hedge accounting for some other specific hedging
relationships. Adoption of SFAS No. 133 will result in no cumulative after-tax
charge to net income and a cumulative after-tax reduction of other comprehensive
income of approximately $261 million in the first quarter of 2001. The adoption
will also impact assets and liabilities recorded on the balance sheet.
Staff Accounting Bulletin No. 101, "Revenue Recognition" (SAB No. 101), was
issued by the SEC on December 3, 1999. SAB No. 101 summarizes some of the SEC
staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. Our consolidated financial statements
reflect the accounting principles provided in SAB No. 101.
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OUR BUSINESS
INTRODUCTION
We are a rapidly growing provider of electricity and energy services with a
focus on the competitive segments of the electric power industry in the United
States and Europe. We acquire, develop and operate electric power generation
facilities that are not subject to traditional cost-based regulation and
therefore can sell power at prices determined by the market. We also trade and
market power, natural gas and other energy-related commodities and provide
related risk management services. We believe our trading, marketing, and risk
management skills complement our generation positions. The combination provides
greater scale and skill associated with the management of our fuel and power
positions, sophisticated commercial insights and understanding of the key
regions in which we participate, and a wider range of ways in which we
participate in the market and are able to meet customer needs.
We intend to become a provider of retail electric services in Texas when
the market opens to retail competition in January 2002 and in other U.S. markets
with favorable regulatory structures and profit opportunities thereafter. We
will initially succeed to a significant retail electric customer base in the
Houston metropolitan area. We intend to build our retail business elsewhere by
capitalizing on the skills and systems we are building for the competitive
market in Houston.
We believe that the combination of our high quality portfolio of power
generation assets, our sophisticated trading, marketing and risk management
operations and our anticipated retail electric customer base in Texas provides
us with the foundation to successfully capitalize on the attractive growth
opportunities in the deregulating electric power markets.
As of December 1, 2000, we owned or leased electric power generation
facilities with an aggregate net generating capacity of 12,707 MW, including
9,231 MW in the United States and 3,476 MW in the Netherlands. According to
Resource Data International, Inc., as of September 30, 2000, we were the third
largest independent electric power producer in the United States based on
estimated total MW of wholesale generation capacity expected to be in operation
by December 31, 2000. We acquired our first power generation facilities in 1998
and have more than tripled our aggregate net generation capacity since December
31, 1998 through a combination of acquisitions and development of new generation
projects. As of December 1, 2000, we had 2,766 MW of additional net generating
capacity under construction. In addition, in December 2000 we entered into an
agreement to acquire a 153 MW generation facility and a power purchase agreement
covering 222 MW of generation capacity from an adjacent facility. We expect this
acquisition will close in June 2001.
Our trading, marketing and risk management operations complement the
performance of our power generation operations. For the first nine months of
2000, we were one of only six companies to rank among both the ten largest power
marketers and the ten largest natural gas marketers in the United States. We
believe the combination of our significant portfolio of power generation
positions and our sophisticated trading, marketing and risk management
operations provides us with a competitive advantage.
We intend to become a significant provider of retail electric services in
the United States. We plan to establish our retail presence first in Texas, and
then in other U.S. markets with favorable regulatory structures and profit
opportunities. We believe the market framework established by the Texas electric
restructuring law will result in attractive opportunities both for incumbents
and for new entrants to the retail market. Starting January 1, 2002, all Texas
customers of investor-owned utilities, as well as those of any municipal utility
or electric cooperative that opts to participate in the competitive marketplace,
will be able to choose their retail electric provider. On that date, we will
become the retail electric provider for all of Reliant Energy's approximately
1.7 million customers in the Houston metropolitan area who do not take action to
select another retail electric provider. We will also be able to acquire and
serve new retail customers elsewhere
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in Texas after that date. We plan to provide value-added electric commodity and
energy management services to large commercial and industrial customers
throughout the United States, including many of the large commercial and
industrial customers currently served by Reliant Energy.
In addition to our wholesale and retail businesses we also engage in other
businesses that we believe provide potential opportunities for future growth.
Our Other Operations business segment includes our eBusiness group, our
communications business and our venture capital operations.
THE ELECTRIC POWER INDUSTRY
DEREGULATION OPPORTUNITY AND MARKET GROWTH IN THE UNITED STATES
Historically, electricity in the United States has been generated,
distributed and sold by regulated, vertically-integrated utilities with
government granted franchises to provide electric services to customers within a
specific geographic area. Retail electricity rates have traditionally been set
by regulatory authorities at levels intended to allow utilities to earn a
targeted rate of return on their invested capital. Similar to what occurred in
the U.S. telecommunications industry, the U.S. electric power industry is being
fundamentally transformed as a result of restructuring initiatives at both the
state and federal levels. The electric power industry includes the following
segments:
- Wholesale. Traditional wholesale operations generally involved only the
generation of electricity and the procurement of fuels used to produce
that electricity. To date, the wholesale market has been the most rapidly
deregulating segment of the electric power industry. As of January 1,
2001, 24 states and the District of Columbia had enacted legislation or
issued comprehensive regulatory orders to promote competition in the
wholesale market for electric power. Wholesale customers include
utilities, municipalities, cooperatives and other resellers of wholesale
power, but exclude the end users of electricity. As a result of the
current deregulation trend, some companies' wholesale generation
operations are now complemented by the wholesale trading and marketing of
fuels and energy, and related risk management services.
- Transmission. Transmission operations involve the transmission of
electricity through high voltage wires from power generation facilities
to the distribution system. In recent years, the FERC has required owners
of transmission facilities to offer "open-access" transmission service to
customers at the same price and on the same terms that the transmission
owner provides itself for its own transactions. These requirements have
helped promote the development of competition in the wholesale electric
markets. Generally, we expect transmission operations to remain subject
to regulated rates.
- Distribution. Distribution operations involve the distribution of
electricity through wires from the transmission system to the end users
of electricity. Generally, we expect distribution operations to remain
subject to traditional rate regulation.
- Retail. Retail operations involve the sale of electricity and related
services to end users of electricity, including industrial, commercial
and residential customers. As of December 31, 2000, retail electric
markets in fourteen states were open to competition. In addition, laws or
regulatory plans providing for future retail electric competition by 2002
had been adopted in another eight states and the District of Columbia.
The degree to which retail electric markets have been or will be
deregulated varies by state, with some states partially deregulating
their markets and others transitioning their markets to full retail
competition. In many of the states that have opened their retail electric
markets to competition, the incumbent utility has been required to offer
power at prices that are too low to generate retail profit margins
sufficient to promote competition.
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The current restructuring trend in the U.S. electric power industry,
including the unbundling of many vertically-integrated utilities, creates
attractive growth opportunities in the wholesale and retail electric markets,
including:
Opportunity to develop additional generation facilities. Supply and demand
dynamics in the U.S. power market have created significant opportunities for us
to develop additional generation facilities. Driven by population growth and
economic prosperity, the demand for electric power in the United States grew
significantly during the 1990s. However, over the same time period, the growth
of aggregate power generating capacity did not keep pace. Over the ten year
period from 1990 through 1999, the increase in peak demand for power in the
United States was approximately double the amount of generation capacity that
was added during that period. Some areas have experienced shortages of power
generation capacity, evidenced at times by actual or threatened brownouts and
blackouts and very high peak prices for electricity in some of the recently
created wholesale power markets. In addition, we expect these shortages may be
exacerbated by the retirement of some older plants that are unable to
economically comply with environmental regulations.
Opportunity to acquire existing generation facilities. Restructuring of the
electric power industry has also resulted in the sale or transfer of generating
capacity from regulated, vertically-integrated utilities to unregulated
wholesale power generation companies. As of December 31, 1999, the total
electric generation capacity of the U.S. market consisted of approximately 5,400
individual facilities with installed capacity of approximately 766,000 MW. Over
the last several years, many vertically-integrated utilities have restructured
and divested their power generation assets. From 1997 through November 2000,
vertically-integrated utilities have sold or have contracted to sell power
plants having approximately 120,000 MW of generation capacity to third parties
and have transferred additional power plants having approximately 24,000 MW of
generation capacity to affiliated unregulated wholesale power generation
companies. In addition, some of these assets have been sold for the second time.
We expect additional generating capacity to be sold as more states restructure
their electric markets and companies continue to refine their strategic
directions. This trend presents significant opportunities for us to acquire
additional generation capacity.
Opportunity to manage energy-related risks. Restructuring of the electric
power industry is changing the manner in which power is purchased. Under the
traditional regulatory framework, customers typically purchase power from a
vertically-integrated utility at prices that do not vary as a function of usage
pattern or of the overall supply/demand balance in the market. However, in
competitive markets, customers have the opportunity to purchase electricity from
a variety of sources at market prices that reflect the actual price of
electricity at a given point in time. As a result, end users are subject to
greater volatility in power prices. We believe that there are attractive
opportunities for us, as a retail electric provider and intermediary, to manage
these risks for customers and to structure products to meet their demand
profiles and risk tolerances. These opportunities for intermediaries are similar
to opportunities presented in the natural gas industry when it was deregulated
in the mid-1980s.
DEREGULATION AND OPPORTUNITY IN EUROPE
Outside the United States, many countries are privatizing their electric
utilities and transmission and distribution networks and developing regulatory
regimes that are expected to encourage competition in the electric power
industry. We believe that the trend toward deregulation of the electricity
markets in Western Europe is similar to the deregulation trend in the United
States. In addition, like the United States, Western European countries have
relatively stable commercial, legal and political infrastructures in place. The
restructuring of these markets is resulting in a transition from markets
dominated by regulated and often state-owned monopolies to open, competitive
markets. The degree to which the European power markets are being restructured
varies by country. In the Netherlands, the only European country in which we
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currently own generation assets, the Dutch Electricity Act of 1998 permits the
private ownership of generation companies. As permitted under this legislation,
we acquired a portfolio of Dutch generation assets effective in October 1999.
Full wholesale competition in the Dutch market began on January 1, 2001. We
believe that deregulation initiatives in other Western European nations will
provide us with further opportunities to grow our business in Europe.
KEY INDUSTRY CONCEPTS
Power generation facilities can generally be categorized by their variable
cost to produce electricity, which determines the order in which they are
utilized to meet fluctuations in electricity demand. "Base-load" facilities are
those that typically have low variable costs and provide power at all times.
Base-load facilities are used to satisfy the base level of demand for power, or
"load," that is not dependent upon time of day or weather. "Peaking" facilities
have the highest variable cost to generate electricity and typically are used
only during periods of highest demand for power. "Intermediate" facilities have
cost and usage characteristics in between those of base-load and peaking
facilities. The various tiers of base-load, intermediate and peaking facilities
serving a particular region are often referred to as the "supply curve" or
"dispatch curve" for that region. Power generation facilities can also be
categorized as "cogeneration" facilities. Cogeneration is the combined
production of steam and electricity in a generation facility. Cogeneration
facilities typically operate at higher thermal efficiency than other forms of
fossil-fuel-fired generation facilities.
The U.S. electricity transmission infrastructure is divided into eleven
geographic areas commonly referred to as "reliability councils." In general,
power moves reasonably freely within any given reliability council. However,
physical and regulatory constraints frequently limit transfers between
reliability councils and occasionally limit transfers within reliability
councils. As a result, each reliability council, or portion of a reliability
council, generally constitutes a separate market for power. The average amount
by which power generating capacity exceeds peak demand in a given reliability
council is commonly referred to as the "reserve margin."
Power transmission facilities in some of these reliability councils are
controlled by regional transmission organizations. A regional transmission
organization, or "RTO," is an organization approved by the FERC to control the
bulk power transmission facilities in a specific region and to assure reliable
transmission operations and nondiscriminatory access to the transmission grid.
The two principal RTO models are the not-for-profit independent system operator,
or "ISO," and the for-profit independent transmission company, or "transco." To
meet the FERC's RTO criteria, both types of organizations must be independent
from market participants and must assume responsibility for regional
transmission planning, managing transmission congestion and providing the
ancillary services needed for transmission operations.
OUR STRATEGY
Our strategy is to aggressively pursue profitable opportunities in the
deregulating wholesale and retail electric markets in order to deliver superior
value to our stockholders. We actively pursue opportunities where we believe our
skills-based commercial approach provides us with a competitive advantage. We
currently do not have any plans to invest outside the United States and Europe.
OUR STRATEGY IN THE U.S. WHOLESALE MARKET
We plan to continue to expand our regional asset portfolios and commercial
positions in the United States and to maximize their profitability. In order to
achieve these goals, we plan to:
- Capitalize on significant market positions in targeted regions of the
United States. We intend to focus our acquisition, development and
long-term contracting efforts in targeted regions that we believe have
attractive market fundamentals and growth opportunities.
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Currently, we are focused on the Mid-Atlantic and Southwest regions,
where we have a substantial presence, and on the Midcontinent region and
the states of Florida and Texas, where we have a growing presence. We
believe that the more significant our presence is in a regional market,
the more we are able to fully utilize our market intelligence and
commercial skills to generate attractive returns on our investments. We
will continually evaluate market fundamentals and regulatory environments
to adjust our targeted markets.
- Target strategic asset portfolios in our regional markets. We target
strategic portfolios of base-load, intermediate and peaking generation
facilities and power contracts in each of our regional markets based on
prevailing supply and demand fundamentals in order to be able to meet the
full electricity requirements of customers. We believe controlling a
diversified portfolio of generation assets enables us to earn superior
rates of return. We may also invest in other assets, such as gas storage
facilities, that allow us to use our commercial skills to capture value
from these assets.
- Grow through a combination of disciplined acquisitions, development of
new facilities and long-term contracts. We plan to continue to grow our
generation portfolio through a combination of disciplined acquisitions of
existing assets, development of new projects and long-term contracts.
-- Acquisitions. Acquisitions often represent opportunities to acquire a
sizeable and diverse portfolio of generating assets that would be
difficult to replicate through development activities. We also view
acquisitions as opportunities to enhance the operational performance of
the assets acquired by applying our skills-based commercial approach.
-- Development Projects. We use our development projects to capitalize on
identified market opportunities for particular types of facilities and
to enhance our regional asset portfolios.
-- Long-term Contracts. We expect to continue to seek opportunities to
enter into various long-term contractual arrangements with other owners
of generation assets that permit us to increase our participation in a
market without a substantial investment of capital.
- Apply our trading, marketing and risk management skills to complement the
value of our generation operations. We apply our trading, marketing, and
risk management skills in a manner that complements our generation
positions. The combination provides greater scale and skill associated
with the management of our fuel and power positions, sophisticated
commercial insights and understanding of the key regions in which we
participate, and a wider range of ways in which we participate in the
market and are able to meet customer needs. We believe the combination of
our significant portfolio of power generation positions and our
sophisticated trading, marketing and risk management operations provides
us with a competitive advantage. Our trading strategy emphasizes using
our market information to capitalize on arbitrage opportunities as they
arise rather than taking large-scale positions, the success of which is
solely dependent on the direction of future changes in commodity prices.
OUR STRATEGY IN THE EUROPEAN WHOLESALE MARKET
We plan to maximize the value of our European operations and position
ourselves for long-term growth opportunities in the European marketplace. In
order to achieve these goals, we plan to:
- Optimize our portfolio of generation assets in the Netherlands. We
believe we have the opportunity to create value from our recently
acquired generation assets in the Netherlands by reducing operating,
maintenance and administrative costs while increasing operational
flexibility and commercializing these assets in the deregulating Dutch
market.
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We intend to accomplish these objectives by applying the same practices
and policies we employ in our U.S. operations. This will include active
trading of energy commodities and related risk management services in the
Dutch market. It will also involve significant forward selling of the
output of our Dutch generating portfolio and hedging of fuel related
risks. As in the United States, we believe controlling a diversified
portfolio of generation assets enables us to earn superior rates of
return.
- Apply our commercial capabilities and incumbent position to
opportunistically participate in additional European markets. We plan to
build upon our commercial platform in the Netherlands to
opportunistically enter other European markets, primarily by applying our
trading skills and origination capabilities. We will also evaluate
partnerships offering access to additional attractive European generation
assets. Initially, we plan to concentrate our activities in Northwest
Europe, particularly in the Netherlands, Germany, Switzerland and the
United Kingdom. We believe we have an advantaged position over existing
European utilities that do not have the experience of competing in a
deregulating environment, and over new entrants to the market that do not
have a significant incumbent asset position.
OUR STRATEGY IN THE U.S. RETAIL MARKET
We plan to establish a significant retail electric business in Texas when
the market opens to retail competition, and elsewhere throughout the United
States as attractive retail opportunities develop thereafter. In order to
achieve these goals, we plan to:
- Maximize retention of customers we will succeed to in Houston. We plan to
capitalize on the high level of consumer awareness and positive
perception of the Reliant Energy brand name in order to maximize
retention of the Reliant Energy customers we will succeed to in the
Houston metropolitan area. Our strategy is to emphasize performance,
trust and value-added relationships with our customers. Additionally, we
intend to continue to provide customized, integrated energy solutions,
including commodity, risk management, e-commerce and energy service
products, to large commercial and industrial customers, including many of
those currently served by Reliant Energy.
- Aggressively pursue Texas customers outside of Reliant Energy's Houston
service territory. We intend to capitalize on our competitive strengths
and build positive brand recognition in areas of Texas outside of Reliant
Energy's Houston territory. We plan to aggressively pursue retail
customers currently served by other electric utilities in these areas by
providing creative product offerings to encourage them to choose us as
their retail electric provider. As part of these offerings, we intend to
develop enhanced products and services, including customer affinity
programs, to offer to residential and small commercial customers. We also
intend to build our retail brand identity as a service-oriented and
highly trusted provider of energy and related services.
- Leverage our retail experience to pursue opportunities in targeted
markets outside Texas. We expect to have the scale, experience, business
systems and products that will enable us to expand into targeted
competitive retail markets outside Texas that have favorable regulatory
structures and profit opportunities.
- Capitalize on our wholesale trading, marketing and risk management
expertise to enhance our competitive retail position. We believe that our
wholesale trading, marketing and risk management expertise will provide
us with a competitive advantage in the retail electric market by enabling
us to more efficiently procure power to meet our retail load and minimize
our supply-side risks. These skills will also assist us in developing
enhanced products and services to offer our retail electric customers.
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OUR STRATEGY FOR OUR OTHER BUSINESSES
We plan to make limited investments in promising new businesses and
technologies as a means of enhancing our core businesses and developing future
complementary growth businesses.
OUR GENERATION FACILITIES
As of December 1, 2000, we owned or leased electric power generation
facilities with an aggregate net generating capacity of 12,707 MW, located in
five regions in the United States and in the Netherlands. We also had 2,766 MW
of generating capacity under construction as of that date. The five regions in
the United States where we own generation facilities are as follows:
- the Mid-Atlantic region, specifically the Pennsylvania, New Jersey and
Maryland market,
- the Southwest region, specifically Southern California and the states of
Nevada and Arizona,
- the Midcontinent region, including the state of Illinois, where we
currently own generation facilities, and nearby states,
- the state of Florida, and
- the state of Texas.
The following table describes the electric power generation facilities we
owned, leased or had under construction by region as of December 1, 2000.
REGIONAL SUMMARY OF OUR GENERATION FACILITIES
<TABLE>
<CAPTION>
NUMBER OF TOTAL NET
GENERATION GENERATING
REGION FACILITIES CAPACITY (MW) DISPATCH TYPE(1) PRIMARY FUEL
------ ---------- ------------- ---------------- ------------
<S> <C> <C> <C> <C>
MID-ATLANTIC
Operating.............. 21 4,262 Base, Inter, Peak Gas/Coal/Oil/Hydro
SOUTHWEST(2)
Operating.............. 6 4,045 Base, Inter, Peak Gas
Under Construction..... 1 563 Base, Peak Gas
-- ------
Combined............... 7 4,608
MIDCONTINENT
Operating.............. 1 255 Peak Gas
Under Construction..... 1 962 Peak Gas
-- ------
Combined............... 2 1,217
FLORIDA
Operating.............. 1 619 Inter, Peak Gas/Oil
Under Construction..... 1 460 Peak Gas/Oil
-- ------
Combined............... 2 1,079
TEXAS(3)
Operating.............. 1 50 Base, CoGen Gas
Under Construction..... 1 781 Base, CoGen Gas
-- ------
Combined............... 2 831
NETHERLANDS
Operating.............. 5 3,476 Base, Inter, Peak (4)
TOTAL
Operating.............. 35 12,707
Under Construction..... 4 2,766
-- ------
Combined............... 39 15,473
======
</TABLE>
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---------------
(1) We use the designations "Base," "Inter," "Peak" and "CoGen" to indicate
whether the facilities described are base-load, intermediate, peaking or
cogeneration facilities, respectively.
(2)We also have entered into an agreement to acquire a power generation facility
in Nevada with a net generating capacity of 153 MW. We expect this
acquisition will close in June 2001.
(3) We also have an option, which is exercisable in January 2004, to acquire
Reliant Energy's interest in a company owning 14,027 MW of net generating
capacity in Texas. For additional information regarding this option, please
read "Texas Genco Option."
(4) Our Dutch facilities are fueled by natural gas, blast furnace gas, coal and
oil.
OUR WHOLESALE ENERGY BUSINESS SEGMENT
MID-ATLANTIC REGION
Facilities. We own or lease 21 electric power generation facilities with an
aggregate net generating capacity of 4,262 MW located in the Pennsylvania-New
Jersey-Maryland market, commonly referred to as the "PJM market." These
facilities include 2,009 MW of base-load, 803 MW of intermediate, and 1,450 MW
of peaking capacity and represent approximately 7% of the total generation
capacity in the PJM market. We sell the power generated by these facilities to
customers located in the PJM market and to buyers in adjacent electricity
markets. We purchased our Mid-Atlantic generation facilities from Sithe
Energies, Inc. in May 2000 for an aggregate purchase price of approximately $2.1
billion.
The following table describes the electric power generation facilities we
currently own or lease in the Mid-Atlantic region of the United States.
MID-ATLANTIC GENERATION FACILITIES
<TABLE>
<CAPTION>
NET
GENERATING
CAPACITY
GENERATION FACILITIES(1) LOCATION (MW) DISPATCH TYPE(2) PRIMARY FUEL
------------------------ -------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Shawville(3)......................... Pennsylvania 613 Base, Peak Coal
Portland............................. Pennsylvania 585 Base, Inter, Peak Coal/Gas/Oil
Keystone(3).......................... Pennsylvania 285 Base Coal/Oil
Titus................................ Pennsylvania 281 Base, Peak Coal/Gas/Oil
Conemaugh(3)......................... Pennsylvania 281 Base Coal
Seward............................... Pennsylvania 196 Base Coal
Gilbert.............................. New Jersey 614 Inter, Peak Gas/Oil
Sayreville........................... New Jersey 449 Inter, Peak Gas/Oil
Warren............................... Pennsylvania 150 Inter Coal/Gas/Oil
Werner............................... New Jersey 252 Peak Oil
Glen Gardner......................... New Jersey 184 Peak Gas/Oil
Hunterstown.......................... Pennsylvania 71 Peak Gas/Oil
Wayne................................ Pennsylvania 66 Peak Oil
Mountain............................. Pennsylvania 47 Peak Gas/Oil
Tolna................................ Pennsylvania 47 Peak Oil
Piney................................ Pennsylvania 29 Peak Hydro
Blossburg............................ Pennsylvania 25 Peak Gas
Hamilton............................. Pennsylvania 23 Peak Oil
Orrtanna............................. Pennsylvania 23 Peak Oil
Shawnee.............................. Pennsylvania 23 Peak Oil
Deep Creek........................... Maryland 18 Peak Hydro
-----
Total....................... 4,262
=====
</TABLE>
---------------
(1) Unless otherwise indicated, we own a 100% interest in each facility listed.
All of these facilities are operational.
(2) We use the designations "Base," "Inter" and "Peak" to indicate whether the
facilities described are base-load, intermediate or peaking facilities,
respectively.
(3) We lease a 100% interest in the Shawville Station, a 16.67% interest in the
Keystone Station and a 16.45% interest in the Conemaugh Station under
facility interest lease agreements with terms of 26.25 years, 33.75 years
and 33.75 years, respectively.
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Market Framework. The PJM market encompasses a region in the northeast part
of the United States that includes all or a portion of the states of
Pennsylvania, New Jersey, Maryland, Delaware and Virginia and the District of
Columbia and contains approximately 9% of the U.S. population. As of August
2000, the PJM market included 139 generating facilities with a total installed
capacity of 60,073 MW. The fuel mix of this aggregate capacity is approximately
35% coal-fired, 21% nuclear, 19% gas-fired, 19% oil-fired, 5% hydroelectric
power and 1% from other sources. As of August 2000, approximately 67% of the
aggregate generating capacity in the PJM market was owned by regulated utilities
or municipalities and 33% was owned by wholesale power generators. Consumption
of electricity in the PJM market was approximately 234 million MWh in 1999, 231
million MWh in 1998 and 228 million MWh in 1997. The reserve margin in the PJM
market was approximately 12% in 1999, 15% in 1998 and 15% in 1997, excluding net
imported power.
The PJM market is one of the most mature and liquid electricity markets
functioning in the United States. In the PJM market, buyers and sellers "clear"
their transactions through an hourly auction process. In addition, buyers and
sellers can negotiate their own contracts outside of the auction process. We
sell power in this market both through the hourly auction process and under
negotiated contracts.
The PJM market has been restructured as a competitive market with an
open-access, non-discriminatory transmission system administered by an
independent system operator approved by the FERC. In addition to managing the
regional transmission system, the PJM independent system operator is responsible
for maintaining competitive wholesale markets, operating the spot wholesale
energy market and determining the market-clearing price for each hour based on
bids submitted by participating generators. These generators indicate the
minimum prices they are willing to accept to dispatch power from each plant at
various incremental generation levels. Bids are currently capped at $1,000/MWh.
SOUTHWEST REGION
Facilities. We own six electric power generation facilities with an
aggregate net generating capacity of 4,045 MW located in the states of
California and Nevada. These facilities include 240 MW of base-load, 3,395 MW of
intermediate and 410 MW of peaking capacity and represent approximately 5% of
the total generation capacity in the Southwest region, which consists of the
southern portions of California and Nevada and the state of Arizona. We sell the
power generated by these facilities to customers located in the Southwest
region.
We purchased our Coolwater, Etiwanda, Ellwood, Mandalay and Ormond Beach
plants from Southern California Edison Company in two transactions in April 1998
and July 1998 for an aggregate purchase price of approximately $292 million.
Concurrently with these purchases, we entered into contracts under which
Southern California Edison agreed to operate and maintain these plants. We have
extended these contracts through March 2003. We exercise management authority
over the operations of these plants.
We own a 50% interest in a 490 MW gas-fired, base-load/peaking facility
located near Las Vegas, Nevada, which we refer to as the "El Dorado plant."
Sempra Energy owns the other 50% interest in this plant. We invested
approximately $56 million to develop the El Dorado plant, which has been in
commercial operation since April 2000.
In addition, we have a 563 MW gas-fired, base-load/peaking generation
facility under construction in Casa Grande, Arizona, which we refer to as the
"Desert Basin plant." As of October 31, 2000, the engineering work for this
facility had been completed and the construction work was approximately 53%
complete. Based on this status, we expect this facility will begin commercial
operation in the third quarter of 2001.
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In December 2000, we entered into an agreement to purchase from Nevada
Power Company a 153 MW gas-fired peaking generation facility located near Las
Vegas, Nevada, which we refer to as the "Sunrise plant," together with Nevada
Power's rights under a power purchase agreement covering 222 MW of generation
capacity from an adjacent facility. Under the purchase agreement we have agreed
to pay an aggregate purchase price of approximately $33 million for both the
Sunrise plant and Nevada Power's rights under the power purchase agreement. We
expect this acquisition will close in June 2001. The power purchase agreement is
scheduled to expire in 2016, at which time we will have the right to acquire the
related generation facility. In connection with this acquisition, we have
entered into a transitional power purchase agreement with Nevada Power under
which we have granted Nevada Power the right to purchase all of the generation
output of the Sunrise plant and the facility subject to the power purchase
agreement discussed above through March 2003.
The following table describes the electric power generation facilities we
currently own or have under construction in the Southwest region of the United
States.
SOUTHWEST GENERATION FACILITIES
<TABLE>
<CAPTION>
NET
GENERATING
CAPACITY DISPATCH PRIMARY
GENERATION FACILITIES(1) LOCATION (MW) TYPE(2) FUEL
------------------------ -------- ---------- -------- -------
<S> <C> <C> <C> <C>
Operating
El Dorado(3).................................. Nevada 245 Base, Peak Gas
Ormond Beach.................................. California 1,500 Inter Gas
Etiwanda...................................... California 1,020 Inter, Peak Gas
Coolwater..................................... California 655 Inter, Peak Gas
Mandalay...................................... California 574 Inter, Peak Gas
Ellwood....................................... California 51 Peak Gas
-----
Total.................................. 4,045
Under Construction
Desert Basin(4)............................... Arizona 563 Base, Peak Gas
-----
Combined........................................ 4,608
=====
</TABLE>
---------------
(1) Unless otherwise indicated, we own a 100% interest in each facility listed.
In addition to the listed facilities, we have entered into an agreement to
acquire a facility in Nevada with a net generating capacity of 153 MW. We
expect this acquisition will close in June 2001.
(2) We use the designations "Base," "Inter" and "Peak" to indicate whether the
facilities described are base-load, intermediate or peaking facilities,
respectively.
(3) We own a 50% interest in the El Dorado facility. Sempra Energy owns the
other 50%.
(4) We expect this facility will begin commercial operation in the third quarter
of 2001.
Market Framework. Our generation facilities are located within the
Southwest portion of the Western Systems Coordinating Council, or "WSCC SW,"
which encompasses a region in the southwest part of the United States that
includes the state of Arizona and the southern portions of California and Nevada
and contains approximately 9% of the U.S. population. As of August 2000, WSCC SW
included 313 generating facilities with a total installed capacity of 80,940 MW.
The fuel mix of this aggregate capacity is approximately 42% gas-fired, 22%
hydroelectric power, 15% coal-fired, 10% nuclear, 4% geothermal steam, 3%
oil-fired, 2% wind and 2% other fuels. As of August 2000, approximately 61% of
the aggregate generating capacity in WSCC SW was owned by regulated utilities or
municipalities and 39% was owned by wholesale power generators. Consumption of
electricity in WSCC SW was approximately 307 million MWh in 1999, 292 million
MWh in 1998 and 290 million MWh in 1997. The reserve margin in WSCC SW was
approximately 4% in 1999, negative 2% in 1998 and 2% in 1997, excluding net
imported power.
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The California market was the first U.S. electricity market to introduce
full wholesale competition. In the California market, wholesale electric power
is sold through two separate entities, an independent system operator, the "Cal
ISO," and a power exchange, the "Cal PX," as well as in bilateral transactions.
The Cal ISO oversees the reliability and stability of the transmission grid
while the Cal PX functions as a market that clears buyers' and sellers' short-
term transactions.
California's energy market, which includes forward and spot markets, is a
mature and liquid market that functions similarly to the PJM market. Buyers'
bids and sellers' offers are matched until demand is met. The last price cleared
sets the price for all transactions.
The California market is currently experiencing shortages of generation
capacity at peak periods. As a result, it is highly dependent on imports from
both the Pacific Northwest and the Desert Southwest. Because of this heavy
dependence on imported power and the slow pace of new plant construction, the
California market experienced dramatically higher prices for electricity since
the summer of 2000. As a result of recent regulatory action, the California
market is undergoing significant changes that will diminish the role of the Cal
PX and place increased emphasis on long-term bilateral contracting.
In Nevada and Arizona, there is presently no regional transmission
organization in place to manage the transmission systems or to operate energy
markets, although several proposals have been advanced for the establishment of
an organization that would assume control over the transmission systems of the
utilities operating in this region.
MIDCONTINENT REGION
Facilities. We own one gas-fired peaking generation facility located in
Shelby County, Illinois, which we refer to as the "Shelby County plant." As of
September 30, 2000, six of the eight generating units at this facility were in
commercial operation. When all of the generating units at this plant are in
commercial operation, it will have an aggregate net generating capacity of 344
MW. We expect the remaining two units to be in operation by April 2001. We sell
the power generated by this facility on the open market. We placed this facility
in commercial operation in June 2000 at an aggregate cost of approximately $156
million. Upon completion, we anticipate the total cost of developing this
facility will be approximately $209 million.
We also have an 873 MW gas-fired peaking generation facility under
construction in Aurora, Illinois, which we refer to as the "Aurora plant." As of
October 31, 2000, the engineering work for this facility was approximately 72%
complete and the construction work was approximately 34% complete. Based on this
status, we expect this facility will begin commercial operation in the second
quarter of 2001.
The following table describes the electric power generation facilities we
currently own or have under construction in the Midcontinent region of the
United States.
MIDCONTINENT GENERATION FACILITIES
<TABLE>
<CAPTION>
NET
GENERATING
CAPACITY DISPATCH PRIMARY
GENERATION FACILITIES(1) LOCATION (MW) TYPE FUEL
------------------------ -------- ---------- -------- -------
<S> <C> <C> <C> <C>
Operating
Shelby County(2)................................. Illinois 255 Peaking Gas
Under Construction
Aurora(3)........................................ Illinois 873 Peaking Gas
Shelby County(2)................................. Illinois 89 Peaking Gas
-----
Combined........................................... 1,217
=====
</TABLE>
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<PAGE> 71
---------------
(1) We own a 100% interest in each facility listed.
(2) Currently 255 MW of this plant's capacity is operational and 89 MW are under
construction.
(3) We expect this facility will begin commercial operation in the second
quarter of 2001.
Market Framework. Our Illinois generating facilities are located in the
Midcontinent region near Chicago and primarily sell their output in the
Mid-America Interconnected Network, or "MAIN," reliability council. However,
they are capable of serving the entire Midcontinent region. The Midcontinent
region encompasses all or a portion of four reliability councils that include
the states of Illinois, Wisconsin, Missouri, Indiana, Ohio, Michigan, Virginia,
West Virginia, Tennessee, Kentucky, Minnesota, and Iowa. As of August 2000, the
Midcontinent region included 928 generating facilities with a total installed
capacity of 233,520 MW. As of August 2000, approximately 84% of the aggregate
generating capacity in the Midcontinent region was owned by regulated utilities
or municipalities and 16% was owned by wholesale power generators. The fuel mix
of this aggregate capacity is 64% coal-fired, 13% nuclear-fueled, 11% gas-fired,
6% hydroelectric power, 5% oil-fired and 1% from other sources. Consumption of
electricity in the Midcontinent region was approximately 1,026 million MWh in
1999, 1,004 million MWh in 1998, and 980 million MWh in 1997. The reserve margin
for the region was approximately 4% in 1999, 9% in 1998 and 11% in 1997,
excluding net imported power.
The Midcontinent region is in the process of establishing a regional
transmission organization that will further define the rules and requirements
around which a competitive market will develop. There are presently two proposed
transmission system organizations in this region, the Midwest Independent System
Operator, an ISO, and the Alliance Regional Transmission Operator, a transco.
Transactions in this market are presently non-standard and highly negotiated for
terms and conditions. Additionally, the short-term market tends to be physical
in nature with no central power exchange or pool clearing all buyers and
sellers. Until the rules around system operations are established, we expect the
Midcontinent region to continue to be somewhat inefficient.
Only a few of the major utilities in the region, principally in Illinois,
have divested any of their generation assets or formally separated their
generation assets into separate subsidiaries. The fragmented nature of the
wholesale market and the lack of a single region-wide transmission system
organization complicate transfers of electricity within the region, increase
transmission congestion and raise transmission costs.
FLORIDA
Facilities. We own one gas-and oil-fired intermediate/peaking generation
facility with an aggregate net generating capacity of 619 MW located near
Titusville, Florida, which we refer to as the "Indian River plant." This
facility can be operated as either an intermediate or a peaking facility and
represents approximately 1.5% of the total generation capacity in the state of
Florida. We sell up to 525 MW of the power generated by this facility to the
Orlando Utilities Commission under a four-year power purchase agreement that is
scheduled to terminate in September 2003. We sell any excess power generated by
the plant to other utilities and rural electric cooperatives within the region.
We purchased this facility from the Orlando Utilities Commission in October 1999
for a net purchase price of approximately $188 million.
In addition to our Indian River plant, we are beginning construction on a
460 MW gas- and oil-fired peaking generation facility in Osceola County,
Florida, which we refer to as the "Osceola plant." As of October 31, 2000, the
engineering work for this facility was approximately 33% complete and the
construction work was approximately 5% complete. We expect this facility will
begin commercial operation in the third quarter of 2001.
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The following table describes the electric power generation facilities we
currently own or have under construction in the state of Florida.
FLORIDA GENERATION FACILITIES
<TABLE>
<CAPTION>
NET
GENERATING
CAPACITY
GENERATION FACILITIES(1) LOCATION (MW) DISPATCH TYPE(2) PRIMARY FUEL
------------------------ -------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Operating
Indian River.............................. Florida 619 Inter, Peak Gas/Oil
Under Construction
Osceola(3)................................ Florida 460 Peak Gas/Oil
-----
Combined.................................... 1,079
=====
</TABLE>
---------------
(1) We own a 100% interest in each facility listed.
(2) We use the designations "Inter" and "Peak" to indicate whether the
facilities described are intermediate or peaking facilities, respectively.
(3) We expect this facility will begin commercial operation in the third quarter
of 2001.
Market framework. The state of Florida (other than a portion of the western
panhandle) constitutes a single reliability council and contains approximately
5% of the U.S. population. As of August 2000, Florida included 90 generating
facilities with a total installed capacity of 40,489 MW. The fuel mix of this
aggregate capacity is approximately 33% oil-fired, 29% gas-fired, 25% coal-
fired, 10% nuclear and 3% other. As of August 2000, approximately 89% of the
aggregate generating capacity in Florida was owned by regulated utilities or
municipalities and 11% was owned by wholesale power generators. Consumption of
electricity in Florida was approximately 177 million MWh in 1999, 177 million
MWh in 1998 and 166 million MWh in 1997. The reserve margin in Florida was
approximately 2% in 1999, negative 4% in 1998 and 6% in 1997, excluding net
imported power.
Florida is in the process of establishing an independent system operator
that will further define the rules and requirements around which a competitive
market will develop. Transactions in the Florida market are presently
non-standard and highly negotiated for terms and conditions. Until the rules for
system operations are established, we expect the Florida market to continue to
be illiquid.
The Florida Reliability Coordinating Council is responsible for maintaining
reliable operations of the bulk electric power supply system in Florida.
Although there is an existing wholesale trading market within Florida, there has
been virtually no electricity market restructuring and no movement toward retail
competition. None of the investor-owned incumbent utilities have divested any of
their generation assets.
There is currently very limited transmission capacity between Florida and
other markets in the Southeast, which reduces the level of imports available to
the Florida market. As a result, the growing electricity load within Florida
must largely be met by in-state generators. The development of merchant
generating plants in Florida, however, has been effectively halted as a result
of a Florida Supreme Court decision finding that existing Florida law does not
permit developers to construct merchant power plants with a steam turbine
capacity greater than 75 MW because of the court's view that such generation
plants can only be constructed if a utility with retail customers has committed
to purchase their power output. Prior to the decision, a number of developers
had announced plans for the construction of new combined-cycle, gas-fired
generating plants throughout the state.
The governor of Florida has appointed a task force to examine electricity
market restructuring. We expect it could be several years, however, before major
changes in the market structure occur.
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TEXAS
Facilities. We own a 50% interest in a 100 MW gas-fired base/cogeneration
facility in Orange, Texas, which we refer to as the "Sabine plant." Air Liquide
owns the other 50% interest in this plant. We invested approximately $32 million
to develop the Sabine plant, which has been in commercial operation since
December 1999. In addition to the Sabine plant, we currently have a 781 MW
gas-fired, combined cycle, cogeneration facility under construction in
Channelview, Texas, which we refer to as the "Channelview plant." As of October
31, 2000, the engineering work for this facility was approximately 66% complete
and the construction work was approximately 21% complete. Based on this status,
we expect this facility will begin commercial operation in the third quarter of
2001. Equistar Chemicals, L.P. has agreed to purchase up to 293 MW of the
Channelview plant's capacity under a 17-year contract.
Texas Genco Option. In addition to the facilities we currently own or have
under construction in Texas, we have an option exercisable in January 2004 to
acquire Reliant Energy's ownership interest in Texas Genco, a company owning
14,027 MW of aggregate net generation capacity in Texas. For additional
information regarding this option, please read "Texas Genco Option." Pursuant to
the Texas electric restructuring law, Texas Genco, as the affiliated power
generator of Reliant Energy's transmission and distribution utility, is required
to sell at auction 15% of the output of its installed generating capacity. This
obligation continues until January 1, 2007, unless before that date the Texas
Utility Commission determines at least 40% of the quantity of electric power
consumed in 2000 by residential and small commercial customers in the utility's
service area is being served by retail electric providers other than us. The
master separation agreement requires Texas Genco to auction all of its remaining
capacity prior to our exercise of the Texas Genco option. We are entitled to
purchase, at prices established in these auctions, up to 50% of the remaining
capacity, energy and ancillary services of Texas Genco auctioned.
DEVELOPMENT ACTIVITIES
In addition to acquisitions, we intend to continue to grow our generation
asset portfolios by developing additional capacity either through building new
facilities or expanding existing facilities in our domestic regional markets. We
currently have 2,766 MW of projects under construction. We consider a project to
be "under construction" once we have acquired the necessary permits to begin
construction, broken ground at the project site and contracted to purchase
machinery for the project, including the combustion turbines. In addition, we
have a significant number of other projects which are in various stages of
development. These projects may or may not have received all of the necessary
permits and approvals to begin construction. We cannot assure you that these
projects will be completed. We have committed to purchase 39 new combustion
turbines from General Electric Company and Siemens Westinghouse Power
Corporation representing approximately 4,888 MW of generating capacity for an
aggregate purchase price of approximately $982 million. These combustion
turbines will be utilized in both simple cycle and combined cycle
configurations. The combined cycle configurations will result in increased
capacity due to the additional electricity generated by the associated steam
turbines. Consequently, the total maximum plant capacity for these turbine
commitments is approximately 5,739 MW. The following table describes the
turbines scheduled for delivery by the end of 2002 that we have committed to
purchase.
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TURBINE COMMITMENTS
<TABLE>
<CAPTION>
GENERATING TOTAL
CAPACITY GENERATING
QUANTITY PER TURBINE CAPACITY
MANUFACTURER AND TYPE OF TURBINES (MW) (MW)
--------------------- ----------- ----------- ----------
<S> <C> <C> <C>
General Electric LM 6000 Turbine............................ 16 44 704
General Electric 7FA Frame CT Turbine....................... 7 172 1,204
General Electric 7FB Frame CT Turbine....................... 6 185 1,110
Siemens Westinghouse 501FD Frame CT Turbine................. 10 187 1,870
Additional capacity generated by steam turbines in a
combined cycle configuration.............................. 851
--- -----
Total.............................................. 39 5,739
=== =====
</TABLE>
DOMESTIC TRADING, MARKETING AND RISK MANAGEMENT OPERATIONS
In addition to our power generation operations, we trade and market power,
natural gas and other energy-related commodities and provide related risk
management services to our customers. For the first nine months of 2000, we were
one of only six companies to rank among both the ten largest power marketers and
the ten largest natural gas marketers in the United States. Our trading,
marketing and risk management operations were acquired by Reliant Energy in
August 1997 as part of its acquisition of RERC. As of December 1, 2000, these
operations employed a staff of 375 employees.
Our domestic trading, marketing and risk management operations complement
our domestic power generation operations by providing a full range of energy
management services. These services include management of the sales and
marketing of energy, capacity and ancillary services from these facilities, and
also management of the purchase and sale of fuels and emission allowances needed
to operate these facilities. Generally we seek to sell a portion of the capacity
of our domestic facilities under fixed-price purchase contracts, fixed-capacity
payments or contracts to purchase generation at a predetermined multiple of
either gas or oil prices. This provides us with certainty as to a portion of our
revenues while allowing us to maintain flexibility with respect to the remainder
of our generation output. We evaluate the regional forward power market versus
our own fundamental analysis of projected future prices in the region to
determine the amount of our capacity we would like to sell and the terms under
which we would like to sell it pursuant to longer-term contracts. We also take
operational constraints and operating risk into consideration in making this
determination. Generally we seek to hedge a portion of our fuel costs, which are
generally linked to our power sales. We also market energy-related commodities
and offer physical and financial wholesale energy marketing and price risk
management products and services to a variety of customers. These customers
include natural gas distribution companies, electric utilities, municipalities,
cooperatives, power generators, marketers or other retail energy providers,
aggregators and large volume industrial customers.
The following table illustrates the growth of our physical power and gas
trading volumes since 1997.
TRADING VOLUMES
<TABLE>
<CAPTION>
FOR THE
FOR THE YEAR ENDED DECEMBER 31, TEN MONTHS
--------------------------------------------- ENDED
1997(1) 1998 1999 OCTOBER 31, 2000
------- ---- ---- ----------------
<S> <C> <C> <C> <C>
Total Power (MWh).................... 12,182,036 65,227,898 112,133,103 147,774,335
Total Gas (MMBtu).................... 365,577,826 1,115,200,981 1,745,869,183 1,922,803,413
</TABLE>
---------------
(1) The 1997 figures only include the months of August through December.
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Electric Power Trading and Marketing. We purchase electric power from other
generators and marketers and sell power primarily to electric utilities,
municipalities and cooperatives and other marketing companies. According to
Power Markets Week, we were the sixth largest power marketer in the United
States for the nine months ended September 30, 2000 based on total MWh of
electricity sold. Our trading and marketing group is also responsible for the
marketing of power produced from the power plants we own. We also provide risk
management and physical and financial fuel and power sales and optimization
services to our customers.
Power Origination. We have a specific group of employees focused on
developing and providing customers with long-term complex products, which we
refer to as "power origination products." These products are designed and
negotiated on a case by case basis to meet the specific energy requirements of
our customers. Our power origination team works closely with our trading and
marketing group and our power generation group to sell long-term products from
our power generation assets. They also work to leverage our market knowledge to
capture attractive opportunities available through selling products that combine
or repackage energy products purchased from third parties with other third-party
products or with products from our power generation assets. Our efforts to sell
power origination products from our power generation assets have been focused on
longer-term forward sales to municipalities, cooperatives and other companies
that serve end-users, as well as selling near-term products that are not widely
traded. Our power origination products that combine or repackage third party
products are generally highly structured and therefore require the application
of our commercial capabilities (e.g., power trading and asset positions). In
particular, we are well positioned to offer risk management and physical
products required by companies that serve end-users. Some representative
examples of power origination products that we have sold to customers include:
- an eight-year exclusive marketing agreement to purchase all excess
capacity, power and ancillary services from a 100 MW generation facility
of a Midcontinent municipality, under which we earn an incentive fee
based on the gross margin realized by the municipality,
- a five-year forward option to purchase 300 MW at a specified multiple of
gas or oil prices with a Florida electric cooperative, and
- a four-year comprehensive energy and exclusive supply package for a Texas
electric cooperative with a peak load of 450 MW.
Natural Gas Trading and Marketing. We purchase natural gas from a variety
of suppliers under daily, monthly, variable load, base load and term contracts
that include either market sensitive or fixed pricing provisions. We sell
natural gas under sales agreements that have varying terms and conditions, most
of which are intended to match seasonal and other changes in demand. We sold an
average of 4.8 billion cubic feet, or "BCF," per day of natural gas in 1999 and
an average of 3.1 BCF per day in 1998, some of which was sold to the natural gas
distribution company subsidiaries of Reliant Energy. Based on figures provided
by Gas Daily, we were the tenth largest marketer of natural gas for the nine
months ended September 30, 2000 based on total BCF of natural gas sold. We plan
to continue to purchase natural gas to supply to our power plants.
Our natural gas marketing activities include contracting to buy natural gas
from suppliers at various points of receipt, aggregating natural gas supplies
and arranging for their transportation, negotiating the sale of natural gas, and
matching natural gas receipts and deliveries based on volumes required by
customers. We make transportation arrangements with affiliated and non-
affiliated interstate and intrastate pipelines through a variety of means,
including short-term and long-term firm and interruptible agreements. We also
enter into various short-term and long-term firm and interruptible agreements
for natural gas storage in order to offer peak delivery services to satisfy
winter heating and summer electric generating demands. These services are also
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intended to provide an additional level of performance security and backup
services to our customers.
Other Commodities and Derivatives. We trade and market other energy-related
commodities. We use derivative financial instruments to manage and hedge our
fixed-price purchase and sale commitments and to provide fixed-price or
floating-price commitments as a service to our customers and suppliers. We also
use derivative financial instruments to reduce our exposure relative to the
volatility of the cash market prices and to protect our investment in storage
inventories. For additional information regarding our financial exposure to
derivative financial instruments, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Quantitative and
Qualitative Disclosures About Market Risk."
In July 2000, we, along with five other leading natural gas and power
companies, American Electric Power, Aquila Energy, Duke Energy, El Paso Energy
and Southern Company, made an equity investment in IntercontinentalExchange, a
new, web-based system for trading commodities. These six companies accounted for
approximately 26% of the natural gas volumes and 30% of the power volumes traded
in the U.S. market for the third quarter of 2000. The exchange, www.intcx.com,
began trading some types of commodities in August 2000 and started trading gas
and power in November 2000. The potential benefits of this investment include
reducing our cost structure and facilitating trading activity by combining the
liquidity of many of the large traders.
Risk Management Controls. We control the scope of our trading, marketing
and risk management operations through a comprehensive set of policies and
procedures involving senior levels of our management. Our board of directors
sets the risk limit parameters and the audit committee of the board has
oversight for the ongoing evaluation of the adequacy of the risk control
organization and policies. A risk oversight committee, comprised of corporate
and business segment officers, oversees all of our activities which include
commodity price, credit, foreign currency, equity and interest rate risk,
including our trading, marketing and risk management operations. The committee
also proposes value-at-risk limits to our board of directors. Our board
ultimately sets our aggregate value-at-risk limit. We have a corporate risk
control organization, headed by a chief risk control officer, which is assigned
responsibility for executing and enforcing the policies, procedures and limits
and evaluating the risks inherent in proposed transactions. Key risk control
activities include credit review and approval, credit and performance risk
measurement and monitoring, validation of transactions, portfolio valuation, and
daily portfolio reporting including mark-to-market valuation, value-at-risk and
other risk measurement metrics. For additional information regarding our risk
management accounting policies, please read "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Quantitative and
Qualitative Disclosures About Market Risk."
OUR EUROPEAN ENERGY BUSINESS SEGMENT
EUROPEAN WHOLESALE OPERATIONS
Facilities. We own, through our indirect subsidiary UNA, five electric
power generation facilities with an aggregate net generating capacity of 3,476
MW located in the Netherlands. These facilities are grouped in three clusters in
the Amsterdam, Utrecht and Velsen regions. UNA is the third largest generating
company in the Netherlands in terms of both installed capacity and electricity
production. In 1999, UNA generated more than 20% of the country's electricity
production, excluding electricity generated by cogeneration or other industrial
processes. UNA has traditionally served the provinces of North-Holland and
Utrecht, as well as the municipalities of Amsterdam and Utrecht, providing
electricity for approximately two million people and more than 12,000 commercial
and industrial users. In addition to electricity, UNA's generating stations
supply a number of municipalities, including Amsterdam, Nieuwegein, Utrecht and
Purmerend,
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with hot water for district heating purposes in cooperation with two large Dutch
distribution companies. In 1999, approximately 56% of UNA's generation output
was natural gas-fired, 20% was blast furnace gas-fired, 24% was coal-fired and
less than 1% was oil-fired. UNA procures its gas from Gasunie, the monopoly gas
supplier in the Netherlands. UNA procures its coal from GKE, a coal trading and
supply company owned jointly by UNA and the three other largest Dutch generation
companies.
We acquired UNA, then named N.V. Energieproduktiebedrijf UNA, effective in
October 1999. UNA was the first Dutch generating company to have its stock sold
to investors under a privatization program established under the Dutch
Electricity Act. The total net purchase price of the acquisition was
approximately $1.9 billion.
The following table describes the electric power generation facilities we
currently own in the Netherlands.
DUTCH GENERATION FACILITIES
<TABLE>
<CAPTION>
NET
GENERATING
CAPACITY
GENERATION FACILITIES(1) LOCATION (MW) DISPATCH TYPE(2) PRIMARY FUEL
------------------------ -------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Hemweg......................... Amsterdam 1,229 Base, Peak Coal/Gas
Velsen......................... Velsen 990 Base, Inter, Peak Blast Furnace Gas/
Gas
Utrecht........................ Utrecht 939 Base, Inter, Peak Gas/Oil
Diemen......................... Amsterdam 249 Base Gas
Purmerend...................... Purmerend 69 Inter Gas
-----
Total................. 3,476
=====
</TABLE>
---------------
(1) We own a 100% interest in each facility listed. All of these facilities are
operational.
(2) We use the designations "Base," "Inter" and "Peak" to indicate whether the
facilities described are base-load, intermediate or peaking facilities,
respectively.
Market Framework. The Netherlands has a peak demand of approximately 14,200
MW. In 1999, UNA and the three other largest Dutch generating companies supplied
approximately 52% of the electricity consumed in the Netherlands. Smaller Dutch
producers supplied about 30% of consumed electricity and the remainder was
imported. The wholesale market opened to competition on January 1, 2001. The
retail market has been open to competition for large industrial customers since
January 1, 1999. In 2002, the next retail segment, composed primarily of
commercial customers, will open to competition. The remaining customers, mainly
residential users, are expected to be able to choose their supplier by early
2003. The timing of the opening of these markets is subject to change at the
discretion of the Dutch Minister of Economic Affairs. For additional
information, please read "-- Regulation -- The Netherlands."
Customers who can select their electric supplier have the choice of
purchasing power through bilateral contracts or on the Amsterdam Power Exchange,
or "APX," which was the first power exchange in Northwest Europe and has been in
operation since the spring of 1999. Distribution companies, which serve the
captive customers in the Netherlands, are effectively required to purchase a
substantial amount of their requirements through bilateral contracts with a term
of at least one year.
With the start of full-scale wholesale deregulation in January 2001, the
high voltage transmission grid company, known as "Tennet," has taken on the role
of independent system operator. In this role, Tennet is responsible for the
stability of the transmission grid.
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EUROPEAN TRADING, MARKETING AND RISK MANAGEMENT OPERATIONS
In October 1999, we established our European trading, marketing and risk
management operations in order to participate in the emerging European energy
trading and marketing businesses. We are initially focusing on trading
opportunities in the Netherlands and Germany and plan to expand into other
European markets in the future. Our marketing operations will initially
concentrate on selling power to large industrial and commercial customers as
well as distribution companies. As of December 1, 2000, our European trading,
marketing and risk management operations employed 98 employees.
Our European trading, marketing and risk management operations utilize the
same business model, including risk management and control policies, as we do in
the United States, while recognizing relevant differences between these markets.
Currently, the primary difference is a much lower level of liquidity in both gas
and power markets in Continental Europe than in the United States. This
difference is largely the result of market maturity. In the United States,
natural gas deregulation preceded power deregulation and began over a decade
ago. In Continental Europe, restructuring of the power markets began less than
two years ago and restructuring of the gas markets is only just beginning. Given
the strides made thus far in Europe and the lessons learned from energy
deregulation from the United States, the United Kingdom and other countries
around the world, we expect liquidity to increase steadily in European gas and
power markets. We expect to capitalize on these developments by drawing on our
U.S. and European experiences to offer the types of products and services that
customers will need in the new and developing environment. As of December 1,
2000, 100% of UNA's expected 2001 production target had been sold.
OUR RETAIL ENERGY BUSINESS SEGMENT
OVERVIEW
We intend to become a provider of retail electric services in Texas when
the market opens to retail competition in January 2002 and in other U.S. markets
with favorable regulatory structures and profit opportunities thereafter.
Beginning on January 1, 2002, we will provide retail electric services to all of
the approximately 1.7 million customers of Reliant Energy located in the Houston
metropolitan area who do not take action to select another retail electric
provider. One of the objectives of the Texas electric restructuring law is to
set the price that the retail electric provider affiliated with the incumbent
utility can charge residential and small commercial customers at a level which
is expected to encourage competition from new retail electric providers. We
believe that this market framework will result in attractive market
opportunities both for incumbent-affiliated retail providers and for new market
entrants. We will be the incumbent-affiliated retail electric provider in the
Houston metropolitan area and will be a new retail electric provider in other
parts of Texas. We believe Reliant Energy's strong relationship with its current
customers and its name recognition in the state of Texas will provide a platform
for us to be a successful retail electric provider in Texas.
We intend to integrate our wholesale trading, marketing and risk management
operations with our retail electric business. We believe this integration will
provide us with significant competitive advantages in the retail markets. We
expect to capitalize on the real-time information flow between our trading and
retail operations to identify new opportunities to better match our wholesale
operations with our demand-side retail operations. We believe the integration of
our retail operations with our wholesale operations will also reduce the overall
supply-side risk of our retail operations through portfolio diversification and
the application of sophisticated wholesale risk management techniques to
emerging retail markets. Also, by integrating our operations, we hope to achieve
economies of scale that will benefit us when entering new retail markets.
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We will provide electricity and related products and services to
residential and small commercial customers through our retail services business.
Our energy solutions business, which we refer to as "Solutions," provides
customized, integrated electric commodity, energy management and e-commerce
services to large commercial and industrial customers. Beginning with full
retail competition in Texas on January 1, 2002, we will offer these services to
the large commercial and industrial customers currently served by Reliant
Energy.
Pursuant to a transition services agreement, we will provide customer care
functions to Reliant Energy's electric utility division and two of its natural
gas distribution divisions until January 1, 2002. These functions may include
call center operations, credit and collections, remittance processing, bill
printing, bill insert and revenue reporting and analysis services. Pursuant to
this transition services agreement, we will use Reliant Energy assets for these
services. The charges Reliant Energy will pay us for these services are
generally intended to allow us to recover the fully allocated costs of providing
the services plus out-of-pocket costs and expenses, but without any profit.
MARKET FRAMEWORK -- TEXAS
The Texas electric restructuring law, enacted in 1999, substantially amends
the regulatory structure governing electric utilities in Texas in order to allow
full retail competition beginning on January 1, 2002 in the service territories
of all investor-owned electric utilities, and in the territories of any
municipally-owned utility and electric cooperative that opts to open its markets
to retail competition. Under the restructuring law, the traditional
vertically-integrated utility is required to separate its generation,
transmission and distribution, and retail activities. Unlike the
vertically-integrated utility, which was subject to cost-of-service rate
regulation, the profit earned by retail electric providers will not be subject
to regulation. Generally, the retail electric provider will procure or buy
electricity from wholesale generators, sell electricity at retail to its
customers and pay the transmission and distribution utility a regulated tariffed
rate for delivering electricity to its customers. All retail electric providers
in an area will pay the same rates and other charges for transmission and
distribution, whether or not they are affiliated with the transmission and
distribution utility for that area. The transmission and distribution rates
which will be in effect as of January 1, 2002 for each utility will be set upon
resolution of rate cases currently pending before the Texas Utility Commission.
The price to beat will not be increased to take into account increased rates or
charges or the assessment of new commission approved charges.
The new Texas law treats municipal utilities and electric cooperatives
differently than investor-owned utilities. Municipally-owned utilities and
electric cooperatives have the option to open their markets to retail
competition any time after January 1, 2002. However, until a municipally-owned
utility or electric cooperative provides retail electric services outside its
service area, its market will not be open to retail competition. Some large
Texas cities, including San Antonio and Austin, are served by municipally-owned
utilities which have not announced when or if they will open their markets to
competition.
The Texas electric restructuring law allows all retail electric customers
of Texas investor-owned utilities, and those of municipal utilities and electric
cooperatives that opt to participate in the competitive marketplace, to take
action to select their retail electric provider for service starting January 1,
2002. In addition, the law provides for retail pilot projects for up to 5% of
each utility's load in all customer classes starting in June 2001. Under the
market framework required by the law, retail electric providers affiliated with
an incumbent utility will be required to sell electricity to residential and
small commercial customers in the incumbent's traditional service territory at a
specified price, which is referred to in the law as the "price to beat." New
retail electric providers entering that market may sell electricity to
residential and small commercial customers at any price. The initial price to
beat for each incumbent-affiliated retail electric provider will be 6% less than
the average rates, on a bundled basis, in effect for the incumbent utility on
January 1, 1999, adjusted to take into account a new fuel factor as of December
31,
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2001. Affiliated retail electric providers will not be permitted to sell
electricity to residential and small commercial customers in the incumbent's
traditional service territory at a price other than the price to beat until
January 1, 2005, unless before that date the Texas Utility Commission determines
that 40% or more of the amount of electric power that was consumed in 2000 by
the relevant class of customers is committed to be served by other retail
electric providers. The affiliated retail electric provider may request that the
Texas Utility Commission adjust the fuel factor included in its price to beat
not more than twice a year if it demonstrates that the existing fuel factor does
not adequately reflect significant changes in the market price of natural gas
and purchased energy used to serve retail customers.
The price to beat only applies to electric services provided to residential
and small commercial customers. Electric services provided to large commercial
and industrial customers, whether by the affiliated retail electric provider or
a non-affiliated retail electric provider, may be provided at any negotiated
price.
To facilitate a competitive market, each power generation company that is
unbundled from an integrated electric utility in Texas will be required to sell
at auction 15% of the output of its installed generating capacity. The first
auction will be held prior to September 1, 2001 for power delivered after
January 1, 2002. This obligation continues until January 1, 2007, unless before
that date the Texas Utility Commission determines that at least 40% of the
quantity of electric power consumed in 2000 by residential and small commercial
customers in the incumbent utility's service area is being served by other
retail electric providers. Under this competitive market framework, all retail
electric providers may purchase power either through purchases in the wholesale
power markets or through the mandated capacity auction. The master separation
agreement requires Texas Genco to auction all of its remaining capacity prior to
our exercise of the Texas Genco option. We are entitled to purchase, at prices
established in these auctions, up to 50% of the remaining capacity, energy and
ancillary services auctioned. We expect to purchase the electric power required
to meet the demands of our Texas retail electric customers through our option
from Texas Genco, the capacity auctions conducted by Texas Genco and other power
generation companies, as well as through the open market. According to the Texas
Utility Commission, as of June 30, 2000, 24 plants totaling 13,817 MW were under
construction in Texas and another 32 plants totaling 17,196 MW were announced to
be under development.
In preparation for retail electric competition in Texas, we have succeeded
to and are expanding an infrastructure of business systems, procedures and
practices to meet the needs of our retail business. These include an SAP
customer care system module and wholesale/retail energy supply, risk management,
e-commerce, scheduling/settlement, customer relationship management and sales
force automation systems. As of September 30, 2000, we had spent approximately
$23 million on retail infrastructure development. We plan to spend approximately
an additional $85 million by the end of 2001.
Houston Area. We are the affiliated retail electric provider for Reliant
Energy for purposes of the Texas electric restructuring law. On January 1, 2002,
we will become the retail electric provider for all of Reliant Energy's
approximately 1.7 million residential, commercial and industrial customers
located in the Houston metropolitan area who do not take action to select
another retail electric provider. We also intend to continue to offer
value-added electric commodity and energy management services to the large
commercial and industrial customers currently served by Reliant Energy. We will
market retail electric services to these customers under the Reliant Energy
brand name. We believe we will be well positioned in this market because of
Reliant Energy's long-standing relationship with these customers. Based on a
number of factors, including the customer behavior exhibited in connection with
the deregulation of the U.S. telecommunications industry, we anticipate that
many residential customers will not take action to change their electricity
supplier and that we will successfully retain a substantial portion of our
retail customers in the Houston metropolitan area following the advent of open
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competition. We are also developing a marketing program and an advertising plan
to enhance our opportunity to retain these customers.
Other Texas Markets. In Texas markets outside of the Houston territory that
are open to retail competition, we, along with other retail electric providers,
will be able to compete to provide retail electric service to customers
beginning January 1, 2002. We will be able to offer retail electric service at
any price we choose, while the incumbent-affiliated retail electric provider in
those areas will be required to provide service at its price to beat. We plan to
capitalize on our infrastructure, commercial expertise, brand recognition and
customer relationships to aggressively pursue retail customers in other key
metropolitan areas of Texas, including Dallas/ Fort Worth. We will also bundle
other products and services, as well as provide various incentives in order to
induce customers to choose us as their retail electric provider. We also plan to
compete outside of the Houston territory in the retail pilot project, which is
scheduled to commence in June 2001 and include five percent of the retail market
currently served by investor-owned utilities.
MARKET FRAMEWORK -- OUTSIDE TEXAS
The competitive retail electric market in the United States is currently in
its initial stages. Very few companies are offering retail services on a
national or multi-regional basis, and to date none of these entrants have
achieved critical scale. With the significant retail customer base we will
succeed to and the skills and infrastructure we are building in Texas, we expect
to be well positioned to compete in the competitive retail electric markets as
they develop.
Each retail electric market has or will have individual market
characteristics and regulatory rules. We plan to evaluate each of these markets
to determine their relative attractiveness based on size and profitability. We
consider a particular retail market to be attractive if it has reasonably mature
wholesale markets capable of providing adequate supply liquidity to retail
providers, and regulations designed to promote competition through profit margin
opportunities or "headroom."
SOLUTIONS
Solutions provides customized, integrated energy solutions, including
commodity, risk management and energy services products, and demand side
management services to large commercial and industrial customers. These services
include the replacement or upgrade of energy intensive capital equipment,
substation development and power quality assurance. Solutions targets
institutional, government, manufacturing, industrial and large commercial
customers, including multi-site retailers and restaurants. These customers
typically have a peak electricity demand of greater than one MW for the
aggregate of their Texas facilities. This customer segment in Texas includes
approximately 7,000 customer accounts consuming an aggregate of 100 million MWh
of electricity per year.
Since its formation in April 1996, Solutions has completed over 215
projects for large commercial, institutional, government and industrial clients.
In November 1999, Solutions acquired the Energy Service Division of Southland
Industries, Inc. for $37 million. This strategic acquisition strengthened
Solutions' engineering and project management expertise and established a
comprehensive marketing arrangement with Southland Industries, a leading
engineering and construction firm. Solutions has also developed an integrated
product offering to serve both the commodity and energy services needs of its
customers.
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OUR OTHER OPERATIONS BUSINESS SEGMENT
EBUSINESS
We formed our eBusiness group in November 1999 to manage, expand and
enhance our Internet presence and capabilities. The eBusiness group is charged
with facilitating Internet use by our core businesses and investing in and
managing a portfolio of Internet-related businesses. As of December 1, 2000, our
eBusiness group has invested approximately $16 million in the following new
Internet-based businesses:
- Pantellos. In June 2000, we, along with 20 other leading power, gas and
pipeline companies, formed Pantellos, an energy industry e-procurement
marketplace. The newly-formed company is preparing to deliver a broad
suite of integrated e-supply chain solutions to the electric, natural gas
distribution, natural gas pipeline and other energy sectors. The website,
www.pantellos.com, became operational in January 2001. We expect
Pantellos' primary competitors will be online vertical marketplaces, such
as Enporion.com and UtilityFrontier.com.
- IntercontinentalExchange. In July 2000, we, along with five other leading
natural gas and power companies, American Electric Power, Aquila Energy,
Duke Energy, El Paso Energy and Southern Company, made an equity
investment in IntercontinentalExchange, a new, web-based system for
trading commodities. The exchange, www.intcx.com, began trading some
types of commodities in August 2000 and started trading gas and power in
November 2000. We expect the exchange will be open to all commercial
market participants. The principal online competitors of
IntercontinentalExchange are EnronOnline, HoustonStreet.com and Altra.com
in addition to more traditional exchanges, such as NYMEX.
- GuideStreet. In August 2000, we announced the launch of GuideStreet.com,
a Houston-based home services management website, www.guidestreet.com.
This co-branded venture, conceived and funded by Reliant Energy, it
provides consumers in the Texas market a single information source to
help them meet all their basic utilities and home maintenance needs.
COMMUNICATIONS
We formed our communications business to be a single source, integrated
communications provider, offering web hosting and web design, enhanced data
services, and local and long distance voice services to business customers
within Texas. In November 1999, we began operation as a competitive local
exchange carrier offering resold voice and data services to small and mid-sized
business customers in Houston. In April 2000, we acquired Insync Internet
Services, a business-to-business Internet services provider based in Houston
with an additional presence in Austin and remote facilities in Dallas and San
Antonio. Our communications business now serves as a facilities-based
competitive local exchange carrier and Internet services provider with switching
capacity, access to a fiber corridor that surrounds the Houston metropolitan
area as well as network operations centers and managed data centers in Houston
and Austin. We plan to expand our portfolio of products and services into other
significant metropolitan regions of Texas. We currently do not plan to provide
communications services to customers outside of the state of Texas. As of
September 2000, we provided communications services to approximately 2,600
customers in Texas. The voice and data transmission markets in which we operate
are highly competitive. We compete with a broad range of competitors, including
the regional local exchange incumbent. As of December 1, 2000, our
communications business employed 184 employees located in Houston and Austin.
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NEW VENTURES
In August 1998, we formed our New Ventures division to manage our existing
new technology investments and to identify and invest in promising new
technologies and businesses that relate to our energy services operations. Our
strategy is to use our advantaged perspective on our core businesses and markets
to invest in early stage companies. Focus areas for investments include
distributed generation, clean energy, energy industry software and systems, and
broadband infrastructure.
We make our investments either directly or indirectly as limited partners
in venture capital funds. As of September 30, 2000, we have invested
approximately $29 million in five venture capital funds with an energy, utility
and communications focus and have made commitments to invest an additional $15
million in these funds. As of November 29, 2000, these funds held investments in
43 companies. Excluding our investment in Grande Communications, Inc. discussed
below, New Ventures' direct investment portfolio consists of seven companies
with a total of $8 million invested as of December 1, 2000.
In September 2000, we agreed to make a $25 million equity investment in
Grande Communications, Inc. Grande Communications is a Texas-based
communications company building a deep fiber broadband network that will offer
bundled services, including high-speed Internet, all-distance telephone and
advanced cable entertainment to homes and businesses. We are also committed,
under some specified conditions, to invest a similar amount in a future Grande
Communications equity financing. Grande Communications has announced its
intention to build a broadband network in Houston. This will be in addition to
the Central Texas cities of Austin, San Marcos and San Antonio which are already
under development.
Our competitors include other large electricity, energy services and
communications companies with venture capital operations and venture capital and
private equity funds. Both we and our competitors are subject to the
fluctuations in the private and public capital markets that may seriously impair
our ability to participate in attractive opportunities for future investments
and/or liquidate investments by private or public market sale.
COMPETITION
WHOLESALE ENERGY BUSINESS SEGMENT
As of December 1, 2000, we owned and operated 9,231 MW of electric
generation assets that serve wholesale energy markets located in the
Mid-Atlantic, Southwest and Midcontinent regions of the United States and the
states of Florida and Texas. Competitive factors affecting the results of
operations of these generation assets include new market entrants, construction
by others of more efficient generation assets, the actions of regulatory
authorities and weather.
Other competitors operate power generation projects in the regions where we
have invested in electric generation assets. Although local permitting and
siting issues often reduce the risk of a rapid growth in supply of generation
capacity in any particular region, projects are likely to be built over time
which will increase competition and lower the value of some of our electric
generation assets.
The results of operations of our generation assets are also affected by
weather conditions in the relevant wholesale energy markets. Extreme seasonal
weather conditions typically increase the demand for wholesale energy.
Conversely, mild weather conditions typically have the opposite effect. In some
regions, especially California, weather conditions associated with hydroelectric
generation resources such as rainfall and snowpack can significantly influence
market prices for electric power by increasing or decreasing the availability
and timing of hydro-based generation which is produced within or imported into
the California market.
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There is significant competition for acquisition of international and
domestic non-rate regulated power projects. We compete against a number of other
participants in the non-utility power generation industry. Competitive factors
relevant to the non-utility power industry include financial resources and
regulatory factors. Some of our competitors have greater financial resources
than we do.
Our trading, marketing and risk management operations compete with other
energy merchants based on the ability to aggregate supplies at competitive
prices from different sources and locations and to efficiently utilize
transportation from third-party pipelines and transmission from electric
utilities. These operations also compete against other energy marketers on the
basis of their relative financial position and access to credit sources. This
competitive factor reflects the tendency of energy customers, wholesale energy
suppliers and transporters to seek financial guarantees and other assurances
that their energy contracts will be satisfied. As pricing information becomes
increasingly available in the energy trading and marketing business and as
deregulation in the electricity markets continues to accelerate, we anticipate
that our trading, marketing and risk management operations will experience
greater competition and downward pressure on per-unit profit margins.
EUROPEAN ENERGY BUSINESS SEGMENT
The European energy market is highly competitive. In addition, over the
next several years, we expect an increasing consolidation of the participants in
the European generating market.
Our European wholesale operations compete in the Netherlands primarily
against the three other largest Dutch generating companies, which are NV
Elektriciteits -- Produktiemaatschappij Zuid -- Nederland (EPZ), NV
Electriciteitsdedrijf Zuid -- Holand (EZH), and NV Elektriciteits --
Produktiemaatschappij Oost-en Noord-Nederland (EPON), various cogenerators of
electric power, various alternate sources of power and non-Dutch generators of
electric power, primarily from France and Germany. At present, the Dutch
electricity system has three operational interconnection points with Germany and
two interconnection points with Belgium. There are also a number of projects
that are at various stages of development and that may increase the number of
interconnections in the future including interconnections with Norway and the
United Kingdom. The Belgian interconnections are used to import electricity from
France, but a larger portion of Dutch electricity imports comes from Germany.
Recent increases in net power imports into the Netherlands were caused primarily
by large price differentials between regulated wholesale power in the
Netherlands and unregulated wholesale power in Germany.
In 1999, UNA and the three other largest Dutch generating companies
supplied approximately 52% of the electricity consumed in the Netherlands.
Smaller Dutch producers supplied about 30% of such consumed electricity, and the
remainder was imported. The Dutch wholesale electric market was completely
opened to competition on January 1, 2001. Retail competition for large
industrial customers began in 1999. The remainder of the market will be open to
competition as early as 2003. The timing of these retail market openings is
subject to change, however, at the discretion of the Dutch Minister of Economic
Affairs.
Our European trading and marketing operations will also be subject to
increasing levels of competition. As of December 29, 2000, there were 32 trading
and marketing companies registered with the Amsterdam Power Exchange.
Competition among power generators for customers is intense, and we expect
competition to increase with the deregulation of the market. The primary
elements of competition affecting both the generation and trading and marketing
facets of our European energy business are price, credit-support and supply and
delivery reliability.
RETAIL ENERGY BUSINESS SEGMENT
We believe that as retail energy markets are opened to new participants and
new services, competition will be intense in the markets where frameworks for
deregulation create attractive
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opportunities for new entrants. We believe our principal competitors in the
Houston metropolitan market will be the affiliated retail electric providers of
other Texas investor-owned utilities as well as other energy industry
participants. Since we will be required to sell electricity to residential and
small commercial customers in the Houston market at the price to beat, we will
not be able to compete for customers on the basis of price during the near-term.
Therefore, we plan to capitalize on the high level of consumer awareness and
positive perception of our brand name to retain the customers we will succeed to
in the Houston metropolitan area.
In general, we believe our principal competitor in each market outside of
the Houston metropolitan area will be the incumbent utility in that market or
its unregulated affiliate. Incumbent utilities may have informational
advantages, high name recognition in their traditional service territory and
long-established customer relationships.
In addition to the utilities and their affiliates, we may face competition
from a number of other energy service providers, including start-up companies
focusing on Internet marketing and online service, other energy industry
participants, and possibly other consumer-oriented service providers, any of
whom may develop businesses that will compete with us, both in specific markets
and nationally. Some of these competitors may be larger and better capitalized
than we are.
REGULATION
OVERVIEW
We are subject to regulation by various federal, state, local and foreign
governmental agencies, including the regulations described below.
FEDERAL ENERGY REGULATORY COMMISSION
Under the Federal Power Act, the Federal Energy Regulatory Commission, or
"FERC," has the exclusive rate-making jurisdiction over wholesale sales of
electricity and the transmission of electricity in interstate commerce by
"public utilities." Public utilities that are subject to the FERC's jurisdiction
must file rates with the FERC applicable to their wholesale sales or
transmission of electricity. Some of our subsidiaries sell power at wholesale
and are public utilities under the Federal Power Act. The FERC has authorized
these subsidiaries to sell electricity and related services at wholesale, at
market-based rates. In its orders authorizing market-based rates, the FERC also
has granted these subsidiaries waivers of many of the accounting, record keeping
and reporting requirements that are imposed on public utilities with cost-based
rate schedules.
The FERC's orders accepting the market-based rate schedules filed by our
subsidiaries or their predecessors, as is customary with such orders, reserved
the right to revoke or limit our market-based rate authority if the FERC
subsequently determines that any of our affiliates possess excessive market
power. If the FERC were to revoke or limit our market-based rate authority, we
would have to file, and obtain the FERC's acceptance of, cost-based rate
schedules for all or some of our sales. In addition, the loss of market-based
rate authority could subject us to the accounting, record keeping and reporting
requirements that the FERC imposes on public utilities with cost-based rate
schedules.
Our trading and marketing operations are subject to the FERC's jurisdiction
under both the Natural Gas Act and the Federal Power Act. As a gas marketer, we
make sales of natural gas in interstate commerce at wholesale pursuant to a
blanket certificate issued by the FERC, but the FERC does not otherwise regulate
the rates, terms or conditions of these gas sales. We are also a "public
utility" under the Federal Power Act, and our wholesale sales of electricity in
interstate commerce are subject to a FERC-filed rate schedule that authorizes us
to make sales at negotiated, market-based rates.
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In authorizing market-based rates for various of our subsidiaries, the FERC
has imposed some restrictions on these entities' transactions with Reliant
Energy's electric utility division, including a prohibition on the receipt of
goods or services on a preferential basis. The FERC also has imposed
restrictions on natural gas transactions between us and Reliant Energy's natural
gas pipeline subsidiaries to preclude any preferential treatment. Similar
restrictions apply to transactions between us and Reliant Energy's electric
utility division under Texas utility regulatory laws.
STATE REGULATION
Texas. The electric utility division of Reliant Energy, our current parent
company, is an electric utility company under Texas law. In June 1999, Texas
adopted the Texas Electric Choice Plan, which we sometimes refer to in this
prospectus as the "Texas electric restructuring law." The Texas electric
restructuring law substantially amends the regulatory structure governing
electric utilities in Texas in order to allow retail competition beginning with
respect to pilot projects for up to 5% of each utility's load in all customer
classes in June 2001 and for all other customers on January 1, 2002. While the
law calls for the commencement of retail competition beginning on January 1,
2002, it authorizes the Texas Utility Commission to delay the date on which the
retail electric market is opened to competition in any power region in Texas if
it determines that the region is unable to offer fair competition and reliable
service to all retail customer classes on that date. Most of the significant
dates in the Texas electric restructuring law, such as the dates on which
capacity auctions and price to beat requirements are scheduled to expire, are
specified anniversaries of the date on which the retail electric market is
opened to competition.
The Texas electric restructuring law requires electric utilities in Texas
to restructure their businesses in order to separate power generation,
transmission and distribution, and retail activities into three different units,
whether commonly or separately owned. The transmission and distribution business
will continue to be subject to cost-of-service rate regulation and will be
responsible for the delivery of electricity to retail customers. Power
generators will sell electric energy to wholesale purchasers, including retail
electric providers, at unregulated rates beginning January 1, 2002. To
facilitate a competitive market, each power generator affiliated with a
transmission and distribution utility will be required to sell at auction 15% of
the output of its installed generating capacity. The first auction will be held
prior to September 1, 2001 for power delivered after January 1, 2002. This
obligation continues until January 1, 2007, unless before that date the Texas
Utility Commission determines that at least 40% of the quantity of electric
power consumed in 2000 by residential and small commercial customers in the
incumbent utility's service area is being served by retail electric providers
not affiliated with the incumbent utility. An affiliated retail electric
provider may not purchase capacity sold by its affiliated power generation
company in the mandated capacity auction.
Under the Texas electric restructuring law, on January 1, 2002, all retail
customers of investor-owned electric utilities in Texas and of any
municipally-owned utility and electric cooperative that opts to open its markets
to retail competition will be entitled to purchase its electricity from any of a
number of "retail electric providers" which have been certified by the Texas
Utility Commission. Retail electric providers will not be permitted to own or
operate generation assets and their prices will not be subject to traditional
cost-of-service rate regulation. Retail electric providers which are affiliates
of, or successors in interest to, electric utilities may compete substantially
statewide for these sales, but prices they may charge within the affiliated
electric utility's traditional service territory are subject to limitations at
the outset of retail competition, as described below. By allowing non-affiliated
retail electric providers to provide retail electric service to customers in an
electric utility's traditional service territory at any price, including a price
below the price to beat, the Texas electric restructuring law encourages
competition among retail electric providers. The Texas electric restructuring
law requires the
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affiliated retail electric provider to reconcile and credit to the affiliated
transmission and distribution utility in early 2004 any positive difference
between the price to beat, reduced by a specified delivery charge, and the
prevailing market price of electricity unless the Texas Utility Commission
determines that, on or prior to January 1, 2004, 40% or more of the amount of
electric power that was consumed in 2000 by residential or small commercial
customers, as applicable, within the affiliated transmission and distribution
utility's traditional service territory as of January 1, 2002 is committed to be
served by other retail electric providers. If the 40% test is not met and a
payment is required, the amount of the credit will not exceed, but could be up
to, $150 per customer multiplied by the number of residential or small
commercial customers, as the case may be, served by the affiliated transmission
and distribution utility that are buying electricity from the affiliated retail
electric provider at the price to beat on January 1, 2004, less the number of
new retail electric customers that the affiliated retail electric provider
serves in areas of Texas outside of the utility's traditional service area.
Two of our subsidiaries have filed applications with the Texas Utility
Commission to be certified as retail electric providers. Under Reliant Energy's
business separation plan, these subsidiaries will be the successor to the retail
functions formerly performed by Reliant Energy. As "affiliated retail electric
providers" of Reliant Energy, our subsidiaries will become on January 1, 2002,
the retail electric provider for all customers of Reliant Energy who do not take
action to select another retail electric provider. As of September 30, 2000,
Reliant Energy had approximately 1.7 million customers. Effective January 1,
2002, our retail rates charged to former Reliant Energy residential and small
commercial customers will be fixed at our price to beat which will be a price
equal to 6% less than Reliant Energy's average rates, on a bundled basis, in
effect on January 1, 1999, adjusted to take into account a new fuel factor as of
December 31, 2001. We have the right to request the Texas Utility Commission to
adjust the fuel factor included in our price to beat not more than twice a year
if we demonstrate that the existing fuel factor does not adequately reflect
significant changes in the market price of natural gas and purchased energy used
to serve retail customers. We may not sell electricity at a price other than the
price to beat to residential or small commercial customer classes in Reliant
Energy's former service territory, the Houston metropolitan area, until January
1, 2005, unless before that date the Texas Utility Commission determines that
40% or more of the amount of electric power that was consumed by the relevant
class of customers in 2000 is committed to be served by retail electric
providers other than us. In addition, so long as an affiliated retail electric
provider continues to provide retail service, the Texas electric restructuring
law requires it to make the price to beat available to residential and small
commercial customers in the traditional service area of the related incumbent
utility through January 1, 2007.
The price to beat only applies to electric services provided to residential
and small commercial customers. Electric services provided to large commercial
and industrial customers, whether by the affiliated retail electric provider or
a non-affiliated retail electric provider, may be provided at any negotiated
price.
In accordance with provisions of the Texas electric restructuring law, the
Texas Utility Commission approved Reliant Energy's business separation plan on
December 1, 2000.
The Texas electric restructuring law requires the Texas Utility Commission
to determine procedures and criteria for designating retail electric providers
to serve as providers of last resort in areas of the state in which retail
competition is in effect. A provider of last resort is required to offer a
standard retail electric service package for each class of customers designated
by the Texas Utility Commission at a fixed rate approved by the Texas Utility
Commission, and is required to provide the service package to any requesting
retail customer in the territory for which it is the provider of last resort.
The Texas Utility Commission is required to designate the initial providers of
last resort by June 1, 2001. In the event that no retail electric provider
applies to be the provider of last resort in a given area of the state, the
Texas Utility Commission may require a retail electric provider to become the
provider of last resort as a condition of receiving
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or maintaining its retail electric provider certificate. In the event that a
retail electric provider fails to serve any or all of its customers, the
provider of last resort is required to offer that customer the standard retail
service package for that customer class with no interruption of service to the
customer.
Other States. All of our existing generation facilities sell power only at
wholesale. None of the states in which these facilities are located regulate
sales from these facilities under traditional utility cost-of-service
regulation. In the PJM market and in California, the independent system
operators have imposed price caps that limit the maximum sales prices for
wholesale power. In addition, in some states, including California, proposals
have been made to re-regulate the provision of wholesale power under traditional
cost-of-service regulation. In New Jersey, existing law provides that the
relevant regulatory agency may re-impose cost-of-service regulation if the
agency concludes that competition is not sufficient. In addition, some states
regulate the siting or construction of generation facilities.
SECURITIES AND EXCHANGE COMMISSION -- PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
Reliant Energy is both a holding company and an electric utility as defined
in the Public Utility Holding Company Act of 1935, which we sometimes refer to
in this prospectus as the "1935 Act". However, Reliant Energy is exempt from
regulation as a holding company under Section 3(a)(2) of the 1935 Act.
UNA is a foreign utility company exempt from regulation as a "public
utility company" under the 1935 Act. The Texas Utility Commission and the state
regulatory commissions of Arkansas and Minnesota have imposed limitations on the
amount of investments that Reliant Energy or its subsidiaries may invest in
foreign utility companies and, in some cases, foreign electric wholesale
generating companies. These limitations are based upon Reliant Energy's
consolidated net worth, retained earnings, and debt and stockholders' equity,
respectively. Subject to some limited exceptions, the 1935 Act also prohibits
any public utility from issuing any security for the purpose of financing the
acquisition, ownership or operation of a foreign utility company, or assuming
any obligation or liability in respect of any security of a foreign utility
company.
Under the Energy Policy Act of 1992, a company engaged exclusively in the
business of owning and/or operating facilities used for the generation of
electric energy exclusively for sale at wholesale and selling electric energy at
wholesale may be exempted from regulation under the 1935 Act as an EWG. Our
electric generation facilities have received from the FERC determinations of EWG
status. If any of these subsidiaries lose their EWG status, we would have to
restructure our organization or, with Reliant Energy and its other subsidiaries,
risk being subjected to regulation under the 1935 Act.
In connection with our separation from Reliant Energy and the distribution
of our stock by Reliant Energy, Reliant Energy plans to restructure its
remaining businesses and to register as a public utility holding company under
the 1935 Act. If Reliant Energy becomes a registered public utility holding
company prior to the distribution of our common stock to its shareholders, we
will be subject to regulation as a "subsidiary company" under the 1935 Act. As a
result, we would be subject to limitations under the 1935 Act related to our
acquisition, ownership and operation of energy assets outside of our current
business plan and payments of dividends by us and our subsidiaries from unearned
surplus. Additionally, we would need to obtain approval under the 1935 Act prior
to acquiring the voting securities of any public utility or taking any other
actions that would result in affiliation with another public utility. Following
the distribution, we would no longer be subject to the provisions of the 1935
Act either as a subsidiary or an affiliate of Reliant Energy.
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THE NETHERLANDS
In 1998, the Netherlands established a privatization program under the
Dutch Electricity Act. Under this legislation, the Dutch electricity market was
opened to limited wholesale and retail competition on January 1, 1999. Beginning
January 1, 2001, the wholesale market was completely opened to competition.
Industrial customers who are end users have been able to select their suppliers
since January 1, 1999. The next customer segment, composed primarily of
commercial customers, will be liberalized in 2002. The remaining customers,
mainly residential, are expected to be able to choose their electric supplier as
early as 2003. The timing of these market openings is subject to change,
however, at the discretion of the Dutch Minister of Economic Affairs. For
information regarding the recent stranded cost legislation in the Netherlands,
please read Note 11(f) to our consolidated financial statements.
UNA, the other large Dutch generating companies and the Dutch distribution
companies historically have operated under various agreements that regulate,
among other things, the rates UNA could charge for its generation output.
Pursuant to these agreements, UNA and other generators sold their generating
output to a national production pool operated by a company owned by the
generators and, in return, received a standardized remuneration. The
remuneration included fuel cost, capital cost and operation and maintenance
expenses. UNA also operated under the protocol, which is an agreement under
which the Dutch generators agreed to provide capacity, energy and various other
services to distributors for a total payment of NLG 3.4 billion ($1.4 billion
based on September 30, 2000 exchange rate of 2.50 NLG per U.S. Dollar) over the
period 1997 through 2000 plus compensation of actual fuel costs. Effective
January 1, 2001, these agreements expired in all material respects.
ENVIRONMENTAL
GENERAL ENVIRONMENTAL ISSUES
We are subject to a number of federal, state and local requirements
relating to:
- the protection of the environment, and
- the safety and health of personnel and the public.
These requirements relate to a broad range of our activities, including:
- the discharge of pollutants into the air and water,
- the identification, generation, storage, handling, transportation,
disposal, record keeping, labeling, reporting of, and emergency response
in connection with, hazardous and toxic materials and wastes, including
asbestos, associated with our operations,
- noise emissions from our facilities, and
- safety and health standards, practices and procedures that apply to the
workplace and to operation of our facilities.
In order to comply with these requirements, we may need to spend
substantial amounts and devote other resources from time to time to:
- construct or acquire new equipment,
- acquire permits and/or marketable allowances or other emission credits
for facility operations,
- modify or replace existing and proposed equipment,
- acquire emissions credits and allowances, and
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- clean up or decommission waste disposal areas, fuel storage and
management facilities and other locations and facilities, including coal
mine refuse piles and generation facilities.
We anticipate investing up to $550 million in capital and other special
project expenditures between 2000 and 2026 for environmental compliance. If we
do not comply with environmental requirements that apply to our operations,
regulatory agencies could seek to impose on us civil, administrative and/or
criminal liabilities as well as seek to curtail our operations. Under some
statutes, private parties could also seek to impose civil fines or liabilities
for property damage, personal injury and possibly other costs.
Air Emissions. Our facilities are subject to the Federal Clean Air Act and
many state laws and regulations relating to air pollution. These laws and
regulations cover, among other pollutants, those contributing to the formation
of ground-level ozone, carbon monoxide, sulfur dioxide, or "SO(2)," and
particulate matter. As a general matter, our facilities emit these pollutants at
levels within regulatory requirements. Fossil-fired electric utility plants are
usually major sources of air pollutants, and are therefore subject to
substantial regulation and enforcement oversight by the applicable governmental
agencies.
Pollutants Contributing to Ozone. Substantially all of our facilities burn
fossil fuels, primarily coal, oil or natural gas to produce electricity. The
combustion of fossil fuels produces nitrogen oxides, or "NO(x)," which can react
chemically with organic and other compounds present in the lower portion of the
atmosphere to form ozone. Ozone in the lower portion of the atmosphere, or
"ground-level ozone," is considered by government health and environmental
protection agencies to be a human health hazard, which has prompted both the
federal and state governments to adopt stringent air emission requirements for
fossil fuel-fired generating stations. These requirements are designed to reduce
emissions that contribute to ozone formation, with particular emphasis on NO(x).
Carbon Dioxide. In November 1998, the United States became a signatory to
the Kyoto Protocol to the United Nations Framework Convention on Climate Change.
The Kyoto Protocol calls for developed nations to reduce their emissions of
greenhouse gases, which are believed to contribute to global climate change.
Carbon dioxide, which is a major byproduct of the combustion of fossil fuel, is
considered to be a greenhouse gas. The Kyoto Protocol, however, will not become
enforceable law in the United States unless and until the U.S. Senate ratifies
it. If the U.S. Senate ultimately ratifies the Kyoto Protocol and greenhouse gas
emission reduction requirements are implemented, the resulting limitations on
power plant carbon dioxide emissions could have a material adverse impact on all
fossil fuel-fired facilities, including our facilities.
Particulates. The U.S. Environmental Protection Agency, or "EPA," issued a
new and more stringent national ambient air quality standard, or "NAAQS," in
July 1997 for fine particulate matter. Under the time schedule announced by the
EPA when the new standard for fine particulates was adopted, geographical areas
that were nonattainment areas for the standard were to be designated in 2002,
and control measures for significant sources of fine particulate emissions were
to be identified in 2005. On May 14, 1999, however, the U.S. Court of Appeals
for the District of Columbia Circuit vacated and remanded the fine particulate
standard to the EPA for further justification. As a result, there is no
presently enforceable standard for fine particulates, and we do not know what
impact, if any, future revision to this standard may have on our facilities. If
an ambient air quality standard for fine particulates is promulgated, further
NO(x) and SO(2) reductions may be required for those of our facilities located
in areas where sampling indicates the ambient air does not comply with the final
standards that are adopted.
Solid Wastes. All of our U.S. facilities operate in states that have been
authorized to administer the federal Resource Conservation and Recovery Act, or
"RCRA," which regulates the management and disposal of hazardous wastes. These
states also regulate, through their own state programs, the management and
proper disposal of non-hazardous waste and recycled
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materials. We have significantly reduced our overall waste disposal amount
through various pollution prevention and waste minimization programs.
Water Issues. The federal Clean Water Act generally prohibits the discharge
of any pollutants, including heat, into any body of surface water, except in
compliance with a discharge permit issued by a state environmental regulatory
agency or the EPA. All of our facilities that are required to have such permits
either have them or have timely applied for extensions of expired permits and
are lawfully operating under the prior permit.
The EPA has issued for public comment proposed rules which would impose
uniform, minimum technology requirements on new cooling water intake structures.
Similar rules for existing intake structures are expected in the summer of 2001.
It is not known at this time what requirements the final rules for existing
intake structures will impose and whether our existing intake structures will
require modification as a result of such requirements.
In July 2000, the EPA issued final rules for the implementation of the
Total Maximum Daily Load, or "TMDL," program of the Clean Water Act. The goal of
the TMDL rules is to establish, over the next 15 years, the maximum amounts of
various pollutants that can be discharged into waterways while keeping those
waterways in compliance with water quality standards. The establishment of TMDL
values may eventually result in more stringent discharge limits in each
facility's wastewater discharge permit. Such limits may require our facilities
to install additional wastewater treatment, modify operational practices or
implement other wastewater control measures. Certain members of Congress have
expressed to EPA concern about the TMDL program with respect to such issues as
the scientific validity of data used to establish TMDLs as well as the costs to
implement the program.
REGIONAL ENVIRONMENTAL ISSUES -- WHOLESALE ENERGY -- MID-ATLANTIC REGION
Liability for Preexisting Conditions. Under the purchase agreement for the
Mid-Atlantic Acquisition, we agreed, with a few exceptions, to:
- assume liability for, and provide indemnification against, remediation
and other consequences of the presence, handling, storage or release of
hazardous and toxic materials on any of the sites of our Mid-Atlantic
region electric generating stations or at off-site locations to the
extent resulting from events on or after November 24, 1999, and any
noncompliance by Sithe Energies with environmental requirements, in each
case, except as noted, whether arising or relating to events occurring
prior to, on or after the date of the acquisition from Sithe Energies,
and
- assume similar indemnification obligations of Sithe Energies owed to the
prior owners of the facilities.
We are not currently aware of any environmental condition at any of our
Mid-Atlantic region facilities that we expect to have a material adverse effect
on our financial position, results of operations or cash flows.
Nitrogen Oxides. A multistate memorandum of understanding dealing with the
control of NO(x) air emissions from major emission sources has been signed by
the Ozone Transport Commission states primarily in the Mid-Atlantic and
Northeastern states. The memorandum of understanding and underlying state laws
establish a regional three-phase plan for reducing NO(x) emissions from electric
generating units and large industrial boilers within the Ozone Transport Region,
or "OTR." Implementation of Phase 1 was the installation of Reasonably Available
Control Technology, or "RACT," no later than May 31, 1995. This was successfully
completed. Phase 2
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commenced in 1999 and will continue through 2002. Phase 3 will begin in 2003.
The rules implementing Phase 2 and 3:
- establish NO(x) budgets, or emissions "caps" during the ozone season of
May through September,
- establish methodology to allocate the allowances to affected sources
within the budget, and
- require an affected source to "account for ozone season NO(x) emissions
through the surrender of NO(x) allowances."
The number of NO(x) allowances available to each facility under the annual
budget decreases as the program progresses; thus, forcing an overall reduction
in NO(x) emissions. We currently have been allocated sufficient NO(x) allowances
to meet the Phase 2 emission reduction targets. During Phase 3, we will receive
fewer allowances under a reduced NO(x) budget. We currently anticipate capital
expenditures of approximately $64 million between 2001 and 2003 to meet the
Phase 3 budget levels for our wholly owned Mid-Atlantic facilities. We also
anticipate that the consortium of owners of the Conemaugh and Keystone stations
will elect to install additional NO(x) controls on one or more of the boilers at
these stations during the next few years to maintain compliance with these
facilities' budget allocations. We will be responsible for the cost of any
capital expenditures at Conemaugh and Keystone in proportion to our ownership
percentage through a NO(x) cap and trade system, similar to that described below
for SO(2). We may purchase NO(x) allowances in addition to those that are
allocated to our facilities in order to minimize the total cost of compliance.
We also believe that recent installations of additional boiler operational
control systems at our Keystone and Conemaugh stations and future installations
at the Portland and Shawville stations will further enhance our ability to
control NO(x) emissions.
Pennsylvania and New Jersey state regulations implement both the Phase 2
and 3 emission reductions through a NO(x) cap and trade system, similar to that
described below for SO(2). Under regulatory systems of this type, we may
purchase NO(x) allowances from other sources in the area in addition to those
that are allocated to our facilities, instead of installing NO(x) emission
control systems at our facilities. Depending on the market conditions, the
purchase of extra allowances for a portion of our NO(x) budget requirements may
minimize the total cost of compliance. Our current NO(x) compliance strategy
relies primarily on emission reduction projects, but does incorporate some
allowance purchases for a small fraction of our expected NO(x) allowance
requirements.
Separate and apart from the requirements described above, the EPA has
initiated several regulatory and enforcement efforts that are intended to impose
limitations on major NO(x) sources located in the eastern United States and the
Midwest in order to reduce the formation and regional transport of ozone. Such
regulatory efforts include the EPA's "Section 126 rule" and the "NO(x) SIP
Call," both of which would establish a federal NO(x) emissions cap-and-trade
program that would apply to some existing utilities and large industrial sources
located in 12 states whose emissions the EPA has determined contribute to air
quality problems in "downwind" states (generally in the northeast corner of the
United States). The Pennsylvania regulations in 25 PA, Chapter 145 and New
Jersey regulations under N.J.A.C. 7:27-31 will satisfy the NO(x) emission goals
specified in those regulatory efforts.
The EPA also has been conducting a nationwide enforcement investigation
regarding the historical compliance of coal-fueled electric generating stations
with various permitting requirements of the Clean Air Act. Specifically, the EPA
and the U.S. Department of Justice have recently initiated formal enforcement
actions and enforcement litigation against several other utility companies that
operate coal-fueled utility stations, alleging that these companies modified
their plants (sometimes more than 20 years ago) without proper preconstruction
permit authority. The Conemaugh station responded to a formal information
request by the EPA in June
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1998 related to this EPA enforcement initiative. Subsequently, the Shawville and
Keystone stations responded to similar, but more detailed, requests. The EPA has
not filed an enforcement action or initiated litigation against us at this time.
Nevertheless, such litigation, if pursued successfully by the EPA against any of
these three stations, could result in the imposition of substantial penalties
and could accelerate the timing of emission reduction expenditures currently
contemplated for the facilities. If fines and penalties connected to such
litigation are imposed on our facilities, affiliates of GPU, Inc. will be
responsible for such fines and penalties but GPU, Inc. will not be responsible
for emission reduction expenditures necessary to correct any historical
non-compliance.
Sulfur Dioxide. The Clean Air Act acid rain provisions require substantial
reductions in SO(2), emissions. Implementation of the acid rain provisions is
achieved through a total cap on SO(2) emissions from affected units and an
allocation of marketable SO(2) allowances to each affected unit. Operators of
electric generating units that emit SO(2) in excess of their allocations can buy
additional allowances from other affected sources. We currently project the
number of SO(2) allowances allocated to our Mid-Atlantic units will be less than
projected SO(2) emissions through 2026. Whether we will have an excess or
deficit of SO(2) allowances for any given year will depend, in part, on the
capacity utilization of each of the units. We currently intend to comply with
acid rain SO(2) requirements by purchasing additional allowances to make up any
deficit from our allowance allocation. However, depending on the extent of any
allowance deficits, the price and the availability of allowances and other
regulatory factors, we will consider changing to low-sulfur coal or other
emission control technologies to maintain compliance.
A number of our coal-fired stations have also had to address concerns
raised by the state and federal environmental agencies regarding impacts on the
ambient air quality caused by the facility's SO(2) emissions, and specifically
impacts on modeled compliance with the NAAQS for SO(2).
The Keystone, Conemaugh and Seward stations are located in the proximity of
the Chestnut and Laurel Ridges. To address concerns expressed by the EPA and the
Pennsylvania Department of Environmental Protection, or "PaDEP," about the
ambient air quality for SO(2) in this area, a prior owner of those stations
conducted air quality modeling studies for these three stations to assess
compliance with the NAAQS for SO(2). Based on these studies, more stringent
SO(2) emission limits were placed on these three stations, and the stations
currently comply with these limits. Based on similar SO(2) NAAQS modeling
studies for the Portland, Warren and Shawville stations, the PaDEP imposed more
stringent SO(2) emissions limits at the Warren station. The results of the
studies show that the Portland and Shawville stations do not require revised
SO(2) emission limits to demonstrate attainment of the SO(2) NAAQS. Finally, the
results of a similar SO(2) NAAQS modeling study for the Titus station suggest
that SO(2) emissions reductions or increased vent gas dispersion may be
necessary to maintain modeled NAAQS compliance. Final resolution of the Titus
SO(2) modeling study could result in the construction of a new emissions stack
to increase vent gas dispersion within the next two or three years, which may
cost an estimated $5 million to $7 million.
Visibility Impairment Rules. The EPA has promulgated regulations relating
to reduction in the impairment of visibility resulting from man-made pollution.
The primary target of these regulations would be SO(2), NO(x) and hydrogen
chloride air emissions from stationary sources. The regulations have been
challenged in court, and the ultimate impact of these regulations on our
facilities is uncertain. Even under the existing regulations, there would be no
impact on our facilities until 2012 and beyond.
Mercury. The EPA is currently considering whether it will regulate steam
electric generating plants under Title III of the Clean Air Act, which addresses
emissions of hazardous air pollutants from specific industrial categories. Power
plants are a source of mercury air emissions. If the EPA decides to regulate the
electric power industry under Title III of the Clean Air Act, it will likely
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establish emission control standards for mercury, as well as, potentially, other
hazardous air pollutants. The standards likely would not be imposed on affected
sources until 2010 or later. The applicable control level is uncertain, as is
the cost of these potential future rules.
Asbestos and Lead-based Paint. Many of our facilities are more than 40
years old, and as a result contain significant amounts of asbestos insulation,
other asbestos containing materials, as well as lead-based paint. Existing state
and federal rules require the proper management and disposal of these
potentially toxic materials. We have developed a management plan that includes
proper maintenance of existing non-friable asbestos installations, and removal
and abatement of asbestos containing materials where necessary because of
maintenance, repairs, replacement or damage to the asbestos itself. We have
planned for the proper management, abatement and disposal of asbestos and
lead-based paint at our facilities in our financial planning.
Clean Water Act. The PaDEP is currently evaluating the existing thermal
load on the stream that receives the Shawville cooling water discharge. This
evaluation may result in a reduced temperature limit in the wastewater discharge
permit for the Shawville cooling water discharge. If the temperature limit is
reduced, we may be required to construct a cooling tower to comply with the
terms of the wastewater discharge permit.
Solid Wastes. Several of our facilities are subject to regulations in
Pennsylvania governing ash disposal sites. These regulations require, among
other things, the development of a groundwater assessment plan if groundwater
monitoring indicates degradation of water quality. A groundwater assessment must
evaluate the cause and determine the need for abatement measures. Groundwater
assessments have been developed for several of our ash disposal sites.
Specifically, the Titus station ash disposal site was upgraded in 1991 and meets
many of the Pennsylvania lined facility requirements. Nevertheless, groundwater
degradation has been identified at that site. In 1996, an abatement plan was
filed with the PaDEP in conjunction with the Titus ash disposal site
repermitting application. The plan states that any contaminated groundwater will
be appropriately abated until the landfill is closed, which is expected to occur
in 2008 or 2009, and, prior to the projected landfill closure, procedures will
be implemented to evaluate the groundwater condition at the site and determine
if additional remediation is required. Similarly, the Portland station ash
disposal site requires significant modifications under a state permit issued in
December 1998 that requires a synthetic liner and a leachate collection and
treatment system. These modifications are nearing completion. In general, we
expect to develop and expand existing ash disposal sites as well as close other
ash disposal sites at various facilities during the lives of those facilities.
These activities may include various remedial activities to address actual or
threatened impacts on groundwater from prior disposal activities or other
technical construction requirements imposed by the applicable regulatory agency.
Other residual waste compliance requirements in Pennsylvania apply to waste
water treatment processes including the use of storage impoundments, which
eventually will also require groundwater monitoring systems, and potential
assessments of the impact, if any, on groundwater. Groundwater abatement may be
necessary at locations where pollution problems are identified. The removal of
all the residual waste, sometimes called clean closure, has been completed at
some of our impoundments to eliminate the need for future monitoring and
abatement requirements. Wastewater storage impoundments must implement
groundwater monitoring plans. The PaDEP has approved the monitoring plans for
the Keystone and Conemaugh stations. Implementation of those plans has begun.
The plans for the Shawville, Titus and Portland stations are awaiting PaDEP
approval.
Hazardous Substances/Site Remediation. Under federal environmental
monitoring requirements, an affiliate of GPU, Inc., as prior owner of our Seward
Station, reported to the PaDEP that contaminants from coal mine refuse piles
were identified in stormwater runoff at the property where the station is
situated. That affiliate of GPU, Inc. signed a modified consent order, effective
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December 1996, and an amendment, in December 1998, that established a schedule
for submitting a plan for long-term remediation, based on future operating
scenarios. We estimate that the remediation on the Seward station property will
range from $6 million to $10 million. These amounts have been included in the
financial projections and anticipated environmental expenditures for the Seward
station. We base this cost estimate on continuing discussions with the PaDEP
about the method of remediation, the extent of remediation required and
available cleanup technologies. Under the acquisition agreements by which Sithe
Energies purchased our facilities from affiliates of GPU, Inc., a GPU, Inc.
affiliate has agreed to retain responsibility for up to $6 million of
environmental liabilities arising as a result of or in connection with the
investigation or remediation of hazardous substances disposed, released or
stored prior to November 24, 1999 in connection with the coal refuse site at the
Seward station. We will be responsible for any amounts in excess of that $6
million. In August 2000 we signed a modified consent order which committed us to
begin the remediation work by September 2000 and to complete it no later than
November 2004.
We are generally responsible for the liabilities associated with site
contamination at our facilities, with the exception of the first $6 million to
remediate the coal mine refuse pile at the Seward station and all costs
associated with the remediation of asbestos contamination identified at an
office building. An affiliate of GPU, Inc. retained liabilities associated with
the disposal of hazardous substances to off-site locations prior to November 24,
1999. In that regard, the presence of hazardous substances at the generating
facilities could expose us to potential liabilities associated with the cleanup
of contaminated soil and groundwater under federal or state "Superfund"
statutes. Under the federal Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended, or "CERCLA" or "Superfund," owners and
operators of facilities from which there has been a release or threatened
release of hazardous substances, together with those who have transported or
arranged for the disposal of those substances, are liable for:
- the costs of responding to that release or threatened release, and
- the restoration of natural resources damaged by any such release.
The liability imposed by the statute is both strict and, under almost all
circumstances, joint and several. Any such liabilities could have a material
adverse effect on us. We are not aware of any liabilities that we are
responsible for under CERCLA that would have a material adverse effect on us,
our financial position, results of operation or cash flows.
We are also responsible for remediation costs under the New Jersey
Industrial Site Recovery Act, or "ISRA," relating to our facilities located in
New Jersey. Under ISRA, owners and operators of industrial properties are
responsible for performing all necessary remediation at the facility prior to
closing, or undertaking actions that ensure that the property will be remediated
after the closing. In connection with the acquisition of our Mid-Atlantic region
facilities from Sithe Energies, Inc., we have agreed to take responsibility for
any costs under ISRA relating to the New Jersey properties, which include the
Gilbert, Sayreville, Glen Gardner and Werner stations. We estimate that the
costs to fulfill our obligations under ISRA will be approximately $5 to $10
million. However, these remedial activities are still in the early investigative
stage. Following further investigation the scope of the necessary remedial work
could increase, and we could, as a result, incur significantly greater costs.
REGIONAL ENVIRONMENTAL ISSUES -- WHOLESALE ENERGY -- SOUTHWEST REGION
We currently operate approximately 4,045 MW of natural gas-fired generation
facilities in California and Nevada. Additional generation capacity of 563 MW is
under construction in Arizona. The California units are required to meet the
strict emission standards prescribed in the South Coast Air Quality Management
District and Ventura County. Our Etiwanda generating
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facility operates under the RECLAIM emission allowance system, which reduces the
allowable amount of NO(x) emissions by reducing the available emission
allowances or credits allocated to each source annually by about 8 percent per
year through 2003. Emission allowance prices have reached record levels during
the summer of 2000; however, we now believe that we have acquired or been
allocated sufficient NO(x) allowances to operate our Etiwanda facility and that
the associated cost will not have a material impact. We have added emission
reduction equipment at our Coolwater station, and are pursuing additional NO(x)
reductions at our Etiwanda generating station to improve profitability of these
facilities.
In order to further assist in meeting peak power supply shortfalls in the
California market, we entered into an agreement with Ventura County Air
Pollution Control District to install NO(x) emission reduction equipment on a
peaking combustion turbine at the Mandalay generating station in Ventura County.
This agreement will allow an increase in the unit's fuel allowance while
engineering and construction of NO(x) emission control equipment is performed.
Project costs are estimated to range from $2.1 million to $5.8 million. An
emission mitigation fee of $4,000 per hour of operation above the current fuel
allowance will be assessed until NO(x) controls are installed by July 2001, and
will go to reduce emissions via replacement of diesel engines in the county. The
Santa Barbara County Air Pollution Control District has agreed to allow the
Ellwood station to operate above the current 200 hour limit, but not beyond the
current permit limit on fuel use if the Cal ISO advises us of an "Imminent Stage
3" energy advisory.
In July 2000, the Ormond Beach station received a notice of violation from
the Ventura County Air Pollution District for operation in excess of permit
limits during a power supply emergency. We believe the operation was authorized
under equipment malfunction notification provisions, and are pursuing resolution
with the agency. However, if not favorably resolved, the notice of violation
could result in penalties. The cost associated with such a penalty, if any, is
not expected to be material.
The asset purchase agreements under which we acquired our California
generating facilities contain a provision that makes the prior owner of those
plants responsible for costs associated with environmental contamination that is
discovered on the sites of the purchased assets within 15 years after the
purchase and can be shown to have resulted from activities of the prior owner.
REGIONAL ENVIRONMENTAL ISSUES -- WHOLESALE ENERGY -- MIDCONTINENT REGION
We currently operate 255 MW of natural gas-fired capacity at Shelby County,
Illinois. In addition, 962 MW of capacity is under construction in Aurora,
Illinois and Shelby County, Illinois. All permits necessary for the construction
and/or operation of these units have been obtained or have been timely applied
for, with receipt expected prior to start-up.
REGIONAL ENVIRONMENTAL ISSUES -- WHOLESALE ENERGY -- FLORIDA
The Indian River plant, located in Brevard County, Florida, is subject to
an ordinance that limits the use of emission allowances allocated as part of
Title IV of the Federal Clean Air Act to those allocated to sources within the
county. While it is not believed that this requirement would withstand a legal
challenge, we elected not to pursue litigation at this time. The full allocation
of allowances was purchased from the Orlando Utilities Commission as part of the
acquisition of the Indian River plant, and our fuel purchase and utilization
strategy is such that the acquired allowances should be adequate for operation
this plant for the foreseeable future.
The Indian River plant discharges wastewater to percolation ponds which in
turn, discharge to groundwater. Elevated levels of vanadium and sodium have been
detected in groundwater monitoring wells. A noncompliance letter has been
received from the Florida Department of Environmental Protection. A study to
evaluate the cause of the elevated constituents will be undertaken. At this
time, if remediation is required, the cost, if any, is not anticipated to be
material.
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We are actively involved in the remediation of two wastewater ponds at the
Indian River plant. These ponds historically received station wash water that
contained small amounts of polychlorinated biphenyl, or "PCBs," from a ruptured
station transformer. The remediation of the ponds is regulated under the federal
Toxic Substances Control Act, or "TSCA." We expect the total cost of the cleanup
will be approximately $500,000.
REGIONAL ENVIRONMENTAL ISSUES -- EUROPEAN ENERGY -- UNA
We currently own and operate 3,476 MW of generation facilities located in
the Netherlands. In 1999, approximately 56% of UNA's generation output was
natural gas-fired, 20% was blast furnace gas-fired, 24% was coal-fired and less
than 1% was oil-fired.
Although currently the Dutch environmental laws are among the most
stringent in Europe, the Dutch environmental policy is becoming more closely
harmonized with European directives. The Dutch federal environmental laws are
for the most part defined in the Wet milieubeheer, the Wet verontreiniging
oppervlaktewater and the Wet op de waterhuishouding. These Acts generally
provide the framework for further definition by Royal Resolutions, ministerial
Resolutions and other directives. Each plant needs an environmental permit.
According to the size of the plant, the licensing authority may be the Province
or the Municipality. The licensing authority for the water pollution Act is the
Directorate General for Public Works and Water Management. The Dutch law permits
so-called Convenanten. These are contractual agreements between the federal
government and a sector of industry, and are used to define environmental
targets for the long term. The environmental laws also address public safety.
UNA facilities hold all necessary authorizations and approvals for their
operation.
The European Union, of which the Netherlands is a member, adopted the Kyoto
Protocol as the goal for greenhouse gas emission targets. Please read
"-- General Environmental Issues -- Carbon Dioxide" for further discussion of
the protocol. UNA, through innovative use of "green fuels" and efficiency
improvements, expects to meet its portion of the target reductions.
UNA facilities are in compliance with applicable Dutch NO(x) emission
standards through the year 2000. Discussions are currently ongoing between the
government and the electric utility industry sector. While no outcome can be
predicted, we currently believe that a market based trading system will be
implemented in the 2002 time frame and that ultimately NO(x) emission reductions
will be required from our generating facilities.
As in the United States, generating facilities in the Netherlands are
subject to requirements to properly handle and abate asbestos. UNA has embarked
upon a remediation program to identify areas of its facilities that contain
asbestos and a detailed program for these facilities has been developed. The
results of the evaluation indicate that reductions in overall operation and
maintenance costs will occur if remediation is completed. It is currently
anticipated that this program may require expenditures of up to $20 million over
the next five years.
EMPLOYEES
As of January 1, 2001, we employed approximately 4,100 people. Of these
employees, approximately 1,600 are covered by collective bargaining agreements.
The collective bargaining agreements expire on various dates between April 2001
and May 2002. We have never experienced a work stoppage, strike or labor
dispute. We consider relations with our employees to be good.
PROPERTIES
Our corporate offices currently occupy approximately 500,000 square feet of
leased office space in Houston, Texas, which lease expires in 2003, subject to
renewal options.
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In addition to our corporate office space, we lease or own various real
property and facilities relating to our generation assets and development
activities. Our principal generation facilities are generally described under
the descriptions of our regional asset portfolios elsewhere in this prospectus.
We believe we have satisfactory title to our facilities in accordance with
standards generally accepted in the electric power industry, subject to
exceptions which, in our opinion, would not have a material adverse effect on
the use or value of the facilities.
LEGAL PROCEEDINGS
We are currently involved in various litigation matters in the ordinary
course of our business. Following price volatility in the California wholesale
electricity markets during the summer of 2000 and price levels that were higher
than prices during the summer of 1999, both the California Public Utility
Commission and the FERC, among other agencies, initiated investigations into the
operation of the wholesale markets and the causes of the price volatility.
Additionally, a number of complaints have been filed at the FERC, which has
jurisdiction over wholesale markets and prices, naming as respondents all
sellers in the California wholesale market, which would include several of our
subsidiaries. On December 15, 2000, as part of its investigation, the FERC
issued an order directing remedies for California wholesale electricity markets.
The December 15 order was issued after written and public comments were
submitted to the FERC in response to a preliminary order proposing remedies for
California's wholesale electricity markets issued on November 1, 2000. In the
December 15 order, the FERC imposed a two-year refund condition on sales made at
market-based rates into the Cal PX or to the Cal ISO. The FERC also adopted a
$150/MW breakpoint for market clearing prices in the markets operated by the Cal
PX and the Cal ISO. Sellers bidding in these markets at or below the breakpoint
would receive the market clearing price during the applicable hour. Sellers
bidding above the breakpoint would receive their actual bid prices, if their
bids are accepted, but would be required to submit data respecting their bids
for review by the FERC. For bid prices above the breakpoint, unless the FERC
issues written notification to a seller that its transaction is still under
review, refund potential on a transaction will end after 60 days. The $150/MW
breakpoint is intended to be replaced with a real time price mitigation program
to be developed and in place by May 1, 2001. The FERC also concluded in the
December 15 order that there was not sufficient evidence in the record to find
that particular sellers have exercised market power or have violated
FERC-approved market rules. The December 15 order did not order any refunds of
amounts previously charged, although it did adopt the prospective refund
condition mentioned above.
In addition, Reliant Energy has been named as one of a number of defendants
in a class action lawsuit filed against a number of companies that own
generation plants in California and other unnamed sellers of electricity in
California markets. Under the terms of the master separation agreement, we have
agreed to indemnify Reliant Energy for any damages arising under this lawsuit
and may elect to defend this suit at our own expense. Our domestic trading and
marketing subsidiary has been named as one of multiple defendants in another
class action lawsuit against marketers and other unnamed sellers of electricity
in California markets. Both of these lawsuits were filed in the Superior Court
of the State of California, San Diego County in November 2000 and allege
violations by the defendants of state antitrust laws and state laws against
unfair and unlawful business practices. The first lawsuit alleges aggregate
damages of over $4 billion. The second lawsuit alleges damages in excess of $1
billion. In addition to injunctive relief, the plaintiffs in these lawsuits seek
treble the amount of damages alleged, restitution of alleged overpayments,
disgorgement of alleged unlawful profits for sales of electricity during all or
portions of 2000, costs of suit and attorneys' fees. A petition to remove each
case to Federal District Court in San Diego was filed in December 2000. These
lawsuits have only recently been filed. Therefore, the ultimate outcome of the
lawsuits cannot be predicted with any degree of certainty at this time. However,
we do not believe, based on our analysis to date of the claims asserted in these
suits and the underlying facts, that the resolution of these
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suits will have a material adverse effect on our financial condition, results of
operations or cash flows.
We are not currently involved in any other litigation or proceedings that
we expect, either individually or in the aggregate, will have a material adverse
effect on our financial condition, results of operations and cash flows.
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table provides information regarding our executive officers
and directors:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
R. Steve Letbetter.................... 52 Chairman, President and Chief
Executive Officer
Robert W. Harvey...................... 45 Executive Vice President and Group
President, Emerging Businesses
Stephen W. Naeve...................... 53 Executive Vice President and Chief
Financial Officer
Joe Bob Perkins....................... 40 Executive Vice President and Group
President, Wholesale Businesses
Hugh Rice Kelly....................... 57 Senior Vice President, General Counsel
and Corporate Secretary
Mary P. Ricciardello.................. 45 Senior Vice President and Chief
Accounting Officer
James A. Baker, III(1)................ 70 Director
Linnet F. Deily(1).................... 55 Director
L. Lowry Mays(1)...................... 65 Director
Philip B. Miller(1)................... 62 Director
</TABLE>
---------------
(1) Expected to be elected as a director at our first regularly scheduled board
meeting following the offering.
R. STEVE LETBETTER is our Chairman, President and Chief Executive Officer.
Mr. Letbetter also serves as Chairman, President and Chief Executive Officer of
Reliant Energy. He has been Chairman of Reliant Energy since January 2000,
President since June 1997 and Chief Executive Officer since June 1999. He has
served since 1978 in various positions as an executive officer of Reliant Energy
and its corporate predecessors. Mr. Letbetter has been a director of Reliant
Energy since 1995 and also serves on the Chase Texas Regional Advisory Board.
Mr. Letbetter will resign as President and Chief Executive Officer of Reliant
Energy at the time of the distribution of our common stock held by Reliant
Energy to its shareholders, but will continue to serve as non-executive Chairman
of Reliant Energy until 2004, subject to his re-election in 2001 as a director
by shareholders to a new three-year term and annually as Chairman by the board.
ROBERT W. HARVEY is our Executive Vice President and Group President,
Emerging Businesses. Mr. Harvey has also served as Vice Chairman of Reliant
Energy since June 1999. From 1982 to 1999, Mr. Harvey was employed with the
Houston office of McKinsey & Co., Inc. He was a director (senior partner) and
was the leader of the firm's North American electric power and natural gas
practice. Mr. Harvey will resign as Vice Chairman of Reliant Energy at the time
of the distribution.
STEPHEN W. NAEVE is our Executive Vice President and Chief Financial
Officer. He has also served as Vice Chairman of Reliant Energy since June 1999
and as Chief Financial Officer of
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Reliant Energy since 1997. From 1997 to 1999, Mr. Naeve held the position of
Executive Vice President and Chief Financial Officer of Reliant Energy. He has
served in various executive officer capacities with Reliant Energy since 1988,
including Vice President -- Strategic Planning and Administration between 1993
and 1996. Mr. Naeve will resign as Vice Chairman and Chief Financial Officer of
Reliant Energy at the time of the distribution.
JOE BOB PERKINS is our Executive Vice President and Group President,
Wholesale Businesses. He served as President and Chief Operating Officer,
Reliant Energy Wholesale Group and as President and Chief Operating Officer,
Reliant Energy Power Generation, Inc. since 1998. In 1998, Mr. Perkins served as
President and Chief Operating Officer of Reliant Energy Power Generation Group.
Between 1996 and 1998, he served as Vice President -- Corporate Planning and
Development.
HUGH RICE KELLY is our Senior Vice President, General Counsel and
Secretary. He has also served as Executive Vice President, General Counsel and
Corporate Secretary of Reliant Energy since 1997. Between 1984 and 1997, he
served as Senior Vice President, General Counsel and Corporate Secretary of
Reliant Energy. Mr. Kelly will resign as an officer of Reliant Energy at the
time of the distribution.
MARY P. RICCIARDELLO is our Senior Vice President and Chief Accounting
Officer. She has also served as Senior Vice President and Chief Accounting
Officer of Reliant Energy since June 1999 and as Vice President and Comptroller
since 1996. She has served in various executive officer capacities with Reliant
Energy since 1993. Ms. Ricciardello will resign as an officer of Reliant Energy
at the time of the distribution.
JAMES A. BAKER, III has been a director of Reliant Energy since 1996. Mr.
Baker will serve as one of our directors and a director of Reliant Energy until
the time of the distribution, at which time he plans to resign from the Board of
Reliant Energy. Mr. Baker is currently a senior partner in the law firm of Baker
Botts L.L.P. in Houston, Texas, Senior Counselor to The Carlyle Group, a
merchant banking firm in Washington D.C., and a director of Electronic Data
Systems Corporation. He served as the U.S. Secretary of State from January 1989
through August 1992 and as White House Chief of Staff and Senior Counselor to
President Bush from August 1992 to January 1993. From 1985 to 1988, Mr. Baker
was the U.S. Secretary of the Treasury and Chairman of the President's Economic
Policy Council in the administration of President Reagan, having previously
served as President Reagan's White House Chief of Staff from 1981 to 1985 and as
President Ford's Under Secretary of Commerce in 1975.
LINNET F. DEILY has been a director of Reliant Energy since 1993. Ms. Deily
will serve as one of our directors and a director of Reliant Energy until the
time of the distribution, at which time she plans to resign from the Board of
Reliant Energy. Ms. Deily is Vice Chairman, Office of the President of the
Charles Schwab Corporation in San Francisco, California. She is also a member of
the firm's Executive Committee. Prior to October 2000, Ms. Deily served as Vice
Chairman and President of the Schwab Retail Group. She previously served as
Chairman, Chief Executive Officer and President of First Interstate Bank of
Texas, N.A. until April 1996, having been Chairman since 1992, Chief Executive
Officer since 1991 and President since 1988.
L. LOWRY MAYS currently serves as Chairman and Chief Executive Officer of
Clear Channel Communications, Inc. Mr. Mays will serve as one of our directors.
Clear Channel Communications, headquartered in San Antonio, Texas, is a global
diversified media company with radio and television stations, outdoor displays
and entertainment venues in 40 countries around the world. Mr. Mays co-founded
Clear Channel Communications in 1972 and has served as its Chairman and Chief
Executive Officer since then. He is also a director of NBC Internet, Inc.
PHILIP B. MILLER currently serves as the Chairman of the Saks Fifth Avenue
group of Saks Incorporated and as a director of Saks Incorporated. Mr. Miller
will serve as one of our directors. Mr. Miller served as Chairman and Chief
Executive Officer of the Saks Fifth Avenue group
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between September 1998 and January 2000. Mr. Miller served as Chairman and Chief
Executive Officer of Saks Holdings, Inc. (the holding company for Saks &
Company, a wholly owned subsidiary that did business as Saks Fifth Avenue, or
"SFA") between March 1996 and September 1998. He joined SFA in 1990. Mr. Miller
also serves on the Board of Directors of Kenneth Cole Productions, Inc.
BOARD STRUCTURE AND COMPENSATION
Beginning the day that Reliant Energy ceases to own at least a majority of
our common stock, our directors will be divided into three classes serving
staggered three-year terms. At each annual meeting, directors will be elected to
succeed the class of directors whose terms have expired. Our classified board of
directors could have the effect of increasing the length of time necessary to
change the composition of a majority of the board of directors. In general, at
least two annual meetings of stockholders will be necessary for stockholders to
effect a change in majority of the members of the board of directors.
Our directors who are also our employees will receive no extra pay for
serving as directors or committee members. Compensation for each non-employee
director will consist of an annual retainer fee of $30,000, a fee of $1,200 for
each board and committee meeting attended and 1,000 shares of our common stock
annually. Directors may defer all or part of their annual retainer fees and
meeting fees under our deferred compensation plan. Directors participating in
this plan are entitled to receive distributions at age 70 or upon leaving the
board of directors, whichever is later. The deferred compensation plan currently
provides for accrual of interest on deferred director compensation at a rate
equal to the average annual yield on the Moody's Long-Term Corporate Bond Index
plus two percentage points.
Our non-employee directors currently participate in a director benefits
plan under which a director who serves at least one full year will receive an
annual cash amount equal to the annual retainer in effect the year the director
terminates service. Benefits under this plan commence the January following the
later of the director's termination of service or attainment of age 65, for a
period equal to the number of full years of service of the director.
Non-employee directors are also eligible to receive nonqualified stock options
under our long-term incentive plan, subject to any terms, conditions and
limitations determined by the board.
Non-employee directors currently participate in our executive life
insurance plan described below under "-- Executive Life Insurance Plan." This
plan provides split-dollar life insurance with a death benefit equal to six
times the director's annual retainer with coverage continuing after termination
of service as a director. The plan also permits us to provide for a tax
reimbursement payment to make the directors whole for any imputed income
recognized with respect to the term portion of the annual insurance premiums.
Upon death, we will receive the balance of the insurance proceeds payable in
excess of the specified death benefit. The plan is designed so that the proceeds
we receive are expected to be at least sufficient to cover our cumulative
outlays to pay premiums and the after-tax cost to us of the tax reimbursement
payments.
BOARD COMMITTEES
Our board is expected to have the following standing committees:
- The audit committee. This committee will oversee our accounting and
internal control matters. This committee will also recommend to the board
of directors the selection of the firm of independent public accountants
to audit our financial statements and will review and approve the plan
and scope of the independent public accountants' audit and non-audit
services and related fees. Each member of the audit committee will be
"independent" as determined in accordance with the rules of the New York
Stock Exchange.
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- The compensation committee. This committee will oversee compensation and
benefits for our senior officers, including salary, bonus and incentive
awards. This committee will also review human resource programs and
monitor and, in certain cases, administer employee benefit plans. We
expect that all of the members of the compensation committee will be
independent directors.
- The governance committee. This committee will recommend the number of
directors to comprise the board, evaluate directors whose terms are
expiring, evaluate and recommend potential candidates for election to the
board, review non-employee director compensation and board processes and
policies and other corporate governance issues. We expect that a majority
of the members of the governance committee will be independent directors.
Our board will designate the members of each committee after our
independent directors are elected to the board. We expect this election will
take place at the first regularly scheduled board meeting following this
offering. Our board may establish other committees from time to time to
facilitate the management of our business and affairs.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of our executive officers has served as a member of a compensation
committee (or if no committee performs that function, the board of directors) of
any other entity that has an executive officer serving as a member of our board
of directors.
STOCK OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERS
All of our stock is currently owned by Reliant Energy and thus none of our
officers or directors owns any of our common stock.
The following table sets forth information as of December 31, 2000 with
respect to the beneficial ownership of Reliant Energy common stock by each
director and executive officer, and all of our directors and executive officers
as a group. Except as otherwise indicated in the footnotes, each individual has
sole voting and investment power with respect to the shares set forth in the
following table. Each director and officer and the directors and officers as a
group beneficially own less than 1% of Reliant Energy's common stock.
<TABLE>
<CAPTION>
SHARES INDIVIDUALS
SHARES HAVE RIGHTS TO
BENEFICIALLY ACQUIRE WITHIN 60
NAME OF BENEFICIAL OWNER OWNED(1) DAYS(2)
------------------------ ------------ ------------------
<S> <C> <C>
James A. Baker, III....................................... 4,000 --
Linnet F. Deily........................................... 5,000(3) --
Robert W. Harvey.......................................... 107,391(4) 98,333
Hugh Rice Kelly........................................... 191,818(4) 116,980
R. Steve Letbetter........................................ 415,558(4) 335,775
L. Lowry Mays............................................. -- --
Philip B. Miller.......................................... 3,000 --
Stephen W. Naeve.......................................... 189,450(4) 147,940
Joe Bob Perkins........................................... 122,765(4) 113,041
Mary P. Ricciardello...................................... 80,851(4) 61,335
All directors, proposed directors and executive officers
as a group.............................................. 1,116,833 873,404
</TABLE>
---------------
(1) Beneficial ownership means the sole or shared power to vote, or to direct
the voting of, a security, or investment power with respect to a security,
or any combination thereof.
(2) Shares indicated are included in the Shares Beneficially Owned column.
(3) Shares are jointly owned with spouse.
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(4) Includes shares held under the Reliant Energy savings plan, for which the
officer has sole voting power (subject to such power being exercised by the
plan's trustee in the same proportion as directed shares in the savings plan
are voted in the event the participant does not exercise voting power).
COMPENSATION OF EXECUTIVE OFFICERS
The following table shows the aggregate compensation paid to our chief
executive officer and our four other most highly compensated executive officers
by Reliant Energy or its subsidiaries during 2000.
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
--------------------
AWARDS
ANNUAL COMPENSATION ---------- PAYOUTS
------------------------------- SECURITIES -------
OTHER ANNUAL UNDERLYING LTIP ALL OTHER
SALARY BONUS COMPENSATION OPTIONS PAYOUTS COMPENSATION
NAME AND PRINCIPAL POSITION ($)(1) ($)(1) ($) ($) ($)(2) ($)(3)
--------------------------- ------- ------ ------------ ---------- ------- ------------
<S> <C> <C> <C> <C> <C> <C>
R. Steve Letbetter,.................. 913,750 -- 393 400,000 213,166 93,531
Chairman, President and Chief
Executive Officer(4)
Robert W. Harvey,.................... 537,500 -- 613 175,000 -- 85,582
Executive Vice President and Group
President, Emerging Businesses(5)
Stephen W. Naeve,.................... 537,500 -- 81 175,000 102,489 53,323
Executive Vice President and Chief
Financial Officer
Joe Bob Perkins,..................... 447,500 -- 82 130,000 65,257 43,461
Executive Vice President and Group
President, Wholesale Businesses
Hugh Rice Kelly,..................... 412,500 -- 1,135 80,000 134,970 63,674
Senior Vice President, General
Counsel and Corporate Secretary
</TABLE>
---------------
(1) The amounts shown include salary earned as well as amounts earned but
deferred. The bonus amounts payable for the year 2000 are not known as of
the date of this prospectus and therefore have been omitted from the table.
(2) Amounts shown represent the dollar value of the Reliant Energy common stock
paid out in 2000 based on the achievement of performance goals for the
performance cycle ending in 1999, plus dividend equivalent accruals during
the performance period.
(3) Amounts include (a) non-discretionary matching contributions to Reliant
Energy's savings plan and accruals under Reliant Energy's savings
restoration plan for contributions as follows: Mr. Letbetter: $41,912; Mr.
Harvey: $34,426; Mr. Naeve: $41,951; Mr. Perkins: $27,974; Mr. Kelly:
$30,926; (b) the term portion of the premiums paid by Reliant Energy under
split-dollar life insurance policies purchased in connection with Reliant
Energy's executive life insurance plan, as follows: Mr. Letbetter: $599; Mr.
Harvey: $935; Mr. Naeve: $123; Mr. Perkins: $125; Mr. Kelly: $1,730; (c)
accrued interest on deferred compensation that exceeds 120% of the
applicable federal long-term rate as follows: Mr. Letbetter; $51,020; Mr.
Harvey: $221; Mr. Naeve: $11,249; Mr. Perkins: $15,362; Mr. Kelly: $31,018.
These amounts do not include the discretionary matching contributions for
2000 under Reliant Energy's savings plan or savings restoration plan, which
have not been determined as of the date of this prospectus.
(4) Mr. Letbetter was elected as President and Chief Executive Officer as of
June 1, 1999 and as Chairman as of January 1, 2000. Effective April 1, 2000,
Mr. Letbetter's annual salary was increased to $935,000.
(5) Reliant Energy also loaned Mr. Harvey $250,000 in connection with his
initial employment. The loan bears interest at a rate of 8% and is to be
forgiven in annual installments through May 31, 2004 so long as Mr. Harvey
remains employed by us as of each relevant anniversary of his employment
date.
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GRANTS OF RELIANT ENERGY STOCK OPTIONS
The following table shows all grants of options to acquire shares of
Reliant Energy common stock to the executive officers named in the summary
compensation table above in the year ended December 31, 2000. Unless exercised
before the distribution of our remaining common stock, the options to purchase
Reliant Energy common stock reflected below will be converted into options to
purchase our common stock and Reliant Energy common stock. Please read
"-- Adjustment of Outstanding Reliant Energy Options and Performance Shares"
below.
<TABLE>
<CAPTION>
SECURITIES % OF 2000
UNDERLYING EMPLOYEE EXERCISE/BASE GRANT DATE
OPTIONS OPTION PURCHASE PRICE EXPIRATION PRESENT
NAME GRANTED(1) GRANTS PER SHARE($)(2) DATE VALUE($)(3)
---- ---------- --------- --------------- ---------- -----------
<S> <C> <C> <C> <C> <C>
R. Steve Letbetter........... 400,000 6.84% 20.50 2/24/2010 2,028,120
Robert W. Harvey............. 175,000 2.99% 20.50 2/24/2010 887,303
Stephen W. Naeve............. 175,000 2.99% 20.50 2/24/2010 887,303
Joe Bob Perkins.............. 130,000 2.22% 20.50 2/24/2010 659,139
Hugh Rice Kelly.............. 80,000 1.37% 20.50 2/24/2010 405,624
</TABLE>
---------------
(1) Options vest in one-third increments per year from the date of grant, so
long as the officer remains our employee. All options would immediately vest
upon a change in control as defined in the Reliant Energy long-term
incentive compensation plan. The offering and the distribution are not
deemed to be a change in control under the plan.
(2) Each exercise price or base purchase price is equal to the fair market value
of Reliant Energy common stock as of each applicable grant date.
(3) Value was calculated using the Black-Scholes option valuation model. The
actual value, if any, ultimately realized depends on the market value of the
underlying common stock at a future date. The following table indicates our
significant assumptions:
<TABLE>
<CAPTION>
DISCOUNT FOR
FORFEITURE RISK:
--------------------
RISK-FREE RATE OF DIVIDEND BEFORE BEFORE
VOLATILITY RETURN OPPORTUNITY TERM VESTING EXPIRATION
---------- ----------------- ----------- ---- ------- ----------
<S> <C> <C> <C> <C> <C>
24.00% 6.57% $1.50/share 10 years None None
</TABLE>
The following table shows the number and value of exercisable and
unexercisable options held by the named executive officers as of December 31,
2000.
2000 YEAR END RELIANT ENERGY OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT DECEMBER 31, 2000
DECEMBER 31, 2000 ($)(2)
--------------------------- ---------------------------
NAME(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
R. Steve Letbetter.................. 202,442 620,001 3,670,676 12,935,673
Robert W. Harvey.................... 40,000 255,000 550,002 5,130,482
Stephen W. Naeve.................... 89,607 271,668 1,594,808 5,627,899
Joe Bob Perkins..................... 69,708 213,334 1,176,795 4,389,085
Hugh Rice Kelly..................... 90,314 140,001 1,720,299 2,865,024
</TABLE>
---------------
(1) None of the named officers exercised any options in 2000.
(2) Based on the average of the high and low sales prices of Reliant Energy's
common stock on the New York Stock Exchange Composite Tape, as reported in
The Wall Street Journal for December 31, 2000.
OUTSTANDING PERFORMANCE SHARES -- RELIANT ENERGY LONG-TERM INCENTIVE
COMPENSATION PLAN
Under the Reliant Energy long-term incentive compensation plan, officers
have received awards of performance shares based on financial objectives
measurable over a three-year performance cycle. The financial objectives for the
cycle shown below are growth in earnings per share, total shareholder return and
cash return on capitalization. Payout levels under the plan are
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calculated by determining the percentage of achievement of each goal. For each
performance goal there are three possible levels of achievement: threshold (for
a payout of 50%), target (for a payout of 100%) or maximum (for a payout of
150%). Achievement levels between threshold, target and maximum result in payout
levels that are adjusted proportionately. The payout to the officer is generally
made based on the weighting for each goal assigned by Reliant Energy's board or
compensation committee.
The following table shows awards made in 2000 under the Reliant Energy
long-term incentive compensation plan to the named executive officers. Awards
outstanding as of the distribution will be treated as described in
"-- Adjustment of Outstanding Reliant Energy Options and Performance Shares"
below.
RELIANT ENERGY LONG-TERM INCENTIVE COMPENSATION PLAN -- AWARDS IN 2000(1)(2)
<TABLE>
<CAPTION>
ESTIMATED FUTURE PAYOUTS UNDER
NON-STOCK PRICE-BASED PLANS
---------------------------------
PERFORMANCE THRESHOLD TARGET MAXIMUM
NUMBER PERIOD UNTIL NUMBER OF NUMBER OF NUMBER
NAME OF SHARES PAYOUT SHARES SHARES OF SHARES
---- --------- ------------ --------- --------- ---------
<S> <C> <C> <C> <C> <C>
R. Steve Letbetter................ 23,206 12/31/2002 11,603 23,206 34,809
Robert W. Harvey.................. 11,375 12/31/2002 5,688 11,375 17,063
Stephen W. Naeve.................. 11,375 12/31/2002 5,688 11,375 17,063
Joe Bob Perkins................... 7,611 12/31/2002 3,806 7,611 11,417
Hugh Rice Kelly................... 6,949 12/31/2002 3,475 6,949 10,424
</TABLE>
---------------
(1) If a change in control of Reliant Energy occurs, such amounts will be paid
in cash at the maximum level, without regard to the achievement of
performance goals.
(2) Does not reflect dividend equivalent accruals during the performance period.
ADJUSTMENT OF OUTSTANDING RELIANT ENERGY OPTIONS AND PERFORMANCE SHARES
Each individual who is actively employed by us as of the date of the
distribution and, on that date, holds unexercised and unexpired options to
purchase Reliant Energy common stock, which we sometimes refer to as a "Reliant
Energy Stock Option," will have his or her options, subject to specific country
tax and legal requirements, converted into options to acquire both Reliant
Energy common stock and our common stock. In general, to the extent an
individual who is actively employed by us holds Reliant Energy Stock Options
that qualify as incentive stock options, as defined in the Internal Revenue
Code, or "Code," the options such individual will be issued to purchase our
stock are also intended to be incentive stock options; provided, however, that
in order for incentive stock options to remain qualified and retain their tax
benefits under the Code, the adjustment formulas described below may be required
to be altered. To the extent an individual holds nonqualified Reliant Energy
Stock Options, the options that individual will be issued to purchase our common
stock will also be nonqualified.
The number of shares subject to each adjusted Reliant Energy Stock Option
will remain the same, but the exercise price of the stock option will be
adjusted to compensate for the decrease in the stock price resulting from the
distribution. The number of shares subject to each of our stock options will
equal the number of shares subject to each Reliant Energy Stock Option
multiplied by a conversion factor, which is the factor used to determine the
number of shares of our common stock that each Reliant Energy shareholder will
receive in the distribution. The exercise price per share of each such adjusted
Reliant Energy Stock Option and option to acquire our common stock will be
determined in a manner such that, immediately following the distribution, the
difference between the exercise price of each option and the fair market value
of the shares underlying each option equals, in the aggregate, the difference
between the exercise price of each original Reliant Energy Stock Option and the
fair market value per share of Reliant
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Energy common stock immediately prior to the date of distribution based on the
average trading prices of our common stock and Reliant Energy's common stock for
the five trading days immediately before the date of the distribution.
Employment with our company will be treated as employment with Reliant Energy
for purposes of the adjusted Reliant Energy Options, and employment with Reliant
Energy will be treated as employment with us for purposes of the converted
options to purchase our common stock. Other than the adjustments described
above, all other terms and conditions of such options (including, but not
limited to, the vesting schedule) will remain in place following the
distribution. Converted options to purchase our common stock will be issued
pursuant to a separate transition option plan recently adopted for this purpose.
We have reserved 9,100,000 shares for issuance under this plan.
Outstanding performance shares (or bookkeeping units representing such
shares) under Reliant Energy's long-term incentive compensation plan will vest
for the performance cycle ending December 31, 2000 according to the terms and
conditions of the plan. Assuming the distribution occurs during the calendar
year 2001, the compensation committee will determine as of the date of the
distribution the level at which the performance objectives are expected to have
been achieved through the end of the performance cycle ending December 31, 2001
and vest the outstanding performance shares as of the date of the distribution
as though such performance objectives were achieved at that level. In addition,
as of the distribution, the compensation committee will convert outstanding
performance shares (or bookkeeping units representing such shares) for the
performance cycle ending December 31, 2002 to a number of time-based restricted
shares of Reliant Energy's common stock equal to the number of performance
shares that would have vested if the performance objectives for the performance
cycle were achieved at the maximum level. Such time-based restricted shares will
vest if the participant holding such shares remains employed with Reliant Energy
or with us through December 31, 2002. On the date of the distribution, holders
of such time-based restricted shares will receive shares of our common stock (or
bookkeeping units representing such shares) in the same manner as other holders
of Reliant Energy common stock, but the shares of our common stock will be
subject to the same time-based vesting schedule and the other terms and
conditions of the applicable plan under which they were granted. Thus, following
the distribution, employees who held performance shares under the Reliant Energy
long-term incentive compensation plan for the performance cycle ending December
31, 2002 will hold time-based restricted shares of Reliant Energy's common stock
and time-based restricted shares of our common stock (or bookkeeping units
representing such shares) which will vest following continuous employment
through December 31, 2002.
On the date of the distribution, holders of then outstanding time-based
restricted shares (or bookkeeping units representing such shares) under Reliant
Energy's incentive plans will retain such shares and will receive shares of our
common stock (or bookkeeping units representing such shares) in the same manner
as other holders of Reliant Energy common stock, each subject to the same
time-based vesting schedule and the other terms and conditions as provided in
the applicable plans under which such shares were granted.
INCENTIVE PLANS
We intend to provide the annual and long-term incentive plans described
below. These plans will be administered by our board of directors or our
compensation committee. The following are descriptions of the material
provisions of the plans.
ANNUAL INCENTIVE COMPENSATION PLAN
Our annual incentive compensation plan, which we sometimes refer to as the
"AICP," is intended to encourage a high level of corporate performance through
the establishment of corporate and individual goals. The compensation committee
determines the terms and
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conditions of awards, designates the recipients and administers the plan. It
may, however, delegate many of its administrative duties to our chief executive
officer or other senior officers. Generally, awards are based on a percentage of
base salary paid to the participant during the plan year. All or part of an
award may be subject to conditions established by the committee, which may
include continuous service, achievement of specific individual and/or business
objectives and other measures of performance.
A performance goal may be based on one or more business criteria that apply
to the individual, one or more of our business units, or our company as a whole.
Performance goals will be based on one or more of the following financial
factors: earnings per share; earnings per share growth; total shareholder
return; economic value added; cash return on capitalization; increased revenue;
revenue ratios (per employee or per customer); net income; stock price; return
on equity; return on assets; return on capital; return on capital compared to
cost of capital; return on capital employed; return on invested capital;
shareholder value; net cash flow; operating income; earnings before interest and
taxes; earnings before interest, taxes, depreciation and amortization; cash
flow; cash flow from operations; cost reductions; cost ratios (per employee or
per customer); proceeds from dispositions; project completion time and budget
goals; net cash flow before financing activities; customer growth and total
market value. Goals may also be based on performance relative to a peer group of
companies.
The AICP may be amended, modified, suspended or terminated by our board in
order to address changes in legal requirements or for other purposes permitted
by law.
Awards under the AICP are intended to qualify as performance-based
compensation under Section 162(m) of the Code. Section 162(m) generally
disallows deductions for compensation in excess of $1 million for some executive
officers unless it meets the requirements for being performance-based. The AICP
contains provisions consistent with these requirements. These provisions include
a limitation that no participant may be granted a performance award that would
result in payment of more than $3.5 million per plan year.
LONG-TERM INCENTIVE PLAN
We have also adopted a long-term incentive plan. Its objectives are to
attract, retain and provide incentives that are aligned with our stockholders'
interests to employees, nonemployee directors and independent contractors.
Employee awards may be in the form of options to purchase our common stock,
stock appreciation rights, restricted or unrestricted grants of our common stock
or units denominated in our common stock or any other property or grants
denominated in cash. The vesting of such grants may be made subject to the
attainment of one or more performance goals. Awards to employees and awards to
independent contractors generally are treated the same under the plan, and the
discussion of employee awards herein applies, except as noted, equally to
independent contractor awards. For information concerning awards to nonemployee
directors, please read "-- Board Structure and Compensation."
We have reserved 16,000,000 shares of common stock for purposes of the
plan, subject to adjustment as described below. No more than 2,000,000 shares of
common stock will be available for incentive stock options. Shares subject to
awards that are forfeited or terminated, exchanged for awards that do not
involve common stock or expire unexercised, or are settled in cash in lieu of
common stock, or otherwise such that the shares covered thereby are not issued,
again become available for awards.
Except in the case of nonemployee director awards, which will be granted
and administered by the board of directors, the compensation committee will
determine the type or types of awards made under the plan and will designate the
recipients of such awards. Employee awards may be granted singly, in combination
or in tandem. Employee awards may also be made in combination
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or in tandem with, in replacement of, or as alternatives to, grants or rights
under the plan or any other employee plan of our company or any of our
subsidiaries, including any acquired entity. An employee award may provide for
the grant or issuance of additional, replacement or alternative employee awards
upon the occurrence of specified events, including the exercise of the original
employee award. At the discretion of the compensation committee, an employee may
be offered an election to substitute an employee award for another employee
award or employee awards of the same or different type. All or part of an
employee award may be subject to conditions established by the compensation
committee, which may include, but are not limited to, continuous service with us
and our affiliates, achievement of specific business objectives, increases in
specified indices, attainment of specified growth rates and other comparable
measurements of performance. Upon the termination of employment by an employee,
any unexercised, deferred, unvested or unpaid employee awards will be treated as
set forth in the applicable award agreement.
A stock option granted pursuant to the plan may consist of either an
incentive stock option that complies with the requirements of Section 422 of the
Code or a nonqualified stock option that does not comply with such requirements.
Independent contractor awards may not include incentive stock options.
Generally, stock options must have an exercise price per share that is not less
than the "fair market value" (as defined in the plan) of the common stock on the
date of grant; provided, however, that fair market value in the case of any
award made in connection with the offering means the price per share of common
stock as set forth on the cover page of this prospectus. The compensation
committee may, in its discretion, make grants of non-qualified stock options
with an exercise price per share that is less than the fair market value of the
common stock on the date of grant with respect to no more than 1,000,000 shares
of common stock.
In general, the options expected to be granted in connection with the
offering will have an exercise price equal to the initial public offering price
and will have a ten-year term. They generally will become exercisable in annual,
one-third increments over the three-year period following the offering as long
as the optionee remains in our continuous employment. Upon a termination of
employment for any reason other than death, disability or for cause, as defined
in the applicable award agreement, an outstanding stock option will remain
exercisable, to the extent exercisable as of the date of termination, for a
period of one year following the date of termination (or until the expiration of
the option term, if earlier). Options will cease to be exercisable upon a
termination for cause. The options will become fully exercisable upon the
optionee's termination of employment due to death or disability, and will remain
fully exercisable for one year following the date of such termination or, if
earlier, the expiration of the term of the option.
The exercise price of any stock option must be paid in full at the time the
stock option is exercised in cash or, if permitted by the compensation committee
and elected by the participant, by means of tendering common stock or
surrendering another award (including restricted stock). At the discretion of
the compensation committee, an award that is a stock option or stock
appreciation right may be settled by a cash payment equal to the difference
between the fair market value per share of common stock on the date of exercise
and the exercise price of the award, multiplied by the number of shares with
respect to which the award is exercised.
A stock appreciation right may be granted under the plan to the holder of a
stock option with respect to all or a portion of the shares of common stock
subject to such stock option or may be granted separately.
Stock awards consist of restricted and unrestricted grants of common stock
or units denominated in common stock. Rights to dividends or dividend
equivalents may be extended to and made part of any stock award in the
discretion of the compensation committee. The
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compensation committee may also establish rules and procedures for the crediting
of interest or other earnings on deferred cash payments and dividend equivalents
for stock awards.
Cash awards consist of grants denominated in cash. The terms, conditions
and limitations applicable to any cash awards will be determined by the
compensation committee.
Performance awards consist of grants made to an employee subject to the
attainment of one or more performance goals. A performance award will be paid,
vested or otherwise deliverable solely upon the attainment of one or more
pre-established, objective performance goals established by the compensation
committee. A performance goal may be based upon one or more business criteria
that apply to the employee, one or more of our business units or our company as
a whole, and may include any of the following: earnings per share, earnings per
share growth, total shareholder return, economic value added, cash return on
capitalization, increased revenue, revenue ratios (per employee or per
customer), net income, stock price, market share, return on equity, return on
assets, return on capital, return on capital compared to cost of capital, return
on capital employed, return on invested capital, shareholder value, net cash
flow, operating income, earnings before interest and taxes, cash flow, cash flow
from operations, cost reductions, cost ratios (per employee or per customer),
proceeds from dispositions, project completion time and budget goals, net cash
flow before financing activities, customer growth and total market value. Goals
may also be based on performance relative to a peer group of companies.
In general, the performance awards expected to be granted in connection
with the offering will consist of shares of common stock, the vesting of which
is subject to the achievement of certain performance goals, as specified by the
compensation committee, over a three-year performance cycle. At the time of the
offering, the grant of a performance award will be implemented by credit to our
bookkeeping accounts. These shares will vest and be issued at the end of the
three-year performance cycle according to the degree to which the established
performance goals are achieved, as follows:
- a threshold level of achievement will result in the vesting of 50% of the
performance shares,
- a target level of achievement will result in the vesting of 100% of the
shares, and
- a maximum level of achievement will result in the vesting of 150% of the
shares.
At the discretion of the compensation committee, additional payments may
also be made to performance award recipients in an amount equivalent to any
dividend payable with respect to performance shares granted to the recipient but
not yet vested The performance awards will be canceled upon any termination of
employment that occurs during the first year of the performance cycle. After
completion of the first year of the performance cycle, an employee whose
employment is terminated due to death, disability, or retirement will be issued,
as soon as possible after such termination, his performance shares available
upon the achievement of the target performance level, but prorated according to
the portion of the performance cycle during which he was employed.
The plan provides that the following limitations will apply to any employee
awards, but not to any independent contractor awards, made thereunder:
- no participant may be granted, during any calendar year, employee awards
consisting of stock options or stock appreciation rights that are
exercisable for or relate to more than 1,500,000 shares of common stock,
- no participant may be granted, during any calendar year, stock awards
covering or relating to more than 500,000 shares of common stock, and
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- no participant may be granted awards of cash or any other form permitted
under the plan, other than employee awards consisting of stock options,
stock appreciation rights or stock awards, in respect of any calendar
year having a value determined on the date of grant in excess of
$3,500,000.
Performance awards under the long-term incentive plan are intended to
qualify as performance-based compensation under Section 162(m) of the Code. As
noted above, Section 162(m) generally disallows deductions for compensation in
excess of $1 million for some executive officers unless it meets the
requirements for being performance-based. The plan contains provisions
consistent with these requirements.
Award agreements with respect to awards granted under the plan are expected
to provide that in the event of a "change in control" (as defined in the award
agreement), awards that were not previously vested or exercisable will become
fully vested and exercisable and generally remain exercisable for the remainder
of their term.
Except to the extent such discretion would cause a performance award that
is intended under Section 162(m) of the Code to cease to qualify as
performance-based compensation thereunder, the compensation committee may, in
its discretion, extend or accelerate the exercisability of, accelerate the
vesting of or eliminate or make less restrictive any restrictions contained in
any award granted under the plan or waive any restriction or other provision of
the plan, insofar as it relates to employee awards, in any manner that is
either:
- not adverse to the employee holding such award, or
- consented to by such employee.
The compensation committee may delegate to the chief executive officer and other
senior officers its duties under the plan. The compensation committee also may
engage or authorize the engagement of third-party administrators to carry out
administrative functions under the plan.
The plan provides for adjustments to the terms of outstanding grants and
the shares reserved for future grants in the event of subdivisions or
combinations of our common stock or stock dividends or stock splits. It also
provides for adjustments to be determined by the compensation committee in the
event of consolidations or mergers of our company with another corporation or
entity, recapitalizations of our company or distributions to holders of our
common stock of securities or property other than normal cash dividends or stock
dividends.
Our board of directors may amend, modify, suspend or terminate the plan for
the purpose of addressing changes in legal requirements or for other purposes
permitted by law.
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LONG-TERM INCENTIVE PLAN -- AWARDS IN CONNECTION WITH THE OFFERING
Effective upon and subject to completion of the offering, we anticipate
making the following grants of stock options to the named executive officers as
shown in the following table. Such options will vest in annual, one-third
increments over a three-year period commencing on the date of the offering. The
exercise price will be equal to the price per share of common stock as set forth
on the cover page of this prospectus.
<TABLE>
<CAPTION>
% OF
SECURITIES EMPLOYEE
UNDERLYING INITIAL
OPTIONS OPTION
NAME GRANTED GRANTS
---- ---------- --------
<S> <C> <C>
R. Steve Letbetter.......................................... 850,000 10.16%
Robert W. Harvey............................................ 420,000 5.02%
Stephen W. Naeve............................................ 420,000 5.02%
Joe Bob Perkins............................................. 350,000 4.18%
Hugh Rice Kelly............................................. 160,000 1.91%
All others.................................................. 77,980 .93%
--------- -----
Total.............................................. 2,277,980 27.22%
========= =====
</TABLE>
Effective upon and subject to completion of the offering, we anticipate
making the following grants of performance shares to the named executive
officers as shown in the following table. Depending on the company's achievement
of specified performance goals, such awards will vest at the end of a three-year
performance cycle commencing on the date of the offering.
<TABLE>
<CAPTION>
% OF EMPLOYEE
INITIAL
PERFORMANCE PERFORMANCE
NAME SHARE GRANT(1) SHARE GRANTS
---- -------------- -------------
<S> <C> <C>
R. Steve Letbetter...................................... 120,000 26.53%
Robert W. Harvey........................................ 60,000 13.26%
Stephen W. Naeve........................................ 60,000 13.26%
Joe Bob Perkins......................................... 50,000 11.05%
Hugh Rice Kelly......................................... 25,000 5.53%
All others.............................................. 11,200 2.48%
------- -----
Total.......................................... 326,200 72.11%
======= =====
</TABLE>
---------------
(1) The number of shares shown represents the "target" level of the award.
Depending on performance, the number of shares vested at the end of the
three-year performance cycle may be less or more than the number of shares
shown, up to a maximum of 150% of the number of shares shown as the target
level of the award.
EMPLOYEE STOCK PURCHASE PLAN
We have also adopted an employee stock purchase plan, which we sometimes
refer to as the "stock purchase plan." The purpose of the stock purchase plan is
to encourage and assist our employees in acquiring an equity interest in our
company through the purchase of shares of our common stock. It is intended to
comply with Section 423 of the Code. A total of 3,000,000 shares of common stock
(subject to anti-dilution adjustments) have been reserved for issuance under the
stock purchase plan.
Under the stock purchase plan, employees may purchase shares of common
stock through payroll deductions made over "purchase periods" generally six
months in duration at a price per share equal to 85% of the lesser of the fair
market value per share on the first trading day of the purchase period or the
last trading day of the purchase period. The initial purchase period will be the
period beginning on the date of the offering and ending December 31, 2001 (or
such other date as the plan administrator determines), and the fair market value
of a share of common stock on the first day of the initial purchase period will
be the price per share of common stock
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as set forth on the cover page of this prospectus. A participant may elect to
make contributions each pay period up to a specified percentage of salary or
subject to other limitations established under the plan, and contributions are
further subject to the limitation that the value of the shares acquired by a
participant in any year may not exceed $25,000, valued on the first day of the
relevant purchase period. The shares to be issued pursuant to the stock purchase
plan may be authorized but unissued shares or previously issued shares that have
been reacquired and are held by us.
Our board of directors may generally amend or terminate the stock purchase
plan at any time, provided that approval of our stockholders must be obtained
for any amendment if required under Section 423 of the Code. Section 423 of the
Code currently requires stockholder approval of a plan amendment that would
change the number of shares subject to the plan or change the class of employees
eligible to participate in the plan.
PENSION AND SAVINGS PLANS
Effective as of the date of the offering, Reliant Energy will amend its
tax-qualified defined benefit retirement plan to provide that our employees will
no longer participate in that plan, and that our employees will be fully vested
in their cash balance accounts. An enhanced benefit to some of our employees who
have attained age 42 with five years of vesting service on December 31, 2000
will be provided. The enhanced benefit will increase the cash balance account of
an eligible employee.
Under Reliant Energy's retirement plan, the named executive officers have
the following accrued benefit, expressed as a present value, as of December 31,
2000:
- Mr. Letbetter, $3,871,873,
- Mr. Harvey, $40,694,
- Mr. Naeve, $2,196,714,
- Mr. Perkins, $143,408, and
- Mr. Kelly, $2,328,465.
The amount for Mr. Kelly includes an additional ten years of service credit
under a supplemental pension arrangement. In addition, Mr. Harvey's cash balance
account will be credited with an additional credit of $481,000 (equivalent to 10
years of service credit) if he remains employed until May 31, 2003. The named
executive officers eligible for the enhanced benefit and the additional cash
balance account amounts resulting from that benefit are:
- Mr. Letbetter, $7,762,000,
- Mr. Naeve, $3,341,850,
- Mr. Kelly, $1,858,926.
These pension enhancements will be provided primarily under Reliant Energy's
nonqualified benefit restoration plan.
We have not established and do not currently expect to establish a defined
benefit pension plan, except for pension plans required to be continued for
certain employees covered by collective bargaining agreements.
Effective as of the date of the offering, Reliant Energy will amend its
tax-qualified savings plan to fully vest our employees in their accounts under
such plan. In addition, effective as of the offering, Reliant Energy's
tax-qualified savings plan will provide to our employees the employer-matching
and discretionary employer contributions described below, and we will be
responsible for participating employer contributions in the Reliant Energy plan.
Effective as of the date of the
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distribution, we will establish a separate savings plan for the benefit of our
employees. Our savings plan will provide a 100% match on employee contributions
of up to 6% of each employee's eligible compensation. Our savings plan will also
contain a discretionary employer contribution feature, that may pay out based on
a range of zero to 3% of our employees' eligible compensation, with a target of
1.5% and/or a discretionary employer contribution on a payroll basis. Matching
contributions and employer contributions, if any, will be fully vested when
made.
Effective as of the offering, we will adopt as a participating employer the
Reliant Energy savings restoration plan, which is a nonqualified deferred
compensation plan that provides benefits in excess of the limits imposed on
tax-qualified plans to a select group of management and highly compensated
individuals.
EXECUTIVE BENEFITS PLAN
Reliant Energy maintains a frozen executive benefits plan that provides
certain salary continuation, disability and death benefits to certain key
officers of ours and certain of our subsidiaries. Mr. Letbetter, Mr. Naeve, Mr.
Perkins and Mr. Kelly participate in this plan pursuant to individual agreements
that generally provide for:
- a salary continuation benefit of 100% of the officer's current salary for
12 months after death during active employment and then 50% of salary for
nine years or until the deceased officer would have attained age 65, if
later, and
- if the officer retires after attainment of age 65, an annual
postretirement death benefit of 50% of the officer's preretirement annual
salary payable for six years.
Effective at the time of the offering, we will adopt the executive benefits plan
for the benefit of our employees who currently have a frozen benefit under the
plan.
EXECUTIVE LIFE INSURANCE PLAN
We have an executive life insurance plan providing a death benefit for
officers, including the named executive officers and members of our board of
directors. The death benefit coverage varies but in each case is based on
coverage (either single life or second to die) that is available for the same
amount of premium that could purchase coverage equal to four times current
salary for Mr. Letbetter and two times current salary for each of the other
named executive officers. The plan also provides that we may make payments to
the covered individuals to compensate for tax consequences of imputed income
that they must recognize for federal income tax purposes based on the term
portion of the annual premiums. If a covered executive retires at age 65 or at
an earlier age under circumstances approved by our board of directors, rights
under the plan vest so that coverage is continued based on the same death
benefit in effect at the time of retirement. Upon death, we will receive the
balance of the insurance proceeds payable in excess of the specified death
benefit, which is expected to be at least sufficient to cover our cumulative
outlays to pay premiums and the after-tax cost to us of the tax reimbursement
payments. There is no arrangement or understanding under which any covered
individuals will receive or be allocated any interest in any cash surrender
value under the policy. Reliant Energy maintained a similar plan on the covered
individuals identified above and funded the benefits under such plan with split
dollar life insurance policies which will be transferred to us to be held under
our executive life insurance plan.
RETIREE MEDICAL PLAN
We will make available certain post-retirement medical insurance benefits
to our retired employees through a group insurance arrangement. The insurance
premiums for post-retirement coverage are paid entirely by retirees who elect
coverage under our plan.
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DEFERRED COMPENSATION PLANS
Since 1985 Reliant Energy has maintained deferred compensation plans that
permit eligible participants to elect each year to defer a percentage (prior to
December 1993 up to 25% or 40%, depending on age, and beginning in December
1993, 100%) of that year's salary and up to 100% of that year's annual bonus.
Effective at the time of the offering, we will adopt Reliant Energy's deferred
compensation plans for the benefit of those participants who become employed
with us and, except as described in the following sentence, will assume the
undistributed liabilities of those participants who are employed with us, and
Reliant Energy will retain the liabilities associated with inactive participants
and those participants who remain with Reliant Energy. Our employees were given
the right to consent to an amendment to Reliant Energy's deferred compensation
plans that treats employment with us as employment with a participating employer
under such plans. If such consent is withheld by any of our employees, then
certain of these deferred amounts will be distributed and Reliant Energy shall
incur the liability for such payments.
Our current deferred compensation plan allows eligible executives to defer
salary and annual bonuses payable under the AICP. In general, employees who
attain the age of 60 during employment and participate in our deferred
compensation plan may elect to have their deferred compensation amounts repaid
in:
- fifteen equal annual installments commencing at the later of age 65 or
termination of employment, or
- a lump-sum distribution following termination of employment.
Interest generally accrues on deferrals at a rate equal to the average Moody's
Long-Term Corporate Bond Index plus two percent, determined annually until
termination when the rate is fixed at the greater of the rate in effect at age
64 or at age 65. Fixed rates of 19% to 24% were established for deferrals made
under Reliant Energy's plan in 1985 through 1988, as a result of then-higher
prevailing rates and other factors. Current accruals of the above-market portion
of the interest on deferred compensation amounts under Reliant Energy's plan are
included in the "All Other Compensation" column of the Summary Compensation
Table.
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OUR RELATIONSHIP WITH RELIANT ENERGY AND RELATED TRANSACTIONS
Historically, Reliant Energy, Incorporated or its subsidiaries have
provided various services to us, including financial and tax accounting, human
resources, cash management and treasury support, purchasing, legal, information
technology system support, regulatory support, insurance brokering and office
management. In addition, we currently use Reliant Energy systems to support some
of our operations, including legal, accounting and treasury, human resources,
payroll and wide-area computer networks. The costs of services and other general
corporate expenses that were provided to us by centralized Reliant Energy
organizations have been directly charged or allocated to us using methods we
believe are reasonable. Amounts charged and allocated to us for these services
and expenses were $11 million during 1999 and $28 million for the first nine
months of 2000. In addition, we have entered into office rental agreements with
Reliant Energy. We incurred $1.2 million of rent expense to Reliant Energy
during 1999 and $3 million during the first nine months of 2000. These increases
are due to our expanded operations.
We also purchase natural gas and transportation services from, supply
natural gas to, and provide marketing and risk management services to, Reliant
Energy and some of its subsidiaries. Purchases of transportation services and
natural gas from Reliant Energy and its subsidiaries were $200 million in 1999
and $177 million in the first nine months of 2000. Our sales and services to
Reliant Energy and its subsidiaries totaled $330 million during 1999 and $425
million during the first nine months of 2000.
A number of the transactions between us and Reliant Energy or its
subsidiaries, some of which relate to specific negotiated financing
transactions, are evidenced by notes payable to or receivable from Reliant
Energy or its subsidiaries. These payables and other borrowings generally bear
interest at market rates. We had $1.3 billion total net accounts and notes
payable to Reliant Energy and its subsidiaries as of December 31, 1999 and $2.4
billion as of September 30, 2000. Net interest expense related to these net
borrowings/receivables was $8 million for the year ended December 31, 1999 and
$122 million for the first nine months of 2000. In the master separation
agreement, Reliant Energy has agreed to convert into a capital contribution any
unpaid indebtedness owed by us or our subsidiaries to Reliant Energy or its
subsidiaries immediately prior to the closing of this offering. Please read "Use
of Proceeds."
Reliant Energy or its subsidiaries made capital contributions to us of $236
million during 1999 and $1.1 billion during the first nine months of 2000.
During 1999, we made a distribution of $170 million to a subsidiary of Reliant
Energy.
We had an investment in a financing subsidiary of Reliant Energy of $108
million as of September 30, 2000. The financing subsidiary was liquidated on
December 29, 2000. As a result of the liquidation, we had $142 million of a note
payable owed to the financing subsidiary cancelled.
In connection with Reliant Energy's initial employment in June 1999 of Mr.
Harvey, our Executive Vice President and Group President, Emerging Businesses,
Reliant Energy loaned Mr. Harvey $250,000. The loan bears interest at a rate of
8% per annum and is to be forgiven in annual installment through May 31, 2004 so
long as Mr. Harvey remains employed by us as of each relevant anniversary of his
employment date. As of September 30, 2000, the outstanding original balance of
the loan was $200,000.
For purposes of governing ongoing relationships between us and Reliant
Energy, we will enter into, or continue, various agreements and relationships,
including those described in this prospectus under "Texas Genco Option" and
"Agreements Between Us and Reliant Energy." These agreements were negotiated in
the context of our separation from Reliant Energy and therefore are not the
result of arm's-length negotiations between independent parties.
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TEXAS GENCO OPTION
OPTION
As a part of Reliant Energy's business separation plan, it will convey the
generating assets of its electric utility division to Texas Genco. The
conveyance will be a part of the proposed restructuring of Reliant Energy's
businesses under a new holding company. When we refer to Texas Genco in this
prospectus, we are referring to Texas Genco after the conveyance and to Reliant
Energy's electric utility generation prior to conveyance. Reliant Energy has
agreed in the Texas Genco option agreement to either issue and sell in an
initial public offering or to distribute to its shareholders 19% of the common
stock of Texas Genco by June 30, 2002.
Pursuant to the Texas Genco option agreement, Reliant Energy has granted us
an option to purchase all of the shares of capital stock of Texas Genco that
will be owned by Reliant Energy after the initial public offering or
distribution of the 19% interest. The Texas Genco option may be exercised
between January 10, 2004 and January 24, 2004. The per share exercise price
under the option will be:
- the average daily closing price on a national exchange for publicly held
shares of common stock of Texas Genco for the 30 consecutive trading days
with the highest average closing price during the 120 trading days
immediately preceding January 10, 2004, plus
- a control premium, up to a maximum of 10%, to the extent a control
premium is included in the valuation determination made by the Texas
Utility Commission relating to the market value of Texas Genco's common
stock equity.
The exercise price formula is based upon the generation asset valuation
methodology in the Texas electric restructuring law that Reliant Energy has
agreed to use in the Texas Genco option agreement. This market value will be
used to determine the amount Reliant Energy will be allowed to recover if the
market value of those assets is less than the book value of those assets.
We have agreed that if we purchase the shares under the Texas Genco option,
we will also purchase all notes and other receivables from Texas Genco then held
by Reliant Energy, at their principal amount plus accrued interest.
The Texas Genco option agreement requires Reliant Energy to organize Texas
Genco as provided in the master separation agreement. The option agreement
obligates Reliant Energy to take commercially reasonable action as may be
appropriate to cause Texas Genco to have a capital structure appropriate, in the
judgement of Reliant Energy's board of directors, for the satisfactory marketing
of Texas Genco common stock in an initial public offering or to establish a
satisfactory trading market for Texas Genco common stock following a
distribution of shares to Reliant Energy's shareholders. The agreement also
contains covenants requiring Texas Genco to operate and maintain its assets and
otherwise conduct its business in the ordinary course in a manner consistent
with past practice and to make expenditures for operations, maintenance, repair
and capital expenditures necessary to keep the assets in good condition and in
compliance with applicable laws, in a manner consistent with good electric
generation industry practice. Texas Genco is also required to maintain customary
levels of insurance, comply with laws and contractual obligations and pay taxes
when due. The option agreement provides that Texas Genco may not permanently
retire generation units, but may "mothball" units if economically warranted.
Prior to Texas Genco's organization, Reliant Energy is required to fulfill
similar covenants with respect to the generation assets that are to be
transferred to Texas Genco.
In the option agreement, Reliant Energy has agreed to maintain ownership of
all equity of Texas Genco until exercise or expiration of the Texas Genco
option, subject to the 19% initial public offering or distribution obligation,
and Texas Genco has agreed to similar restrictions on
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issuances or sales of its equity. Reliant Energy has agreed to lend funds to
Texas Genco for operating needs upon request from time to time following the
initial public offering or distribution until the exercise or expiration of the
option, upon specified terms and conditions. Texas Genco may instead obtain
third-party financing if it so desires. The option agreement contains covenants
restricting Texas Genco's ability to:
- merge or consolidate with another entity,
- sell assets,
- enter into long-term agreements and commitments outside the ordinary
course of business,
- engage in other businesses,
- construct or acquire new generation plants or capacity, except as
contemplated in its capital budget,
- engage in hedging transactions,
- encumber its assets, or
- make certain loans, investments or advances to its affiliates.
The Texas Genco option agreement provides for Texas Genco to have, prior to
the exercise or expiration of the Texas Genco option, a specified number of
directors who meet stock exchange independence requirements and who are not
directors, officers or employees of Reliant Energy or our company. In addition,
following the offering or distribution, the chief executive officer of Texas
Genco is required to be a full time employee of Texas Genco.
Reliant Energy's separation plan approved by the Texas Utility Commission
contemplates the grant of the Texas Genco option. Exercise of the option will be
subject to various regulatory approvals, including Hart-Scott-Rodino antitrust
clearance and Nuclear Regulatory Commission license transfer approval. The
option will be exercisable only if Reliant Energy distributes all of the shares
of our common stock it owns to its shareholders.
FACILITIES
The following table describes the electric power generation facilities to
be conveyed by Reliant Energy to Texas Genco.
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TEXAS GENCO GENERATION FACILITIES
<TABLE>
<CAPTION>
NET
GENERATING
CAPACITY
GENERATION FACILITIES (IN MW) DISPATCH TYPE(1) PRIMARY FUEL
--------------------- ---------- ----------------- ------------
<S> <C> <C> <C>
W. A. Parish............................................ 3,593 Base, Inter, Peak Gas/Coal
Limestone............................................... 1,532 Base Lignite
South Texas Project(2).................................. 770 Base Nuclear
San Jacinto............................................. 162 Base Gas
Cedar Bayou............................................. 2,260 Inter Gas/Oil
P. H. Robinson.......................................... 2,213 Inter Gas
T. H. Wharton........................................... 1,254 Inter, Peak Gas
S. R. Bertron........................................... 844 Inter, Peak Gas
Greens Bayou............................................ 760 Inter, Peak Gas/Oil
Webster................................................. 387 Inter, Peak Gas
Deepwater............................................... 174 Inter, Peak Gas
H. O. Clarke............................................ 78 Peak Gas
------
Total............................................ 14,027
======
</TABLE>
---------------
(1) We use the designations "Base," "Inter" and "Peak" to indicate whether the
facilities described are base-load, intermediate, or peaking facilities,
respectively.
(2) Reliant Energy owns a 30.8% interest in the South Texas Project electric
generating station, a nuclear generating plant consisting of two 1,250 MW
generating units.
AGREEMENTS BETWEEN US AND RELIANT ENERGY
We have provided below a summary description of the master separation
agreement and several other important related agreements. This summary describes
the material terms of these agreements, but may not describe a term or provision
that you would consider important. Therefore, we encourage you to read the full
text of these agreements, which have been filed with the SEC as exhibits to the
registration statement of which this prospectus is a part.
MASTER SEPARATION AGREEMENT
The master separation agreement provides for the separation of our assets
and businesses from those of Reliant Energy. It also contains agreements
relating to the conduct of this offering and for subsequent transactions. In
addition, it contains several agreements governing the relationship between us
and Reliant Energy following this offering and specifies the related ancillary
agreements that we and Reliant Energy will sign.
To effect the separation, Reliant Energy has transferred or agreed to
transfer to us the stock of several subsidiaries and other assets and we have
assumed or agreed to assume liabilities associated with the transferred assets
and businesses. We refer to these transfers of assets and assumptions of
liabilities as the "separation." The effective date of the separation, which we
refer to as the "separation date," is December 31, 2000. Except as set forth in
the master separation agreement, no party is making any representation or
warranty as to the assets or liabilities transferred or assumed as a part of the
separation and all assets are being transferred on an "as is, where is" basis.
The master separation agreement provides for cross-indemnities intended to
place sole financial responsibility on us and our subsidiaries for all
liabilities associated with the current and historical businesses and operations
we conduct after giving effect to the separation, regardless of the time those
liabilities arise, and to place sole financial responsibility for liabilities
associated with Reliant Energy's other businesses with Reliant Energy and its
other subsidiaries. Each party has also agreed to assume and be responsible for
some specified liabilities associated with activities and operations of the
other party and its subsidiaries to the extent performed for or on
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behalf of the first party's current or historical business. The master
separation agreement also contains indemnification provisions under which we and
Reliant Energy each indemnify the other with respect to breaches by the
indemnifying party of the master separation agreement or any ancillary
agreements. We have agreed to indemnify Reliant Energy and its other
subsidiaries against liabilities arising from misstatements or omissions in this
prospectus or the registration statement of which it is a part, except for
information regarding Reliant Energy provided by Reliant Energy for inclusion in
this prospectus or the registration statement. In addition, we have agreed to
indemnify Reliant Energy in connection with the guarantees by one of its
subsidiaries of the performance of a portion of the obligations of our trading
and marketing subsidiaries.
Reliant Energy has agreed in the master separation agreement to maintain
all guarantees or other credit support arrangements issued for the benefit of us
or any of our subsidiaries prior to the separation date until such arrangements
terminate by their terms or are released at our request.
The master separation agreement contains a general release under which we
will release Reliant Energy and its affiliates, agents, successors and assigns,
and Reliant Energy will release us and our affiliates, agents, successors and
assigns, from any liabilities arising from events between us or our subsidiaries
on the one hand, and Reliant Energy or its subsidiaries on the other hand
occurring on or before the closing of this offering, including events occurring
on or before the closing of this offering in connection with the activities to
implement the separation and this offering. The general release does not apply
to obligations under the master separation agreement or any ancillary agreement
or to specified ongoing contractual arrangements.
The master separation agreement requires us to use our reasonable
commercial efforts to satisfy the conditions precedent for the consummation of
this offering and requires us to apply the proceeds of the offering in the
manner described under "Use of Proceeds."
The master separation agreement provides for the spin-off distribution by
Reliant Energy of the remainder of our common stock it will own after completion
of this offering but does not obligate Reliant Energy to effect such a
distribution. It also provides for actions required to be taken in connection
with the restructuring of Reliant Energy's regulated businesses under a new
holding company as contemplated in Reliant Energy's business separation plan,
including assumption of specified debt obligations and requirements for consents
and approvals.
In addition, the master separation agreement provides for the organization
of Texas Genco and specifies the assets and liabilities to be transferred to or
assumed by it when it is organized. Pursuant to the Texas electric restructuring
law, Texas Genco, as the affiliated power generator of Reliant Energy's
transmission and distribution utility, is required to sell at auction 15% of the
output of its installed generating capacity. This obligation continues until
January 1, 2007, unless before that date the Texas Utility Commission determines
at least 40% of the quantity of electric power consumed in 2000 by residential
and small commercial customers in the utility's service area is being served by
retail electric providers other than us. The master separation agreement
requires Texas Genco to auction all of its remaining capacity prior to our
exercise of the Texas Genco option. We are entitled to purchase, at prices
established in these auctions, up to 50% of the remaining capacity, energy and
ancillary services of Texas Genco auctioned.
The master separation agreement also contains several provisions regarding
our corporate governance that apply as long as Reliant Energy owns specified
percentages of our common stock. It specifies the form of our restated
certificate of incorporation and bylaws to be in effect at the time of this
offering. As long as Reliant Energy owns common stock representing a majority of
the voting power of our outstanding voting stock it will have the right to
nominate for designation by our board of directors, or a nominating committee of
the board, a majority of the members of our board. If Reliant Energy's
beneficial ownership of our common stock is reduced to a level below 50% of the
voting power of our outstanding voting stock but is at least 20% of
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that voting power, Reliant Energy will have the right to designate for
nomination a number of directors proportionate to its voting power.
We have also agreed that following the closing of this offering and prior
to the distribution date, we will obtain Reliant Energy's consent before we
issue any additional stock or securities convertible or exchangeable for our
stock if the issuance would cause Reliant Energy to fail to meet specified
requirements of the Code in connection with the distribution.
TRANSITION SERVICES AGREEMENT
We have entered into a transition services agreement with Reliant Energy
under which Reliant Energy will provide us, on an interim basis, various
corporate support services that include accounting, finance, investor relations,
planning, legal, communications, governmental and regulatory affairs and human
resources, as well as information technology services and other previously
shared services such as corporate security, facilities management, accounts
receivable, accounts payable and payroll, office support services and purchasing
and logistics. These services will consist generally of the same types of
services as have been provided on an intercompany basis prior to this offering.
The charges we will pay for the services will be on a basis generally intended,
as has been the case prior to this offering, to allow Reliant Energy to recover
the fully allocated direct and indirect costs of providing the services, plus
all out-of-pocket costs and expenses, but without any profit to Reliant Energy.
The transition services agreement provides that interim corporate support
services will terminate no later than the time Reliant Energy completes the
disposition of the shares of our common stock it continues to own after this
offering. The agreement provides that interim information technology services
and other interim shared services will continue to be provided until December
31, 2004. In all cases, we may terminate any of these discrete service
categories on an individual basis at any time by giving specified advance
notice. Pursuant to a separate lease agreement, Reliant Energy will also lease
to us office space in its headquarters building in Houston, Texas for an interim
period expected to end no later than .
AGREEMENTS RELATING TO OPERATIONS OF TEXAS GENCO
Under a technical services agreement, we will provide engineering and
technical support services and environmental, safety and industrial health
services to support operation and maintenance of Texas Genco's facilities. We
will also provide systems, technical, programming and consulting support
services and hardware maintenance (but excluding plant-specific hardware)
necessary to provide dispatch planning, dispatch and settlement and
communication with the independent system operator. The fees we will charge for
these services will be designated to allow us to recover our fully allocated
direct and indirect costs and reimbursement of all out-of-pocket expenses.
Expenses associated with capital investment in systems and software that benefit
both the operation of Texas Genco's facilities and our facilities in other
regions will be allocated on an installed megawatt basis.
The term of the technical services agreement will begin on the separation
date. The term of this agreement will end on the first to occur of:
- our exercise of the Texas Genco option,
- Reliant Energy's sale of Texas Genco, or all or substantially all of the
assets of Texas Genco, if we do not exercise the Texas Genco option, or
- December 31, 2004, provided that if the Texas Genco option is not
exercised, Texas Genco may extend the term of this agreement until
December 31, 2005.
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TEXAS GENCO OPTION AGREEMENT
We and Reliant Energy will enter into the Texas Genco Option Agreement
described under "Texas Genco Option."
RETAIL AGREEMENT
Under a retail agreement, we will provide customer service call center
operations and credit and collections for Reliant Energy's electric utility
division and revenue reporting and analysis services to Reliant Energy for its
electric utility division and two of its natural gas distribution divisions.
Reliant Energy will provide the office and equipment space for us to perform
these services. We will pay rent to Reliant Energy at the same rates charged by
Reliant Energy to its other business units. These services will terminate on
January 1, 2002, when the Texas retail electric market opens to competition. The
charges Reliant Energy will pay us for these services are generally intended to
allow us to recover the fully allocated costs of providing the services, plus
out-of-pocket costs and expenses, but without any profit.
After January 1, 2002, we have agreed to provide remittance processing
services to Reliant Energy's natural gas utilities. We will be paid for these
services on the same basis as for similar services provided before January 1,
2002. These services will terminate on January 1, 2004 or earlier by Reliant
Energy giving specified advance notice.
REGISTRATION RIGHTS AGREEMENT
Although Reliant Energy has expressed its intent to distribute to its
shareholders the remaining shares of our common stock that it will own after
completion of this offering, we cannot assure you as to whether or when this
distribution will occur. In the event that Reliant Energy does not divest all of
its shares of our common stock in the distribution, Reliant Energy could not
freely sell all those shares publicly without registration under the Securities
Act. We have entered into a registration rights agreement with Reliant Energy
under which, at the request of Reliant Energy, we will use our best efforts to
register shares of our common stock that are held by Reliant Energy after
completion of this offering, and any additional shares that are issued in
respect of those shares, for public sale under the Securities Act. As long as
Reliant Energy or a permitted transferee under the agreement own a majority of
the voting power of our outstanding capital stock, there is no limit to the
number of registrations that they may request. Once Reliant Energy or a
permitted transferee owns less than a majority of our voting power, they can
request three additional registrations. We will also provide Reliant Energy with
rights to include such shares in future registrations of our common stock under
the Securities Act. There is no limit on the number of these registrations in
which Reliant Energy may request its shares be included. These rights will
terminate once Reliant Energy is able to dispose of all of its shares of our
common stock within a three-month period pursuant to the exemption from
registration provided under Rule 144 of the Securities Act. We have agreed to
cooperate in these registrations and related offerings.
EMPLOYEE MATTERS AGREEMENT
We have entered into an agreement with Reliant Energy addressing asset and
liability allocation relating to our employees and their continued participation
in Reliant Energy's benefit plans.
All of our eligible employees can participate in Reliant Energy's welfare
benefit plans (or a mirror plan after the date of the distribution), excluding
the retiree medical plan, through 2001. We will arrange for certain retiree
medical coverage through a group insurance arrangement fully paid for by
retirees who elect such coverage. Our employees who are eligible for retiree
medical
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benefits under Reliant Energy's retiree medical plan on the date of the closing
of this offering will retain their rights to such benefits at retirement but
will not accrue any additional benefits under Reliant Energy's plan.
As of the date of the closing of this offering, our employees' accounts
(except for some union employees) under Reliant Energy's savings plan will be
fully vested. They may continue to participate in that plan, under which we are
a participating employer, providing a matching contribution and possible
discretionary employer contributions. As of the distribution date, we will
establish a separate savings plan, providing the same types of contributions. As
soon as reasonably practicable following the date of the distribution, Reliant
Energy's plan will transfer assets for our employees to our plan.
As of the date of the closing of this offering, our employees' accounts
under Reliant Energy's retirement plan will be fully vested and our employees
will cease participation therein, except for some union employees. Some
employees will receive a one time benefit enhancement. We will not establish a
similar retirement plan, except as required under a collective bargaining
agreement. These affected employees may leave their account balance in Reliant
Energy's plan, roll that account over to an eligible retirement plan or take a
distribution, subject to taxation and possible early withdrawal penalties.
In other respects, we will establish benefit plans substantially comparable
in the aggregate to Reliant Energy's plans for our active employees. Each of the
plans that we establish will generally provide that all service, compensation
and other determinations affecting benefits under the corresponding Reliant
Energy plan will receive full credit under our plan to the same extent as if
they had occurred under our plan, except to the extent duplication of benefits
would result. With certain exceptions, our plans generally will assume all
liabilities under Reliant Energy's plans for our current employees, and certain
assets funding such liabilities will be transferred from Reliant Energy's plans
to our plans. However, we may replace some of Reliant Energy's plans with
different types of plans more suitable to our business and workforce, including
an employee stock purchase plan. We may modify or terminate any plan we
establish in accordance with its terms and our policies. No benefits will
duplicate benefits provided under any Reliant Energy plan.
In general, each individual actively employed by us as of the distribution
date that holds unexercised and unexpired Reliant Energy stock options will have
these options converted into options to acquire both Reliant Energy common stock
and our common stock. Employment with our company will be treated as employment
with Reliant Energy for purposes of the adjusted Reliant Energy stock options,
and employment with Reliant Energy will be treated as employment with us for
purposes of the converted options to purchase our common stock. All terms of
these options, including the vesting schedule, will continue in effect.
Converted options to purchase our common stock will be issued pursuant to a
separate transition option plan recently adopted for this purpose.
Performance shares under Reliant Energy's long-term incentive compensation
plan will vest for the cycle ending December 31, 2000 in accordance with the
plan. If the distribution occurs during 2001, the compensation committee will
estimate the level at which performance goals are expected to be achieved
through December 31, 2001 and vest the outstanding performance shares
accordingly. In addition, the committee will convert outstanding performance
shares (or bookkeeping units representing the shares) for the cycle ending
December 31, 2002 to time-based restricted shares of Reliant Energy's stock
equal to the number of performance shares that would have vested if the
performance objectives for the performance cycle were achieved at the maximum
level. These time-based restricted shares will vest if the participant remains
employed with Reliant Energy or us through December 31, 2002. On the date of the
distribution, holders of such time-based restricted shares will receive shares
of our common stock, or bookkeeping units representing the shares, in the same
manner as other holders of Reliant
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Energy common stock, but our common stock will be subject to the vesting
schedule and other terms and conditions applicable under the plan under which
they were awarded.
With some exceptions, we have agreed to indemnify Reliant Energy for
employment liabilities arising from any acts of our employees or from claims by
our officers against Reliant Energy. Reliant Energy has agreed to similarly
indemnify us.
TAX ALLOCATION AGREEMENT
We have entered into a tax allocation agreement with Reliant Energy to
govern the allocation of U.S. income tax liabilities and to set forth agreements
with respect to other tax matters. Under the Internal Revenue Code of 1986, as
amended, we will cease to be a member of the Reliant Energy consolidated group
upon completion of the distribution or if at any time Reliant Energy owns less
than 80% of the vote and value of our outstanding capital stock.
Reliant Energy will be responsible for filing any U.S. income tax returns
required to be filed for any company or group of companies of the Reliant Energy
consolidated group through the date of the distribution. Any tax return filed by
Reliant Energy that is for or includes us will be subject to our reasonable
review and approval. Reliant Energy will also be responsible for paying the
taxes related to the returns it is responsible for filing. We will pay Reliant
Energy our allocable share of such taxes.
Reliant Energy will determine all tax elections for tax periods during
which we are a member of the Reliant Energy consolidated group unless we request
Reliant Energy to make a particular election with respect to us, in which case
Reliant Energy will not unreasonably withhold its consent to such request. We
will prepare and file all tax returns required to be filed by us and pay all
taxes related to such returns for all tax periods after we cease to be a member
of the Reliant Energy consolidated group.
Generally, if there are tax adjustments related to us arising after the
distribution date, which relate to a tax return filed for a pre-distribution
period, we will not be responsible for any increased taxes and we will not
receive the benefit of any tax refunds. We will still be responsible for tax
adjustments arising after the distribution date, which relate to any tax returns
filed for specified pre-distribution periods of Reliant Energy Services, Inc.
and Arkla Finance Corp., relate to specified timing adjustments for which we
expect to receive a corresponding tax benefit in the future or relate to any tax
position that we requested Reliant Energy adopt on a tax return. We have agreed
to cooperate with and assist Reliant Energy in any tax audits, litigation or
appeals that involve, directly or indirectly, tax returns filed for
pre-distribution periods and to provide Reliant Energy with information related
to such periods. We and Reliant Energy have agreed to indemnify each other for
any tax liabilities resulting from the failure to pay any amounts due under the
terms of the tax allocation agreement.
We and Reliant Energy have agreed that any and all taxes arising from our
deconsolidation with the Reliant Energy consolidated group will be the
responsibility of Reliant Energy.
We and Reliant Energy are required to comply with representations that are
made to the Internal Revenue Service in connection with the private letter
ruling that we expect to be issued to Reliant Energy regarding the tax-free
nature of the distribution of our stock by Reliant Energy to Reliant Energy
shareholders. In addition, we and Reliant Energy have agreed not to enter into
transactions after the distribution date that would result in a change of
control of either party pursuant to a plan unless a ruling is obtained from the
Internal Revenue Service that the transaction will not affect the tax-free
nature of the distribution. If either party takes any action which results in
the distribution becoming a taxable transaction, such party will indemnify the
other party for any and all taxes, on an after-tax basis, resulting from such
actions.
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CERTAIN FEDERAL TAX MATTERS RELATED TO OUR SEPARATION FROM RELIANT ENERGY
Reliant Energy currently owns 100% of our common stock. Thus, we are
members of the same consolidated group. As members of the same consolidated
group, we file a consolidated federal income tax return with Reliant Energy.
This allows Reliant Energy to offset its federal taxable income with our tax
losses, if any. After this offering, we and Reliant Energy will continue to file
a consolidated federal income tax return.
Within twelve months after this offering, Reliant Energy intends to
distribute its remaining ownership interest in our company to its shareholders
in direct proportion to their holdings of Reliant Energy stock. Reliant Energy
intends to obtain a ruling from the Internal Revenue Service that the
distribution is tax-free under Section 355 of the Internal Revenue Code.
However, if we breach any representations with respect to the ruling, take any
action that causes such representations to be untrue or engage in transactions
after the distribution that cause the spin-off to be taxable, we will be
required to indemnify Reliant Energy for any and all taxes resulting from the
failure of the spin-off to qualify as a tax-free transaction as provided in the
tax allocation agreement. Any indemnification payments by us would be material.
After the distribution of our common stock by Reliant Energy to its
shareholders, we will cease to be a member of the Reliant Energy consolidated
tax group. This separation will have both current and future income tax
implications to us. The event of deconsolidation itself will result in the
triggering of deferred intercompany gains. We will recognize taxable income
related to these gains which will not have a material impact on our net income
and cash flow.
Subsequent to the distribution, there will then exist two separate groups
for tax purposes, the Reliant Energy group and our group. Each group will file
separate consolidated federal income tax returns, and Reliant Energy will not be
able to use our tax losses, if any. We will make a tax election to forego the
carrying back of net operating losses, if any, our group generates in tax years
after deconsolidation to tax years when we were part of the Reliant Energy
group. We will be able to utilize such net operating losses in our group's tax
years after deconsolidation (subject to the applicable carryforward limitation
periods) but only to the extent of our group's income in such tax years.
Under the tax sharing agreement between Reliant Energy and us, Reliant
Energy is obligated to pay us for the utilization of net operating losses, if
any, generated by us to offset Reliant Energy's consolidated federal income tax
liability. Because Reliant Energy will no longer have the ability to use these
net operating losses, if any, we will no longer receive these payments from
Reliant Energy. Additionally, under the tax allocation agreement with Reliant
Energy, we may be required to make other payments to Reliant Energy for tax
liabilities.
In addition to the current income tax consequences triggered by the act of
deconsolidation discussed above, our separation from the Reliant Energy
consolidated tax group will change our overall future income tax posture. As a
result, we could be limited in our future ability to effectively use future tax
deductions and credits. We intend to undertake appropriate measures after
deconsolidation in order to mitigate any adverse tax effect of no longer being a
part of the Reliant Energy consolidated tax group.
PRINCIPAL STOCKHOLDER
Prior to this offering, all of the outstanding shares of our common stock
have been owned by Reliant Energy. After this offering, Reliant Energy will own
approximately 82.2% of our common stock, or approximately 80.1% if the
underwriters fully exercise their option to purchase additional shares of our
common stock. Under Delaware corporate law and our charter documents, prior to
the distribution by Reliant Energy of its ownership of our common stock, Reliant
Energy will be able, acting alone, to elect our entire board of directors and to
approve any action requiring the approval of our stockholders. Except for
Reliant Energy, we are not
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aware of any person or group that will beneficially own more than five percent
of the outstanding shares of our common stock following this offering. None of
our executive officers, directors or director nominees currently owns any shares
of our common stock, but those who own shares of Reliant Energy common stock
will be treated on the same terms as other holders of Reliant Energy stock in
any distribution by Reliant Energy. Please read "Management -- Stock Ownership
of Directors and Executive Officers" for a description of the ownership of
Reliant Energy stock by our directors and executive officers.
DESCRIPTION OF OUR CAPITAL STOCK
GENERAL
The following descriptions are summaries of material terms of our common
stock, preferred stock, restated certificate of incorporation and amended and
restated bylaws. This summary is qualified by reference to our restated
certificate of incorporation and bylaws, copies of which have been filed as
exhibits to the registration statement of which this prospectus is a part, and
by the provisions of applicable law.
Our authorized capital stock consists of 2,000,000,000 shares of common
stock, par value $0.001 per share, and 125,000,000 shares of preferred stock,
par value $0.001 per share. Immediately following the offering, 292,000,000
shares of common stock, or 299,800,000 shares if the underwriters exercise their
over-allotment option in full, will be outstanding.
Prior to this offering, there has been no public market for our common
stock. Although we intend to apply to list our common stock on the New York
Stock Exchange, we cannot assure you that a market for our common stock will
develop, or, if one develops, that it will be sustained.
COMMON STOCK
Each share of common stock entitles the holder to one vote on all matters
submitted to a vote of stockholders, including the election of directors. There
are no cumulative voting rights. Accordingly, holders of a majority of the total
votes entitled to vote in an election of directors will be able to elect all of
the directors standing for election. Subject to preferences that may be
applicable to any outstanding preferred stock, the holders of common stock are
entitled to dividends when, as and if declared by the board of directors out of
funds legally available for that purpose. If we are liquidated, dissolved or
wound up, the holders of common stock will be entitled to a pro rata share in
any distribution to stockholders, but only after satisfaction of all of our
liabilities and of the prior rights of any outstanding series of our preferred
stock. The common stock has no preemptive or conversion rights or other
subscription rights. There are no redemption or sinking fund provisions
applicable to the common stock. All outstanding shares of our common stock are
fully paid and nonassessable.
PREFERRED STOCK
Our board of directors has the authority, without stockholder approval, to
issue shares of preferred stock from time to time in one or more series, and to
fix the number of shares and terms of each such series. The board may determine
the designation and other terms of each series, including:
- dividend rates,
- redemption rights,
- liquidation rights,
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- sinking fund provisions,
- conversion rights,
- voting rights,
- and any other terms.
The issuance of preferred stock, while providing desired flexibility in
connection with possible acquisitions and other corporate purposes, could
adversely affect the voting power of holders of common stock. It could also
affect the likelihood that holders of common stock will receive dividend
payments and payments upon liquidation. We have no present plans to issue any
preferred stock.
The issuance of shares of preferred stock, or the issuance of rights to
purchase shares of preferred stock, could be used to discourage an attempt to
obtain control of our company. For example, if, in the exercise of its fiduciary
obligations, our board were to determine that a takeover proposal was not in our
best interest, the board could authorize the issuance of a series of preferred
stock containing class voting rights that would enable the holder or holders of
the series to prevent or make the change of control transaction more difficult.
Alternatively, a change of control transaction deemed by the board to be in our
best interest could be facilitated by issuing a series of preferred stock having
sufficient voting rights to provide a required percentage vote of the
stockholders.
Holders of common stock may purchase shares of our Series A preferred stock
if the rights associated with their common stock are exercisable and the holders
exercise the rights. Please read the "-- Stockholder Rights Plan" section below.
SERIES A PREFERRED STOCK
Our Series A preferred stock ranks junior to all other series of our
preferred stock, and senior to our common stock with respect to dividend and
liquidation rights. If we liquidate, dissolve or wind up, we may not make any
distributions to holders of our common stock unless we first pay holders of our
Series A preferred stock an amount equal to:
- $1,000 per share, plus
- accrued and unpaid dividends and distributions on our Series A preferred
stock, whether or not declared, to the date of such payment.
If the dividends or distributions payable on our Series A preferred stock are in
arrears, we may not:
- declare or pay dividends on,
- make any other distributions on,
- redeem,
- purchase, or
- otherwise acquire for consideration
any shares of our common stock, or
- redeem,
- purchase, or
- otherwise acquire for consideration,
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any shares of our Series A preferred stock, until we have paid all such unpaid
dividends or distributions, except in accordance with a purchase offer to all
holders of our Series A preferred stock upon terms that our board of directors
determine will be fair and equitable.
We may redeem shares of our Series A preferred stock at any time at a
redemption price determined in accordance with the provisions of our restated
certificate of incorporation.
Holders of shares of our Series A preferred stock are entitled to vote
together with holders of our common stock as one class on all matters submitted
to a vote of our stockholders. Each share of our Series A preferred stock
entitles its holder to a number of votes equal to the "adjustment number"
specified in our restated certificate of incorporation. The adjustment number is
initially equal to 1,000 and is subject to adjustment in the event we:
- declare any common stock dividend on our outstanding shares of common
stock,
- subdivide our outstanding shares of common stock, or
- combine our outstanding shares of common stock into a smaller number of
shares.
For a complete description of the terms of our Series A preferred stock, we
encourage you to read our restated certificate of incorporation, which we have
filed as an exhibit to the registration statement of which this prospectus is a
part.
ANTITAKEOVER EFFECTS OF DELAWARE LAWS AND OUR CHARTER AND BYLAW PROVISIONS
Some provisions of Delaware law and our restated certificate of
incorporation and bylaws could make the following more difficult:
- acquisition of us by means of a tender offer,
- acquisition of control of us by means of a proxy contest or otherwise, or
- removal of our incumbent officers and directors.
These provisions, as well as our stockholder rights plan and our ability to
issue preferred stock, are designed to discourage coercive takeover practices
and inadequate takeover bids. These provisions are also designed to encourage
persons seeking to acquire control of us to first negotiate with our board of
directors. We believe that the benefits of increased protection give us the
potential ability to negotiate with the proponent of an unfriendly or
unsolicited proposal to acquire or restructure us, and that the benefits of this
increased protection outweigh the disadvantages of discouraging those proposals,
because negotiation of those proposals could result in an improvement of their
terms.
CHARTER AND BYLAW PROVISIONS
ELECTION AND REMOVAL OF DIRECTORS
Our board of directors will be comprised of between one and 15 directors,
the exact number to be fixed from time to time by resolution of our board of
directors. Beginning at the time Reliant Energy directly or indirectly owns less
than a majority of our outstanding common stock, our board of directors will be
divided into three classes. The directors in each class will serve for a
three-year term, with only one class being elected each year by our
stockholders. See "Management -- Directors and Executive Officers." This system
of electing and removing directors may discourage a third party from making a
tender offer or otherwise attempting to obtain control of us, because it
generally makes it more difficult for stockholders to replace a majority of the
directors. In addition, beginning at the time Reliant Energy directly or
indirectly owns less than a majority of our outstanding common stock, no
director may be removed except
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for cause, and directors may be removed for cause by a majority of the shares
then entitled to vote at an election of directors. Any vacancy occurring on the
board of directors and any newly created directorship may only be filled by a
majority of the remaining directors in office.
STOCKHOLDER MEETINGS AND ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER NOMINATIONS
AND PROPOSALS
Our restated certificate of incorporation and our bylaws provide that
special meetings of holders of common stock may be called only by the chairman
of our board of directors, our president and chief executive officer, or a
majority of the board of directors and may not be called by the holders of
common stock. In addition, as of the day that Reliant Energy directly or
indirectly ceases to own at least a majority of our common stock, our restated
certificate of incorporation specifically denies any power of the stockholders
to call a special meeting.
ELIMINATION OF STOCKHOLDER ACTION BY WRITTEN CONSENT
Our restated certificate of incorporation and our bylaws provide that
beginning the day that Reliant Energy ceases to own at least a majority of our
common stock, holders of our common stock will not be able to act by written
consent without a meeting. Prior to the distribution of our common stock,
Reliant Energy will be able to take any action requiring approval of our
stockholders by written consent and without the affirmative vote of our other
stockholders.
MODIFICATION OF CERTIFICATE OF INCORPORATION
The provisions described above under "-- Election and Removal of
Directors," "-- Stockholder Meetings and Advanced Notice Requirements for
Stockholder Nominations and Proposals" and "-- Elimination of Stockholder Action
by Written Consent" may be amended only by the affirmative vote of holders of at
least 66 2/3% of the voting power of outstanding shares of capital stock
entitled to vote in the election of directors, voting together as a single
class.
MODIFICATION OF BYLAWS
Our board of directors has the power to alter, amend or repeal our bylaws
or adopt new bylaws by the affirmative vote of at least 80% of all directors
then in office at any regular or special meeting of the board of directors
called for that purpose. This right is subject to repeal or change by the
affirmative vote of holders of at least 80% of the voting power of all
outstanding shares of our capital stock entitled to vote in the election of
directors, voting together as a single class.
OTHER LIMITATIONS ON STOCKHOLDER ACTIONS
Our bylaws also impose some procedural requirements on stockholders who
wish to:
- make nominations in the election of directors,
- propose that a director be removed,
- propose any repeal or change in our bylaws, or
- propose any other business to be brought before an annual or special
meeting of stockholders.
Under these procedural requirements, a stockholder must deliver timely notice to
our corporate secretary of the nomination or proposal along with evidence of:
- the stockholder's status as a stockholder,
- the number of shares beneficially owned by the stockholder,
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- a list of the persons with whom the stockholder is acting in concert, and
- the number of shares such persons beneficially own.
To be timely, a stockholder must deliver notice:
- in connection with an annual meeting of stockholders, not less than 90
nor more than 180 days prior to the date on which the immediately
preceding year's annual meeting of stockholders was held, or
- in connection with a special meeting of stockholders, not less than 40
nor more than 60 days prior to the date of the special meeting.
In order to submit a nomination for our board of directors, a stockholder must
also submit information with respect to the nominee that we would be required to
include in a proxy statement, as well as some other information. If a
stockholder fails to follow the required procedures, the stockholder's nominee
or proposal will be ineligible and will not be voted on by our stockholders.
We have agreed, in the master separation agreement, that for so long as
Reliant Energy owns at least 30% of the voting power of outstanding shares of
our capital stock, we will not, without the consent of Reliant Energy, adopt any
amendments to our restated certificate of incorporation or bylaws or take or
recommend any action to our stockholders that would:
- impose limits on the legal rights of Reliant Energy,
- involve the issuance of specified warrants, rights, capital stock or
other securities, excluding the rights described under " --Stockholder
Rights Plan,"
- deny any benefit to Reliant Energy proportionately as holders of any
class of voting securities generally, or
- alter voting or other rights of holders of any class of voting securities
so that those rights are determined with reference to the amount of voting
securities held by Reliant Energy.
LIMITATION ON LIABILITY OF DIRECTORS
Our restated certificate of incorporation provides that no director shall
be personally liable to us or our stockholders for monetary damages for breach
of fiduciary duty as a director, except as required by law, as in effect from
time to time. Currently, Delaware law requires that liability be imposed for the
following:
- any breach of the director's duty of loyalty to our company or our
stockholders,
- any act or omission not in good faith or which involved intentional
misconduct or a knowing violation of law,
- unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General Corporate
Law, and
- any transaction from which the director derived an improper personal
benefit.
Our bylaws provide that, to the fullest extent permitted by law, we will
indemnify any person made or threatened to be made a party to any action by
reason of the fact that the person is or was our director or officer, or served
any other enterprise at our request as a director or officer. We will reimburse
the expenses, including attorneys' fees, incurred by a person indemnified by
this provision when we receive an undertaking to repay such amounts if it is
ultimately determined that the person is not entitled to be indemnified by us.
Amending this provision will not reduce our indemnification obligations relating
to actions taken before an amendment.
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TRANSACTIONS AND CORPORATE OPPORTUNITIES
Our restated certificate of incorporation includes provisions that regulate
and define the conduct of some business and affairs of our company. These
provisions serve to determine and delineate the respective rights and duties of
our company, Reliant Energy and some of our directors and officers in
anticipation of the following:
- directors, officers and/or employees of Reliant Energy serving as our
directors, officers and/or employees,
- Reliant Energy engaging in lines of business that are the same as,
similar or related to, or overlap or compete with, our lines of business,
and
- we and Reliant Energy engaging in material business transactions,
including transactions pursuant to the various agreements related to our
separation from Reliant Energy described elsewhere in this prospectus.
We may, from time to time, enter into and perform agreements with Reliant
Energy to engage in any transaction. We may also enter into and perform
agreements with Reliant Energy to compete or not to compete with each other,
including agreements to allocate, or to cause our and their respective
directors, officers and employees to allocate, corporate opportunities between
Reliant Energy and us. Our restated certificate of incorporation provides that
no such agreement, or its performance, shall be considered contrary to any
fiduciary duty of Reliant Energy, as the controlling stockholder of our company,
or of a director, officer or employee of our company or Reliant Energy, if any
of the following conditions are satisfied:
- the agreement was entered into before we ceased to be a wholly owned
subsidiary of Reliant Energy and is continued in effect after this time,
- the agreement or transaction was approved, after being made aware of the
material facts as to the agreement or transaction, by:
- our board, by affirmative vote of a majority of directors who are not
interested persons,
- a committee of our board consisting of members who are not interested
persons, by affirmative vote of a majority of those members, or
- one or more of our officers or employees who is not an interested person
and who was authorized by our board or a board committee as specified
above or, in the case of an employee, to whom authority has been
delegated by an officer to whom the authority to approve such an action
has been so delegated,
- the agreement or transaction was fair to us as of the time it was entered
into, or
- the agreement or transaction was approved by the affirmative vote of a
majority of the shares of capital stock entitled to vote and which do
vote on the agreement or transaction, excluding Reliant Energy and any
interested person in respect of such agreement or transaction.
Under our restated certificate of incorporation, Reliant Energy has no duty
to refrain from engaging in similar activities or lines of business as us and,
except as discussed below, neither Reliant Energy nor any of its officers,
directors or employees will be liable to us or our stockholders for breach of
any fiduciary duty by reason of any of these activities. In addition, if Reliant
Energy becomes aware of a potential transaction which may be a corporate
opportunity for both Reliant Energy and us, Reliant Energy will have no duty to
communicate or offer this corporate opportunity to us and will not be liable to
us or our stockholders for breach of any fiduciary duty as a stockholder by
reason of the fact that Reliant Energy pursues or acquires the
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corporate opportunity for itself, directs the corporate opportunity to another
person or does not communicate information regarding such corporate opportunity
to us.
Similarly, in the event that one of our directors or officers, who is also
a director or officer of Reliant Energy, acquires knowledge of a potential
transaction which may be a corporate opportunity for both us and Reliant Energy,
the director or officer will have no duty to communicate or offer this corporate
opportunity to us and will not be liable to us or our stockholders for breach of
any fiduciary duty as one of our directors or officers by reason of the fact
that Reliant Energy pursues or acquires the corporate opportunity for itself,
directs the corporate opportunity to another person or does not communicate
information regarding such corporate opportunity to us.
For purposes of these provisions, an interested person is generally any
director, officer or employee of Reliant Energy and an individual who has a
financial interest in Reliant Energy or the relevant transaction.
The provisions of our restated certificate of incorporation with regard to
such transactions and/or corporate opportunities will terminate when Reliant
Energy, together with its affiliates, ceases to be the owner of voting stock
representing 20% or more of the votes entitled to be cast by the holders of all
of the then outstanding voting stock; provided, however, that the termination
will not terminate the effect of these provisions with respect to any agreement
between us and Reliant Energy that was entered into before the time of
termination or any transaction entered into in the performance of such
agreement, whether entered into before such time, or any transaction entered
into between us and Reliant Energy or the allocation of any opportunity between
us and Reliant Energy before such time. These provisions do not alter the
fiduciary duty of loyalty of our directors under applicable Delaware law. By
becoming a stockholder in our company, you will be deemed to have notice of and
consented to these provisions of our restated certificate of incorporation.
These provisions may not be amended or repealed except by the vote of the
holders of at least 66 2/3% of the voting power of outstanding shares of capital
stock entitled to vote in the election of directors, voting together as a single
class.
STOCKHOLDER RIGHTS PLAN
Each share of common stock includes one right to purchase from us a unit
consisting of one-thousandth of a share of our Series A preferred stock at a
purchase price of $ per unit, subject to adjustment. The rights are issued
pursuant to a rights agreement between us and The Chase Manhattan Bank as rights
agent. We have summarized selected portions of the rights agreement and the
rights below. For a complete description of the rights, we encourage you to read
the summary below and the rights agreement, which we have filed as an exhibit to
the registration statement of which this prospectus is a part.
DETACHMENT OF RIGHTS; EXERCISABILITY
The rights are attached to all certificates representing our currently
outstanding common stock and will attach to all common stock certificates we
issue prior to the "distribution date." That date will occur, except in some
cases, on the earlier of:
- ten days following a public announcement that a person or group of
affiliated or associated persons, who we refer to collectively as an
"acquiring person," has acquired, or obtained the right to acquire,
beneficial ownership of 20% or more of the outstanding shares of our
common stock, or
- ten business days following the start of a tender offer or exchange offer
that would result in a person becoming an acquiring person.
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Our board of directors may defer the distribution date in some circumstances.
Also, some inadvertent acquisitions of our common stock will not result in a
person becoming an acquiring person if the person promptly divests itself of
sufficient common stock.
Until the distribution date:
- common stock certificates will evidence the rights,
- the rights will be transferable only with those certificates,
- new common stock certificates will contain a notation incorporating the
rights agreement by reference, and
- the surrender for transfer of any common stock certificate will also
constitute the transfer of the rights associated with the common stock
represented by the certificate.
The rights are not exercisable until the distribution date and will expire
at the close of business on January 15, 2011, unless we redeem or exchange them
at an earlier date as described below or we extend the expiration date prior to
January 15, 2011.
As soon as practicable after the distribution date, the rights agent will
mail certificates representing the rights to holders of record of common stock
as of the close of business on the distribution date. From that date on, only
separate rights certificates will represent the rights. We will issue rights
with all shares of common stock issued prior to the distribution date. We will
also issue rights with shares of common stock issued after the distribution date
in connection with some employee benefit plans or upon conversion of some
securities. Except as otherwise determined by our board of directors, we will
not issue rights with any other shares of common stock issued after the
distribution date.
FLIP-IN EVENT
A "flip-in event" will occur under the rights agreement when a person
becomes an acquiring person otherwise than pursuant to a "permitted offer." The
rights agreement defines "permitted offer" as a tender or exchange offer for all
outstanding shares of our common stock at a price and on terms that a majority
of the independent directors of our board of directors determines to be fair to
and otherwise in our best interests and the best interest of our stockholders.
If a flip-in event occurs, each right, other than any right that has become
null and void as described below, will become exercisable to receive the number
of shares of common stock, or in some specified circumstances, cash, property or
other securities, which has a "current market price" equal to two times the
exercise price of the right. Please refer to the rights agreement for the
definition of "current market price."
FLIP-OVER EVENT
A "flip-over event" will occur under the rights agreement when, at any time
from and after the time a person becomes an acquiring person:
- we are acquired or we acquire such person in a merger or other business
combination transaction, other than specified mergers that follow a
permitted offer, or
- 50% or more of our assets, cash flow or earning power is sold, leased or
transferred.
If a flip-over event occurs, each holder of a right, except rights that are
voided as described below, will thereafter have the right to receive, on
exercise of the right, a number of shares of common stock of the acquiring
company that has a current market price equal to two times the exercise price of
the right.
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When a flip-in event or a flip-over event occurs, all rights that then are,
or under the circumstances the rights agreement specifies previously were,
beneficially owned by an acquiring person or specified related parties will
become null and void in the circumstances the rights agreement specifies.
SERIES A PREFERRED STOCK
After the distribution date, each right will entitle the holder to purchase
a fractional share of our Series A preferred stock, which will be essentially
the economic equivalent of one share of common stock. Please refer to the
"-- Preferred Stock -- Series A Preferred Stock" section in this prospectus for
additional information about our Series A preferred stock.
ANTIDILUTION
The number of rights associated with a share of outstanding common stock,
the number of fractional shares of Series A preferred stock issuable upon
exercise of a right and the exercise price of the right are subject to
adjustment in the event of a stock dividend on, or a subdivision, combination or
reclassification of, our common stock occurring prior to the distribution date.
The exercise price of the rights and the number of fractional shares of Series A
preferred stock or other securities or property issuable on exercise of the
rights are subject to adjustment from time to time to prevent dilution in the
event of some specified transactions affecting the Series A preferred stock.
With some exceptions, we will not be required to adjust the exercise price
of the rights until cumulative adjustments amount to at least 1% of the exercise
price. The rights agreement also will not require us to issue fractional shares
of Series A preferred stock that are not integral multiples of the specified
fractional share and, in lieu thereof, we will make a cash payment based on the
market price of the Series A preferred stock on the last trading date prior to
the date of exercise. Pursuant to the rights agreement, we reserve the right to
require prior to the occurrence of any flip-in event or flip-over event that, on
any exercise of rights, a number of rights be exercised so that we will issue
only whole shares of Series A preferred stock.
REDEMPTION OF RIGHTS
At any time until the time a person becomes an acquiring person, we may
redeem the rights in, whole, but not in part, at a price of $.005 per right,
payable, at our option, in cash, shares of common stock or such other
consideration as our board of directors may determine. Upon such redemption, the
rights will terminate and the only right of the holders of rights will be to
receive the $.005 redemption price.
EXCHANGE OF RIGHTS
At any time after the occurrence of a flip-in event and prior to a person's
becoming the beneficial owner of 50% or more of our outstanding common stock or
the occurrence of a flip-over event, we may exchange the rights, other than
rights owned by an acquiring person or an affiliate or an associate of an
acquiring person, which will have become void, in whole or in part, at an
exchange ratio of one share of common stock, and/or other equity securities
deemed to have the same value as one share of common stock, per right, subject
to adjustment.
SUBSTITUTION
If we have an insufficient number of authorized but unissued shares of
common stock available to permit an exercise or exchange of rights upon the
occurrence of a flip-in event, we may substitute other specified types of
property for common stock so long as the total value received by the holder of
the rights is equivalent to the value of the common stock that the
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stockholder would otherwise have received. We may substitute cash, property,
equity securities or debt, reduce the exercise price of the rights or use any
combination of the foregoing.
NO RIGHTS AS A STOCKHOLDER; TAXES
Until a right is exercised, a holder of rights will have no rights to vote
or receive dividends or any other rights as a stockholder of our common stock.
Stockholders may, depending upon the circumstances, recognize taxable income in
the event that the rights become exercisable for our common stock, or other
consideration, or for the common stock of the acquiring company or are exchanged
as described above.
AMENDMENT OF TERMS OF RIGHTS
Our board of directors may amend any of the provisions of the rights
agreement, other than some specified provisions relating to the principal
economic terms of the rights and the expiration date of the rights, at any time
prior to the time a person becomes an acquiring person. Thereafter, our board of
directors may only amend the rights agreement in order to cure any ambiguity,
defect or inconsistency or to make changes that do not materially and adversely
affect the interests of holders of the rights, excluding the interests of any
acquiring person.
We have agreed, in the master separation agreement, not to amend or modify
the terms of the rights agreement without the consent of Reliant Energy for so
long as Reliant Energy continues to own at least 30% of the voting power of
outstanding shares of our capital stock.
RIGHTS AGENT
The Chase Manhattan Bank serves as rights agent with regard to the rights.
ANTITAKEOVER EFFECTS
The rights will have anti-takeover effects. They will cause substantial
dilution to any person or group that attempts to acquire us without the approval
of our board of directors. As a result, the overall effect of the rights may be
to make more difficult or discourage any attempt to acquire us even if such
acquisition may be favorable to the interests of our stockholders. Because our
board of directors can redeem the rights or approve a permitted offer, the
rights should not interfere with a merger or other business combination approved
by our board of directors.
DELAWARE ANTITAKEOVER LAW
We are subject to Section 203 of the Delaware General Corporation Law. That
section prohibits Delaware corporations from engaging in a wide range of
specified transactions with any interested stockholder. An interested
stockholder is any person, other than the corporation and any of its
majority-owned subsidiaries, who owns 15% or more of any class or series of
stock entitled to vote generally in the election of directors. Section 203 may
tend to deter any potential unfriendly offers or other efforts to obtain control
of our company that are not approved by our board. This may deprive the
stockholders of opportunities to sell shares of our common stock at prices
higher than the prevailing market price. Because Reliant Energy will own more
than 15% of our voting stock before we become a public company and upon
completion of the offering, Section 203 is currently not applicable to
transactions with Reliant Energy, even though Reliant Energy owns more than 15%
of our outstanding stock. If any other person acquires 15% or more of our
outstanding stock, that person will be subject to the provisions of Section 203.
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LISTING OF COMMON STOCK
We intend to apply for the listing of our common stock on the New York
Stock Exchange under the symbol "RRI."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar of our common stock is Reliant Energy,
Incorporated.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. The market price of our common stock could drop because of sales of a
large number of shares in the open market following this offering or the
perception that those sales may occur. These factors also could make it more
difficult for us to raise capital through future offerings of common stock.
After this offering, we will have 292,000,000 shares of our common stock
outstanding. If the underwriters exercise their over-allotment option in full,
we will have a total of 299,800,000 shares of common stock outstanding. All of
the shares of our common stock sold in this offering will be freely tradable
without restriction under the Securities Act, except for any shares that may be
acquired by an affiliate of ours, as that term is defined in Rule 144 under the
Securities Act. Persons who may be deemed to be affiliates generally include
individuals or entities that control, are controlled by, or are under common
control with, us and may include our directors and officers as well as our
significant stockholders. We, Reliant Energy and our executive officers and
directors have agreed with the underwriters not to dispose of or hedge any of
our common stock or securities convertible into or exchangeable for shares of
our common stock for a period of 180 days after the date of this prospectus,
without the prior written consent of the underwriters, except for issuances
under our employee or director compensation plans. We can give no assurance
concerning how long these parties will continue to hold their common stock after
these agreements expire.
Reliant Energy currently plans to complete the distribution of our common
stock within 12 months of this offering. Shares of our common stock distributed
to Reliant Energy shareholders in the distribution generally will be freely
transferable, except for shares of common stock received by persons who may be
deemed to be our affiliates. Persons who are affiliates will be permitted to
sell the shares of common stock that are issued in this offering or that they
receive in the distribution only through registration under the Securities Act,
or under an exemption from registration, such as the one provided by Rule 144.
The 240,000,000 shares of our common stock held by Reliant Energy before
the distribution are deemed "restricted securities" as defined in Rule 144, and
may not be sold other than through registration under the Securities Act or
under an exemption from registration, such as the one provided by Rule 144.
In general, a stockholder subject to Rule 144 who has owned common stock of
an issuer for at least one year may, within any three-month period, sell up to
the greater of:
- 1% of the total number of shares of common stock then outstanding, and
- the average weekly trading volume of the common stock during the four
weeks preceding the stockholder's required notice of sale is filed with
the SEC.
Rule 144 requires stockholders to aggregate their sales with other
affiliated stockholders for purposes of complying with this volume limitation. A
stockholder who has owned common stock for at least two years, and who has not
been an affiliate of the issuer for at least 90 days, may sell common stock free
from the volume limitation and notice requirements of Rule 144.
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In connection with this offering, we are granting options to purchase
approximately shares of our common stock. Immediately after this offering,
we intend to file a registration statement on Form S-8 covering all options
granted under our Long-Term Incentive Plan. Shares of our common stock
registered under this registration statement will be available for sale in the
open market, subject to vesting restrictions. Any sales of these shares by one
of our affiliates will be subject to the volume limitations of Rule 144
described above.
We have granted Reliant Energy registration rights with respect to our
shares it will hold after this offering. These registration rights generally
become effective at such time as Reliant Energy informs us that it no longer
intends to complete the distribution of these shares to its shareholders. Please
read "Agreements Between Us and Reliant Energy -- Registration Rights
Agreement."
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UNDERWRITING
We and the underwriters named below have entered into an underwriting
agreement with respect to the shares being offered. Subject to certain
conditions, each underwriter has severally agreed to purchase the number of
shares indicated in the following table. Goldman, Sachs & Co., Credit Suisse
First Boston Corporation, ABN AMRO Rothschild LLC, Banc of America Securities
LLC, Deutsche Banc Alex. Brown Inc., Merrill Lynch, Pierce, Fenner & Smith
Incorporated and UBS Warburg LLC are the representatives of the underwriters.
<TABLE>
<CAPTION>
Underwriters Number of Shares
------------ ----------------
<S> <C>
Goldman, Sachs & Co. .......................................
Credit Suisse First Boston Corporation......................
ABN AMRO Rothschild LLC.....................................
Banc of America Securities LLC..............................
Deutsche Banc Alex. Brown Inc. .............................
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...................................
UBS Warburg LLC.............................................
----------
Total............................................. 52,000,000
==========
</TABLE>
Under the terms and conditions of the underwriting agreement, the
underwriters are obligated to purchase all of the shares offered hereby (other
than those covered by the over-allotment option described below), if they
purchase any of the shares. If the underwriters sell more shares than the total
number set forth in the table above, the underwriters have an option to buy up
to an additional 7,800,000 shares from us to cover such sales. They may exercise
the option for 30 days. If any shares are purchased pursuant to this option, the
underwriters will severally purchase shares in approximately the same proportion
as set forth in the table above.
The following table shows the per share and total underwriting discounts
and commissions to be paid to the underwriters by Reliant Resources. Such
amounts are shown assuming both no exercise and full exercise of the
underwriters' option to purchase additional shares.
<TABLE>
<CAPTION>
Paid by Reliant Resources No Exercise Full Exercise
------------------------- ----------- -------------
<S> <C> <C>
Per Share............................................. $ $
Total................................................. $ $
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial public offering price. Any such
securities dealers may resell any shares purchased from the underwriters to
other brokers or dealers at a discount of up to $ per share from the initial
public offering price. If all of the shares are not sold at the initial public
offering price, the representatives may change the offering price and the other
selling terms.
A prospectus in electronic format may be made available on the web sites
maintained by Goldman, Sachs & Co., Credit Suisse First Boston Corporation and
Merrill Lynch, Pierce, Fenner & Smith Incorporated and may also be made
available on web sites maintained by other underwriters. The underwriters may
agree to allocate a number of shares to underwriters for sale to their online
brokerage account holders. Internet distributions will be allocated by the lead
managers to underwriters that may make Internet distributions on the same basis
as other allocations.
We, Reliant Energy and our executive officers and directors have agreed
with the underwriters not to dispose of or hedge any of our common stock or
securities convertible into
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or exchangeable for shares of our common stock during the period from the date
of this prospectus continuing through the date 180 days after the date of this
prospectus, except with the prior written consent of the representatives. This
agreement does not generally apply to issuances under our employee or director
compensation plans. Please read "Shares Eligible For Future Sale" for a
discussion of transfer restrictions.
At our request, the underwriters have reserved for sale at the initial
public offering price up to 2,600,000 shares of common stock for sale to our
employees and the employees and directors of Reliant Energy, Incorporated. Any
shares purchased by these individuals will be subject to lock-up agreements with
terms similar to those described in the preceding paragraph. The number of
shares of common stock available for sale to the general public in the offering
will be reduced to the extent these persons purchase these reserved shares. Any
shares not so purchased will be offered by the underwriters to the general
public on the same basis as the other shares offered hereby.
Prior to this offering, there has been no public market for our common
stock. The initial public offering price will be negotiated among us and the
representatives. Among the factors to be considered in determining the initial
public offering price of the shares, in addition to prevailing market
conditions, will be our historical performance, estimates of our business
potential and earnings prospects, an assessment of our management and the
consideration of the above factors in relation to the market valuation of
companies in related businesses. There can be no assurance that the prices at
which the shares will sell in the public market after this offering will not be
lower than the prices at which they are sold by the underwriters or that an
active trading market in the common stock will develop and continue after this
offering.
We intend to apply for the listing of our common stock on the New York
Stock Exchange under the symbol "RRI." The underwriters intend to sell shares of
common stock to a minimum of 2,000 beneficial owners in lots of 100 or more
shares so as to meet the New York Stock Exchange distribution requirements for
trading.
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. "Covered"
short sales are sales made in an amount not greater than the underwriters'
option to purchase additional shares from us in the offering. The underwriters
may close out any covered short position by either exercising their option to
purchase additional shares or purchasing shares in the open market. In
determining the source of shares to close out the covered short position, the
underwriters will consider, among other things, the price of shares available
for purchase in the open market as compared to the price at which they may
purchase shares through the overallotment option. "Naked" short sales are any
sales in excess of such option. The underwriters must close out any naked short
position by purchasing shares in the open market. A naked short position is more
likely to be created if the underwriters are concerned that there may be
downward pressure on the price of the common stock in the open market after
pricing that could adversely affect investors who purchase in the offering.
Stabilizing transactions consist of various bids for or purchases of common
stock made by the underwriters in the open market prior to the completion of the
offering.
The underwriters may also impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such underwriter in stabilizing or short covering
transactions.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of our
stock, and together with the imposition of the penalty bid, may stabilize,
maintain or otherwise affect the market price of the
135
<PAGE> 139
common stock. As a result, the price of the common stock may be higher than the
price that otherwise might exist in the open market. If these activities are
commenced, they may be discontinued at any time. These transactions may be
effected on the New York Stock Exchange, in the over-the-counter market or
otherwise.
The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.
We estimate that the total expenses of the offering, excluding underwriting
discounts and commissions, will be approximately $10 million.
We have agreed to indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act of 1933.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed on for us by
Baker Botts L.L.P., Houston, Texas and for the underwriters by Vinson & Elkins
L.L.P., Houston, Texas.
136
<PAGE> 140
EXPERTS
The consolidated financial statements of Reliant Resources, Inc. and
Subsidiaries as of December 31, 1998 and 1999 and September 30, 2000 and for
each of the three years in the period ended December 31, 1999 and the nine
months ended September 30, 2000 included in this prospectus and the related
financial statement schedule included elsewhere in the registration statement
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their reports appearing herein and elsewhere in the registration statement, and
have been so included in reliance upon the reports of such firm given upon their
authority as experts in accounting and auditing.
The consolidated balance sheet of Reliant Resources, Inc. and Subsidiary as
of September 30, 2000 included in this prospectus has been audited by Deloitte &
Touche LLP, independent auditors, as stated in their report appearing herein,
and has been so included in reliance upon the report of such firm given upon
their authority as experts in accounting and auditing.
The combined financial statements of Reliant Energy Mid-Atlantic Power
Holdings, LLC and Related Companies as of December 31, 1999 and for the period
from November 24, 1999 to December 31, 1999 included in this prospectus have
been audited by Deloitte & Touche LLP, independent auditors, as stated in their
report appearing herein, and has been so included in reliance upon the report of
such firm given upon their authority as experts in accounting and auditing.
The consolidated financial statements of N.V. UNA as of September 30, 1999
and for the nine months then ended included in this prospectus have been audited
by Deloitte & Touche Accountants, independent auditors, as stated in their
report appearing herein, and has been so included in reliance upon the report of
such firm given upon their authority as experts in accounting and auditing.
The consolidated financial statements of N.V. UNA as of December 31, 1998
and for the two year period then ended included in this prospectus have been
audited by PricewaterhouseCoopers N.V., independent auditors, as stated in their
reports appearing herein, and are included in reliance upon the reports of such
firm given upon their authority as experts in accounting and auditing.
The combined financial statements of Reliant Energy Services, Inc. and
Related Company for the seven month period ended July 31, 1997 included in this
prospectus have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their report appearing herein, and has been so included in reliance
upon the report of such firm given upon their authority as experts in accounting
and auditing.
137
<PAGE> 141
WHERE YOU CAN FIND MORE INFORMATION
This prospectus is part of a registration statement we have filed with the
SEC relating to our common stock. As permitted by SEC rules, this prospectus
does not contain all of the information we have included in the registration
statement and the accompanying exhibits and schedules we file with the SEC. You
may refer to the registration statement, exhibits and schedules for more
information about us and our common stock. You may read and copy the
registration statement, exhibits and schedules at the SEC's Public Reference
Room at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the regional
offices of the SEC located at 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511, and at 7 World Trade Center, Suite 1300, New York, New York
10048. You may obtain further information about the operation of the SEC's
Public Reference Room by calling the SEC at 1-800-SEC-0330. Our filings are also
available to the public on the SEC's Internet site located at
http://www.sec.gov.
Following this offering, we will be required to file current reports,
quarterly reports, annual reports, proxy statements and other information with
the SEC. You may read and copy those reports, proxy statements and other
information at the SEC's Public Reference room or through its Internet site. We
intend to furnish our stockholders with annual reports that will include a
description of our operations and audited consolidated financial statements
certified by an independent public accounting firm.
138
<PAGE> 142
INDEX TO FINANCIAL STATEMENTS
RELIANT RESOURCES, INC. AND SUBSIDIARIES
<TABLE>
<S> <C>
Consolidated Financial Statements
Independent Auditors' Report.............................. F-3
Statements of Consolidated Operations for the Years Ended
December 31, 1997, 1998 and 1999 and Nine Months Ended
September 30, 1999 (unaudited) and 2000................ F-4
Consolidated Balance Sheets as of December 31, 1998 and
1999 and September 30, 2000............................ F-5
Statements of Consolidated Cash Flows for the Years Ended
December 31, 1997, 1998 and 1999 and Nine Months Ended
September 30, 1999 (unaudited) and 2000................ F-6
Statements of Consolidated Stockholder's Equity and
Accumulated Other Comprehensive Loss for the Years
Ended December 31, 1997, 1998 and 1999 and Nine Months
Ended September 30, 2000............................... F-7
Notes to Consolidated Financial Statements................ F-8
</TABLE>
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
<TABLE>
<S> <C>
Audited Combined Financial Statements
Independent Auditors' Report.............................. F-56
Statement of Combined Operations for the Period from
November 24, 1999 to December 31, 1999................. F-57
Combined Balance Sheet as of December 31, 1999............ F-58
Statement of Combined Cash Flows for the Period from
November 24, 1999 to December 31, 1999................. F-59
Statement of Combined Member's and Shareholder's Equity
for the Period from November 24, 1999 to December 31,
1999................................................... F-60
Notes to Combined Financial Statements.................... F-61
Unaudited Interim Condensed Combined Financial Statements
Interim Condensed Statement of Combined Operations for the
Three Months Ended March 31, 2000...................... F-69
Interim Condensed Combined Balance Sheets as of March 31,
2000 and December 31, 1999............................. F-70
Interim Condensed Statement of Combined Cash Flows for the
Three Months Ended March 31, 2000...................... F-71
Interim Condensed Statement of Combined Member's and
Shareholder's Equity for the Three Months Ended March
31, 2000............................................... F-72
Notes to Unaudited Interim Condensed Combined Financial
Statements............................................. F-73
</TABLE>
F-1
<PAGE> 143
N.V. UNA
<TABLE>
<S> <C>
Audited Consolidated Financial Statements
Independent Auditors' Report for the Nine Months Ended
September 30, 1999..................................... F-76
Independent Auditors' Report for the Year Ended December
31, 1998............................................... F-77
Independent Auditors' Report for the Year Ended December
31, 1997............................................... F-78
Statements of Consolidated Income for the Nine Months
Ended September 30, 1999 and Years Ended December 31,
1998 and 1997.......................................... F-79
Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998...................................... F-80
Statements of Consolidated Cash Flows for the Nine Months
Ended September 30, 1999 and Years Ended December 31,
1998 and 1997.......................................... F-81
Notes to Consolidated Financial Statements................ F-82
</TABLE>
RELIANT ENERGY SERVICES, INC. AND RELATED COMPANY
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
<TABLE>
<S> <C>
Audited Combined Financial Statements
Independent Auditors' Report.............................. F-104
Statement of Combined Operations for the Seven Months
Ended July 31, 1997.................................... F-105
Statements of Combined Owner's Net Investment and
Accumulated Other Comprehensive Income for the Seven
Months Ended July 31, 1997............................. F-106
Statement of Combined Cash Flows for the Seven Months
Ended July 31, 1997.................................... F-107
Notes to Combined Financial Statements.................... F-108
</TABLE>
RELIANT RESOURCES, INC. AND SUBSIDIARIES
<TABLE>
<S> <C>
Unaudited Pro Forma Condensed Consolidated Financial
Statements
Introduction to Unaudited Pro Forma Condensed Consolidated
Financial Statements................................... F-115
Unaudited Pro Forma Condensed Consolidated Balance Sheet
as of September 30, 2000............................... F-117
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the Nine Months Ended September 30,
2000................................................... F-118
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the Year Ended December 31, 1999........ F-119
Notes to Unaudited Pro Forma Condensed Consolidated
Financial Statements................................... F-120
</TABLE>
F-2
<PAGE> 144
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholder of
Reliant Resources, Inc. and Subsidiaries
Houston, Texas
We have audited the accompanying consolidated balance sheets of Reliant
Resources, Inc. and Subsidiaries (the Company), the unregulated energy services
operations of Reliant Energy, Incorporated and its subsidiaries, as of December
31, 1998 and 1999 and September 30, 2000, and the related consolidated
statements of operations, cash flows, and stockholder's equity and accumulated
other comprehensive loss for each of the three years in the period ended
December 31, 1999 and the nine months ended September 30, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of the Company at
December 31, 1998 and 1999 and September 30, 2000, and the consolidated results
of its operations and its consolidated cash flows for each of the three years in
the period ended December 31, 1999 and the nine months ended September 30, 2000,
in conformity with accounting principles generally accepted in the United States
of America.
DELOITTE & TOUCHE LLP
Houston, Texas
January 15, 2001
F-3
<PAGE> 145
RELIANT RESOURCES, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(THOUSANDS OF DOLLARS AND SHARES, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------ --------------------------
1997 1998 1999 1999 2000
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES.......................... $1,320,768 $4,370,756 $8,052,565 $5,827,617 $12,819,656
EXPENSES:
Fuel and cost of gas sold....... 978,255 2,352,309 3,984,953 2,682,075 6,248,956
Purchased power................. 313,122 1,823,932 3,735,819 2,935,667 5,517,439
Operation and maintenance....... 17,306 64,546 158,597 123,466 288,319
General, administrative and
development................... 19,979 77,439 93,680 43,197 158,498
Depreciation and amortization... 1,478 15,196 43,383 15,906 130,351
---------- ---------- ---------- ---------- -----------
Total.................... 1,330,140 4,333,422 8,016,432 5,800,311 12,343,563
---------- ---------- ---------- ---------- -----------
OPERATING (LOSS) INCOME........... (9,372) 37,334 36,133 27,306 476,093
---------- ---------- ---------- ---------- -----------
OTHER (EXPENSE) INCOME:
Interest expense................ (684) (1,808) (12,441) (488) (36,863)
Interest income................. 494 1,109 1,870 749 10,503
Interest income (expense) --
affiliated companies, net..... 1,700 2,209 (7,653) -- (121,875)
Gains (losses) from investments,
net........................... -- -- 15,964 (28) (16,767)
(Losses) income of equity
investment of unconsolidated
subsidiaries.................. -- (601) (793) (569) 33,108
Gain on sale of development
project....................... -- -- -- -- 18,011
Other, net...................... (634) 366 (6,474) (5,973) 2,332
---------- ---------- ---------- ---------- -----------
Total other income
(expense).............. 876 1,275 (9,527) (6,309) (111,551)
---------- ---------- ---------- ---------- -----------
(LOSS) INCOME BEFORE INCOME
TAXES........................... (8,496) 38,609 26,606 20,997 364,542
INCOME TAX (BENEFIT) EXPENSE...... (2,364) 17,477 2,560 12,352 120,158
---------- ---------- ---------- ---------- -----------
(LOSS) INCOME BEFORE EXTRAORDINARY
ITEM............................ (6,132) 21,132 24,046 8,645 244,384
Extraordinary item, net of
tax........................... -- -- -- -- 7,445
---------- ---------- ---------- ---------- -----------
NET (LOSS) INCOME................. $ (6,132) $ 21,132 $ 24,046 $ 8,645 $ 251,829
========== ========== ========== ========== ===========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
F-4
<PAGE> 146
RELIANT RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- SEPTEMBER 30,
1998 1999 2000
---- ---- -------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 12,668 $ 49,271 $ 253,868
Marketable debt securities................................ -- 128,553 --
Accounts and notes receivable, principally customer,
net..................................................... 343,175 619,803 1,175,533
Inventory................................................. 97,417 39,377 104,104
Price risk management assets.............................. 265,203 722,429 1,917,680
Prepayments and other current assets...................... 1,233 29,826 313,644
---------- ---------- ----------
Total current assets............................... 719,696 1,589,259 3,764,829
---------- ---------- ----------
PROPERTY, PLANT AND EQUIPMENT, NET.......................... 269,634 2,407,197 3,722,010
---------- ---------- ----------
OTHER ASSETS:
Goodwill, net............................................. 195,156 1,025,971 963,340
Air emissions regulatory allowances and other intangibles,
net..................................................... 4,326 126,197 283,381
Equity investments in unconsolidated subsidiaries......... 42,253 78,041 116,345
Investment in affiliate................................... 107,540 107,540 107,540
Price risk management assets.............................. 19,971 173,590 615,883
Other..................................................... 50,232 115,801 282,423
---------- ---------- ----------
Total other assets................................. 419,478 1,627,140 2,368,912
---------- ---------- ----------
TOTAL ASSETS....................................... $1,408,808 $5,623,596 $9,855,751
========== ========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY AND ACCUMULATED OTHER COMPREHENSIVE LOSS
CURRENT LIABILITIES:
Current portion of long-term debt......................... $ -- $ 20,268 $ 539
Short-term borrowings..................................... -- 169,571 203,574
Accounts payable, principally trade....................... 287,420 594,250 1,142,716
Accounts and notes payable -- affiliated companies, net... 20,555 262,579 2,179,661
Price risk management liabilities......................... 227,652 718,228 1,880,983
Business purchase obligation.............................. -- 414,026 --
Other..................................................... 60,460 67,427 349,041
---------- ---------- ----------
Total current liabilities.......................... 596,087 2,246,349 5,756,514
---------- ---------- ----------
OTHER LIABILITIES:
Accumulated deferred income taxes......................... -- 62,946 65,650
Notes payable -- affiliated companies, net................ -- 1,070,357 239,070
Price risk management liabilities......................... 40,532 142,305 592,658
Business purchase obligation.............................. -- 596,303 --
Major maintenance reserve................................. 35,249 45,875 22,683
Other..................................................... 84,905 278,859 311,570
---------- ---------- ----------
Total other liabilities............................ 160,686 2,196,645 1,231,631
---------- ---------- ----------
LONG-TERM DEBT.............................................. -- 439,917 801,138
---------- ---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTE 11)
STOCKHOLDER'S EQUITY AND ACCUMULATED OTHER COMPREHENSIVE
LOSS:
Stockholder's net investment.............................. 668,039 757,751 2,077,483
Accumulated other comprehensive loss...................... (16,004) (17,066) (11,015)
---------- ---------- ----------
Stockholder's net investment and accumulated other
comprehensive loss............................... 652,035 740,685 2,066,468
---------- ---------- ----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY AND
ACCUMULATED OTHER COMPREHENSIVE LOSS............. $1,408,808 $5,623,596 $9,855,751
========== ========== ==========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
F-5
<PAGE> 147
RELIANT RESOURCES, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------- -------------------------
1997 1998 1999 1999 2000
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income................................. $(6,132) $ 21,132 $ 24,046 $ 8,645 $ 251,829
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Depreciation and amortization................... 1,478 15,196 43,383 15,906 130,351
Deferred income taxes........................... 5,107 1,691 15,556 24,734 10,097
Gains on marketable debt securities, net........ -- -- (15,964) -- (9,737)
Proceeds from sale of debt securities........... -- -- -- -- 123,428
Undistributed loss (income) of unconsolidated
subsidiaries.................................. -- 601 793 569 (33,108)
Impairment of marketable equity securities...... -- -- -- -- 26,504
Extraordinary item, net......................... -- -- -- -- (7,445)
Changes in other assets and liabilities:
Accounts and notes receivable, net............ (39,575) 29,027 (236,750) (234,158) (563,872)
Accounts receivable/payable -- affiliated
companies, net.............................. (29,778) 34,222 32,328 64,336 (48,668)
Inventory..................................... 2,357 (90,684) 68,982 30,832 (7,147)
Other current assets.......................... 10,685 (839) (11,667) (2,849) (234,668)
Accounts payable.............................. 54,516 (60,375) 269,584 161,653 538,560
Other current liabilities..................... 6,093 18,740 18,970 52,166 335,071
Net price risk management assets and
liabilities................................. -- (16,990) (18,496) (11,836) (24,436)
Restricted deposits........................... -- -- -- -- (76,084)
Margin deposits on energy trading
activities.................................. (11,053) 42,630 (55,667) (73,371) (59,032)
Other, net.................................... (15,279) 3,278 (49,224) (31,480) (117,611)
------- --------- ----------- --------- -----------
Net cash (used in) provided by operating
activities................................ (21,581) (2,371) 85,874 5,147 234,032
------- --------- ----------- --------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.............................. (2,458) (31,456) (293,197) (72,148) (676,890)
Payment of business purchase obligation........... -- -- -- -- (981,789)
Business acquisitions, net of cash acquired....... -- (292,398) (1,065,013) -- (2,127,503)
Proceeds from sale-leaseback transactions......... -- -- -- -- 1,000,000
Investments in unconsolidated subsidiaries........ (1,926) (40,928) (36,581) (31,528) (5,196)
Other, net........................................ 11 171 (8,741) (173) 11,349
------- --------- ----------- --------- -----------
Net cash used in investing activities....... (4,373) (364,611) (1,403,532) (103,849) (2,780,029)
------- --------- ----------- --------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt, net................. -- -- 61,601 -- 695,916
Payments of long-term debt........................ -- -- -- -- (299,375)
(Decrease) Increase in short-term
borrowings, net................................. -- -- (76,529) -- 54,548
Increase in notes with affiliated companies,
net............................................. 22,081 28,640 1,306,053 411,812 1,221,300
Contributions from owner.......................... 3,722 350,364 235,877 41,666 1,067,903
Distribution to owner............................. -- -- (170,211) -- --
Other, net........................................ -- -- (2,990) -- 621
------- --------- ----------- --------- -----------
Net cash provided by financing activities... 25,803 379,004 1,353,801 453,478 2,740,913
------- --------- ----------- --------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
CASH EQUIVALENTS.................................. -- -- 460 -- 9,681
------- --------- ----------- --------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS....................................... (151) 12,022 36,603 354,776 204,597
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.... 797 646 12,668 12,668 49,271
------- --------- ----------- --------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.......... $ 646 $ 12,668 $ 49,271 $ 367,444 $ 253,868
======= ========= =========== ========= ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized)........... $ 233 $ 12,787 $ 37,126 $ 10,766 $ 158,397
Income taxes.................................... -- 20,270 16,496 737 62,459
</TABLE>
See Notes to the Company's Consolidated Financial Statements
F-6
<PAGE> 148
RELIANT RESOURCES, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDER'S EQUITY AND
ACCUMULATED OTHER COMPREHENSIVE LOSS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
UNREALIZED TOTAL
LOSS ON FOREIGN ACCUMULATED
STOCKHOLDER'S AVAILABLE FOR CURRENCY OTHER TOTAL
NET SALE TRANSLATION COMPREHENSIVE STOCKHOLDER'S COMPREHENSIVE
INVESTMENT SECURITIES ADJUSTMENTS LOSS EQUITY (LOSS) INCOME
------------- ------------- ----------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE JANUARY 1, 1997............ $ 11,761 $ 11,761
COMPREHENSIVE LOSS:
Net loss......................... (6,132) (6,132) $ (6,132)
Capital contribution from owner
of Reliant Energy Services,
Inc. and Related Company....... 287,192 287,192
Other contributions from owner... 3,722 3,722
Other comprehensive loss:
Unrealized loss on available
for sale securities, net of
tax of $3,193................ $ (5,634) $ (5,634) (5,634) (5,634)
--------
Comprehensive loss......... (11,766)
---------- -------- -------- -------- ---------- ========
BALANCE DECEMBER 31, 1997.......... 296,543 (5,634) (5,634) 290,909
COMPREHENSIVE INCOME:
Net income....................... 21,132 21,132 21,132
Contributions from owner......... 350,364 350,364
Other comprehensive loss:
Unrealized loss on available
for sale securities, net of
tax of $5,877................ (10,370) (10,370) (10,370) (10,370)
--------
Comprehensive income....... 10,762
---------- -------- -------- -------- ---------- ========
BALANCE DECEMBER 31, 1998.......... 668,039 (16,004) (16,004) 652,035
COMPREHENSIVE INCOME:
Net income....................... 24,046 24,046 24,046
Contributions from owner......... 235,877 235,877
Distribution to owner............ (170,211) (170,211)
Other comprehensive loss:
Unrealized loss on available
for sale securities, net of
tax of $373.................. (1,224) (1,224) (1,224) (1,224)
Foreign currency translation
adjustments.................. 162 162 162 162
--------
Comprehensive income....... 22,984
---------- -------- -------- -------- ---------- ========
BALANCE DECEMBER 31, 1999.......... 757,751 (17,228) 162 (17,066) 740,685
COMPREHENSIVE INCOME:
Net income....................... 251,829 251,829 251,829
Contributions from owner......... 1,067,903 1,067,903
Other comprehensive loss:
Foreign currency translation
adjustments.................. (11,177) (11,177) (11,177) (11,177)
Reclassification adjustment for
impairment loss on available
for sale securities realized
in net income, net of tax of
$9,276....................... 17,228 17,228 17,228 17,228
--------
Comprehensive income....... $257,880
---------- -------- -------- -------- ---------- ========
BALANCE SEPTEMBER 30, 2000......... $2,077,483 $ -- $(11,015) $(11,015) $2,066,468
========== ======== ======== ======== ==========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
F-7
<PAGE> 149
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 AND
NINE MONTHS ENDED SEPTEMBER 30, 1999 (UNAUDITED) AND 2000
(1) BACKGROUND AND BASIS OF PRESENTATION
On July 27, 2000, Reliant Energy, Incorporated (Reliant Energy) announced
its intention to form a company to own and operate a substantial portion of its
unregulated operations and to offer approximately 20% of the common stock of
this company in an initial public offering (Offering). Reliant Energy expects
the Offering to be followed by a distribution to Reliant Energy's or its
successor's shareholders of the remaining common stock of this company
(Distribution) within 12 months of the Offering (Distribution Date). There can
be no assurances that the Offering and Distribution will be completed. Reliant
Energy, together with its subsidiaries, is a diversified international energy
services company consisting of regulated and unregulated energy operations.
The unregulated operations included in the consolidated financial
statements for the years ended December 31, 1997, 1998 and 1999 and the nine
months ended September 30, 1999 (unaudited) and 2000 (Consolidated Financial
Statements) consist of Reliant Energy's or its direct and indirect subsidiaries'
unregulated power generation and related energy trading and marketing operations
in North America and Europe; a portion of its retail electric operations; and
some other operations, including a communications business, an eBusiness group,
and a venture capital operation. Throughout the period covered by the
Consolidated Financial Statements, these operations were conducted by Reliant
Energy and its direct and indirect subsidiaries. These operations are
collectively referred to herein as the "Company."
On August 9, 2000, Reliant Energy formed Reliant Resources, Inc., a
Delaware corporation, as a wholly owned subsidiary. Reliant Resources, Inc. was
originally incorporated with 1,000 shares of common stock. Effective December
31, 2000, Reliant Energy consolidated its unregulated operations under Reliant
Resources, Inc (the Consolidation). A subsidiary of Reliant Energy, Reliant
Energy Resources Corp., transferred some of its subsidiaries, including its
trading and marketing subsidiaries' to Reliant Resources, Inc. Also effective
December 31, 2000, Reliant Energy transferred its wholesale power generation
businesses, its unregulated retail electric operations, its communications
business and eBusiness group and most of its other unregulated businesses to
Reliant Resources, Inc.
The accompanying Consolidated Financial Statements are presented on a
carve-out basis and include the historical operations of the Company. The
Consolidated Financial Statements included herein have been prepared from
Reliant Energy's historical accounting records.
The Statements of Consolidated Operations include all revenues and costs
directly attributable to the Company, including costs for facilities and costs
for functions and services performed by centralized Reliant Energy organizations
and directly charged to the Company based on usage or other allocation factors.
The results of operations in these Consolidated Financial Statements also
include general corporate expenses allocated by Reliant Energy to the Company.
All significant intercompany transactions and balances within the Company are
eliminated in the Consolidated Financial Statements.
All of the allocations in the Consolidated Financial Statements are based
on assumptions that management believes are reasonable under the circumstances.
However, these allocations may not necessarily be indicative of the costs and
expenses that would have resulted if the Company had been operated as a separate
entity.
The Company's financial reporting segments include the following: Wholesale
Energy, European Energy, Retail Energy and Other Operations. The Wholesale
Energy segment engages
F-8
<PAGE> 150
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
in the acquisition, development and operation of domestic non-rate regulated
electric power generation facilities as well as wholesale energy trading,
marketing and risk management activities related to energy and energy-related
commodities in North America. The European Energy segment, which was formed in
the fourth quarter of 1999, operates power generation facilities in the
Netherlands and conducts wholesale energy trading and marketing in Western
Europe. The Retail Energy segment includes the Company's retail electric
operations. This segment provides customized, integrated energy services to
large commercial and industrial customers and is currently developing an
infrastructure to enable the Company to provide retail electric services in
Texas when the Texas electric market opens to retail competition on a pilot
project basis in June 2001, and for all other customers on January 1, 2002. In
addition, Retail Energy historically includes billing and remittance services
provided to Reliant Energy's regulated electric utility and two of its natural
gas utilities. Retail Energy charges the regulated electric and gas utilities
for the services provided to these utilities at the Company's cost. The Other
Operations segment includes unallocated general corporate expenses, a start-up
communications business, a start-up eBusiness group and non-operating
investments.
The interim consolidated financial statements for the nine months ended
September 30, 1999 are unaudited and omit certain financial statement
disclosures. The Company's interim consolidated financial statements for the
nine months ended September 30, 1999 reflect all normal recurring adjustments
that are, in the opinion of management, necessary to present fairly the
financial position and results of operations. Amounts reported in the Company's
Statements of Consolidated Operations for the nine months ended September 30,
2000 and 1999, are not necessarily indicative of amounts expected for a full
year period due to the effects of, among other things, (a) seasonal variations
in energy consumption, (b) timing of maintenance and other expenditures and (c)
acquisitions and dispositions of assets and other interests.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) USE OF ESTIMATES.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(b) MARKET RISK AND UNCERTAINTIES.
The Company is subject to the risk associated with price movements of
energy commodities and the credit risk associated with the Company's risk
management activities. For additional information regarding these risks, see
Note 6. The Company is also subject to risks relating to the supply and prices
of fuel and electricity, seasonal weather patterns, technological obsolescence
and the regulatory environment in the United States and Western Europe.
(c) PRINCIPLES OF CONSOLIDATION.
The accounts of wholly owned and majority owned subsidiaries of the Company
are included in the Consolidated Financial Statements. The Company accounts for
investments in entities in which the Company has an ownership interest between
20% and 50% and exercises significant influence using the equity method of
accounting. For additional information regarding investments recorded using the
equity method of accounting, see Note 7. Other investments, excluding marketable
securities, are generally carried at cost.
F-9
<PAGE> 151
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) REVENUES.
Revenues from energy sales and services are recorded under the accrual
method and generally are recognized upon delivery. Energy sales and services not
billed by month-end are accrued based upon estimated energy and services
delivered. Domestic electric power and other energy services are sold at
market-based prices through existing power exchanges or through third party
contracts. Energy revenues related to the Company's power generation facilities
in Europe are generated under a regulated pricing structure, which includes
compensation for the cost of fuel, capital and operation and maintenance
expenses. The electric generation market in the Netherlands opened to wholesale
competition on January 1, 2001. The Company's energy trading and marketing
operations are accounted for under mark-to-market accounting. In 1998, the
Company adopted mark-to-market accounting for all its energy trading, marketing
and price risk management operations. See Notes 2(s) and 6.
(e) GENERAL, ADMINISTRATIVE AND DEVELOPMENT EXPENSES.
The general, administrative and development expenses in the Statements of
Consolidated Operations include employee related costs of the trading, marketing
and risk management operations; corporate services (including management
services, financial and tax accounting, cash management and treasury support,
legal, information technology system support, office management, and human
resources); and business development costs.
(f) LONG-LIVED ASSETS AND INTANGIBLES.
The Company records property, plant and equipment at historical cost. The
Company recognizes repair and maintenance costs incurred in connection with
planned major maintenance, such as turbine and generator overhauls, control
system upgrades and air conditioner replacements, under the "accrual in advance"
method for its power generation operations acquired or developed prior to
December 31, 1999. Planned major maintenance cycles primarily range from two to
ten years. Under the accrual in advance method, the Company estimates the costs
of planned major maintenance and accrues the related expense over the
maintenance cycle. As of December 31, 1998 and 1999 and September 30, 2000, the
Company's major maintenance reserve was $35 million, $48 million and $31
million, respectively, of which zero, $2 million and $8 million were included in
other current liabilities, respectively. The Company expenses all other repair
and maintenance costs as incurred. For the power generation operations acquired
or developed subsequent to January 1, 2000, the Company expenses all repair and
maintenance costs as incurred, including planned major maintenance. Property,
plant and equipment includes the following:
<TABLE>
<CAPTION>
ESTIMATED DECEMBER 31,
USEFUL LIVES -------------- SEPTEMBER 30,
(YEARS) 1998 1999 2000
------------ ---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Electric generation facilities.................. 10 - 40 $237 $2,348 $2,690
Building and building improvements.............. 15 - 20 -- 2 11
Other........................................... 3 - 10 27 39 59
Land and land improvements...................... -- 17 48 141
Assets under construction....................... -- -- 11 942
---- ------ ------
Total property, plant and equipment............. 281 2,448 3,843
Accumulated depreciation........................ (11) (41) (121)
---- ------ ------
Total property, plant and equipment,
net.................................. $270 $2,407 $3,722
==== ====== ======
</TABLE>
F-10
<PAGE> 152
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company records goodwill for the excess of the purchase price over the
fair value assigned to the net assets of an acquisition. Goodwill is amortized
on a straight-line basis over 10 to 40 years. See Note 5 and the following table
for further information regarding goodwill and the related amortization periods.
<TABLE>
<CAPTION>
DECEMBER 31,
AMORTIZATION ------------- SEPTEMBER 30,
ACQUISITION PERIOD (YEARS) 1998 1999 2000
----------- -------------- ---- ------ -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Reliant Energy Mid-Atlantic Power Holdings, LLC...... 35 $ -- $ -- $ 7
N.V. UNA............................................. 30 -- 864 885
Florida Generation Plant............................. 35 -- 2 2
California Generation Plants......................... 30 70 70 70
Reliant Energy Services, Inc. ....................... 40 131 131 131
Other................................................ 10 - 15 -- 37 59
---- ------ ------
Total goodwill.............................. 201 1,104 1,154
Accumulated amortization............................. (6) (17) (38)
Foreign currency exchange impact..................... -- (61) (153)
---- ------ ------
Total goodwill, net......................... $195 $1,026 $ 963
==== ====== ======
</TABLE>
The Company recognizes specifically identifiable intangibles, including air
emissions regulatory allowances, water rights and permits when specific rights
and contracts are acquired. The Company amortizes air emissions regulatory
allowances primarily on a units-of-production basis as utilized. The Company
amortizes other acquired intangibles on a straight-line basis over the lesser of
their contractual or estimated useful lives that range between 20 and 35 years.
The Company periodically evaluates long-lived assets, including property,
plant and equipment, goodwill and specifically identifiable intangibles, when
events or changes in circumstances indicate that the carrying value of these
assets may not be recoverable. The determination of whether an impairment has
occurred is based on an estimate of undiscounted cash flows attributable to the
assets, as compared to the carrying value of the assets. To date, no impairment
has been indicated.
(g) DEPRECIATION AND AMORTIZATION EXPENSE.
Depreciation for the years ended December 31, 1997, 1998 and 1999 and the
nine months ended September 30, 1999 and 2000, was $1 million, $10 million, $31
million, $11 million (unaudited) and $82 million, respectively. Amortization of
goodwill for the same periods was $1 million, $5 million, $11 million, $4
million (unaudited) and $21 million, respectively. Other amortization expense,
including amortization of air emissions regulatory allowances and other
intangibles, was $27 million during the nine months ended September 30, 2000 and
less than $1 million during the years ended December 31, 1997, 1998 and 1999 and
nine months ended September 30, 1999 (unaudited), respectively.
(h) CAPITALIZATION OF INTEREST.
Interest is capitalized as a component of projects under construction and
will be amortized over the projects' estimated useful lives. During the year
ended December 31, 1999 and the nine months ended September 30, 1999 and 2000,
the Company capitalized interest of $8 million, $1 million (unaudited) and $23
million, respectively. There was no interest capitalized in 1998 and 1997.
F-11
<PAGE> 153
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(i) INCOME TAXES.
The Company is included in the consolidated income tax returns of Reliant
Energy. The Company calculates its income tax provision on a separate return
basis under a tax sharing agreement with Reliant Energy. The Company uses the
liability method of accounting for deferred income taxes and measures deferred
income taxes for all significant income tax temporary differences. Current
federal and state income taxes are payable to or receivable from Reliant Energy.
Unremitted earnings from the Company's foreign operations are deemed to be
permanently reinvested in foreign operations. For additional information
regarding income taxes, see Note 10.
(j) EARNINGS PER SHARE.
Prior to August 9, 2000, the Company was not a separate legal entity and
therefore had no historical capital structure. Accordingly, historical earnings
per share have not been presented for the accompanying consolidated statements
of operations.
(k) ALLOWANCE FOR DOUBTFUL ACCOUNTS.
Accounts and notes receivable, principally from customers, on the Company's
Consolidated Balance Sheets are net of an allowance for doubtful accounts of $7
million, $15 million and $19 million at December 31, 1998 and 1999 and September
30, 2000, respectively. The provision for doubtful accounts in the Statements of
Consolidated Operations for the years ended December 1998 and 1999, and the nine
months ended September 30, 2000 was $6 million, $1 million and $4 million,
respectively. The provision for doubtful accounts in 1997 was immaterial.
(l) INVENTORY.
Inventory consists principally of materials and supplies, coal, natural gas
and heating oil inventories. Inventories used in the production of electricity
are valued at the lower of average cost or market. Heating oil and natural gas
used in the trading and marketing operations are accounted for under
mark-to-market accounting as discussed in Note 6. Below is a detail of
inventory:
<TABLE>
<CAPTION>
DECEMBER 31,
------------- SEPTEMBER 30,
1998 1999 2000
---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C>
Materials and supplies.................................. $ 3 $ 9 $ 46
Coal.................................................... -- -- 12
Natural gas............................................. 13 9 20
Heating oil............................................. 81 21 26
--- --- ----
Total inventory................................ $97 $39 $104
=== === ====
</TABLE>
(m) INVESTMENT IN OTHER DEBT AND EQUITY SECURITIES.
As of December 31, 1998 and 1999 and September 30, 2000, the Company held
marketable equity securities of $11 million, $9 million and $9 million,
respectively, classified as "available-for-sale." In accordance with Statement
of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS No. 115), the Company reports
"available-for-sale" securities at estimated fair value in other long-term
assets in the Company's Consolidated Balance Sheets and any unrealized gain or
loss, net of tax, as a
F-12
<PAGE> 154
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
separate component of stockholder's equity and accumulated other comprehensive
loss. At December 31, 1998 and 1999 and September 30, 2000, the accumulated
unrealized loss, net of tax, relating to these equity securities was $16 million
and $17 million and zero, respectively. During the nine months ended September
30, 2000 pursuant to SFAS No. 115, the Company incurred pre-tax impairment loss
equal to the $27 million of cumulative unrealized losses that had been charged
to other comprehensive income through December 31, 1999. Management's
determination to recognize this impairment resulted from a combination of events
occurring in 2000 related to this investment. Such events affecting the
investment included changes occurring in the investment's senior management,
announcement of significant restructuring charges and related downsizing for the
entity, reduced earnings estimates for this entity by brokerage analysts and the
bankruptcy of a competitor of the investment in the first quarter of 2000. These
events coupled with the stock market value of the Company's investment in these
securities continuing to be below the Company's cost basis, caused management to
believe the decline in fair value of these "available-for-sale" securities to be
other than temporary.
In addition, the Company holds debt and equity securities classified as
"trading." In accordance with SFAS No. 115, the Company reports "trading"
securities at estimated fair value in the Company's Consolidated Balance Sheets
and any unrealized holding gains and losses are recorded as gains (losses) from
investments in the Statements of Consolidated Operations. As of December 31,
1999, the Company held $129 million of debt securities that were classified as
"trading." This investment was recorded in marketable debt securities in the
Company's Consolidated Balance Sheet as of December 31, 1999. As of December 31,
1999 and September 30, 2000, the Company held $14 million of equity securities
that are classified as "trading." As of December 31, 1998, equity securities
which are classified as "trading" were not material. The Company recorded
unrealized holding gains on "trading" securities included in gains from
investments in the Statements of Consolidated Operations of $7 million and $6
million for the year ended December 31, 1999 and nine months ended September 30,
2000, respectively. No unrealized gains or losses on "trading" securities were
recorded in 1997 or 1998.
(n) PROJECT DEVELOPMENT COSTS.
Project development costs include costs for professional services, permits
and other items that are incurred incidental to a particular project. The
Company expenses these costs as incurred until the project is considered
probable. After a project is considered probable, capitalizable costs incurred
are capitalized to the project. When project operations begin, the Company
begins to amortize these costs on a straight-line basis over the life of the
facility. As of December 31, 1998 and 1999 and September 30, 2000, the Company
had recorded in the Consolidated Balance Sheets project development costs of $8
million, $3 million and $4 million, respectively.
(o) LONG-TERM OTHER ASSETS.
Long-term other assets in the Consolidated Balance Sheets include margin
deposits on energy marketing and trading activities, certain marketable
securities and deferred debits. As of December 31, 1999 and September 30, 2000,
margin deposits on energy marketing and trading activities were $34 million and
$93 million, respectively, and were not material as of December 31, 1998.
F-13
<PAGE> 155
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(p) ENVIRONMENTAL COSTS.
The Company expenses or capitalizes environmental expenditures, as
appropriate, depending on their future economic benefit. The Company expenses
amounts that relate to an existing condition caused by past operations, and that
do not have future economic benefit. The Company records undiscounted
liabilities related to these future costs when environmental assessments and/or
remediation activities are probable and the costs can be reasonably estimated.
(q) FOREIGN CURRENCY TRANSLATION.
Local currencies are the functional currency of the Company's foreign
operations. Foreign subsidiaries' assets and liabilities have been translated
into U.S. dollars using the exchange rate at the balance sheet date. Revenues,
expenses, gains and losses have been translated using the weighted average
exchange rate for each month prevailing during the periods reported. Cumulative
adjustments resulting from translation have been recorded in stockholder's
equity and accumulated other comprehensive loss.
(r) STATEMENTS OF CONSOLIDATED CASH FLOWS.
For purposes of reporting cash flows, the Company considers cash
equivalents to be short-term, highly liquid investments readily convertible to
cash.
(s) CHANGES IN ACCOUNTING PRINCIPLES.
Effective January 1, 1998, the Company adopted mark-to-market accounting
for all of its energy trading, marketing and risk management operations. Under
mark-to-market accounting, the Company records at each balance sheet date the
fair value of energy related derivative financial instruments, including
physical forward contracts, swaps, options and exchange-traded futures and
option contracts. These amounts are recorded as price risk management assets and
liabilities in the Company's Consolidated Balance Sheets. The realized and
unrealized gains and losses are recorded as a component of revenues. There was
no material cumulative effect resulting from this accounting change.
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This statement
requires capitalization of some costs of internal-use software. The Company
adopted SOP 98-1 in the second quarter of 1998 without a material impact on the
Consolidated Financial Statements.
The AICPA's SOP 98-5, "Reporting on the Costs of Start-Up Activities," was
adopted by the Company in the fourth quarter of 1998. This statement requires
that certain costs of start-up activities and organizational costs be expensed
as incurred. The adoption of SOP 98-5 did not have a material impact on the
Consolidated Financial Statements.
The Company adopted Emerging Issues Task Force Issue (EITF) 98-10,
"Accounting for Contracts Involved in Energy Trading and Risk Management
Activities" (EITF 98-10), on January 1, 1999. The adoption of EITF 98-10 had no
material impact on the Consolidated Financial Statements.
F-14
<PAGE> 156
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(t) NEW ACCOUNTING PRONOUNCEMENTS.
Effective January 1, 2001, the Company is required to adopt SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" as amended (SFAS
No. 133), which establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. This statement requires that derivatives
be recognized at fair value in the balance sheet and that changes in fair value
be recognized either currently in earnings or deferred as a component of other
comprehensive income, depending on the intended use of the derivative, its
resulting designation and its effectiveness. In addition, in June 2000, the
Financial Accounting Standards Board issued an amendment that narrows the
applicability of the pronouncement to some purchase and sales contracts and
allows hedge accounting for some other specific hedging relationships. Adoption
of SFAS No. 133 will result in no cumulative after-tax change in net income and
a cumulative after-tax reduction of other comprehensive income of approximately
$261 million in the first quarter of 2001. The adoption will also impact assets
and liabilities recorded on the balance sheet.
Staff Accounting Bulletin No. 101, "Revenue Recognition" (SAB No. 101), was
issued by the SEC on December 3, 1999. SAB No. 101 summarizes certain of the SEC
staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. The Company's Consolidated Financial
Statements reflect the accounting principles provided in SAB No. 101.
(u) COMPREHENSIVE INCOME(UNAUDITED).
The following table summarizes the components of total comprehensive income
for the nine months ended September 30, 1999 (in millions).
<TABLE>
<S> <C>
Net income.................................................. $ 9
Other comprehensive loss:
Unrealized loss on available for sale securities.......... (1)
---
Comprehensive income........................................ $ 8
===
</TABLE>
(3) HISTORICAL RELATED PARTY TRANSACTIONS
The Consolidated Financial Statements include significant transactions
between the Company and Reliant Energy involving services, including various
corporate support services (including accounting, finance, investor relations,
planning, legal, communications, governmental and regulatory affairs and human
resources), information technology services and other shared services such as
corporate security, facilities management, accounts receivable, accounts payable
and payroll, office support services and purchasing and logistics. The costs of
services have been directly charged or allocated to the Company using methods
that management believes are reasonable. These methods include negotiated usage
rates, dedicated asset assignment, and proportionate corporate formulas based on
assets, operating expenses and employees. These charges and allocations are not
necessarily indicative of what would have been incurred had the Company been a
separate entity. Amounts charged and allocated to the Company for these services
were $0.7 million, $3 million, $11 million, $7 million (unaudited) and $28
million for the years ended December 31, 1997, 1998 and 1999 and the nine months
ended September 30, 1999 and 2000, respectively, and are included primarily in
operation and maintenance expenses and general and administrative expenses. In
addition, some subsidiaries of the Company have entered into office rental
agreements with Reliant Energy. In the years ended December 31, 1997, 1998 and
1999 and the nine months ended September 30, 1999 and
F-15
<PAGE> 157
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2000, the Company incurred $0.2 million, $0.9 million, $1.2 million, $0.9
million (unaudited) and $3 million, respectively, of rent expense to Reliant
Energy.
These services and office space lease arrangements between the Company and
Reliant Energy will continue after the Offering under transition service
agreements or other long-term agreements. It is not anticipated that a change,
if any, in these costs and revenues would have a material effect on the
Company's consolidated results of operations, cash flows or financial position.
For additional information regarding these services and office space lease
arrangements between the Company and Reliant Energy, see Note 4(a).
Below is a detail of accounts and notes receivable from and payable to
affiliated companies that are not part of the Company:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------- SEPTEMBER 30,
1998 1999 2000
---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C>
Net accounts payable -- affiliated companies.............. $(40) $ (75) $ (11)
Net short-term notes (payable) receivable -- affiliated
companies............................................... 20 (188) (2,169)
Net long-term notes (payable) receivable -- affiliated
companies............................................... 3 (1,070) (239)
---- ------- -------
Total net accounts and notes payable --affiliated
companies...................................... $(17) $(1,333) $(2,419)
==== ======= =======
</TABLE>
Net accounts payable to affiliated companies, representing primarily
current month balances of transactions between the Company and Reliant Energy or
its subsidiaries, relate primarily to natural gas purchases and sales, interest,
charges for services and office space rental. Net short-term notes
payable/receivable to/from affiliated companies represent the accumulation of a
variety of cash transfers and operating transactions and specific negotiated
financing transactions with Reliant Energy or its subsidiaries and generally
bear interest at market-based rates. Net long-term notes payable/receivable
to/from affiliated companies primarily relate to specific negotiated financing
transactions with Reliant Energy or its subsidiaries that bear interest at
market-based rates. See discussion below for information regarding the notes
payable entered into by the Company with Reliant Energy related to the
acquisition of N.V. UNA (UNA), a Dutch power generation company, during 1999 and
the acquisition of certain assets and operations held by Reliant Energy
Mid-Atlantic Power Holdings, LLC or its subsidiaries (collectively REMA), during
May 2000. Net interest expense related to these net borrowings/receivables was
$8 million, zero (unaudited) and $122 million for the year ended December 31,
1999 and nine months ended September 30, 1999 and 2000, respectively. Net
interest income related to these net borrowings/receivables was $2 million for
both of the years ended December 31, 1997 and 1998. See Note 4(c) for
information regarding the conversion into equity of some of these intercompany
obligations in connection with the closing of the Offering.
Funds for the acquisition of REMA were made available through loans from
Reliant Energy. In May 2000, $1.0 billion of these loans was converted to equity
and $1.0 billion of these loans was repaid in August 2000 from proceeds received
from the sale-leaseback transactions (see Note 5(a)). The loans bear interest at
9.4%.
In connection with funding its purchase of UNA shares (see Note 5(b)), the
Company entered into a 560 million Euro-denominated note (approximately $563
million and $494 million based on the December 31, 1999 and September 30, 2000
exchange rate of 1.0062 and 0.8823 U.S. dollars per Euro, respectively) with
Reliant Energy, which matures on July 1, 2001. At
F-16
<PAGE> 158
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
September 30, 2000 and December 31, 1999, the entire Euro 560 million was
outstanding on this note. The note issued under the facility is pre-payable at
any time and is due at the expiration of the facility. Outstanding indebtedness
under the note bore interest at the inter-bank offered rate for Euros (EURIBOR)
plus 0.75% per annum. The applicable interest rate was 4.1% and 5.6% at December
31, 1999 and September 30, 2000, respectively. In connection with the funding of
the second tranche of its purchase obligation for UNA, the Company also issued a
$266 million dollar denominated note payable to Reliant Energy in December 1999,
due March 30, 2001. The note payable bears interest at the London inter-bank
offered rate (LIBOR) plus 0.75% per annum. The applicable interest rate was 6.1%
at December 31, 1999. In February 2000, in connection with the funding of the
third tranche of its purchase obligation for UNA, the $266 million dollar
denominated note payable to Reliant Energy was replaced by a $670 million note
payable to Reliant Energy, due June 1, 2001. The note bears interest at LIBOR
plus 0.75% per annum. The applicable interest rate was 7.2% at September 30,
2000. These notes payable are secured by a junior pledge of 100% of the shares
of the holding company of the Company's European operations.
As of December 31, 1999 and September 30, 2000, Reliant Energy Services,
Inc. (Reliant Energy Services), part of the consolidated Company, had a
long-term note payable of $241 million and $239 million, respectively, owed to
an indirect subsidiary of Reliant Energy. This note payable bears interest at
the prime rate which was 8.50% and 9.50% as of December 31, 1999 and September
30, 2000, respectively. The funds were used for general operating expenses.
The Company had an investment in a financing subsidiary of Reliant Energy
of $108 million at December 31, 1998 and 1999 and September 30, 2000. The
financing subsidiary was liquidated on December 29, 2000. As a result of the
liquidation, the Company had $142 million of a note payable owed to the
financing subsidiary cancelled.
The Company purchases natural gas and transportation services from,
supplies natural gas to, and provides marketing and risk management services to
affiliates of Reliant Energy that are not part of the Company. Purchases of
transportation services and natural gas from Reliant Energy and its subsidiaries
were $59 million, $177 million, $200 million, $155 million (unaudited) and $177
million in the years ended December 31, 1997, 1998 and 1999 and nine months
ended September 30, 1999 and 2000, respectively. During the years ended December
31, 1997, 1998 and 1999 and nine months ended September 30, 1999 and 2000, the
sales and services to Reliant Energy and its subsidiaries totaled $74 million,
$176 million, $330 million, $209 million (unaudited) and $425 million,
respectively.
During the years ended December 31, 1997, 1998 and 1999 and the nine months
ended September 30, 1999 and 2000, Reliant Energy or its subsidiaries made
contributions to the Company of $291 million, $350 million, $236 million, $42
million (unaudited) and $1,068 million, respectively. During 1999, the Company
made distributions to a subsidiary of Reliant Energy of $170 million. The
contributions in 1999 primarily related to cash contributions used to fund (a)
the acquisition of a generating facility in Florida (see Note 5(c)) and (b)
general operating costs. In addition, during 1999, Arkla Finance Corporation, a
subsidiary of the Company, received payment of $170 million on a long-term note
receivable from an affiliate. Arkla Finance Corporation distributed the $170
million to its parent company, Reliant Energy Resources Corp. The capital
contributions in 1998 primarily related to cash contributions used to fund (a)
the acquisition of five electric generation plants in California (see Note
5(d)), (b) the acquisition of other fixed assets and (c) general operating
costs. The capital contributions in 1997 primarily related to a non-cash
contribution of Reliant Energy Services and Arkla Finance Corporation,
F-17
<PAGE> 159
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
businesses acquired by Reliant Energy (see Note 5(e)). The contributions in the
nine months ended September 30, 2000 primarily related to the conversion of a
portion of the borrowings from Reliant Energy used to fund the acquisition of
REMA (see Note 5(a)).
(4) AGREEMENTS BETWEEN RELIANT ENERGY AND THE COMPANY
(a) SERVICES AGREEMENTS.
The Company will enter into agreements with Reliant Energy under which
Reliant Energy will provide the Company with services, including various
corporate support services (including accounting, finance, investor relations,
planning, legal, communications, governmental and regulatory affairs and human
resources), information technology services and other previously shared services
such as corporate security, facilities management, accounts receivable, accounts
payable and payroll, office support services and purchasing and logistics.
These intercompany arrangements will continue after the Offering under a
transition services agreement providing for their continuation until December
31, 2004, or, in the case of certain corporate support services until the
Distribution Date. The charges the Company will pay Reliant Energy for these
services are generally intended to allow Reliant Energy to recover its fully
allocated costs of providing the services, plus out-of-pocket costs and
expenses, but without profit. In each case, the Company will have the right to
terminate categories of services at an earlier date. It is not anticipated that
termination of these service arrangements will have a material effect on the
Company's financial position, results of operations or cash flows.
Pursuant to a lease agreement, Reliant Energy will lease the Company office
space in its headquarters building in Houston, Texas for an interim period.
Under a retail customer care services contract, the Company will provide
customer service, call center operations and credit and collections for Reliant
Energy's electric utility division and revenue reporting and analysis services
to Reliant Energy for its electric utility division and two of its natural gas
distribution divisions. Reliant Energy will provide the office and equipment
space for the Company to perform these services. The Company will pay rent to
Reliant Energy at the same rates charged by Reliant Energy to its other business
units. These services will terminate on January 1, 2002. The charges Reliant
Energy will pay the Company for these services are generally intended to allow
the Company to recover its fully allocated costs of providing the services, plus
out-of-pocket costs and expenses, but without any profit. After January 1, 2002,
the Company will provide remittance processing services to Reliant Energy's
natural gas utilities. The Company will be paid for these services on the same
basis as for similar services provided before January 1, 2002. These services
will terminate on January 1, 2004 or earlier by Reliant Energy giving specified
advance notice.
(b) AGREEMENTS RELATING TO TEXAS GENCO.
In connection with the separation of the Company's businesses from those of
Reliant Energy, Reliant Energy will grant the Company an option to purchase all
of the shares of capital stock of an entity (Texas Genco) that will hold the
Texas generating assets of Reliant Energy's electric utility division that will
be owned by Reliant Energy after the initial public offering or distribution
described below. Reliant Energy has agreed either to issue and sell in an
initial public offering or to distribute to its shareholders approximately 19%
of the common stock of Texas Genco by June 30, 2002. The Texas Genco option may
be exercised between January 10, 2004 and January 24, 2004. The per share
exercise price under the option will be the average daily closing price on the
national exchange for publicly held shares of common stock of Texas Genco
F-18
<PAGE> 160
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
for the 30 consecutive trading days with the highest average closing price
during the 120 trading days immediately preceding January 10, 2004, plus a
control premium, up to a maximum of 10%, to the extent a control premium is
included in the valuation determination made by the Public Utility Commission of
Texas (Texas Utility Commission) relating to the market value of Texas Genco's
common stock equity.
The Texas Genco option agreement will require Reliant Energy to lend to or
contribute to the capital of Texas Genco all funds necessary to operate the
business in the ordinary course consistent with past practices and to satisfy
its debts and other obligations and to take commercially reasonable action to
cause Texas Genco to have a capital structure appropriate, in the judgment of
Reliant Energy's board of directors, for the satisfactory marketing of Texas
Genco common stock in an initial public offering or to establish a satisfactory
trading market for Texas Genco common stock following a distribution of shares
to Reliant Energy's shareholders at the time of the initial public offering or
distribution. It also will contain covenants relating to the operation of the
Texas Genco assets prior to the exercise or expiration of the option and
requires that Reliant Energy maintain ownership of all equity of Texas Genco
until exercise or expiration of the Texas Genco option, subject to the 19%
initial public offering or distribution obligation.
The Company will provide engineering and technical support services and
environmental, safety and industrial health services to support operation and
maintenance of Texas Genco's facilities. The Company will also provide systems,
technical, programming and consulting support services and hardware maintenance
(but excluding plant-specific hardware) necessary to provide dispatch planning,
dispatch and settlement and communication with the independent system operator.
The fees charged for these services will be designated to allow the Company to
recover its fully allocated direct and indirect costs and reimbursement of
out-of-pocket expenses. Expenses associated with capital investment in systems
and software that benefit both the operation of Texas Genco's facilities and our
facilities in other regions will be allocated on an installed megawatt basis.
The term of the technical services agreement will begin on the Distribution
Date. The term of this agreement will end on the first to occur of (a) the
Company's exercise of the Texas Genco option, (b) Reliant Energy's sale of Texas
Genco, or all or substantially all of the assets of Texas Genco, if the Company
does not exercise the Texas Genco option, or (c) December 31, 2004, provided the
Texas Genco option is not exercised, Texas Genco may extend the term of this
agreement until December 31, 2005.
When Texas Genco is organized, it will become the beneficiary of the
decommissioning trust that has been established to provide funding for
decontamination and decommissioning of a nuclear electric generation station in
which Reliant Energy owns a 30.8% interest. The master separation agreement will
provide that Reliant Energy will collect through rates or other authorized
charges to its electric utility customers amounts designated for funding the
decommissioning trust, and will pay the amounts to Texas Genco. Texas Genco will
in turn be required to deposit these amounts received from Reliant Energy into
the decommissioning trust. Upon decommissioning of the facility, in the event
funds from the trust are inadequate, Reliant Energy will be required to collect
through rates or other authorized charges to customers as contemplated by the
Texas Utilities Code all additional amounts required to fund Texas Genco's
obligations relating to the decommissioning of the facility. Following the
completion of the decommissioning, if surplus funds remain in the
decommissioning trust, the excess will be refunded to Reliant Energy's
ratepayers.
F-19
<PAGE> 161
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(c) CONVERSION OF INDEBTEDNESS TO RELIANT ENERGY AND ITS SUBSIDIARIES.
Reliant Energy will agree that all indebtedness owed by the Company to
Reliant Energy and its subsidiaries prior to the closing of the Offering will be
converted into equity as a capital contribution which will be recorded as an
increase to stockholder's equity.
(d) OTHER AGREEMENTS.
In connection with the separation of the Company's businesses from those of
Reliant Energy, the Company will also enter into other agreements providing,
among other things, for mutual indemnities and releases with respect to the
Company's respective businesses and operations, matters relating to corporate
governance, matters relating to responsibility for employee compensation and
benefits, and allocation of tax liabilities.
In addition, the Company and Reliant Energy will enter into various
agreements relating to ongoing commercial arrangements, including among other
things the leasing of optical fiber and related maintenance activities, rights
to build fiber networks along existing rights of way, and the provision of local
exchange telecommunications and data services in the greater Houston
metropolitan area and long distance telecommunications services.
(5) BUSINESS ACQUISITIONS
(a) RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC.
On May 12, 2000, a subsidiary of the Company purchased entities owning
electric power generating assets and development sites located in Pennsylvania,
New Jersey and Maryland having an aggregate net generating capacity of
approximately 4,262 megawatts (MW). With the exception of development entities
that were sold to another subsidiary of the Company in July 2000, the assets of
the entities acquired are held by REMA. The purchase price for the May 2000
transaction was $2.1 billion. The Company accounted for the acquisition as a
purchase with assets and liabilities of REMA reflected at their estimated fair
values. Subsequent to the issuance of its financial statements for the nine
months ended September 30, 2000, management determined that its preliminary
purchase price allocation for the REMA acquisition should be reallocated. This
reallocation resulted in the elimination of major maintenance reserves, and
related reductions of goodwill and deferred tax assets, previously recorded in
connection with the REMA acquisition. As a result, the Company has revised its
September 30, 2000 consolidated balance sheet to reduce major maintenance
reserves, goodwill and deferred tax assets by $110 million, $67 million and $44
million, respectively. In addition, the Company recognized an increase in
deferred tax liabilities of $21 million resulting from book/tax basis
differences of recorded air emissions regulatory allowances. Such deferred tax
effects and the corresponding increase in goodwill had not been considered in
connection with the Company's previously recorded REMA acquisition purchase
price allocation. On a preliminary basis, the Company's fair value adjustments
related to the acquisition primarily included adjustments in property, plant and
equipment, air emissions regulatory allowances, materials and supplies
inventory, environmental reserves and related deferred taxes. The Company
believes that the fair value allocated to property, plant and equipment acquired
in connection with the REMA acquisition properly reflects planned major
maintenance activities. The air emissions regulatory allowances of $153 million
are being amortized on a units-of-production basis as utilized. The excess of
the purchase price over the fair value of net assets acquired of approximately
$7 million was recorded as goodwill and is being amortized over 35 years. The
Company expects to finalize these fair value adjustments no later than May 2001,
based on valuation reports of property, plant and equipment and intangible
assets and does not anticipate additional material modifications to the
preliminary adjustments. Funds for the acquisition of REMA were made available
through loans from Reliant Energy. In
F-20
<PAGE> 162
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
May 2000, $1.0 billion of these loans were subsequently converted to equity.
Reliant Energy obtained these funds through commercial paper borrowings by a
finance subsidiary, which borrowings were supported by bank credit facilities.
The net purchase price of REMA was allocated and the fair value adjustments
to the seller's book value are as follows (in millions):
<TABLE>
<CAPTION>
PURCHASE FAIR
PRICE VALUE
ALLOCATION ADJUSTMENTS
---------- -----------
<S> <C> <C>
Current assets.............................................. $ 75 $ (37)
Property, plant and equipment............................... 1,941 670
Goodwill.................................................... 7 (144)
Other intangibles........................................... 153 (10)
Other assets................................................ 4 (4)
Current liabilities......................................... (45) (8)
Other liabilities........................................... (38) (14)
------ -----
$2,097 $ 453
====== =====
</TABLE>
Adjustments to property, plant and equipment, other intangibles which
includes air emissions regulatory allowances, and environmental reserves
included in other liabilities are based primarily on preliminary or final
valuation reports prepared by independent appraisers and consultants.
In August 2000, the Company sold to and leased back from each of three
owner-lessors in separate lease transactions the Company's respective 16.45%,
16.67% and 100% interests in the Conemaugh, Keystone and Shawville generating
stations, respectively, acquired as part of the REMA acquisition. As lessee, the
Company leases an interest in each facility from each owner-lessor under a
facility lease agreement. As consideration for the sale of the Company's
interest in the facilities, the Company received $1.0 billion in cash. The
Company used the $1.0 billion of sale proceeds to repay intercompany
indebtedness owed by the Company to Reliant Energy.
The Company's results of operations include the results of REMA only for
the period beginning May 12, 2000. Prior to November 24, 1999, the acquired
entities' operations were fully integrated with, and their results of operations
were consolidated into, the regulated electric utility operations of a prior
owner of the facilities. In addition, prior to November 24, 1999, the electric
output of the facilities was sold based on rates set by regulatory authorities
and are not indicative of REMA's future results. The following table presents
selected actual financial information and unaudited pro forma information for
the nine months ended September 30, 2000 and the year ended December 31, 1999,
as if the acquisition had occurred on January 1, 2000 and November 24, 1999, as
applicable. Pro forma information has not been presented for REMA for the nine
months ended September 30, 1999. Pro forma information would not be meaningful
since historical financial results of the business and the revenue generating
activities underlying that period as described above are substantially different
from the wholesale generation activities that REMA has been engaged in after
November 24, 1999. Pro forma amounts also give effect to the sale and leaseback
of interests in three of the REMA generating plants, which were consummated in
August 2000.
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 1999 SEPTEMBER 30, 2000
------------------ -------------------
ACTUAL PRO FORMA ACTUAL PRO FORMA
------ --------- ------- ---------
(IN MILLIONS, EXCEPT FOR PER SHARE)
<S> <C> <C> <C> <C>
Revenues................................................ $8,053 $8,082 $12,820 $12,986
Income before extraordinary item........................ 24 14 245 222
Net income.............................................. 24 14 252 229
</TABLE>
F-21
<PAGE> 163
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
These unaudited pro forma results, based on assumptions deemed appropriate
by the Company's management, have been prepared for informational purposes only
and are not necessarily indicative of the amounts that would have resulted if
the acquisition of the REMA entities had occurred on January 1, 2000 and
November 24, 1999, as applicable. Purchase-related adjustments to the results of
operations include the effects on depreciation and amortization, interest
expense and income taxes.
(b) UNA.
Effective October 7, 1999, the Company acquired UNA, a Dutch electric
generation company, for a total net purchase price, payable in Dutch Guilders
(NLG), of $1.9 billion based on an exchange rate on October 7, 1999 of 2.06 NLG
per U.S. dollar. The aggregate purchase price paid in 1999 by the Company
consisted of $833 million in cash. On March 1, 2000, under the terms of the
acquisition agreement, the Company funded the remaining purchase obligation for
$982 million. The business purchase obligation was recorded in the Consolidated
Balance Sheet as of December 31, 1999, based on the exchange rate on December
31, 1999, of 2.19 NLG per U.S. dollar. A portion ($596 million) of the business
purchase obligation was classified as a non-current liability, as this portion
of the obligation was financed with a three-year term loan facility obtained
subsequent to December 31, 1999 (see Note 8). The impact of UNA's results of
operations from October 1 through October 7, 1999 was immaterial to the
Company's consolidated results of operations.
The Company recorded the UNA acquisition under the purchase method of
accounting, with assets and liabilities of UNA reflected at their estimated fair
values. As outlined in the table below, on a preliminary basis, the Company's
fair value adjustments related to the acquisition of UNA primarily included
increases in property, plant and equipment, long-term debt, severance
liabilities, post-employment benefit liabilities and deferred taxes.
Additionally, a $19 million receivable, was recorded in connection with the
acquisition as the selling shareholders agreed to fully indemnify UNA for
certain obligations incurred prior to the purchase of UNA. Adjustments to
property, plant and equipment are based primarily on valuation reports prepared
by independent appraisers and consultants. The excess of the purchase price over
the fair value of net assets acquired of approximately $885 million was recorded
as goodwill and will be amortized on a straight-line basis over 30 years. The
Company finalized these fair value adjustments during September 2000. The
Company finalized a severance plan (the UNA Plan) in connection with the UNA
acquisition in September 2000 (commitment date) and in accordance with EITF 95-3
"Recognition of Liabilities in Connection with a Purchase Business Combination,"
recorded this liability of $19 million in the September 30, 2000 Consolidated
Balance Sheet.
In connection with the acquisition of UNA, the Company developed a
comprehensive business process reengineering and employee severance plan
intended to make UNA competitive in the deregulated Dutch electricity market
that began January 1, 2001. The UNA Plan's initial conceptual formulation was
initiated prior to the acquisition of UNA in October 1999. The finalization of
the UNA Plan was approved and completed in September 2000. The Company
identified 195 employees which will be involuntarily terminated in UNA's
following functional areas: plant operations and maintenance, procurement,
inventory, general and administrative, legal, finance and support. The Company
has notified all employees identified as redundant under the severance component
of the UNA Plan that they are subject to involuntary termination and that the
majority of terminations will occur over a period not to exceed twelve months
from the date of finalization of the UNA Plan. The termination benefits under
the UNA Plan are governed by UNA's Social Plan, a collective bargaining
agreement between UNA and its various representative labor unions signed in
1998. The Social Plan provides defined benefits for
F-22
<PAGE> 164
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
involuntarily severed employees depending upon age, tenure and other factors,
and was agreed to by the management of UNA as a result of the anticipated
deregulation of the Dutch electricity market. The Social Plan is still in force
and binding on the current management of the Company and UNA. The Company is
currently executing the UNA Plan as of the date of these Consolidated Financial
Statements.
The net purchase price of UNA was allocated and the fair value adjustments
to the seller's book value are as follows (in millions):
<TABLE>
<CAPTION>
PURCHASE
PRICE FAIR VALUE
ALLOCATION ADJUSTMENTS
---------- -----------
<S> <C> <C>
Current assets.............................................. $ 229 $ 19
Property, plant and equipment............................... 1,899 719
Goodwill.................................................... 885 885
Current liabilities......................................... (336) --
Deferred taxes.............................................. (81) (81)
Long-term debt.............................................. (422) (87)
Other long-term liabilities................................. (244) (35)
------ ------
$1,930 $1,420
====== ======
</TABLE>
The following table presents selected actual financial information for the
years ended December 31, 1998 and 1999, and unaudited pro forma information for
the years ended December 31, 1998 and 1999, as if the acquisition of UNA had
occurred on January 1, 1998 and 1999, respectively. The pro forma results are
based on assumptions deemed appropriate by the Company's management, have been
prepared for informational purposes only and are not necessarily indicative of
the consolidated results that would have resulted if the acquisition of UNA had
occurred on January 1, 1998 and 1999. Purchase related adjustments to results of
operations include amortization of goodwill, interest expense and the effects on
depreciation and amortization of the assessed fair value of some of UNA's net
assets and liabilities.
<TABLE>
<CAPTION>
1998 1999
------------------ ------------------
ACTUAL PRO FORMA ACTUAL PRO FORMA
------ --------- ------ ---------
(IN MILLIONS, EXCEPT FOR PER SHARE)
<S> <C> <C> <C> <C>
Revenues............................................ $4,371 $5,203 $8,053 $8,533
Net income (loss)................................... 21 73 24 (3)
</TABLE>
(c) FLORIDA GENERATION PLANT PURCHASE.
On October 6, 1999, the Company purchased a steam turbine generation plant
(Indian River) with a net generating capacity of 619 MW from a Florida
municipality (the Municipality) for a net purchase price of $188 million. Indian
River, located near Titusville, Florida, consists of three conventional steam
generation units fueled by both oil and natural gas. Under the Company's
ownership, the units will continue to provide electricity to the Municipality
through a four-year power purchase agreement. The Company expects excess power
to be sold to other utilities and rural electric cooperatives within the state
and other entities within the Florida wholesale market. The Company recorded the
acquisition under the purchase method of accounting. The purchase price has been
allocated to assets acquired and liabilities assumed based on their estimated
fair market values at the date of acquisition. The Company's fair value
adjustments related to the acquisition of Indian River primarily included
increases in property, plant and equipment, specific intangibles related to
water rights and permits, major maintenance reserves and related deferred taxes.
The specific intangibles of $112 million are being amortized
F-23
<PAGE> 165
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
over their contractual lives of 35 years. The Company finalized these fair value
adjustments during September 2000. There were no material adjustments made to
the purchase allocation subsequent to December 31, 1999.
Net purchase price of Indian River was allocated as follows (in millions):
<TABLE>
<S> <C>
Current assets.............................................. $ 15
Property, plant and equipment............................... 93
Goodwill.................................................... 2
Other intangibles........................................... 112
Major maintenance reserve................................... (3)
Other long-term liabilities................................. (31)
----
$188
====
</TABLE>
The Company's results of operations include Indian River's results of
operations only for the period beginning with the October 6, 1999 acquisition
date. Pro forma information has not been presented for Indian River for 1999 and
1998. Pro forma information would not be meaningful since historical financial
results of the business and the revenue generating activities underlying that
period as described below are substantially different from the wholesale
generation activities that Indian River has been engaged in after October 6,
1999. Prior to the Company's acquisition, the acquired Indian River generation
operations were fully integrated with, and its results of operations were
consolidated into, the Municipality's vertically-integrated utility operations.
In addition, prior to the Company's acquisition, the electric output of these
facilities was sold based on rates set by regulatory authorities and are not
indicative of these assets' future operating results as a wholesale electricity
provider.
(d) CALIFORNIA GENERATION PLANT PURCHASE.
In April and July 1998, the Company completed the acquisitions of five
natural gas-fired, electric generation plants located in southern California
with a total net generating capacity of 3,800 MW from Southern California Edison
Company (the Utility) for $292 million. Although the Company exercises
management authority over these five plants, the Company has contracted with the
Utility to operate and maintain these five plants through March 2003; however,
the Company has elected to terminate this agreement in April 2001. The Company
recorded the acquisitions under the purchase method of accounting. The purchase
price has been allocated to assets acquired and liabilities assumed based on
their estimated fair market values at the date of acquisition, while the balance
of $70 million was recorded as goodwill and is being amortized on a
straight-line basis over 30 years. The Company's fair value adjustments related
to the acquisition of the California generating plants primarily included
adjustments to inventory, property, plant and equipment, major maintenance
reserves and related deferred taxes.
The net purchase price of the California generating plants was allocated
and the fair value adjustments to the seller's book value are as follows (in
millions):
<TABLE>
<CAPTION>
PURCHASE FAIR
PRICE VALUE
ALLOCATION ADJUSTMENTS
---------- -----------
<S> <C> <C>
Property, plant and equipment............................... $247 $ (7)
Goodwill.................................................... 70 70
Other assets................................................ 6 (3)
Major maintenance reserve................................... (31) (31)
---- ----
$292 $ 29
==== ====
</TABLE>
F-24
<PAGE> 166
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reserve for major maintenance has been recorded to conform to the
Company's policy to account for major maintenance costs using the accrual in
advance method (see Note 2(f)).
The Company's results of operations include the California generating
plants' results of operations only for the period beginning with the respective
acquisition dates. Pro forma information has not been presented for the
California generating plants for 1998 and 1997. Pro forma information would not
be meaningful since historical financial results of the business and the revenue
generating activities underlying that period as described below are
substantially different from the wholesale generation activities that the
California generating plants have been engaged in after the acquisitions. Prior
to the Company's acquisition, the acquired California generating operations were
fully integrated with, and their results of operations were consolidated into,
the Utility's regulated vertically-integrated utility operations. In addition,
prior to the Company's acquisition, the electric output of these facilities was
sold based on rates set by regulatory authorities and were not indicative of
these assets' future operating results as a wholesale electricity provider.
(e) RELIANT ENERGY SERVICES, INC. AND RELATED COMPANY.
In August 1997, a subsidiary of Reliant Energy merged with Reliant Energy
Resources Corp. (formerly NorAm Energy Corp.) (collectively with its
subsidiaries, RERC), a natural gas gathering, transmission, marketing and
distribution company. The aggregate consideration paid to RERC's stockholders
consisted of $1.4 billion in cash and 47.8 million shares of Reliant Energy's
common stock valued at approximately $1.0 billion. The acquisition of RERC was
recorded under the purchase method of accounting with assets and liabilities
reflected at their estimated fair values at the date of acquisition. Some
subsidiaries of RERC are included in the Company. These subsidiaries consist of
(a) Reliant Energy Services, a company conducting wholesale energy trading,
marketing and risk management services operation and (b) Arkla Finance
Corporation, a company that holds an investment in marketable equity securities
(collectively, Unregulated RERC). The acquisition of these operations is
reflected as a capital contribution to the Company in August 1997 of $287
million in the Consolidated Financial Statements. The consolidated balance
sheets of Unregulated RERC after the acquisition reflect adjustments associated
with the allocation of the purchase price. Debt to fund the cash portion of the
purchase consideration was not allocated or "pushed down" to Unregulated RERC
and is not reflected in the Consolidated Financial Statements of the Company.
The Company recorded the excess of the purchase price allocated to
Unregulated RERC over the fair value of net assets of $131 million as goodwill,
which is being amortized on a straight-line basis over 40 years. The fair value
adjustments for Unregulated RERC included unrecognized pension and
postretirement benefits liabilities, severance liabilities, reserves for losses
on transportation contracts and related deferred taxes. The fair value
adjustment of $11 million for reserves for transportation contracts recorded in
other liabilities was based on published future prices or quoted prices as of
the acquisition date.
F-25
<PAGE> 167
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The net purchase price of Unregulated RERC was allocated and the fair value
adjustments to the seller's book value are as follows (in millions):
<TABLE>
<CAPTION>
PURCHASE
PRICE FAIR VALUE
ALLOCATION ADJUSTMENTS
---------- -----------
<S> <C> <C>
Current assets.............................................. $ 333 $ --
Long-term notes receivables from affiliates, net............ 165 --
Goodwill.................................................... 131 131
Other assets................................................ 142 --
Accounts and notes payable -- affiliated companies, net..... (126) --
Other current liabilities................................... (292) (3)
Deferred taxes.............................................. (24) (15)
Other liabilities........................................... (42) (11)
----- ----
$ 287 $102
===== ====
</TABLE>
The Company's results of operations include Unregulated RERC's results only
for the period beginning with the acquisition date. The following table presents
certain actual and unaudited pro forma financial information for the year ended
December 31, 1997, as if the acquisition of Unregulated RERC had occurred on
January 1, 1997. The pro forma results are based on assumptions deemed
appropriate by the Company's management, have been prepared for informational
purposes only and are not necessarily indicative of the consolidated results
that would have resulted if the acquisition of Unregulated RERC had occurred on
January 1, 1997. Purchase related adjustments to results of operations include
amortization of goodwill.
<TABLE>
<CAPTION>
1997
--------------------
ACTUAL PRO FORMA
------ ---------
(IN MILLIONS, EXCEPT
FOR PER SHARE)
<S> <C> <C>
Revenues.................................................... $1,321 $2,913
Net loss.................................................... (6) (23)
</TABLE>
(6) DERIVATIVE FINANCIAL INSTRUMENTS
(a) PRICE RISK MANAGEMENT AND TRADING ACTIVITIES.
The Company offers energy price risk management services primarily related
to natural gas, electric power and other energy related commodities. The Company
provides these services by utilizing a variety of derivative financial
instruments, including (a) fixed and variable-priced physical forward contracts,
(b) fixed and variable-priced swap agreements, (c) options traded in the
over-the-counter financial markets and (d) exchange-traded energy futures and
option contracts (Trading Derivatives). Fixed-price swap agreements require
payments to, or receipts of payments from, counterparties based on the
differential between a fixed and variable price for the commodity.
Variable-price swap agreements require payments to, or receipts of payments
from, counterparties based on the differential between industry pricing
publications or exchange quotations.
Prior to 1998, the Company applied hedge accounting to some physical
commodity activities that qualified for hedge accounting (see Note 2(s)). In
1998, the Company adopted mark-to-market accounting for all of its energy
trading, marketing and price risk management operations. Accordingly, since
1998, these Trading Derivatives are recorded at fair value with realized and
unrealized gains (losses) recorded as a component of revenues. The recognized,
unrealized balances are included in price risk management assets/liabilities.
F-26
<PAGE> 168
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The notional quantities, maximum terms and the estimated fair value of
Trading Derivatives at December 31, 1998 and 1999 and September 30, 2000, are
presented below (volumes in billions of British thermal units equivalent (Bbtue)
and dollars in millions):
<TABLE>
<CAPTION>
VOLUME-FIXED VOLUME-FIXED MAXIMUM
PRICE PAYOR PRICE RECEIVER TERM (YEARS)
------------ -------------- ------------
<S> <C> <C> <C>
DECEMBER 31, 1998
Natural gas.................................... 937,264 977,293 9
Electricity.................................... 122,950 124,878 3
Crude oil and refined products................. 205,499 204,223 3
DECEMBER 31, 1999
Natural gas.................................... 936,716 939,416 9
Electricity.................................... 251,592 248,176 10
Crude oil and refined products................. 143,857 144,554 3
SEPTEMBER 30, 2000
Natural gas.................................... 2,033,018 2,027,613 12
Electricity.................................... 589,042 586,617 7
Crude oil and refined products................. 129,198 128,616 2
</TABLE>
<TABLE>
<CAPTION>
AVERAGE
FAIR VALUE FAIR VALUE(1)
-------------------- --------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
Natural gas........................................... $ 222 $ 212 $ 124 $ 108
Electricity........................................... 34 33 186 186
Crude oil and refined products........................ 29 23 21 17
------ ------ ------ ------
$ 285 $ 268 $ 331 $ 311
====== ====== ====== ======
DECEMBER 31, 1999
Natural gas........................................... $ 581 $ 564 $ 550 $ 534
Electricity........................................... 122 91 96 74
Crude oil and refined products........................ 193 206 183 187
------ ------ ------ ------
$ 896 $ 861 $ 829 $ 795
====== ====== ====== ======
SEPTEMBER 30, 2000
Natural gas........................................... $2,068 $2,024 $1,391 $1,367
Electricity........................................... 394 372 429 386
Crude oil and refined products........................ 72 78 72 80
------ ------ ------ ------
$2,534 $2,474 $1,892 $1,833
====== ====== ====== ======
</TABLE>
---------------
(1) Computed using the ending balance of each quarter.
In addition to the fixed-price notional volumes above, the Company also had
variable-priced agreements, as discussed above, totaling 1,702,977 Bbtue,
3,797,824 Bbtue and 7,759,006 Bbtue as of December 31, 1998 and 1999 and
September 30, 2000, respectively. Notional amounts reflect the volume of
transactions but do not represent the amounts exchanged by the parties to the
financial instruments. Accordingly, notional amounts do not accurately measure
the Company's exposure to market or credit risks.
All of the fair values shown in the tables above at December 31, 1998 and
1999 and September 30, 2000, have been recognized in income. The Company
estimated the fair value as of December 31, 1998 and 1999 and September 30,
2000, using quoted prices where available and considering the liquidity of the
market for the Trading Derivatives. The prices and fair values are subject to
significant changes based on changing market conditions.
F-27
<PAGE> 169
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted-average term of the trading portfolio, based on volumes, is
less than one year. The maximum and average terms disclosed herein are not
indicative of likely future cash flows, as these positions may be changed by new
transactions in the trading portfolio at any time in response to changing market
conditions, market liquidity and the Company's risk management portfolio needs
and strategies. Terms regarding cash settlements of these contracts vary with
respect to the actual timing of cash receipts and payments.
In addition to the risk associated with price movements, credit risk is
also inherent in the Company's risk management activities. Credit risk relates
to the risk of loss resulting from non-performance of contractual obligations by
a counterparty. The following table shows the composition of the total price
risk management assets of the Company as of December 31, 1998 and 1999 and
September 30, 2000.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1999 SEPTEMBER 30, 2000
------------------ ------------------ -------------------
INVESTMENT INVESTMENT INVESTMENT
GRADE(1) TOTAL GRADE(1) TOTAL GRADE(1) TOTAL
---------- ----- ---------- ----- ---------- -----
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Energy marketers................. $103 $124 $202 $230 $ 777 $ 832
Financial institutions........... 62 62 90 159 643 645
Gas and electric utilities....... 47 48 220 221 752 762
Oil and gas producers............ 7 8 31 31 216 265
Industrials...................... 2 3 3 4 42 45
Independent power producers...... 1 1 -- 2 -- --
Others........................... 45 45 174 261 -- --
---- ---- ---- ---- ------ ------
Total................... $267 291 $720 908 $2,430 2,549
==== ==== ======
Credit and other reserves........ (6) (12) (15)
---- ---- ------
Energy price risk management
assets(2)...................... $285 $896 $2,534
==== ==== ======
</TABLE>
---------------
(1) "Investment Grade" is primarily determined using publicly available credit
ratings along with the consideration of credit support (such as parent
company guarantees) and collateral, which encompass cash and standby letters
of credit.
(2) As of September 30, 2000, the Company had no credit risk exposure to any
single counterparty that represents greater than 5% of price risk management
assets.
(b) NON-TRADING ACTIVITIES.
To reduce the risk from market fluctuations in the revenues derived from
the sale of electric power and natural gas, the Company enters into futures
transactions, forward contracts, swaps and options (Energy Derivatives) in order
to hedge some expected purchases of electric power and natural gas and sales of
electric power and natural gas (a portion of which are firm commitments at the
inception of the hedge). The Company applies hedge accounting for its derivative
financial instruments utilized in non-trading activities. Unrealized changes in
the market value of Energy Derivatives utilized as hedges are not generally
recognized in the Company's Statements of Consolidated Operations until the
underlying hedged transaction occurs. Once it becomes probable that an
anticipated transaction will not occur, the Company recognizes deferred gains
and losses. In general, the financial impact of transactions involving these
Energy Derivatives is included in the Company's Statements of Consolidated
Operations under the captions (a) fuel expenses, in the case of natural gas
transactions, (b) purchased power, in the case of electric power purchase
transactions, and (c) revenues, in the case of electric power sales
transactions. Cash flows resulting from these transactions in Energy Derivatives
are
F-28
<PAGE> 170
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
included in the Company's Statements of Consolidated Cash Flows in the same
category as the item being hedged.
In connection with the Company's acquisition of UNA in 1999, the Company
entered into call option agreements with several banks to hedge the impact of
foreign exchange movements on the Dutch guilder. These call options provided the
right, but not the obligation, to purchase 695 million NLG from specific banks
at specific strike prices. The total premium paid, classified as other expense
on the Statement of Consolidated Operations, for all of the options that were to
expire on October 26, 1999, was $8 million. On October 12, 1999, the Company
sold the remaining value in the call options for $0.6 million. The proceeds were
reflected in the results of operations as a reduction of other expense.
During November 1999 and February 2000, the Company entered into foreign
currency swaps for 258 million and 413 million Euros, respectively
(approximately $228 million and $364 million), terminating in September 2000 and
also issued Euro denominated debt to a subsidiary of Reliant Energy, maturing in
March and June 2001, to hedge its net investment in UNA. During September 2000,
the Company entered into four foreign currency swaps for a total of 671 million
Euros (approximately $592 million) terminating in January 2001. The Company
records changes in the value of the swap and debt as foreign currency
translation adjustments as a component of stockholder's equity and accumulated
other comprehensive loss. The effectiveness of the hedging instruments can be
measured by the net change in foreign currency translation adjustments
attributed to the UNA transaction. These amounts generally offset amounts
recorded in stockholder's equity as adjustments resulting from translation of
the hedged investment into U.S. dollars. As of December 31, 1999 and September
30, 2000, the net carrying value of the currency swaps was a $6 million
receivable and $22 million payable, respectively, and was recorded in other
current assets and other current liabilities in the Consolidated Balance Sheets.
For transactions involving either Energy Derivatives or foreign currency
derivatives, hedge accounting is applied only if the derivative (a) reduces the
risk of the underlying hedged item and (b) is designated as a hedge at its
inception. Additionally, the derivatives must be expected to result in financial
impacts that are inversely correlated to those of the item(s) to be hedged. This
correlation, a measure of hedge effectiveness, is measured both at the inception
of the hedge and on an ongoing basis, with an acceptable level of correlation of
at least 80% for hedge designation. If and when correlation ceases to exist at
an acceptable level, hedge accounting ceases and mark-to-market accounting is
applied.
At December 31, 1998 and 1999 and September 30, 2000, the Company was a
fixed-price payor in Energy Derivatives covering 598 billion British thermal
units (Bbtu), 3,512 Bbtu and 206,367 Bbtu of natural gas, respectively. Also, at
December 31, 1998 and 1999 and September 30, 2000, the Company was a party to
variable-priced Energy Derivatives totaling 846 Bbtu, 3,617 Bbtu and 20,821 Bbtu
of natural gas, respectively. The weighted average maturity of these instruments
is less than one year.
The notional amount is intended to be indicative of the Company's level of
activity in these derivatives. However, the amounts at risk are significantly
smaller because, in view of the price movement correlation required for hedge
accounting, changes in the market value of these derivatives generally are
offset by changes in the value associated with the underlying physical
transactions or in other derivatives. When Energy Derivatives are closed out in
advance of the underlying commitment or anticipated transaction, however, the
market value changes may not offset due to the fact that price movement
correlation ceases to exist when the positions are
F-29
<PAGE> 171
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
closed, as further discussed below. Under those circumstances, gains (losses)
are deferred and recognized as a component of income when the underlying hedged
item is recognized in income.
The average maturity discussed above and the fair value discussed in Note
12 are not necessarily indicative of likely future cash flows, as these
positions may be changed by new transactions in the trading portfolio at any
time in response to changing market conditions, market liquidity and the
Company's risk management portfolio needs and strategies. Terms regarding cash
settlements of these contracts vary as to the actual timing of cash receipts and
payments.
(c) TRADING AND NON-TRADING -- GENERAL POLICY.
In addition to the risk associated with price movements, credit risk is
also inherent in the Company's risk management activities. Credit risk relates
to the risk of loss resulting from non-performance of contractual obligations by
a counterparty. While the Company has experienced only minor losses due to the
credit risk associated with these arrangements to date, the Company has
off-balance sheet risk to the extent that the counterparties to these
transactions may fail to perform as required by the terms of each contract. In
order to minimize this risk, the Company enters into these contracts primarily
with counterparties having a minimum Standard & Poor's or Moody's rating of BBB-
or Baa3, respectively. For long-term arrangements, the Company periodically
reviews the financial condition of these firms in addition to monitoring the
effectiveness of these financial contracts in achieving the Company's
objectives. If the counterparties to these arrangements fail to perform, the
Company would seek to compel performance at law or otherwise obtain compensatory
damages. The Company might be forced to acquire alternative hedging arrangements
or be required to honor the underlying commitment at then-current market prices.
In this event, the Company might incur additional losses to the extent of
amounts, if any, already paid to the counterparties. In view of its criteria for
selecting counterparties, its process for monitoring the financial strength of
these counterparties and its experience to date in successfully completing these
transactions, the Company believes that the risk of incurring a significant
financial statement loss due to the non-performance of counterparties to these
transactions is minimal.
The Company's policies prohibit the use of leveraged financial instruments.
Reliant Energy has established a Risk Oversight Committee comprised of
corporate and business segment officers that oversees all commodity price and
credit risk activities, including the Company's trading, marketing and risk
management activities. The committee's duties are to establish the Company's
commodity risk policies, allocate risk capital within limits established by
Reliant Energy's board of directors, approve trading of new products and
commodities, monitor risk positions and ensure compliance with Reliant Energy's
risk management policies and procedures and trading limits established by
Reliant Energy's board of directors.
(7) EQUITY INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
In April 1998, the Company formed a limited liability corporation to
construct and operate a 490 MW electric generation plant in Boulder City, Nevada
in which the Company has a 50% interest. The plant became operational in May
2000. In October 1998, the Company entered into a partnership to construct and
operate a 100 MW cogeneration plant in Orange, Texas in which its ownership
interest is 50%. The plant began commercial operations in December 1999. As of
December 31, 1998 and 1999 and September 30, 2000, the Company's net investment
in these projects was $42 million, $78 million and $116 million, respectively.
The Company's equity income from these investments was $33 million in the nine
months ended September 30, 2000. The
F-30
<PAGE> 172
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's equity loss from these investments was $0.6 million and $0.8 million
in 1998 and 1999, respectively. During the years ended December 31, 1998 and
1999 and the nine months ended September 30, 2000, there were no distributions
from these investments.
(8) SHORT-TERM BORROWINGS AND LONG-TERM DEBT TO THIRD PARTIES
The following table presents the components of short-term borrowings and
long-term debt to third parties as of December 31, 1999 and September 30, 2000.
There was no debt to third parties outstanding as of December 31, 1998.
<TABLE>
<CAPTION>
DECEMBER 31, 1999 SEPTEMBER 30, 2000
---------------------- ----------------------
LONG-TERM CURRENT(1) LONG-TERM CURRENT(1)
--------- ---------- --------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Total short-term borrowings(2)........... $ -- $170 $ -- $204
Long-term debt:
Reliant Energy Power Generation, Inc.
Notes payable........................ 68 -- 209 --
European Energy(2)(3).................. 347 14 589 1
Debentures unamortized premium(3).... 25 6 3 --
---- ---- ---- ----
Total long-term borrowings...... 440 20 801 1
---- ---- ---- ----
Total borrowings................ $440 $190 $801 $205
==== ==== ==== ====
</TABLE>
---------------
(1) Includes amounts due within one year of the date noted.
(2) Borrowings are denominated in Dutch guilders. The assumed exchange rate is
2.19 NLG and 2.50 NLG per U.S. dollar, the exchange rate on December 31,
1999 and September 30, 2000, respectively.
(3) UNA debt was adjusted to fair market value as of the acquisition date. The
unamortized premium is related to these fair value adjustments and is being
amortized over the respective remaining term of the related long-term debt.
(a) SHORT-TERM BORROWINGS.
As of September 30, 2000, the Company had $1.8 billion of committed credit
facilities, which included facilities of subsidiaries of Reliant Energy Power
Generation, Inc. (REPG) and UNA. The facilities expire as follows: $331 million
in 2001, $475 million in 2002 and $949 million in 2003. As of September 30,
2000, $473 million was unused. Credit facilities aggregating $843 million were
unsecured. As of September 30, 2000, letters of credit under two of the
facilities aggregated $385 million. As of September 30, 2000, borrowings of $739
million were outstanding under these facilities that were classified as
long-term debt, based upon the availability of committed credit facilities with
expiration dates exceeding one year and management's intention to maintain these
amounts in excess of one year.
As of December 31, 1999, the Company had $1.2 billion of committed credit
facilities, which included facilities of subsidiaries of REPG and UNA. As of
December 31, 1999, borrowings of $68 million were outstanding under these
facilities. These borrowings were classified as long-term debt based upon the
availability of committed credit facilities with expiration dates exceeding one
year and management's intention to maintain these amounts in excess of one year.
For further discussion of the $68 million borrowings, see Note 8(b) below.
In July 2000, UNA entered into two credit facilities to refinance an
existing multi-currency credit agreement that matured in October 2000. The two
new credit facilities include (a) a 364-day revolving credit facility for Euro
250 million ($221 million assuming the September 30, 2000 exchange rate of
0.8823 U.S. dollar per Euro) and (b) a three-year letter of credit facility for
$420 million. These credit facilities will be used by UNA for working capital
purposes and to support UNA's contingent obligations under its cross border
leases (see Note 11(d)). Under the
F-31
<PAGE> 173
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
two facilities, there is no recourse to any affiliate of the Company other than
UNA. The 364-day revolving credit facility for Euro 250 million bears interest
at EURIBOR plus a margin. A commitment fee of 0.175% per annum is payable on the
average daily unused portion of the Euro 250 million facility. At September 30,
2000, borrowings of $159 million (based on the exchange rate on September 30,
3000 of 0.8823 U.S. dollar per Euro) were outstanding. The weighted average
interest rate for these borrowings was 5.6% as of September 30, 2000. Under the
letter of credit facility, a fee is payable by the Company on each letter of
credit that is outstanding based on UNA's credit rating. A commitment fee of
0.25% per annum is payable on the average daily unused portion of the $420
million letter of credit facility. At September 30, 2000, letters of credit of
$275 million were outstanding under this facility. These facilities contain
covenants and requirements that must be met to borrow funds or issue letters of
credit, as applicable. These covenants are not anticipated to materially
restrict the Company from borrowing funds or issuing letters of credit, as
applicable, under these facilities.
In August 2000, the Company entered into a new $110 million letter of
credit facility, which expires in January 2001, to support REMA's lease
obligations discussed in Note 11(c). The Company pays a fee equal to 1% of the
total committed amount. Direct borrowings under the letters of credit bear
interest at (a) the sum of the higher of the Federal Funds Rate plus .5% or the
Prime Rate plus a margin or (b) the sum of the LIBOR rate plus a margin, at the
option of the Company. At September 30, 2000, $110 million of letters of credit
were outstanding under this facility. There were no direct borrowings under the
letter of credit agreement as of September 30, 2000.
On October 5, 1999, UNA entered into an unsecured Euro denominated bridge
facility of $685 million. This facility was replaced on December 21, 1999, by a
$685 million multi-currency credit agreement that matured on October 2, 2000.
The facility was intended to enable UNA to repay or provide letter of credit
support in respect of any amounts that are or may become payable under existing
UNA debt obligations or to support contingent obligations under its cross border
leases. No portion was used under this facility as of December 31, 1999. The
bridge facility bore interest at EURIBOR plus a margin. A commitment fee of 0.4%
per annum was payable on the average daily unused portion of this facility. In
July 2000, the multi-currency credit agreement was refinanced, as discussed
above.
At December 31, 1999 and September 30, 2000, the Company, through UNA, had
$170 million and $45 million, respectively, of short-term unsecured borrowings.
These borrowings are used by UNA to meet its short-term liquidity requirements.
The weighted average interest rate on these short-term borrowings as of December
31, 1999 and September 30, 2000 was 3.60% and 4.70%, respectively.
(b) LONG-TERM DEBT.
In February 2000, a subsidiary of the Company established a Euro 600
million term loan facility ($529 million assuming the September 30, 2000
exchange rate of 0.8823 U.S. dollar per Euro) that terminates in March 2003. The
facility bears interest at EURIBOR plus a margin. A commitment fee of 0.4% per
annum is payable on the average daily unused portion of this facility. This
facility contains covenants and requirements that must be met to borrow funds.
These covenants are not anticipated to materially restrict the Company from
borrowing funds under the facility. At September 30, 2000, $529 million under
this facility was outstanding at an interest rate of 5.46%. This facility is
secured.
On December 15, 1999, REPG entered into a $475 million syndicated bank
credit facility to finance the construction and start-up operations of an
electric power generation plant located in
F-32
<PAGE> 174
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Channelview, Texas. The maximum availability under this facility is (a) $92
million in equity bridge loans for the purpose of paying or reimbursing project
costs, (b) $369 million in non-recourse loans to finance the construction of the
project and (c) $14 million in revolving loans for general working capital
purposes. As of December 31, 1999 and September 30, 2000, REPG had drawn $68
million in equity bridge loans and $209 million in equity bridge and
construction loans, respectively. The loans bear interest, at REPG's option, at
either (a) a base rate, (b) a Euro dollar rate plus a margin ranging from 0.625%
to 3.41%, or (c) a fixed rate of 9.547%. The applicable interest rate was 7.125%
and 7.855% at December 31, 1999 and September 30, 2000, respectively. Notes
issued under the facility are pre-payable at any time and are due at various
expiration dates beginning November 2002 through August 2024. Amounts drawn
under the construction loan facilities are convertible into non-recourse term
loans. Under the credit agreement, the equity bridge loans and the construction
loans will be repaid upon conversion into term loans. Final maturities of the
non-recourse term loans range from 15 to 22 years following the plant's
commercial operation. Advances under the working capital facility mature five
years after the plant begins commercial operations. A commitment fee of 0.35%
per annum is payable on the average daily unused portions of the equity and
construction loan commitments. The Company incurred $7 million in debt financing
costs in 1999 associated with this project financing. These costs are being
amortized over the term of the facility. Obligations under the construction and
non-recourse term loans and revolving credit facility are secured by a first
priority security interest in the assets and future revenues of the plant and a
pledge of REPG's ownership interest in the plant. Although the $369 million in
construction loans are non-recourse in nature, an indemnification agreement
exists that may require REPG, in some circumstances, to reimburse the lender for
amounts up to the total contract price for the construction of the plant
(approximately $326 million). The $475 million credit facility contains
covenants and requirements that must be met to borrow funds. These covenants are
not anticipated to materially restrict REPG from borrowing funds under the
facility.
Outstanding long-term indebtedness of UNA of $361 million and $61 million
at December 31, 1999 and September 30, 2000, respectively, consisted primarily
of loans maturing through 2010. Some covenants under these loans restrict some
actions by UNA. The weighted-average interest rate of these loans at December
31, 1999 and September 30, 2000 was 7.56% and 7.37%, respectively. During the
second quarter of 2000, UNA negotiated the repurchase of $272 million aggregate
principal amount of its long-term debt for a total cost of $286 million,
including $14 million in expenses. The book value of the debt repurchased was
$293 million, resulting in an extraordinary gain on the early extinguishment of
long-term debt of $7 million. Borrowings under a short-term banking facility and
proceeds from the sale of trading securities by UNA were used to finance the
debt repurchase.
As of September 30, 2000, maturities of long-term debt for the Company were
$21 million in 2001, $209 million in 2002, $529 million in 2003, $35 million in
2004 and zero in 2005 and $5 million in 2006 and beyond.
(9) STOCK-BASED INCENTIVE COMPENSATION PLANS AND RETIREMENT PLANS
(a) INCENTIVE COMPENSATION PLANS.
The Company participates in Reliant Energy's Long-Term Incentive
Compensation Plan (LICP) and other incentive compensation plans that provide for
the issuance of stock-based incentives, including performance-based stock
compensation, restricted shares, stock options and stock appreciation rights, to
key employees of the Company, including officers. No stock appreciation rights
have ever been issued under the LICP. Stock-based incentive grants and
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<PAGE> 175
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
expense information presented herein represents the Company's portion of the
overall plans. As of September 30, 2000, 250 employees of the Company
participate in the plans.
Performance-based shares and restricted shares are granted to employees
without cost to the participants. The performance shares vest three years after
the grant date based upon the performance of Reliant Energy over a three-year
cycle. The restricted shares vest to the participants at various times ranging
from immediate vesting to vesting at the end of a three-year period. Upon
vesting, the shares are released to the plans' participants. During the nine
months ended September 30, 2000 and years ended December 31, 1997, 1998 and
1999, the Company recorded compensation expense of $3.4 million, $0.4 million,
$1.6 million and $0.9 million, respectively, related to performance-based shares
and restricted share grants. The following table summarizes performance-based
shares and restricted share grant activity related to the Company for the years
1997 through 1999 and the nine months ended September 30, 2000:
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF
PERFORMANCE-BASED RESTRICTED
SHARES SHARES
----------------- ----------
<S> <C> <C>
</TABLE>
<TABLE>
<CAPTION>
Outstanding at December 31, 1996. 19,896 --
<S> <C> <C>
Granted................................................. 21,765 --
Released to participants................................ (5,686) --
-------- --------
Outstanding at December 31, 1997.......................... 35,975 --
Granted................................................. 107,364 8,626
Released to participants................................ (8,038) --
-------- --------
Outstanding at December 31, 1998.......................... 135,301 8,626
Granted................................................. 115,501 87,429
Released to participants................................ (14,764) (2,869)
-------- --------
Outstanding at December 31, 1999.......................... 236,038 93,186
Granted................................................. 87,392 51,141
Released to participants................................ (21,624) (2,511)
-------- --------
Outstanding at September 30, 2000......................... 301,806 141,816
-------- --------
Weighted average fair value of performance and restricted
stock granted for the year ended December 31, 1997...... $ 22.00 $ --
======== ========
Weighted average fair value of performance and restricted
stock granted for the year ended December 31, 1998...... $ 22.86 $ 26.32
======== ========
Weighted average fair value of performance and restricted
stock granted for the year ended December 31, 1999...... $ 26.16 $ 26.97
======== ========
Weighted average fair value of performance and restricted
stock granted for the nine months ended September 30,
2000.................................................... $ 25.68 $ 26.48
======== ========
</TABLE>
Outstanding performance shares under the LICP will vest for the performance
cycle ending December 31, 2000 according to the terms and conditions of the
plan. Assuming the Distribution occurs during the calendar year 2001, the
Reliant Energy's compensation committee will determine as of the Distribution
Date the level at which the performance objectives are expected to have been
achieved through the end of the performance cycle ending December 31, 2001 and
vest the outstanding performance shares as of the Distribution Date as though
the performance objectives were achieved at that level. In addition, as of the
Distribution Date, Reliant Energy's compensation committee will convert
outstanding performance shares for the performance cycle ending December 31,
2002 to a number of time-based restricted shares of Reliant Energy's common
stock equal to the number of performance shares that would have vested if the
performance objectives for the performance cycle were achieved at the maximum
level. These
F-34
<PAGE> 176
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
time-based restricted shares will vest if the participant holding the shares
remains employed with Reliant Energy or with the Company through December 31,
2002. On the Distribution Date, holders of such time-based restricted shares
will receive shares of the Company's common stock in the same manner as other
holders of Reliant Energy common stock, but the shares of the Company's common
stock will be subject to the same time-based vesting schedule. Thus, following
the Distribution, employees who held performance shares under the LICP for the
performance cycle ending December 31, 2002 will hold time-based restricted
shares of Reliant Energy's common stock and time-based restricted shares of the
Company's common stock which will vest following continuous employment through
December 31, 2002. Subject to the Distribution, the Company will incur a
non-cash charge related to the performance-based shares granted in 2000 for the
difference between the expense recorded up to the Distribution Date based on the
achievement of performance goals to the Distribution Date and the expense based
on the achievement of performance goals at the maximum level. This non-cash
charge is dependent upon the timing of the Distribution, the number of
performance shares granted in 2000 and the expense recorded up to the
Distribution Date. Holders of Reliant Energy restricted share grants will be
treated like other shareholders at the Distribution Date.
On January 1, 2001, some employees of Reliant Energy, primarily corporate
support and executive officers, transferred to the Company. As of January 1,
2001, these employees held Reliant Energy performance-based shares and
restricted shares of approximately 196,000 and approximately 59,000,
respectively.
F-35
<PAGE> 177
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock options generally become exercisable in one-third increments on each
of the first through third anniversaries of the grant date. The exercise price
is the average of the high and low sales price of Reliant Energy common stock on
the New York Stock Exchange on the grant date. The Company applies Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
No. 25), and related interpretations in accounting for its stock option plans.
Accordingly, no compensation expense has been recognized for these fixed stock
options. The following table summarizes stock option activity related to the
Company for the years 1997 through 1999 and the nine months ended September 30,
2000:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Outstanding at December 31, 1996............................ 20,006 $21.77
Options granted........................................... 162,227 20.68
Options converted at acquisition(1)....................... 63,543 9.49
Options exercised......................................... (26,943) 9.60
---------
Outstanding at December 31, 1997............................ 218,833 15.42
---------
Options granted........................................... 601,535 26.27
Options exercised......................................... (94,451) 9.73
Options canceled.......................................... (44,808)
---------
Outstanding at December 31, 1998............................ 681,109 25.11
---------
Options granted........................................... 1,311,657 27.06
Options exercised......................................... (21,836) 14.47
Options canceled.......................................... (145,345)
---------
Outstanding at December 31, 1999............................ 1,825,585 26.47
---------
Options granted........................................... 2,071,667 21.11
Options exercised......................................... (270,849) 25.06
Options canceled.......................................... (304,472)
---------
Outstanding at September 30, 2000........................... 3,321,931 23.47
---------
Options exercisable at December 31, 1997.................... 120,181 11.06
=========
Options exercisable at December 31, 1998.................... 60,014 18.63
=========
Options exercisable at December 31, 1999.................... 256,958 24.92
=========
Options exercisable at September 30, 2000................... 606,471 26.67
=========
</TABLE>
---------------
(1) Effective upon the merger with RERC, each holder of an unexpired RERC stock
option, whether or not then exercisable, was entitled to elect to either (a)
have all or any portion of their RERC stock options canceled and "cashed
out" or (b) have all or any portion of their RERC stock options converted to
Reliant Energy's stock options. There were 84,550 RERC stock options related
to Unregulated RERC'S employees converted into 63,543 of Reliant Energy's
stock options at the merger date.
Exercise prices for Reliant Energy stock options outstanding and held by
the Company employees ranged from $20.50 to $32.06. The following table provides
certain information with respect to Reliant Energy stock options outstanding
related to the Company's employees at September 30, 2000:
<TABLE>
<CAPTION>
AVERAGE REMAINING AVERAGE
OPTIONS EXERCISE CONTRACTUAL LIFE
OUTSTANDING PRICE (YEARS)
----------- -------- -----------------
<S> <C> <C> <C>
Ranges of Exercise Prices
Exercisable at:
$20.50-$26.00.............................. 2,210,771 $21.61 9.1
$26.00-$32.06.............................. 1,111,160 27.18 8.6
---------
Total................................. 3,321,931 23.47 8.9
========= ======
</TABLE>
F-36
<PAGE> 178
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table provides certain information with respect to Reliant
Energy stock options exercisable related to the Company's employees at September
30, 2000:
<TABLE>
<CAPTION>
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
----------- --------------
<S> <C> <C>
Ranges of Exercise Prices Exercisable at:
$20.50--$26.00.......................................... 250,778 $25.68
$26.00--$32.06.......................................... 355,693 27.37
-------
Total.............................................. 606,471 26.67
======= ======
</TABLE>
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company applies the rules contained in APB No. 25, and discloses the
required pro forma effect on net income of the fair value based method of
accounting for stock compensation. The weighted average fair values at date of
grant for options granted during the years ended December 31, 1997, 1998 and
1999 and nine months ended September 30, 2000 were $3.14, $4.27, $3.13 and
$3.05, respectively, and were estimated using the Black-Scholes option valuation
model with the following weighted-average assumptions:
<TABLE>
<CAPTION>
1997 1998 1999 2000
---- ---- ---- ----
<S> <C> <C> <C> <C>
Expected life in years...................................... 10 10 5 5
Interest rate............................................... 6.58% 5.65% 5.10% 6.61%
Volatility.................................................. 22.06% 24.01% 21.23% 23.70%
Expected common stock dividend.............................. $ 1.50 $ 1.50 $ 1.50 $ 1.50
</TABLE>
Pro forma information for the years ended December 31, 1997, 1998 and 1999
and the nine months ended September 30, 2000 is provided below, to take into
account the amortization of stock-based compensation to expense on a
straight-line basis over the vesting period. Had compensation costs been
determined as prescribed by SFAS No. 123, the Company's net income would have
been reduced by $0.6 million, $1.3 million and $1.9 million in years ended
December 31, 1998 and 1999 and the nine months ended September 30, 2000,
respectively.
Subject to the Distribution, Reliant Energy expects to convert all Reliant
Energy stock option grants to a combination of new Reliant Energy stock options
and Company stock options. For the converted Reliant Energy stock options, the
sum of the intrinsic value of Reliant Energy stock options immediately prior to
the Distribution will equal the sum of the intrinsic values of the new Reliant
Energy stock options and the Company stock options granted immediately after the
Distribution. As such, Reliant Energy employees that do not work for the Company
will hold stock options of the Company. On January 1, 2001, some employees of
Reliant Energy, primarily corporate support and executive officers, transferred
to the Company. As of January 1, 2001, these employees held Reliant Energy stock
options of approximately 3.5 million. In addition, prior to the Distribution
Date, some additional Reliant Energy and its subsidiaries employees will
transfer to the Company. The number of options held by these employees cannot be
estimated until the employees are identified and their related number of
outstanding Reliant Energy stock options are known.
Subject to the Distribution, the Company expects to offer a long-term
incentive compensation plan that provides for the issuance of stock-based
incentives, including performance-based stock compensation, restricted shares,
stock options and stock appreciation rights. All employees and non-employee
directors will be eligible to participate in the new plan. Subsequent to the
Distribution, the Company expects to provide a discounted employee stock
purchase plan to all Company employees.
F-37
<PAGE> 179
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(b) PENSION.
Except for its foreign subsidiaries, the Company participates in Reliant
Energy's noncontributory retirement plan. Prior to 1999, Unregulated RERC
participated in RERC's noncontributory retirement plan which covered certain
employees of RERC. Effective January 1, 1999, RERC's noncontributory retirement
plan was merged into Reliant Energy's plan. The plans provided retirement
benefits based on years of service and compensation. Reliant Energy's funding
policy is to review amounts annually in accordance with applicable regulations
in order to achieve adequate funding of projected benefit obligations. The
assets of the plan consist principally of common stocks and high-quality,
interest-bearing obligations. The net periodic pension costs, prepaid pension
costs and benefit obligation have been determined separately for each plan prior
to the plans being merged.
UNA is a foreign subsidiary of the Company and participates along with
other companies in the Netherlands in making payments to pension funds which are
not administered by the Company. The Company treats these as a defined
contribution pension plan which provides retirement benefits for most of its
employees. The contributions are principally based on a percentage of the
employee's base compensation and charged against income as incurred. This
expense was $1.7 million and $5 million for the three months ended December 31,
1999 and the nine months ended September 30, 2000, respectively.
Net pension cost for the Company (excluding UNA) includes the following
components:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
--------------------- SEPTEMBER 30,
1997 1998 1999 2000
---- ---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Service cost -- benefits earned during the period........... $ 1.1 $ 1.6 $ 1.8 $ 2.7
Interest cost on projected benefit obligation............... 1.1 1.3 1.8 1.6
Expected return on plan assets.............................. (1.3) (1.9) (2.3) (2.5)
Net amortization............................................ -- 0.2 0.1 (0.2)
----- ----- ----- -----
Net pension cost................................... $ 0.9 $ 1.2 $ 1.4 $ 1.6
===== ===== ===== =====
</TABLE>
F-38
<PAGE> 180
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Following are reconciliations of the Company's beginning and ending
balances of its retirement plan benefit obligation, plan assets and funded
status for the years ended December 31, 1998 and 1999 and the nine months ended
September 30, 2000 (excluding UNA).
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
----------------------- SEPTEMBER 30,
1998 1999 2000
---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of period................... $ 19.8 $ 23.5 $ 24.0
Service cost.............................................. 1.6 1.8 2.7
Interest cost............................................. 1.3 1.8 1.6
Plan amendments........................................... (3.5) -- --
Actuarial loss (gain)..................................... 4.3 (3.1) 5.8
---------- ---------- ----------
Benefit obligation, end of period......................... $ 23.5 $ 24.0 $ 34.1
========== ========== ==========
CHANGE IN PLAN ASSETS
Plan asset, beginning of period........................... $ 18.5 $ 23.2 $ 31.0
Employer contributions.................................... 2.4 -- --
Actual investment return.................................. 2.3 7.8 5.1
---------- ---------- ----------
Plan assets, end of period................................ $ 23.2 $ 31.0 $ 36.1
========== ========== ==========
RECONCILIATION OF FUNDED STATUS
Funded status............................................. $ (0.3) $ 7.0 $ 2.0
Unrecognized prior service cost........................... (3.2) (3.0) (2.8)
Unrecognized actuarial loss (gain)........................ 7.4 (1.5) 1.7
---------- ---------- ----------
Net amount recognized..................................... $ 3.9 $ 2.5 $ 0.9
========== ========== ==========
ACTUARIAL ASSUMPTIONS
Discount rate............................................. 6.5% 7.5% 7.5%
Rate of increase in compensation levels................... 3.5 - 5.5% 3.5 - 5.5% 3.5 - 5.5%
Expected long-term rate of return on assets............... 10.0% 10.0% 10.0%
</TABLE>
In 1998, Reliant Energy's board of directors approved the amendment and
restatement of the retirement plan, effective January 1, 1999, which converted
the present value of the accrued benefits under the existing pension plans into
a cash balance pension plan and grandfathered the existing benefit formulas for
a period of ten years, if benefits under the previously existing pension plans
were greater. Under the cash balance formula, each participant has an account,
for recordkeeping purposes only, to which credits are allocated annually based
on a percentage of the participant's pay. The applicable percentage for 1999 and
2000 was 4% in each period. As a result of the January 1, 1999 amendment and
restatement, which is reflected in the December 31, 1998 disclosure, the
Company's projected benefit obligation declined $3.5 million.
The actuarial gains and losses are due to changes in certain actuarial
assumptions.
Upon the Offering, the Company does not expect to provide a noncontributory
retirement plan to its domestic non-union employees. Upon the Offering, the
Company expects each non-union participant's unvested pension account balance
will be vested and a one-time benefit enhancement will be provided to some
qualifying participants. At the Distribution Date, each Company participant will
be able to elect to have his pension account balance (a) left in the Reliant
Energy pension plan, (b) rolled over to a new Company savings plan or an
individual IRA account, or (c) cashed out. The Company expects to incur in the
period of the Offering a charge to earnings of approximately $76 million
(pre-tax) for the one-time benefit enhancement discussed above and a gain of $23
million (pre-tax) related to the curtailment of Reliant Energy's pension plan.
At the time of Distribution, the Company expects to incur a loss of $21 million
(pre-tax) related to the settlement of Reliant Energy's pension plan. These
charges include the employees of Reliant Energy, primarily corporate support and
executive officers,
F-39
<PAGE> 181
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
which transferred to the Company on January 1, 2001. In addition, prior to the
Distribution Date, some additional employees of Reliant Energy and its
subsidiaries will transfer to the Company. The charges related to providing
these employees the one-time benefit enhancement and any additional curtailment
and settlement discussed above cannot be estimated until the employees are
identified.
In addition to the noncontributory pension plans discussed above, Reliant
Energy maintains a non-qualified plan which allows participants to retain the
benefits to which they would have been entitled under Reliant Energy's
noncontributory plan except for the federally mandated limits on these benefits
or on the level of salary on which these benefits may be calculated. Prior to
1999, RERC maintained certain similar non-qualified plans. Effective January 1,
1999, RERC's non-qualified plans were merged into Reliant Energy's non-qualified
plan. The expense associated with these non-qualified plans was not material in
the nine months ended September 30, 2000 and years ended December 31, 1997, 1998
and 1999. Upon the Offering, the Company does not expect to provide such a
non-qualified plan to its employees.
(c) SAVINGS PLAN.
Except for its foreign subsidiaries, the Company participates in Reliant
Energy's employee savings plan that qualifies as cash or deferred arrangement
under Section 401(k) of the Internal Revenue Code of 1986, as amended (the
Code). Under the plan, participating employees may contribute a portion of their
compensation, pre-tax or after-tax, up to a maximum of 16% of compensation. In
1999, the savings plan was amended so that Reliant Energy now matches 75% to
125% of the first 6% of each employee's compensation contributed, subject to a
vesting schedule, based on certain performance goals achieved by Reliant Energy
and its subsidiaries. Through 1998, Reliant Energy matched 70% of the first 6%
of each employee's compensation contributed, subject to a vesting schedule.
Substantially all of Reliant Energy's match is invested in Reliant Energy common
stock.
Prior to April 1, 1999, Unregulated RERC participated in RERC's employee
savings plan. Under the terms of the RERC's employee savings plan, employees
could contribute up to 12% of total compensation in 1997 and 1998, which
contributions up to 6% were matched. Beginning January 1, 1999, employees could
contribute up to 16% of total compensation, which contributions up to 6% were
matched by Reliant Energy. Effective April 1, 1999, RERC's employee savings plan
was merged into Reliant Energy's savings plan.
The Company's savings plan benefit expense was $1 million, $1 million, $2
million and $5 million in the years ended December 31, 1997, 1998, and 1999 and
the nine months ended September 30, 2000, respectively.
Effective as of the Offering, the Company expects Reliant Energy's employee
savings plan will be amended to provide benefits for the Company's participants
so that the Company matches 100% of the first 6% of each employee's
compensation. The Company also expects Reliant Energy's employee savings plan
will be amended to provide at the Company's sole discretion a profit sharing
contribution on behalf of the Company's employees which together with the match
will be always fully vested.
Subsequent to the Distribution Date, the Company expects to establish an
employee savings plan that qualifies as cash or deferred arrangement under
Section 401(k) of the Code for substantially all its employees except for its
foreign subsidiaries' employees. The Company expects its saving plan match and
discretionary profit sharing contribution will be made in cash, in the Company's
common stock, or both.
F-40
<PAGE> 182
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) POSTRETIREMENT BENEFITS.
Through Reliant Energy and UNA postretirement plans, the Company provides
certain postretirement benefits (primarily medical care and life insurance
benefits) for its retired employees, substantially all of whom may become
eligible for these benefits when they retire. Under the plans, Reliant Energy
reserves the right to change, modify or discontinue its plans. Under SFAS No.
106, "Employer's Accounting for Postretirement Benefits Other Than Pensions"
(SFAS No. 106), postretirement benefits are accounted for on an accrual basis
using a specified actuarial method based on benefits and years of service. The
Company is amortizing over a 20 year period approximately $4 million to cover
the "transition cost" of adopting SFAS No. 106. The Company funds its portion of
the postretirement benefits on a pay-as-you-go basis.
Net postretirement benefit cost for the Company includes the following
components:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
------------------ SEPTEMBER 30,
1997 1998 1999 2000
---- ---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Service cost -- benefits earned during the period........... $0.2 $0.3 $0.5 $1.0
Interest cost on projected benefit obligation............... 0.3 0.3 1.0 1.6
Net amortization............................................ 0.2 0.2 0.4 0.3
---- ---- ---- ----
Net postretirement benefit cost.................... $0.7 $0.8 $1.9 $2.9
==== ==== ==== ====
</TABLE>
Following are reconciliations of the Company's beginning and ending
balances of its postretirement benefit plans benefit obligation, plan assets and
funded status for the years ended December 31, 1998 and 1999 and the nine months
ended September 30, 2000.
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
------------------- SEPTEMBER 30,
1998 1999 2000
---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of period................... $ 4.0 $ 8.5 $ 31.5
Service cost.............................................. 0.3 0.5 1.0
Interest cost............................................. 0.3 1.0 1.6
Benefit payments.......................................... -- -- (0.8)
Acquisitions.............................................. -- 23.4 2.1
Plan amendments........................................... 3.4 -- --
Foreign exchange impact................................... -- (1.1) (2.8)
Actuarial loss (gain)..................................... 0.5 (0.8) 1.1
----- ----------- -----------
Benefit obligation, end of period......................... $ 8.5 $ 31.5 $ 33.7
===== =========== ===========
RECONCILIATION OF FUNDED STATUS
Funded status............................................. $(8.5) $ (31.5) $ (33.7)
Unrecognized transition obligation........................ 3.1 2.9 2.8
Unrecognized prior service cost........................... 3.4 3.2 3.0
Unrecognized actuarial loss............................... 1.1 0.3 1.4
----- ----------- -----------
Net amount recognized at end of year...................... $(0.9) $ (25.1) $ (26.5)
===== =========== ===========
ACTUARIAL ASSUMPTIONS
Discount rate............................................. 6.5% 6.6 - 7.5% 6.6 - 7.5%
Rate of increase in compensation levels................... -- 2.0% 2.0%
</TABLE>
F-41
<PAGE> 183
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1998, Reliant Energy's board of directors approved an amendment,
effective January 1, 1999, which created an account balance based on credited
service at December 31, 1998. Under the new plan, each participant has an
account, for recordkeeping purposes only, to which a $750 credit is allocated
annually. This account balance vests after five years of service after age 50.
At retirement the account balance is converted into one of several annuity
options, the proceeds of which can be used solely to offset the cost of
purchasing medical benefits under Reliant Energy's medical plans. It may not be
taken as cash. As a result of the January 1, 1999 amendment, which is reflected
in the December 31, 1998 disclosure, the Company's benefit obligation increased
$3.4 million. The plan amendment had no impact on 1998 expense.
The actuarial gains and losses are due to changes in certain actuarial
assumptions.
Subsequent to the Offering, the Company does not expect to continue to
provide subsidized postretirement benefits to its domestic non-union employees.
The Company expects to incur at the time of the Offering a loss of $38 million
(pre-tax) related to the curtailment of the Company's postretirement obligation.
At the time of Distribution, the Company expects to incur a gain of $21 million
(pre-tax) related to the settlement of the post-retirement benefit obligation.
These charges include the effect of the curtailment and settlement of the
post-retirement obligation for employees of Reliant Energy, primarily corporate
support and executive officers, which transferred to the Company on January 1,
2001. In addition, prior to the Distribution Date, some additional employees of
Reliant Energy and its subsidiaries will transfer to the Company. The gains and
losses related to any additional settlement and curtailment cannot be estimated
until the employees are identified.
(e) POSTEMPLOYMENT BENEFITS.
The Company records postemployment benefits based on SFAS No. 112,
"Employer's Accounting for Postemployment Benefits," which requires the
recognition of a liability for benefits provided to former or inactive
employees, their beneficiaries and covered dependents, after employment but
before retirement (primarily health care and life insurance benefits for
participants in the long-term disability plan). Net postemployment benefit costs
were not material in the years ended December 31, 1997, 1998 and 1999 and the
nine months ended September 30, 2000.
(f) OTHER NON-QUALIFIED PLANS.
Since 1985, Reliant Energy has had in effect deferred compensation plans
which permit eligible participants to elect each year to defer a percentage of
that year's salary (prior to December 1993, up to 25% or 40%, depending on age,
and beginning in December 1993, up to 100%) and up to 100% of that year's annual
bonus. The Company participates in Reliant Energy's deferred compensation plans.
In general, employees who attain the age of 60 during employment and participate
in Reliant Energy's deferred compensation plans may elect to have their deferred
compensation amounts repaid in (a) fifteen equal annual installments commencing
at the later of age 65 or termination of employment or (b) a lump-sum
distribution following termination of employment. Interest generally accrues on
deferrals made in 1989 and subsequent years at a rate equal to the average
Moody's Long-Term Corporate Bond Index plus 2%, determined annually until
termination when the rate is fixed at the greater of the rate in effect at age
64 or at age 65. Fixed rates of 19% to 24% were established for deferrals made
in 1985 through 1988. During the years ended December 31, 1997, 1998 and 1999
and the nine months ended September 30, 2000, the Company recorded interest
expense related to its deferred compensation obligation of approximately $1
million in each period. The discounted deferred
F-42
<PAGE> 184
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
compensation obligation recorded by the Company was $4 million, $5 million and
$6 million as of December 31, 1998 and 1999 and September 30, 2000,
respectively. On January 1, 2001, some employees of Reliant Energy, primarily
corporate support and executive officers, transferred to the Company. As of
January 1, 2001, these employees' discounted deferred compensation obligation
that was transferred to the Company was $13 million. Prior to the Distribution
Date, some additional employees of Reliant Energy and its subsidiaries will
transfer to the Company. The discounted deferred compensation obligation related
to these employees cannot be determined until the employees are identified.
(g) OTHER EMPLOYEE MATTERS.
As of September 30, 2000, approximately 53% of the Company's employees are
subject to collective bargaining arrangements, of which 37% will expire prior to
September 30, 2001. 28% of the employees subject to collective bargaining
agreements work for UNA in the Netherlands.
(10) INCOME TAXES
The Company and Reliant Energy have entered into a federal and state tax
sharing agreement. Under the tax sharing agreement, the Company pays Reliant
Energy the Company's allocable share of taxes that are paid by Reliant Energy on
a consolidated basis. The Company's allocable share equals the sum of the tax
liability that the Company would have incurred had the Company and each
affiliate computed the tax liability on a separate company basis.
The components of (loss) income before taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, NINE MONTHS ENDED
--------------------- SEPTEMBER 30,
1997 1998 1999 2000
---- ---- ---- -----------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
United States............................................ $(8.5) $38.6 $ 1.7 $362.2
Foreign.................................................. -- -- 24.9 2.3
----- ----- ----- ------
(Loss) income before income taxes............... $(8.5) $38.6 $26.6 $364.5
===== ===== ===== ======
</TABLE>
The Company's current and deferred components of income tax (benefit)
expense were as follows:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
---------------------- SEPTEMBER 30,
1997 1998 1999 2000
---- ---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Current
Federal................................................. $(7.7) $12.5 $(13.6) $ 92.2
State................................................... 0.2 3.3 0.6 16.3
Foreign................................................. -- -- -- 1.6
----- ----- ------ ------
Total current.................................... (7.5) 15.8 (13.0) 110.1
----- ----- ------ ------
Deferred
Federal................................................. 5.0 0.8 16.4 7.6
State................................................... 0.1 0.9 (0.8) 2.1
Foreign................................................. -- -- -- 0.4
----- ----- ------ ------
Total deferred................................... 5.1 1.7 15.6 10.1
----- ----- ------ ------
Income tax (benefit) expense.............................. $(2.4) $17.5 $ 2.6 $120.2
===== ===== ====== ======
</TABLE>
F-43
<PAGE> 185
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the federal statutory income tax rate to the effective
income tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
--------------------- SEPTEMBER 30,
1997 1998 1999 2000
---- ---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
(Loss) income before income taxes.......................... $(8.5) $38.6 $26.6 $364.5
Federal statutory rate..................................... 35% 35% 35% 35%
----- ----- ----- ------
Income tax (benefit) expense at statutory rate............. (3.0) 13.5 9.3 127.6
----- ----- ----- ------
Net addition (reduction) in taxes resulting from:
State income taxes, net of federal income tax benefit.... 0.2 2.7 (0.1) 12.1
Equity dividend exclusion................................ (0.2) (1.0) (0.1) (0.4)
UNA tax holiday.......................................... -- -- (10.1) (28.0)
International rate difference............................ -- -- -- 0.4
Goodwill amortization.................................... 0.4 1.2 1.4 1.5
Valuation allowance...................................... -- -- 1.6 9.3
Other, net............................................... 0.2 1.1 0.6 (2.3)
----- ----- ----- ------
Total............................................. 0.6 4.0 (6.7) (7.4)
----- ----- ----- ------
Income tax (benefit) expense............................... $(2.4) $17.5 $ 2.6 $120.2
===== ===== ===== ======
Effective rate............................................. 27.8% 45.3% 9.6% 33.0%
</TABLE>
UNA TAX HOLIDAY. Under 1998 Dutch tax law relating to the Dutch
electricity industry, UNA qualifies for a zero percent tax rate through December
31, 2001. The tax holiday applies only to the Dutch income earned by UNA.
Beginning January 1, 2002, UNA will be subject to Dutch corporate income tax at
standard statutory rates.
UNDISTRIBUTED EARNINGS OF FOREIGN SUBSIDIARIES. The undistributed earnings
of foreign subsidiaries aggregated $129 million as of September 30, 2000, which,
under existing tax law, will not be subject to U.S. income tax until
distributed. Of the total undistributed earnings, provisions for U.S. taxes have
not been accrued on $110 million related to earnings that have been, or are
intended to be, permanently reinvested. In the event of a distribution of those
earnings in the form of dividends, the Company will be subject to U.S. income
taxes net of allowable foreign tax credits.
F-44
<PAGE> 186
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Following were the Company's tax effects of temporary differences between
the carrying amounts of assets and liabilities in the financial statements and
their respective tax bases:
<TABLE>
<CAPTION>
DECEMBER 31,
------------- SEPTEMBER 30,
1998 1999 2000
---- ---- -------------
(IN MILLIONS)
<S> <C> <C> <C>
Deferred tax assets:
Employee benefits......................................... $ 2.1 $ 6.7 $ 9.9
Operating loss carryforwards.............................. 1.5 3.8 12.8
Maintenance reserve....................................... 12.5 12.5 7.8
Environmental reserves.................................... -- 4.8 19.2
Equity investments........................................ -- 5.2 --
Deferred gas costs........................................ 3.7 2.2 0.8
Other..................................................... 2.1 1.0 2.3
Valuation allowance....................................... (1.4) (3.0) (12.3)
----- ----- ------
Total deferred tax assets, net..................... 20.5 33.2 40.5
----- ----- ------
Deferred tax liabilities:
Depreciation.............................................. 10.4 95.8 105.2
Equity investments........................................ 7.0 -- 0.9
Other..................................................... 1.5 0.3 0.1
----- ----- ------
Total deferred tax liabilities..................... 18.9 96.1 106.2
----- ----- ------
Accumulated deferred income taxes -- net........... $(1.6) $62.9 $ 65.7
===== ===== ======
</TABLE>
TAX ATTRIBUTE CARRYFORWARDS. At September 30, 2000, the Company had
approximately $2.5 million, $24 million and $20 million of federal, state and
foreign net operating losses, respectively. The losses are available to offset
future respective federal and state taxable income through the year 2020 and
2019, respectively. The foreign losses available to offset future foreign
taxable income will not expire under current foreign jurisdiction tax law. The
valuation allowance reflects a net increase of $0.2 million and $9.3 million in
the year ended December 31, 1999 and the nine months ended September 30, 2000.
This net increase resulted from a reassessment of the Company's future ability
to use federal, state and foreign tax net operating losses, offset by changes in
valuation allowances provided for expiring state net operating loss
carryforwards.
(11) COMMITMENTS AND CONTINGENCIES
(a) COMMITMENTS.
The Company has various commitments for capital expenditures, fuel,
purchased electric power and operating leases. As of September 30, 2000, the
Wholesale Energy segment had entered into commitments associated with various
electric generating projects aggregating $324 million along with various
generating equipment purchases aggregating $318 million for delivery from 2000
to 2001 that are anticipated to be used for future development projects. As of
September 30, 2000, REMA is a party to several long-term fuel supply contracts
that have various quantity requirements and durations. Minimum payment
obligations under these agreements that extend through 2004 are as follows as of
September 30, 2000 (in millions):
<TABLE>
<S> <C>
2001........................................................ $ 64
2002........................................................ 55
2003........................................................ 29
2004........................................................ 14
----
Total.............................................. $162
====
</TABLE>
F-45
<PAGE> 187
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In October 2000, the Company acquired the naming rights for the new
football stadium for the Houston Texans, the National Football League's newest
franchise. In addition, the naming rights cover the entertainment and convention
facilities included in the complex with the stadium. The agreement extends for
32 years. In addition to naming rights, the agreement provides the Company with
significant sponsorship rights. The aggregate cost of the naming rights was
approximately $300 million. During the fourth quarter of 2000, the Company
incurred an obligation to pay $12 million in order to secure the long-term
commitment and for the initial advertising of which $10 million of the $12
million will be expensed in the Statement of Consolidated Operations. Starting
in 2002, when the new stadium is operational, the Company will pay $9.5 million
each year through 2032 for annual advertising.
In addition, the Company's other commitments have various quantity
requirements and durations and are not considered material either individually
or in the aggregate to the Company's results of operations or cash flows.
(b) TRANSPORTATION AGREEMENT.
Prior to the merger of a subsidiary of Reliant Energy and RERC, a
predecessor of Reliant Energy Services entered into a transportation agreement
(ANR Agreement) with ANR Pipeline Company (ANR) that contemplated a transfer to
ANR of an interest in some of RERC's pipelines and related assets that are not a
part of the Company. The interest represented capacity of 250 million cubic feet
(Mmcf)/day. Under the ANR agreement, an ANR affiliate advanced $125 million to
Unregulated RERC. Subsequently, the parties restructured the ANR Agreement and
Unregulated RERC refunded in 1993 and 1995, $34 million and $50 million,
respectively, to ANR. As of December 31, 1998 and 1999 and September 30, 2000,
Reliant Energy Services had recorded $24 million, $26 million and $28 million,
respectively, in long-term other liabilities in the Consolidated Balance Sheets
to reflect the Company's discounted obligation to ANR for the use of 130
Mmcf/day of capacity in some of RERC's transportation facilities. The level of
transportation will decline to 100 Mmcf/day in the year 2003 with a refund of $5
million to ANR. The ANR Agreement will terminate in 2005 with a refund of the
remaining balance of $36 million.
Prior to the Offering, the Company expects that Reliant Energy Services and
a subsidiary of Reliant Energy will enter into an agreement whereby the
subsidiary of Reliant Energy will agree to reimburse Reliant Energy Services for
any transportation payments made under the ANR Agreement and for the refund of
the $41 million discussed above. In the Consolidated Balance Sheets, the Company
has recorded a long-term notes receivable from an affiliate of $24 million, $26
million and $28 million as of December 31, 1998 and 1999 and September 30, 2000,
respectively.
(c) LEASE COMMITMENTS.
In August 2000, the Company sold to and leased back from each of three
owner-lessors in separate lease transactions the Company's respective 16.45%,
16.67% and 100% interests in the Conemaugh,Keystone and Shawville generating
stations, respectively, acquired in the REMA acquisition. As lessee, the Company
leases an interest in each facility from each owner-lessor under a facility
lease agreement. The equity interests in all the subsidiaries of REMA are
pledged as collateral for REMA's lease obligations. In addition, the
subsidiaries have guaranteed the lease obligations. The lease documents contain
some restrictive covenants that restrict REMA's ability to, among other things,
make dividend distributions unless REMA satisfies various conditions. The
covenant restricting dividends would be suspended if the direct or indirect
parent of REMA,
F-46
<PAGE> 188
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
meeting specified criteria, guarantees the lease obligations. The Company will
make lease payments through 2029. The lease term expires in 2034.
The following table sets forth the Company's obligation under these
long-term operating leases as of September 30, 2000:
<TABLE>
<CAPTION>
REMA SALE-
LEASE
OBLIGATION OTHER TOTAL
---------- ----- -----
(IN MILLIONS)
<S> <C> <C> <C>
2001........................................................ $ 259 $ 1 $ 260
2002........................................................ 137 1 138
2003........................................................ 77 1 78
2004........................................................ 84 1 85
2005........................................................ 75 1 76
2006 and beyond............................................. 1,187 9 1,196
------ --- ------
$1,819 $14 $1,833
====== === ======
</TABLE>
Total lease expense for all leases was $0.3 million, $1 million, $2 million
and $2 million, in the years ended December 31, 1997, 1998 and 1999 and the nine
months ended September 30, 2000, respectively.
(d) CROSS BORDER LEASES.
During the period from 1994 through 1997, under cross border lease
transactions, UNA leased several of its power plants and related equipment and
turbines to non-Netherlands based investors (the head leases) and concurrently
leased the facilities back under sublease arrangements with remaining terms as
of September 30, 2000 of one to 24 years. UNA utilized proceeds from the head
lease transactions to prepay its sublease obligations and to provide a source
for payment of end of term purchase options and other financial undertakings.
The initial sublease obligations totaled approximately $2.4 billion of which
approximately $1.8 billion remained outstanding as of September 30, 2000. These
transactions involve UNA providing to a foreign investor an ownership right in
(but not necessarily title to) an asset, with a leaseback of that asset. The net
proceeds to UNA of the transactions were recorded as a deferred gain and are
currently being amortized to income over the lease terms. At December 31, 1999
and September 30, 2000, the unamortized deferred gain on these transactions
totaled $87 million and $73 million, respectively. The power plants, related
equipment and turbines remain on the financial statements of UNA and continue to
be depreciated.
UNA is required to maintain minimum insurance coverages, perform minimum
annual maintenance and, in specified situations, post letters of credit. UNA's
shareholder is subject to certain restrictions with respect to the liquidation
of UNA's shares. In the case of early termination of these contracts, UNA would
be contingently liable for some payments to the sublessors, which at September
30, 2000 are estimated to be $116 million. Prior to March 1, 2000, UNA was
required by some of the lease agreements to obtain standby letters of credit in
favor of the sublessors in the event of early termination. The amount of the
required letters of credit was $275 million as of September 30, 2000.
Commitments for these letters of credit have been obtained as of September 30,
2000. (See Note 8(a)).
F-47
<PAGE> 189
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(e) ENVIRONMENTAL AND LEGAL MATTERS.
The Company is involved in environmental and legal proceedings before
various courts and governmental agencies regarding matters arising in the
ordinary course of business, some of which involve substantial amounts. The
Company's management regularly analyzes current information and, as necessary,
provides accruals for probable liabilities on the eventual disposition of these
matters. The Company's management believes that the effect on the Company's
respective financial statements, if any, from the disposition of these matters
will not have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
Under the agreement to acquire REMA, the Company became responsible for
liabilities associated with ash disposal site closures and site contamination at
the acquired facilities in Pennsylvania and New Jersey prior to a plants
closing, except for the first $6 million of remediation costs at the Seward
Generating Station. A prior owner retained liabilities associated with the
disposal of hazardous substances to off-site locations prior to November 24,
1999. As of September 30, 2000, REMA has liabilities associated with six ash
disposal site closures and six site investigations and environmental
remediations. The Company has recorded its estimate of these environmental
liabilities in the amount of $35 million as of September 30, 2000. The Company
expects approximately $13 million will be paid over the next five years.
In connection with the acquisition of UNA (see Note 5(b)), the Company
assumed a $25 million obligation primarily related to asbestos abatement, as
required by Dutch law, and soil remediation at six sites. During 2000, the
Company initiated a review of potential environmental matters associated with
the UNA properties. UNA began remediation in 2000 of the properties identified
to have exposed asbestos and soil contamination, as required by Dutch law and
the terms of certain leasehold agreements with municipalities in which the
contaminated properties are located. All remediation efforts are to fully
completed by 2005. As of December 31, 1999 and September 30, 2000, the
undiscounted liability for this asbestos abatement and soil remediation was $25
million.
(f) INDEMNIFICATION OF STRANDED COSTS.
The stranded costs in the Dutch electricity market are considered to be the
liabilities, uneconomical contractual commitments, and other costs associated
with obligations entered into by the coordinating body for the Dutch electricity
generating sector, N.V. Samenwerkende elecktriciteits-produktiebedrijven (SEP),
plus certain district heating contracts with certain municipalities in Holland.
SEP was incorporated as the coordinating body for four of the large-scale
Dutch electricity generation companies, including UNA, which currently has an
equity interest in SEP of 25%. Among other things, SEP historically managed the
dispatch for the national transmission grid, coordinated the fuel supply,
managed the import and the export of electricity, and settled production costs
for the electricity generation companies.
Under the Cooperation Agreement (OvS Agreement), UNA and the other Dutch
generators agreed to sell their generating output through SEP. Over the years,
SEP has incurred stranded costs as a result of a perceived need to cover
anticipated shortages in energy production supply. SEP stranded costs consist
primarily of investments in alternative energy sources and fuel and power
purchase contracts currently estimated to be uneconomical.
In December 2000, the Dutch parliament adopted legislation, The Electricity
Production Sector Transitional Arrangements Act (Transition Act), allocating to
the Dutch generation sector,
F-48
<PAGE> 190
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
including UNA, financial responsibility for various stranded cost contracts and
other liabilities of SEP. The Transition Act also authorizes the government to
purchase from SEP at least a majority of the shares in the Dutch national
transmission grid company. The legislation became effective in all material
respects on January 1, 2001.
The Transition Act allocates financial responsibility to the individual
Dutch generators based on their average share in the costs and revenues under
the OvS Agreement during the past ten years. UNA's allocated share of these
costs has been set at 22.5%. In particular, the Transition Act allocates to the
four Dutch generation companies, including UNA, financial responsibility for
SEP's obligations to purchase electricity and gas under an import gas supply
contract and three electricity import contracts. The gas import contract expires
in 2015 and provides for gas imports aggregating 2.283 billion cubic meters per
year. The three electricity contracts have the following capacities and terms:
(a) 300 MW through 2005, (b) 600 MW through 2005 and (c) 600 MW through 2002 and
750 MW through 2009. The generators have the option of assuming their pro rata
interests in the contracts or, subject to the assignment terms of the contracts,
selling their interests to third parties.
The Transition Act provides that, subject to the approval of the European
Commission, the Dutch government will make financial compensations to the Dutch
generation sector for the out of market costs associated with two stranded cost
items: an experimental coal facility and district heating contracts.
The four Dutch generation companies and SEP are in discussions with the
Dutch Ministry of Economic Affairs regarding the implementation of the
Transition Act. The parties have reached an agreement in principle with the
Dutch Ministry of Economic Affairs regarding the compensation to be paid to SEP
for the national transmission grid company. The proposed compensation amount is
NLG 2.55 billion. Although the Transition Act clarifies many issues regarding
the anticipated resolution of the stranded cost debate in the Netherlands, there
remain considerable uncertainties regarding the exact manner in which the
Transition Act will be implemented and the potential for third parties to
challenge the Transition Act on legal and constitutional grounds.
In connection with the acquisition of UNA, the selling shareholders of UNA
agreed to indemnify UNA for certain stranded costs in an amount not to exceed
NGL 1.4 billion (approximately $560 million based on an exchange rate of 2.50
NLG per U.S. dollar as of September 30, 2000), which may be increased in certain
circumstances at the option of the Company up to NLG 1.9 billion (approximately
$760 million). Of the total consideration paid by the Company for the shares of
UNA, NLG 900 million (approximately $360 million) has been placed by the selling
shareholders in an escrow account to secure the indemnity obligations. Although
the Company's management believes that the indemnity provision will be
sufficient to fully satisfy UNA's ultimate share of any stranded cost
obligation, this judgment is based on numerous assumptions regarding the
ultimate outcome and timing of the resolution of the stranded cost issue, the
former shareholders timely performance of their obligations under the indemnity
arrangement, and the amount of stranded costs which at present is not
determinable.
(g) PAYMENT TO RELIANT ENERGY IN 2004.
The Company will be required to make a payment to Reliant Energy in early
2004 unless the Texas Utility Commission determines that, on or prior to January
1, 2004, 40% or more of the amount of electric power that was consumed in 2000
by residential or small commercial customers, as applicable, within Reliant
Energy's Houston, Texas service territory as of January 1, 2002 is committed to
be served by retail electric providers other than the Company. If
F-49
<PAGE> 191
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the 40% test is not met and a payment is required, the amount of this payment
will not exceed, but could be up to $150 per customer multiplied by the number
of residential or small commercial customers, as the case may be, that the
Company serves on January 1, 2004 in Reliant Energy's traditional service
territory, less the number of new retail electric customers the Company serves
in other areas of Texas. As of September 30, 2000, Reliant Energy had
approximately 1.5 million residential and small commercial customers. In the
master separation agreement between the Company and Reliant Energy, the Company
has agreed to make this payment, if any, to Reliant Energy.
(h) CALIFORNIA WHOLESALE MARKET.
Following price volatility in the California wholesale electricity markets
during the summer of 2000 and price levels that were higher than prices during
the summer of 1999, both the California Public Utility Commission and the
Federal Energy Regulatory Commission (FERC), among other agencies, initiated
investigations into the operation of the wholesale markets and the causes of the
price volatility. Additionally, a number of complaints have been filed at the
FERC, which has jurisdiction over wholesale markets and prices, naming as
respondents all sellers in the California wholesale market, which would include
several of the Company's subsidiaries. On December 15, 2000, as part of its
investigation, the FERC issued an order directing remedies for California
wholesale electricity markets. The December 15 order was issued after written
and public comments were submitted to the FERC in response to a preliminary
order proposing remedies for California's wholesale electricity markets issued
on November 1, 2000. In the December 15 order, the FERC imposed a two-year
refund condition on sales made at market-based rates into the Cal PX or to the
Cal ISO. The FERC also adopted a $150/MW breakpoint for market clearing prices
in the markets operated by the Cal PX and the Cal ISO. Sellers bidding in these
markets at or below the breakpoint would receive the market clearing price
during the applicable hour. Sellers bidding above the breakpoint would receive
their actual bid prices, if their bids are accepted, but would be required to
submit data respecting their bids for review by the FERC. For bid prices above
the breakpoint, unless the FERC issues written notification to a seller that its
transaction is still under review, refund potential on a transaction will end
after 60 days. The $150/MW breakpoint is intended to be replaced with a real
time price mitigation program to be developed and in place by May 1, 2001. The
FERC also concluded in the December 15 order that there was not sufficient
evidence in the record to find that particular sellers have exercised market
power or have violated FERC-approved market rules. The December 15 order did not
order any refunds of amounts previously charged, although it did adopt the
prospective refund condition mentioned above.
In addition, Reliant Energy has been named as one of a number of defendants
in a class action lawsuit filed against a number of companies that own
generation plants in California and other unnamed sellers of electricity in
California markets. Under the terms of the master separation agreement between
the Company and Reliant Energy, the Company has agreed to indemnify Reliant
Energy for any damages arising under this lawsuit and may elect to defend this
suit at the Company's own expense. Additionally, the Company's domestic trading
and marketing subsidiary has been named as one of multiple defendants in another
class action lawsuit against marketers and other unnamed sellers of electricity
in California markets. Both of these lawsuits were filed in the Supreme Court of
the State of California, San Diego County in November 2000 and allege violations
by the defendants of state antitrust laws and state laws against unfair and
unlawful business practices. The first lawsuit alleges aggregate damages of over
$4 billion. In addition to injunctive relief, the plaintiffs in these lawsuits
seek treble the amount of damages alleged, restitution of alleged overpayments,
disgorgement of alleged unlawful profits for sales of
F-50
<PAGE> 192
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
electricity during all or portions of 2000, costs of suit and attorneys' fees. A
petition to remove each case to Federal District Court in San Diego was filed in
December 2000. These lawsuits have only recently been filed. Therefore, the
ultimate outcome of the lawsuits cannot be predicted with any degree of
certainty at this time. However, the Company does not believe, based on its
analysis to date of the claims asserted in these suits and the underlying facts,
that the resolution of these suits will have a material adverse effect on the
Company's financial condition, results of operations or cash flows.
(12) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of cash and cash equivalents and short-term and long-term
borrowings to third parties and affiliates are estimated to be equivalent to the
carrying amounts. Investments in debt and equity securities classified as
"available-for-sale" and "trading" in accordance with SFAS No. 115 and financial
instruments included in the trading operations are stated at fair value in the
Consolidated Balance Sheets. As of December 31, 1999 and September 30, 2000, the
fair value of foreign currency swaps were a $6 million receivable and a $22
million payable respectively. The foreign currency swaps' fair values have been
determined using quoted market prices of the same or similar instruments. As of
December 31, 1998, there were no foreign currency swaps. The fair values of
energy derivatives related to non-trading activities were not material at
December 31, 1998 and 1999 and September 30, 2000.
(13) UNAUDITED QUARTERLY INFORMATION
Summarized quarterly financial data is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
---------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Revenues.......................... $864 $ 894 $1,601 $1,012
Operating (loss) income........... (5) (34) 92 (16)
Net (loss) income................. (2) (22) 60 (15)
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
---------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Revenues.......................... $ 994 $1,890 $2,943 $2,226
Operating (loss) income........... (6) 1 32 9
Net (loss) income................. (5) (3) 17 15
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 2000
----------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER
------------- -------------- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Revenues.......................... $2,267 $3,658 $6,895
Operating (loss) income........... (1) 176 302
(Loss) income before extraordinary
item............................ (26) 107 164
Net (loss) income................. (26) 114 164
</TABLE>
The quarterly operating results incorporate the results of operations of
REMA, UNA, Indian River and the five electric generation plants located in
southern California from their respective acquisition dates as discussed in Note
5. The variances in revenues from quarter to quarter were primarily due to these
acquisitions, the seasonal fluctuations in demand for energy and energy services
and changes in energy commodity prices. Changes in operating (loss) income and
net
F-51
<PAGE> 193
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(loss) income from quarter to quarter were primarily due to these acquisitions,
the seasonal fluctuations in demand for energy and energy services, changes in
energy commodity prices and timing of maintenance expenses on electric
generation plants.
(14) REPORTABLE SEGMENTS
The Company has identified the following reportable segments: Wholesale
Energy, European Energy, Retail Energy and Other Operations. For descriptions of
the financial reporting segments, see Note 1. The Company's determination of
reportable segments considers the strategic operating units under which the
Company manages sales, allocates resources and assesses performance of various
products and services to wholesale or retail customers. Financial information
for REMA, Unregulated RERC, UNA, Indian River and the five electric generation
plants located in Southern California are included in the segment disclosures
only for periods beginning on their respective acquisition dates. The Company
evaluates performance based on operating income. There were no material
intersegment revenues during the years ended December 31, 1997, 1998, and 1999
and nine months ended September 30, 1999 and 2000.
F-52
<PAGE> 194
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Financial data for business segments, products and services and geographic
areas are as follows:
<TABLE>
<CAPTION>
WHOLESALE EUROPEAN RETAIL OTHER
ENERGY ENERGY ENERGY OPERATIONS CONSOLIDATED
--------- -------- ------ ---------- ------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
AS OF AND FOR THE YEAR ENDED
DECEMBER 31, 1997:
Revenues from external customers............ $ 1,300 $ -- $ 21 $ -- $ 1,321
Depreciation and amortization............... 2 -- -- -- 2
Operating loss.............................. (7) -- (2) -- (9)
Total assets................................ 608 -- 3 211 822
Equity investments in unconsolidated
subsidiaries.............................. 2 -- -- -- 2
Expenditures for long-lived assets.......... 4 -- -- -- 4
AS OF AND FOR THE YEAR ENDED
DECEMBER 31, 1998:
Revenues from external customers............ 4,338 -- 33 -- 4,371
Depreciation and amortization............... 14 -- -- 1 15
Operating income (loss)..................... 40 -- (2) (1) 37
Total assets................................ 1,341 -- 24 44 1,409
Equity investments in unconsolidated
subsidiaries.............................. 42 -- -- -- 42
Expenditures for long-lived assets.......... 353 -- -- 12 365
AS OF AND FOR THE YEAR ENDED
DECEMBER 31, 1999:
Revenues from external customers............ 7,866 153 34 -- 8,053
Depreciation and amortization............... 21 20 -- 2 43
Operating income (loss)..................... 19 34 (13) (4) 36
Total assets................................ 2,710 2,782 70 62 5,624
Equity investments in unconsolidated
subsidiaries.............................. 78 -- -- -- 78
Expenditures for long-lived assets.......... 501 839 55 -- 1,395
AS OF AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1999 (UNAUDITED):
Revenues from external customers............ 5,798 -- 29 -- 5,827
Depreciation and amortization............... 15 -- -- 1 16
Operating income (loss)..................... 39 -- (10) (2) 27
Total assets................................ 2,389 -- (5) 45 2,429
Equity investments in unconsolidated
subsidiaries.............................. 73 -- -- -- 73
Expenditures for long-lived assets.......... 93 -- 11 -- 104
AS OF AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2000:
Revenues from external customers............ 12,342 415 59 4 12,820
Depreciation and amortization............... 70 55 2 3 130
Operating income (loss)..................... 470 69 (38) (24) 477
Total assets................................ 7,312 2,308 120 116 9,856
Equity investments in unconsolidated
subsidiaries.............................. 116 -- -- -- 116
Expenditures for long-lived assets.......... 1,741 1,000 9 41 2,791
</TABLE>
F-53
<PAGE> 195
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
AS OF AND FOR THE YEAR SEPTEMBER 30,
ENDED DECEMBER 31, ---------------------
-------------------------- (UNAUDITED)
1997 1998 1999 1999 2000
---- ---- ---- ----------- ----
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
RECONCILIATION OF OPERATING (LOSS)
INCOME TO NET (LOSS) INCOME:
Operating (loss) income....................... $ (9) $ 37 $ 36 $ 27 $ 477
Interest expense.............................. (1) (2) (12) -- (37)
Interest income............................... -- 1 2 1 11
Interest income (expense) -- affiliated
companies, net.............................. 2 2 (8) -- (122)
Gains (Losses) from investments............... -- -- 16 -- (17)
(Losses) income of equity investment of
unconsolidated subsidiaries................. -- (1) (1) (1) 33
Gain on sale of development project........... -- -- -- -- 18
Other income (expense)........................ -- 1 (7) (6) 2
Income tax benefit (expense).................. 2 (17) (2) (12) (120)
Extraordinary gain............................ -- -- -- -- 7
------ ------ ------ ------ -------
Net (loss) income...................... $ (6) $ 21 $ 24 $ 9 $ 252
====== ====== ====== ====== =======
REVENUES BY PRODUCTS AND SERVICES:
Wholesale energy and energy related sales..... $1,300 $4,338 $8,019 $5,798 $12,761
Energy products and services.................. 21 33 34 29 59
------ ------ ------ ------ -------
Total.................................. $1,321 $4,371 $8,053 $5,827 $12,820
====== ====== ====== ====== =======
REVENUES AND LONG-LIVED ASSETS BY
GEOGRAPHIC AREAS:
REVENUES:
US.......................................... $1,321 $4,371 $7,783 $5,806 $11,820
Netherlands................................. -- -- 153 -- 415
Canada...................................... -- -- 117 21 585
------ ------ ------ ------ -------
Total.................................. $1,321 $4,371 $8,053 $5,827 $12,820
====== ====== ====== ====== =======
LONG-LIVED ASSETS:
US.......................................... $ 456 $ 689 $1,471 $ 947 $ 3,832
Netherlands................................. -- -- 2,563 -- 2,244
Canada...................................... -- -- -- -- 15
------ ------ ------ ------ -------
Total.................................. $ 456 $ 689 $4,034 $ 947 $ 6,091
====== ====== ====== ====== =======
</TABLE>
F-54
<PAGE> 196
RELIANT RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) SUBSEQUENT EVENTS
(a) STOCK SPLIT
The Company and Reliant Energy effected a 240,000 to 1 stock split on
January 5, 2001. The Company has filed a registration statement on Form S-1 to
register with the Securities and Exchange Commission up to $1.3 billion maximum
aggregate offering price of the Company's authorized but unissued shares of
common stock. The Offering is expected to reduce Reliant Energy's ownership in
the Company to approximately 80%. There can be no assurance that the Offering
will occur.
(b) ACQUISITION OF SUNRISE POWER PLANT
In December 2000, a subsidiary of the Company announced that it agreed to
purchase the Sunrise Power Plant, a 153 MW power generating facility, located
near Las Vegas, Nevada, together with rights under a power purchase agreement
covering 222 MW of generation capacity from an adjacent generation facility. The
purchase price for both the plant and the rights under the power purchase
agreement is approximately $33 million.
(c) CREDIT FACILITIES
Between December 2000 and January 2001, the Company entered into a total of
nine credit facilities with financial institutions which provide for an
aggregate of $1.4 billion in committed credit. The facilities became effective
on January 2, 2001 and expire on October 1, 2001. Interest rates on the
borrowings are based on the prime rate plus a margin, the Federal Funds
Effective Rate plus a margin, LIBOR plus a margin, a base rate or a rate
determined through a bidding process. These facilities contain various business
and financial covenants requiring the Company to, among other things, maintain a
ratio of net debt to the sum of net debt, shareholder's equity and subordinated
affiliate debt not to exceed 0.60 to 1.00. Such covenants are not anticipated to
materially restrict the Company from borrowing funds under such facilities. The
facilities are subject to commitment and usage fees that are calculated based on
the outstanding amounts under the facilities.
(d) FOREIGN CURRENCY SWAPS
On January 11, 2001, the Company entered into five foreign currency swaps
for 671 million Euros (approximately $633 million), to replace the four foreign
currency swaps that expired in January 2001 (see Note 6(b)). These five foreign
currency swaps terminate in January 2002. The Company will record changes in the
value of these foreign currency swaps as a component of stockholder's equity and
accumulated other comprehensive loss.
(e) RELATED PARTY TRANSACTIONS
On January 9, 2001, the Company entered into a subordinated note agreement
with Reliant Energy for approximately $1.8 billion. The proceeds of the
subordinated note were used to pay off existing notes payable between the
Company and Reliant Energy or its subsidiaries. The subordinated note is due in
July 2002, and bears interest at market rates, payable quarterly. Reliant Energy
will agree that this subordinated note will be converted to equity as a capital
contribution prior to the closing of the Offering (see Note 4(c)).
* * *
F-55
<PAGE> 197
INDEPENDENT AUDITORS' REPORT
To the Directors, Shareholder and Member of
Reliant Energy Mid-Atlantic Power Holdings, LLC
Reliant Energy New Jersey Holdings, LLC
Reliant Energy Maryland Holdings, LLC
Reliant Energy Mid-Atlantic Power Services, Inc.
We have audited the accompanying combined balance sheet of Reliant Energy
Mid-Atlantic Power Holdings, LLC (formerly Sithe Pennsylvania Holdings, LLC)
(REMA) and related companies as of December 31, 1999, and the related combined
statements of operations, member's and shareholder's equity, and cash flows for
the period from November 24, 1999 to December 31, 1999. The combined financial
statements include the accounts of Reliant Energy Mid-Atlantic Power Holdings,
LLC and three related companies, Reliant Energy New Jersey Holdings, LLC
(formerly Sithe New Jersey Holdings, LLC), Reliant Energy Maryland Holdings, LLC
(formerly Sithe Maryland Holdings, LLC) and Reliant Energy Mid-Atlantic Power
Services, Inc. (formerly Sithe Mid-Atlantic Power Services, Inc.). These
companies are under common ownership and common management. These financial
statements are the responsibility of REMA's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such combined financial statements present fairly, in all
material respects, the combined financial position of Reliant Energy
Mid-Atlantic Power Holdings, LLC and related companies at December 31, 1999, and
the combined results of their operations and their combined cash flows for the
period from November 24, 1999 to December 31, 1999, in conformity with
accounting principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
July 12, 2000
(except for Note 8(c) to the combined financial
statements which is dated August 24, 2000)
F-56
<PAGE> 198
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
STATEMENT OF COMBINED OPERATIONS
FOR THE PERIOD FROM NOVEMBER 24, 1999 TO DECEMBER 31, 1999
(THOUSANDS OF DOLLARS)
<TABLE>
<S> <C>
REVENUES FROM AFFILIATE..................................... $29,526
EXPENSES:
Fuel, including $5.7 million from affiliate............... 10,754
Operation and maintenance................................. 7,084
Administrative and general................................ 1,584
Project development....................................... 1,606
Other taxes............................................... 746
Depreciation and amortization............................. 4,842
-------
Total Expenses..................................... 26,616
-------
OPERATING INCOME............................................ 2,910
Interest Expense to Affiliate, net.......................... 12,588
-------
NET LOSS.................................................... $(9,678)
=======
</TABLE>
See Notes to the Combined Financial Statements
F-57
<PAGE> 199
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
COMBINED BALANCE SHEET
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
DECEMBER 31,
1999
-----------------
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 570
Fuel inventories.......................................... 6,411
Material and supplies inventories......................... 52,965
Other current assets...................................... 637
----------
Total current assets............................... 60,583
PROPERTY, PLANT AND EQUIPMENT, NET.......................... 1,286,319
OTHER NONCURRENT ASSETS:
Goodwill, net............................................. 184,518
Air emissions regulatory allowances, net.................. 166,791
Project development costs................................. 7,689
----------
Total other noncurrent assets...................... 358,998
----------
TOTAL ASSETS................................................ $1,705,900
==========
LIABILITIES AND MEMBER'S AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 10,244
Payable to affiliates..................................... 7,928
Accrued payroll........................................... 5,273
Asset purchase consideration payable...................... 27,296
Demand notes payable to affiliate......................... 1,575,312
Other current liabilities................................. 3,856
----------
Total current liabilities.......................... 1,629,909
NONCURRENT LIABILITIES:
Accrued environmental liabilities......................... 28,030
Other noncurrent liabilities.............................. 3,030
----------
Total noncurrent liabilities....................... 31,060
COMMITMENTS AND CONTINGENCIES
MEMBER'S AND SHAREHOLDER'S EQUITY:
Common stock ($0.01 par value, 1,500 shares authorized,
100 shares issued and outstanding)...................... --
Member's capital contributions............................ 54,609
Retained deficit.......................................... (9,678)
----------
Total member's and shareholder's equity............ 44,931
----------
TOTAL LIABILITIES AND MEMBER'S AND SHAREHOLDER'S
EQUITY............................................ $1,705,900
==========
</TABLE>
See Notes to the Combined Financial Statements
F-58
<PAGE> 200
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
STATEMENT OF COMBINED CASH FLOWS
FOR THE PERIOD FROM NOVEMBER 24, 1999 TO DECEMBER 31, 1999
(THOUSANDS OF DOLLARS)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $ (9,678)
Adjustments to reconcile net loss to net cash provided by
operations:
Depreciation and amortization expense................... 4,842
Changes in assets and liabilities:
Fuel inventories...................................... 1,591
Material and supplies inventories..................... (181)
Other assets.......................................... (421)
Accounts payable...................................... 10,244
Other current liabilities............................. (5,367)
-----------
Net cash provided by operating activities.......... 1,030
-----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of generating stations........................ (1,629,921)
Capital expenditures...................................... (4,421)
-----------
Net cash flows used in investing activities........ (1,634,342)
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contribution...................................... 54,609
Proceeds from demand notes payable to affiliate........... 1,575,312
Net change in payables to affiliates...................... 3,961
-----------
Net cash flows provided by financing activities.... 1,633,882
-----------
NET CHANGE IN CASH AND CASH EQUIVALENTS..................... 570
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. --
-----------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 570
===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid to affiliate................................ $ 12,588
===========
</TABLE>
See Notes to the Combined Financial Statements
F-59
<PAGE> 201
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
STATEMENT OF COMBINED MEMBER'S AND SHAREHOLDER'S EQUITY
FOR THE PERIOD FROM NOVEMBER 24, 1999 TO DECEMBER 31, 1999
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
TOTAL
MEMBER'S MEMBER'S AND
COMMON CAPITAL RETAINED SHAREHOLDER'S
STOCK CONTRIBUTIONS DEFICIT EQUITY
------ ------------- -------- -------------
<S> <C> <C> <C> <C>
BALANCE, BEGINNING OF PERIOD.................... $ -- $ -- $ -- $ --
Capital contributions......................... -- 54,609 -- 54,609
Net loss...................................... -- -- (9,678) (9,678)
---- ------- ------- -------
BALANCE, END OF PERIOD.......................... $ -- $54,609 $(9,678) $44,931
==== ======= ======= =======
</TABLE>
See Notes to the Combined Financial Statements
F-60
<PAGE> 202
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC.
Reliant Energy Mid-Atlantic Power Holdings, LLC (formerly Sithe
Pennsylvania Holdings, LLC) and related companies which include the affiliates
and subsidiaries listed below (collectively, REMA) were indirect wholly-owned
subsidiaries of Sithe Energies, Inc. (Sithe) as of December 31, 1999. See Note
8. REMA acquired its generating stations and various related assets (including
the capital stock of Sithe Mid-Atlantic Power Services, Inc.) from operating
subsidiaries of GPU, Inc. (GPU), a utility holding company, on November 24,
1999. REMA was formed as follows:
<TABLE>
<CAPTION>
RELATION TO RELIANT
ENERGY
MID-ATLANTIC POWER
HOLDINGS AT
DECEMBER 31,
FORMATION DATE 1999
-------------- -------------------
<S> <C> <C>
Operating Entities:
Sithe Pennsylvania Holdings, LLC................... December 28, 1998 N/A
Sithe New Jersey Holdings, LLC..................... December 28, 1998 Affiliate
Sithe Maryland Holdings, LLC....................... December 28, 1998 Affiliate
Sithe Northeast Management Company................. April 11, 1994 Subsidiary
Sithe Mid-Atlantic Power Services, Inc............. June 11, 1999 Affiliate
Developmental Entities:
Sithe Portland, LLC................................ March 31, 1999 Subsidiary
Sithe Hunterstown, LLC............................. March 31, 1999 Subsidiary
Sithe Seward, LLC.................................. March 31, 1999 Subsidiary
Sithe Erie West, LLC............................... March 31, 1999 Subsidiary
Sithe Atlantic, LLC................................ March 31, 1999 Affiliate
Sithe Gilbert, LLC................................. March 31, 1999 Affiliate
Sithe Titus, LLC................................... March 31, 1999 Subsidiary
</TABLE>
In May 2000, Sithe, through an indirect wholly-owned subsidiary, sold all
of its equity interests in REMA to an indirect wholly-owned subsidiary of
Reliant Energy Power Generation, Inc. (REPG). REPG is a wholly-owned subsidiary
of Reliant Energy, Incorporated (Reliant Energy). See Note 8. Following this
transaction, REMA changed its name and the names of its operating and
developmental entities. Sithe Pennsylvania Holdings, LLC was renamed Reliant
Energy Mid-Atlantic Power Holdings, LLC. In all other cases, the names were
changed such that "Sithe" was replaced with "Reliant Energy."
REMA owns interests in and operates 21 electric generation plants in
Pennsylvania, New Jersey and Maryland with an annual average net generating
capacity of approximately 4,262 megawatts (MW).
(b) BASIS OF PRESENTATION AND PRINCIPLES OF COMBINATION.
These financial statements present the results of operations for the period
from November 24, 1999 (the date that REMA acquired the generation assets from
GPU) to December 31, 1999. There are no separate financial statements available
with regard to the facilities of REMA prior to the acquisition because their
operations were fully integrated with, and their results of operations were
consolidated into, the former owners of the facilities of REMA. In addition, the
electric output of the facilities was sold based on rates set by regulatory
authorities. As a result
F-61
<PAGE> 203
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
and because electricity rates will now be set by the operation of market forces,
the historical financial data with respect to the facilities of REMA prior to
November 24, 1999 is not meaningful or indicative of REMA's future results.
REMA's results of operations in the future will depend primarily on revenues
from the sale of energy, capacity and ancillary services, and the level of its
operating expenses.
The acquisition of REMA's generating assets was recorded under the purchase
method of accounting, with assets and liabilities of REMA reflected at their
estimated fair values as of the date of the purchase. On a preliminary basis,
REMA's fair value adjustments included increases in property, plant and
equipment and air emissions regulatory allowances. The allocation of the
purchase price is preliminary, since the valuation of property, plant and
equipment and air emissions regulatory allowances as well as the valuation of
material and supplies inventories and environmental reserves have not been
finalized. REMA's liabilities include $27.3 million of asset purchase
consideration payable in connection with REMA's acquisition of its generating
assets.
The combined financial statements include the accounts of REMA and related
companies including the affiliates and subsidiaries described in Note 1(a). All
significant inter-affiliate and intercompany transactions and balances are
eliminated in combination. The combination of affiliates and subsidiaries
includes all of the operations and assets acquired from GPU on November 24,
1999, which have been managed together since that acquisition date.
Investments that represent direct interests in the assets, liabilities and
operations of ventures are reported as REMA's share of each account in the
venture. See Note 2.
(c) USE OF ESTIMATES.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
(d) REVENUE RECOGNITION.
Revenue includes energy, capacity and ancillary service sales. During 1999,
REMA's power and services, excluding capacity, were sold at market-based prices
through sales to a related party and wholly-owned subsidiary of Sithe (the Sithe
Affiliate) for resale. The Sithe Affiliate acted as agent on behalf of REMA on
most market-based sales. REMA's capacity was also sold to the Sithe Affiliate at
terms that mirror a transition power purchase agreement between Sithe and GPU.
The transition power purchase agreement extends from November 24, 1999 to May
31, 2002. Sales not billed by month-end are accrued based upon estimated energy
or services delivered.
(e) CASH AND CASH EQUIVALENTS.
Cash and cash equivalents are considered to be highly liquid investments
with an original maturity of three months or less, which are cash or are readily
convertible to cash.
(f) INVENTORIES.
Inventories are comprised of materials, supplies and fuel stock held for
consumption and are stated at the lower of weighted-average cost or market.
F-62
<PAGE> 204
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(g) Fair Values of Financial Instruments.
The recorded amounts for financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and affiliate receivables and
payables approximate fair value due to the short-term nature of these
instruments.
(h) PROPERTY, PLANT AND EQUIPMENT.
Property, plant and equipment are stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives, commencing when
assets, or major components thereof, are either placed in service or acquired,
as appropriate.
(i) INTANGIBLE ASSETS.
Cost in excess of fair value of net assets acquired (goodwill) is amortized
on a straight-line basis over the estimated useful life of 40 years. Goodwill
amortization expense during 1999 was $481,000.
Other intangible assets consist primarily of air emissions regulatory
allowances that have already been issued to REMA and allowances that REMA
expects to be allocated during the remaining useful lives of the plants. These
intangible assets are amortized on a unit-of-production basis as utilized.
Amortization expense recognized in 1999 related to other intangible assets was
$209,000.
(j) IMPAIRMENT OF LONG-LIVED ASSETS.
REMA periodically compares the carrying value of its long-lived assets,
including goodwill and other intangible assets, to the anticipated undiscounted
future net cash flows from their corresponding businesses, and no impairment is
indicated at December 31, 1999.
(k) PROJECT DEVELOPMENT COSTS.
REMA capitalizes the deposits made toward future combustion turbine
deliveries as well as the direct costs associated with viable projects,
including some third-party legal, accounting and consulting costs. These
capitalized costs are amortized over the estimated life of the project on a
straight-line basis, beginning when the project becomes operational. Other
project development costs are expensed as incurred.
(l) INCOME TAXES.
REMA and some of its affiliates that are limited liability companies are
not taxable for federal income tax purposes. Any taxable earnings or losses and
certain other tax attributes are reported by the member on its income tax
return. Other affiliates that are taxable corporate entities have incurred tax
and book losses but are not subject to any tax-sharing agreements with Sithe. As
such, no tax benefits have been recorded for these entities since the tax
benefits are not considered realizable. These tax benefits and the offsetting
valuation allowance are less than $1 million.
(m) MARKET RISK AND UNCERTAINTIES.
REMA is subject to risks including the supply and price of fuel, seasonal
weather patterns, technological obsolescence and the regulatory environment
within the United States.
F-63
<PAGE> 205
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(n) COMPREHENSIVE INCOME.
REMA had no items of comprehensive income for the financial statement
period presented.
(o) NEW ACCOUNTING PRONOUNCEMENT.
Effective January 1, 2001, REMA is required to adopt Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended (SFAS No. 133), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. This
statement requires that derivatives be recognized at fair value in the balance
sheet and that changes in fair value be recognized either currently in earnings
or deferred as a component of other comprehensive income, depending on the
intended use of the derivative, its resulting designation and its effectiveness.
In addition, in June 2000, the Financial Accounting Standards Board issued an
amendment that narrows the applicability of the pronouncement to some purchase
and sales contracts and allows hedge accounting for some other specific hedging
relationships.
Staff Accounting Bulletin No. 101, "Revenue Recognition" (SAB No. 101), was
issued by the SEC on December 3, 1999. SAB No. 101 summarizes some of the SEC
staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. REMA's combined financial statements
reflect the accounting principles provided in SAB No. 101.
(2) JOINTLY OWNED ELECTRIC GENERATION PLANTS
REMA has partial undivided interests in two jointly owned generation
stations in Pennsylvania and bears a corresponding share of the capital and
operating costs associated with the facilities. The following table summarizes
certain financial and operational information about REMA's jointly owned
coal-fired facilities as of December 31, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
CONEMAUGH KEYSTONE
STATION STATION
--------- --------
<S> <C> <C>
Ownership interest.......................................... 16.45% 16.67%
REMA's share of capacity (MW)............................... 281 285
Net investment.............................................. $257,410 $207,334
Accumulated depreciation.................................... $ 537 $ 432
</TABLE>
The Conemaugh and Keystone stations (Conemaugh and Keystone, respectively)
are each owned as a tenancy in common among their co-owners, with each owner
retaining its undivided ownership interest in the generating units and the
electrical output from those units. Reliant Energy Northeast Management Company,
a subsidiary of Reliant Energy Mid-Atlantic Power Holdings, LLC, operates and
manages Conemaugh and Keystone under separate operating agreements that the
owners of Conemaugh and Keystone have elected to terminate effective December
31, 2002. The owners of each station have not yet decided on the operating
arrangements for this station for the period beginning on January 1, 2003.
F-64
<PAGE> 206
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(3) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following at December 31 (in
thousands):
<TABLE>
<CAPTION>
ESTIMATED USEFUL
LIVES (YEARS) 1999
---------------- ----
<S> <C> <C>
Land........................................................ -- $ 28,154
Generation plant-in-service................................. 11 to 45 1,242,166
Buildings................................................... 30 to 32 6,045
Machinery and equipment..................................... 10 13,353
----------
Total plant-in-service...................................... 1,289,718
Construction work-in-progress............................... 753
----------
Total.............................................. 1,290,471
Less -- Accumulated depreciation............................ (4,152)
----------
Property, plant and equipment -- net........................ $1,286,319
==========
</TABLE>
(4) DEMAND NOTES PAYABLE TO AFFILIATE
In connection with Sithe's acquisition of its generating assets from GPU,
REMA executed and issued approximately $1.6 billion of demand notes payable to
Sithe Northeast Generating Company, Inc. (an indirect wholly-owned subsidiary of
Sithe) due August 20, 2001. The notes bear interest at a financing rate based on
the London interbank offered rate (LIBOR) plus (a) 1.9% per annum through
November 24, 2000 and (b) 2.4% per annum thereafter. The applicable interest
rate was 7.644% at December 31, 1999. Borrowings outstanding under these
unsecured notes payable approximate fair value, as the individual borrowings
bear interest at current market rates. In connection with the acquisition of
REMA in May 2000, Sithe Northeast Generating Company, Inc. sold these notes to
an indirect wholly-owned subsidiary of REPG. See Note 8.
(5) COMMITMENTS AND CONTINGENCIES
(a) ENVIRONMENTAL.
Under the agreement to acquire REMA's generating assets from GPU,
liabilities associated with ash disposal site closure and site contamination at
the acquired facilities in Pennsylvania and New Jersey prior to plant closing
were assumed, except for the first $6 million of remediation costs at the Seward
Station. GPU retained liabilities associated with the disposal of hazardous
substances to off-site locations prior to November 24, 1999. REMA has recorded
its estimate of these environmental liabilities in the amount of $28.0 million
as of December 31, 1999.
(b) OPERATING LEASES.
REMA leases some equipment and vehicles under noncancelable operating
leases extending through 2004. Future minimum rentals under lease agreements are
as follows (in thousands):
<TABLE>
<S> <C>
2000........................................................ $371
2001........................................................ 243
2002........................................................ 143
2003........................................................ 50
2004........................................................ 12
----
Total.............................................. $819
====
</TABLE>
F-65
<PAGE> 207
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Rent expense incurred under operating leases aggregated approximately
$35,000 in 1999.
(c) FUEL SUPPLY AGREEMENTS.
REMA, primarily through its ownership interests in Conemaugh and Keystone,
is a party to several long-term fuel supply contracts that have various quantity
requirements and durations. Minimum payment obligations under these agreements
that extend through 2004 are as follows (in millions):
<TABLE>
<S> <C>
2000........................................................ $ 67
2001........................................................ 47
2002........................................................ 40
2003........................................................ 19
2004........................................................ 13
----
Total.............................................. $186
====
</TABLE>
(d) OTHER.
REMA is party to various legal proceedings that arise from time to time in
the ordinary course of business. While REMA cannot predict the outcome of these
proceedings, REMA does not expect these matters to have a material adverse
effect on REMA's financial position, operations or cash flows.
(6) EMPLOYEE BENEFIT PLANS AND OTHER EMPLOYEE MATTERS
Substantially all of REMA's union employees participate in a
noncontributory pension plan (the Hourly Plan). The Hourly Plan provides
retirement benefits based on years of service and compensation. The funding
policy of REMA is to contribute amounts annually in accordance with applicable
regulations in order to achieve adequate funding of projected benefit
obligations. Sithe included REMA's union employees in its pension plan effective
November 24, 1999, and all pension liabilities associated with employee service
periods prior to that date were retained by GPU pursuant to the purchase
agreement between Sithe and GPU. Pension expense for 1999 for REMA employees was
approximately $500,000.
Effective November 24, 1999, REMA participated in Sithe's savings plan (the
Savings Plan), which covered substantially all of REMA's employees. The Savings
Plan limits non-union employees' pre-tax and/or after-tax contributions to 16%
of covered compensation, not to exceed the annual contribution limits of the
Internal Revenue Code of 1986, as amended (the Code). REMA matches up to 100% of
the first 3% of each non-union employee's contributions (based on the employee's
service). REMA matches between 55% and 65% (based upon the terms of the
applicable collective bargaining agreement) of the first 4% of each union
employee's pre-tax and/or after-tax contributions (up to the annual Code
contribution limits) to the Savings Plan. Employer matching contributions for
non-union employees are subject to a vesting schedule, which entitles the
employee to a percentage of the employer matching contributions, depending on
years of service, but union employees are fully vested in their employer
matching contributions. Sithe's savings plan benefit expense for REMA employees
for 1999 was approximately $93,000.
Effective November 24, 1999, Sithe provided various health care benefits to
eligible REMA employees. Health care expense for 1999 was approximately
$400,000. These benefits were funded from the general assets of REMA as they
were incurred. All health care liabilities
F-66
<PAGE> 208
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
associated with employee service periods prior to November 24, 1999 were
retained by GPU pursuant to the purchase agreement between Sithe and GPU. All
retiree medical obligations for REMA employees were retained by GPU pursuant to
the purchase agreement between Sithe and GPU.
Approximately 67% of REMA's employees are the subject of three collective
bargaining arrangements. Of these employees, 7% representing 5% of REMA's total
workforce are subject to arrangements that expire prior to December 31, 2000.
(7) RELATED PARTY TRANSACTIONS
In 1999, REMA sold most of the electric power generated by its facilities
to the Sithe Affiliate. REMA also purchased fuel for its generating plants
(other than coal for Keystone and Conemaugh) from the Sithe Affiliate. In
connection with the acquisition of REMA in May 2000, REMA now markets its power
through and purchases fuel from Reliant Energy Services, Inc., an affiliate of
REPG.
(8) SUBSEQUENT EVENT
(a) ACQUISITION BY REPG.
In February 2000, REPG reached a definitive agreement to purchase the
equity of REMA and the $1.6 billion of pre-existing affiliate debt from Sithe
for an aggregate purchase price of $2.1 billion, subject to adjustments.
Included within this purchase transaction were transition power purchase
agreements, including the capacity transition contract with GPU described in
Note 1(d). The transaction was completed in May 2000. The acquisition was
accounted for as a purchase, and the purchase price allocations were pushed down
to REMA.
(b) RESTRUCTURING.
In July 2000, Reliant Energy Mid-Atlantic Power Holdings, LLC acquired the
ownership interests in the following affiliates, which are included in these
combined financial statements:
Reliant Energy New Jersey Holdings, LLC
Reliant Energy Maryland Holdings, LLC
Reliant Energy Mid-Atlantic Power Services, Inc.
These affiliates were acquired from an indirect wholly-owned subsidiary of
REPG for a purchase price of $167 million, and REMA issued a note in this amount
to the subsidiary. In addition, the developmental entities listed in Note 1(a)
were distributed to Reliant Energy Mid-Atlantic Development, Inc., a
wholly-owned subsidiary of REPG but not of REMA.
(c) LEASE FINANCING.
In August 2000, REMA sold to and leased back from each of three
owner-lessors in separate lease transactions REMA's respective 16.45%, 16.67%
and 100% interests in the Conemaugh, Keystone and Shawville generating stations.
As lessee, REMA leases an interest in each facility from each owner-lessor under
a facility lease agreement. The lease agreements contain some restrictive
covenants that restrict REMA's ability to, among other things, make dividend
distributions unless REMA satisfies various conditions. The covenant restricting
dividends would be suspended if a direct or indirect parent of REMA meeting
specified criteria guarantees the lease obligations. As consideration for the
sale of REMA's interest in each of the
F-67
<PAGE> 209
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
facilities, REMA received $1.0 billion in cash. These proceeds were utilized to
return capital of $183 million, with the remainder used to reduce affiliate
debt. The equity interests in all of the affiliates of REMA are pledged as
collateral for REMA's lease obligations. In addition, these affiliates have also
guaranteed the payments under the lease obligations.
The following table sets forth REMA's obligation under these long-term
operating lease (in millions):
<TABLE>
<S> <C>
Inception of lease to December 31, 2000..................... $ 0.9
2001........................................................ 259.3
2002........................................................ 136.5
2003........................................................ 76.5
2004........................................................ 84.5
2005 and beyond............................................. 1,262.3
--------
$1,820.0
========
</TABLE>
* * *
F-68
<PAGE> 210
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
INTERIM CONDENSED STATEMENT OF COMBINED OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<S> <C>
REVENUES FROM AFFILIATE..................................... $107,432
EXPENSES:
Fuel, including $26.4 million from affiliate.............. 38,500
Operation and maintenance................................. 23,283
Administrative and general................................ 4,813
Project development....................................... 2,733
Other taxes............................................... 2,021
Depreciation and amortization............................. 12,885
--------
Total Expenses..................................... 84,235
--------
OPERATING INCOME............................................ 23,197
Interest Expense to Affiliate, net.......................... 31,812
--------
NET LOSS.................................................... $ (8,615)
========
</TABLE>
See Notes to the Combined Interim Financial Statements
F-69
<PAGE> 211
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
INTERIM CONDENSED COMBINED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1999 2000
------------ ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 570 $ 48
Fuel inventories.......................................... 6,411 7,017
Material and supplies inventories......................... 52,965 52,931
Other current assets...................................... 637 1,742
---------- ----------
Total current assets............................... 60,583 61,738
PROPERTY, PLANT AND EQUIPMENT, NET.......................... 1,286,319 1,280,243
OTHER NONCURRENT ASSETS:
Goodwill, net............................................. 184,518 183,367
Air emissions regulatory credits, net..................... 166,791 165,542
Project development costs................................. 7,689 7,689
---------- ----------
Total other noncurrent assets...................... 358,998 356,598
---------- ----------
TOTAL ASSETS....................................... $1,705,900 $1,698,579
========== ==========
LIABILITIES AND MEMBER'S AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 10,244 $ 10,929
Payable to affiliates..................................... 7,928 3,124
Accrued payroll........................................... 5,273 5,256
Asset purchase consideration payable...................... 27,296 27,296
Demand notes payable to affiliate......................... 1,575,312 1,575,312
Other current liabilities................................. 3,856 9,286
---------- ----------
Total current liabilities.......................... 1,629,909 1,631,203
NONCURRENT LIABILITIES:
Accrued environmental liabilities......................... 28,030 28,030
Other noncurrent liabilities.............................. 3,030 3,030
---------- ----------
Total noncurrent liabilities....................... 31,060 31,060
COMMITMENTS AND CONTINGENCIES
MEMBER'S AND SHAREHOLDER'S EQUITY:
Common stock ($.01 par value, 1,500 shares authorized, 100
shares issued and outstanding).......................... -- --
Member's capital contributions............................ 54,609 54,609
Retained deficit.......................................... (9,678) (18,293)
---------- ----------
Total member's and shareholder's equity............ 44,931 36,316
---------- ----------
TOTAL LIABILITIES AND MEMBER'S AND SHAREHOLDER'S
EQUITY........................................... $1,705,900 $1,698,579
========== ==========
</TABLE>
See Notes to the Combined Interim Financial Statements
F-70
<PAGE> 212
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
INTERIM CONDENSED STATEMENT OF COMBINED CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(8,615)
Adjustments to reconcile net loss to net cash provided by
operations:
Depreciation and amortization expense................... 12,885
Changes in assets and liabilities:
Fuel inventories........................................ (606)
Material and supplies inventories....................... 34
Other assets............................................ (1,105)
Accounts payable........................................ 685
Other current liabilities............................... 5,413
-------
Net cash provided by operating activities.......... 8,691
-------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (4,409)
-------
Net cash flows used in investing activities........ (4,409)
-------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in payables to affiliates...................... (4,804)
-------
Net cash flows used in financing activities........ (4,804)
-------
NET DECREASE IN CASH AND CASH EQUIVALENTS................... (522)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 570
-------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 48
=======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid to affiliate................................ $31,812
=======
</TABLE>
See Notes to the Combined Interim Financial Statements
F-71
<PAGE> 213
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
INTERIM CONDENSED STATEMENT OF COMBINED MEMBER'S AND SHAREHOLDER'S EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
TOTAL
MEMBER'S MEMBER'S AND
COMMON CAPITAL RETAINED SHAREHOLDER'S
STOCK CONTRIBUTIONS DEFICIT EQUITY
------ ------------- -------- -------------
<S> <C> <C> <C> <C>
BALANCE JANUARY 1, 2000....................... $-- $54,609 $(9,678) $44,931
Net loss.................................... -- -- (8,615) (8,615)
--- ------- -------- -------
BALANCE MARCH 31, 2000........................ $-- $54,609 $(18,293) $36,316
=== ======= ======== =======
</TABLE>
See Notes to the Combined Interim Financial Statements
F-72
<PAGE> 214
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO UNAUDITED INTERIM CONDENSED COMBINED
FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
These interim condensed combined financial statements (Interim Financial
Statements) include the accounts of Reliant Energy Mid-Atlantic Power Holdings,
LLC and the affiliates and subsidiaries (collectively, REMA) described in Note
1(a) to REMA's December 31, 1999 Financial Statements (1999 Financial
Statements). These Interim Financial Statements are unaudited, omit certain
information included in financial statements prepared in accordance with
generally accepted accounting principles and should be read in combination with
the 1999 Financial Statements included in this prospectus.
As described in Notes 1 and 8 to the 1999 Financial Statements, REMA
(formerly Sithe Pennsylvania Holdings, LLC), together with its affiliates and
subsidiaries, were indirect wholly-owned subsidiaries of Sithe Energies, Inc.
(Sithe) as of December 31, 1999. REMA acquired its generating stations and
various related assets from the operating subsidiaries of GPU, Inc. (GPU), a
utility holding company, on November 24, 1999. In May 2000, Sithe, through an
indirect wholly-owned subsidiary, sold all of its equity interests in REMA to an
indirect wholly-owned subsidiary of Reliant Energy Power Generation, Inc.
(REPG).
There are no separate financial statements available with regard to the
facilities of REMA, prior to the date that REMA acquired the generation assets
from GPU, because their operations were fully integrated with, and their results
of operations were consolidated into, the former owners of the facilities of
REMA. In addition, the electric output of the facilities was sold based on rates
set by regulatory authorities. As a result and because electricity rates will
now be set by the operation of market forces, the historical financial data with
respect to the facilities of REMA prior to November 24, 1999 is not meaningful
or indicative of REMA's future results. REMA's results of operations in the
future will depend primarily on revenues from the sale of energy, capacity and
other related products, and the level of its operating expenses.
The acquisition of REMA's generating assets was recorded under the purchase
method of accounting, with assets and liabilities of REMA reflected at their
estimated fair values as of the date of the purchase. On a preliminary basis,
REMA's fair value adjustments included increases in property, plant and
equipment and air emissions regulatory allowances. The allocation of the
purchase price is preliminary, since the valuation of property, plant and
equipment and air emissions regulatory allowances as well as the valuation of
material and supplies inventories and environmental reserves have not been
finalized. REMA's liabilities include $27.3 million of asset purchase
consideration payable in connection with REMA's acquisition of its generating
assets.
The Interim Financial Statements reflect all normal recurring adjustments
that are, in the opinion of management, necessary to present fairly the
financial position and results of operations. Amounts reported in the interim
condensed statement of combined operations are not necessarily indicative of
amounts expected for a full year period due to the effects of, among other
things, seasonal variations in energy consumption and timing of maintenance and
other expenditures.
Note 5 to the 1999 Financial Statements relates to material contingencies.
This note, updated by the notes contained in these Interim Financial Statements,
is incorporated herein by reference.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of
F-73
<PAGE> 215
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO UNAUDITED INTERIM CONDENSED COMBINED
FINANCIAL STATEMENTS -- (CONTINUED)
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.
(2) DEMAND NOTES PAYABLE TO AFFILIATE
In connection with REMA's acquisition of its generating assets from GPU,
REMA entered into approximately $1.6 billion of demand notes payable to Sithe
Northeast Generating Company, Inc. (an indirect wholly-owned subsidiary of
Sithe) due August 20, 2001. The notes bear interest at a financing rate based on
the London interbank offered rate (LIBOR) plus (a) 1.9% per annum through
November 24, 2000 and (b) 2.4% per annum thereafter. The applicable interest
rate was 7.88% at March 31, 2000. Borrowings outstanding under these unsecured
notes payable approximate fair value, as the individual borrowings bear interest
at current market rates. In connection with the acquisition of REMA in May 2000,
Sithe Northeast Generating Company, Inc. sold these notes to an indirect
wholly-owned subsidiary of REPG. See Note 4(a).
(3) NEW ACCOUNTING PRONOUNCEMENT
Effective January 1, 2001, REMA is required to adopt Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended (SFAS No. 133), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. This
statement requires that derivatives be recognized at fair value in the balance
sheet and that changes in fair value be recognized either currently in earnings
or deferred as a component of other comprehensive income, depending on the
intended use of the derivative, its resulting designation and its effectiveness.
In addition, in June 2000, the Financial Accounting Standards Board issued an
amendment that narrows the applicability of the pronouncement to some purchase
and sales contracts and allows hedge accounting for some other specific hedging
relationships.
Staff Accounting Bulletin No. 101, "Revenue Recognition" (SAB No. 101), was
issued by the SEC on December 3, 1999. SAB No. 101 summarizes some of the SEC
staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. REMA's combined financial statements
reflect the accounting principles provided in SAB No. 101.
(4) SUBSEQUENT EVENTS
(a) ACQUISITION BY REPG.
In February 2000, REPG reached a definitive agreement to purchase the
equity in REMA and the $1.6 billion of pre-existing affiliate debt from Sithe
for an aggregate purchase price of $2.1 billion, subject to adjustments.
Included within this purchase transaction were transition power purchase
agreements, including the capacity transition contract with GPU described in
Note 1(d) to REMA's 1999 Financial Statements. The transaction was completed in
May 2000. The acquisition was accounted for as a purchase, and the purchase
price allocations were pushed down to REMA.
F-74
<PAGE> 216
RELIANT ENERGY MID-ATLANTIC POWER HOLDINGS, LLC
(FORMERLY SITHE PENNSYLVANIA HOLDINGS, LLC) AND RELATED COMPANIES
NOTES TO UNAUDITED INTERIM CONDENSED COMBINED
FINANCIAL STATEMENTS -- (CONTINUED)
(b) RESTRUCTURING.
In July 2000, Reliant Energy Mid-Atlantic Power Holdings, LLC acquired the
ownership interests in the following affiliates, which are included in these
combined financial statements:
Reliant Energy New Jersey Holdings, LLC
Reliant Energy Maryland Holdings, LLC
Reliant Energy Mid-Atlantic Power Services, Inc.
These affiliates were acquired from an indirect wholly-owned subsidiary of
REPG for a purchase price of $167 million, which amount was borrowed from an
indirect wholly-owned subsidiary of REPG. In addition, the developmental
entities listed in Note 1(a) to REMA's 1999 Financial Statements were
distributed to Reliant Energy Mid-Atlantic Development, Inc., a wholly-owned
subsidiary of REPG, but not of REMA.
(c) LEASE FINANCING.
In August 2000, REMA sold to and leased back from each of three
owner-lessors in separate lease transactions REMA's respective 16.45%, 16.67%
and 100% interests in the Conemaugh, Keystone and Shawville generating stations.
As lessee, REMA leases an interest in each facility from each owner lessor under
a facility lease agreement. The lease agreements contain some restrictive
covenants that restrict REMA's ability to, among other things, make dividend
distributions unless REMA satisfies various conditions. The covenant restricting
dividends would be suspended if a direct or indirect parent of REMA meeting
specified criteria guarantees the lease obligations. As consideration for the
sale of REMA's interest in each of the facilities; REMA received $1.0 billion in
cash. These proceeds were utilized to return capital of $183 million, with the
remainder used to reduce affiliate debt. In connection with the lease
transactions, REMA entered into working capital facilities with affiliates in
the aggregate amount of $150 million.
The following table sets forth REMA's obligation under these long-term
operating leases (in millions):
<TABLE>
<S> <C>
Inception of lease to December 31, 2000..................... $ 0.9
2001........................................................ 259.3
2002........................................................ 136.5
2003........................................................ 76.5
2004........................................................ 84.5
2005 and beyond............................................. 1,262.3
--------
$1,820.0
========
</TABLE>
The equity interests in all of the subsidiaries of REMA are pledged as
collateral for REMA's lease obligations. In addition, these subsidiaries have
also guaranteed the payments under the lease obligations. The guaranties of
these subsidiaries of the lease obligations are all full, unconditional, and
joint and several. There are no significant restrictions on the Company's
ability to obtain funds from these subsidiaries.
* * *
F-75
<PAGE> 217
INDEPENDENT AUDITORS' REPORT
N.V. UNA
Keulsekade 189
3503 RL Utrecht
Introduction
We have audited the accompanying financial statements of N.V. UNA, Utrecht
for the nine month period ended September 30, 1999. Our audit procedures also
included the disclosures included in the supplementary information under the
caption "Reconciliation of Reported Stockholders' Equity and Net Earnings to
United States Generally Accepted Accounting Principles (U.S. GAAP) for the Nine
Month Period Ended September 30, 1999." The financial statements of N.V. UNA for
the years ended December 31, 1998 and 1997 were audited by other auditors whose
reports, dated May 11, 1999 and May 28, 1998 expressed an unqualified opinion on
those financial statements. The financial statements and such supplementary
information are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements and such
supplementary information based on our audits.
Scope
We conducted our audit in accordance with auditing standards generally
accepted in the Netherlands and the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
Opinion
In our opinion, the financial statements of N.V. UNA give a true and fair
view of the financial position of the company as of September 30, 1999 and of
the result for the nine month period then ended in accordance with accounting
principles generally accepted in the Netherlands and comply with the legal
requirements for financial statements as included in Part 9, Book 2 of the
Netherlands Civil Code.
Generally accepted accounting principles in the Netherlands vary in certain
significant respects from generally accepted accounting principles in the United
States of America. Application of generally accepted accounting principles in
the United States of America would have affected net income for the nine month
period ended September 30, 1999 and stockholders' equity as of September 30,
1999, to the extent summarized in the supplementary information under the
caption "Reconciliation of Reported Stockholders' Equity and Net Earnings to
United States Generally Accepted Accounting Principles (U.S. GAAP) for the Nine
Month Period Ended September 30, 1999." In our opinion, such supplementary
information when considered in relationship to the basic financial statements
taken as a whole presents fairly in all material respects the information set
forth therein.
DELOITTE & TOUCHE ACCOUNTANTS
Amsterdam, The Netherlands
December 6, 2000
F-76
<PAGE> 218
AUDITOR'S REPORT
Introduction
We have audited the 1998 financial statements of N.V.
Energieproduktiebedrijf UNA, Utrecht. These financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
Scope
We conducted our audit in accordance with auditing standards generally
accepted in the Netherlands and the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
Opinion
In our opinion, the financial statements give a true and fair view of the
financial position of the company as at December 31, 1998 and of the result for
the year then ended in accordance with accounting principles generally accepted
in the Netherlands and comply with the financial reporting requirements included
in Part 9, Book 2 of the Dutch Civil Code.
PricewaterhouseCoopers N.V.
Utrecht, May 11, 1999
F-77
<PAGE> 219
AUDITOR'S REPORT
Introduction
We have audited the 1997 financial statements of N.V.
Energieproduktiebedrijf UNA, Utrecht. These financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
Scope
We conducted our audit in accordance with auditing standards generally
accepted in the Netherlands and the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
Opinion
In our opinion, the financial statements give a true and fair view of the
financial position of the company as at December 31, 1997 and of the result for
the year then ended in accordance with accounting principles generally accepted
in the Netherlands and comply with the financial reporting requirements included
in Part 9, Book 2 of the Dutch Civil Code.
PricewaterhouseCoopers N.V.
Utrecht, May 28, 1998
F-78
<PAGE> 220
N.V. UNA
STATEMENTS OF CONSOLIDATED INCOME
(IN THOUSANDS OF NLG)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
(RESTATED)
<S> <C> <C> <C>
INCOME
Net sales................................. 953,341 1,611,208 1,554,972
Other operating income.................... 19,489 38,207 54,602
------- --------- ---------
TOTAL.............................. 972,830 1,649,415 1,609,574
EXPENSES
Raw materials............................. 352,264 575,934 613,316
SEP production costs...................... 91,899 284,834 221,568
Costs of work contracted out, cost of
material and other external expenses.... 63,645 125,970 88,987
Personnel expenses........................ 72,111 97,124 92,130
Amortization/depreciation charges......... 215,070 276,019 300,322
Other operating expenses.................. 125,266 1,395 45,283
------- --------- ---------
TOTAL.............................. 920,255 1,361,276 1,361,606
------- --------- ---------
OPERATING PROFIT............................ 52,575 288,139 247,968
------- --------- ---------
Interest and similar expenses............. 126,418 111,703 133,190
Interest and similar income............... 75,401 38,794 21,902
Income (expense) from affiliated
companies............................... 2,425 (7,749) (17,603)
------- --------- ---------
TOTAL.............................. 48,592 80,658 128,891
------- --------- ---------
INCOME BEFORE TAXATION...................... 3,983 207,481 119,077
Corporate income tax...................... -- -- --
------- --------- ---------
NET INCOME.................................. 3,983 207,481 119,077
======= ========= =========
</TABLE>
See Notes to the Consolidated Financial Statements
F-79
<PAGE> 221
N.V. UNA
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF NLG)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(RESTATED)
<S> <C> <C>
ASSETS
FIXED ASSETS
Net tangible fixed assets................................. 2,408,172 2,613,117
Financial fixed assets.................................... 19,415 13,639
--------- ---------
2,427,587 2,626,756
CURRENT ASSETS
Inventories............................................... 5,258 7,011
Accounts receivable....................................... 125,601 108,341
Marketable securities..................................... 298,756 310,751
Cash and cash equivalents................................. 1,438 11,690
--------- ---------
2,858,640 3,064,549
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Stockholders' equity...................................... 944,247 940,264
Deferred income........................................... 193,500 248,140
Provisions................................................ 236,188 162,671
Long-term debt............................................ 792,727 1,087,515
Short-term debt........................................... 691,978 625,959
--------- ---------
2,858,640 3,064,549
========= =========
</TABLE>
See Notes to the Consolidated Financial Statements
F-80
<PAGE> 222
N.V. UNA
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN THOUSANDS OF NLG)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
(RESTATED)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Income.................................... 3,983 207,481 119,077
Amortization/depreciation..................... 215,070 276,019 300,322
Changes in provisions and deferred income..... 17,692 (33,554) 64,298
-------- -------- --------
236,745 449,946 483,697
CHANGES IN WORKING CAPITAL
Inventories................................... 1,753 (518) 187
Accounts receivable........................... (17,260) (10,344) 6,067
Short-term debt............................... 16,987 (83,922) 33,770
-------- -------- --------
1,480 (94,784) 40,024
Dividends..................................... -- (17,952) (30,000)
-------- -------- --------
CASH FLOW FROM OPERATING ACTIVITIES........... 238,225 337,210 493,721
INVESTING ACTIVITIES
Additions to tangible fixed assets............ (10,158) (27,452) (90,498)
Disposals of tangible fixed assets............ 33 23,023 --
(Additions to) disposals of financial fixed
assets...................................... 6,219 782 (84,793)
-------- -------- --------
CASH FLOW FROM INVESTING ACTIVITIES........... (3,906) (3,647) (175,291)
FINANCING ACTIVITIES
Long-term financing........................... 18,871 8,715 141,069
Repayment of long-term financing.............. (312,474) (492,054) (369,588)
Change in short-term loans, net............... 49,032 159,692 (89,433)
-------- -------- --------
CASH FLOW FROM FINANCING ACTIVITIES........... (244,571) (323,647) (317,952)
SUMMARY STATEMENT
Cash flow from operating activities........... 238,225 337,210 493,721
Cash flow from investing activities........... (3,906) (3,647) (175,291)
Cash flow from financing activities........... (244,571) (323,647) (317,952)
-------- -------- --------
CHANGE IN CASH AND CASH EQUIVALENTS........... (10,252) 9,916 478
======== ======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
F-81
<PAGE> 223
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The accompanying consolidated financial statements of N.V. UNA (UNA)
(formerly N.V. Energieproduktiebedrijf UNA, Utrecht) were prepared in accordance
with generally accepted accounting principles in the Netherlands (Dutch GAAP),
for purposes of inclusion in the S-1 filing for Reliant Resources, Inc. These
consolidated financial statements have been reconciled to accounting principles
generally accepted in the United States of America (U.S. GAAP) in the
accompanying financial statement footnotes.
CONSOLIDATED FINANCIAL STATEMENTS
The UNA parent company financial data has been incorporated into the
consolidated figures as included in these financial statements. Therefore, the
accompanying parent company corporate financial statements are presented in the
short format in accordance with the Article 402 of the Dutch Civil Code.
The consolidated financial statements of UNA include the financial data of:
- N.V. UNA;
- UNA Milieu N.V.;
- B.V. Antraciet Handelsvereeniging;
- Power Investment B.V.;
- Power Services B.V.
CHANGES IN ACCOUNTING POLICIES
During 1999, UNA made the following changes in accounting policies,
reflecting changes in UNA's operating environment as a result of deregulation of
the electricity market in the Netherlands.
- As of January 1, 1999, profits associated with the cross-border lease
transactions are deferred and amortized over the terms of the underlying
lease contracts. Previously, for lease contracts with a perceived lower
risk profile, results were taken directly to income.
- Prior to 1999, UNA recorded a provision for self-insurance for future
equipment accidents. As of January 1, 1999, this policy was discontinued.
The net effect on consolidated stockholders' equity of the above changes is
summarized as follows (in NLG '000):
<TABLE>
<S> <C> <C>
Consolidated stockholders' equity as of December 31, 1998... 923,592
Net effect of changes in accounting policy
Deferral of cross-border lease profits.................... (12,799)
Provision for self-insurance.............................. 29,471
-------
Net effect of changes in accounting policy.................. 16,672
-------
Adjusted consolidated stockholders' equity as of December
31, 1998.................................................. 940,264
</TABLE>
The net effect on income from the above changes for the period January 1,
1999 through September 30, 1999 and for the year ended December 31, 1998
amounted to a decrease of NLG 0.6 million and an increase of NLG 2.7 million,
respectively.
F-82
<PAGE> 224
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In accordance with Dutch GAAP, the comparative 1998 consolidated financial
statements were restated to reflect the changes in accounting policies referred
to above.
PRINCIPLES OF VALUATION AND INCOME RECOGNITION
GENERAL
Unless otherwise stated, assets and liabilities are carried at historical
cost and amounts included in the tables are denominated in thousands of Dutch
guilders. The consolidated balance sheets as of September 30, 1999 and December
31, 1998, and the related consolidated income statements and the consolidated
statements of cash flows for the nine months ended September 30, 1999, and for
the years ended December 31, 1998 and 1997, respectively, have been included for
comparative purposes.
NATIONAL SETTLEMENT SYSTEM VIA N.V. SEP
The principles of valuation and income recognition are mainly based on the
National Settlement System of reimbursement for production costs through N.V.
SEP (SEP). The basic principles of this national settlement system are as
follows:
UNA is deemed to have made its heat and electricity production capacity
available to SEP and to have supplied all kWhs produced to SEP. In return, UNA
receives a standardized payment for costs related to fuel consumption, capital
expenditures, operations, maintenance and indirect production. Based on UNA's
share in the national settlement load, SEP charges the costs of capacity to UNA
via the national basic rate (LBT kW). SEP charges fuel costs to UNA using the
LBT kWh based on the kWhs supplied. Furthermore, in accordance with the
established heat production agreement, UNA pays SEP an amount for each heat unit
sold. The effects of the national settlement system are included in the income
statement under the "SEP Production Costs" item. The composition of the
settlement is detailed in the notes to the consolidated financial statements.
FOREIGN CURRENCIES
Assets and liabilities denominated in foreign currencies are translated at
the prevailing exchange rates on the balance sheet date. Income and expenses
denominated in foreign currencies are translated at the prevailing exchange
rates on the date on which the amounts are settled. Unrealized transaction
holding gains for investments in noncurrent debt securities denominated in
foreign currencies are included in the balance sheet under the "Deferred Income"
item until either the asset matures, or the asset is liquidated at which point
the deferred transaction gain is realized in income.
TANGIBLE FIXED ASSETS
Tangible fixed assets are carried at historical cost less accumulated
depreciation. Interest on debt that is attributable to assets under construction
is capitalized. Capitalized interest is reported as construction interest under
the "Interest and Similar Expenses" item.
Tangible fixed assets that are financed through financial lease
transactions are capitalized.
The depreciation periods for assets subject to the national settlement
system are based on the terms for the compensation of capital charges. Other
tangible fixed assets are depreciated over the estimated useful lives of the
assets. Depreciation is computed using the straight-line
F-83
<PAGE> 225
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
method, except where it concerns lump-sum payments for leasehold land, which are
depreciated on the basis of level annuities.
FINANCIAL FIXED ASSETS
Investments over which significant influence is exercised are valued in
accordance with the equity method. Where necessary, the accounting policies of
UNA's subsidiaries are adjusted to reflect the accounting policies followed by
UNA.
Investments where no significant influence is exercised are valued at the
lower of acquisition cost or net realizable value.
Long-term loans and advances are carried at face value.
CURRENT ASSETS
Inventories are valued at historical cost, less an allowance for
obsolescence.
Receivables are carried at face value less an appropriate allowance for
estimated uncollectable amounts.
Marketable securities are carried at fair value. Realized and unrealized
gains and losses are classified under "Interest and Similar Income" item.
DEFERRED INCOME
Profits on lease transactions are deferred and amortized over the remaining
sub-lease period on a straight-line basis. Realized profit is recorded in the
income statement under the "Interest and Similar Income" item.
PROVISIONS
The provision for employee healthcare benefits is carried at present value,
using actuarial estimates. Other provisions are carried at nominal value. The
provisions are classified under long-term liabilities.
DEBT
The "55+ Plan" is carried at present value. The Medium-Term Notes are
recorded at face value and are decreased or increased by any unamortized
discount or premium. Any discount or premium is amortized to income based on the
terms of the notes. All other debt is recorded at face value.
Debts which are due within one year are considered short term and are
included as such under "Short-Term Debts" item.
NET SALES
UNA charges the regional bulk supply rate (RGLT) to the distributing
companies for the supply of electricity, both for the national settlement load
for capacity (RGLT-kW) and for electrical energy (RGLT-kWh). The cost to supply
heat is charged in accordance with the heat supply agreements between the
company and the heat-distributing companies.
F-84
<PAGE> 226
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CORPORATE INCOME TAX
Under a 1998 Dutch tax law relating to the Dutch electricity industry, UNA
qualifies for a zero percent corporate income tax rate through December 31,
2001. The tax holiday applies only to Dutch income earned by UNA. Beginning
January 1, 2002, UNA will be subject to Dutch corporate income tax at standard
statutory rates.
F-85
<PAGE> 227
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS OF NLG)
2. NET TANGIBLE FIXED ASSETS
<TABLE>
<CAPTION>
ASSETS NOT
OTHER INCLUDED IN FIXED ASSETS
CHANGES IN TANGIBLE LAND AND PLANT AND FIXED PRODUCTION UNDER
FIXED ASSETS BUILDINGS MACHINERY ASSETS PROCESS CONSTRUCTION TOTAL
------------------- --------- --------- ------ ----------- ------------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AS OF JANUARY
1, 1999
Cost................... (+) 972,100 4,986,589 69,455 1,795 40,299 6,070,238
Depreciation........... (-) 545,300 2,858,840 51,247 1,734 -- 3,457,121
------- --------- ------ ----- ------- ---------
Book value............. (=) 426,800 2,127,749 18,208 61 40,299 2,613,117
CHANGES IN 1999
Additions.............. (+) -- -- -- -- 10,158 10,158
Transfers.............. (+) 771 45,077 29 -- (45,877) --
Disposals
- Cost................. (-) 158 463 -- 79 -- 700
- Depreciation......... (+) 125 463 -- 79 -- 667
Depreciation........... (-) 31,986 180,253 2,811 20 -- 215,070
------- --------- ------ ----- ------- ---------
Net changes............ (=) (31,248) (135,176) (2,782) (20) (35,719) (204,945)
BALANCE AS OF SEPTEMBER
30, 1999
Cost................... (+) 972,713 5,031,203 69,484 1,716 4,580 6,079,696
Depreciation........... (-) 577,161 3,038,630 54,058 1,675 -- 3,671,524
------- --------- ------ ----- ------- ---------
Book value............. (=) 395,552 1,992,573 15,426 41 4,580 2,408,172
</TABLE>
During the period from 1994 through 1997, the company conducted U.S.,
German and Austrian cross-border lease and lease-back transactions with respect
to the Hemweg 8, Merwedekanaal 12, Purmerend and Diemen 33 units and their joint
installations. The undivided property rights, consisting of the ownership of
these plants and their joint installations, as well as the ownership of the land
on which they are located, were leased to third parties. The third parties
concerned subsequently sub-leased the undivided shares to the company. After
expiration of the sub-lease term, the company is entitled to buy the third
parties' position under the lease. The legal and economic ownership of the
assets is retained by the company. Therefore, these assets have been included in
the same manner as those whose unencumbered legal and economic ownership rests
with the company.
The other tangible fixed assets that are subject to financial leases are
included in the same manner as the tangible fixed assets which the company holds
in full ownership. This also applies to the tangible fixed assets held in legal
ownership by third parties, since the economic ownership rests with the company.
There are financial leases also conducted in the period from 1994 through 1997
with respect to the Diemen units 31 and 32, the gas and steam turbines of Diemen
33 and Lage Weide 6, the turbogenerator of Hemweg 8 and movable components of
Lage Weide 5.
Land and buildings at Hemweg 8, Diemen, Purmerend and Utrecht were
mortgaged in order to serve as collateral for certain cross-border lease
transactions.
F-86
<PAGE> 228
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
The specific data regarding the above mentioned lease-transactions are as
follows:
<TABLE>
<CAPTION>
UNIT TYPE TRANSACTION VALUE INTEREST RATE END DATE
---- ---- ----------------- ------------- --------
<S> <C> <C> <C> <C>
U.S. LEASES
Hemweg 8......................... Lease & leaseback USD 1,041,157,945 7.32% Jan. 2022
Diemen 33........................ Lease & leaseback USD 250,130,548 7.49% Jan. 2024
Merwede kanaal 12................ Lease & leaseback USD 240,000,000 7.90% Jan. 2013
Purmerend 01..................... Lease & leaseback USD 87,000,000 7.85% Jan. 2013
Diemen 31/32..................... Sale & leaseback USD 166,000,000 7.90% Mar. 2001
GERMAN LEASES
Hemweg 8 Turbo generator......... Sale & leaseback DEM 450,000,000 8.00% Jun. 2008
Diemen 33 Steam turbine.......... Sale & leaseback DEM 43,600,000 8.25% Nov. 2008
Diemen 33 Gas turbine............ Sale & leaseback DEM 114,000,000 8.25% Nov. 2008
Lage Weide 6 Steam turbine....... Sale & leaseback DEM 43,000,000 8.00% May 2008
Diemen 33 Gas turbine............ Sale & leaseback DEM 110,000,000 8.00% May 2008
AUSTRIAN LEASE
Lage Weide 5..................... Sale & leaseback ATS 1,353,000,000 -- Jun. 2002
</TABLE>
The useful lives of the various assets applied for the purpose of
depreciation are as follows:
Depreciation on assets subject to the national settlement system:
<TABLE>
<S> <C>
- buildings, site facilities, plant and machinery, and
furniture, fixtures and fittings.......................... 15 years
- assets of the Lage Weide 5 and Hemweg 7 units............. 10 years
</TABLE>
Depreciation on assets not subject to the national settlement system:
<TABLE>
<S> <C>
- lump-sum payments for leasehold land at Nieuwe Hemweg..... 32 years
- buildings................................................. 25 years
- plant and machinery:
- stations.............................................. 20 years
- lines and cables...................................... 30 years
- other fixed assets, depending on their nature:............ 3 to 10 years
- assets not included in the production process:
- company houses........................................ 40 years
</TABLE>
3. FINANCIAL FIXED ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Affiliated companies (equity method)....................... 12,994 8,195
Affiliated companies (cost basis).......................... 4,296 3,380
Accounts receivable........................................ 2,125 2,064
------ ------
19,415 13,639
====== ======
</TABLE>
The following investments in affiliates are valued in accordance with the
equity method.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
AFFILIATED COMPANIES
Beginning balance........................................... 8,195 22,229
Dispositions................................................ (1,088) (5,385)
Equity in earnings (losses)................................. 5,887 (8,649)
------ ------
Ending balance.............................................. 12,994 8,195
====== ======
</TABLE>
F-87
<PAGE> 229
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
BREAKDOWN OF AFFILIATES (EQUITY METHOD):
<TABLE>
<CAPTION>
EQUITY IN
EARNINGS
NINE MONTHS
SHARE IN EQUITY ENDED
INTEREST SEPTEMBER 30, SEPTEMBER 30,
AFFILIATED COMPANY, DOMICILE AS A % 1999 1999
---------------------------- -------- --------------- -------------
<S> <C> <C> <C>
Electrorisk BV, Arnhem.............................. 21% 9,446 6,286
Power Projects BV, Utrecht.......................... 50% 112 2
Power Total Maintenance BV, Utrecht................. 50% 50 (17)
Axima BV, Diemen.................................... 45% 3,386 (384)
------ -----
12,994 5,887
====== =====
</TABLE>
The company's share in NV SEP is valued at zero given SEP's obligations
related to stranded costs.
The percentages indicate UNA's relative interests in the affiliated
companies as of September 30, 1999.
BREAKDOWN OF AFFILIATES (COST BASIS):
<TABLE>
<CAPTION>
COST VALUE AS SHARE IN EQUITY
OF AS OF
INTEREST SEPTEMBER 30, SEPTEMBER 30,
AFFILIATED COMPANY, DOMICILE AS A % 1999 1999
---------------------------- -------- ------------- ---------------
<S> <C> <C> <C>
GKE, De Bilt........................................ 16% 90 90
KEMA, Arnhem........................................ 10% 62 6,938
Vliegasunie, De Bilt................................ 16% 90 145
Vasim, Nijmegen..................................... 15% -- 1,344
Howo Gmbh, Wolfen................................... 10% 563 9,395
APX, Amsterdam...................................... 10% 2,997 2,997
NEM BV.............................................. 2% 494 494
----- -------
Affiliated Companies (cost basis) 4,296 21,403
===== =======
</TABLE>
During the reporting year, the interest in NEM BV decreased from 20% to 2%.
UNA acquired a 10% interest in APX. The interest in Vasim has permanently
decreased in value due to a near liquidation.
The percentages indicate UNA's relative interests in the affiliated
companies as of September 30, 1999.
4. INVENTORIES
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Ancillary materials........................................ 4,624 6,265
Fuels...................................................... 634 746
----- -----
5,258 7,011
===== =====
</TABLE>
Inventories are valued at historical cost less an allowance for
obsolescence. The allowance amounts to NLG 9,899 at September 30, 1999 (1998:
NLG 7,425).
F-88
<PAGE> 230
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
5. ACCOUNTS RECEIVABLE
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Trade receivables.......................................... 36,695 26,393
Other accounts receivable.................................. 18,935 16,473
Prepayments and accrued income............................. 69,971 65,475
------- -------
125,601 108,341
======= =======
</TABLE>
Trade receivables are carried at face value, less an allowance for
non-collectability. As of September 30, 1999, the allowance amounts to NLG 410
(1998: NLG 720).
Other accounts receivable are carried at face value, less an allowance for
non-collectability. As of September 30, 1999, the allowance amounts to NLG
18,400 (1998: NLG 0).
Prepayments and accrued income include an amount of NLG 24,240 (1998: NLG
26,544), which is of a long-term nature.
6. MARKETABLE SECURITIES
The "marketable securities" item includes portfolio investments, which are
negatively pledged to financial institutions. Such securities, which are treated
as "trading" securities under U.S. GAAP, are reported at their estimated fair
value at each balance sheet date.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Portfolio investments...................................... 298,756 310,751
------- -------
298,756 310,751
======= =======
</TABLE>
7. CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Cash at banks.............................................. 1,367 11,635
Cash on hand............................................... 71 55
----- ------
1,438 11,690
===== ======
</TABLE>
8. STOCKHOLDERS' EQUITY
The composition of and movements in stockholders' equity are detailed in
the notes to the corporate balance sheet.
9. DEFERRED INCOME
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance.......................................... 248,140 247,676
Amortization............................................... (54,640) (12,335)
Amortization adjustment.................................... -- 12,799
------- -------
Ending Balance............................................. 193,500 248,140
======= =======
</TABLE>
F-89
<PAGE> 231
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
Deferred income consisted of two components; the cash gains on lease and
leaseback transactions and the unrealized holding gains on the investments. The
unrealized investment gains mainly relate to investments in U.S. bonds which
were converted into Eurobonds in July 1999. Consequently, all previously
unrealized investment gains were realized and recorded in income at that time.
During 1999, a change in accounting principle was made for deferred gains
on cross-border leases. The NLG 12,799 amortization adjustment is the result of
the change in accounting principle, see Note 1.
10. PROVISIONS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Provision for maintenance.................................. 30,903 31,342
Provision for dismantling.................................. 141,430 109,479
Provision for employee healthcare benefits................. 23,855 21,850
Provision for reorganization expenses...................... 40,000 --
------- -------
236,188 162,671
======= =======
</TABLE>
The Company recognizes repair and maintenance costs incurred in connection
with planned major maintenance cycles. The amount is based on the estimated cost
of future repairs and the programmed schedule for repairs to be made. The change
in estimates for 1999 is a result of a change in management's expectations of
major maintenance based on a revised asset utilization plan. A revised asset
utilization plan was made as a result of the deregulation of the electricity
industry. The change in estimate in 1998 was a result of maintenance being
estimated at the group level rather than at the unit level as had been done in
the years preceding 1998.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance.......................................... 31,342 58,033
Increase (decrease)........................................ 30,096 (13,013)
------- -------
61,438 45,020
Maintenance and repairs made............................... (30,535) (13,678)
------- -------
Ending Balance............................................. 30,903 31,342
======= =======
</TABLE>
As described under changes in accounting policies in Note 1, the provision
for self-insurance has been retroactively eliminated from the 1998 consolidated
balance sheet.
The provision for dismantling has been recorded to reflect the income
statement effect of costs of dismantling power plants and auxiliary heat
stations, including the necessary environmental measures, over the expected
useful lives of the assets. The provision is determined on the basis of
estimated future dismantling costs and the number of years the plants have been
in operation. The September 30, 1999, balance reflects an addition to this
provision for an amount of NLG 20.8 million. This addition represents the net
effect of changes in accounting estimates relating to certain environmental
liabilities (increase of NLG 54.2 million)
F-90
<PAGE> 232
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
and to revised estimates of asset utilizations of and useful lives of the plants
(decrease of NLG 33.4 million).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance.......................................... 109,479 100,814
Increase................................................... 31,951 8,729
Withdrawal due to dismantling.............................. -- (64)
------- -------
Ending Balance............................................. 141,430 109,479
======= =======
</TABLE>
The provision for employee healthcare benefits represents the present value
of the future liability for the employer's health insurance contribution (IZR)
for active and retired employees.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance.......................................... 21,850 19,906
Increase................................................... 2,887 3,104
------ ------
24,737 23,010
Benefits paid.............................................. (882) (1,160)
------ ------
Ending Balance............................................. 23,855 21,850
====== ======
</TABLE>
In June 1999, UNA management finalized a plan for reorganization in
response to the competitive environment created by the 1998 Electricity Act.
Under the plan, 125 employees will be severed and the related costs will be paid
by the Company. As of September 30, 1999, the total estimated liability related
to this plan is NLG 40 million. See Supplementary Information, Note 1,
Subsequent Events for further events relating to the reorganization.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance.......................................... -- --
Provision.................................................. 40,000 --
------ ------
40,000 --
Withdrawal................................................. -- --
------ ------
Ending Balance............................................. 40,000 --
====== ======
</TABLE>
11. LONG-TERM DEBT
BREAKDOWN OF LONG-TERM DEBT:
<TABLE>
<CAPTION>
DUE AFTER DUE AFTER
SEPTEMBER 30, CURRENT MORE THAN AVERAGE DECEMBER 31, CURRENT MORE THAN
1999 PORTION FIVE YEARS INTEREST RATE 1998 PORTION FIVE YEARS
------------- ------- ---------- ------------- ------------ ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Medium-term notes............... 337,626 -- -- 7.01% 442,130 100,000 217,000
Other loans..................... 447,140 43,666 150,888 7.96% 636,540 147,797 147,540
------- ------ ------- --------- ------- -------
Total debt instruments... 784,766 43,666 150,888 1,078,670 247,797 364,540
55+ pension plan................ 2,224 4,087
Other long-term debt............ 5,737 4,758
------- ---------
792,727 1,087,515
======= =========
<CAPTION>
AVERAGE
INTEREST RATE
-------------
<S> <C>
Medium-term notes............... 6.44%
Other loans..................... 7.79%
Total debt instruments...
55+ pension plan................
Other long-term debt............
</TABLE>
F-91
<PAGE> 233
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
MEDIUM-TERM NOTES:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Balance of notes placed at beginning of period.............. 444,000 768,883
Notes repaid and notes purchased............................ (105,000) (324,883)
-------- --------
Balance of notes placed at end of period.................... 339,000 444,000
(Discounts) and premiums, net............................... (1,374) (1,870)
-------- --------
Ending Balance.............................................. 337,626 442,130
======== ========
</TABLE>
PRIVATE LOANS:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance........................................... 636,540 796,479
Loans drawn................................................. 18,871 6,765
-------- --------
655,411 803,244
Installments paid........................................... (208,271) (166,704)
-------- --------
Ending Balance.............................................. 447,140 636,540
======== ========
</TABLE>
The 55+ pension plan represents the present value of future commitments to
those employees who make use of the plan as of the end of the reporting periods.
This item also includes future commitments to employees under similar plans.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance........................................... 4,087 9,224
Provision................................................... 302 361
------ ------
4,389 9,585
Withdrawal due to payments relating to these commitments.... (2,165) (4,643)
Releases.................................................... -- (855)
------ ------
Ending Balance.............................................. 2,224 4,087
====== ======
</TABLE>
12. SHORT-TERM DEBT
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Amounts owed to credit institutions......................... 488,667 439,635
Other debts................................................. 203,311 186,324
-------- --------
691,978 625,959
======== ========
</TABLE>
BREAKDOWN OF AMOUNTS OWED TO CREDIT INSTITUTIONS:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Banks....................................................... -- 378
Commercial paper............................................ 118,600 160,000
Money market and call loans................................. 370,067 279,257
------- -------
488,667 439,635
======= =======
</TABLE>
F-92
<PAGE> 234
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
BREAKDOWN OF OTHER DEBTS:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Suppliers............................................... 12,948 16,954
Items payable relating to capital expenditure
realized.............................................. 20,320 32,807
60+ Pension plan, commitments relating to overtime
compensation, holiday pay and leave days.............. 12,129 11,450
Social obligations relating to recent
graduates/long-term unemployment...................... 249 180
Taxes, pension premiums and other social security
contributions payable................................. 10,750 17,510
Dividends payable....................................... -- 17,952
Interest payable........................................ 87,639 36,323
Other accruals and deferred income...................... 64,146 53,148
------- -------
208,181 186,324
======= =======
</TABLE>
13. CONTINGENT LIABILITIES
Commitments relating to orders placed with suppliers and bank guarantees
outstanding total NLG 28.7 million at September 30, 1999.
The net present value of the cross-border leases regarding UNA's tangible
fixed assets have early termination penalties at September 30, 1999 of
approximately USD 241 million (NLG 602 million) and DEM 25 million.
As a consequence of the energy market in the Netherlands being
liberalized -- based on the Electricity Act of 1998 -- the company will in the
near future be faced with insufficient coverage of existing, unprofitable
investments, which are pooled via the Cooperation Agreement and of
non-competitive electricity supply contracts.
In February 1999, the Minister for Economic Affairs decreed that, due to
the fact that the four production companies were unable to reach an agreement as
to the allocation of the costs of the exposure outlined above, it will provide
for the allocation to the separate production companies by an Act of Parliament.
As of the date of this report, the extent to which this exposure will produce an
adverse effect on the company's capital is unknown.
14. NET SALES
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Capacity......................................... 407,511 685,747 641,353
Energy........................................... 545,830 923,305 912,404
Other............................................ -- 2,156 1,215
------- --------- ---------
953,341 1,611,208 1,554,972
======= ========= =========
</TABLE>
F-93
<PAGE> 235
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
15. OTHER OPERATING INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Reimbursed Costs................................. 9,556 12,389 21,729
Services provided to third parties............... 2,080 2,627 9,123
Damage claims.................................... 1,721 117 10,774
Gain on sale of assets........................... 856 1,638
Costs charged on reformation of the Large-Scale
Production Company............................. 266 11,807 8,167
Other income (items totaling less than NLG 1
million)....................................... 5,010 9,629 4,809
------ ------ ------
19,489 38,207 54,602
====== ====== ======
</TABLE>
16. RAW MATERIALS
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Fuel expended in the production of electricity
and heat....................................... 352,264 575,934 613,316
------- --------- ---------
352,264 575,934 613,316
======= ========= =========
</TABLE>
17. SEP PRODUCTION COSTS
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Settlement relating to supply of electricity and
heat........................................... 904,012 1,536,619 1,483,188
Compensations received........................... (812,113) (1,251,785) (1,261,620)
-------- ---------- ----------
91,899 284,834 221,568
======== ========== ==========
</TABLE>
18. COST OF WORK CONTRACTED OUT, COST OF MATERIALS AND OTHER EXTERNAL EXPENSES
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Consumer goods and materials from third
parties........................................ 10,853 18,679 24,683
Services rendered by third parties............... 48,860 94,932 57,917
Other external expenses.......................... 3,932 12,359 6,387
------- ------- ------
63,645 125,970 88,987
======= ======= ======
</TABLE>
The services rendered by third parties were significantly lower in 1999 due
to lower consultancy fees regarding the formation of the Large-Scale Production
Company, lower expenses for day-to-day maintenance as a major overhaul program
was executed in 1999 and the influences from the "Koploper" cost savings
program.
F-94
<PAGE> 236
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
19. PERSONNEL EXPENSES
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Salaries.................................... 49,409 69,391 69,774
Social security charges, including pension
premiums.................................. 16,991 21,495 15,553
Other personnel expenses.................... 5,711 6,238 6,803
------ ------- -------
72,111 97,124 92,130
====== ======= =======
</TABLE>
The average workforce (including the employees of N.V. GKE and Vliegasunie
B.V.) totaled 928 full time employees in 1999 (1998: 974).
20. AMORTIZATION/DEPRECIATION CHARGES
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Depreciation on
historical cost................................ 215,070 306,019 300,322
Release of provisions for Hemweg 8 unit boiler... -- (30,000) --
------- ------- -------
Depreciation on tangible fixed assets............ 215,070 276,019 300,322
======= ======= =======
</TABLE>
21. OTHER OPERATING EXPENSES
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
KEMA contribution.................................. 3,214 5,321 6,481
Net allocations to provisions:
-- for major repairs............................... 30,096 (13,013) 28,655
-- for reorganization.............................. 40,000 -- --
-- for dismantling................................. 31,951 8,729 8,808
------- ------- -------
105,261 1,037 43,944
Bad debt expense and inventory obsolescence........ 22,481 286 1,095
Other operating expenses........................... (2,476) 72 244
------- ------- -------
125,266 1,395 45,283
======= ======= =======
</TABLE>
Bad debt expense and inventory obsolescence, totaling NLG 22,481,
represents a decrease in the value of the inventory of consumer goods by NLG
1,042 (1998: NLG 347) and a decrease in the value of the other accounts
receivable and prepayments by NLG 21,439 (1998: NLG (61)).
F-95
<PAGE> 237
N.V. UNA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
22. INTEREST AND SIMILAR EXPENSE
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Interest on long-term debt......................... 63,862 94,810 126,042
Interest on short-term debt........................ 7,714 14,528 7,849
Other financial expense............................ 56,169 3,009 4,803
------- ------- -------
127,745 112,347 138,694
Construction interest allocated to capital
expenditures..................................... (1,327) (644) (5,504)
------- ------- -------
126,418 111,703 133,190
======= ======= =======
</TABLE>
Construction interest is allocated to projects requiring a capital
expenditure of more than NLG 1 million and with terms exceeding one year.
The interest on long-term debt includes the premium and discount of the
Medium-Term Notes program. The settlements of interest on derivatives
attributable to the reporting year are classified as interest on long-term and
short-term debt.
23. INTEREST AND SIMILAR INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
<S> <C> <C> <C>
Interest received.................................. 666 3,510 1,789
Amortization of deferred income.................... 54,640 12,335 11,813
Other financial income............................. 20,095 22,949 8,300
------ ------ ------
75,401 38,794 21,902
====== ====== ======
</TABLE>
Other financial income consists mainly of investment results.
F-96
<PAGE> 238
N.V. UNA
CORPORATE FINANCIAL STATEMENTS
(IN THOUSANDS OF NLG)
CORPORATE BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(RESTATED)
<S> <C> <C>
ASSETS
FIXED ASSETS
Net tangible fixed assets................................... 2,408,172 2,613,117
Financial fixed assets...................................... 32,909 29,266
--------- ---------
2,441,081 2,642,383
CURRENT ASSETS
Inventories................................................. 5,258 7,011
Accounts receivable......................................... 135,837 116,709
Marketable securities....................................... 298,756 310,751
Cash and cash equivalents................................... 1,288 11,444
--------- ---------
2,882,220 3,088,298
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Stockholders' equity........................................ 944,247 940,264
Deferred Income............................................. 193,500 248,140
Provisions.................................................. 236,188 162,671
Long-term debt.............................................. 792,727 1,087,515
Short-term debt............................................. 715,558 649,708
--------- ---------
2,882,220 3,088,298
========= =========
</TABLE>
CORPORATE INCOME STATEMENTS
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------------- ------------ ------------
(RESTATED)
<S> <C> <C> <C>
Income from operations........................... 3,231 216,765 137,203
Income from affiliated companies................. 752 (9,284) (18,126)
------ ------- -------
NET INCOME.............................. 3,983 207,481 119,077
====== ======= =======
</TABLE>
F-97
<PAGE> 239
N.V. UNA
NOTES TO CORPORATE FINANCIAL STATEMENTS
(IN THOUSANDS OF NLG)
A. FINANCIAL FIXED ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Interest in group companies................................. 17,442 18,160
Affiliated companies........................................ 9,609 6,225
Securities.................................................. 3,733 2,817
Accounts receivable......................................... 2,125 2,064
------ ------
32,909 29,266
====== ======
</TABLE>
BREAKDOWN OF INTERESTS IN GROUP COMPANIES:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
--------------- ----------------
<S> <C> <C> <C> <C>
UNA Milieu N.V.
- Participating interest.................................... (8,458) (12,238)
- Income.................................................... (314) 3,780
------ -------
(8,772) (8,458)
B.V. Anthraciet Handelsvereniging........................... 2,243 2,243
Power Services B.V.
- Participating interest.................................... (356) 74
- Income.................................................... (288) (430)
------ -------
(644) (356)
Power Investment B.V.
- Participating interest.................................... 24,730 25,649
- Income.................................................... (115) (918)
------ -------
24,615 24,731
------ ------
17,442 18,160
====== ======
</TABLE>
B. ACCOUNTS RECEIVABLE
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Trade receivables........................................... 36,717 26,393
Amounts owed by affiliated companies........................ 8,181 10,262
Other accounts receivable................................... 21,305 17,224
Prepayments and accrued income.............................. 69,634 62,830
------- -------
135,837 116,709
======= =======
</TABLE>
C. STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Authorized and paid-in-capital.............................. 255,000 255,000
General reserve............................................. 689,247 672,490
Legal reserve -- undistributed earnings of investments...... -- 12,774
------- -------
944,247 940,264
======= =======
</TABLE>
Authorized and issued share capital totals NLG 255 million as of September
30, 1999, which is unchanged from December 31, 1998.
F-98
<PAGE> 240
N.V. UNA
NOTES TO CORPORATE FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS OF NLG)
RESERVES
GENERAL RESERVE:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance........................................... 672,490 468,550
Change due to changes in accounting policies relating to
self-insurance............................................ -- 29,471
Change due to changes in accounting policies relating to
deferred income........................................... -- (12,799)
Transfer from (to) legal reserve............................ 12,774 (2,261)
Addition due to income appropriation........................ 3,983 189,529
------- -------
Ending Balance.............................................. 689,247 672,490
======= =======
</TABLE>
LEGAL RESERVE -- UNDISTRIBUTED EARNINGS OF INVESTMENTS:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Beginning Balance........................................... 12,774 10,513
Transfer to general reserves................................ (12,774) 2,261
------- ------
Ending Balance.............................................. -- 12,774
======= ======
</TABLE>
D. SHORT-TERM DEBT
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Amounts owed to credit institutions......................... 488,667 439,635
Amounts owed to group companies............................. 25,127 25,098
Other debts................................................. 201,764 184,975
------- -------
715,558 649,708
======= =======
</TABLE>
E. REMUNERATION AND FEES OF MANAGING AND SUPERVISORY DIRECTORS
Due to the fact that the remuneration of the managing directors represents
payments to one person only, this remuneration is not presented (as it was not
in 1998). In the reporting year, fees totaling NLG 35 were granted to members of
the Supervisory Board.
The members of the Supervisory Board as of September 30, 1999 are:
D.H. Kok (chairman)
Ms G. ter Horst (vice-chairman)
H.H.M. Groen
H.H.W. Kernkamp
H.M. Meijdam
Ms M.A. Wildekamp
M.J. Haks
The statutory director as of September 30, 1999 is:
P. Koppen de Neve
F-99
<PAGE> 241
SUPPLEMENTARY INFORMATION
1. SUBSEQUENT EVENTS
On October 5, 1999 the Company entered into a Bridge Facility with ABN AMRO
of NLG 1.5 billion. This facility was replaced on December 21, 1999 by a NLG 1.5
billion Multi-Currency Credit Agreement with a maturity date of October 2, 2000.
On July 17, 2000 the Multi-Currency Credit Agreement was replaced with two
facilities; a 250 million Euro revolving credit line (July 16, 2001, maturity
date) and a Letter of Credit facility of USD 420 million (July 17, 2003,
expiration date). The facilities are intended to enable the company to repay or
provide cash collateral in respect of any amounts that are or may become payable
under existing facilities.
On October 2, 2000, standby Letters of Credit up to a total of NLG 686.5
million were issued for coverage of obligations for U.S. cross-border leases as
partial replacement of contingent liabilities for cross-border leases as
mentioned under the off-balance commitments.
During 2000, UNA received an amount of NLG 40 million from its former
shareholders. The payment was a result of an agreement dated October 6, 1999
stipulating that UNA's former shareholders would compensate UNA for the costs
associated with its reorganization.
2. PROPOSED INCOME APPROPRIATION
Article 32 of the Articles of Association stipulates the following on the income
appropriation:
a. profits will initially be used to defray earlier losses;
b. a sum to be determined by the General Meeting of Shareholders will be
added to one or more reserve funds;
c. a dividend will be distributed on the shares, which, in percentage of
the par value of the shares, shall amount to a maximum of the weighted average
yield of the long-term government loans issued in the reporting year plus two
percent (2%);
d. a dividend in the form of shares will be distributed on the shares,
which, in percentage of the par value of the shares, shall amount to a maximum
of the weighted average yield of the long-term government loans issued in the
reporting year plus two percent (2%);
e. any remaining profit will in principle be added to a reserve fund to be
used to reduce the energy supply rates of the regional distribution companies.
The Management Board proposes that income totaling NLG 3,983,000 will be
charged to the general reserve. This proposal has been recorded in the Balance
Sheet as of September 30, 1999.
3. RECONCILIATION OF REPORTED STOCKHOLDERS' EQUITY AND NET EARNINGS TO UNITED
STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (U.S. GAAP) FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 1999
The accompanying financial statements are presented using generally
accepted accounting principles in the Netherlands (Dutch GAAP) and are
denominated in Netherlands guilders. The exchange rate between NLG and USD at
September 30, 1999 was 2.0663. Inclusion of separate parent company financial
statements as a component of the basic financial statements is a requirement
under Dutch GAAP. No similar requirement exists under U.S. GAAP.
F-100
<PAGE> 242
SUPPLEMENTARY INFORMATION -- (CONTINUED)
THE COMPANY
UNA is in the business of generating heat and electricity. UNA produces
electricity through twelve production units: combined heat and power,
coal-fired, gas-fired, and blast-furnace gas-fired stations. In addition, UNA
supplies steam to Hoogovens and heat for urban heating systems throughout
northwest and middle Holland. The company has been in existence since February
29, 1988.
EMPLOYEE BENEFIT PLANS
The company sponsors a defined benefit postretirement medical benefit plan.
Statement of Financial Accounting Standards No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions" (SFAS 106), stipulates different
actuarial assumptions, such as estimated future salary increases and discount
factors based on market rates, when calculating benefits expense from that
required for Dutch GAAP purposes. For Dutch GAAP purposes, determination of
medical benefits expense does not take future salary increases into account, but
does consider prior service costs and lower discount rates.
USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the revenues and
expenses during the period reported. Actual results could differ from those
estimates.
REVENUE RECOGNITION
Revenues from energy sales and services are recorded under the accrual
method and generally are recognized upon delivery. Energy sales and services not
billed by month-end are accrued based upon estimated energy and services
delivered. Energy revenues related to the Company's power generation facilities
are generated under a regulated pricing structure, which includes compensation
for the cost of fuel, capital and operation and maintenance expenses. It is
expected that the electric generation market in the Netherlands will be open to
wholesale competition in January 2001. The timing of wholesale competition in
the Netherlands is subject to change at the discretion of the Dutch government.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the company to concentration
risk consist primarily of trade receivables. Accounts receivable are typically
unsecured and are derived from revenues earned from customers located in the
Netherlands. The company performs on-going credit evaluations of its customers
and maintains reserves for potential credit losses. Historically, such losses
have been within management's expectations. As of September 30, 1999 there were
3 customers (Eneco, ENW and Remu) that accounted for 10% or more of the accounts
receivable balance.
SEGMENT INFORMATION
The company operates in one business segment only. All income is derived
from this segment.
F-101
<PAGE> 243
SUPPLEMENTARY INFORMATION -- (CONTINUED)
RELATED PARTY TRANSACTIONS
During the nine month period ended September 30, 1999 there were no
significant related party transactions.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates the recoverability of its tangible assets in
accordance with Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" (SFAS 121) for U.S. GAAP purposes. SFAS 121 requires recognition of an
impairment of long-lived assets in the event the net book value of such assets
exceeds the future undiscounted cash flows attributable to such assets. If a
long-lived asset is deemed to be impaired, impairment losses are measured as the
amount by which the carrying amount of the assets exceeds the fair value of the
asset based on discounted cash flows. To date, no impairment has been indicated.
EARNINGS PER SHARE
Statement of Financial Accounting Standards No. 128 "Earnings per Share,"
establishes standards for computing and presenting earnings per share (EPS) and
applies to entities with publicly held common stock or potential common stock.
The weighted average shares outstanding for both the nine months ended September
30, 1999 and for the year ended December 31, 1998 was 2,550 shares. Basic and
Diluted EPS for the nine months ended September 30, 1999 was NLG 21.3.
FOREIGN CURRENCY TRANSLATION
The Dutch Guilder (or Euro) is the functional currency of the Company. The
reporting currency of the Company is the U.S. dollar. The Company's assets and
liabilities are translated into U.S. dollars using the exchange rate at the
balance sheet date. Revenues, expenses, gains and losses have been translated
using the weighted average exchange rate for each month prevailing during the
periods reported. Cumulative adjustments resulting from translation are recorded
as a component of equity.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2001, the Company is required to adopt SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", as amended (SFAS
No. 133), which establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. This statement requires that derivatives
be recognized at fair value in the balance sheet and that changes in fair value
be recognized either currently in earnings or deferred as a component of other
comprehensive income, depending on the intended use of the derivative, its
resulting designation and its effectiveness. In addition, in June 2000, the
Financial Accounting Standards Board issued an amendment that narrows the
applicability of the pronouncement to some purchase and sales contracts and
allows hedge accounting for some other specific hedging relationships.
F-102
<PAGE> 244
SUPPLEMENTARY INFORMATION -- (CONTINUED)
RECONCILIATION OF REPORTED STOCKHOLDERS' EQUITY AND NET EARNINGS TO U.S. GAAP
<TABLE>
<CAPTION>
SEPTEMBER 30,
1999
-------------
NLG
<S> <C>
Reported stockholders' equity............................... 944,247
Post retirement benefits (SFAS 106)....................... (25,128)(1)
-------
Stockholders' equity based on U.S. GAAP..................... 919,119
=======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1999
-----------------
NLG
<S> <C>
Reported net income......................................... 3,983
Post-retirement benefits (SFAS 106)....................... (377)(1)
------
Net income based on U.S. GAAP............................... 3,606
======
</TABLE>
---------------
(1) Under Dutch GAAP, different actuarial assumptions and methodologies are
applied in determining post-retirement medical benefit expense as compared
to U.S. GAAP.
STATEMENT OF CASH FLOWS
The consolidated statement of cash flows for the nine months ended
September 30, 1999 is not impacted by the above reconciling items. Cash flows
provided from investing activities for the nine months ended September 30, 1999
would be 355,162 under U.S. GAAP as compared to 337,210 under Dutch GAAP. Cash
flows provided from financing activities for the nine months ended September 30,
1999 would be 341,599 under U.S. GAAP as compared to 323,647 under Dutch GAAP.
STATEMENT OF COMPREHENSIVE INCOME
Statement of Financial Accounting Standard No. 130, Reporting Comprehensive
Income, requires that all items recognized as components of comprehensive income
under U.S. GAAP be reported in a separate financial statement. For the nine
months ended September 30, 1999, the difference between net income and total
comprehensive income was not material.
* * *
F-103
<PAGE> 245
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholder of
Reliant Energy Services, Inc. and Related Company
Houston, Texas
We have audited the accompanying combined statements of operations, owner's
net investment and accumulated other comprehensive loss and cash flows for the
seven months ended July 31, 1997, of Reliant Energy Services, Inc. and related
company (collectively, Unregulated RERC). The combined financial statements
include the accounts of Reliant Energy Services, Inc. and Arkla Finance
Corporation. These companies are under common ownership and common management.
These financial statements are the responsibility of Unregulated RERC's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such combined financial statements present fairly, in all
material respects, Unregulated RERC's combined results of operations and
combined cash flows for the seven months ended July 31, 1997, in conformity with
accounting principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Houston, Texas
October 14, 2000
F-104
<PAGE> 246
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
STATEMENT OF COMBINED OPERATIONS
SEVEN MONTHS ENDED JULY 31, 1997
(THOUSANDS OF DOLLARS)
<TABLE>
<S> <C>
REVENUES.................................................... $1,592,608
EXPENSES:
Natural gas............................................... 1,592,657
Operation and maintenance................................. 14,544
General and administrative................................ 9,790
Depreciation.............................................. 159
Taxes other than income taxes............................. 752
----------
Total.............................................. 1,617,902
----------
OPERATING LOSS.............................................. (25,294)
----------
OTHER INCOME (EXPENSE):
Interest income -- affiliated companies, net.............. 3,361
Interest expense.......................................... (989)
Other, net................................................ (387)
----------
Total other income................................. 1,985
----------
LOSS BEFORE INCOME TAXES.................................... (23,309)
Income Tax Benefit.......................................... 8,815
----------
NET LOSS.................................................... $ (14,494)
==========
</TABLE>
See Notes to the Combined Financial Statements
F-105
<PAGE> 247
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
STATEMENT OF COMBINED OWNER'S NET INVESTMENT
AND ACCUMULATED OTHER COMPREHENSIVE INCOME
SEVEN MONTHS ENDED JULY 31, 1997
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
OWNER'S NET COMPREHENSIVE COMPREHENSIVE
INVESTMENT INCOME TOTAL LOSS
----------- ------------- ----- -------------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996................ $197,428 $ 5 $197,433
Comprehensive loss:
Net loss.................................. (14,494) (14,494) $(14,494)
Other comprehensive income:
Unrealized gain on available for sale
securities, net of tax of $3,329...... 5,874 5,874 5,874
--------
Comprehensive loss.................... $ (8,620)
-------- ------ -------- ========
Balance at July 31, 1997.................... $182,934 $5,879 $188,813
======== ====== ========
</TABLE>
See Notes to the Combined Financial Statements
F-106
<PAGE> 248
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
STATEMENT OF COMBINED CASH FLOWS
SEVEN MONTHS ENDED JULY 31, 1997
(THOUSANDS OF DOLLARS)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(14,494)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation............................................ 159
Deferred income taxes................................... 2,331
Changes in other assets and liabilities:
Accounts and notes receivable, net.................... (94,330)
Accounts receivable/payable, affiliated companies..... 66,314
Inventories........................................... 930
Other current assets.................................. (8,265)
Accounts payable...................................... (41,749)
Other current liabilities............................. (6,268)
Margin deposits on trading activities................. 3,352
Other, net............................................ 24,079
--------
Net cash used in operating activities.............. (67,941)
--------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (2,388)
--------
Net cash used in investing activities.............. (2,388)
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in notes with affiliated companies, net.......... 70,328
--------
Net cash provided by financing activities................. 70,328
--------
NET DECREASE IN CASH........................................ (1)
CASH AT BEGINNING OF THE PERIOD............................. 2
--------
CASH AT END OF THE PERIOD................................... $ 1
========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest................................................ $ 5,429
Income taxes............................................ --
</TABLE>
See Notes to the Combined Financial Statements
F-107
<PAGE> 249
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
NOTES TO THE COMBINED FINANCIAL STATEMENTS
FOR THE SEVEN MONTHS ENDED JULY 31, 1997
(1) ORGANIZATION AND BASIS OF PRESENTATION
(a) ORGANIZATION.
Reliant Energy Services, Inc., formerly NorAm Energy Services, Inc.,
(Reliant Energy Services) and Arkla Finance Corporation (Arkla Finance) are
indirect wholly-owned subsidiaries of Reliant Energy Resources Corp. (RERC),
formerly NorAm Energy Corp, a natural gas gathering, transmission, marketing and
distribution company. Reliant Energy Services engages in wholesale energy
trading, marketing and risk management operations in North America. Arkla
Finance is a company that holds an investment in marketable equity securities
(collectively, Unregulated RERC).
In August 1997, a subsidiary of Reliant Energy, Incorporated (Reliant
Energy) merged with RERC (the Merger). The aggregate consideration paid to
RERC's stockholders consisted of $1.4 billion in cash and 47.8 million shares of
Reliant Energy common stock valued at approximately $1.0 billion. The
acquisition of RERC was recorded under the purchase method of accounting, with
assets and liabilities reflected at their estimated fair values at the date of
acquisition. The purchase price was pushed down to RERC and its subsidiaries
resulting in a "new basis" of accounting. The Combined Balance Sheets of
Unregulated RERC after the acquisition reflect adjustments associated with the
allocation of the purchase price, and $287 million was allocated to Unregulated
RERC. Debt to fund the cash portion of the purchase consideration was not
allocated or "pushed down" to Unregulated RERC.
On July 27, 2000, Reliant Energy announced its intention to form a company
to own and operate a substantial portion of its unregulated operations and to
offer approximately 20% of the common stock of this company (the Company) in an
initial public offering (Offering). Reliant Energy expects the Offering to be
followed by a distribution to Reliant Energy's or its successor's shareholders
of the remaining common stock of the Company (Distribution) within 12 months of
the Offering. Prior to the Offering, RERC will contribute the capital stock of
Arkla Finance to Reliant Energy Services, which will then be transferred to the
Company. There can be no assurances that the Offering and Distribution will be
completed.
The accompanying combined financial statements for the seven months ended
July 31, 1997 (Combined Financial Statements) are presented on a carve-out basis
and include the historical operations of Reliant Energy Services and Arkla
Finance. No direct ownership exists between Reliant Energy Services and Arkla
Finance; accordingly, RERC's net investment in Unregulated RERC (Owner's Net
Investment) is shown in lieu of Stockholder's Equity in the Combined Financial
Statements. The Combined Financial Statements included herein have been prepared
from RERC's historical accounting records.
The Statement of Combined Operations includes all revenues and costs
directly attributable to Unregulated RERC, including costs for facilities and
costs for functions and services performed by centralized RERC's organizations
and directly charged to Unregulated RERC based on usage or other allocation
factors. The results of operations also include allocations of general corporate
expenses from RERC. All significant intercompany transactions and balances
within Unregulated RERC are eliminated in the Combined Financial Statements.
All of the allocations in the Combined Financial Statements are based on
assumptions that management believes are reasonable under the circumstances.
However, these allocations are
F-108
<PAGE> 250
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
not necessarily indicative of the costs and expenses that would have resulted if
Unregulated RERC had been operated as a separate entity.
(b) DEPRECIATION EXPENSE.
Depreciation expense for equipment is computed using the straight-line
method based on economic lives. The range of equipment depreciable lives is
three to five years.
(c) REVENUES.
During the seven months ended July 31, 1997, Unregulated RERC applied hedge
accounting to some physical commodity activities that qualified for hedge
accounting, and accordingly, unrealized gains and losses associated with these
transactions are deferred. For trading transactions that do not qualify for
hedge accounting, Reliant Energy Services used mark-to-market accounting.
Accordingly, these financial instruments are recorded at fair value with
realized and unrealized gains (losses) recorded as a component of revenues.
(d) GENERAL AND ADMINISTRATIVE EXPENSES.
Included in the general and administrative expenses in the Statement of
Combined Operations are employee related costs of the trading, marketing and
risk management operations and corporate services, including management
services, financial and tax accounting, cash management and treasury support,
legal, information technology system support, office management, and human
resources.
(e) INCOME TAXES.
Prior to the Merger, RERC and its subsidiaries filed a consolidated federal
income tax return. Unregulated RERC calculates its income tax provision on a
separate return basis under a tax sharing agreement with RERC. Unregulated RERC
uses the liability method of accounting for deferred income taxes and measures
deferred income taxes for all significant income tax temporary differences.
Current federal and state income taxes are payable to or receivable from RERC.
For additional information regarding income taxes, see Note 4.
(f) INVESTMENTS IN MARKETABLE EQUITY SECURITIES.
Unregulated RERC holds equity securities classified as "available-for-sale"
and, in accordance with Statement of Financial Accounting Standards (SFAS) No.
115, "Accounting for Certain Investments in Debt and Equity Securities," reports
any unrealized gain or loss, net of tax, as a separate component of owner's net
investment and other accumulated comprehensive income.
(g) LOSS PER SHARE.
As no direct ownership relationship existed among the companies comprising
Unregulated RERC, loss per share has not been presented in the Combined
Financial Statements.
(h) RELATED PARTY TRANSACTIONS.
Reliant Energy Services supplies natural gas to, purchases natural gas for
resale from, and purchases transportation services from, RERC and affiliates of
Unregulated RERC. During the
F-109
<PAGE> 251
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
seven months ended July 31, 1997, the sales to RERC and affiliates of
Unregulated RERC totaled $86 million. Purchases of natural gas and
transportation services from RERC and affiliates of Unregulated RERC totaled $78
million for the seven months ended July 31, 1997.
RERC provides corporate services and office space to Unregulated RERC that
are allocated or direct billed to Unregulated RERC, including management
support, financial and tax accounting, human resources, information technology
system support, cash management and treasury support, legal services and other
general services. During the seven months ended July 31, 1997, the allocated and
direct billed corporate services to Unregulated RERC totaled approximately $1.2
million.
Unregulated RERC has short-term notes payable and short-term and long-term
notes receivable to/from affiliated companies that represent the accumulation of
a variety of cash transfers and operating transactions with RERC and affiliates
of Unregulated RERC and generally bear interest at market-based rates. Net
interest income related to these net borrowings/ receivables was $3.4 million
for the seven months ended July 31, 1997.
(i) USE OF ESTIMATES.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(j) MARKET RISK AND UNCERTAINTIES.
Unregulated RERC is subject to the risk associated with price movements of
energy commodities and the credit risk associated with Unregulated RERC's risk
management activities. For additional information regarding these risks, see
Note 2.
(2) DERIVATIVE FINANCIAL INSTRUMENTS
(a) PRICE RISK MANAGEMENT AND TRADING ACTIVITIES.
During the seven months ended July 31, 1997, Unregulated RERC offered
energy price risk management services primarily related to natural gas.
Unregulated RERC provides these services by utilizing a variety of derivative
financial instruments, including (i) fixed and variable-priced physical forward
contracts, (ii) fixed and variable-priced swap agreements, (iii) options traded
in the over-the-counter financial markets and (iv) exchange-traded energy
futures and option contracts (Energy Derivatives). Fixed-price swap agreements
require payments to, or receipts of payments from, counterparties based on the
differential between a fixed and variable price for the commodity.
Variable-price swap agreements require payments to, or receipts of payments
from, counterparties based on the differential between industry pricing
publications or exchange quotations.
During the seven months ended July 31, 1997, Unregulated RERC applied hedge
accounting to some physical commodity activities that qualified for hedge
accounting, and accordingly, unrealized gains and losses associated with these
transitions are deferred. For trading transactions that did not qualify for
hedge accounting, Reliant Energy Services used mark-to-market accounting.
Accordingly, these financial instruments are recorded at fair value, with
realized and unrealized gains (losses) recorded as a component of revenues.
F-110
<PAGE> 252
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(b) TRADING -- GENERAL POLICY.
In addition to the risk associated with price movements, credit risk is
also inherent in Unregulated RERC's risk management activities. Credit risk
relates to the risk of loss resulting from non-performance of contractual
obligations by a counterparty. While Unregulated RERC has experienced only minor
losses due to the credit risk associated with these arrangements, Unregulated
RERC has off-balance sheet risk to the extent that the counterparties to these
transactions may fail to perform as required by the terms of each contract. In
order to minimize this risk, Unregulated RERC enters into these contracts
primarily with counterparties having a minimum Standard & Poor's or Moody's
rating of BBB- or Baa3, respectively. For long-term arrangements, Unregulated
RERC periodically reviews the financial condition of these firms in addition to
monitoring the effectiveness of these financial contracts in achieving
Unregulated RERC's objectives. If the counterparties to these arrangements fail
to perform, Unregulated RERC would seek to compel performance at law or
otherwise obtain compensatory damages. Unregulated RERC might be forced to
acquire alternative hedging arrangements or be required to honor the underlying
commitment at then-current market prices. In this event, Unregulated RERC might
incur additional losses to the extent of amounts, if any, already paid to the
counterparties. In view of its criteria for selecting counterparties, its
process for monitoring the financial strength of these counterparties and its
experience to date in successfully completing these transactions, Unregulated
RERC believes that the risk of incurring a significant financial statement loss
due to the non-performance of counterparties to these transactions is minimal.
Unregulated RERC's policies prohibit the use of leveraged financial
instruments.
(3) STOCK-BASED INCENTIVE COMPENSATION PLANS AND EMPLOYEE BENEFIT PLANS
(a) INCENTIVE COMPENSATION PLANS.
Prior to the Merger, RERC had several incentive compensation plans that
provided for the issuance of stock-based incentives (including restricted
shares, stock options and stock appreciation rights) to directors and key
employees of RERC and its subsidiaries, including officers. Unregulated RERC
participated in these plans during the seven months ended July 31, 1997. The
charge to earnings recorded by Unregulated RERC during the seven months ended
July 31, 1997 related to these incentive compensation plans was $103,000. All
stock options granted under these plans were either converted into similar
Reliant Energy options or "cashed out" prior to the Merger. All restricted stock
and substantially all stock appreciation rights were "cashed out" with the
Merger.
Prior to the Merger, beginning January 1st after the grant date of RERC's
options, the options became exercisable in one-third increments each year. The
exercise price was the closing market value of RERC common stock on the date
granted. Unregulated RERC applies the rules contained in Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Accordingly, no compensation expense has been
F-111
<PAGE> 253
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
recognized for these fixed stock options. The following table summarizes stock
option activity related to Unregulated RERC for the seven months ended July 31,
1997:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED
SHARES AVERAGE PRICE
--------- -------------
<S> <C> <C>
Outstanding at December 31, 1996............................ 133,776 $ 6.98
Options granted........................................... 40,833 15.36
Options exercised......................................... (90,059) 15.42
-------
Outstanding at July 31, 1997................................ 84,550 11.45
=======
</TABLE>
Had compensation cost been determined in accordance with the provisions of
SFAS No. 123 "Accounting for Stock-Based Compensation," based on the "fair value
methodology," the impact on Unregulated RERC for the seven months ended July 31,
1997, would have been an increase in net loss of approximately $38,000. For
purposes of determining the "fair value" of these stock options under the
Black-Scholes option pricing model, Unregulated RERC assumed (i) a risk free
interest rate based on U.S. Treasury strips of 5.24% to 7.84%, (ii) an expected
option life of five years, (iii) an unexpected volatility of 31.6% to 36.4% and
(iv) an expected dividend yield of 3.4%.
(b) PENSION.
During the seven months ended July 31, 1997, RERC had a noncontributory
retirement plan that covered substantially all employees of Unregulated RERC.
The plan provided retirement benefits based on years of service and
compensation. Pension expense for the seven months ended July 31, 1997 was
$109,000.
In addition to the noncontributory plans, RERC maintained non-qualified
plans that allowed participants to retain the benefits to which they would have
been entitled under its noncontributory plans, except for the federally mandated
limits on these benefits or on the level of salary on which these benefits may
be calculated. Expense related to these non-qualified plans was not material for
the seven months ended July 31, 1997.
(c) SAVINGS PLAN.
During the seven months ended July 31, 1997, RERC had an employee savings
plan that qualified as cash or deferred arrangements under Section 401(k) of the
Internal Revenue Code of 1986, as amended, that covered substantially all of
Unregulated RERC's employees. During 1997, under the terms of the RERC savings
plan, employees could contribute up to 12% pre-tax of total compensation and
RERC matched contributions up to 6%. Savings plan benefit expense related to
Unregulated RERC was $255,000 for the seven months ended July 31, 1997. In
addition to the savings plan, RERC maintained a contributory non-qualified plan
that allowed participants to retain the benefits to which they would have been
entitled under the savings plan except for the federally mandated limits on
these benefits or on the level of salary on which these benefits may be
calculated. Expense related to this non-qualified plan was not material for the
seven months ended July 31, 1997.
F-112
<PAGE> 254
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(d) POSTRETIREMENT BENEFITS.
Unregulated RERC records the liability for postretirement benefit plans
other than pensions (primarily health care) under SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other than Pensions." Net postretirement
benefit expense for the seven months ended July 31, 1997 was $7,000.
(e) POSTEMPLOYMENT BENEFITS.
Unregulated RERC records postemployment benefits based on SFAS No. 112,
"Employer's Accounting for Postemployment Benefits," which requires the
recognition of a liability for benefits provided to former or inactive
employees, their beneficiaries and covered dependents, after employment but
before retirement (primarily health care and life insurance benefits for
participants in the long-term disability plan). Net postemployment benefit costs
were not material for the seven months ended July 31, 1997.
(4) INCOME TAXES
Prior to the Merger, RERC and its subsidiaries filed a consolidated federal
income tax return. RERC's pre-acquisition consolidated federal income tax
returns have been audited and settled through the year 1996. During the seven
months ended July 31, 1997, Unregulated RERC calculated its income tax provision
on a separate return basis under a tax sharing agreement with RERC.
The components of Unregulated RERC's income tax benefit (provision) for the
seven months ended July 31, 1997 are set forth below (in thousands):
<TABLE>
<S> <C>
Federal
Current................................................... $10,775
Deferred.................................................. (3,017)
State
Current................................................... 371
Deferred.................................................. 686
-------
Income tax benefit.......................................... $ 8,815
=======
</TABLE>
The income tax benefit (provision) differs from the amount computed by
applying the statutory federal income tax rate of 35% to loss from continuing
operations. The reasons for this difference are as follows (in thousands):
<TABLE>
<S> <C>
Loss before income taxes.................................... $23,309
Statutory rate.............................................. 35%
-------
Income taxes at statutory rate.............................. 8,158
-------
Increase in tax benefit resulting from:
State income taxes, net of federal income tax............. 687
Other, net................................................ (30)
-------
Total.............................................. 657
=======
Income tax benefit.......................................... $ 8,815
=======
Effective rate.............................................. 37.8%
</TABLE>
F-113
<PAGE> 255
RELIANT ENERGY SERVICES, INC.
(A WHOLLY-OWNED SUBSIDIARY OF RELIANT ENERGY RESOURCES CORP.)
AND RELATED COMPANY
NOTES TO THE COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(5) COMMITMENTS AND CONTINGENCIES
(a) TRANSPORTATION AGREEMENT.
A predecessor of Reliant Energy Services entered into a transportation
agreement (ANR Agreement) with ANR Pipeline Company (ANR), which contemplated a
transfer to ANR of an interest in some pipeline and related assets of a
subsidiary of RERC that are not a part of Unregulated RERC. The interest
represented capacity of 250 million cubic feet (Mmcf)/day. Under the ANR
agreement, an ANR affiliate advanced $125 million to Unregulated RERC.
Subsequently, the parties restructured the ANR Agreement providing for the use
of 130 Mmcf/day of capacity in some of RERC's transportation facility and
Unregulated RERC refunded in 1995 and 1993, $50 million and $34 million
respectively, to ANR. The level of transportation will decline to 100 Mmcf/day
in the year 2003 with a refund of $5 million to ANR. The ANR Agreement will
terminate in 2005 with a refund to ANR of the remaining balance of $36 million.
(b) LEASE COMMITMENTS.
As of July 31, 1997, Unregulated RERC did not have any material
non-cancelable long-term operating leases. Total rental expense for all leases
was approximately $230,000 for the seven months ended July 31, 1997.
(c) LEGAL MATTERS.
Unregulated RERC is involved in legal proceedings before various courts
regarding matters arising in the ordinary course of business. Unregulated RERC's
management regularly analyzes current information and, as necessary, provides
accruals for probable liabilities on the eventual disposition of these matters.
Unregulated RERC's management believes that the disposition of these matters
will not have a material adverse effect on Unregulated RERC's financial
condition, results of operations or cash flows.
* * *
F-114
<PAGE> 256
INTRODUCTION TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma condensed consolidated financial
statements of Reliant Resources Inc. and Subsidiaries (the Company) for the year
ended December 31, 1999, and as of and for the nine months ended September 30,
2000, have been prepared based upon our historical consolidated financial
statements, which reflect the Company's separation from Reliant Energy. The pro
forma financial statements have been prepared to describe the effects of the
following:
- our acquisition of N.V. UNA (UNA),
- our acquisition of 21 electric generating facilities in the Mid-Atlantic
region from Sithe Energies, Inc. (Mid-Atlantic Acquisition),
- the related sale and leaseback of three generating facilities originally
acquired in the Mid-Atlantic Acquisition (Sale-Leaseback), and
- the planned recapitalization of net accounts and notes
payable -- affiliated companies (Intercompany Notes) into Stockholder's
Equity (Recapitalization).
Effective October 7, 1999, we acquired UNA for a total net purchase price
of $1.9 billion and have reflected this acquisition in the Company's historical
consolidated balance sheet as of September 30, 2000. UNA's results of operations
have been included in the Company's historical results of operations subsequent
to October 1, 1999. The acquisition was accounted for using the purchase method.
The unaudited pro forma condensed consolidated statement of operations for the
year ended December 31, 1999, gives effect to the acquisition of UNA as if this
transaction had occurred on January 1, 1999, using the historical results of
operations of UNA for the period prior to the acquisition, January 1, 1999
through September 30, 1999.
The Company acquired the Mid-Atlantic generating facilities from Sithe
Energies, Inc. (Sithe) for a total purchase price of $2.1 billion on May 12,
2000, and have reflected this acquisition in the Company's historical
consolidated balance sheet as of September 30, 2000. The results of operations
of the facilities acquired in the Mid-Atlantic Acquisition have been included in
the Company's historical results of operations subsequent to the acquisition
date. The acquisition was accounted for using the purchase method. The unaudited
pro forma condensed consolidated statements of operations for the nine months
ended September 30, 2000, and the year ended December 31, 1999, give effect to
the Mid-Atlantic Acquisition as if this transaction had occurred on January 1,
2000, and November 24, 1999, the date Sithe acquired these facilities.
On a preliminary basis, the Company's purchase price allocation related to
the Mid-Atlantic Acquisition and included in the historical consolidated balance
sheet as of September 30, 2000, primarily included fair value adjustments in
property, plant and equipment, air emissions regulatory allowances, material and
supplies inventory, environmental reserves and related deferred taxes. The
Company expects to finalize these fair value adjustments no later than May 2001,
based on valuation reports of property, plant and equipment and intangible
assets. The Company does not anticipate any additional material modifications to
the preliminary adjustments.
On a preliminary basis, the Company's purchase price allocation related to
UNA and included in the historical consolidated balance sheet as of September
30, 2000, primarily included fair value adjustments in property, plant and
equipment, long-term debt, severance liabilities, post-employment benefit
liabilities and related deferred taxes. The Company finalized these fair value
adjustments during September 2000.
In August 2000, the Company completed the Sale-Leaseback which was
contemplated in connection with the Mid-Atlantic Acquisition and has reflected
the Sale-Leaseback in the
F-115
<PAGE> 257
Company's historical consolidated balance sheet as of September 30, 2000. The
Sale-Leaseback represents a financing of a portion of the original purchase
price of the Mid-Atlantic Acquisition. The unaudited pro forma condensed
consolidated statements of operations for the nine months ended September 30,
2000, and for the year ended December 31, 1999, give effect to the Sale-
Leaseback as if this transaction had been completed on January 1, 2000, and
November 24, 1999, respectively.
The Recapitalization is one of the required transactions contemplated by
the master separation agreement between the Company and Reliant Energy. This
agreement provides that all Intercompany Notes prior to the closing of the
offering of approximately 20% of the common stock of the Company in an initial
public offering (Offering) will be converted into equity as a capital
contribution from Reliant Energy, resulting in an increase to stockholder's
equity by a corresponding amount.
Accordingly, stockholder's equity will increase by the sum of the
outstanding balance of the Intercompany Notes prior to the Offering. For pro
forma condensed consolidated statement of operations purposes, the Company
assumed that the Intercompany Notes were eliminated as of the beginning of each
period presented and, therefore, all historical intercompany interest relating
to this debt has been eliminated.
The "As Adjusted" amounts give effect to the receipt of net proceeds from
the Offering.
The unaudited pro forma condensed consolidated financial statements do not
purport to present the Company's actual results of operations as if the
transactions described above had occurred on January 1, 2000, January 1, 1999
and November 24, 1999, as applicable, nor are they necessarily indicative of the
Company's financial position or results of operations that may be achieved in
the future.
The unaudited condensed pro forma financial statements should be read in
conjunction with the Company's consolidated financial statements and related
notes, and related notes and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this prospectus.
F-116
<PAGE> 258
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
HISTORICAL RECAPITALIZATION PRO FORMA OFFERING AS
BALANCE ADJUSTMENTS BALANCE ADJUSTMENTS ADJUSTED
---------- ---------------- --------- ----------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents......... $ 253,868 $ 253,868 $803,000(a) $ 1,056,868
Accounts and notes receivable..... 1,175,533 1,175,533 1,175,533
Price risk management assets...... 1,917,680 1,917,680 1,917,680
Prepayments and other current
assets.......................... 417,748 417,748 417,748
---------- ----------- ---------- -------- -----------
Total current assets............ 3,764,829 3,764,829 803,000 4,567,829
---------- ----------- ---------- -------- -----------
Property, Plant and Equipment --
net............................. 3,722,010 3,722,010 3,722,010
---------- ----------- ---------- -------- -----------
Goodwill and intangible assets.... 1,246,721 1,246,721 1,246,721
Investment in affiliate........... 107,540 107,540 107,540
Price risk management assets...... 615,883 615,883 615,883
Other assets...................... 398,768 398,768 398,768
---------- ----------- ---------- -------- -----------
Total other assets.............. 2,368,912 2,368,912 2,368,912
---------- ----------- ---------- -------- -----------
Total Assets............. $9,855,751 $ -- $9,855,751 $803,000 $10,658,751
========== =========== ========== ======== ===========
Short-term borrowings and current
portion of long-term debt....... $ 204,113 $ 204,113 $ 204,113
Accounts and notes payable --
affiliated companies, net....... 2,179,661 $(2,179,661) -- --
Accounts payable, principally
trade........................... 1,142,716 1,142,716 1,142,716
Price risk management
liabilities..................... 1,880,983 1,880,983 1,880,983
Other current liabilities......... 349,041 349,041 349,041
---------- ----------- ---------- -------- -----------
Total current liabilities....... 5,756,514 (2,179,661) 3,576,853 3,576,853
---------- ----------- ---------- -------- -----------
Notes payable -- affiliated
companies, net.................. 239,070 (239,070) -- --
Price risk management
liabilities..................... 592,658 592,658 592,658
Other liabilities................. 399,903 399,903 399,903
---------- ----------- ---------- -------- -----------
Total other liabilities......... 1,231,631 (239,070) 992,561 992,561
---------- ----------- ---------- -------- -----------
Long-term Debt.................... 801,138 801,138 801,138
---------- ----------- ---------- -------- -----------
Stockholder's Equity and
Accumulated Other Comprehensive
Loss............................ 2,066,468 2,418,731 4,485,199 $803,000(a) 5,288,199
---------- ----------- ---------- -------- -----------
$9,855,751 $ -- $9,855,751 $803,000 $10,658,751
========== =========== ========== ======== ===========
</TABLE>
See notes to unaudited pro forma condensed consolidated financial statements
F-117
<PAGE> 259
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
MID-ATLANTIC
MID-ATLANTIC ACQUISITION AND
HISTORICAL PRE-ACQUISITION SALE-LEASEBACK RECAPITALIZATION PRO FORMA
BALANCE ACTIVITY ADJUSTMENTS ADJUSTMENTS BALANCE
---------- --------------- --------------- ---------------- ---------
(THOUSANDS OF DOLLARS AND SHARES, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Revenues............................. $12,819,656 $166,490 $12,986,146
Expenses:
Fuel and cost of gas sold.......... 6,248,956 53,628 6,302,584
Purchased power.................... 5,517,439 -- 5,517,439
Operation and maintenance.......... 288,319 40,372 $ 38,220(b) 366,911
General, administrative and
development...................... 158,498 13,122 171,620
Depreciation and amortization...... 130,351 19,537 8,022(c) 143,634
(16,558)(b)
2,282(f)
----------- -------- -------- -------- -----------
Total........................ 12,343,563 126,659 31,966 12,502,188
----------- -------- -------- -------- -----------
Operating Income..................... 476,093 39,831 (31,966) 483,958
----------- -------- -------- -------- -----------
Other Income (Expense):
Interest expense................... (36,863) -- (36,863)
Interest income.................... 10,503 -- 10,503
Interest expense -- affiliates,
net.............................. (121,875) (46,519) (41,721)(h) $159,896(i) --
50,219(j)
Losses from investments, net....... (16,767) -- (16,767)
Income of equity investments of
unconsolidated subsidiaries...... 33,108 -- 33,108
Gains on sale of development
project.......................... 18,011 -- 18,011
Other, net......................... 2,332 -- 2,332
----------- -------- -------- -------- -----------
Total........................ (111,551) (46,519) 8,498 159,896 10,324
----------- -------- -------- -------- -----------
Income Before Income Taxes........... 364,542 (6,688) (23,468) 159,896 494,282
Income Tax Expense................... 120,158 -- (6,787)(k) 55,964(k) 166,539
(2,796)(l)
----------- -------- -------- -------- -----------
Income from Continuing Operations.... $ 244,384 $ (6,688) $(13,885) $103,932 $ 327,743
=========== ======== ======== ======== ===========
Weighted Average Shares
Outstanding........................ 240,000
===========
Earnings per Share................... $ 1.37
===========
</TABLE>
See notes to unaudited pro forma condensed consolidated financial statements
F-118
<PAGE> 260
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
ACQUISITIONS
MID-ATLANTIC UNA PRE- AND SALE-
PRE-ACQUISITION ACQUISITION LEASEBACK RECAPITALIZATION PRO FORMA
HISTORICAL ACTIVITY ACTIVITY ADJUSTMENTS ADJUSTMENTS BALANCE
---------- --------------- ----------- ------------ ---------------- ---------
(THOUSANDS OF DOLLARS AND SHARES, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
Revenues........................ $8,052,565 $ 29,526 $480,731 $8,562,822
Expenses:
Fuel and cost of gas sold..... 3,984,953 10,754 171,843 4,167,550
Purchase power................ 3,735,819 44,699 3,780,518
Operation and maintenance..... 158,597 7,830 135,357 $ 6,105(b) 307,889
General, administrative and
development................. 93,680 3,190 -- 96,870
Depreciation and
amortization................ 43,383 4,842 105,247 2,273(c) 126,707
(1,923)(b)
(49,897)(d)
22,125(e)
657(f)
---------- -------- -------- -------- ------- ----------
Total................... 8,016,432 26,616 457,146 (20,660) 8,479,534
---------- -------- -------- -------- ------- ----------
Operating Income................ 36,133 2,910 23,585 20,660 83,288
---------- -------- -------- -------- ------- ----------
Other Income (Expense):
Interest expense.............. (12,441) -- (61,303) (17,904)(g) (91,648)
Interest income............... 1,870 -- 40,948 42,818
Interest
expense -- affiliates,
net......................... (7,653) (12,588) -- (10,548)(h) $90,138(i) --
9,766(j)
(69,115)(g)
Gains from investments, net... 15,964 -- 15,964
Other, net.................... (7,267) -- (1,245) (8,512)
---------- -------- -------- -------- ------- ----------
Total................... (9,527) (12,588) (21,600) (87,801) 90,138 (41,378)
---------- -------- -------- -------- ------- ----------
Income Before Income Taxes...... 26,606 (9,678) 1,985 (67,141) 90,138 41,910
Income Tax Expense.............. 2,560 -- -- (29,862)(k) 31,548(k) 200
(4,046)(l)
---------- -------- -------- -------- ------- ----------
Income from Continuing
Operations.................... $ 24,046 $ (9,678) $ 1,985 $(33,233) $58,590 $ 41,710
========== ======== ======== ======== ======= ==========
Weighted Average Shares
Outstanding................... 240,000
==========
Earnings per Share.............. $ 0.17
==========
</TABLE>
See notes to unaudited pro forma condensed consolidated financial statements
F-119
<PAGE> 261
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(a) Represents our receipt of estimated net proceeds from the Offering of $803
million, excluding the exercise of the underwriters' overallotment option.
The estimated net proceeds assumes an Offering price of $16.50 per share,
which is the mid-point of the Offering price range indicated on the cover
page of this prospectus.
(b) Reflects the elimination of depreciation expense associated with the
Sale-Leaseback and the recognition of lease expense associated with the
facilities involved in the Sale-Leaseback (see note (j) for related
elimination of interest expense).
(c) Represents adjustments to depreciation expense (based upon our preliminary
allocation of the purchase price of the Mid-Atlantic Acquisition). The
average economic life of the assets acquired is 35 years.
(d) Represents an adjustment to depreciation expense (based upon our allocation
of the UNA purchase price) recorded by UNA for the period prior to
acquisition (January 1, 1999 to September 30, 1999). The average economic
life of the assets acquired is 30 years.
(e) Reflects the incremental amortization expense resulting from goodwill of
$885 million associated with the UNA acquisition, based upon a 30-year
life.
(f) Represents the incremental amortization expense resulting from identifiable
intangible assets with a fair value of $153 million over a 30-year
estimated life and of goodwill of $7 million over a 35-year estimated life.
Both of these items were recorded in connection with the Mid-Atlantic
Acquisition.
(g) Represents the additional interest expense on the $1.9 billion of
intercompany and external debt issued to finance the acquisition of UNA.
The average annual interest rate of the debt was 6.0%.
(h) Represents the additional interest expense on the $1.1 billion of
intercompany debt issued to finance the Mid-Atlantic Acquisition. Funds for
the acquisition were made available through loans from Reliant Energy, $1.0
billion of these loans were subsequently converted to equity. The annual
interest rate of the intercompany debt was 9.4%.
(i) Reflects the elimination of intercompany interest expense associated with
the Intercompany Notes converted into stockholder's equity.
(j) Reflects the elimination of interest expense associated with the repayment
of indebtedness with proceeds received from the Sale-Leaseback.
(k) Represents the income tax expense (benefit) effect of the pro forma
adjustments excluding nondeductible goodwill amortization and UNA income
(due to the tax holiday that is in effect for the Dutch utility industry
through December 31, 2001).
(l) Prior to acquisition, some of the prior owners of the Mid-Atlantic
generating facilities operated as limited liability companies. An
adjustment has been made to include the effect of income tax benefit for
the period prior to the Mid-Atlantic Acquisition at the applicable 42%
combined federal and state statutory rate.
* * *
F-120
<PAGE> 262
------------------------------------------------------
------------------------------------------------------
No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell only the shares offered hereby, but only under circumstances
and in jurisdictions where it is lawful to do so. The information contained in
this prospectus is current only as of its date.
----------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary................... 1
Cautionary Statement Regarding
Forward-Looking Information........ 8
Risk Factors......................... 9
Our Separation from Reliant Energy... 27
Use of Proceeds...................... 28
Dividend Policy...................... 29
Capitalization....................... 30
Dilution............................. 31
Selected Financial Data.............. 32
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 34
Our Business......................... 57
Management........................... 96
Our Relationship with Reliant Energy
and Related Transactions........... 112
Texas Genco Option................... 113
Agreements between Us and Reliant
Energy............................. 115
Certain Federal Tax Matters Related
to Our Separation from Reliant
Energy............................. 121
Principal Stockholder................ 121
Description of Our Capital Stock..... 122
Shares Eligible for Future Sale...... 132
Underwriting......................... 134
Legal Matters........................ 136
Experts.............................. 137
Where You Can Find More
Information........................ 138
Index to Financial Statements........ F-1
</TABLE>
----------------------
Through and including , 2001 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to an unsold allotment or subscription.
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
52,000,000 Shares
RELIANT RESOURCES, INC.
Common Stock
---------------------
[RELIANT RESOURCES LOGO]
---------------------
GOLDMAN, SACHS & CO.
CREDIT SUISSE FIRST BOSTON
ABN AMRO ROTHSCHILD LLC
BANC OF AMERICA SECURITIES LLC
DEUTSCHE BANC ALEX. BROWN
MERRILL LYNCH & CO.
UBS WARBURG LLC
Representatives of the Underwriters
------------------------------------------------------
------------------------------------------------------
<PAGE> 263
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The expenses to be paid in connection with the issuance and distribution of
the securities being registered, other than underwriting discounts and
commissions, are as follows:
<TABLE>
<S> <C>
SEC registration fee........................................ $ 343,200
NASD filing fee............................................. 30,500
NYSE Listing fee............................................ 500,000
Printing and engraving expenses............................. 1,700,000
Accounting fees and expenses................................ 2,500,000
Legal fees and expenses..................................... 1,400,000
Blue sky fees and expenses (including legal fees)........... 10,000
Transfer agent and registrar fees........................... 10,000
Miscellaneous............................................... 3,471,300
----------
Total.............................................. $9,965,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Reliant Resources, Inc. is incorporated under the laws of the State of
Delaware. Section 145 ("Section 145") of Title 8 of the Delaware Code gives a
corporation power to indemnify any person who was or is a party or is threatened
to be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of the corporation) by reason of the fact that the
person is or was a director, officer, employee or agent of the corporation, or
is or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, against expenses (including attorneys' fees), judgments, fines
and amounts paid in settlement actually and reasonably incurred by the person in
connection with such action, suit or proceeding if the person acted in good
faith and in a manner the person reasonably believed to be in or not opposed to
the best interests of the corporation, and, with respect to any criminal action
or proceeding, had no reasonable cause to believe the person's conduct was
unlawful.
Section 145 also gives a corporation power to indemnify any person who was
or is a party or is threatened to be made a party to any threatened, pending or
completed action or suit by or in the right of the corporation to procure a
judgment in its favor by reason of the fact that the person is or was a
director, officer, employee or agent of the corporation, or is or was serving at
the request of the corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise
against expenses (including attorneys' fees) actually and reasonably incurred by
the person in connection with the defense or settlement of such action or suit
if the person acted in good faith and in a manner the person reasonably believed
to be in or not opposed to the best interests of the corporation and except that
no indemnification shall be made in respect of any claim, issue or matter as to
which such person shall have been adjudged to be liable to the corporation
unless and only to the extent that the Delaware Court of Chancery or the court
in which such action or suit was brought shall determine upon application that,
despite the adjudication of liability but in view of all the circumstances of
the case, such person is fairly and reasonably entitled to indemnity for such
expenses which the Delaware Court of Chancery or such other court shall deem
proper. Section 145 further provides that, to the extent that a present or
former director or officer of a corporation has been successful on the merits or
otherwise in defense of any such action, suit or proceeding, or in defense of
any claim, issue or matter therein, such person shall be indemnified against
expenses (including attorneys' fees) actually and reasonably incurred by such
person in connection therewith.
II-1
<PAGE> 264
Section 145 also authorizes a corporation to purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise, against any liability asserted against
him and incurred by him in any such capacity, arising out of his status as such,
whether or not the corporation would otherwise have the power to indemnify him
under Section 145.
Reliant Resources' Restated Certificate of Incorporation and Bylaws provide
for the indemnification of officers and directors to the fullest extent
permitted by the General Corporation Law. The underwriting agreement also
provides for the indemnification of the directors and officers in certain
circumstances.
All of Reliant Resources' directors and officers will be covered by
insurance policies maintained by Reliant Resources against certain liabilities
for actions taken in their capacities as such, including liabilities under the
Securities Act of 1933, as amended.
The master separation agreement contains indemnification provisions under
which we and Reliant Energy each indemnify the other with respect to breaches by
the indemnifying party of the master separation agreement or any ancillary
agreements and against liabilities arising from misstatements or omissions by
the indemnifying party in the prospectus or the registration statement of which
it is a part. For this purpose we are considered to have provided the
information in the prospectus and registration statement about our assets and
businesses.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Reliant Resources has not sold any securities, registered or otherwise,
within the past three years, except for the shares issued upon formation to our
sole stockholder, Reliant Energy.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following exhibits are filed as part of this Registration
Statement:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1* -- Form of Underwriting Agreement.
3.1 -- Restated Certificate of Incorporation.
3.2* -- Bylaws.
4.1* -- Specimen Stock Certificate.
4.2 -- Rights Agreement effective as of January 15, 2001 between
Reliant Resources, Inc. and The Chase Manhattan Bank, as
Rights Agent, including a form of Rights Certificate.
5.1 -- Opinion of Baker Botts L.L.P.
10.1* -- Form of Master Separation Agreement.
10.2* -- Form of Transition Services Agreement.
10.3* -- Form of Technical Services Agreement.
10.4* -- Form of Texas Genco Option Agreement.
10.5* -- Form of Employee Matters Agreement.
10.6* -- Form of Retail Agreement.
10.7* -- Form of Registration Rights Agreement.
10.8* -- Form of Tax Allocation Agreement.
10.9* -- Form of Annual Incentive Compensation Plan.
</TABLE>
II-2
<PAGE> 265
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.10* -- Form of Long-Term Incentive Plan.
10.11* -- Form of Employee Stock Purchase Plan.
10.12* -- Form of Deferred Compensation Plan.
21.1* -- Subsidiaries of Registrant.
23.1 -- Independent Auditors' Consent and Report on Schedule of
Deloitte & Touche LLP.
23.2 -- Independent Auditors' Consent of Deloitte & Touche
Accountants.
23.3 -- Consent of Independent Public Accountants of
PricewaterhouseCoopers N.V.
23.4 -- Consent of Baker Botts L.L.P. (included in Exhibit 5.1).
23.5+ -- Consent of James A. Baker, III.
23.6+ -- Consent of Linnet F. Deily.
23.7 -- Consent of L. Lowry Mays.
23.8 -- Consent of Philip B. Miller.
24.1+ -- Powers of Attorney (included on signature page of initial
filing).
27.1+ -- Financial Data Schedule (for SEC use only).
</TABLE>
---------------
* To be filed by amendment.
+ Previously filed.
Exhibits listed above that have been filed with the Securities and Exchange
Commission and that were designated as noted above are hereby incorporated
herein by reference and made a part hereof with the same effect as if filed
herewith.
(b) The following financial statement schedule is filed as part of this
Registration Statement: Schedule II -- Valuation and Qualifying Accounts and
Reserves of Reliant Resources, Inc. for the three years ended December 31, 1999.
All other schedules are omitted, because the required information is
inapplicable, or the information is presented in the consolidated Financial
Statements or related notes.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-3
<PAGE> 266
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For purposes of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 267
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Houston, State of Texas, on January
17, 2001.
RELIANT RESOURCES, INC.
By: /s/ R. STEVE LETBETTER
----------------------------------
R. Steve Letbetter
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this amendment
has been signed by the following persons in the capacities indicated below and
on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ R. STEVE LETBETTER Chairman, President, Chief January 17, 2001
----------------------------------------------------- Executive Officer and Sole
R. Steve Letbetter Director
(Principal Executive
Officer)
/s/ STEPHEN W. NAEVE Executive Vice President and January 17, 2001
----------------------------------------------------- Chief Financial Officer
Stephen W. Naeve (Principal Financial
Officer)
/s/ MARY P. RICCIARDELLO Senior Vice President and January 17, 2001
----------------------------------------------------- Chief Accounting Officer
Mary P. Ricciardello (Principal Accounting
Officer)
</TABLE>
II-5
<PAGE> 268
RELIANT RESOURCES, INC. AND AFFILIATES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE THREE YEARS ENDED DECEMBER 31, 1999 AND NINE MONTHS ENDED SEPTEMBER 30,
2000
(IN THOUSANDS)
<TABLE>
<CAPTION>
--------------------------------------------- ---------- ----------------------- ----------- ----------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
--------------------------------------------- ---------- ----------------------- ----------- ----------
ADDITIONS
-----------------------
BALANCE AT CHARGED CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING TO OTHER FROM END
DESCRIPTION OF PERIOD INCOME ACCOUNT(2) RESERVES(1) OF PERIOD
--------------------------------------------- ---------- ------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
For the Nine Months ended September 30, 2000:
Accumulated provisions:
Uncollectible accounts receivable $15,293 $3,800 $ -- $ 164 $18,929
Reserves deducted from price risk
management assets 11,511 3,472 -- -- 14,983
Reserves for accrue-in-advance major
maintenance 47,809 17,149 (2,215) 32,083 30,660
Reserves for inventory 5,716 92 20,602 16,179 10,231
Reserves for severance 17,760 -- 17,223 3,771 31,212
For the Year ended December 31, 1999:
Accumulated provisions:
Uncollectible accounts receivable 6,703 1,100 7,490 -- 15,293
Reserves deducted from price risk
management assets 6,464 5,047 -- -- 11,511
Reserves for accrue-in-advance major
maintenance 35,249 5,826 17,411 10,677 47,809
Reserves for inventory 6,505 -- -- 789 5,716
Reserves for severance -- -- 18,080 320 17,760
For the Year Ended December 31, 1998:
Accumulated provisions:
Uncollectible accounts receivable 1,152 5,551 -- -- 6,703
Reserves deducted from price risk
management assets -- 6,464 -- -- 6,464
Reserves for accrue-in-advance major
maintenance -- 4,181 31,068 -- 35,249
Reserves for inventory -- -- 7,026 521 6,505
Reserves for severance 2,988 -- -- 2,988 --
For the Year Ended December 31, 1997:
Accumulated provisions:
Uncollectible accounts receivable -- 82 1,157 87 1,152
Reserves for severance -- -- 2,988 -- 2,988
</TABLE>
---------------
(1) Deductions from reserves represent losses or expenditures for which the
respective reserves were created. In the case of the uncollectible accounts
reserve, such deductions are net of recoveries of amounts previously written
off.
(2) Charged to other account represents obligations acquired through business
acquisitions and foreign currency translation losses in the 2000 severance
reserves and reserves for accrue-in-advance major maintenance.
II-6
<PAGE> 269
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1* -- Form of Underwriting Agreement.
3.1 -- Restated Certificate of Incorporation.
3.2* -- Bylaws.
4.1* -- Specimen Stock Certificate.
4.2 -- Rights Agreement effective as of January 15, 2001 between
Reliant Resources, Inc. and The Chase Manhattan Bank, as
Rights Agent, including a form of Rights Certificate.
5.1 -- Opinion of Baker Botts L.L.P.
10.1* -- Form of Master Separation Agreement.
10.2* -- Form of Transition Services Agreement.
10.3* -- Form of Technical Services Agreement.
10.4* -- Form of Texas Genco Option Agreement.
10.5* -- Form of Employee Matters Agreement.
10.6* -- Form of Retail Agreement.
10.7* -- Form of Registration Rights Agreement.
10.8* -- Form of Tax Allocation Agreement.
10.9* -- Form of Annual Incentive Compensation Plan.
10.10* -- Form of Long-Term Incentive Plan.
10.11* -- Form of Employee Stock Purchase Plan.
10.12* -- Form of Deferred Compensation Plan.
21.1* -- Subsidiaries of Registrant.
23.1 -- Consent and Report on Schedule of Deloitte & Touche LLP.
23.2 -- Consent of Deloitte & Touche Accountants.
23.3 -- Consent of PricewaterhouseCoopers N.V.
23.4 -- Consent of Baker Botts L.L.P. (included in Exhibit 5.1).
23.5+ -- Consent of James A. Baker, III.
23.6+ -- Consent of Linnet F. Deily.
23.7 -- Consent of L. Lowry Mays
23.8 -- Consent of Philip B. Miller
24.1+ -- Powers of Attorney (included on signature page of initial
filing).
27.1+ -- Financial Data Schedule (for SEC use only).
</TABLE>
---------------
* To be filed by amendment.
+ Previously filed.
