<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to _______________
------------------------------
Commission file number 1-3187
HOUSTON INDUSTRIES INCORPORATED
(Exact name of registrant as specified in its charter)
Texas 74-0694415
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
------------------------------
Commission file number 1-13265
NORAM ENERGY CORP.
(Exact name of registrant as specified in its charter)
Delaware 76-0511406
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 207-3000
(Registrant's telephone number, including area code)
-----------------------------
NORAM ENERGY CORP. MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a)
AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE REDUCED
DISCLOSURE FORMAT.
Indicate by check mark whether the registrants: (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
As of May 6, 1998, Houston Industries Incorporated had 296,039,637 shares of
common stock outstanding, including 11,984,708 ESOP shares not deemed
outstanding for financial statement purposes and excluding 98,866 shares held as
treasury stock. As of May 6, 1998, all 1,000 shares of NorAm Energy Corp.'s
common stock were held by Houston Industries Incorporated.
<PAGE> 2
THIS COMBINED QUARTERLY REPORT ON FORM 10-Q IS SEPARATELY FILED BY
HOUSTON INDUSTRIES INCORPORATED (COMPANY) AND NORAM ENERGY CORP. (NORAM).
INFORMATION CONTAINED HEREIN RELATING TO NORAM IS FILED BY THE COMPANY AND
SEPARATELY BY NORAM ON ITS OWN BEHALF. NORAM MAKES NO REPRESENTATION AS TO
INFORMATION RELATING TO THE COMPANY (EXCEPT AS IT MAY RELATE TO NORAM AND ITS
SUBSIDIARIES), HOUSTON INDUSTRIES ENERGY, INC., HOUSTON INDUSTRIES POWER
GENERATION, INC. OR ANY OTHER AFFILIATE OR SUBSIDIARY OF THE COMPANY.
HOUSTON INDUSTRIES INCORPORATED
AND NORAM ENERGY CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part I. Financial Information Page No.
- ------- --------------------- --------
<S> <C> <C>
COMPANY
Item 1. Financial Statements
Statements of Consolidated Income
Three Months Ended March 31, 1998 and 1997 1
Consolidated Balance Sheets
March 31, 1998 and December 31, 1997 2
Statements of Consolidated Cash Flows
Three Months Ended March 31, 1998 and 1997 4
Statements of Consolidated Retained Earnings
Three Months Ended March 31, 1998 and 1997 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations of the Company 16
Item 3. Quantitative and Qualitative Disclosure
About Market Risk of the Company 29
NORAM
Item 1. Financial Statements
Statements of Consolidated Income
Three Months Ended March 31, 1998 and 1997 30
Consolidated Balance Sheets
March 31, 1998 and December 31, 1997 31
Statements of Consolidated Cash Flows
Three Months Ended March 31, 1998 and 1997 33
</TABLE>
(i)
<PAGE> 3
<TABLE>
<S> <C>
Consolidated Statements of Stockholders' Equity
Three Months Ended March 31, 1998 and 1997 34
Notes to Unaudited Consolidated Financial Statements 36
Item 2. Management's Narrative Analysis of the
Results of Operations of NorAm Energy Corp.
And Consolidated Subsidiaries 39
Item 3. Quantitative and Qualitative Disclosure
About Market Risk of NorAm (omitted pursuant
to General Instruction H(2)(c))
Part II. Other Information
Item 1. Legal Proceedings 47
Item 2. Changes in Securities and Use of Proceeds 47
Item 6. Exhibits and Reports on Form 8-K 47
Signature(s) 48
</TABLE>
(ii)
<PAGE> 4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
REVENUES:
Electric Operations ........................................ $ 846,562 $ 856,534
Natural Gas Distribution ................................... 716,896
Interstate Pipeline ........................................ 70,981
Energy Marketing ........................................... 1,045,619
International .............................................. 27,246 19,830
Other ...................................................... 24,106 1,737
Eliminations ............................................... (94,698)
----------- -----------
Total ................................................ 2,636,712 878,101
----------- -----------
EXPENSES:
Fuel and cost of gas sold .................................. 1,286,092 223,965
Purchased power ............................................ 412,652 100,992
Operation and maintenance .................................. 375,897 196,010
Taxes other than income taxes .............................. 88,777 62,454
Depreciation and amortization .............................. 175,599 130,990
Other operating expenses ................................... 16,726 7,474
----------- -----------
Total .............................................. 2,355,743 721,885
----------- -----------
OPERATING INCOME .............................................. 280,969 156,216
----------- -----------
OTHER INCOME (EXPENSE):
Unrealized loss on ACES .................................... (189,320)
Time Warner dividend income ................................ 10,313 10,403
Interest income - IRS refund ............................... 981
Other - net ................................................ 6,233 (1,762)
----------- -----------
Total .............................................. (171,793) 8,641
----------- -----------
INTEREST AND OTHER CHARGES:
Interest on long-term debt ................................. 106,029 62,801
Other interest ............................................. 24,359 16,410
Distributions on trust securities .......................... 7,410 4,519
Allowance for borrowed funds used during
construction ........................................... (957) (1,100)
Preferred dividends of subsidiary .......................... 2,125
----------- -----------
Total .............................................. 136,841 84,755
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES AND PREFERRED DIVIDENDS ..... (27,665) 80,102
INCOME TAXES .................................................. 3,575 20,482
PREFERRED DIVIDENDS ........................................... 97
----------- -----------
NET INCOME (LOSS) ............................................. $ (31,337) $ 59,620
=========== ===========
BASIC EARNINGS (LOSS) PER COMMON SHARE ........................ $ (.11) $ .26
DILUTED EARNINGS (LOSS) PER COMMON SHARE ...................... $ (.11) $ .26
</TABLE>
See Notes to Consolidated Financial Statements.
1
<PAGE> 5
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
----------- -----------
<S> <C> <C>
PROPERTY, PLANT AND EQUIPMENT - AT COST:
Electric plant:
Plant in service .................................. $12,725,730 $12,614,000
Construction work in progress ..................... 172,893 224,959
Nuclear fuel ...................................... 256,423 255,567
Plant held for future use ......................... 48,631 48,631
Gas plant and pipelines:
Natural gas distribution .......................... 1,351,870 1,326,442
Interstate pipelines .............................. 1,259,530 1,258,087
Energy marketing .................................. 167,573 162,519
Other property ....................................... 164,580 149,019
----------- -----------
Total ....................................... 16,147,230 16,039,224
Less accumulated depreciation and amortization ....... 4,907,060 4,770,179
----------- -----------
Property, plant and equipment - net ......... 11,240,170 11,269,045
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ............................ 139,066 51,712
Accounts receivable - net ............................ 698,323 962,974
Accrued unbilled revenues ............................ 136,381 205,860
Time Warner dividends receivable ..................... 10,313 10,313
Fuel stock and petroleum products .................... 63,398 88,819
Materials and supplies, at average cost .............. 151,407 156,160
Restricted deposit for bond redemption ............... 290,000
Prepayments and other current assets ................. 25,485 42,169
----------- -----------
Total current assets ........................ 1,514,373 1,518,007
----------- -----------
OTHER ASSETS:
Goodwill--net ........................................ 2,013,907 2,026,395
Investment in Time Warner securities ................. 990,000 990,000
Equity investments in and advances to foreign and
non-rate regulated affiliates - net ............... 712,888 704,102
Deferred plant costs - net ........................... 555,124 561,569
Deferred debits ...................................... 503,904 510,686
Regulatory tax asset - net ........................... 355,065 356,509
Unamortized debt expense and premium on
reacquired debt ................................... 213,617 202,453
Fuel-related debits .................................. 184,604 197,304
Recoverable project costs - net ...................... 68,230 78,485
----------- -----------
Total other assets .......................... 5,597,339 5,627,503
----------- -----------
Total .................................... $18,351,882 $18,414,555
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
2
<PAGE> 6
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
CAPITALIZATION AND LIABILITIES
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------ ------------
<S> <C> <C>
CAPITALIZATION:
Common stock equity:
Common stock, no par value ..................................................... $ 3,122,071 $ 3,112,098
Treasury stock, at cost ........................................................ (2,207) (2,066)
Unearned ESOP shares ........................................................... (226,175) (229,827)
Retained earnings .............................................................. 1,875,213 2,013,055
Foreign currency loss .......................................................... (702) (821)
Unrealized loss on marketable equity securities ................................ (4,255) (5,634)
------------ ------------
Total common stock equity ............................................... 4,763,945 4,886,805
------------ ------------
Preference stock, none outstanding
Cumulative preferred stock, no par value,
not subject to mandatory redemption ............................................ 9,740 9,740
------------ ------------
Company/NorAm obligated mandatorily redeemable trust
preferred securities of subsidiary trusts holding solely subordinated debentures
of Company/NorAm ............................................................... 355,952 362,172
------------ ------------
Long-term debt:
Automatic common exchange securities (ACES) .................................... 1,363,106 1,173,786
Debentures ..................................................................... 969,002 669,291
First mortgage bonds ........................................................... 1,931,610 2,495,459
Notes payable .................................................................. 742,534 745,889
Pollution control revenue bonds ................................................ 512,685 118,000
Other .......................................................................... 15,364 15,590
------------ ------------
Total long-term debt .................................................... 5,534,301 5,218,015
------------ ------------
Total capitalization ................................................ 10,663,938 10,476,732
------------ ------------
CURRENT LIABILITIES:
Notes payable ............................................................... 1,738,004 2,124,956
Accounts payable ............................................................ 725,480 879,612
Taxes accrued ............................................................... 172,165 240,739
Interest accrued ............................................................ 102,781 109,901
Dividends declared .......................................................... 113,552 110,716
Customer deposits ........................................................... 82,064 82,437
Current portion of long-term debt ........................................... 708,421 251,169
Other ....................................................................... 158,328 193,384
------------ ------------
Total current liabilities ............................................. 3,800,795 3,992,914
------------ ------------
DEFERRED CREDITS:
Accumulated deferred income taxes ................................................. 2,737,976 2,792,781
Benefit liabilities ............................................................... 405,600 397,586
Unamortized investment tax credit ................................................. 344,041 349,072
Fuel-related credits .............................................................. 69,775 75,956
Other ............................................................................. 329,757 329,514
------------ ------------
Total deferred credits ................................................ 3,887,149 3,944,909
------------ ------------
COMMITMENTS AND CONTINGENCIES
Total ................................................................. $ 18,351,882 $ 18,414,555
============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE> 7
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .......................................................................... $ (31,337) $ 59,620
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization ........................................................... 175,599 130,990
Amortization of nuclear fuel ............................................................ 6,714 6,657
Deferred income taxes ................................................................... (54,805) 6,191
Investment tax credit ................................................................... (5,031) (4,879)
Unrealized loss on ACES ................................................................. 189,320
Fuel surcharge .......................................................................... 21,966 31,239
Fuel cost (under) recovery .............................................................. (28,381) (39,828)
Changes in other assets and liabilities:
Accounts receivable - net ............................................................ 193,598 8,365
Accounts receivable - IRS ............................................................ 140,532
Inventory ............................................................................ 31,389 9,138
Other current assets ................................................................. 35,222 9,831
Accounts payable ..................................................................... (154,132) (55,588)
Interest and taxes accrued ........................................................... (75,694) (103,121)
Other current liabilities ............................................................ (51,188) (21,743)
Other - net .......................................................................... 30,297 1,822
--------- ---------
Net cash provided by operating activities ........................................ 424,069 38,694
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (including allowance for borrowed funds used during construction) ..... (108,497) (44,384)
Non-rate regulated electric power project expenditures (including capitalized interest) .... (4,926) (18,913)
Other - net ................................................................................ (9,225) (1,880)
--------- ---------
Net cash used in investing activities ............................................ (122,648) (65,177)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of Company obligated mandatorily redeemable trust
preferred securities of subsidiary trusts holding solely subordinated
debentures of
Company - net ........................................................................... 340,810
Payment of matured bonds ................................................................... (1,000) (190,000)
Proceeds from issuance of debentures ....................................................... 300,000
Restricted deposit for bond redemption ..................................................... (290,000)
Proceeds from issuance of pollution control revenue bonds .................................. 386,757 115,795
Redemption of preferred stock .............................................................. (127,928)
Payment of common stock dividends .......................................................... (106,448) (87,567)
Increase (decrease) in notes payable - net ................................................. (390,307) 101,750
Extinguishment of long-term debt ........................................................... (107,263) (120,360)
Conversion of convertible securities ....................................................... (3,255)
Other - net ................................................................................ (2,551) 1,333
--------- ---------
Net cash provided by (used in) financing activities .............................. (214,067) 33,833
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ....................................................... 87,354 7,350
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ................................................ 51,712 8,001
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................................................... $ 139,066 $ 15,351
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) ................................................... $ 145,348 $ 80,721
Income taxes ............................................................................ 15,158 27,914
</TABLE>
See Notes to Consolidated Financial Statements
4
<PAGE> 8
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED RETAINED EARNINGS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Balance at Beginning of Period ......... $ 2,013,055 $ 1,997,490
Net Income (Loss) for the Period ....... (31,337) 59,620
----------- -----------
Total ......................... 1,981,718 2,057,110
Common Stock Dividends ................. (106,505) (87,656)
----------- -----------
Balance at End of Period ............... $ 1,875,213 $ 1,969,454
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
-5-
<PAGE> 9
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The interim financial statements and notes (Interim Financial
Statements) in this joint Form 10-Q (Form 10-Q) include the accounts of Houston
Industries Incorporated (Company) and its wholly owned and majority owned
subsidiaries including, effective as of August 6, 1997 (Acquisition Date), the
accounts of NorAm Energy Corp. (NorAm) and its wholly owned and majority owned
subsidiaries. For information regarding the Company's acquisition of NorAm, see
Note 1(b) to the joint Annual Report on Form 10-K of the Company (File No.
1-3187) (Company's Form 10-K) and NorAm (File No. 1-13265) (NorAm's Form 10-K)
for the fiscal year ended December 31, 1997. The 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 Company's Form 10-K and NorAm's Form 10-K . For
additional information regarding the presentation of interim period results, see
Note 11 below.
The following notes to the financial statements in the Company's Form
10-K and NorAm's Form 10-K relate to material contingencies. These notes, as
updated by the notes contained in the Interim Financial Statements, are
incorporated herein by reference:
Company: Note 1(c) (Regulatory Assets and Other Long-Lived Assets), Note
1(n) (Investments in Time Warner Securities), Note 2 (Derivative Financial
Instruments (Risk Management)), Note 3 (Rate Matters), Note 4 (Jointly
Owned Electric Utility Plant), Note 5 (Equity Investments in Foreign
Affiliates) and Note 12 (Commitments and Contingencies).
NorAm: Note 1(c) (Regulatory Assets and Regulation), Note 2 (Derivative
Financial Instruments (Risk Management)) and Note 8 (Commitments and
Contingencies).
(2) PRO FORMA COMBINED RESULTS OF OPERATIONS DATA
The Company's results of operations incorporate NorAm's results of
operations only for the period beginning on the Acquisition Date. The following
table presents certain unaudited pro forma information for the quarter ended
March 31, 1997, as if the acquisition of NorAm had occurred on January 1, 1997.
6
<PAGE> 10
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMBINED RESULTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31,
--------------------------
1998 1997
----------- ----------
ACTUAL PRO FORMA
(UNAUDITED)
<S> <C> <C>
Revenues .................................... $ 2,637 $ 2,802
Net Income (Loss)(1) ........................ $ (31) $ 110
Basic Earnings Per Share (1) ................ $ (0.11) $ 0.39
Diluted Earnings Per Share (1) .............. $ (0.11) $ 0.39
</TABLE>
- ---------------
(1) Includes a $123 million or .43 per share (after-tax) non-cash unrealized
accounting loss recorded in the first quarter of 1998 relating to the
Company's Automatic Common Exchange Securities (ACES). For additional
information, see Note 5.
These and other pro forma results appearing in this Form 10-Q 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 combined results that would have resulted had the acquisition of NorAm
occurred at the beginning of 1997. Purchase related adjustments to results of
operations include amortization of goodwill and the effects on depreciation,
amortization, interest expense and deferred income taxes of the revaluation, on
a preliminary basis, of the fair value of certain NorAm assets and liabilities.
For information regarding the recording of the NorAm acquisition under the
purchase method of accounting, see Note 1(b) to the Company's Form 10-K.
(3) COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS No.
130). SFAS No. 130 requires that all items that meet the definition of a
component of comprehensive income (as defined below) be reported in a financial
statement for the fiscal period in which they are recognized and the total
amount of comprehensive income be prominently displayed in that same financial
statement. Comprehensive income is defined to include not only net income
(loss), but also the change in equity of a business enterprise during a period
from transactions and other events and circumstances from non-owner sources. The
Company's total comprehensive loss of $30 million for the first quarter of 1998
reflects the Company's $31 million net loss for the quarter offset by a foreign
currency gain and an unrealized gain on the Company's investment in shares of
Itron, Inc., a marketable equity security. For the first quarter of 1997, total
comprehensive income was $63 million reflecting the Company's $60 million net
income in the quarter and the unrealized gain on the Company's investment in
Time Warner common stock offset by a foreign currency loss.
7
<PAGE> 11
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) DEPRECIATION
The Company calculates depreciation using the straight-line method. The
Company's depreciation expense for the first quarter of 1998 was $127 million,
compared to $90 million for the same period in 1997.
(5) INVESTMENT IN TIME WARNER SECURITIES
The Company owns 11 million shares of non-publicly traded Time Warner,
Inc. (Time Warner) convertible preferred stock (TW Preferred). The TW Preferred
is convertible into approximately 22.9 million shares of Time Warner common
stock. For additional information regarding TW Preferred (including its dividend
rate, liquidation preference and voting rights), see Note 1(n) to the Company's
Form 10-K.
The Company has recorded its $990 million investment in the TW
Preferred under the cost method. Dividends on these securities are recognized as
income at the time they are earned. The Company recorded pre-tax dividend income
with respect to these securities of $10.3 million in the first quarters of 1998
and 1997.
To monetize its investment in the TW Preferred, the Company sold in
July 1997, 22.9 million of its unsecured 7% ACES. As a result of the issuance of
the ACES, a portion of the increase in the market value above $55.5844 per share
of Time Warner common stock (the security into which the TW Preferred is
convertible) results in unrealized accounting losses to the Company for the
ACES, pending the conversion of the Company's TW Preferred into Time Warner
common stock. For example, prior to the conversion of the TW Preferred into Time
Warner common stock, when the market price of Time Warner common stock increases
above $55.5844, the Company records in Other Income (Expense) an accounting loss
for the ACES equal to (i) the aggregate amount of such increase as applicable to
all ACES multiplied by (ii) 0.8264. In accordance with generally accepted
accounting principles, this accounting loss (which reflects the unrealized
increase in the Company's indebtedness with respect to the ACES) may not be
offset by accounting recognition of the increase in the market value of the Time
Warner common stock that underlies the TW Preferred. Upon conversion of the TW
Preferred, the Company will begin recording unrealized net changes in the market
prices of the Time Warner common stock and the ACES as a component of common
stock equity and other comprehensive income.
As of March 31, 1998, the market price of Time Warner common stock was
$72.00 per share. Accordingly, the Company recognized an increase of $189
million during the first quarter of 1998 in the unrealized liability relating to
its ACES indebtedness (which resulted in an after-tax earnings reduction of $123
million or $.43 per share). The Company believes that the cumulative unrealized
loss for the ACES of $311 million is more than economically offset by the
approximately $659 million unrecorded unrealized gain at March 31, 1998 relating
to the increase in the fair value of the Time Warner common stock underlying the
investment in TW Preferred since the date of its acquisition. For the quarter
ended March 31, 1998, there was an increase in the unrecorded unrealized gain in
the fair value of Time Warner common stock underlying the investment in TW
Preferred of $229 million. Any gain related to the increase in the fair value of
Time Warner common stock would be recognized upon the sale of the TW Preferred
or the shares of common
8
<PAGE> 12
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stock into which such TW Preferred is converted.
(6) CAPITAL STOCK
(a) Common Stock.
At March 31, 1998, the Company had 283,719,977 shares of common stock
issued and outstanding (out of a total of 700,000,000 authorized shares). At
December 31, 1997, the Company had 282,875,266 shares of common stock issued and
outstanding. Outstanding common shares excluded (i) shares pledged to secure a
loan to the Company's Employee Stock Ownership Plan (11,984,708 and 12,388,551
at March 31, 1998 and December 31, 1997, respectively) and (ii) treasury shares
(98,866 and 93,459 at March 31, 1998 and December 31, 1997, respectively).
(b) Earnings Per Share.
Effective December 31, 1997, the Company adopted SFAS No. 128,
"Earnings per Share" (SFAS No. 128). This statement requires restatement of all
prior period earnings per share (EPS) data presented herein. SFAS No. 128
requires dual presentation of basic and diluted EPS on the face of the
Statements of Consolidated Income and requires a reconciliation of the
numerators and denominators used in the basic and diluted earnings per share
calculations.
The following table presents a reconciliation of the Company's
numerators and denominators of basic and diluted earnings per share
calculations:
9
<PAGE> 13
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
MARCH 31,
-------------------------
1998 1997
----------- ---------
(In thousands, except per
share amounts)
<S> <C> <C>
Basic EPS Calculation:
Income (loss) before preferred dividends ................. $ (31,240) $ 59,620
Less: Preferred dividends ................................ 97
--------- ---------
Net income (loss) attributable to common stock ........... $ (31,337) $ 59,620
========= =========
Weighted average shares outstanding ...................... 283,528 233,689
Basic EPS:
Income (loss) before preferred dividends ................. $ (0.11) $ 0.26
Less: Preferred dividends
--------- ---------
Net income (loss) attributable to common stock ........... $ (0.11) $ 0.26
========= =========
Diluted EPS Calculation:
Income (loss) before preferred dividends ................. $ (31,240) $ 59,620
Plus: Income impact of assumed conversions:
Interest on 6 1/4% convertible debentures ............. 118
--------- ---------
Income (loss) before preferred dividends assuming
dilution .............................................. $ (31,122) $ 59,620
Less: Preferred dividends ................................ 97
--------- ---------
Net income (loss) attributable to common stock ........... $ (31,219) $ 59,620
========= =========
Weighted average shares outstanding ...................... 283,528 233,689
Plus: Incremental shares from assumed conversions:
Stock options ......................................... 235 32
Restricted stock ...................................... 492 369
6 1/4% convertible debentures ......................... 359
--------- ---------
Weighted average shares assuming dilution ................ 284,614 234,090
========= =========
Diluted EPS:
Income (loss) before preferred dividends ................. $ (0.11) $ 0.26
Less: Preferred dividends
--------- ---------
Net income (loss) attributable to common stock ........... $ (0.11) $ 0.26
========= =========
</TABLE>
10
<PAGE> 14
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options to purchase 85,837 shares of common stock at prices ranging
from $29.13 to $35.18 per share were outstanding at March 31, 1998 but were not
included in the computation of diluted EPS because, during the reporting period,
the options' exercise prices were greater than the average market price of the
common shares of $26.375 and would thus be anti-dilutive if conversion were
assumed.
(c) Preferred Stock.
At March 31, 1998 and December 31, 1997, the Company had 10,000,000
authorized shares of preferred stock, of which 97,397 shares of $4.00 Preferred
Stock were outstanding. The $4.00 Preferred Stock pays an annual dividend of
$4.00 per share, is redeemable at $105 per share and has a liquidation price of
$100 per share.
(d) Preference Stock.
At March 31, 1998 and December 31, 1997, the Company had 10,000,000
authorized shares of preference stock, of which 700,000 shares are designated as
Series A Preference Stock and 27,000 shares are designated as Series B
Preference Stock. On March 27, 1998, the Company designated 1,575 shares of its
preference stock as Series C Preference Stock. As of March 31, 1998, there were
no shares of Series A Preference Stock issued and outstanding (such shares being
issuable in accordance with the Company's Shareholder Rights Agreement upon the
occurrence of certain events). The number of shares of Series B Preference Stock
and Series C Preference Stock issued as of March 31, 1998 was 17,000 and 1,575,
respectively. The Series B and Series C Preference Stock are not deemed
outstanding for financial reporting purposes, because the sole holders of such
series are wholly owned financing subsidiaries of the Company.
(7) COMPANY/NORAM OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES
OF SUBSIDIARY TRUSTS HOLDING SOLELY SUBORDINATED DEBENTURES OF THE COMPANY
AND NORAM
For information regarding (i) $250 million of preferred securities and
$100 million of capital securities issued by two statutory business trusts
formed by the Company and (ii) $177.8 million of convertible preferred
securities issued by a statutory business trust formed by NorAm, of which $11.6
million were outstanding at March 31, 1998, see Note 9 to the Company's Form
10-K. The sole asset of each trust consists of junior subordinated debentures of
the Company or NorAm (as the case may be) having interest rates and maturity
dates corresponding to each issue of preferred or capital securities, and the
principal amounts corresponding to the common and preferred or capital
securities issued by such trust.
(8) LONG-TERM DEBT AND SHORT-TERM FINANCING
(a) Consolidated Debt.
The Company's consolidated long-term and short-term debt outstanding is
summarized in the following table. Of the amount of long-term and short-term
debt outstanding as of March 31, 1998, $1.8
11
<PAGE> 15
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
billion represents debt of NorAm. The Company adjusted the recorded value of
NorAm debt to fair market value as of the Acquisition Date.
CONSOLIDATED LONG-TERM DEBT AND SHORT-TERM BORROWINGS
(IN MILLIONS)
<TABLE>
<CAPTION>
MARCH 31, 1998 DECEMBER 31, 1997
---------------------------------- ------------------------------------
Long-Term Current Long-Term Current
------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Short-Term Borrowings:
Commercial Paper......................... $ 1,286 $ 1,435
Lines of Credit.......................... 150 390
NorAm Receivables Facility............... 300 300
Notes Payable............................ 2
------------- --------------- --------------- ---------------
Total Short-Term Borrowings................ 1,738 2,125
------------- --------------- --------------- ---------------
Long-Term Debt - net:
ACES..................................... $ 1,363 $ 1,174
Debentures(1)(2)......................... 969 669
First Mortgage Bonds(1).................. 1,931 460 2,495
Pollution Control Bonds.................. 513 5 118 5
NorAm Medium-Term Notes(2)............... 182 78 182 79
Notes Payable(2)......................... 561 164 565 166
Capital Leases........................... 15 1 15 1
------------- --------------- --------------- ---------------
Total Long-Term Debt....................... 5,534 708 5,218 251
------------- --------------- --------------- ---------------
Total Long-Term and Short-Term Debt...... $ 5,534 $ 2,446 $ 5,218 $ 2,376
------------- --------------- --------------- ---------------
</TABLE>
- ----------
(1) Includes unamortized discount related to debentures of approximately $1
million at March 31, 1998 and December 31, 1997 and unamortized discount
related to first mortgage bonds of approximately $14 million at March 31,
1998 and December 31, 1997, respectively.
(2) Includes unamortized premium related to fair value adjustments of
approximately $15.5 million and $15.8 million for debentures at March 31,
1998 and December 31, 1997, respectively. The unamortized premium for NorAm
long-term and current medium-term notes at March 31, 1998 was approximately
$15.6 million and $2.6 million, respectively, and $16.7 million and $2.8
million at December 31, 1997, respectively. The unamortized premium for
long-term and current notes payable was approximately $10.6 million and
$2.4 million, respectively, at March 31, 1998 and $13.7 million and $3.3
million at December 31, 1997.
Consolidated maturities of long-term debt and sinking fund requirements
for the Company (including NorAm) are approximately $242 million for the
remainder of 1998, not including funds that were on deposit in trust accounts at
March 31, 1998 of $290 million.
(b) FinanceCo and FinanceCo II Credit Facilities.
In August 1997, a limited partnership special purpose subsidiary of the
Company (FinanceCo), established a five-year, $1.644 billion revolving credit
facility with a consortium of commercial banks (FinanceCo Facility). The
FinanceCo Facility supported $1.167 billion in commercial paper borrowings by
FinanceCo at March 31, 1998 recorded as notes payable in the Consolidated
Balance Sheet. The weighted average interest rate of these borrowings at March
31, 1998 was 5.85%. For more information regarding the FinanceCo Facility, see
Note 8(c) to the Company's Form 10-K. In the first quarter of 1998, the
FinanceCo
12
<PAGE> 16
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Facility was amended to, among other things, release certain collateral
previously pledged under the agreement (including the shares of common stock of
NorAm held by the Company and the capital stock of Houston Industries Energy,
Inc. (HI Energy)) and to ease restrictions on repurchases of common stock and
certain types of investments in subsidiaries.
In March 1998, another limited partnership special purpose subsidiary
of the Company (FinanceCo II), entered into a $150 million credit agreement with
a bank (FinanceCo II Facility). The FinanceCo II Facility terminates September
30, 1998, but may be extended. Borrowings under the FinanceCo II Facility were
used to fund a portion of four electric generation plants acquired by Houston
Industries Power Generation, Inc. (HIPG), a wholly owned subsidiary of the
Company, in April 1998. Borrowings under the FinanceCo II Facility bear interest
at a rate based upon either LIBOR plus a margin or a base rate. At March 31,
1998, FinanceCo II had $150 million of borrowings under this facility at an
interest rate of 5.94%. For additional information regarding HIPG's acquisition
of the generation plants, see Note 10(b) below.
The FinanceCo II Facility requires the Company to maintain a ratio of
consolidated indebtedness for borrowed money to consolidated capitalization, as
defined, that does not exceed 0.62:1.00 through December 31, 1998, and 0.60:1.00
from January 1, 1999 until termination of the FinanceCo II Facility. Similar to
the FinanceCo facility, the FinanceCo II Facility also contains restrictions
applicable to the Company and certain of its subsidiaries with respect to, among
other things, (i) liens, (ii) consolidations, mergers and dispositions of
assets, (iii) dividends and repurchases of common stock, (iv) certain types of
investments and (v) certain changes in its business. The FinanceCo II Facility
contains customary covenants and default provisions applicable to FinanceCo II
and its subsidiaries, including limitations on, among other things, additional
indebtedness (other than certain permitted indebtedness), liens and certain
investments or loans.
Subject to certain conditions and limitations, the Company is required,
pursuant to a support agreement entered into in connection with the FinanceCo II
Facility, to make cash payments from time to time to FinanceCo II from the
Company's excess cash flow (as defined) to the extent necessary to enable
FinanceCo II to meet its obligations. Borrowings under the FinanceCo II Facility
are secured by pledges of 1,575 shares of Series C Preference Stock of the
Company, which have an aggregate liquidation amount of $157.5 million, and all
rights of FinanceCo II under the support agreement. The obligations under the
FinanceCo II Facility are not secured by the utility assets of the Company or
NorAm or by the Company's investment in TW Preferred.
(c) Pollution Control Revenue Bonds.
In January 1998, the Matagorda County Navigation District Number One
(MCND) issued on behalf of the Company $104.7 million aggregate principal amount
of pollution control revenue refunding bonds with $29.7 million at 5.25% and $75
million at 5.15%. The MCND bonds will mature in 2029. The Company used the
proceeds from the sale of these securities to redeem during the quarter ended
March 31, 1998 all outstanding 7 7/8% MCND Series 1989A pollution control
revenue bonds ($29.7 million) and 7.70% MCND Series 1989B pollution control
revenue bonds ($75 million) at a redemption price of 102% of the aggregate
principal amount of each series.
In February 1998, the Brazos River Authority (BRA) issued on behalf of
the Company $290 million aggregate principal amount of pollution control revenue
refunding bonds. The BRA bonds will mature in May 2019 ($200 million at 5 1/8%)
and November 2020 ($90 million at 5 1/8%). In May of 1998, the Company used the
proceeds from the sale of these securities to redeem all outstanding 8.25% BRA
Series 1988A pollution control revenue bonds ($100 million), 8.25% BRA Series
1988B pollution control revenue
13
<PAGE> 17
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bonds ($90 million), and 8.10% BRA Series 1988C pollution control revenue bonds
($100 million) at a redemption price of 102% of the aggregate principal amount
of each series. Although the proceeds of the bond offerings were deposited into
trust accounts for the redemption in May 1998 of $290 million principal amount
of bonds (as reflected on the Consolidated Balance Sheets and Statements of
Consolidated Cash Flows), such bonds were deemed for financial reporting
purposes to be outstanding at March 31, 1998.
(d) NorAm Short-Term and Long-Term Debt.
In March 1998, NorAm replaced its $400 million revolving credit
facility with a five-year $350 million revolving credit facility (NorAm Credit
Facility). Borrowings under the NorAm Credit Facility are unsecured and bear
interest at a rate based upon either LIBOR plus a margin, a base rate or a rate
determined through a bidding process. The NorAm Credit Facility is expected to
be used to support NorAm's issuance of up to $350 million of commercial paper.
There were no loans outstanding under the NorAm Credit Facility at March 31,
1998.
In February 1998, NorAm issued $300 million principal amount of 6 1/2%
debentures due February 1, 2008. The 6 1/2% debentures are not redeemable prior
to maturity and are not subject to any sinking fund requirements. The proceeds
from the sale of the 6 1/2% debentures were used to repay short-term
indebtedness of NorAm, including the indebtedness incurred in connection with
the 1997 purchase of $101 million aggregate principal amount of NorAm's 10%
debentures and the repayment of $53 million aggregate principal amount of NorAm
debt that matured in December 1997 and January 1998.
In the first quarter of 1998, NorAm repaid at maturity $1 million of
its 9.30% medium-term notes and satisfied the $6.5 million sinking fund
requirement for its 6% convertible subordinated debentures due 2012 using
debentures purchased in 1996 and 1997.
(9) RATE MATTERS
In May 1998, the Public Utility Commission of Texas (Texas Utility
Commission) issued an order approving the transition to competition plan filed
by Electric Operations in December 1997 (Transition Plan). The order establishes
the Company's tariffs to be in effect through 1999, subject to certain force
majeure and other events. The order provides final approval for the base rate
credits to residential customers of 4% in 1998 and an additional 2% in 1999.
Commercial customers whose monthly billing kva is 1000 kva or less will receive
base rate credits of 2% in 1998 which remains in effect for 1999. The Company
implemented the terms of the Transition Plan effective January 1, 1998.
In addition, in order to reduce the Company's exposure to potential
stranded costs, the order permits the Company to redirect depreciation expenses
normally taken from transmission, distribution and general assets to generation
assets. The Texas Utility Commission made one modification to the original
Transition Plan related to the earnings cap. The Transition Plan originally
contemplated that all earnings by Electric Operations above a 9.95% overall rate
of return would be calculated pursuant to a return cap formula to be used to
write-down Electric Operation's investment in generation assets. The Texas
Utility Commission modified the percentage to 9.84% to reflect the impact of $11
million of imputed revenues from the discount rates offered by the Company. It
is not expected that the change in the Transition Plan ordered by the Texas
Utility Commission will have a material adverse impact on the Company's
financial statements.
For additional information regarding the Transition Plan, see Note 3(b)
to the Company's Form 10-K.
14
<PAGE> 18
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(10) SUBSEQUENT EVENTS
(a) International Operations -- Privatization of Brazilian Electric Utility.
In April 1998, Light Servicos de Eletricidade S.A. (Light), a Brazilian
corporation in which HI Energy owns an 11.57% common stock interest, purchased
74.88% of the common stock of Metropolitana Electricidade de Sao Paulo S.A.
(Metropolitana), the utility that provides electric transmission and
distribution services to the metropolitan area of Sao Paulo, Brazil. The
purchase price for the shares was approximately $1.8 billion. Light financed the
purchase of the shares of Metropolitana with proceeds from bank borrowings made
on a non-recourse basis by Light's shareholders (including HI Energy).
For additional information regarding HI Energy's investment in Light,
see Note 5 to the Company's Form 10-K.
(b) HIPG Purchase of Generating Assets
In April 1998, HIPG completed its $230 million acquisition of four
California gas-fired generating plants totaling 2,276 megawatts of capacity from
Southern California Edison Company (SCE). The acquisition was financed with the
proceeds from borrowings made by subsidiaries of the Company. In addition HIPG
has contracted to purchase SCE's Ormond Beach Generating Station for $43
million. The Ormond Beach facility has two natural gas-fired units totaling
1,500 megawatts of capacity. HIPG expects to close the acquisition of the Ormand
Beach Generating Station in June 1998.
(11) INTERIM PERIOD RESULTS: RECLASSIFICATIONS
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 for the respective periods.
Amounts reported in the Consolidated Statements of Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (i) the acquisition of NorAm, (ii) seasonal temperature
variations in energy consumption and (iii) the timing of maintenance and other
expenditures. In addition, certain amounts from the prior year have been
reclassified to conform to the Company's presentation of financial statements in
the current year. Such reclassifications do not affect earnings.
15
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF THE COMPANY.
The following discussion and analysis should be read in combination
with Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company in Item 7 of the Company's Form 10-K, Management's
Narrative Analysis of the Results of Operations of NorAm and Consolidated
Subsidiaries in Item 7 of NorAm's Form 10-K, the consolidated financial
statements and notes contained in Item 8 of the Company's Form 10-K and NorAm's
Form 10-K and the Interim Financial Statements and the NorAm Interim Financial
Statements contained in this joint Form 10-Q.
Statements contained in this joint Form 10-Q that are not historical
facts are forward-looking statements as defined in the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are based on
management's beliefs as well as assumptions made by and information currently
available to management. Because such statements are based on expectations as to
future economic performance and are not statements of fact, actual results may
differ materially from those projected. Important factors that could cause
future results to differ include (i) the effects of competition in the electric
power and natural gas industries, (ii) legislative and regulatory changes, (iii)
fluctuations in the weather, (iv) fluctuations in energy commodity prices, (v)
environmental liabilities, (vi) changes in the economy and (vii) other factors
discussed in this and other filings by the Company and NorAm with the Securities
and Exchange Commission. When used in the Company's or NorAm's documents or oral
presentations, the words "anticipate," "estimate," "expect," "objective,"
"projection," "forecast," "goal" or similar words are intended to identify
forward- looking statements. The sections of Management's Discussion and
Analysis of Financial Condition and Results of Operations of the Company
captioned "Results of Operations by Business Segment" and "Certain Factors
Affecting Future Earnings of the Company and its Subsidiaries" contain or
incorporate by reference forward-looking statements.
HOUSTON INDUSTRIES INCORPORATED
Houston Industries Incorporated (Company) is a diversified
international energy services company. It operates the nation's tenth largest
electric utility in terms of kilowatt-hour (KWH) sales, and NorAm's three
natural gas distribution divisions together form the nation's third largest
natural gas distribution operation in terms of customers served. The Company
also invests in international electric utility privatizations, gas distribution
projects and the development of non-rate regulated power generation projects.
The Company, through NorAm, is also a major interstate natural gas pipeline and
energy services company, providing gas transportation, supply, gathering and
storage, and wholesale natural gas and electric power marketing services.
The Company is exempt from regulation as a public utility holding
company based upon an order granted in July 1997 by the Securities and Exchange
Commission under Section 3(a)(2) of the Public Utility Holding Company Act of
1935, as amended (1935 Act), except with respect to the acquisition of certain
voting securities of other domestic public utility companies and utility holding
companies.
CONSOLIDATED RESULTS OF OPERATIONS
In 1997, the Company acquired NorAm, a natural gas gathering,
transmission, marketing and distribution company. Because the acquisition was
accounted for as a purchase, the Company's results of operations include NorAm's
results of operations only for the period beginning on August 6, 1997
16
<PAGE> 20
(Acquisition Date). To enhance comparability between reporting periods, certain
consolidated and business segment information in Management's Discussion and
Analysis of Financial Condition and Results of Operations of the Company is
presented on a pro forma basis as if the acquisition of NorAm had occurred as of
January 1, 1997. The Company believes that the presentation of pro forma data
provides a more meaningful basis for comparing revenues and earnings trends. The
pro forma information is not necessarily indicative of the results of operations
of the Company and its business segments that would have occurred had these
events occurred at the beginning of such period.
The Company's first quarter of 1998 results of operations and first
quarter of 1997 pro forma results of operations reflect the effects of the
acquisition of NorAm, which include (i) significant increases in amortization
attributable to purchase accounting, (ii) increases in shares outstanding and
interest expense, and (iii) the impact of additional revenues and operating
expenses from the newly acquired NorAm businesses.
CONSOLIDATED RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
QUARTER ENDED QUARTER ENDED
MARCH 31, MARCH 31,
------------------ --------------------
1998 1997 1998 1997 % Change
------- ------- ------- --------- --------
(Actual) (Actual) (Pro Forma)
(in millions, except per share data)
<S> <C> <C> <C> <C> <C>
Revenues ...................................................... $ 2,637 $ 878 $ 2,637 $ 2,802 (6%)
Operating Expenses ............................................ 2,356 722 2,356 2,509 (6%)
Operating Income .............................................. 281 156 281 293 (4%)
Other Expenses, Net (1) ....................................... 309 76 309 123 251%
Income Taxes .................................................. 3 20 3 60 (95%)
Net Income (1) ................................................ (31) 60 (31) 110 --
Basic Earnings Per Share (1) .................................. (0.11) 0.26 (0.11) 0.39 --
Diluted Earnings Per Share (1) ................................ (0.11) 0.26 (0.11) 0.39 --
</TABLE>
- ---------------
(1) Includes a $189 million ($123 million after-tax) or $.43 per share
non-cash unrealized accounting loss recorded in the first quarter of 1998
relating to the Company's 7% Automatic Common Exchange Securities (ACES). See
Note 5 to the Company's Form 10-Q.
First Quarter of 1998 Compared to First Quarter of 1997 (Actual). The
Company had a consolidated net loss for the first quarter of 1998 of $31 million
($0.11 per share) compared to net income of $60 million ($0.26 per share) in the
same period in 1997. The Company's results of operations for the first quarter
of 1998 reflect a $123 million (after-tax) non-cash, unrealized accounting loss
on the ACES. For a discussion of the accounting loss in connection with the
ACES, see Note 5 to the Company's Form 10-Q. Excluding the ACES accounting loss,
the Company would have had consolidated earnings of $92 million ($0.32 per
share). The increase in earnings is primarily a result of additional earnings
from the business segments acquired in the NorAm acquisition and improved
results from HI Energy. These earnings were partially offset by milder weather,
base rate credits implemented by Electric Operations pursuant to its Transition
Plan (as described below) and increased interest expense primarily related to
the NorAm acquisition.
The consolidated tax expense in the first quarter of 1998 takes into
account the impact of non-deductible goodwill expense, higher state tax expense
arising from the NorAm acquisition, and the loss of the dividends received
deduction on the TW Preferred.
17
<PAGE> 21
First Quarter of 1998 Actual Compared to First Quarter of 1997 Pro
Forma. The Company's consolidated net loss for the first quarter of 1998 was $31
million ($0.11 per share) compared with pro forma consolidated earnings of $110
million ($0.39 per share) in the first quarter of 1997.
Excluding the ACES accounting loss described above, the Company's first
quarter of 1998 adjusted net income would have been $92 million ($0.32 per
share) compared to $110 million ($0.39 per share) in the first quarter of 1997.
The decrease in adjusted earnings is primarily the result of: (i) decreased
operating income at Electric Operations due to milder weather and the
implementation of base rate credits; (ii) decreased operating income at Natural
Gas Distribution due to warmer weather; and (iii) increased operating expenses
at the Company's Corporate segment.
Partially offsetting the decrease in earnings is increased operating
income from International due to increased equity earnings. In addition, pro
forma net income in the first quarter of 1997 reflects non-recurring hedging
losses and losses from sale of gas at Energy Marketing in that quarter.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The Company's operating activities include the following segments:
Electric Operations, Natural Gas Distribution, Interstate Pipeline, Energy
Marketing, International and Corporate.
The following table presents operating income on (i) an actual basis
for the quarters ended March 31, 1998 and 1997 and (ii) a pro forma basis for
the quarter ended March 31, 1997 (assuming the NorAm acquisition had occurred on
January 1, 1997) for each of the Company's business segments (other than
Electric Operations):
OPERATING INCOME (LOSS) BY BUSINESS SEGMENT
<TABLE>
<CAPTION>
QUARTER ENDED
MARCH 31, (1)
----------------------------------
1998 1997 1997
-------- --------- ---------
(ACTUAL) (ACTUAL) (PRO FORMA)
(in millions)
<S> <C> <C> <C>
Electric Operations .......... $ 143 $ 160 $ 160
Natural Gas Distribution ..... 102 107
Interstate Pipeline .......... 32 35
Energy Marketing ............. 10 (1)
International ................ 11 3 2
Corporate .................... (17) (7) (10)
----- ----- -----
Total Consolidated ..... $ 281 $ 156 $ 293
===== ===== =====
</TABLE>
- ---------------
(1) PRO FORMA ADJUSTMENTS GIVE RETROACTIVE EFFECT TO PURCHASE-RELATED
ADJUSTMENTS, INCLUDING AMORTIZATION OF GOODWILL AND THE REVALUATION ON A
PRELIMINARY BASIS OF THE FAIR MARKET VALUE OF CERTAIN NORAM ASSETS AND
LIABILITIES.
18
<PAGE> 22
ELECTRIC OPERATIONS
Electric Operations are conducted under the name "Houston Lighting &
Power Company" or "HL&P" (HL&P), an unincorporated division of the Company.
Electric Operations provides electric generation, transmission, distribution and
sales to approximately 1.6 million customers in a 5,000 square mile area on the
Texas Gulf Coast, including Houston (the nation's fourth largest city).
The following table provides summary data regarding the actual results
of operations of Electric Operations, including operating statistics, for the
quarters ended March 31, 1998 and 1997.
<TABLE>
<CAPTION>
QUARTER ENDED
MARCH 31,
--------------------------- PERCENT
1998 1997 CHANGE
------------ ---------- ------------
(in millions)
<S> <C> <C> <C>
Base Revenues (1) ...................... $ 534 $ 553 (3%)
Transmission Revenues .................. 21
Reconcilable Fuel Revenues (2) ......... 292 304 (4%)
Operating Expenses:
Fuel and Purchased Power .......... 305 320 (5%)
Operation and Maintenance ......... 214 184 16%
Depreciation and Amortization ..... 130 130
Other Taxes ............................ 55 63 (14%)
----------- -----------
Operating Income ....................... $ 143 $ 160 (11%)
=========== ===========
Electric Sales (MWH):
Residential .............. 3,597,021 3,955,258 (9%)
Commercial ............... 3,424,350 3,398,796 1%
Industrial - Firm ........ 6,367,979 6,456,671 (1%)
Total Firm Sales .............. 14,298,521 14,202,623 1%
Average Cost of Fuel
(Cents/MMBtu) ........ 172.6 187.5 (8%)
</TABLE>
- -----------
(1) Includes miscellaneous revenues, certain non-reconcilable fuel revenues and
certain purchased power-related revenues.
(2) Includes revenues collected through a fixed fuel factor and surcharge, net
of the over/under recovery of fuel. See "-- Operating Revenues - Electric
Operations."
Operating Income - Electric Operations. In the first quarter of 1998,
Electric Operations' operating income decreased by $17 million from operating
income for the first quarter of 1997. The decrease in operating income was due
to decreases in base revenues primarily due to milder weather and the
implementation of the base rate credits pursuant to Electric Operations'
Transition Plan (Transition Plan).
Operating Revenues - Electric Operations. Electric Operations' decrease
in base revenue for the first
19
<PAGE> 23
quarter of 1998 compared to the first quarter of 1997 is primarily the result of
milder weather and the implementation of the Transition Plan. These factors were
partially offset by customer growth. Beginning in January 1998, Electric
Operations implemented base rate credits under the Transition Plan, which
resulted in lower base revenues of $11 million for the quarter. For information
regarding the Transition Plan, see Note 9 to the Company's Form 10-Q.
Electric Operations' transmission revenues (which are considered
miscellaneous revenues) in the first quarter of 1998 were $21 million but were
offset by transmission expenses of $22 million. Electric Operations began
recording transmission revenues and expenses in the second quarter of 1997 as a
result of the implementation of wholesale transmission tariffs within the
Electric Reliability Council of Texas (ERCOT). For information regarding these
tariffs, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations of the Company--Results of Operations by Business--Certain
Factors Affecting Future Earnings of the Company and its Subsidiaries--
Competition--Electric Operations--Competition in Wholesale Market"
in the Company's Form 10-K.
Electric Operation's first quarter of 1998 firm KWH sales decreased 3%
compared to the same period in 1997 due to milder weather, partially offset by
steady growth in the number of customers.
Electric Operations' 4% decrease in reconcilable fuel revenue resulted
primarily from decreased natural gas prices. The Texas Utility Commission
provides for recovery of certain fuel and purchased power costs through a fixed
fuel factor included in electric rates. The fixed fuel factor is established
during either a utility's general rate proceeding or its fuel factor proceeding
and is generally effective for a minimum of six months. Revenues collected
through such factor are adjusted monthly to equal expenses; therefore, such
revenues and expenses have no effect on earnings unless fuel costs are
determined not to be recoverable. The adjusted over/under recovery of fuel costs
is recorded on the Company's Consolidated Balance Sheets as fuel- related
credits or fuel-related debits, respectively. Fuel costs are reviewed during
periodic fuel reconciliation proceedings, which are required at least every
three years. Electric Operations filed a fuel reconciliation proceeding with the
Texas Utility Commission on January 30, 1998 for the three year period ending
July 31, 1997.
In January 1998, Electric Operations implemented (i) a $102 million
temporary fuel surcharge (inclusive of interest) for under recoveries that
occurred from March 1997 through August 1998, with recovery extending from 8
months to 16 months depending on the customer class. Electric Operations
requested the surcharge in order to recover its under-recovery of fuel expenses
for the period March 1997 through August 1997. In April 1998, Electric
Operations filed a petition to revise the fuel factor and implement a surcharge
for under-collected fuel costs of $128 million, (inclusive of the previously
existing fuel surcharge balance) to be collected over a 24 to 30 month period.
This surcharge will replace the one implemented in January and will recover its
remaining uncollected balance, as well as, the under-recovery balance from
September 1997 through February 1998. As of March 31, 1998, Electric Operations
cumulative under-recovery of fuel costs was $165 million, including interest.
For information regarding the recovery of fuel costs, see "Business Electric
Operations - Fuel - Recovery of Fuel Costs" in Item 1 of the Company's Form
10-K.
Fuel and Purchased Power Expenses - Electric Operations. Fuel and purchased
power expenses in the first quarter of 1998 decreased by $15 million compared to
the same period in 1997. The decrease was driven by decreases in the average
unit cost of natural gas, which declined to $2.43 per MMBtu in 1998 from $3.09
per MMBtu in 1997 and the cost of purchased power (see Note 12(c) to the
Company's Form 10-K for information on Electric Operations' joint dispatching
agreement with the City of San Antonio for purchased power).
20
<PAGE> 24
Operation and Maintenance Expenses - Electric Operations. Operation and
Maintenance expenses increased $31 million in the first quarter of 1998,
including $22 million due to transmission tariffs within ERCOT. These
transmission tariff expenses are largely offset by $21 million of revenue
associated with wholesale transmission services discussed above.
Maintenance expense increased by $2 million in the first quarter of
1998 compared to the same period of 1997 primarily due to the scheduling of
routine plant and line maintenance and inspection outages.
NATURAL GAS DISTRIBUTION
NorAm's domestic natural gas distribution operations (Natural Gas
Distribution) are conducted through its Arkla, Entex and Minnegasco divisions.
These operations consist of natural gas sales to, and natural gas transportation
for, residential, commercial and certain industrial customers in six states:
Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma and Texas.
The following table provides summary data regarding the results of
operations of Natural Gas Distribution, including operating statistics, for the
quarters ended March 31, 1998 and 1997 on an actual basis for the first quarter
of 1998 and on a pro forma basis for the first quarter of 1997 (as if the
acquisition of NorAm had occurred as of January 1, 1997).
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31, PERCENT
1998 1997 CHANGE
-------- ------------ -------
(ACTUAL) (PRO FORMA)
(in millions)
<S> <C> <C> <C>
Operating Revenues ................................................... $717 $881 (19%)
Operating Expenses:
Natural Gas ..................................................... 458 616 (26%)
Operation and Maintenance ....................................... 98 97 1%
Depreciation and Amortization ................................... 32 30 7%
Other Operating Expenses ........................................ 27 31 (10%)
---- ----
Total Operating Expenses .................................... 615 774 (20%)
---- ----
Operating Income ..................................................... $102 $107 (5%)
==== ====
Throughput Data (in Bcf):
Residential and Commercial Sales ................................ 126 137 (8%)
Industrial Sales ................................................ 15 15
Transportation .................................................. 13 12 8%
---- ----
Total Throughput ............................................. 154 164 (6%)
==== ====
</TABLE>
Natural Gas Distribution operating income decreased $5 million in the
first quarter of 1998 compared to pro forma operating income in the first
quarter of 1997 due primarily to weather-related factors. This decrease in
operating income is partially offset by the favorable impact of Arkla's charges
associated with the applicable state regulatory commission's methodology of
calculating the price of gas charged to customers (the purchased gas adjustment)
in the first quarter of 1998 as compared to the first quarter of 1997.
Natural Gas Distribution operating revenue decreased $164 million for
the first quarter of 1998 compared to pro forma operating revenue for the
corresponding period of 1997 due principally to the warmer weather, which
resulted in lower customer usage at Entex and Minnegasco, and a decrease in gas
prices.
21
<PAGE> 25
Operating expenses decreased $159 million in the first quarter of 1998
compared to pro forma operating expenses in the same period of 1997 due to the
same factors that affected operating revenues as discussed above.
INTERSTATE PIPELINE
NorAm's interstate natural gas pipeline operations (Interstate
Pipeline) are conducted through NorAm Gas Transmission Company (NGT) and
Mississippi River Transmission Corporation (MRT), two wholly owned subsidiaries
of NorAm. The NGT system consists of approximately 6,200 miles of natural gas
transmission lines located in portions of Arkansas, Kansas, Louisiana,
Mississippi, Missouri, Oklahoma, Tennessee and Texas. The MRT system consists of
approximately 2,000 miles of pipeline serving principally the greater St. Louis
area in Missouri and Illinois.
The following table provides summary data regarding the results of
operations of Interstate Pipeline, including operating statistics, on an actual
basis for the first quarter of 1998 and on a pro forma basis for the first
quarter of 1997 (as if the acquisition of NorAm had occurred as of January 1,
1997).
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31,
---------------------- PERCENT
1998 1997 CHANGE
-------- ------------ --------
(ACTUAL) (PRO FORMA)
(in millions)
<S> <C> <C> <C>
Operating Revenues ................................................ $ 71 $ 84 (15%)
Operating Expenses:
Natural Gas .................................................. 8 11 (27%)
Operation and Maintenance .................................... 17 22 (23%)
Depreciation and Amortization ................................ 9 13 (31%)
Other Operating Expenses ..................................... 5 3 67%
----- -----
Total Operating Expenses ................................ 39 49 (20%)
----- -----
Operating Income .................................................. $ 32 $ 35 (8%)
===== =====
Throughput Data (in million MMBtu):
Natural Gas Sales .............................................. 4 5 (20%)
Transportation ................................................. 237 250 (5%)
Elimination (1) ........................................... (4) (4) --
----- -----
Total Throughput .................................................. 237 251 (5%)
===== =====
</TABLE>
- ---------------
(1) Elimination refers to volumes of natural gas both transported and sold by
Interstate Pipeline and, therefore, excluded from total throughput.
Interstate Pipeline operating income decreased $3 million in the first
quarter of 1998 compared to pro forma operating income in the first quarter of
1997 due primarily to non-recurring items occurring in the first quarter of 1997
and milder weather in the first quarter of 1998. These factors were partially
offset by lower operating expenses in the first quarter of 1998.
Operating revenues for Interstate Pipeline decreased by $13 million for
the first quarter of 1998
22
<PAGE> 26
compared to pro forma operating revenues for the same period in 1997. The
decrease in revenues is primarily due to $7 million of non-recurring
transportation revenues recognized in the first quarter of 1997 upon completion
of settlement negotiations with Arkla related to service provided in several of
its operating jurisdictions. In addition, the decrease in revenues is also
attributable to a reduction in natural gas volumes and decreased gas prices.
Operation and maintenance expenses decreased $5 million in the first
quarter of 1998 compared to pro forma operation and maintenance expenses for the
same period of 1997 primarily due to decreased maintenance due to milder weather
and lower costs resulting from cost control initiatives.
Depreciation and amortization expenses decreased $4 million in the
first quarter of 1998 in comparison to pro forma depreciation and amortization
expenses for the same period of 1997 due to a $4.8 million rate settlement
recorded in the first quarter of 1998. The rate settlement, effective January
1998, provided for a reduction of MRT's depreciation rates retroactive to July
1996.
ENERGY MARKETING
NorAm's energy marketing and gathering business (Energy Marketing)
includes the operations of NorAm's wholesale and retail energy marketing
businesses and natural gas gathering activities (conducted, respectively, by
NorAm Energy Services, Inc. (NES), NorAm Energy Management, Inc. and NorAm Field
Services Corp., three wholly owned subsidiaries of NorAm).
The following table provides summary data regarding the unaudited pro
forma results of operations of Energy Marketing, including operating statistics,
on an actual basis for the first quarter of 1998 and on a pro forma basis for
the first quarter of 1997 (as if the acquisition of NorAm had occurred as of
January 1, 1997).
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31,
----------------------- PERCENT
1998 1997 CHANGE
--------- ----------- -------
(ACTUAL) (PRO FORMA)
(in millions )
<S> <C> <C> <C>
Operating Revenues ................................. $ 1,046 $ 1,045 --
Operating Expenses:
Natural Gas and Purchased Power, net .......... 1,009 1,023 (1%)
Operation and Maintenance ..................... 22 19 16%
Depreciation and Amortization ................. 3 3 --
Other Operating Expenses ...................... 2 1 --
------- -------
Total Operating Expenses ................. 1,036 1,046 (1%)
------- -------
Operating Income (loss) ............................ $ 10 $ (1)
======= =======
Operations Data:
Natural Gas (in Bcf):
Sales ....................................... 337 320 5%
Transportation .............................. 7 7 --
Gathering ................................... 58 60 (3%)
------- -------
Total .................................. 402 387 4%
------- -------
Electricity:
Wholesale Power Sales (in thousand MWH) ..... 13,770 4,584 200%
======= =======
</TABLE>
23
<PAGE> 27
Energy Marketing operating income increased $11 million in the first
quarter of 1998 in comparison to pro forma operating income for the same period
in 1997. This increase is primarily attributed to hedging losses and losses from
the sale of gas in 1997 partially offset by increased operating expenses in 1998
as discussed below. After adjusting for these prior losses, operating income
decreased for the first quarter of 1998 by approximately $6 million compared to
the same period in 1997, as explained below.
Operating Revenues. Operating revenues for Energy Marketing remained
substantially unchanged because: (i) increases in natural gas volumes at NES
were more than offset by decreases in the price of natural gas and (ii)
substantial increases in wholesale power volumes (200%) offset gas sales
declines at NES.
Operating Expenses. Operation and maintenance expenses increased $3
million when compared to pro forma operation expenses for the first quarter of
1997 largely due to increased staffing and marketing activities made in support
of the increased sales and expanded marketing efforts at NES. The Company
believes that NES' energy marketing and risk management services have the
potential of complementing the Company's strategy of developing and/or acquiring
unregulated generation assets in other markets. As a result, the Company has
made, and expects to continue to make, significant investments in developing
NES' internal software, trading and personnel resources.
Natural gas and purchased power expense decreased $14 million in the
first quarter of 1998 when compared to the first quarter of 1997 primarily due
to the nonrecurrence of 1997 losses related to: (i) hedging losses associated
with anticipated first quarter 1997 sales under peaking contracts and (ii)
losses from the sale of natural gas held in storage and unhedged in the first
quarter of 1997 totaling $17 million. Partially offsetting these losses were
increased gas and electricity marketing activities. Excluding the 1997 hedging
losses described above, natural gas and purchased power expenses increased $3
million, primarily attributable to approximately $2 million in losses on
wholesale power sales.
To minimize fluctuations in the price of natural gas and
transportation, the Company, primarily through NES, enters into futures
transactions, swaps and options in order to hedge against market price changes
affecting (i) certain commitments to buy, sell and transport natural gas, (ii)
existing gas storage inventory and (iii) certain anticipated transactions, some
of which carry off-balance sheet risk. NES also enters into natural gas
derivatives for trading purposes and electricity derivatives for hedging and
trading purposes. For a discussion about the Company's accounting treatment of
derivative instruments, see Note 2 to the Company's Form 10-K and Item 7A
(Quantitative and Qualitative Disclosure About Market Risk) in the Company's
Form 10-K.
INTERNATIONAL
The Company's international business segment (International) includes
the results of operations of HI Energy, a wholly owned subsidiary of the Company
that participates in the development and acquisition of foreign independent
power projects and the privatization of foreign generation and distribution
facilities, and the international operations of NorAm. Substantially all of
International's operations to date have been in Central and South America.
Results of operations data for International are presented in the
following table on an actual basis for the quarter ended March 31, 1998 and on a
pro forma basis for the quarter ended March 31, 1997 as if
24
<PAGE> 28
the NorAm acquisition had occurred as of January 1, 1997. The primary pro forma
adjustment gives effect to project development costs and other expenditures
incurred by NorAm prior to the Acquisition Date. The adjustment had no effect on
operating revenues.
<TABLE>
<CAPTION>
QUARTER ENDED
MARCH 31,
-------------------- PERCENT
1998 1997 CHANGE
-------- ---------- ------
(ACTUAL) (PRO FORMA)
(in millions)
<S> <C> <C> <C>
Operating Revenues ..................... $27 $20 35%
Operating Expenses:
Fuel ................................. 5 4 25%
Operation and Maintenance ............ 10 13 (23%)
Depreciation and Amortization ........ 1 1 --
--- ---
Total Operating Expenses ..... 16 18 (11%)
--- ---
Operating Income ....................... $11 $ 2 --
=== ===
</TABLE>
International operating income increased $9 million in the first
quarter of 1998 compared to pro forma operating income in the first quarter of
1997. Operating revenues increased $7 million in the first quarter of 1998 due
primarily to increased equity earnings from HI Energy's investment in Light, the
electric utility serving Rio de Janeiro, Brazil and HI Energy's interest in
EPSA, a Colombian electric utility acquired in June 1997. Operation and
maintenance expenses decreased $3 million when compared to proforma operating
and maintenance expenses as a result of the timing of development costs.
In April 1998, a bidding consortium comprised of HI Energy and a
Mexican co-investor submitted bids for two natural gas distribution concessions
in and around Mexico City. If successful, the consortium would be required to
purchase the existing natural gas distribution assets of one of the concessions
($79.7 million or $104.9 million, depending on the concession) and undertake to
construct and operate an expanded natural gas distribution network.
For additional information regarding International's foreign
investments and investment strategies, see Note 10(a) to the Company's Form
10-Q, Note 5 to the Company's Form 10-K and "Management's Discussion and
Analysis of Financial Condition and Results of Operations of the
Company--Results of Operations by Business Segment--International," "--Certain
Factors Affecting Future Earnings of the Company and its Subsidiaries," and
"--Liquidity and Capital Resources--Company's Consolidated Capital Resources" in
the Company's Form 10-K.
CORPORATE
Corporate. The Company's corporate and other business segment
(Corporate) includes the operations of HIPG, which is engaged in the
acquisition, development and operation of domestic non-rate regulated power
generation facilities, the Company's unregulated retail services business,
certain real estate holdings of the Company, corporate costs and inter-unit
eliminations.
In the first quarter of 1998, Corporate's operating loss of $17 million
reflects an increase of $7
25
<PAGE> 29
million when compared to pro forma results for the first quarter of 1997.
The increase in pro forma operating loss was primarily due to (i) losses
associated with the Company consumer services business; (ii) start-up costs
associated with the Company's non-rate regulated retail electric services
business; and (iii) expenses related to the development of domestic power
generation projects.
HIPG. HIPG was formed in March 1997 to pursue the acquisition of
domestic electric generation assets as well as the development of new domestic
non-rate regulated power generation facilities. For the quarter ended March 31,
1998, HIPG had an operating loss of $3.4 million primarily as a result of
business development activities.
HIPG expect to spend approximately $339 million in 1998 pursuant to
commitments entered into with respect to bids previously awarded to HIPG and
existing development construction activities by HIPG. This amount includes $230
million for the acquisition of four gas-fired generating plants which was
completed on April 7, 1998. For additional information, see Note 10(b) to the
Company's Form 10-Q.
HIPG expects to finance its acquisitions and construction projects
primarily by borrowings obtained by one or more subsidiaries of the Company.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
OF THE COMPANY AND ITS SUBSIDIARIES
For information on developments, factors and trends that may have an
impact on the Company's future earnings, reference is made to Item 7 of the
Company's Form 10-K, "Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Company--Certain Factors Affecting
Future Earnings of the Company and its Subsidiaries."
RATE PROCEEDINGS -- ELECTRIC OPERATIONS
The Texas Utility Commission has jurisdiction (or, in some cases,
appellate jurisdiction) over the electric rates of Electric Operations and, as
such, monitors Electric Operations' earnings to ensure that Electric Operations
is not earning in excess of a reasonable rate of return.
For information regarding the Transition Plan, see Note 8 of the
Interim Financial Statements.
ACCOUNTING TREATMENT OF ACES
The Company accounts for its investment in TW Preferred under the cost
method. As a result of the Company's issuance of the ACES, certain increases in
the market value of Time Warner common stock (the security into which the TW
Preferred is convertible) could result in an accounting loss to the Company,
pending the conversion of the Company's TW Preferred into Time Warner common
stock.
For additional information regarding the accounting treatment of the TW
Preferred, see Note 5 to the Company's Form 10-Q.
26
<PAGE> 30
LIQUIDITY AND CAPITAL RESOURCES
The Company and its subsidiaries generated $424 million in cash flow
from operations in the first quarter of 1998. Overall, the Company's cash flow
from operating activities for the first quarter 1998 exceeded its cash flow used
in investing activities by $301 million. Investing activities were primarily due
to capital expenditures of $70 million and $39 million at the electric
operations and gas distribution segments, respectively.
COMPANY CONSOLIDATED SOURCES OF CAPITAL RESOURCES AND LIQUIDITY
Company. In January 1998, pollution control revenue refunding bonds
aggregating $104.7 million with $29.7 million bearing an interest rate of 5.25%
and $75 million bearing an interest rate of 5.15%, were issued on behalf of the
Company by the MCND. The bonds will mature in 2029. Proceeds from the issuances
were used in February 1998 to redeem, at 102% of the aggregate principal amount,
pollution control revenue bonds aggregating $104.7 million.
In February 1998, pollution control revenue bonds aggregating $290
million were issued on behalf of the Company by the BRA. The BRA bonds bear an
interest rate of 5 1/8% and mature in May 2019 ($200 million) and November 2020
($90 million). Proceeds from the issuances were used in May 1998 to redeem, at
102% of the aggregate principal amount, pollution control revenue bonds
aggregating $290 million.
At March 31, 1998, the Company, exclusive of subsidiaries, had a
revolving credit facility of $200 million which supported $131 million of
commercial paper having a weighted average interest rate of 5.92%. In addition,
at March 31, 1998, the Company had shelf registration statements providing for
the future issuance, subject to market and other conditions, of $230 million
aggregate liquidation value of its preferred stock and $580 million aggregate
principal amount of its debt securities.
NorAm. In February 1998, NorAm issued $300 million principal amount of
6.5% debentures due February 1, 2008. The proceeds from the sale of the
debentures were used to repay short-term indebtedness of NorAm, including the
indebtedness incurred in connection with the purchase of $101.4 million
aggregate principal amount of its 10% debentures and the repayment of $53
million aggregate principal amount of NorAm debt that matured in December 1997
and January 1998.
In the first quarter of 1998, NorAm repaid at maturity $1 million of
its 9.3% medium-term notes and satisfied the $6.5 million sinking fund
requirement for its 6% convertible subordinated debentures due March 2012 using
debentures purchased in 1996 and 1997.
In March 1998, NorAm replaced its $400 million revolving credit
facility with a five-year $350 million revolving credit facility. Borrowings
under the NorAm Credit Facility are unsecured. There were no loans outstanding
under the NorAm Credit Facility at March 31, 1998. The NorAm Credit Facility is
expected to be used to support NorAm's issuance of up to $350 million of
commercial paper. At March 31, 1998, NorAm also had a trade receivables facility
of $300 million under which receivables of $300 million had been sold and a
shelf registration statement providing for the future issuance of debt
securities of up to $200 million aggregate principal amount.
Financing Subsidiaries. At March 31, 1998, Houston Industries FinanceCo
LP's (FinanceCo) $1.6 billion revolving credit facility supported $1.2 billion
in commercial paper borrowings having a
27
<PAGE> 31
weighted average interest rate of 5.85%. Proceeds from the initial issuances of
commercial paper by FinanceCo in 1997 were used to fund the cash portion of the
consideration paid to stockholders of the Former NorAm Energy Corp. For
additional information regarding the FinanceCo Facility, see Note 8(c) to the
Company's Form 10-K.
In March 1998, FinanceCo II, a limited partnership subsidiary of the
Company, entered into the FinanceCo II Facility, a six-month $150 million credit
facility. At March 31, 1998, borrowings from the FinanceCo II Facility totaled
$150 million. Proceeds from borrowings under the FinanceCo II Facility were used
to fund a portion of HIPG's April 1998 purchase of four electric generation
plants. For additional information regarding the FinanceCo II Facility, see Note
7(b) to the Interim Financial Statements.
General. The Company has established a "money fund" through which its
subsidiaries can borrow or invest on a short-term basis. The funding
requirements of individual subsidiaries are aggregated ,and borrowing or
investing is based on the net cash position. At March 31, 1998, NorAm had
invested $110 million in the money fund at 6.375%. The money fund's net funding
requirements are met with commercial paper. At March 31, 1998, temporary
external investments aggregated $54 million and had a rate of 6%.
The Company believes that its current level of cash and borrowing
capability along with future cash flows from operations are sufficient to meet
the needs of its existing businesses. However, to achieve its objectives, the
Company may, when necessary, supplement its available cash resources by seeking
funds in the equity or debt markets.
NEW ACCOUNTING ISSUES
The FASB issued SFAS No. 130, "Reporting Comprehensive Income" (SFAS
No. 130), which is required to be implemented for financial statements issued
for fiscal periods beginning after December 15, 1997. For further discussion,
see Note 3 to the Interim Financial Statements.
The FASB recently issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" (SFAS No. 131) and SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits" (SFAS
No. 132) effective for financial statements issued for fiscal periods beginning
after December 15, 1997. SFAS No. 131 requires that companies report financial
and descriptive information about reportable operating segments in financial
statements. Segments are to be defined based upon the way in which management
reviews its operations in order to assess performance and allocate its
resources. SFAS No. 132 revises employers' disclosures about pension and other
postretirement benefit plans. The Company and NorAm will adopt SFAS No. 131 and
SFAS No. 132 for the 1998 fiscal year.
28
<PAGE> 32
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK OF THE
COMPANY
The Company and its subsidiaries have financial instruments that
involve various market risks and uncertainties. For information regarding the
Company's exposure to risks associated with interest rates, equity market prices
and energy commodity prices see Item 7A of the Company's Form 10-K.
In the first quarter of 1998, the Company recorded an additional $123
million unrealized loss (net of tax) related to the ACES. For further discussion
of this loss see Note 5 to the Company's Form 10-Q. The Company believes that
this additional unrealized loss for the ACES is more than economically hedged by
the unrecorded unrealized gain relating to the increase in the fair value of the
Time Warner common stock underlying the investment in TW Preferred since the
date of its acquisition. An increase of 15% in the price of the Time Warner
common stock above its March 31, 1998 market value of $72.00 per share would
result in the recognition of an additional unrealized accounting loss (net of
tax) of approximately $133 million.
The Company's risk associated with interest rates, equity market prices
(other than those related to ACES) and energy commodity prices have not
materially changed from the market risks faced by the Company at December 31,
1997.
29
<PAGE> 33
ITEM 1. FINANCIAL STATEMENTS.
NORAM ENERGY CORP. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
CURRENT FORMER
NORAM NORAM
------------ ------------
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
1998 1997
------------ -----------
<S> <C> <C>
Revenues: ..................................................... $ 1,759,931 $ 1,924,182
----------- -----------
Expenses:
Natural gas and purchased power, net ........................ 1,388,349 1,579,178
Operation and maintenance ................................... 151,609 127,640
Depreciation and amortization ............................... 44,730 35,988
Taxes other than income taxes ............................... 33,672 36,155
----------- -----------
1,618,360 1,778,961
----------- -----------
Operating Income .............................................. 141,571 145,221
Other Income (Expense):
Interest expense, net ....................................... (26,900) (35,472)
Distributions on trust securities ........................... (268) (2,705)
Other - net ................................................. 2,556 6,309
----------- -----------
(24,612) (31,868)
----------- -----------
Income Before Income Taxes .................................... 116,959 113,353
Income Taxes .................................................. 56,353 44,943
----------- -----------
Income Before Extraordinary Item .............................. 60,606 68,410
Extraordinary gain on early retirement of debt, less taxes .... 237
----------- -----------
Net Income .................................................... $ 60,606 $ 68,647
=========== ===========
</TABLE>
See Notes To NorAm's Consolidated Financial Statements.
30
<PAGE> 34
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
---------- ------------
<S> <C> <C>
Property, Plant and Equipment
Natural gas distribution ................................. $1,351,870 $1,326,442
Interstate pipeline ...................................... 1,259,530 1,258,087
Energy marketing ......................................... 167,573 162,519
Other .................................................... 13,367 14,972
---------- ----------
Total ............................................ 2,792,340 2,762,020
Less accumulated depreciation and amortization ........... 85,852 59,531
---------- ----------
Property, plant and equipment-- net ...................... 2,706,488 2,702,489
---------- ----------
Current Assets
Cash and cash equivalents ................................ 51,665 35,682
Accounts and notes receivable, principally customer ...... 774,140 969,248
Accounts receivable - affiliated companies ............... 116,809 10,161
Gas in underground storage ............................... 31,423 63,702
Materials and supplies ................................... 31,271 29,611
Gas purchased in advance of delivery ..................... 6,200 6,200
Other current assets ..................................... 8,001 24,386
---------- ----------
Total current assets ............................. 1,019,509 1,138,990
---------- ----------
Other Assets
Goodwill, net ............................................ 2,013,907 2,026,395
Prepaid pension asset .................................... 91,478 92,064
Investment in marketable equity securities ............... 29,206 27,046
Regulatory asset for environmental costs ................. 21,248 21,745
Gas purchased in advance of delivery ..................... 22,765 29,048
Deferred debits, net ..................................... 71,479 93,010
---------- ----------
Total other assets ............................... 2,250,083 2,289,308
---------- ----------
Total Assets ............................................... $5,976,080 $6,130,787
========== ==========
</TABLE>
See Notes to NorAm's Consolidated Financial Statements
31
<PAGE> 35
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
Stockholder's Equity:
Common stock ........................................................ $ 1 $ 1
Paid-in capital ..................................................... 2,463,831 2,463,831
Retained earnings ................................................... 81,453 20,847
Unrealized loss on marketable equity securities, net of tax ......... (4,255) (5,634)
----------- -----------
Total ....................................................... 2,541,030 2,479,045
----------- -----------
NorAm-Obligated Mandatorily Redeemable Convertible Trust Preferred
Securities of Subsidiary Trust Holding Solely
Subordinated Debentures of NorAm, net ............................... 15,021 21,290
Long-Term Debt, less Current Maturities ............................... 1,211,440 916,703
Current Liabilities:
Current maturities of long-term debt ................................ 230,590 232,145
Notes payable to banks .............................................. 390,000
Notes payable to parent ............................................. 22,100
Receivables facility ................................................ 300,000 300,000
Accounts payable, principally trade ................................. 532,617 668,269
Accounts payable - affiliated companies ............................. 2,578
Income taxes payable ................................................ 47,505
Interest payable .................................................... 20,402 27,273
General taxes ....................................................... 41,936 41,315
Customer deposits ................................................... 36,985 36,626
Other current liabilities ........................................... 117,702 133,278
----------- -----------
Total current liabilities ................................... 1,330,315 1,851,006
----------- -----------
Deferred Credits and Other Liabilities:
Accumulated deferred income taxes ................................... 503,084 488,299
Estimated environmental remediation costs ........................... 21,248 21,745
Payable under capacity lease agreement .............................. 41,000 41,000
Benefit liabilities ................................................. 173,623 182,687
Estimated obligations under indemnification provisions of sale
agreements ....................................................... 9,919 11,391
Other ............................................................... 129,400 117,621
----------- -----------
Total ....................................................... 878,274 862,743
----------- -----------
Commitments and Contingencies
Total Liabilities and Stockholder's Equity ............................ $ 5,976,080 $ 6,130,787
=========== ===========
</TABLE>
See Notes to NorAm's Consolidated Financial Statements
32
<PAGE> 36
NORAM ENERGY CORP. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
CURRENT FORMER
NORAM NORAM
------------ ------------
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
1998 1997
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income ............................................................... $ 60,606 $ 68,647
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization ......................................... 44,730 35,988
Deferred income taxes ................................................. 14,785 7,360
Extraordinary (gain), less taxes ...................................... (237)
Changes in other assets and liabilities, net of the effects of the
acquisition:
Accounts and notes receivable-net ................................... 198,560 179,133
Accounts receivable - affiliated companies .......................... (110,100)
Inventories ......................................................... 29,930 45,500
Other current assets ................................................ 16,238 6,529
Accounts payable .................................................... (133,074) (249,848)
Interest and taxes accrued .......................................... 41,255 30,776
Other current liabilities ........................................... (15,216) (37,204)
Other - net ......................................................... 29,724 10,956
--------- ---------
Net cash provided by operating activities ........................ 177,438 97,600
--------- ---------
Cash Flows from Investing Activities:
Capital expenditures ..................................................... (38,639) (26,700)
Other - net .............................................................. 2,371 4,987
--------- ---------
Net cash used in investing activities ............................ (36,268) (21,713)
--------- ---------
Cash Flows from Financing Activities:
Retirements and reacquisitions of long-term debt ........................ (1,000) (5,515)
Proceeds from sale of debentures ........................................ 300,000
Decrease in notes payable ............................................... (417,027) (28,000)
Decrease in receivables facility ........................................ (10,000)
Common and preferred stock dividends .................................... (9,631)
Conversion of convertible securities .................................... (3,255)
Other-net ............................................................... (3,905) (16,123)
--------- ---------
Net cash used in financing activities ............................. (125,187) (69,269)
--------- ---------
Net Increase In Cash And Cash Equivalents .................................. 15,983 6,618
Cash and Cash Equivalents at Beginning of the Period ....................... 35,682 27,981
--------- ---------
Cash and Cash Equivalents at End of the Period ............................. $ 51,665 $ 34,599
========= =========
Supplemental Disclosure of Cash Flow Information:
Interest (net of amounts capitalized) .................................... $ 39,194 $ 36,120
Income taxes, net ........................................................ (13,792) 3,770
</TABLE>
See Notes To NorAm's Consolidated Financial Statements
33
<PAGE> 37
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK(1) RETAINED INVESTMENT
-------------------------- PAID-IN EARNINGS GAIN (LOSS)
SHARES AMOUNT CAPITAL (DEFICIT) NET OF TAX TOTAL
------------ ---------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
FORMER NORAM:
Balance at January 1, 1997....... 137,908,173 $ 86,193 $ 1,001,053 $ (286,703) $ 5 $ 800,548
Net income....................... 68,647 68,647
Cash dividends:
Common stock -- $0.07
per share.................... (9,631) (9,631)
Change in Market Value of
Marketable Equity
Securities, net of tax......... 1,199 1,199
Other Issuances.................. 321,152 200 3,757 3,957
----------- ---------- ----------- ---------- ---------- -----------
Balance at March 31, 1997........ 138,229,325 86,393 1,004,810 (227,687) 1,204 864,720
----------- ---------- ----------- ---------- ---------- ----------
Net Income....................... (22,535) (22,535)
Cash Dividends:
Common Stock -- $0.07
per share.................... (9,650) (9,650)
Change in Market Value of
Marketable Equity
Securities, Net of Tax......... 4,675 4,675
Conversion of
NorAm-Obligated
Mandatorily Redeemable
Convertible Trust Preferred
Securities of Subsidiary
Trust Holding Solely
Subordinated Debentures
of Noram to Common
Stock.......................... 11,428,262 7,143 131,425 138,568
Other Issuances.................. 26,375 16 2,039 2,055
----------- ---------- ----------- ---------- ---------- ----------
Balance at July 31, 1997....... 149,683,962 93,552 1,138,274 (259,872) 5,879 977,833
----------- ---------- ----------- ---------- ---------- ----------
CURRENT NORAM (POST
MERGER):
Adjustments due to Merger:
Eliminate Former NorAm
Balances..................... (149,683,962) (93,552) (1,138,274) 259,872 (5,879) (977,833)
Capital Contribution from
Parent......................... 1,000 1 2,463,831 2,463,832
Net Income....................... 20,847 20,847
Change in Market Value of
Marketable Equity
Securities, Net of Tax......... (5,634) (5,634)
----------- ---------- ----------- ---------- ---------- ----------
Balance at December 31, 1997..... 1,000 $ 1 $ 2,463,831 $ 20,847 $ (5,634) $2,479,045
----------- ---------- ----------- ---------- ---------- ----------
</TABLE>
(continued on next page)
34
<PAGE> 38
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK(1) RETAINED INVESTMENT
--------------- PAID-IN EARNINGS GAIN(LOSS)
SHARES AMOUNT CAPITAL (DEFICIT) NET OF TAX TOTAL
------ ------ --------- --------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Net Income....................... 60,606 60,606
Change in Market
Value of Marketable Equity
Securities, net of tax..... 1,379 1,379
Balance at March 31,
1998.......................... 1,000 $ 1 $2,463,831 $ 81,453 $ (4,255) $ 2,541,030
====== ==== ========== ========= ========= ============
</TABLE>
- -------------
(1) $.625 par, authorized 250,000,000 shares. On the Acquisition Date, NorAm's
pre-merger common stock was canceled and replaced with 1,000 shares of common
stock (all of which are owned by Houston Industries).
See Notes to NorAm's Consolidated Financial Statements.
35
<PAGE> 39
NORAM ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
On August 6, 1997 (Acquisition Date), Houston Industries Incorporated
(Former HI) merged with and into Houston Lighting & Power Company, which was
renamed "Houston Industries Incorporated" (Houston Industries), and NorAm
Energy Corp. (Former NorAm) merged with and into a subsidiary of Houston
Industries, HI Merger, Inc., which was renamed "NorAm Energy Corp." (NorAm).
Effective upon the mergers (collectively, the Merger), each outstanding share
of common stock of Former NorAm was converted into the right to receive
$16.3051 cash or 0.74963 shares of common stock of Houston Industries. For more
information regarding the Merger, see Note 2 below.
The interim financial statements and notes (NorAm's Interim Financial
Statements) in this Form 10-Q (NorAm's Form 10-Q) include the accounts of NorAm
and its wholly owned subsidiaries. NorAm's 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 joint Annual Report on Form 10-K (NorAm's Form 10-K) for
the year ended December 31, 1997 (File No. 1-13265) and Houston Industries
Annual Report on Form 10-K (Houston Industries Form 10-K) for the year ended
December 31, 1997 (File No. 1-3187). For additional information regarding the
presentation of interim period results, see Note 6 below.
The following notes to the financial statements in NorAm's Form 10-K
relate to material contingencies. These notes, as updated by the notes contained
in the NorAm Form 10-Q, are incorporated herein by reference and include the
following:
NorAm: Note 1(c) (Regulatory Assets and Regulation), Note 2 (Derivative
Financial Instruments (Risk Management)) and Note 8 (Commitments and
Contingencies).
(2) ACQUISITION OF NORAM
The aggregate consideration paid to Former NorAm stockholders in
connection with the Merger consisted of $1.4 billion in cash and 47.8 million
shares of Houston Industries common stock valued at approximately $1.0 billion.
The overall transaction was valued at $4.0 billion consisting of $2.4 billion
paid for Former NorAm's common stock and common stock equivalents and $1.6
billion of Former NorAm's debt ($1.3 billion of which was long-term debt).
The Merger was recorded under the purchase method of accounting with
assets and liabilities of NorAm reflected at their estimated fair values as of
the Acquisition Date, resulting in a "new basis" of accounting. In NorAm's
Interim Financial Statements, periods which reflect the new basis of accounting
are labeled as "Current NorAm" and periods which do not reflect the new basis of
accounting are labeled as "Former NorAm."
NorAm's Consolidated Balance Sheets for periods after the Acquisition
Date reflect adjustments associated with Houston Industries' assignment of the
purchase price, principally consisting of (1) the
36
<PAGE> 40
revaluation of certain property, plant and equipment and long-term debt to their
estimated fair market value, (2) the recognition of certain pension and
postretirement benefit obligations previously being recognized through
amortization, (3) the recognition of goodwill as described above, (4) the
elimination of NorAm's historical goodwill, (5) the elimination of NorAm's
historical stockholders' equity balances and accumulated depreciation and
amortization as of the Acquisition Date and (6) the recognition of the
associated deferred income tax effects. In addition, NorAm's pre-merger common
stock was canceled and replaced with 1,000 shares of common stock (all of which
are owned by Houston Industries), rendering presentation of per share data no
longer meaningful. Houston Industries' debt to fund the cash portion of the
purchase consideration has not been allocated or "pushed down" to NorAm and is
not reflected on NorAm's Interim Financial Statements.
NorAm's Statements of Consolidated Income for periods after the
Acquisition Date are principally affected by (1) the amortization (over 40
years) of the newly-recognized goodwill, partially offset by the elimination of
the amortization of NorAm's historical goodwill, (2) the amortization (to
interest expense) of the revaluation of long-term debt, (3) the removal of the
amortization (to operating expense) previously associated with the pension and
postretirement obligations as described above and (4) the deferred income tax
expense associated with these adjustments. Interest expense on Houston
Industries' debt which was used to fund the cash portion of the acquisition has
not been allocated or "pushed down" to NorAm and is not reflected on NorAm's
Interim Financial Statements. For these reasons, among others, certain financial
information for periods before and after the Acquisition Date is not comparable.
Assuming the Merger occurred on January 1, 1997, NorAm's unaudited pro
forma net income for the first quarter of 1997 is $63.1 million. Pro forma
results are based on assumptions deemed appropriate by NorAm's management, have
been prepared for informational purposes only and are not necessarily indicative
of the results which would have resulted had the Merger actually taken place on
the date indicated.
(3) COMPREHENSIVE INCOME
Effective January 1, 1998, NorAm adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS No.
130). SFAS No. 130 requires that all items that meet the definition of a
component of comprehensive income (as defined below) be reported in a financial
statement for the fiscal period in which they are recognized and the total
amount of comprehensive income be prominently displayed in that same financial
statement. Comprehensive income is defined to include not only net income but
also the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources. NorAm's
total comprehensive income which includes unrealized gain on marketable equity
securities for the quarters ended March 31, 1998 and 1997 is $62 million and $70
million, respectively. Adoption of SFAS No.130 has no impact on NorAm's net
income or stockholders' equity.
(4) DEPRECIATION
NorAm calculates depreciation using the straight-line method. NorAm's
depreciation expense for the first quarter of 1998 was $34 million.
(5) LONG-TERM DEBT AND SHORT-TERM FINANCINGS
In March 1998, NorAm replaced its $400 million revolving credit
facility with a five-year $350 million revolving credit facility (NorAm Credit
Facility). Borrowings under the NorAm Credit Facility are unsecured and bear
interest at a rate based upon either the London interbank offered rate (LIBOR)
plus a margin, a base rate or a rate determined through a bidding process. The
NorAm Credit Facility is expected to be used to support NorAm's issuance of up
to $350 million of commercial paper. There were no loans
37
<PAGE> 41
outstanding under the NorAm Credit Facility at March 31, 1998.
In February 1998, NorAm issued $300 million principal amount of its
6 1/2% Debentures due February 1, 2008 (6 1/2% Debentures). The 6 1/2%
Debentures are not redeemable prior to maturity and are not subject to any
sinking fund requirements. The proceeds from the sale of the 6 1/2% Debentures
were used to repay short-term indebtedness of NorAm, including the indebtedness
incurred in connection with the 1997 purchase of $101 million aggregate
principal amount of its 10% Debentures and the repayment of $53 million
aggregate principal amount of NorAm debt that matured in December 1997 and
January 1998.
In the first quarter of 1998, NorAm repaid at maturity $1 million of
its 9.30% medium-term notes and satisfied the $6.5 million sinking fund
requirement for its 6% Debentures due 2012 using debentures purchased in 1996
and 1997.
(6) NORAM OBLIGATED MANDATORILY REDEEMABLE TRUST SECURITIES OF SUBSIDIARY TRUSTS
HOLDING SOLELY SUBORDINATED DEBENTURES OF NORAM.
For information regarding $177.8 million of convertible preferred
securities issued by a statutory business trust formed by Former NorAm, of which
$11.6 million were outstanding at March 31, 1998, see Note 5 to NorAm's Form
10-K. The sole asset of the trust consists of junior subordinated debentures of
NorAm having interest rates and maturity dates corresponding to the preferred
securities, and the principal amount corresponding to the common and preferred
securities issued by the trust.
(7) INTERIM PERIOD RESULTS: RECLASSIFICATIONS
NorAm's Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position and results of operations for the respective periods.
Amounts reported in the Consolidated Statements of Income are not necessarily
indicative of amounts expected for a full year period due to the effects of,
among other things, (i) the Merger, (ii) seasonal temperature variations in
energy consumption and (iii) the timing of maintenance and other expenditures.
In addition, certain amounts from the prior year have been reclassified to
conform to NorAm's presentation of financial statements in the current year.
Such reclassifications do not affect earnings.
38
<PAGE> 42
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS OF NORAM
ENERGY CORP. AND CONSOLIDATED SUBSIDIARIES.
NorAm meets the conditions specified in General Instruction H to Form
10-Q and is thereby permitted to use the reduced disclosure format for wholly
owned subsidiaries of reporting companies specified therein. Accordingly, NorAm
has omitted from this Form 10-Q the information called for by Item 3 of Part I
and the following Part II items of Form 10-Q: Item 2 (changes in securities and
use of proceeds), Item 3 (defaults upon senior securities), and Item 4
(submission of matters to a vote of security holders). In lieu of the
information called for by Item 2 (management's discussion and analysis of
financial condition and results of operations) of Form 10-Q, NorAm has included
the following Management's Narrative Analysis of the Results of Operations of
NorAm Energy Corp. and Consolidated Subsidiaries to explain material changes in
the amount of revenue and expense items of NorAm between the first quarter of
1998 and the first quarter of 1997. Reference is made to Management's Narrative
Analysis of the Results of Operations in Item 7 of NorAm's Form 10-K, NorAm's
consolidated financial statements and notes contained in Item 8 of NorAm's Form
10-K and NorAm's Interim Financial Statements contained in this Form 10-Q.
Statements contained in this Form 10-Q that are not historical facts
are forward-looking statements as defined in the Private Securities Litigation
Reform Act of 1995. Forward-looking statements are based on management's beliefs
as well as assumptions made by and information currently available to
management. Because such statements are based on expectations as to future
economic performance and are not statements of fact, actual results may differ
materially from those projected. Important factors that could cause future
results to differ include (i) the effects of competition in the natural gas
industry, (ii) legislative and regulatory changes, (iii) fluctuations in the
weather, (iv) fluctuations in energy commodity prices, (v) environmental
liabilities, (vi) changes in the economy and (vii) other factors discussed in
this and other filings by NorAm with the Securities and Exchange Commission.
When used in NorAm's documents or oral presentations, the words "anticipate,"
"estimate," "expect," "objective," "projection," "forecast," "goal" or similar
words are intended to identify forward-looking statements. The section of
Management's Narrative Analysis of the Results of Operations of NorAm Energy
Corp. and Consolidated Subsidiaries captioned "Results of Operations By Business
Unit" contains or incorporates by reference forward-looking statements.
NORAM ENERGY CORP.
NorAm conducts operations primarily in the natural gas industry,
including gathering, transmission, marketing, storage and distribution.
Collectively, these operations accounted for in excess of 90% of NorAm's total
revenues, income or loss and identifiable assets in the first quarter of 1998.
Accordingly, NorAm is not required to report on a "segment" basis, although
NorAm is organized into, and the following business description focuses on, the
operating units described below. NorAm also makes sales of electricity,
non-energy sales and provides certain non-energy services, primarily to retail
gas distribution customers. In recognition of the manner in which NorAm manages
its portfolio of businesses, NorAm has segregated its results of operations
into: Natural Gas Distribution, Interstate Pipeline, Energy Marketing and
Corporate.
On August 6, 1997 (Acquisition Date), NorAm became a wholly owned
subsidiary of Houston Industries Incorporated (Houston Industries) in a
transaction involving the merger (Merger) of NorAm Energy Corp. (Former NorAm)
with and into a subsidiary of Houston Industries. For additional information
regarding Houston Industries' acquisition of NorAm, see Note 2 to NorAm's
Interim Financial Statements.
39
<PAGE> 43
CONSOLIDATED RESULTS OF OPERATIONS
Seasonality and Other Factors. NorAm's results of operations are
seasonal due to seasonal fluctuations in the demand for and, to a lesser extent,
the price of natural gas. NorAm's results of operations are also affected by,
among other things, the actions of various federal and state governmental
authorities having jurisdiction over rates charged by NorAm and its
subsidiaries, competition in NorAm's various business operations, debt service
costs and income tax expense. For a discussion of certain other factors that may
affect NorAm's future earnings see "Management's Discussion and Analysis of
Financial Condition and Results of Operations of the Company--Certain Factors
affecting Future Earnings of the Company and its Subsidiaries" in the Company's
Form 10-K.
Accounting Impact of the Merger. The Merger created a new basis of
accounting for NorAm, resulting in new carrying values for certain of NorAm's
assets, liabilities and equity commencing upon the Acquisition Date. NorAm's
Statements of Consolidated Income for periods after the Acquisition Date are
principally affected by (1) the amortization (over 40 years) of the
newly-recognized goodwill, partially offset by the elimination of the
amortization of NorAm's historical goodwill, (2) the amortization (to interest
expense) of the revaluation of long-term debt, (3) the removal of the
amortization (to operating expense) previously associated with the pension and
post-retirement obligations and (4) the deferred income tax expense associated
with these adjustments. Interest expense on Houston Industries' debt which was
used to fund the cash portion of the acquisition has not been allocated or
"pushed down" to NorAm and is not reflected on NorAm's Interim Financial
Statements. For these reasons, among others, certain financial information for
periods before and after the Acquisition Date is not comparable.
Because results of operations and other financial information for
periods before and after the Acquisition Date are not comparable, NorAm is
presenting certain financial data on an actual basis and on a pro forma basis as
if the Merger had taken place at the beginning of the period presented. These
results do not necessarily reflect the results which would have been obtained if
the Merger had actually occurred on the dates indicated or the results that may
be expected in the future.
The following table sets forth selected financial and operating data on
an actual basis for the quarters ended March 31, 1998 and 1997 and on a pro
forma basis for the quarter ended March 31, 1997, followed by a discussion of
significant variances in period-to-period results:
40
<PAGE> 44
SELECTED FINANCIAL RESULTS:
<TABLE>
<CAPTION>
ACTUAL
QUARTER ENDED MARCH 31, QUARTER ENDED MARCH 31,
----------------------------- -------------------------------------------
1998 1997 1998 1997 PERCENT
(ACTUAL) (ACTUAL) (ACTUAL) (PRO FORMA)(1) CHANGE
------------- ----------- ----------- -------------- ------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
Operating Revenues:
Natural Gas Distribution............ $ 716,896 $ 881,251 $ 716,896 $ 881,251 (19%)
Interstate Pipeline ................ 70,981 84,284 70,981 84,284 (16%)
Energy Marketing ................... 1,045,619 1,045,466 1,045,619 1,045,466
Corporate and Other ................ 21,116 16,759 21,116 16,759 26%
Elimination of Intersegment
Revenues (2) .................... (94,681) (103,578) (94,681) (103,578) (9%)
----------- ----------- ----------- ----------
$ 1,759,931 $ 1,924,182 $ 1,759,931 $1,924,182 (9%)
=========== =========== =========== ==========
Operating Income (Loss):
Natural Gas Distribution ........... 101,604 112,652 101,604 106,751 (5%)
Interstate Pipelines ............... 32,073 38,851 32,073 34,915 (8%)
Energy Marketing ................... 9,581 682 9,581 (1,042)
Corporate and Other ................ (1,687) (6,964) (1,687) (4,012) (58%)
----------- ----------- ----------- ----------
Consolidated ......................... 141,571 145,221 141,571 136,612 4%
Interest Expense, Net ................ 26,900 35,472 26,900 30,564 (12%)
Distributions on Subsidiary Trust
Securities ......................... 268 2,705 268 514 (48%)
Other (Income) and Deductions ........ (2,556) (6,309) (2,556) (6,309) (59%)
Income Tax Expense ................... 56,353 44,943 56,353 48,712 16%
----------- ----------- ----------- ----------
Net Income.......................... $ 60,606 $ 68,410 $ 60,606 $ 63,131 (4%)
=========== =========== =========== ==========
</TABLE>
- ----------
(1) Pro forma results reflect purchase accounting adjustments as if the Merger
had occurred on January 1, 1997. Adjustments for goodwill have been
allocated to the respective business units.
(2) Elimination of operating revenues derived from sales to affiliated business
units.
First Quarter of 1998 Compared to First Quarter of 1997 (Pro Forma).
Noram's operating income increased $5 million in the first quarter of 1998
compared to pro forma operating income for the first quarter of 1997. This
increase is primarily attributed to hedging losses and losses from the sale of
gas in the first quarter of 1997, partially offset by increased operating
expenses in 1998 as discussed below. After adjusting for these prior losses,
operating income in the first quarter of 1998 decreased by approximately $12
million compared to the same period of 1997 as explained below.
Operating revenues decreased $164 million in the first quarter of 1998
compared to pro forma operating revenues for the first quarter of 1997.
Operating expenses for the first quarter of 1998 were $1,618 million compared to
pro forma operating expenses of $1,788 million for the same period of 1997
resulting in a decrease of $170 million. This decrease in operating income
(adjusted, as explained above) is principally the result of (i) a
weather-related decline in sales volumes of approximately $10 million on an
operating income basis from natural gas distribution, (ii) increased
administrative and general expense of approximately $3 million associated with
increased staffing and marketing in connection with increasing the scope of
energy marketing activities and (iii) non-recurring transportation revenues
recognized in the first quarter of 1997 of $7 million. These factors were
partially offset by decreases in depreciation and amortization expenses due to a
$4.8 Million rate settlement recorded in the first quarter of 1998 by Interstate
Pipeline and lower natural gas costs at Arkla of $4 million attributable to the
purchase gas adjustments
41
<PAGE> 45
recorded in the first quarter of 1998 as discussed below. For a more detailed
comparative discussion regarding pro forma operating revenue and expense items,
see "Results of Operations by Business Unit" below.
First Quarter of 1998 Compared to First Quarter of 1997 (Actual). Noram had
actual operating revenues of $1.8 Billion in the first quarter of 1998 compared
to $1.9 Million in the first quarter of 1997. Actual operating expenses for the
first quarter of 1998 were $1.6 Billion compared to operating expenses of $1.8
Billion in the first quarter of 1997. Noram's operating income decreased $4
million in the first quarter of 1998 compared to operating income for the first
quarter of 1997. Noram's operating income for the first quarter of 1998 includes
expenses associated with purchase accounting of approximately $9 million.
Adjusting for these purchase accounting expenses, the change in operating income
was caused by the same factors referenced in the discussion of pro forma
operating income.
RESULTS OF OPERATIONS BY BUSINESS UNIT
NATURAL GAS DISTRIBUTION
NorAm's domestic natural gas distribution operations (Natural Gas
Distribution) are conducted through its Arkla, Entex and Minnegasco divisions.
These operations consist of natural gas sales to, and natural gas transportation
for, residential, commercial and certain industrial customers in six states:
Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma and Texas.
The following table provides summary data regarding the results of
operations of Natural Gas Distribution, including operating statistics, for the
quarters ended March 31, 1998 and 1997 on an actual basis for the first quarter
of 1998 and on a pro forma basis for the first quarter of 1997 (as if the
acquisition of NorAm had occurred as of January 1, 1997).
42
<PAGE> 46
<TABLE>
<CAPTION>
Quarter Ended MARCH 31, PERCENT
1998 1997 CHANGE
-------- ------------ -------
(ACTUAL) (PRO FORMA)
(in millions)
<S> <C> <C> <C>
Operating Revenues ....................... $717 $881 (19%)
Operating Expenses:
Natural Gas ......................... 458 616 (26%)
Operation and Maintenance ........... 98 97 1%
Depreciation and Amortization ....... 32 30 7%
Other Operating Expenses ............ 27 31 (10%)
---- ----
Total Operating Expenses ........ 615 774 (20%)
---- ----
Operating Income ......................... $102 $107 (5%)
==== ====
Throughput Data (in Bcf):
Residential and Commercial Sales .... 126 137 (8%)
Industrial Sales .................... 15 15
Transportation ...................... 13 12 8%
---- ----
Total Throughput ................. 154 164 (6%)
==== ====
</TABLE>
Natural Gas Distribution operating income decreased $5 million in the
first quarter of 1998 compared to pro forma operating income in the first
quarter of 1997 due primarily to weather-related factors. This decrease in
operating income is partially offset by the favorable impact of Arkla's charges
associated with the applicable state regulatory commission's methodology of
calculating the price of gas charged to customers (the purchased gas adjustment)
in the first quarter of 1998 as compared to the first quarter of 1997.
Natural Gas Distribution operating revenue decreased $164 million for
the first quarter of 1998 compared to pro forma operating revenue for the
corresponding period of 1997 due principally to the warmer weather, which
resulted in lower customer usage at Entex and Minnegasco, and a decrease in gas
prices.
Operating expenses decreased $159 million in the first quarter of 1998
compared to pro forma operating expenses in the same period of 1997 due to the
same factors that affected operating revenues as discussed above.
43
<PAGE> 47
INTERSTATE PIPELINE
NorAm's interstate natural gas pipeline operations (Interstate
Pipeline) are conducted through NorAm Gas Transmission Company (NGT) and
Mississippi River Transmission Corporation (MRT), two wholly owned subsidiaries
of NorAm. The NGT system consists of approximately 6,200 miles of natural gas
transmission lines located in portions of Arkansas, Kansas, Louisiana,
Mississippi, Missouri, Oklahoma, Tennessee and Texas. The MRT system consists of
approximately 2,000 miles of pipeline serving principally the greater St. Louis
area in Missouri and Illinois.
The following table provides summary data regarding the results of
operations of Interstate Pipeline, including operating statistics, on an actual
basis for the first quarter of 1998 and on a pro forma basis for the first
quarter of 1997 (as if the acquisition of NorAm had occurred as of January 1,
1997).
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31,
----------------------- PERCENT
1998 1997 CHANGE
-------- ----------- --------
(ACTUAL) (PRO FORMA)
(in millions)
<S> <C> <C> <C>
Operating Revenues ..................... $ 71 $ 84 (15%)
Operating Expenses:
Natural Gas ....................... 8 11 (27%)
Operation and Maintenance ......... 17 22 (23%)
Depreciation and Amortization ..... 9 13 (31%)
Other Operating Expenses .......... 5 3 67%
----- -----
Total Operating Expenses ..... 39 49 (20%)
----- -----
Operating Income ....................... $ 32 $ 35 (8%)
===== =====
Throughput Data (in million MMBtu):
Natural Gas Sales ................... 4 5 (20%)
Transportation ...................... 237 250 (5%)
Elimination (1) ................ (4) (4) --
----- -----
Total Throughput ....................... 237 251 (5%)
===== =====
</TABLE>
- ----------
(1) Elimination refers to volumes of natural gas both transported and sold by
Interstate Pipeline and, therefore, excluded from total throughput.
Interstate Pipeline operating income decreased $3 million in the first
quarter of 1998 compared to pro forma operating income in the first quarter of
1997 due primarily to non-recurring items occurring in the first quarter of 1997
and milder weather in the first quarter of 1998. These factors were partially
offset by lower operating expenses in the first quarter of 1998.
Operating revenues for Interstate Pipeline decreased by $13 million for
the first quarter of 1998 compared to pro forma operating revenues for the same
period in 1997. The decrease in revenues is primarily due to $7 million of
non-recurring transportation revenues recognized in the first quarter of 1997
upon completion of settlement negotiations with Arkla related to service
provided in several of their operating jurisdictions. In addition, the decrease
in revenues is also attributable to a reduction in natural gas volumes and
decreased gas prices.
Operation and maintenance expenses decreased $5 million in the first
quarter of 1998 compared to pro forma operation and maintenance expenses for the
same period of 1997 primarily due to decreased maintenance due to milder weather
and lower costs resulting from cost control initiatives.
44
<PAGE> 48
Depreciation and amortization expenses decreased $4 million in the
first quarter of 1998 in comparison to pro forma depreciation and amortization
expenses for the same period of 1997 due to a $4.8 million rate settlement
recorded in the first quarter of 1998. The rate settlement, effective January
1998, provided for a reduction of MRT's depreciation rates retroactive to July
1996.
ENERGY MARKETING
NorAm's energy marketing and gathering business (Energy Marketing)
includes the operations of NorAm's wholesale and retail energy marketing
businesses and natural gas gathering activities (conducted, respectively, by
NorAm Energy Services, Inc. (NES), NorAm Energy Management, Inc. and NorAm Field
Services Corp., three wholly owned subsidiaries of NorAm).
The following table provides summary data regarding the unaudited pro
forma results of operations of Energy Marketing, including operating statistics,
on an actual basis for the first quarter of 1998 and on a pro forma basis for
the first quarter of 1997 (as if the acquisition of NorAm had occurred as of
January 1, 1997).
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31, PERCENT
1998 1997 CHANGE
------- ----------- -------
(ACTUAL) (PRO FORMA)
(in millions )
<S> <C> <C> <C>
Operating Revenues ................................ $ 1,046 $ 1,045 --
Operating Expenses:
Natural Gas and Purchased Power, net ......... 1,009 1,023 (1%)
Operation and Maintenance .................... 22 19 16%
Depreciation and Amortization ................ 3 3 --
Other Operating Expenses ..................... 2 1 --
------- -------
Total Operating Expenses ................ 1,036 1,046 (1%)
------- -------
Operating Income (loss) ........................... $ 10 $ (1)
======= =======
Operations Data:
Natural Gas (in Bcf):
Sales ...................................... 337 320 5%
Transportation ............................. 7 7 --
Gathering .................................. 58 60 (3%)
------- -------
Total ................................. 402 387 4%
------- -------
Electricity:
Wholesale Power Sales (in thousand MWH) .... 13,770 4,584 200%
======= =======
</TABLE>
Energy Marketing operating income increased $11 million in the first
quarter of 1998 in comparison to pro forma operating income for the same period
in 1997. This increase is primarily attributed to hedging losses and losses from
the sale of gas in 1997 partially offset by increased operating expenses in 1998
as discussed below. After adjusting for these prior losses, operating income
decreased for the first quarter of 1998 by approximately $6 million compared to
the same period in 1997, as explained below.
Operating Revenues. Operating revenues for Energy Marketing remained
substantially unchanged because: (i) increases in natural gas volumes at NES
were more than offset by decreases in the price of natural gas and (ii)
substantial increases in wholesale power volumes (200%) offset gas sales
declines at NES.
45
<PAGE> 49
Operating Expenses. Operation and maintenance expenses increased $3
million when compared to pro forma operation expenses for the first quarter of
1997 largely due to increased staffing and marketing activities made in support
of the increased sales and expanded marketing efforts at NES. Houston Industries
believes that NES' energy marketing and risk management services have the
potential of complementing Houston Industries' strategy of developing and/or
acquiring unregulated generation assets in other markets. As a result, Houston
Industries has made, and expects to continue to make, significant investments in
developing NES' internal software, trading and personnel resources.
Natural gas and purchased power expense decreased $14 million in the
first quarter of 1998 when compared to the first quarter of 1997 primarily due
to the nonrecurrence of 1997 losses related to: (i) hedging losses associated
with anticipated first quarter 1997 sales under peaking contracts and (ii)
losses from the sale of natural gas held in storage and unhedged in the first
quarter of 1997 totaling $17 million. Partially offsetting these losses were
increased gas and electricity marketing activities. Excluding the 1997 hedging
losses described above, natural gas and purchased power expenses increased $3
million, primarily attributable to approximately $2 million in losses on
wholesale power sales.
To minimize fluctuations in the price of natural gas and
transportation, NorAm, primarily through NES, enters into futures transactions,
swaps and options in order to hedge against market price changes affecting (i)
certain commitments to buy, sell and transport natural gas, (ii) existing gas
storage inventory and (iii) certain anticipated transactions, some of which
carry off-balance sheet risk. NES also enters into natural gas derivatives for
trading purposes and electricity derivatives for hedging and trading purposes.
For a discussion about NorAm's accounting treatment of derivative instruments,
see Note 2 to NorAm's Form 10-K and Item 7A (Quantitative and Qualitative
Disclosure About Market Risk) in Houston Industries' Form 10-K.
CORPORATE
NorAm's corporate and other business (Corporate) includes the
operations of NorAm's unregulated retail services business, international
operations, certain real estate investments, corporate costs and elimination of
transactions between affiliated business units.
Corporate operating revenues increased $4 million and operating loss
decreased $2 million in the first quarter of 1998 when compared to pro forma
operating revenues and operating loss for the same period in 1997. The increased
revenues and reduced operations loss were due to increased activities associated
with NorAm's utility services and consumer services businesses and reduced
corporate expenses.
NON-OPERATING INCOME AND EXPENSE
The increase of $7.6 million in income tax expense in comparison to pro
forma income tax expense for the first quarter of 1997 is primarily due to the
impact of higher state tax expense and miscellaneous other non-deductible items.
Reference is made to Note 5 of NorAm's Interim Financial Statements for
a discussion of NorAm's short- and long-term debt.
NEW ACCOUNTING ISSUES
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Company -- New Accounting Issues" in
Item 2 of Houston Industries' Form 10-Q, which has been jointly filed with the
NorAm Form 10-Q, for a discussion of certain new accounting issues.
46
<PAGE> 50
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For a description of legal proceedings affecting the Company
and its subsidiaries, including NorAm, reference is made to
Item 3 of the Company's Form 10-K, Notes 3 and 5 to the
Company's Form 10-K and Note 8 to NorAm's Form 10-K, which
information is incorporated herein by reference. For
information regarding a franchise fee lawsuit pending against
the Company, see Note 12(h) to the financial statements in the
Company's Form 10-K. In December 1997, a similar lawsuit
(pending in the 239th District Court, Brazoria County, Texas)
was filed against NorAm by the City of Pearland, Texas, and
similarly situated cities in Entex's service areas.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On March 31, 1998, the Company sold 1,575 shares of its Series
C Preference Stock, without par value, to Houston Industries
FinanceCo II, LP, a limited partnership financing subsidiary
of the Company, for $150,000,000. The transaction was exempt
from registration under the Securities act of 1933, as
amended, pursuant to Section 4(2) thereunder. For additional
information regarding this transaction, see Note 6(d) to the
Company's Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Houston Industries Incorporated:
<TABLE>
<S> <C>
Exhibit 3 - Statement of Resolution Establishing Series of Shares
designated Series C Preference Stock.
Exhibit 27 - Financial Data Schedule. (Houston Industries)
Exhibit 99(a) - Notes 1(c), 1(n), 2, 3, 4, 5 and 12 to the Company's
Interim Financial Statements included on pages 64,
68, pages 69 through 77, and pages 92 through 94 of
the Company's Form 10-K.
NorAm Energy Corp.:
Exhibit 27 - Financial Data Schedule (NorAm Energy).
Exhibit 99(a) - Notes 1(c), 2 and 8 to NorAm's Interim Financial
Statements included on pages 116, 117 and pages 118
through 121, and pages 132 through 135 of NorAm's
Form 10-K. (NorAm)
</TABLE>
(b) Reports on Form 8-K.
Form 8-K of NorAm dated February 5, 1998. (Items 5 and 7)
47
<PAGE> 51
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOUSTON INDUSTRIES INCORPORATED
(Registrant)
/s/ Mary P. Ricciardello
-----------------------------------
Mary P. Ricciardello
Vice President and Comptroller
(Principal Accounting Officer)
Date: May 14, 1998
48
<PAGE> 52
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NORAM ENERGY CORP.
(Registrant)
/s/ Mary P. Ricciardello
-------------------------------------
Mary P. Ricciardello
Vice President and Comptroller
(Principal Accounting Officer)
Date: May 14, 1998
49
<PAGE> 53
(a) Exhibits.
Houston Industries Incorporated:
<TABLE>
<S> <C>
Exhibit 3 - Statement of Resolution Establishing Series of Shares
designated Series C Preference Stock.
Exhibit 27 - Financial Data Schedule (Houston Industries)
Exhibit 99(a) - Notes 1(c), 1(n), 2, 3, 4, 5 and 12 to the Company's
Interim Financial Statements included on pages 64, 68,
pages 69 through 77, and pages 92 through 94 of the
Company's Form 10-K.
NorAm Energy Corp.:
Exhibit 27 - Financial Data Schedule. (NorAm Energy)
Exhibit 99(a) - Notes 1(c), 2 and 8 to NorAm's Interim Financial
Statements included on pages 116, 117 and pages 118
through 121, and pages 132 through 135 of NorAm's Form
10-K.
</TABLE>
(b) Reports on Form 8-K.
<PAGE> 1
EXHIBIT 3
STATEMENT OF RESOLUTION ESTABLISHING SERIES OF SHARES
designated
SERIES C PREFERENCE STOCK
of
HOUSTON INDUSTRIES INCORPORATED
Pursuant to Article 2.13D of
the Texas Business Corporation Act
Pursuant to the provisions of Article 2.13D of the Texas
Business Corporation Act, the undersigned corporation submits the following
statement for the purpose of establishing and designating a series of shares of
its Preference Stock, without par value, designated "Series C Preference Stock"
and fixing and determining the relative rights and preferences thereof:
1. The name of the corporation is HOUSTON INDUSTRIES
INCORPORATED (the "Corporation").
2. The following resolution establishing and designating a
series of shares and fixing and determining the relative rights and preferences
thereof, was duly adopted by all necessary action on the part of the Corporation
on March 27, 1998:
RESOLVED, that pursuant to the authority vested in the Board
of Directors of this Corporation in accordance with the provisions of
the Restated Articles of Incorporation, a series of Preference Stock,
without par value, of the Corporation be and hereby is created, and
that the designation and number of shares thereof and the preferences,
limitations and relative rights, including voting rights, of the shares
of such series and the qualifications, limitations and restrictions
thereof are as follows:
SERIES C PREFERENCE STOCK
1. Designation and Amount. There shall be a series of
Preference Stock that shall be designated as "Series C Preference Stock," and
the number of shares constituting such series shall be 1,575. Such number of
shares may be increased or decreased by resolution of the Board of Directors;
provided, however, that no decrease shall reduce the number of shares of Series
C Preference Stock to less than the number of shares then issued and outstanding
plus the number of shares issuable upon exercise of outstanding rights, options
or warrants or upon conversion of outstanding securities issued by the
Corporation.
-1-
<PAGE> 2
2. Certain Defined Terms.
Capitalized terms not otherwise defined herein shall have the
respective meanings ascribed to them in that certain Credit Agreement (the
"Credit Agreement") to be entered into among Houston Industries FinanceCo II,
LP, a Delaware limited partnership to be the Borrower thereunder, Houston
Industries Incorporated, a Texas corporation, and the Bank(s) parties thereto,
including Credit Suisse First Boston, as the Initial Bank thereunder, as in
effect at the time of the initial funding thereunder, and as such terms may be
amended in the Credit Agreement to the extent approved by the affirmative vote
of the holders of two-thirds or more of the outstanding shares of Series C
Preference Stock, voting separately as a class. In addition, the following terms
are used herein as defined below:
(i) "Computed Dividend Portion" means, within any
Dividend Interval Period, an amount equal to the interest expense
accrued on the indebtedness for borrowed money of the Borrower from the
prior Dividend Payment Date to the Determination Date for the current
Dividend Interval Period.
(ii) "Determination Date" means the date occurring
five Business Days prior to a Dividend Declaration Date.
(iii) "Dividend" means the dividend on the Series C
Preference Stock declared by the Corporation's Board of Directors with
respect to a Dividend Interval Period.
(iv) "Dividend Declaration Amount" means, as of any
Determination Date, the Preliminary Dividend Amount, less the sum of
(a) the Interest Reconciliation Amount, (b) the Support Agreement
Reconciliation Amount, and (c) the Other Sources Reconciliation Amount.
The Dividend Declaration Amount may be greater than or less than the
Preliminary Dividend Amount.
(v) "Dividend Declaration Date" means the date on
which Dividends on the Series C Preference Stock are declared (or would
have been declared but for the fact that the amount of the Dividend
determined in accordance herewith would have been zero) during a
Dividend Interval Period by the Corporation's Board of Directors.
(vi) "Dividend Interval Period" means the period
beginning on a Dividend Payment Date and extending to the next Dividend
Payment Date.
(vii) "Dividend Payment Date" means the date
occurring five Business Days after a Dividend Declaration Date.
(viii) "Interest Reconciliation Amount" means an
amount equal to (a) the Preliminary Dividend Amount computed for the
prior Dividend Interval Period, less (b) the actual interest expense
accrued on the indebtedness for borrowed money of the Borrower during
such period.
-2-
<PAGE> 3
(ix) "Other Sources Reconciliation Amount" means the
sum of (a) to the extent applied to pay interest on the indebtedness
for borrowed money of the Borrower or available in cash on the current
Determination Date therefor, the amount of income or cash proceeds
received by the Borrower from sources other than pursuant to the
Support Agreement (including, without limitation, interest received on
loans to Affiliates), and (b) the cash proceeds of new borrowings under
the Credit Agreement that are utilized to pay interest on outstanding
borrowings thereunder, from the Determination Date occurring in the
Prior Dividend Interval Period to the Determination Date occurring in
the current Dividend Interval Period.
(x) "Preliminary Dividend Amount" means the sum of
the Computed Dividend Portion and the Projected Dividend Portion.
(xi) "Projected Dividend Portion" means, within any
Dividend Interval Period, an amount equal to the projected interest
expense that will be accrued on the indebtedness for borrowed money of
the Borrower from the Determination Date for such Dividend Interval
Period to the Dividend Payment Date.
(xii) "Support Agreement Reconciliation Amount" means
the amount of cash payments made pursuant to the Support Agreement by
the Corporation to the Borrower from the Determination Date occurring
in the immediately prior Dividend Interval Period to the Determination
Date occurring in the current Dividend Interval Period.
3. Dividends and Distributions.
(A) Subject to the prior and superior rights of the holders of
(i) any shares of any series of Preference Stock ranking prior and superior to
the shares of Series C Preference Stock with respect to dividends and (ii) any
shares of Preferred Stock, the holders of shares of Series C Preference Stock,
in preference to the holders of shares of any class or series of stock of the
Corporation ranking junior to the Series C Preference Stock, shall be entitled
to receive the amounts set forth below, when, as and if declared by the Board of
Directors in the manner described below out of assets of the Corporation legally
available for the purpose:
(a) On every regularly scheduled meeting of the
Corporation's Board of Directors while any shares of Series C
Preference Stock remain outstanding, the Board of Directors shall
declare an aggregate Dividend (if a positive amount) equal the lesser
of (i) the Dividend Declaration Amount or (ii) the Excess Cash Flow
projected to be available as of the applicable Dividend Payment Date
with respect to the then current Dividend Interval Period.
(b) If, with respect to any Dividend Interval Period,
the aggregate Dividend declared by the Corporation's Board of Directors
is less than the Dividend Declaration Amount for such Dividend Interval
Period because the Excess Cash Flow projected to be available as of the
applicable Dividend Payment Date is less than the Dividend Declaration
Amount, the amount of such deficiency shall be added to the Dividend
Declaration Amount computed for the next Dividend Interval Period and
such aggregate amount shall become the
-3-
<PAGE> 4
Dividend Declaration Amount for such period. The Dividend for such
succeeding Dividend Interval Period shall equal the Dividend
Declaration Amount unless such amount would exceed the Excess Cash Flow
projected to be available as of the applicable Dividend Payment Date,
in which case the Dividend shall be the amount of the projected Excess
Cash Flow.
(c) The aggregate Dividends paid on the shares of
Series C Preference Stock in accordance with this Section 3(A) shall be
allocated pro rata on a share-by-share basis among all such shares at
the time outstanding.
(B) Accrued but unpaid dividends shall not bear interest. The
Board of Directors may fix a record date for the determination of holders of
shares of Series C Preference Stock entitled to receive payment of a dividend or
distribution declared thereon.
4. Voting Rights. Except as otherwise required by law or the
Restated Articles of Incorporation of the Corporation or as otherwise provided
herein, the holders of shares of Series C Preference Stock shall have no voting
rights.
5. Certain Restrictions. At any time when dividends or
distributions payable on the Series C Preference Stock as provided in Section 3
are in arrears, thereafter and until all accrued and unpaid dividends and
distributions, whether or not declared, on shares of Series C Preference Stock
outstanding shall have been paid in full, the Corporation shall not:
(i) declare dividends on, or redeem or purchase or
otherwise acquire for consideration any shares of stock ranking junior
(either as to dividends or upon liquidation, dissolution or winding up)
to the Series C Preference Stock; or
(ii) declare dividends on any shares of stock ranking
on a parity (either as to dividends or upon liquidation, dissolution or
winding up) with the Series C Preference Stock, except dividends
declared ratably on the Series C Preference Stock and all such parity
stock on which dividends are payable or in arrears in proportion to the
total amounts to which the holders of all such shares are then
entitled.
6. Reacquired Shares. Any shares of Series C Preference Stock
purchased or otherwise acquired by the Corporation in any manner whatsoever
shall be retired and canceled promptly after the acquisition thereof. All such
shares shall upon their cancellation become authorized but unissued shares of
Preference Stock and may be reissued as part of a new series of Preference Stock
to be created by resolution or resolutions of the Board of Directors, subject to
any conditions and restrictions on issuance set forth herein.
7. Liquidation, Dissolution or Winding Up.
(A) Upon any liquidation (voluntary or otherwise), dissolution
or winding up of the Corporation, no distribution shall be made to the holders
of shares of stock ranking junior (either as to dividends or upon liquidation,
dissolution or winding up) to the Series C Preference Stock unless, prior
thereto, the holders of shares of Series C Preference Stock shall have received
$100,000 per
-4-
<PAGE> 5
share, plus an amount equal to accrued and unpaid dividends and distributions
thereon, whether or not declared, to the date of such payment (the "Series C
Liquidation Preference"). Following the payment of the full amount of the Series
C Liquidation Preference, no additional distributions shall be made to the
holders of shares of Series C Preference Stock.
(B) In the event that there are not sufficient assets
available to permit payment in full of the Series C Liquidation Preference and
the liquidation preferences of all other series of Preference Stock, if any,
that rank on a parity with the Series C Preference Stock, then such remaining
assets shall be distributed ratably to the holders of such parity shares in
proportion to their respective liquidation preferences.
(C) Neither the merger or consolidation of the Corporation
into or with another corporation nor the merger or consolidation of any other
corporation into or with the Corporation shall be deemed to be a liquidation,
dissolution or winding up of the Corporation within the meaning of this Section
7, but the sale, lease or conveyance of all or substantially all of the
Corporation's assets shall be deemed to be a liquidation, dissolution or winding
up of the Corporation within the meaning of this Section 7.
8. Redemption.
(A) The Corporation, at its option, may redeem shares of the
Series C Preference Stock in whole at any time and in part from time to time, at
a redemption price equal to $100,000 per share, plus, in the event all
outstanding shares of the Series C Preference Shares are to be redeemed, unpaid
accumulated dividends to the date of redemption.
(B) In the event that fewer than all the outstanding shares of
the Series C Preference Stock are to be redeemed, (i) the number of shares to be
redeemed shall be determined by the Board of Directors and the shares to be
redeemed shall be determined by lot or pro rata as may be determined by the
Board of Directors or by any other method that may be determined by the Board of
Directors in its sole discretion to be equitable.
(C) Except to the extent notice is waived in accordance with
applicable law, notice of any such redemption shall be given by mailing to the
holders of the shares of Series C Preference Stock to be redeemed a notice of
such redemption, first class postage prepaid, not later than the twentieth day
and not earlier than the sixtieth day before the date fixed for redemption, at
their last address as the same shall appear upon the books of the Corporation.
Each such notice shall state: (i) the redemption date; (ii) the number of shares
to be redeemed and, if fewer than all the shares held by such holder are to be
redeemed, the number of such shares to be redeemed from such holder; (iii) the
redemption price; (iv) the place or places where certificates for such shares
are to be surrendered for payment of the redemption price; and (v) that
dividends on the shares to be redeemed will cease to accrue on the close of
business on such redemption date. Any notice that is mailed in the manner herein
provided shall be conclusively presumed to have been duly given, whether or not
the shareholder received such notice, and failure duly to give such notice by
mail, or any defect in such notice, to any holder of Series C Preference Stock
shall not affect the validity of the proceedings for the redemption of any other
shares of Series C Preference Stock that are to be redeemed. On or after the
date fixed for redemption as stated in such notice, each holder of the
-5-
<PAGE> 6
shares called for redemption shall surrender the certificate evidencing such
shares to the Corporation at the place designated in such notice and shall
thereupon be entitled to receive payment of the redemption price. If fewer than
all the shares represented by any such surrendered certificate are redeemed, a
new certificate shall be issued representing the unredeemed shares.
(D) The shares of Series C Preference Stock shall not be
subject to the operation of any purchase, retirement or sinking fund.
9. Ranking. The Series C Preference Stock shall rank junior to
all series of the Corporation's Preferred Stock and pari passu with all other
series of the Corporation's Preference Stock (other than any such series of
Preference Stock the terms of which shall provide otherwise) in respect to
dividend and liquidation rights and shall rank senior to the Common Stock as to
such matters.
10. Amendment. At any time that any shares of Series C
Preference Stock are outstanding, the Restated Articles of Incorporation of the
Corporation shall not be amended in any manner which would materially alter or
change the powers, preferences or special rights of the Series C Preference
Stock so as to affect them adversely without the affirmative vote of the holders
of two-thirds or more of the outstanding shares of Series C Preference Stock,
voting separately as a class.
11. Fractional Shares. Series C Preference Stock may be issued
in fractions of a share that shall entitle the holder, in proportion to such
holder's fractional shares, to exercise any voting rights, receive dividends,
participate in distributions and to have the benefit of all other rights of
holders of Series C Preference Stock.
IN WITNESS WHEREOF, HOUSTON INDUSTRIES INCORPORATED has
caused this Statement to be executed on its behalf by the undersigned officer
this 27th day of March, 1998.
HOUSTON INDUSTRIES INCORPORATED
/s/ Marc Kilbride
-----------------------------------
Name: Marc Kilbride
Title: Treasurer
-6-
<TABLE> <S> <C>
<ARTICLE> UT
<CIK> 0000048732
<NAME> HOUSTON INDUSTRIES INCORPORATED
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
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<TOTAL-ASSETS> 18,351,882
<COMMON> 2,888,732
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0
9,740
<LONG-TERM-DEBT-NET> 5,874,889
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<TABLE> <S> <C>
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<CIK> 0001042773
<NAME> NORAM ENERGY CORP.
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,308,159
<OTHER-PROPERTY-AND-INVEST> 1,427,535
<TOTAL-CURRENT-ASSETS> 1,019,509
<TOTAL-DEFERRED-CHARGES> 2,220,877
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 5,976,080
<COMMON> 1
<CAPITAL-SURPLUS-PAID-IN> 2,459,576
<RETAINED-EARNINGS> 81,453
<TOTAL-COMMON-STOCKHOLDERS-EQ> 2,541,030
0
0
<LONG-TERM-DEBT-NET> 1,226,461
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 300,000
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 230,590
0
<CAPITAL-LEASE-OBLIGATIONS> 0
<LEASES-CURRENT> 0
<OTHER-ITEMS-CAPITAL-AND-LIAB> 1,677,999
<TOT-CAPITALIZATION-AND-LIAB> 5,976,080
<GROSS-OPERATING-REVENUE> 1,759,931
<INCOME-TAX-EXPENSE> 56,353
<OTHER-OPERATING-EXPENSES> 1,618,360
<TOTAL-OPERATING-EXPENSES> 1,618,360
<OPERATING-INCOME-LOSS> 141,571
<OTHER-INCOME-NET> 2,556
<INCOME-BEFORE-INTEREST-EXPEN> 144,127
<TOTAL-INTEREST-EXPENSE> 26,900
<NET-INCOME> 60,606
0
<EARNINGS-AVAILABLE-FOR-COMM> 60,606
<COMMON-STOCK-DIVIDENDS> 0
<TOTAL-INTEREST-ON-BONDS> 26,900
<CASH-FLOW-OPERATIONS> 177,438
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
<PAGE> 1
EXHIBIT 99(a)
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
These and other pro forma results appearing in this Form 10-K 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
combined results that would have resulted had the Merger occurred at the
beginning of the 1996 and 1997 reporting periods presented. Purchase related
adjustments to results of operations include amortization of goodwill and the
effects on depreciation, amortization, interest expense and deferred income
taxes of the revaluation, on a preliminary basis, of the fair value of certain
NorAm assets and liabilities.
As a result of the Merger, the Company has organized its financial
reporting into the following segments: Electric Operations, Natural Gas
Distribution, Interstate Pipeline, Energy Marketing, International and
Corporate. For segment information, see Note 15.
(c) Regulatory Assets and Other Long-Lived Assets.
The Company and certain subsidiaries of NorAm apply the accounting policies
established in SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," to the accounts of Electric Operations, Natural Gas Distribution
and the Interstate Pipeline operations of MRT. In general, SFAS No. 71 permits a
company with cost-based rates to defer certain costs that would otherwise be
expensed to the extent that the rate regulated company is recovering or expects
to recover such costs in rates charged to its customers.
The following is a list of regulatory assets and liabilities reflected on
the Company's Consolidated Balance Sheet as of December 31, 1997, detailed by
Electric Operations and other segments.
<TABLE>
<CAPTION>
ELECTRIC TOTAL
OPERATIONS OTHER COMPANY
---------- ----- -------
(MILLIONS OF DOLLARS)
<S> <C> <C> <C>
Deferred plant costs -- net............................. $ 562 $ 562
Recoverable project costs -- net........................ 78 78
Regulatory tax asset -- net............................. 357 357
Unamortized loss on reacquired debt..................... 127 127
Deferred debits......................................... 71 $48 119
Accumulated deferred income taxes -- regulatory tax
asset................................................. (99) (99)
------ --- ------
Total......................................... $1,096 $48 $1,144
====== === ======
</TABLE>
If, as a result of changes in regulation or competition, the Company and
NorAm's ability to recover these assets and/or liabilities would not be assured,
then pursuant to SFAS No. 101, "Accounting for the Discontinuation of
Application of SFAS No. 71" and SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company and
NorAm would be required to write off or write down such net regulatory assets to
the extent that they ultimately were determined not to be recoverable.
Effective January 1, 1996, the Company and NorAm adopted SFAS No. 121. SFAS
No. 121 requires that long-lived assets and certain identifiable intangibles to
be held and used or disposed of by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Adoption of the standard did not result in a write-down
of the carrying amount of any asset on the books of the Company or NorAm.
In July 1997, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on Issue No. 97-4, "Deregulation of the Pricing of
Electricity -- Issues Related to the Application of FASB Statements No. 71,
Accounting for the Effects of Certain Types of Regulation, and No. 101,
Regulated Enterprises -- Accounting for the Discontinuation of Application of
FASB Statement No. 71" (EITF 97-4). EITF 97-4 concluded that the application of
SFAS No. 71 to a segment which is subject to a deregulation
64
<PAGE> 2
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
reporting period, the options' exercise prices were greater than the average
market price of the common shares of $21.875 and would thus be anti-dilutive if
conversion were assumed.
(k) Statements of Consolidated Cash Flows.
For purposes of reporting cash flows, cash equivalents are considered to be
short-term, highly liquid investments readily convertible to cash.
(l) Derivative Financial Instruments (Risk Management).
For information regarding the Company's accounting for derivative financial
instruments associated with its subsidiaries' natural gas, electric power and
transportation risk management activities, see Note 2.
(m) Income Taxes.
The Company and its subsidiaries file a consolidated federal income tax
return. The Company follows a policy of comprehensive interperiod income tax
allocation. Investment tax credits were deferred and are being amortized over
the estimated lives of the related property. For additional information
regarding income taxes, see Note 11.
(n) Investments in Time Warner Securities.
The Company owns 11 million shares of non-publicly traded Time Warner
convertible preferred stock (TW Preferred). The TW Preferred is redeemable after
July 6, 2000, has an aggregate liquidation preference of $100 per share (plus
accrued and unpaid dividends), is entitled to annual dividends of $3.75 per
share until July 6, 1999, is currently convertible by the Company and after July
6, 1999 is exchangeable by Time Warner into approximately 22.9 million shares of
Time Warner common stock. Each share of preferred stock is entitled to two votes
(voting together with the holders of the Time Warner common stock as a single
class).
The Company has recorded its investment in these securities at a value of
$990 million on the Company's Consolidated Balance Sheets. Investment in the TW
Preferred is accounted for under the cost method. Dividends on these securities
are recognized as income at the time they are earned. The Company recorded
pre-tax dividend income with respect to the Time Warner securities of $41.3
million, $41.6 million and $20.1 million in 1997, 1996 and 1995, respectively.
To monetize its investment in the TW Preferred, the Company sold in July
1997, 22.9 million of its unsecured 7% ACES. For additional information about
the offering of ACES, see Note 8(e). As a result of the issuance of the ACES, a
portion of the increase in the market value above $55.5844 per share of Time
Warner common stock (the security into which the TW Preferred is convertible)
results in unrealized accounting losses to the Company for the ACES, pending the
conversion of the Company's TW Preferred into Time Warner common stock. For
example, prior to the conversion of the TW Preferred into Time Warner common
stock, when the market price of Time Warner common stock increases above
$55.5844, the Company records in Other Income (Expense) an accounting loss for
the ACES equal to (i) the aggregate amount of such increase as applicable to all
ACES multiplied by (ii) 0.8264. In accordance with generally accepted accounting
principles, this accounting loss (which reflects the unrealized increase in the
Company's indebtedness with respect to the ACES) may not be offset by accounting
recognition of the increase in the market value of the Time Warner common stock
that underlies the TW Preferred. Upon conversion of the TW Preferred, the
Company will begin recording unrealized net changes in the market prices of the
Time Warner common stock and the ACES as a component of common stock equity.
As of December 31, 1997, the market price of Time Warner common stock was
$62.00 per share. Accordingly, the Company recognized an increase of $121
million in the unrealized liability relating to its ACES indebtedness (which
resulted in an after-tax earnings reduction of $79 million or $.31 per share).
The
68
<PAGE> 3
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Company believes that this unrealized loss for the ACES is more than
economically hedged by the approximately $430 million unrecorded unrealized gain
at December 31, 1997 relating to the increase in the fair value of the Time
Warner common stock underlying the investment in TW Preferred since the date of
its acquisition. As of February 28, 1998, the price of Time Warner common stock
was $67.50 per share which would have resulted in the Company recognizing an
additional increase of $104 million in the unrealized liability represented by
its indebtedness under the ACES. The related unrecorded unrealized gain as of
February 28, 1998 would have been computed as an additional $126 million.
(o) Investment in Other Debt and Equity Securities.
The securities held in the Company's nuclear decommissioning trust are
classified as "available-for-sale" and, in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," (SFAS No.
115) are reported at estimated fair value of $92.9 million as of December 31,
1997 and $67 million as of December 31, 1996 on the Company's Consolidated
Balance Sheets under deferred debits. The liability for nuclear decommissioning
is reported on the Company's Consolidated Balance Sheets under deferred credits.
Any unrealized gains or losses are accounted for in accordance with SFAS No. 71
as a regulatory asset/liability and reported on the Company's Consolidated
Balance Sheets as a deferred debit/ credit.
The Company, through its subsidiary, NorAm, holds certain equity securities
classified as "available-for-sale" and in accordance with SFAS No. 115 reports
such investments at estimated fair values on the Company's Consolidated Balance
Sheets as deferred debits and any unrealized gain or loss, net of tax, as a
separate component of stockholders' equity. At December 31, 1997, the unrealized
loss relating to these equity securities was approximately $5.6 million, net of
tax.
(p) Discontinued Operations.
In July 1995, the Company sold KBLCOM, its cable television subsidiary. The
Company's 1995 earnings include a one-time after-tax gain of $708 million
related to the sale, which includes the net loss for discontinued operations of
KBLCOM through the date of sale (July 6, 1995).
(q) Reclassifications and Use of Estimates.
Certain amounts from the previous years have been reclassified to conform
to the 1997 presentation of financial statements. Such reclassifications do not
affect earnings.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(r) Other.
For information regarding executive incentive compensation, pensions and
other benefits, see Note 10.
(2) DERIVATIVE FINANCIAL INSTRUMENTS (RISK MANAGEMENT)
(a) Trading Activities.
The Company, through NES, a subsidiary of NorAm, offers price risk
management services primarily in the natural gas and electric industries. NES
provides these services through, and by utilizing, a variety of derivative
financial instruments, including fixed-price swap agreements, variable-price
swap agreements,
69
<PAGE> 4
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
exchange-traded energy futures and option contracts, and swaps and options
traded in the over-the-counter financial markets. 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 either industry pricing
publications or exchange quotations.
Certain trading transactions qualify 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, NES uses
mark-to-market accounting. Accordingly, such financial instruments are recorded
at fair value with realized and unrealized gains (losses) recorded as a
component of operating revenues in the Company's Consolidated Statements of
Income. The recognized, unrealized balance is recorded as a deferred debit on
the Company's Consolidated Balance Sheets.
The notional quantities and maximum terms of derivative financial
instruments held for trading purposes at December 31, 1997 are presented below
(volumes in billions of British thermal units equivalent (Bbtue)):
<TABLE>
<CAPTION>
VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
PRICE PAYOR RECEIVER TERM (YEARS)
------------ ------------ ------------
<S> <C> <C> <C>
Natural gas...................................... 85,701 64,890 4
Electricity...................................... 40,511 42,976 1
</TABLE>
In addition to the fixed-price notional volumes above, NES also has
variable-price swap agreements, as discussed above, totaling 101,465 Bbtue.
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.
The estimated fair value of derivative financial instruments held for
trading purposes at December 31, 1997 are presented below (dollars in millions):
<TABLE>
<CAPTION>
AVERAGE FAIR
FAIR VALUE VALUE(A)
--------------------- ---------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Natural gas.................................. $46 $39 $56 $48
Electricity.................................. $ 6 $ 6 $ 3 $ 2
</TABLE>
- ---------------
(a) Computed using the ending balance of each month.
Substantially all of the fair value shown in the table above at December
31, 1997 has been recognized in income. The fair value as of and for the year
ended December 31, 1997 was estimated using quoted prices where available and
considering the liquidity of the market for the derivative financial
instruments. The prices are subject to significant changes based on changing
market conditions. The derivative financial instruments included in the NES
trading portfolio as of and for the year ended December 31, 1996 were
immaterial.
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.
70
<PAGE> 5
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(b) Non-Trading Activities.
To reduce the risk from market fluctuations in the price of electric power,
natural gas and related transportation, NorAm and certain of its subsidiaries
enter into futures transactions, swaps and options (Energy Derivatives) in order
to hedge certain natural gas in storage, as well as certain expected purchases,
sales and transportation of natural gas and electric power (a portion of which
are firm commitments at the inception of the hedge). Energy Derivatives are also
utilized to fix the price of compressor fuel or other future operational gas
requirements, although usage to date for this purpose has not been material.
Usage of electricity derivative financial instruments by the Company and its
subsidiaries for purposes other than trading is immaterial.
Certain subsidiaries of the Company also utilize interest-rate derivatives
(principally interest-rate swaps) in order to adjust the portion of its overall
borrowings which are subject to interest-rate risk, and also utilize such
derivatives to effectively fix the interest rate on debt expected to be issued
for refunding purposes.
For transactions involving either Energy Derivatives or interest-rate
derivatives, hedge accounting is applied only if the derivative (i) reduces the
price risk of the underlying hedged item and (ii) is designated as a hedge at
its inception. Additionally, the derivatives must be expected to result in
financial impacts which 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
a 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.
In the case of interest-rate swaps associated with existing obligations,
cash flows and expenses associated with the interest-rate derivative
transactions are matched with the cash flows and interest expense of the
obligation being hedged, resulting in an adjustment to the effective interest
rate. When interest rate swaps are utilized to effectively fix the interest rate
for an anticipated debt issuance, changes in the market value of the
interest-rate derivatives are deferred and recognized as an adjustment to the
effective interest rate on the newly issued debt.
Unrealized changes in the market value of Energy Derivatives utilized as
hedges are not generally recognized in the Company's Consolidated Statements of
Income until the underlying hedged transaction occurs. Once it becomes probable
that an anticipated transaction will not occur, deferred gains and losses are
recognized. In general, the financial impact of transactions involving these
Energy Derivatives is included in the Company's Statement of Consolidated Income
under the captions (i) fuel expenses, in the case of natural gas transactions,
and (ii) purchased power, in the case of electric power transactions. Cash flows
resulting from these transactions in Energy Derivatives are included in the
Company's Statements of Consolidated Cash Flows in the same category as the item
being hedged.
At December 31, 1997, subsidiaries of NorAm were fixed-price payors and
fixed-price receivers in Energy Derivatives covering 38,754 Bbtu and 7,647 Bbtu
of natural gas, respectively. Also, at December 31, 1997 subsidiaries of NorAm
were parties to variable-priced Energy Derivatives totaling 3,630 Bbtu of
natural gas. The weighted average maturity of these instruments is less than one
year.
The notional amount is intended to be indicative of the Company and its
subsidiaries' level of activity in such derivatives, although 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
closed as further discussed below. Under such circumstances, gains (losses) are
deferred and recognized as a component of income when the underlying hedged item
is recognized in income.
71
<PAGE> 6
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The average maturity discussed above and the fair value discussed in Note
13 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 with respect 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 and its subsidiaries' risk management activities.
Credit risk relates to the risk of loss resulting from non-performance of
contractual obligations by a counterparty. While, as yet, the Company and its
subsidiaries have experienced no significant losses due to the credit risk
associated with these arrangements, 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 such contract. In order to minimize this risk, the
Company and/or its subsidiaries, as the case may be, enter into such contracts
primarily with those counterparties with a minimum Standard & Poor's or Moody's
rating of BBB- or Baa3, respectively. For long-term arrangements, the Company
and its subsidiaries periodically review the financial condition of such firms
in addition to monitoring the effectiveness of these financial contracts in
achieving the Company's objectives. Should the counterparties to these
arrangements fail to perform, the Company would seek to compel performance at
law or otherwise, or obtain compensatory damages in lieu thereof. The Company
might be forced to acquire alternative hedging arrangements or be required to
honor the underlying commitment at then current market prices. In such event,
the Company might incur additional loss 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.
The Company has established a Risk Oversight Committee to oversee all
corporate price and credit risk, including NES' risk management and trading
activities. The Risk Oversight Committee's responsibilities include reviewing
the Company and its subsidiaries' overall risk management strategy and
monitoring risk management activities to ensure compliance with the Company's
risk management limitations, policies and procedures.
(3) RATE MATTERS
(a) Electric Proceedings.
The Texas Utility Commission has original (or in some cases appellate)
jurisdiction over Electric Operations' electric rates and services. Texas
Utility Commission orders may be appealed to a District Court in Travis County,
and from that court's decision an appeal may be taken to the Court of Appeals
for the 3rd District at Austin (Austin Court of Appeals). Discretionary review
by the Supreme Court of Texas may be sought from decisions of the Austin Court
of Appeals. In the event that the courts ultimately reverse actions of the Texas
Utility Commission, such matters are remanded to the Texas Utility Commission
for action in light of the courts' orders.
(b) Transition and Price Reduction Plan.
In 1997, the Texas legislature considered but did not pass legislation
intended to address various issues concerning the restructuring of the electric
utility industry, including proposals that would permit Texas retail electric
customers to choose their own electric suppliers beginning on December 31, 2001.
The legislative proposals included provisions relating to full stranded cost
recovery; rate reductions; rate freezes; the
72
<PAGE> 7
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
unbundling of generation operations, transmission and distribution and customer
service operations; securitization of regulatory assets; and consumer
protections. Although the Company and certain other parties (including the Texas
Utility Commission) supported the bill, it was not enacted prior to the
expiration of the legislative session.
In October 1997, the Company announced a proposed transition to competition
plan intended to address certain aspects of the proposals contained in the
legislation formerly pending before the Texas legislature. By mid December 1997,
negotiations resulted in a settlement agreement (Settlement Agreement) executed
by the Company, the staffs of the Texas Utility Commission and the City of
Houston, representatives of the state's principal consumer and industrial groups
and others. The Settlement Agreement was subsequently filed with the Texas
Utility Commission, where it is currently under consideration.
Under the terms of the Settlement Agreement, residential customers will
receive a 4% credit to the base cost of electricity in 1998, increasing to 6% in
1999. Small and mid-sized businesses will receive a 2% credit to their base
costs beginning in 1998. The combined effect of these reductions is expected to
decrease base revenues by $166 million over a two year period. In addition, the
Company (over the next two years) will be permitted, as a way to assist the
Company in mitigating its potentially stranded costs, to (i) redirect to
production property all of its current depreciation expenses that would
otherwise be credited to accumulated depreciation for transmission and
distribution property, and (ii) apply any and all earnings above a rate of
return cap of 9.95% to increase the depreciation of production property. The
Company estimates that redirected depreciation over the two-year period of 1998
and 1999 will be approximately $364 million. As part of the Settlement
Agreement, the Company agreed to support proposed legislation in the 1999 Texas
legislative session that includes provisions providing for retail customer
choice effective December 31, 2001 and other provisions consistent with those in
the 1997 proposed legislation.
The Settlement Agreement is currently under consideration by the Texas
Utility Commission, the City of Houston and other cities served by HL&P. In
December 1997, the Texas Utility Commission approved the petition filed by the
Company to implement the requested base rate credits on a temporary basis
beginning January 1, 1998, and pending final Texas Utility Commission
consideration. The approval also included the accounting order necessary to
permit the Company to begin redirecting depreciation from its transmission and
distribution facilities to production property on a temporary basis pending
final Texas Utility Commission consideration. A procedural schedule has been
developed by the Texas Utility Commission whereby a final decision regarding the
Settlement Agreement would be reached by the end of March 1998.
(c) 1995 Rate Case.
In August 1995, the Texas Utility Commission unanimously approved a
settlement resolving the Company's most recent rate case (Docket No. 12065) as
well as a separate proceeding (Docket No. 13126) regarding the prudence of
operation of the South Texas Project.
See Note 1(f) regarding additional depreciation and amortization that is
permitted under the 1995 Rate Case Settlement with respect to the South Texas
Project and the Company's investment in certain lignite reserves associated with
a canceled generating station.
(d) Docket No. 6668.
In September 1997, the Company received a judgment dismissing all
outstanding appeals of the Texas Utility Commission's order in Docket No. 6668,
an inquiry into the prudence of the planning and construction of the South Texas
Project. In that order, the Texas Utility Commission had determined that $375.5
million of the Company's $2.8 billion investment in the South Texas Project had
been imprudently incurred. That ruling was incorporated into Electric
Operations' 1988 and 1991 rate cases. As a result of this judgment, all
73
<PAGE> 8
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
outstanding appeals of prior rate cases involving the Company have now been
dismissed and the orders granted in such cases are now final.
(4) JOINTLY OWNED ELECTRIC UTILITY PLANT
(a) Investment in South Texas Project.
The Company has a 30.8% interest in the South Texas Project, which consists
of two 1,250 MW nuclear generating units, and bears a corresponding 30.8% share
of capital and operating costs associated with the project. As of December 31,
1997, the Company's investment in the South Texas Project was $1.8 billion (net
of $714 million accumulated depreciation). The Company's investment in nuclear
fuel (including AFUDC) was $51 million (net of $205 million amortization) as of
such date.
Effective November 1997, the Company and the other three owners of the
South Texas Project completed the transfer of the Company's responsibilities for
operation of the South Texas Project to a new Texas non-profit corporation
formed by the four owners and known as the STP Nuclear Operating Company
(STPNOC). STPNOC was formed exclusively for the purpose of operating the South
Texas Project, and the Company's officers and employees who had been responsible
for day-to-day operation and management of the South Texas Project were
transferred to the operating company in October, 1997 and the related employee
benefit obligations were transferred in December, 1997. The operating company is
managed by a board of directors composed of one director from each of the four
owners, along with the chief executive officer of STPNOC. Formation of STPNOC
did not affect the underlying ownership of the South Texas Project, which
continues as a tenancy in common among the four owners, with each owner
retaining its undivided ownership interest in the two nuclear-fueled generating
units and the electrical output from those units. The four owners continue to
provide overall oversight of the operations of the South Texas Project through
an owners' committee composed of representatives of each of the owners and
through the board of directors of STPNOC.
(b) 1996 Settlement of South Texas Project Litigation.
In 1996, the Company recorded an aggregate $95 million ($62 million net of
tax) charge in connection with various settlements of lawsuits filed by
co-owners of the South Texas Project. The formation of STPNOC by the four
co-owners (including the Company) of the South Texas Project was contemplated by
these settlements. For information about the execution of an operations
agreement with the City of San Antonio in connection with one of these
settlements, see Note 12(c).
(c) Nuclear Insurance.
The Company and the other owners of the South Texas Project maintain
nuclear property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
This coverage consists of $500 million in primary property damage insurance and
excess property insurance in the amount of $2.25 billion. With respect to excess
property insurance, the Company and the other owners of the South Texas Project
are subject to assessments, the maximum aggregate assessment under current
policies being $11.5 million during any one policy year. The application of the
proceeds of such property insurance is subject to the priorities established by
the Nuclear Regulatory Commission (NRC) regulations relating to the safety of
licensed reactors and decontamination operations.
Pursuant to the Price Anderson Act (Act), the maximum liability to the
public of owners of nuclear power plants, such as the South Texas Project, was
$8.72 billion as of December 1997. Owners are required under the Act to insure
their liability for nuclear incidents and protective evacuations by maintaining
the
74
<PAGE> 9
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
maximum amount of financial protection available from private sources and by
maintaining secondary financial protection through an industry retrospective
rating plan. The assessment of deferred premiums provided by the plan for each
nuclear incident is up to $79.3 million per reactor, subject to indexing for
inflation, a possible 5% surcharge (but no more than $10 million per reactor per
incident in any one year) and a 3% state premium tax. The Company and the other
owners of the South Texas Project currently maintain the required nuclear
liability insurance and participate in the industry retrospective rating plan.
There can be no assurance that all potential losses or liabilities will be
insurable, or that the amount of insurance will be sufficient to cover them. Any
substantial losses not covered by insurance would have a material effect on the
Company's financial condition and results of operations.
(d) Nuclear Decommissioning.
The Company contributes $14.8 million per year to a trust established to
fund its share of the decommissioning costs for the South Texas Project. For a
discussion of securities held in the Company's nuclear decommissioning trust,
see Note 1(o). In May 1994, an outside consultant estimated the Company's
portion of decommissioning costs to be approximately $318 million (1994
dollars). The consultant's calculation of decommissioning costs for financial
planning purposes used the DECON methodology (prompt removal/dismantling), one
of the three alternatives acceptable to the NRC, and assumed deactivation of
Units Nos. 1 and 2 upon the expiration of their 40-year operating licenses.
While the current and projected funding levels currently exceed minimum NRC
requirements, no assurance can be given that the amounts held in trust will be
adequate to cover the actual decommissioning costs of the South Texas Project.
Such costs may vary because of changes in the assumed date of decommissioning,
changes in regulatory and accounting requirements, changes in technology and
changes in costs of labor, materials and equipment.
(e) Assessment Fees for Spent Fuel Disposal and Enrichment and Decommission
By contract, the United States Department of Energy (DOE) has committed
itself ultimately to take possession of all spent fuel generated by the South
Texas Project. The DOE contract currently requires payment of a spent fuel
disposal fee on nuclear plant-generated electricity of one mill (one-tenth of a
cent) per net KWH sold. This fee is subject to adjustment to ensure full cost
recovery by the DOE. The Energy Policy Act also includes a provision that
assesses a fee upon domestic utilities that purchased nuclear fuel enrichment
services from the DOE before October 24, 1992. The South Texas Project's
assessment is approximately $2 million per year (subject to escalation for
inflation). The Company has a remaining estimated liability of $5.5 million for
such assessments.
(5) EQUITY INVESTMENTS IN FOREIGN AFFILIATES
HI Energy, a wholly owned subsidiary of the Company formed in 1993,
participates primarily in the development and acquisition of foreign independent
power projects and the privatization of foreign generating and distribution
companies.
The Company accounts for affiliate investments of its subsidiaries under
the equity method of accounting where: (i) the subsidiary's ownership interest
in the affiliate ranges from 20% to 50%, (ii) the ownership interest is less
than 20% but the subsidiary exercises significant influence over operating and
financial policies of such affiliate or (iii) the subsidiary's ownership
interest in the affiliate exceeds 50% but the subsidiary does not exercise
control over the affiliate. The Company's proportionate share of the equity in
net income in these affiliates for the years ended December 31, 1997, 1996 and
1995 was $48.6 million, $17 million and $.5 million, respectively, which amounts
are included on the Company's Statements of Consolidated Income in
Revenues -- International.
75
<PAGE> 10
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company's and its subsidiaries' equity investments in foreign and
non-regulated affiliates at December 31, 1997 and 1996 were $704 million and
$502 million, respectively.
(a) Acquisitions.
In May 1996, a subsidiary of HI Energy acquired 11.35% of the common stock
of Light, a publicly held Brazilian corporation, for $393 million which includes
the direct costs of the acquisition. Light is the operator under a 30-year
concession agreement of an integrated electric power and distribution system
that serves a portion of the state of Rio de Janeiro, Brazil, including the city
of Rio de Janeiro. The winning bidders in the government-sponsored auction of
Light, including a subsidiary of HI Energy, formed a consortium whose aggregate
ownership interest of 50.44% represents a controlling interest in Light.
In June 1997, a consortium of investors which included a subsidiary of HI
Energy, acquired for $496 million a 56.7% controlling ownership interest in
Empresa de Energia del Pacifico S.A.E.S.P. (EPSA), an electric utility system
serving the Valle de Cauca region of Colombia, including the area surrounding
the city of Cali. HI Energy contributed $152 million of the purchase price for a
28% ownership interest in EPSA. In addition to its distribution facilities, EPSA
owns 850 MW of electric generation capacity.
In May 1997, HI Energy increased its indirect ownership interest in Empresa
de la Plata S.A. (EDELAP), an Argentina electric utility, from 48% to 63%. The
purchase price of the additional interest was $28 million. HI Energy has
recorded its investment in EDELAP using the equity method because of the
significance of the participatory rights held by a minority shareholder.
HI Energy has accounted for these transactions under purchase accounting
and has recorded its investments and its interest in the affiliates' earnings
after the acquisition dates using the equity method. The purchase prices were
allocated on the basis of the estimated fair market values of the assets
acquired and the liabilities assumed as of the dates of acquisition. The
differences between the amounts paid and the underlying fair values of the net
assets acquired are being amortized as a component of earnings attributable to
unconsolidated affiliates over the estimated lives of the projects ranging from
30 to 40 years. Purchase price adjustments to fixed assets are being amortized
over the underlying assets' estimated useful lives.
(b) Valuation Allowance.
HI Energy is an investor in two waste tire-to-energy projects in the State
of Illinois. The projects had been developed by HI Energy in reliance upon a
state subsidy intended to encourage development of energy project facilities for
the disposal of solid waste. In March 1996, the State of Illinois repealed the
subsidy. As a result of the loss of the subsidy, the Company recorded (i) a $28
million valuation allowance effective in the fourth quarter of 1995 (resulting
in an $18 million after-tax charge in that year) and (ii) an additional $8
million valuation allowance in the first quarter of 1996 (resulting in a $5
million after-tax charge in that year). At the time of the Illinois
legislature's actions, construction work on one of the waste-to-energy projects
had been substantially completed.
The valuation allowance reflects the combined amounts lent to the projects
on a subordinated basis by HI Energy. HI Energy also is a party to two separate
note purchase agreements committing it, under certain circumstances, to lend up
to an additional $16 million. The Company has entered into a support agreement
to enable HI Energy to honor its obligation under these note purchase
agreements. In the Company's opinion, it is unlikely that additional loans would
be required to be made under the note purchase agreements relating to the
facility for which construction had been substantially completed (Ford Heights
Project). In March 1996, a subsidiary of HI Energy purchased from a senior
lending bank all notes relating to the project for which construction had not
yet commenced (Fulton Project) (approximately $4.1 million). As a consequence,
HI Energy has discretion over when, if ever, the construction activities for the
Fulton project will
76
<PAGE> 11
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
resume and, in turn, control over future obligations of HI Energy to acquire
additional subordinated notes for the Fulton project.
The Company and HI Energy are defendants in various lawsuits filed in
connection with the Ford Heights Project. CGE Ford Heights, L.L.C., (CGE Ford
Heights) the owner of the project, has filed for reorganization under Chapter 11
of the Federal Bankruptcy Code. In October 1997, CGE Ford Heights filed a
lawsuit against First Trust National Association, HI Energy and Zurn Industries,
Inc. (Zurn). CGE Ford Heights is seeking a determination of the funding
obligations of HI Energy and Zurn. In addition, the trustee for the holders of
the bonds issued to finance the project has filed suit against the Company, HI
Energy and Zurn. The trustee alleges that the Company and HI Energy are
obligated to contribute to CGE Ford Heights approximately $15 million in the
form of subordinated debt obligations. The Company and HI Energy are vigorously
contesting the matter. The Company does not believe that the litigation will
have a material adverse impact on the Company's or HI Energy's financial
statements.
(6) COMMON STOCK
At December 31, 1997, the Company had 282,875,266 shares of common stock
issued and outstanding (out of a total of 700,000,000 authorized shares). At
December 31, 1996, the number of shares of outstanding common stock of Former HI
was 233,335,481.
Outstanding common shares excluded (i) shares pledged to secure a loan to
the Company's Employee Stock Ownership Plan (12,388,551 and 13,370,939 at
December 31, 1997 and 1996, respectively) and (ii) treasury shares (93,459 and
16,042,027 at December 31, 1997 and 1996, respectively). Treasury shares at
December 31, 1996 represent shares purchased under a common stock repurchase
program prior to the Merger. In connection with the Merger, these treasury
shares were canceled and retired in August 1997. At December 31, 1997, the
Company held 93,459 shares, which shares were received from holders of Company
stock options, who surrendered shares of Company stock as partial payment for
the exercise price of their stock options.
In 1997, the Company paid four regular quarterly dividends aggregating
$1.50 per share on its common stock pursuant to dividend declarations made in
December 1996, March 1997, June 1997 and September 1997. In December 1997, the
Company declared its regular quarterly dividend of $0.375 per share to be paid
in March 1998. For information regarding certain restrictions on payments of
dividends, see Note 8(c).
(7) PREFERRED AND PREFERENCE STOCK
(a) Preferred Stock.
At December 31, 1997, the Company had 10,000,000 authorized shares of
preferred stock, of which 97,397 shares were outstanding. As of such date, the
Company's only outstanding series of preferred stock was its $4.00 Preferred
Stock. The $4.00 Preferred Stock pays an annual dividend of $4.00 per share, is
redeemable at $105 per share and has a liquidation price of $100 per share.
In April 1997, the Company redeemed all remaining 257,000 shares of its
$9.375 cumulative preferred stock pursuant to mandatory sinking fund
requirements at a cost of $25.7 million, plus accrued dividends. In February
1997, the Company redeemed the following three series of its cumulative
preferred stock at the redemption prices, plus accrued dividends, indicated:
<TABLE>
<CAPTION>
NUMBER OF REDEMPTION PRICE
SERIES SHARES PER SHARE
------ --------- ----------------
<S> <C> <C>
$6.72.................................................... 250,000 $102.51
$7.52.................................................... 500,000 $102.35
$8.12.................................................... 500,000 $102.25
</TABLE>
77
<PAGE> 12
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
$6.4 million was recorded at the Acquisition Date. In addition, NorAm has
approximately $58 million of federal alternative minimum tax credits which are
available to reduce future federal income taxes payable, if any, over an
indefinite period (although not below the tentative minimum tax otherwise due in
any year), and approximately $2.6 million of state alternative minimum tax
credits which are available to reduce future state income taxes payable, if any,
through the year 2001.
(12) COMMITMENTS AND CONTINGENCIES
(a) Commitments.
The Company has various commitments for capital expenditures, fuel,
purchased power, cooling water and operating leases. Commitments in connection
with Electric Operations' capital program are generally revocable by the
Company, subject to reimbursement to manufacturers for expenditures incurred or
other cancellation penalties. The Company's and its subsidiaries' other
commitments have various quantity requirements and durations. However, if these
requirements could not be met, various alternatives are available to mitigate
the cost associated with the contracts' commitments.
(b) Fuel and Purchased Power.
The Company is a party to several long-term coal, lignite and natural gas
contracts which have various quantity requirements and durations. Minimum
payment obligations for coal and transportation agreements are approximately
$200 million in 1998, $203 million in 1999 and $177 million in 2000.
Additionally, minimum payment obligations for lignite mining and lease
agreements are approximately $9 million for 1998, $9 million for 1999 and $10
million for 2000. Minimum payment obligations for both natural gas purchase and
storage contracts associated with Electric Operations are approximately $9
million annually in 1998, 1999 and 2000.
The Company also has commitments to purchase firm capacity from
cogenerators of approximately $22 million in both 1998 and 1999. Texas Utility
Commission rules currently allow recovery of these costs through Electric
Operations' base rates for electric service and additionally authorize the
Company to charge or credit customers through a purchased power cost recovery
factor for any variation in actual purchased power costs from the cost utilized
to determine its base rates. In the event that the Texas Utility Commission, at
some future date, does not allow recovery through rates of any amount of
purchased power payments, the two principal firm capacity contracts contain
provisions allowing the Company to suspend or reduce payments and seek repayment
for amounts disallowed.
(c) Operations Agreement with City of San Antonio.
As part of the settlement with the City of San Antonio, the Company entered
into a 10-year joint operations agreement under which the Company and the City
of San Antonio, acting through the City Public Service Board of San Antonio
(CPS), share savings resulting from the joint dispatching of their respective
generating assets in order to take advantage of each system's lower cost
resources. Under the terms of the joint operations agreement entered into
between CPS and Electric Operations, the Company has guaranteed CPS minimum
annual savings of $10 million and a minimum cumulative savings of $150 million
over the 10-year term of the agreement. Based on current forecasts and other
assumptions regarding the combined operation of the two generating systems, the
Company anticipates that the savings resulting from joint operations will equal
or exceed the minimum savings guaranteed under the joint operating agreement. In
1996, savings generated for CPS' account for a partial year of joint operations
were approximately $14 million. In 1997, savings generated for CPS' account for
a full year of operation were approximately $22 million.
(d) Transportation Agreement.
NorAm had an agreement (the ANR Agreement) with ANR Pipeline Company (ANR)
which contemplated a transfer to ANR of an interest in certain of NorAm's
pipeline and related assets, representing
92
<PAGE> 13
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
capacity of 250 Mmcf/day, and pursuant to which ANR had advanced $125 million to
the Company. The ANR Agreement has been restructured and, after refunds of $84
million through December 31, 1997, NorAm currently retains $41 million (recorded
as a liability) in exchange for ANR's or its affiliates' use of 130 Mmcf/ day of
capacity in certain of NorAm'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 and the ANR Agreement will terminate in 2005 with a refund of the
remaining balance.
(e) Lease Commitments.
The following table sets forth certain information concerning NorAm's
obligations under operating leases:
Minimum Lease Commitments at December 31, 1997(1)
<TABLE>
<CAPTION>
(MILLIONS OF DOLLARS)
---------------------
<S> <C>
1998....................................................... $ 24
1999....................................................... 19
2000....................................................... 16
2001....................................................... 15
2002....................................................... 9
2003 and beyond............................................ 22
----
Total............................................ $105
====
</TABLE>
- ---------------
(1) Principally consisting of rental agreements for building space and data
processing equipment and vehicles (including major work equipment).
NorAm has a master leasing agreement which provides for the lease of
vehicles, construction equipment, office furniture, data processing equipment
and other property. For accounting purposes, the lease is treated as an
operating lease. At December 31, 1997, NorAm had leased assets with a value of
approximately $58.1 million under this lease with a basic term of one year.
NorAm does not expect to lease additional property under this lease agreement.
Lease payments related to NorAm's master leasing agreement are included in
the preceding table for only their basic term. Total rental expense for all
leases since the Acquisition Date was approximately $15 million in 1997.
(f) Letters of Credit.
At December 31, 1997, NorAm had letters of credit incidental with its
ordinary business operations totaling approximately $42 million under which
NorAm is obligated to reimburse drawings, if any.
(g) Indemnity Provisions.
At December 31, 1997, NorAm has $11.4 million accounting reserve on the
Company's Consolidated Balance Sheet in Other Deferred Credits for possible
indemnity claims asserted in connection with its disposition of NorAm's former
subsidiaries or divisions, including the sale of (i) Louisiana Intrastate Gas
Corporation, a former NorAm subsidiary engaged in the intrastate pipeline and
liquids extraction business; (ii) Arkla Exploration Company, a former NorAm
subsidiary engaged in oil and gas exploration and production activities; and
(iii) Dyco Petroleum Company, a former NorAm subsidiary engaged in oil and gas
exploration and production.
93
<PAGE> 14
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(h) Other.
Electric Operations' service area is heavily dependent on oil, gas, refined
products, petrochemicals and related businesses. Significant adverse events
affecting these industries would negatively affect the revenues of the Company.
The Company and NorAm are involved in legal, tax and regulatory proceedings
before various courts, regulatory commissions 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 and NorAm's respective financial statements, if any,
from the disposition of these matters will not be material.
In February 1996, the cities of Wharton, Galveston and Pasadena filed suit,
for themselves and a proposed class, against the Company and Houston Industries
Finance Inc. (formerly a wholly owned subsidiary of the Company) citing
underpayment of municipal franchise fees. The plaintiffs claim, among other
things, that from 1957 to the present, franchise fees should have been paid on
sales taxes collected by HL&P on non-electric receipts as well as electric
sales. Plaintiffs advance their claims notwithstanding their failure to notice
such claims over the previous four decades. Because all of the franchise
ordinances affecting HL&P expressly impose fees only on electric sales, the
Company regards plaintiffs' allegations as spurious and is vigorously contesting
the matter. The plaintiffs' pleadings assert that their damages exceed $250
million. No trial date is currently set. Although the Company believes the
claims to be without merit, the Company cannot at this time estimate a range of
possible loss, if any, from the lawsuit, nor can any assurance be given as to
its ultimate outcome
The Company is a party to litigation (other than that specifically noted)
which arises in the normal course of business. Management regularly analyzes
current information and, as necessary, provides accruals for probable
liabilities on the eventual disposition of these matters. Management believes
that the effect on the Company's financial statements, if any, from the
disposition of these matters will not be material.
94
<PAGE> 1
EXHIBIT 99(a)
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
depreciation and amortization as of the Acquisition Date and (6) the recognition
of the associated deferred income tax effects. In addition, NorAm's pre-merger
common stock was canceled and replaced with 1,000 shares of common stock (all of
which are owned by Houston Industries), rendering presentation of per share data
no longer meaningful. Houston Industries' debt to fund the cash portion of the
purchase consideration has not been allocated or "pushed down" to NorAm and is
not reflected on NorAm's Financial Statements.
NorAm's Statements of Consolidated Income for periods after the Acquisition
Date are principally affected by (1) the amortization (over 40 years) of the
newly-recognized goodwill, partially offset by the elimination of the
amortization of NorAm's historical goodwill, (2) the amortization (to interest
expense) of the revaluation of long-term debt, (3) the removal of the
amortization (to operating expense) previously associated with the pension and
postretirement obligations as described preceding and (4) the deferred income
tax expense associated with these adjustments. Interest expense on Houston
Industries' debt which was used to fund the cash portion of the acquisition has
not been allocated or "pushed down" to NorAm and is not reflected on NorAm's
Financial Statements. For these reasons, among others, certain financial
information for periods before and after the Acquisition Date is not comparable.
If the Merger had occurred on January 1, 1997 and 1996, NorAm's unaudited
pro forma net income for 1997 and 1996 would have been $68.3 million and $76.9
million, respectively. Pro forma results are based on assumptions deemed
appropriate by NorAm's management, have been prepared for informational purposes
only and are not necessarily indicative of the results which would have resulted
had the Merger actually taken place on the date indicated.
(c) Regulatory Assets and Regulation.
In general, NorAm's interstate pipelines are subject to regulation by the
Federal Energy Regulatory Commission, while its natural gas distribution
operations are subject to regulation at the state or municipal level.
Historically, all of NorAm's rate-regulated businesses have followed the
accounting guidance contained in Statement of Financial Accounting Standards
(SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation" .
NorAm discontinued application of SFAS No. 71 to NGT in 1992. As a result of the
continued application of SFAS No. 71 to MRT and the natural gas distribution
operations, NorAm's financial statements contain assets and liabilities which
would not be recognized by unregulated entities.
At December 31, 1997 approximately $48 million in regulatory assets are
reflected on NorAm's Consolidated Balance Sheet as deferred debits. These assets
represent probable future revenue to NorAm associated with certain incurred
costs as these costs are recovered through the rate making process. These costs
are being recovered through rates over varying periods up to 40 years.
(d) Principles of Consolidation.
NorAm's Consolidated Financial Statements include the accounts of NorAm and
its wholly owned subsidiaries (NorAm). All significant intercompany transactions
and balances are eliminated in consolidation.
(e) Property, Plant and Equipment.
Property, plant and equipment have been revalued to estimated fair market
value as of the Acquisition Date in accordance with the purchase method of
accounting, and depreciated or amortized on a straight-line basis over their
estimated useful lives; see Note 1(b) above. Prior to the Acquisition Date, such
assets were carried at cost. Additions to and betterments of utility property
are charged to property accounts at cost, while the costs of maintenance,
repairs and minor replacements are charged to expense as incurred. Upon normal
retirement of units of utility property, plant and equipment, the cost of such
property, together with cost of removal less salvage, is charged to accumulated
depreciation.
116
<PAGE> 2
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(f) Depreciation and Amortization Expense.
Goodwill, none of which is being recovered in regulated service rates, is
amortized on a straight-line basis over 40 years. Approximately $29.9 million of
goodwill was amortized during 1997. Of this amount, $21.6 million represents
amortization related to the Merger and incurred during the period from the
Acquisition Date through December 31, 1997. Goodwill amortization for 1996 was
approximately $14.2 million. NorAm periodically compares the carrying value of
its goodwill to the anticipated undiscounted future operating income from the
businesses whose acquisition gave rise to the goodwill and, as yet, no
impairment is indicated or expected. For additional information regarding the
amortization of goodwill in connection with the Merger, see Note 1(b) above.
(g) Fuel Stock and Other Inventories.
Inventories principally follow the average cost method. Gas inventory (at
average cost) was $63.7 million and $70.7 million at December 31, 1997 and 1996,
respectively. All non-utility inventories held for resale are valued at the
lower of cost or market.
(h) Revenues.
NorAm's rate-regulated divisions/subsidiaries bill customers on a monthly
cycle billing basis. Revenues are recorded on an accrual basis, including an
estimate for gas delivered but unbilled at the end of each accounting period.
(i) Statements of Consolidated Cash Flows.
For purposes of reporting cash flows, cash equivalents are considered to be
short-term, highly liquid investments readily convertible into cash.
(j) Derivative Financial Instruments (Risk Management).
For information regarding NorAm's accounting for derivative financial
instruments associated with natural gas, electric power and transportation risk
management activities, see Note 2.
(k) Income Taxes.
Houston Industries files a consolidated federal income tax return, in which
NorAm and its subsidiaries are included (as of the Acquisition Date). Houston
Industries follows a policy of comprehensive interperiod income tax allocation.
For additional information regarding income taxes, see Note 7.
(l) Investments in Marketable Equity Securities.
A subsidiary of NorAm holds certain equity securities classified as
"available-for-sale" and, in accordance with SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," reports such investments at
estimated fair value with any unrealized gain or loss, net of tax, as a separate
component of stockholders' equity. At December 31, 1997, NorAm's unrealized loss
relating to these marketable equity securities was approximately $5.6 million,
net of tax of $3.0 million.
(m) Reclassifications and Use of Estimates.
Certain amounts from the previous years have been reclassified to conform
to the 1997 presentation of financial statements. Such reclassifications do not
affect earnings.
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
117
<PAGE> 3
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
(n) Early Retirement and Severance.
During the first quarter of 1996, NorAm instituted several early retirement
and reorganization plans, pursuant to which a total of approximately 400
positions were eliminated resulting in expense for severance payments and
enhanced retirement benefits reported as a non-recurring pre-tax charge of
approximately $22.3 million (approximately $13.4 million after tax).
(o) Merger Transaction Costs.
"Merger transaction costs" include expenses associated with completion of
the business combination with Houston Industries (see Note 1(b)), principally
consisting of investment banking and legal fees.
(p) Allowance for Doubtful Accounts.
Accounts and notes receivable, principally customer as presented on NorAm's
Consolidated Balance Sheets are net of an allowance for doubtful accounts of
$15.3 million and $13.0 million at December 31, 1997 and 1996, respectively.
(q) Accounts Payable.
Certain of NorAm's cash balances reflect credit balances to the extent that
checks written have not yet been presented for payment. Such balances included
in accounts payable, principally trade on the NorAm Consolidated Balance Sheets
were approximately $17.0 million and $53.5 million at December 31, 1997 and
1996, respectively.
(2) DERIVATIVE FINANCIAL INSTRUMENTS (RISK MANAGEMENT)
(a) Trading Activities.
NorAm, through NES, offers price risk management services primarily in the
natural gas and electric industries. NES provides these services through, and by
utilizing, a variety of derivative financial instruments, including fixed-price
swap agreements, variable-price swap agreements, exchange-traded energy futures
and option contracts, and swaps and options traded in the over-the-counter
financial markets. 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 either industry pricing publications or exchange
quotations.
Certain trading transactions qualify 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, NES uses
mark-to-market accounting. Accordingly, such financial instruments are recorded
at fair value with realized and unrealized gains (losses) recorded as a
component of revenues in NorAm's Statements of Consolidated Income. The
recognized, unrealized balance is recorded as a deferred debit on NorAm's
Consolidated Balance Sheets.
118
<PAGE> 4
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
The notional quantities and maximum terms of derivative financial
instruments held for trading purposes at December 31, 1997 are presented below
(volumes in billions of British thermal units equivalent (Bbtue)):
<TABLE>
<CAPTION>
VOLUME-FIXED VOLUME-FIXED MAXIMUM
PRICE PAYOR PRICE RECEIVER TERM (YEARS)
------------ -------------- ------------
<S> <C> <C> <C>
Natural gas.................................. 85,701 64,890 4
Electricity.................................. 40,511 42,976 1
</TABLE>
In addition to the fixed-price notional volumes above, NES also has
variable-price swap agreements, as discussed above, totaling 101,465 Bbtue.
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 NorAm's exposure to market or credit
risks.
The estimated fair value of derivative financial instruments held for
trading purposes at December 31, 1997 are presented below (dollars in millions):
<TABLE>
<CAPTION>
FAIR VALUE AVERAGE FAIR VALUE(A)
--------------------- -----------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Natural gas.................................. $46 $39 $56 $48
Electricity.................................. $ 6 $ 6 $ 3 $ 2
</TABLE>
- ---------------
(a) Computed using the ending balance of each month.
Substantially all of the fair value shown in the table above at December
31, 1997 has been recognized in income. The fair value as of and for the year
ended December 31, 1997 was estimated using quoted prices where available and
considering the liquidity of the market for the derivative financial
instruments. The prices are subject to significant changes based on changing
market conditions. The derivative financial instruments included in the NES
trading portfolio as of and for the year ended December 31, 1996 were
immaterial.
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 NorAm'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.
(b) Non-Trading Activities.
To reduce the risk from market fluctuations in the price of electric power,
natural gas and related transportation, NorAm and certain of its subsidiaries
enter into futures transactions, swaps and options (Energy Derivatives) in order
to hedge certain natural gas in storage, as well as certain expected purchases,
sales and transportation of natural gas and electric power (a portion of which
are firm commitments at the inception of the hedge). Energy Derivatives are also
utilized to fix the price of compressor fuel or other future operational gas
requirements, although usage to date for this purpose has not been material.
Usage of electricity derivative financial instruments by NorAm and its
subsidiaries for purposes other than trading is immaterial.
NorAm also utilizes interest-rate derivatives (principally interest-rate
swaps) in order to adjust the portion of its overall borrowings which are
subject to interest-rate risk, and also utilizes such derivatives to effectively
fix the interest rate on debt expected to be issued for refunding purposes.
For transactions involving either Energy Derivatives or interest-rate
derivatives, hedge accounting is applied only if the derivative (i) reduces the
price risk of the underlying hedged item and (ii) is designated as a hedge at
its inception. Additionally, the derivatives must be expected to result in
financial impacts which are
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NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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 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.
In the case of interest-rate swaps associated with existing obligations,
cash flows and expenses associated with the interest-rate derivative
transactions are matched with the cash flows and interest expense of the
obligation being hedged, resulting in an adjustment to the effective interest
rate. When interest rate swaps are utilized to effectively fix the interest rate
for an anticipated debt issuance, changes in the market value of the
interest-rate derivatives are deferred and recognized as an adjustment to the
effective interest rate on the newly issued debt.
Unrealized changes in the market value of Energy Derivatives utilized as
hedges are not generally recognized in NorAm's Statements of Consolidated Income
until the underlying hedged transaction occurs. Once it becomes probable that an
anticipated transaction will not occur, deferred gains and losses are
recognized. In general, the financial impact of transactions involving these
Energy Derivatives is included in NorAm's Statements of Consolidated Income
under the caption natural gas and purchased power, net. Cash flows resulting
from these transactions in Energy Derivatives are included in NorAm's Statements
of Consolidated Cash Flows in the same category as the item being hedged.
At December 31, 1997, subsidiaries of NorAm were fixed-price payors and
fixed-price receivers in Energy Derivatives covering 38,754 Bbtu and 7,647 Bbtu
of natural gas, respectively. At December 31, 1996, subsidiaries of NorAm were
fixed-price payors and fixed-price receivers in Energy Derivatives covering
approximately 150,300 Bbtu and 66,500 Bbtu of natural gas, respectively. Also,
at December 31, 1997, subsidiaries of NorAm were parties to variable-priced
Energy Derivatives totaling 3,630 Bbtu of natural gas. The weighted average
maturity of these instruments at December 31, 1997 and 1996, respectively, is
less than one year.
NorAm has entered into options with various third parties which principally
serve to limit the year-to-year escalation from January 1998 to April 1999 in
the purchase price of gas which NorAm is committed to deliver to a distribution
affiliate. These options, which covered 9,800 Bbtu and 2,400 Bbtu at December
31, 1997 and 1996, respectively, expired in January 1998 unexercised. NorAm
previously established a reserve equal to its projected maximum exposure to
losses during the term of this commitment and, accordingly, no impact on
earnings is expected.
The notional amount is intended to be indicative of NorAm and its
subsidiaries' level of activity in such derivatives, although 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
closed as further discussed below. Under such 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
10 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 NorAm'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.
(c) Trading and Non-trading -- General Policy.
In addition to the risk associated with price movements, credit risk is
also inherent in NorAm and its subsidiaries' risk management activities. Credit
risk relates to the risk of loss resulting from non performance
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NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
of contractual obligations by a counterparty. While, as yet, NorAm and its
subsidiaries have experienced no significant losses due to the credit risk
associated with these arrangements, NorAm 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 such contract. In order to minimize this risk,
NorAm and/or its subsidiaries, as the case may be, enter into such contracts
primarily with those counterparties with a minimum Standard & Poor's or Moody's
rating of BBB- or Baa3, respectively. For long-term arrangements, NorAm and its
subsidiaries periodically review the financial condition of such firms in
addition to monitoring the effectiveness of these financial contracts in
achieving NorAm's objectives. Should the counterparties to these arrangements
fail to perform, NorAm would seek to compel performance at law or otherwise, or
obtain compensatory damages in lieu thereof. NorAm might be forced to acquire
alternative hedging arrangements or be required to honor the underlying
commitment at then-current market prices. In such event, NorAm might incur
additional loss 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, NorAm believes
that the risk of incurring a significant financial statement loss due to the
non-performance of counterparties to these transactions is minimal.
NorAm's policies prohibit the use of leveraged financial instruments.
Houston Industries has established a Risk Oversight Committee that oversees
all price and credit risk, including NES's risk management and trading
activities. The Risk Oversight Committee's responsibilities include reviewing
NorAm's overall risk management strategy and monitoring risk management
activities to ensure compliance with Houston Industries' risk management
limitations, policies and procedures.
(3) CAPITAL STOCK
(a) Earnings Per Share.
As a result of the Merger, NorAm is no longer required to present earnings
per share (EPS) data as its common shares (all of which are owned by Houston
Industries) are not publicly held. EPS data for 1996 and 1995 has not been
included because NorAm believes it is no longer meaningful.
(b) Equity Transactions Prior to the Merger.
In June 1996, NorAm issued 11,500,000 shares of NorAm common stock to the
public at a price of $9.875 per share, yielding net cash proceeds of
approximately $109 million. The net proceeds from the offering principally were
used to retire debt as described in Note 4(b).
(c) Direct Stock Purchase Plan and Dividend Reinvestment Plan.
The Direct Stock Purchase Plan and Dividend Reinvestment Plan were
suspended and canceled in connection with the Merger.
(4) LONG-TERM AND SHORT-TERM FINANCING
(a) Short-Term Financing.
In 1997 and 1996, NorAm met its short-term financing needs primarily
through a bank facility, bank lines of credit and a receivables facility.
NorAm's principal short-term credit facility (NorAm Credit Facility) of $400
million expires in December 1998. Borrowings under the NorAm Credit Facility are
unsecured. The weighted average interest rate at December 31, 1997 and 1996 was
6.3%. NorAm pays a facility fee on the $400 million facility of .14% per annum
which is subject to increase based on NorAm's debt rating. Borrowings under the
credit facility at December 31, 1997 and 1996 were $340 million and $115
million, respectively. In addition, NorAm had $50 million of outstanding loans
under uncommitted lines of credit at December 31, 1997 having a weighted average
interest rate of 6.82%.
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NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES
(a) Lease Commitments.
The following table sets forth certain information concerning NorAm's
obligations under operating leases:
Minimum Lease Commitments at December 31, 1997(1)
<TABLE>
<CAPTION>
(MILLIONS OF DOLLARS)
---------------------
<S> <C>
1998....................................................... $ 24
1999....................................................... 19
2000....................................................... 16
2001....................................................... 15
2002....................................................... 9
2003 and beyond............................................ 22
----
Total............................................ $105
====
</TABLE>
- ---------------
(1) Principally consisting of rental agreements for building space and data
processing equipment and vehicles (including major work equipment).
NorAm has a master leasing agreement which provides for the lease of
vehicles, construction equipment, office furniture, data processing equipment
and other property. For accounting purposes, the lease is treated as an
operating lease. At December 31, 1997, NorAm had leased assets with a value of
approximately $58.1 million under this lease with a basic term of one year.
NorAm does not expect to lease additional property under this lease agreement.
Lease payments related to NorAm's leasing agreements are included in the
preceding table for only their basic term. Total rental expense for all leases
was $24.0 million, $33.4 million and $48.9 million in 1997, 1996 and 1995,
respectively.
(b) Letters of Credit.
At December 31, 1997, NorAm had letters of credit incidental to its
ordinary business operations totaling approximately $42 million under which
NorAm is obligated to reimburse drawings, if any.
(c) Indemnity Provisions.
At December 31, 1997, NorAm has an $11.4 million accounting reserve on its
Consolidated Balance Sheets in "Estimated obligations under indemnification
provisions of sale agreements" for possible indemnity claims asserted in
connection with its disposition of former subsidiaries or divisions, including
the sale of (i) Louisiana Intrastate Gas Corporation, a former subsidiary
engaged in the intrastate pipeline and liquids extraction business (1992); (ii)
Arkla Exploration Company, a former subsidiary engaged in oil and gas
exploration and production activities (June 1991); and (iii) Dyco Petroleum
Company, a former subsidiary engaged in oil and gas exploration and production
(1991).
(d) Sale of Receivables.
Certain of NorAm's receivables are collateral for receivables which have
been sold pursuant to the terms of NorAm's receivables facility, see
"Receivables Facility" included in Note 4(a).
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NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(e) Gas Purchase Claims.
In conjunction with settlements of "take-or-pay" claims, NorAm has prepaid
for certain volumes of gas, which prepayments have been recorded at their net
realizable value and, to the extent that NorAm is unable to realize at least the
carrying amount as the gas is delivered and sold, NorAm's earnings will be
reduced, although such reduction is not expected to be material. In addition to
these prepayments, NorAm is a party to a number of agreements which require it
to either purchase or sell gas in the future at prices which may differ from
then prevailing market prices or which require it to deliver gas at a point
other than the expected receipt point for volumes to be purchased. To the extent
that NorAm expects that these commitments will result in losses over the
contract term, NorAm has established reserves equal to such expected losses.
(f) Transportation Agreement.
NorAm had an agreement (ANR Agreement) with ANR Pipeline Company (ANR)
which contemplated a transfer to ANR of an interest in certain of NorAm's
pipeline and related assets, representing capacity of 250 Mmcf/day, and pursuant
to which ANR had advanced $125 million to NorAm. The ANR Agreement has been
restructured and, after refunds of $50 million and $34 million in 1995 and 1993,
respectively, NorAm currently retains $41 million (recorded as a liability) in
exchange for ANR's or its affiliates' use of 130 Mmcf/ day of capacity in
certain of NorAm'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 and
the ANR Agreement will terminate in 2005 with a refund of the remaining balance.
(g) Environmental Matters.
To the extent that potential environmental remediation costs are quantified
within a range, NorAm establishes reserves equal to the most likely level of
costs within the range and adjusts such accruals as better information becomes
available. In determining the amount of the liability, future costs are not
discounted to their present value and the liability is not offset by expected
insurance recoveries. If justified by circumstances within NorAm's business
subject to SFAS No. 71, corresponding regulatory assets are recorded in
anticipation of recovery through the rate making process.
Manufactured Gas Plant Sites. NorAm and its predecessors operated a
manufactured gas plant (MGP) adjacent to the Mississippi River in Minnesota
formerly known as Minneapolis Gas Works (FMGW) until 1960. NorAm has completed
remediation of the main site other than ongoing water monitoring and treatment.
There are six other former MGP sites in the Minnesota service territory.
Remediation has been completed on one site. Of the remaining five sites, NorAm
believes that two were neither owned nor operated by NorAm; two were owned by
NorAm at one time but were operated by others and are currently owned by others;
and one site was previously operated by NorAm but was owned by others. NorAm
believes it has no liability with respect to the sites it neither owned nor
operated.
At December 31, 1997, NorAm had estimated a range of $15 million to $77
million for possible remediation of the Minnesota sites. The low end of the
range was determined based on only those sites presently owned or known to have
been operated by NorAm, assuming use of NorAm's proposed remediation methods.
The upper end of the range was determined based on the sites once owned by
NorAm, whether or not operated by NorAm. The cost estimates for the FMGW site
are based on studies of that site. The remediation costs for other sites are
based on industry average costs for remediation of sites of similar size. The
actual remediation costs will be dependent upon the number of sites remediated,
the participation of other potentially responsible parties, if any, and the
remediation methods used.
In its 1995 rate case, NorAm's Minnegasco division was allowed to recover
approximately $7 million annually for remediation costs. Such costs are subject
to a true-up mechanism whereby any over or under recovered amounts, net of
certain insurance recoveries, plus carrying charges, would be deferred for
recovery
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NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
or refund in the next rate case. At December 31, 1997 and 1996, Minnegasco had
recorded a liability of $20.6 million and $35.9 million, respectively, to cover
the cost of future remediation. In addition, at December 31, 1997, Minnegasco
had receivables from insurance settlements of $2.9 million. These insurance
settlements will be collected through 1999. Minnegasco expects that
approximately half of its accrual as of December 31, 1997 will be expended
within the next five years. The remainder will be expended on an ongoing basis
for an estimated 40 years. In accordance with the provisions of SFAS No. 71, a
regulatory asset has been recorded equal to the liability accrued. Minnegasco is
continuing to pursue recovery of at least a portion of these costs from
insurers. Minnegasco believes the difference between any cash expenditures for
these costs and the amount recovered in rates during any year will not be
material to NorAm's overall cash requirements, results of operations or cash
flows.
At December 31, 1997 and 1996, NorAm had recorded an accrual of $3.3
million (with a maximum estimated exposure of approximately $18 million) and an
offsetting regulatory asset for environmental matters in connection with a
former fire training facility and a landfill for which future remediation may be
required. This accrual is in addition to the accrual for MGP sites as previously
discussed.
Issues relating to the identification and remediation of MGPs are common in
the natural gas distribution industry. NorAm has received notices from the EPA
and others regarding its status as a potentially responsible party for other
sites. Based on current information, NorAm has not been able to quantify a range
of environmental expenditures for potential remediation expenditures with
respect to other MGP sites.
Mercury Contamination. Like other natural gas pipelines, NorAm's pipeline
operations have in the past employed elemental mercury in meters used on its
pipelines. Although the mercury has now been removed from the meters, it is
possible that small amounts of mercury have been spilled at some of those sites
in the course of normal maintenance and replacement operations and that such
spills have contaminated the immediate area around the meters with elemental
mercury. Such contamination has been found by NorAm at some sites in the past,
and NorAm has conducted remediation at sites found to be contaminated. Although
NorAm is not aware of additional specific sites, it is possible that other
contaminated sites exist and that remediation costs will be incurred for such
sites. Although the total amount of such costs cannot be known at this time,
based on experience by NorAm and others in the natural gas industry to date and
on the current regulations regarding remediation of such sites, NorAm believes
that the cost of any remediation of such sites will not be material to NorAm's
financial position, results of operation or cash flows.
Potentially Responsible Party Notifications. From time to time NorAm and
its subsidiaries have been notified that they are potentially responsible
parties with respect to properties which environmental authorities have
determined warrant remediation under state or federal environmental laws and
regulations. In October 1994 the United States Environmental Protection Agency
issued such a notice with respect to a landfill site in West Memphis, Arkansas,
and in December 1995, the Louisiana Department of Environmental Quality advised
that one of NorAm subsidiaries had been identified as a potentially responsible
party with respect to a hazardous waste site in Shreveport, Louisiana.
Considering the information currently known about such sites and the involvement
of NorAm or its subsidiaries in activities at these sites, NorAm does not
believe that these matters will have a material adverse effect on NorAm's
financial position, results of operation or cash flows.
(h) Other
NorAm Merger Lawsuit. In August 1996, a purported NorAm stockholder filed a
lawsuit, Shaw v. NorAm Energy Corp., et al., in the District Court of Harris
County, Texas, against NorAm, certain of its officers and directors and the
Company to enjoin the Merger or to rescind the Merger and/or to recover damages
in the event that the Merger was consummated. In February 1998, the plaintiffs
withdrew their lawsuit and the court issued an order of non-suit dismissing the
litigation.
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NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
NorAm is a party to litigation (other than that specifically noted) which
arises in the normal course of business. Management regularly analyzes current
information and, as necessary, provides accruals for probable liabilities on the
eventual disposition of these matters. Management believes that the effect on
NorAm's financial statements, if any, from the disposition of these matters will
not be material.
135
